<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 1999
Commission file number 0-24059
MGC Communications, Inc.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Nevada 88-0360042
(State of incorporation) (IRS Employer Identification Number)
</TABLE>
3301 North Buffalo Drive
Las Vegas, Nevada 89129
(Address of principal executive offices)
(702) 310-1000
(Registrant's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days:
YES X NO
----- -----
The number of shares outstanding of the issuer's
common stock, as of November 15, 1999:
Common stock ($.001 par value) .... 22,906,952 shares outstanding
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MGC COMMUNICATIONS, INC.
INDEX
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<TABLE>
<CAPTION>
Page No.
<S> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations -- Three and Nine months
ended September 30, 1999 and 1998 (Unaudited) 3
Consolidated Balance Sheets -- September 30, 1999 (Unaudited)
and December 31, 1998 4
Consolidated Statements of Redeemable Preferred Stock and Stockholders'
Equity for the period from December 31, 1997 to September 30, 1999
(Unaudited) 5
Consolidated Statements of Cash Flows -- Nine months ended
September 30, 1999 and 1998 (Unaudited) 6
Condensed Notes to Unaudited Interim Consolidated
Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Changes in Securities and Use of Proceeds 14
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 17
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
September 30, September 30,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Operating revenues:
Telecommunications services $ 15,036 $ 4,908 $ 34,922 $ 11,772
Operating expenses:
Cost of operating revenues 12,460 4,789 31,449 10,575
Selling, general and administrative 10,544 5,364 27,469 11,250
Depreciation and amortization 4,740 1,158 12,406 3,149
------------ ------------ ------------ ------------
27,744 11,311 71,324 24,974
------------ ------------ ------------ ------------
Loss from operations (12,708) (6,403) (36,402) (13,202)
Other income (expense):
Gain on sale of investments available-
for-sale -- -- 252 --
Interest income 2,348 2,524 5,228 6,989
Interest expense(net of amounts capitalized) (4,635) (5,213) (13,822) (16,080)
------------ ------------ ------------ ------------
Net loss (14,995) (9,092) (44,744) (22,293)
Accrued preferred stock dividend (1,197) -- (1,926) --
------------ ------------ ------------ ------------
Net loss applicable to common stockholders $ (16,192) $ (9,092) $ (46,670) $ (22,293)
============ ============ ============ ============
Basic and diluted loss per share of
common stock $ (.76) $ (.53) $ (2.50) $ (1.69)
============ ============ ============ ============
Basic and diluted weighted average
shares outstanding 21,282,609 17,154,034 18,670,645 13,171,681
============ ============ ============ ============
</TABLE>
See accompanying condensed notes to unaudited interim consolidated
financial statements.
<PAGE> 4
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
--------- ---------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................ $ 93,224 $ 11,886
Investments available-for-sale ........................... 50,177 9,851
Restricted investments ................................... 30,375 20,797
Accounts receivable, less allowance for doubtful
accounts of $478 and $257 ............................. 16,145 6,360
Prepaid expenses and other ................................ 599 208
--------- ---------
Total current assets ............................. 190,520 49,102
Property and equipment, net ................................ 151,159 116,380
Investments available-for-sale ............................. 35,560 63,212
Restricted investments ..................................... -- 18,582
Deferred financing costs, net of amortization of $1,686
and $1,065 4,093 4,714
Other assets ............................................... 482 129
--------- ---------
Total assets ..................................... $ 381,814 $ 252,119
========= =========
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt ..................... $ 283 $ 332
Accounts payable:
Trade ................................................. 8,912 5,314
Property and equipment ................................ 15,276 18,577
Accrued interest ......................................... 10,400 5,200
Accrued other expenses ................................... 8,492 2,473
--------- ---------
Total current liabilities ........................ 43,363 31,896
Senior Secured Notes, net of unamortized discount of $2,875
and $3,307 ............................................... 157,125 156,693
Other long-term debt ....................................... 269 270
--------- ---------
Total liabilities ................................ 200,757 188,859
--------- ---------
Commitments and contingencies
Redeemable preferred stock:
10% Series B convertible preferred stock, 5,277,779 shares
authorized and outstanding ............................... 46,663 --
Stockholders' equity:
Preferred stock, 44,722,221 shares authorized and unissued -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 22,810,060 and 17,190,428 shares issued,
and 22,800,920 and 17,190,428 outstanding ............. 23 17
Additional paid-in capital ............................... 227,955 108,991
Accumulated deficit ...................................... (91,062) (44,392)
Less: Treasury stock ..................................... (76) --
--------- ---------
136,840 64,616
Accumulated other comprehensive (loss)income ............ (360) 817
Notes receivable from stockholders for issuance of common
stock ................................................. (2,086) (2,173)
--------- ---------
Total stockholders' equity ....................... 134,394 63,260
--------- ---------
Total liabilities, redeemable preferred stock and
stockholders' equity ........................... $ 381,814 $ 252,119
========= =========
</TABLE>
See accompanying condensed notes to unaudited interim consolidated
financial statements.
