<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended June 30, 1999
Commission file number 0-24059
MGC Communications, Inc.
(Exact name of registrant as specified in its charter)
Nevada 88-0360042
(State of incorporation) (IRS Employer Identification Number)
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 August 3, 1999:
Common stock ($.001 par value) .... 22,721,818 shares outstanding
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MGC COMMUNICATIONS, INC.
INDEX
==============================================================================
<TABLE>
<CAPTION>
Page No.
--------
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations -- Three and Six months
ended June 30, 1999 (as restated) and 1998 (Unaudited) 3
Consolidated Balance Sheets -- June 30, 1999 (as restated)
(Unaudited) and December 31, 1998 4
Consolidated Statements of Redeemable Preferred Stock and
Stockholders' Equity for the period from December 31, 1997
to June 30, 1999 (as restated) 5
Consolidated Statements of Cash Flows -- Six months ended
June 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 4. Submission of Matters to a Vote of Security Holders 16
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> (as restated) <C> <C> (as restated) <C>
Operating revenues:
Telecommunications services $ 11,485 $ 4,018 $ 19,886 $ 6,864
Operating expenses:
Cost of operating revenues 10,506 3,415 18,989 5,786
Selling, general and administrative 9,197 3,325 16,924 5,887
Depreciation and amortization 4,182 1,123 7,666 1,990
----------- ----------- ----------- -----------
23,885 7,863 43,579 13,663
----------- ----------- ----------- -----------
Loss from operations (12,400) (3,845) (23,693) (6,799)
Other income (expense):
Gain on sale of investments available-for-sale 47 -- 252 --
Interest income 1,380 2,296 2,880 4,465
Interest expense (net of amounts capitalized) (4,564) (5,363) (9,188) (10,868)
----------- ----------- ----------- -----------
Net loss (15,537) (6,912) (29,749) (13,202)
Accrued preferred stock dividend (729) -- (729) --
Accretion of preferred stock to redemption value (1,349) -- (1,349) --
----------- ----------- ----------- -----------
Net loss applicable to common stockholders (17,615) (6,912) (31,827) (13,202)
=========== =========== =========== ===========
Basic and diluted loss per share of
common stock $ (1.01) $ (.52) $ (1.84) $ (1.18)
=========== =========== =========== ===========
Basic and diluted weighted average
shares outstanding 17,474,941 13,377,938 17,340,688 11,147,502
=========== =========== =========== ===========
</TABLE>
See accompanying condensed notes to unaudited interim
consolidated financial statements.
<PAGE> 4
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
--------- ------------
ASSETS (UNAUDITED)
<S> <C>(as restated) <C>
Current assets:
Cash and cash equivalents ...................................... $ 11,256 $ 11,886
Investments available-for-sale ................................. 31,119 9,851
Restricted investments ......................................... 22,286 20,797
Accounts receivable, less allowance for doubtful
accounts of $425 and $257, .................................. 10,980 6,360
Prepaid expenses 370 208
--------- ---------
Total current assets ................................... 76,011 49,102
Property and equipment, net ...................................... 132,683 116,380
Investments available-for-sale ................................... 41,980 63,212
Restricted investments ........................................... 7,664 18,582
Deferred financing costs, net of amortization
of $1,476 and $1,065 ........................................... 4,303 4,714
Other assets ..................................................... 625 129
--------- ---------
Total assets ........................................... $ 263,266 $ 252,119
========= =========
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt ........................... $ 266 $ 332
Accounts payable:
Trade ....................................................... 7,873 5,314
Property and equipment ...................................... 7,246 18,577
Accrued interest ............................................... 5,200 5,200
Accrued other expenses ......................................... 6,643 2,473
--------- ---------
Total current liabilities .............................. 27,228 31,896
Senior Secured Notes, net of unamortized discount of $3,019
and $3,307 ..................................................... 156,981 156,693
Other long-term debt ............................................. 238 270
--------- ---------
Total liabilities ...................................... 184,447 188,859
--------- ---------
Commitments and contingencies
Redeemable preferred stock:
10% Series B Convertible Preferred Stock, 5,278,000 shares
authorized and 5,277,779 shares issued and outstanding ......... 47,849 --
Stockholders' equity:
Preferred stock, 44,722,000 shares authorized and unissued ..... -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 17,611,880 and 17,190,428 shares
issued and outstanding ...................................... 18 17
Additional paid-in capital ..................................... 109,660 108,991
Accumulated deficit ............................................ (76,219) (44,392)
--------- ---------
33,459 64,616
Accumulated other comprehensive income ......................... (316) 817
Notes receivable from stockholders for issuance of common
stock ....................................................... (2,173) (2,173)
--------- ---------
Total stockholders' equity ............................. 30,970 63,260