<PAGE> 5
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
REDEEMABLE
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------------------ ------------------------------ PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
---------- ------- ---------- ------ ---------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997 ..... 5,148,570 $16,665 8,799,600 $9 $22,118
Common stock issued for cash ..... -- -- 100,680 -- 774
Common stock issued for notes
receivable ..................... -- -- 189,000 -- 1,485
Warrants and options exercised
for common stock ............... -- -- 133,309 -- 14
8% Series A Convertible Preferred
Stock issued for cash .......... 1,422,857 4,980 -- -- --
Accrued preferred stock dividend . -- -- -- -- --
Common stock issued for cash (IPO) -- -- 4,025,000 4 62,959
Conversion of preferred stock to
common stock .................. (6,571,427) (21,645) 3,942,839 4 21,641
Unrealized gain on investments
available-for-sale ............ -- -- -- -- --
Net loss ......................... -- -- -- -- --
--------- ------- ---------- --- --------
BALANCE AT DECEMBER 31, 1998 ..... -- $ -- 17,190,428 $17 $108,991
Unrealized loss on investments
available-for-sale ............ -- -- -- -- --
Common stock issued .............. -- -- 5,027,001 5 118,309
Warrants and options exercised
for common stock .............. -- -- 592,631 1 655
Payment on stockholder's note .... -- -- -- -- --
Repurchase of common stock ....... -- -- (9,140) -- --
10% Series B Convertible Preferred
Stock issued for cash .......... 5,277,779 46,663 -- -- --
Accrued preferred stock dividend . -- -- -- -- --
Net loss ......................... -- -- -- -- --
--------- ------- ---------- --- --------
BALANCE AT SEPTEMBER 30, 1999 .... 5,277,779 $46,663 22,800,920 $23 $227,955
(UNAUDITED) .................. ========= ======= ========== === ========
NOTES
RECEIVABLE FROM ACCUMULATED
TREASURY STOCK STOCKHOLDERS FOR OTHER TOTAL
ACCUMULATED --------------------- ISSUANCE OF COMPREHENSIVE STOCKHOLDERS'
DEFICIT SHARES AMOUNT COMMON STOCK INCOME EQUITY
----------- ------- ------- --------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997 ..... $(12,463) -- -- $(688) $-- $8,976
Common stock issued for cash ..... -- -- -- -- -- 774
Common stock issued for notes
receivable ..................... -- -- -- (1,485) -- --
Warrants and options exercised
for common stock ............... -- -- -- -- -- 14
8% Series A Convertible Preferred
Stock issued for cash .......... -- -- -- -- -- --
Accrued preferred stock dividend . (654) -- -- -- -- (654)
Common stock issued for cash (IPO) -- -- -- -- -- 62,963
Conversion of preferred stock to
common stock .................. 790 -- -- -- -- 22,435
Unrealized gain on investments
available-for-sale ............ -- -- -- -- 817 817
Net loss ......................... (32,065) -- -- -- -- (32,065)
-------- ----- ---- ------- ----- --------
BALANCE AT DECEMBER 31, 1998 ..... $(44,392) -- -- $(2,173) $817 $63,260
Unrealized loss on investments
available-for-sale ............ -- -- -- -- (1,177) (1,177)
Common stock issued .............. -- -- -- -- -- 118,314
Warrants and options exercised
for common stock .............. -- -- -- -- -- 656
Payment on stockholder's note .... -- -- -- 11 -- 11
Repurchase of common stock ....... -- 9,140 (76) 76 -- --
10% Series B Convertible Preferred
Stock issued for cash .......... -- -- -- -- -- --
Accrued preferred stock dividend . (1,926) -- -- -- -- (1,926)
Net loss ......................... (44,744) -- -- -- -- (44,744)
-------- ----- ---- ------- ----- --------
BALANCE AT SEPTEMBER 30, 1999 .... $(91,062) 9,140 $(76) $(2,086) $(360) $134,394
(UNAUDITED) .................. ======== ===== ==== ======= ===== ========
</TABLE>
See accompanying condensed notes to unaudited interim
consolidated financial statements.
<PAGE> 6
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
September 30,
--------------------------
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss .......................................................... $(44,744) $(22,293)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ................................... 12,406 3,149
Gain on sale of investments available-for-sale .................. (252) --
Amortization of debt discount ................................... 432 431
Amortization of deferred financing costs ........................ 621 658
Changes in assets and liabilities:
Increase in accounts receivable, net ......................... (9,785) (2,531)
Increase(decrease) in prepaid expenses and other ............. (391) 47
Increase in other assets ..................................... (403) (40)
Increase in accounts payable - trade ......................... 3,598 2,862
Increase in accrued interest and other expenses .............. 9,292 8,644
--------- ---------
Net cash used in operating activities ...................... (29,226) (9,073)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net of
payables ........................................................ (46,888) (58,681)
Decrease in accounts payable - property and equipment ............. (3,301) --
Purchase of investments held-to-maturity .......................... -- (42,622)
Purchase of investments available-for-sale ........................ (58,720) --
Sale of investments available-for-sale ............................ 45,121 --
Sale of restricted investments .................................... 9,004 8,355
--------- ---------
Net cash used in investing activities ...................... (54,784) (92,948)
--------- ---------
Cash flows from financing activities:
Costs associated with issuance of Senior Secured
Notes and warrants .............................................. -- (133)
Proceeds from issuance of Convertible Preferred
Stock, net of issuance costs .................................... 46,663 4,980
Payments on other long term debt .................................. (296) (210)
Payments received on stockholder's note ........................... 11 --
Proceeds from issuance of common stock ............................ 118,970 787
Proceeds from issuance of common stock (IPO) ...................... -- 62,963
--------- ---------
Net cash provided by financing activities .................. 165,348 68,387
--------- ---------
Net increase (decrease) in cash ............................ 81,338 (33,634)
Cash and cash equivalents at beginning of period .................... 11,886 45,054
--------- ---------
Cash and cash equivalents at the end of period ...................... $ 93,224 $ 11,420
========= =========
Supplemental schedule of non-cash investing and financing activities:
Increase in property and equipment purchases included
in accounts/notes payable -- property and equipment ............. $ -- $ 8,455
========= =========
Property acquired under capital lease ............................. $ 247 --
========= =========
Stock issued / repurchased from notes receivable .................. $ (76) $ 1,485
========= =========
Increase in accrued preferred stock dividends ..................... $ 1,926 $ --
========= =========
Other disclosures:
Cash paid for interest net of amounts capitalized ................. $ 7,570 $ 10,996
========= =========
</TABLE>
See accompanying condensed notes to unaudited interim consolidated
financial statements.
<PAGE> 7
MGC COMMUNICATIONS, INC.
Condensed Notes to Unaudited Interim Consolidated Financial Statements
(1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements of
MGC Communications, Inc. (the "Company" or "MGC"), a Nevada corporation, include
the accounts of the Company and its wholly-owned subsidiaries, MGC Lease
Corporation and MGC LJ.Net, Inc. All significant inter-company balances and
transactions have been eliminated.
These consolidated financial statements reflect all normal recurring
adjustments, which management believes are necessary to present fairly the
financial position, results of operations, and cash flows for the Company for
the respective periods presented. Certain information and footnote disclosures
normally included in the annual financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission for Form
10-Q. These unaudited interim consolidated financial statements should be read
in conjunction with the audited consolidated financial statements and notes
thereto included in the Company's annual report on Form 10-K filed with the
Securities and Exchange Commission.
The consolidated balance sheet at December 31, 1998 was derived from
the audited consolidated financial statements, but does not include all
disclosures required under generally accepted accounting principles.
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
----------- ------------
(UNAUDITED)
<S> <C> <C>
Building and property........................... $ 5,298 $ 2,653
Switching equipment............................. 113,132 57,045
Leasehold improvements.......................... 860 740
Computer hardware and software.................. 3,629 2,218
Office equipment and vehicles................... 1,532 901
------- -------
124,451 63,557
Less accumulated depreciation and
amortization.................................. (18,834) (6,555)
------- -------
105,617 57,002
Switching equipment under construction.......... 45,542 59,378
------- -------
Net property and equipment............ $151,159 $116,380
======== ========
</TABLE>
(3) COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
In the ordinary course of business, the Company enters into purchase
agreements with its vendors of telecommunications equipment. As of September 30,
1999 and December 31, 1998, the Company had a total for all vendors of
approximately $53.4 million and $15.4 million, respectively, of remaining
purchase commitments for purchases of switching and other telecommunications
equipment.
<PAGE> 8
(4) RISKS AND UNCERTAINTIES
The Company recognizes operating revenues from communications services
in the period the related services are provided. Due to current disputes and
pending arbitration and litigation, the Company has recognized switched access
revenues based on management's best estimate of the probable collections from
such revenue. For the nine month period ended September 30, 1999 and for the
year ended December 31, 1998, the Company has recognized in operating revenues
switched access revenues of approximately $12,079,000 and $7,378,000,
respectively. Included in accounts receivable in the accompanying balance sheets
as of September 30, 1999 and December 31, 1998 are net receivables from carrier
access billings of approximately $12,262,000 and $3,590,000, respectively.
(5) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
In May 1999, the Company completed a private placement offering in
which 5,277,779 shares of Series B Convertible Preferred Stock were issued at
$9.00 per share for proceeds to the Company of $46.7 million, net of expenses.
Dividends accrue at the rate of 10% per annum, are cumulative and are
payable in preference to any dividends that may be paid with respect to the
Company's common stock. Beginning November 22, 1999, the Company may elect to
terminate the accrual of dividends if the Company's stock price exceeds $27.00
per share (subject to certain adjustments) for 20 consecutive trading days (the
"Market Threshold") prior to May 4, 2002.
The holders of the Series B Preferred Stock have the right to nominate
one or more directors depending on the size of the Company's Board of Directors
and the percentage of the Company's stock represented by the outstanding Series
B Preferred Stock. The holders of the Series B Preferred Stock also have the
right to have their Board representative serve on each committee of the
Company's Board. The holders of the Series B Preferred will vote along with
the common stock on an as-converted basis.
The Series B Preferred Stock is convertible into common stock at any
time at the option of the holder. Initially, each share of Series B Preferred
Stock is convertible into one share of common stock. The conversion price is
subject to adjustment as a result of stock splits, stock dividends and certain
other issuances of additional stock.
After the earlier of May 24, 2000 or the date on which the holders of
the Series B Preferred Stock exercise their demand registration rights, the
Company has the right to require the conversion of the Series B Preferred Stock
if the Company's stock price exceeds the Market Threshold referenced above. If
the Company requires conversion before May 4, 2002, no accrued dividends will be
paid.
In July 1999, the Company issued 5,000,000 shares of common stock and
received net proceeds, after expenses, of approximately $118.1 million. In this
offering, existing stockholders sold an additional 587,695 shares of common
stock for which the Company did not receive any proceeds.
In September 1999, the Company reacquired 9,140 shares of its common
stock at an aggregate purchase price of $76,136 in partial cancellation of a
note receivable from stockholder for issuance of common stock and is classified
as treasury stock in the accompanying consolidated financial statements.
(6) SUBSEQUENT EVENTS
In October 1999, the Company entered into an agreement with Providence
Equity Partners III L.P. and affiliate ("Providence")and JK&B Capital III L.P.
("JK&B III") under which Providence and JK&B III (the "Purchasers") are to
purchase 1,250,000 shares of newly issued Series C Convertible Preferred Stock
at $28.00 per share for a total consideration of $35.0 million. The terms of the
new class of Series C Preferred Stock will be similar to those of the Series B
Preferred Stock except for pricing and related features.
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We began providing competitive local dialtone services to small
business and residential customers in December 1996, and began offering long
distance services by February 1998. Currently, we have switches fully
operational in Las Vegas, Atlanta, Chicago, southern Florida, and in selected
areas of southern California, including Los Angeles and San Diego.
Our revenues are generated from sales of communications services
consisting primarily of local phone service, long distance services, switched
access billings and non-recurring charges, principally installation charges.
Our principal operating expenses consist of cost of operating revenues,
selling, general and administrative expenses and depreciation and amortization
expense. Cost of operating revenues consists primarily of access charges, line
installation expenses, transport expenses, compensation expenses of technical
personnel, long distance expenses and collocation lease expenses. Selling,
general and administrative expenses consist primarily of compensation expenses,
advertising, provision for bad debts, professional fees and office rentals.
Depreciation and amortization expense includes depreciation of switching and
collocation equipment as well as general property and equipment.
During 1998, we expanded significantly with the installation of four
additional switches and the build-out of 182 additional collocation sites.
During the first nine months of 1999, we have continued this expansion with the
build-out of 81 additional collocation sites. As expected, both cost of
operating revenues and selling, general and administrative expenses increased as
many of the fixed costs of providing service in new markets are incurred before
significant revenue can be generated from those markets. In addition, we
incurred significant marketing costs to build our initial base of customers in
our new markets.
Building and expanding our business has required and will continue to
require us to incur significant capital expenditures primarily consisting of the
costs of purchasing switches, associated equipment and land for switching sites
and constructing buildings or improving leased buildings to house our switching
and collocation facilities. As part of our "smart build" network strategy, we
purchased and installed host switches in each of our markets while leasing the
means of transporting voice and data traffic from these switches to our
customers' telephones or other equipment. We believe this facilities-based
strategy, while initially increasing our level of capital expenditures and
operating losses, will enhance long-term financial performance in comparison to
a resale strategy.
We have experienced operating losses and generated negative cash flow
from operations since inception and expect to continue to generate negative cash
flow from operations for the foreseeable future while we continue to expand our
network and develop our product offerings and customer base. There can be no
assurance our revenue or customer base will grow or that we will be able to
achieve or sustain positive cash flow from operations.
RESULTS OF OPERATIONS
QUARTER ENDED - SEPTEMBER 30, 1999 VS. SEPTEMBER 30, 1998
Total operating revenues increased to $15.0 million for the quarter
ended September 30,1999 as compared to $4.9 million for the quarter ended
September 30, 1998. The 206% increase is a result of the increase in the number
of lines. We had 117,210 lines in service at the end of the third quarter 1999
as compared to 35,246 lines in service at September 30, 1998, a 233% increase.
Cost of operating revenues for the quarter ended September 30, 1999 was
$12.5 million as compared to $4.8 million for the quarter ended September 30,
1998. The 160% increase is due to the increased number of lines in service and
installation and operational expenses associated with the expansion of our
network.
<PAGE> 10
For the quarter ended September 30, 1999, selling, general and
administrative expenses totaled $10.5 million; a 94% increase over the $5.4
million for the quarter ended September 30, 1998. The increase is a result of
increased costs attributable to marketing and delivering our service and
supporting our continued network expansion.
For the quarter ended September 30, 1999, depreciation and amortization
was $4.7 million as compared to $1.2 million for the quarter ended September 30,
1998. This increase is a result of placing additional assets in service in
accordance with the planned build-out of our network.
Gross interest expense for the quarter ended September 30, 1999, totaled
$5.6 million compared to $5.5 million for the quarter ended September 30, 1998.
Interest capitalized for the quarter ended September 30, 1999 increased to $1.0
million as compared to $0.3 million for the quarter ended September 30, 1998.
The increase in interest capitalized is due to the increase in switching
equipment under construction. Gross interest expense is primarily attributable
to the 13% Senior Secured Notes due 2004 ("Senior Secured Notes") we issued in
September 1997.
Interest income was $2.4 million during the quarter ended September 30,
1999 compared to $2.5 million for the quarter ended September 30, 1998. The 4%
decrease is a result of lower cash balances as cash and investments have been
used to purchase switching equipment, pay interest on the Senior Secured Notes,
and fund operating losses.
We incurred net losses of $15.0 million during third quarter 1999 and
$9.1 million during the third quarter 1998.
NINE MONTH PERIOD ENDED - SEPTEMBER 30, 1999 VS. SEPTEMBER 30, 1998
Total operating revenues increased to $34.9 million for the nine months
ended September 30, 1999 as compared to $11.8 million for the nine months ended
September 30, 1998. The 196% increase is a result of the increase in the number
of lines in service and increased long distance service and switched access
revenues.
Cost of operating revenues for the nine months ended September 30, 1999
was $31.4 million as compared to $10.6 million for the nine months ended
September 30, 1998. The 196% increase is due to the increased number of lines in
service and installation and operational expenses associated with the expansion
of our network.
For the nine months ended September 30, 1999, selling, general and
administrative expenses totaled $27.5 million; a 143% increase over the $11.3
million for the nine months ended September 30, 1998. The increase is a result
of increased costs attributable to marketing and delivering our service and
supporting our continued network expansion.
For the nine months ended September 30, 1999, depreciation and
amortization was $12.4 million as compared to $3.1 million for the nine months
ended September 30, 1998. This increase is a result of placing additional assets
in service in accordance with the planned build-out of our network.
Gross interest expense during each nine-month period ended September 30,
1999 and 1998 totaled $16.7 million. Interest capitalized for the nine months
ended September 30, 1999 increased to $2.9 million as compared to $0.6 million
for the nine months ended September 30, 1998. The increase in interest
capitalized is due to the increase in switching equipment under construction.
Gross interest expense is primarily attributable to the Senior Secured Notes
issued in September 1997.
Interest income was $5.2 million during the nine months ended September
30, 1999 compared to $7.0 million for the nine months ended September 30, 1998.
The 26% decrease is a result of the decrease in cash and investments since
September 30, 1998. Cash and investments have been used to purchase switching
equipment, pay interest on the Senior Secured Notes, and fund operating losses.
We incurred net losses of $44.7 million and $22.3 million for the
nine-month periods ended September 30, 1999 and 1998, respectively.
<PAGE> 11
LIQUIDITY AND CAPITAL RESOURCES
Our operations require substantial capital investment for the purchase
of communications equipment and the development and installation of our network.
Capital expenditures for the quarter ended September 30, 1999 were $22.9
million. We expect we will continue to require substantial amounts of capital to
fund the purchase of the equipment necessary to continue expanding our network
footprint in our existing markets and to develop new products and services. In
addition, we expect to enter new markets during 2000. We expect capital
expenditures of approximately $400.0 million over the next five years, including
approximately $25 million of capital expenditures expected during the last
three months of 1999. We expect to fund these capital expenditures from cash on
hand and public or private debt or equity financing. In addition, we are
currently evaluating financing proposals from vendors and equipment lease
financing companies. We cannot assure you that we will be successful in raising
sufficient debt or equity capital on acceptable terms.
In May 1999, we issued 5,277,779 shares of Series B Convertible
Preferred Stock at $9.00 per share for net proceeds of $46.7 million.
In July 1999, we issued 5,000,000 shares of common stock and received
net proceeds, after expenses, of approximately $118.1 million. In this offering,
existing stockholders sold an additional 587,695 shares of common stock for
which we did not receive any proceeds.
In October 1999, we entered into an agreement with Providence and JK&B
III under which Providence and JK&B III agreed to purchase 1,250,000 shares of
newly issued Series C Convertible Preferred Stock at $28.00 per share for a
total consideration of $35.0 million.
The substantial capital investment required to initiate services and
fund our initial operations has exceeded our operating cash flow. This negative
cash flow from operations results from the need to establish our network in
anticipation of connecting revenue-generating customers. We expect to continue
recording negative cash flow from operations for a period of time because we are
continuing network expansion activities. We cannot assure you we will attain
break-even cash flow from operations in subsequent periods. Until sufficient
cash flow from operations is generated, we will need to use our current and
future capital resources to meet our cash flow requirements and may be required
to issue additional debt and/or equity securities. We expect our available cash
should be adequate to fund our operations and planned capital expenditures
through the end of the first quarter 2001. The indenture governing the Senior
Secured Notes and the terms of our Series B Convertible Preferred Stock impose
restrictions upon our ability to incur additional debt or issue preferred stock.
IMPACT OF YEAR 2000
The Year 2000 issue, commonly referred to as Y2K, is a result of the
way some computer systems store dates. In many cases, when a date is stored by a
computer, a two digit field has been used to store the year (i.e., 01/01/98 =
January 1, 1998). The system assumes that the first two digits in the year field
are "19." With the end of the century approaching, those same systems should
reflect 01/01/00 as being "January 1, 2000." However, a non-compliant system
will read 01/01/00 as January 1, 1900.
We have been focused on Year 2000 issues since our inception in 1996.
In recognition of the priority associated with the Year 2000 issue, we
established a Year 2000 Project Team at the corporate level to lead the Year
2000 effort. Since we are young, much of the hardware and software currently in
place was purchased with Y2K readiness in mind. However, in most cases, we have
relied on representations of our vendors as to the Y2K compliance of the
hardware and software we have purchased. We cannot assure you the vendor
representations we relied upon are accurate or complete or that we will have
recourse against any vendors whose representations prove misleading.
Our Y2K plans include a number of phases designed to evaluate the Y2K
readiness of our network and computer systems. We have completed the inventory
and assessment of all network and information systems and have begun the
renovation and testing phases. Renovation of mission critical components of our
network and operation support system for Year 2000 compliance was completed in
June 1999. We will continue integration testing throughout the remainder of
1999.
<PAGE> 12
Subject to additional compliance testing, we believe our essential processes,
systems and business functions will be ready for the 1999 to 2000 transition.
Our significant vendors, including the major communications equipment
suppliers, have assured us their applications are Year 2000 compliant. Our
business also relies on other third parties. The ability of third parties upon
whom we rely to adequately address their Year 2000 issues is outside our
control. However, we are coordinating efforts with these parties to minimize the
extent to which our business will be vulnerable to their failure to remediate
their own Year 2000 issues. We cannot assure you the systems of the third
parties will be modified on a timely basis. Our business, financial condition
and results of operations could be materially adversely affected by the failure
of the systems and applications of third parties to properly operate after 1999.
We are continuously evaluating our contingency plans should mission
critical systems fail as a result of Y2K issues.
In a recent SEC release regarding Year 2000 disclosure, the SEC stated
that public companies must disclose the most reasonably likely worst case Year
2000 scenario. Although it is not possible to assess the likelihood of any of
the following events, each must be included in a consideration of worst case
scenarios: widespread failure of electrical, gas and similar suppliers serving
us; widespread disruption of the services provided by common communications
carriers; similar disruption to the means and modes of transportation for our
employees, contractors, suppliers and customers; significant disruption to our
ability to gain access to, and remain working in, office buildings and other
facilities; the failure of substantial numbers of our critical computer hardware
and software systems, including both internal business systems and systems
controlling operational facilities such as electrical generation, transmission
and distribution systems; and the failure of outside entities' systems,
including systems related to banking and finance.
If we cannot operate effectively after December 31, 1999, we could,
among other things, face substantial claims by customers or loss of revenue due
to service interruptions, inability to fulfill contractual obligations or to
bill customers accurately and on a timely basis, as well as increased expenses
associated with litigation, stabilization of operations following critical
system failures and the execution of contingency plans. We could also experience
an inability by customers and others to pay, on a timely basis or at all,
obligations owed to us. Under these circumstances, the adverse effects, although
not quantifiable at this time, could be material.
FORWARD LOOKING STATEMENTS
Certain statements contained in this Report that state our intentions,
hopes, beliefs, expectations or predictions of the future are forward-looking
statements. We wish to caution you these forward-looking statements such as our
plans to expand our existing network through collocation and into new markets,
statements regarding development, introduction and acceptance of our products or
business, statements regarding our ability to achieve or exceed our goals or
reach profitability in the future, statements regarding the adequacy or
availability of financing, statements regarding the outcome of regulatory
proceedings or litigation or the effect of government regulations, statements
regarding our ability or the ability of others to become Y2K compliant or
similar statements contained in this Report regarding matters that are not
historical facts, are only estimates or predictions. Actual results may differ
materially as a result of risks facing us or actual results differing from
assumptions underlying such statements. Such risks and assumptions include, but
are not limited to, our ability to successfully market our existing and proposed
services to current and new customers in existing and planned markets,
successfully develop commercially viable data and Internet offerings, access
markets, install switches and obtain suitable locations for our switches,
negotiate and renew suitable interconnection agreements with the ILECs, obtain
an acceptable level of cooperation from the ILECs, all in a timely manner, at
reasonable cost and on satisfactory terms and conditions, as well as regulatory,
competitive, legislative and judicial developments that could materially affect
our future results. All forward-looking statements made in this Report are
expressly qualified in their entirety by these cautionary statements.
<PAGE> 13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of our long-term debt bears fixed interest rates, however, the fair
market value of this debt is sensitive to changes in prevailing interest rates.
We run the risk that market rates will decline and the fair market value of
required payments will exceed those based on the current market rate. We do not
use interest rate derivative instruments to manage our exposure to interest rate
changes.
<PAGE> 14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are a party to numerous state and federal administrative
proceedings. In these proceedings, we are seeking to define and/or enforce ILEC
performance requirements related to:
- the cost and provisioning of unbundled network elements;
- the establishment of customer care and provisioning;
- the allocation of subsidies; and
- collocation costs and procedures.
The outcome of these proceedings will establish the rates and
procedures by which we obtain and provide unbundled network elements and could
have a material effect on our operating costs.
We are also involved in legal proceedings in which we are seeking to
enforce our tariffed rates for originating and terminating switched access. As
of September 30, 1999, we had outstanding receivables of approximately $12.2
million attributable to access charges from long distance carriers. Some of
these long distance carriers have refused to pay the full amount of the access
charges billed to them. We initiated proceedings against AT&T at the FCC under
an FCC procedure for expedited settlement of disputes between common carriers.
On July 16, 1999, the FCC released a decision ordering AT&T to pay us the full
amount we billed to them for originating switched access charges from August
1998 through March 1999 at our tariffed rate, plus interest. This decision is
subject to appeal by AT&T. We are currently preparing to file a similar
complaint against Sprint. The final outcomes of the disputes with AT&T and
Sprint are uncertain. If we are unable to collect our tariffed access charges
from these long distance carriers, it could have a material impact on our
financial condition.
On July 29, 1999, we settled our antitrust lawsuit against Sprint
Corporation. Under the terms of the settlement, we and other CLECs will receive
a residential market entry incentive of up to $3.65 per residential line in
Nevada per month for the term of the agreement, which expires June 30, 2002.
From time to time, we engage in other litigation and governmental
proceedings in the ordinary course of business. We do not believe that any
pending litigation or governmental proceedings will have a material adverse
effect on our results of operations or financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable
(b) Not applicable
(c) During third quarter 1999, we issued 145,000 shares of common stock
pursuant to the exercise of warrants acquired in a private placement, with
respect to which we received nominal proceeds. All of the securities were
acquired by the recipients thereof for investment and with no view toward the
sale or redistribution thereof. In each instance, the offers and sales were made
without any public solicitation; the stock certificates bear restrictive
legends; and appropriate stop transfer instruction have been or will be given to
the transfer agent. No underwriter was involved in this transaction and no
commissions were paid with respect to the sale of such securities. These
issuances of securities were made in reliance on the exemption from registration
provided by Section 4(2) of the Securities Act of 1933 (as a transaction by an
issuer not involving a public offering) and by Section 3(a)(9) of the Securities
Act of 1933.
(d) Our Registration Statement No. 333-49085 was declared effective on
May 11, 1998, which was the offering date of our common stock thereunder. During
the period from May 11, 1998 until
<PAGE> 15
September 30, 1999, we paid $4,790,000 in underwriting discounts and commissions
and other offering expenses of $672,000 for total offering expenses of
$5,462,000, resulting in net offering proceeds to us of $62,963,000. Of such
amounts, expenses of $16,000 were paid for charter services to a related party
of which two current board members are major shareholders. No other amounts were
paid for offering expenses directly or indirectly to officers, Directors, 10% or
greater stockholders or other affiliates of ours.
During the period from May 11, 1998 until September 30, 1999, the net
offering proceeds were invested in government securities and money market funds.
None of such amounts were paid directly or indirectly to officers, Directors,
10% or greater stockholders or other affiliates of ours.
ITEM 3. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as part of this report. The exhibit
numbers refer to Item 601 of Regulation S-K.
27 Financial Data Schedule
(b) The following Current Reports on Form 8-K have been filed by the Company:
Form 8-K dated July 19, 1999 to report the second quarter 1999
earnings.
Form 8-K dated October 14, 1999 to report the third quarter 1999
earnings and the hiring of a new chief executive officer and an
agreement to issue $35 million of preferred stock at $28.00 per
share.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf of the
undersigned, thereunto duly authorized.
<TABLE>
<S> <C>
MGC COMMUNICATIONS, INC.
Date: November 15, 1999 /s/ Maurice J. Gallagher, Jr.
-----------------------------
Maurice J. Gallagher, Jr.
Chairman of the Board
Date: November 15, 1999 /s/ Linda M. Sunbury
-----------------------------
Linda M. Sunbury
Senior Vice President
Chief Financial Officer
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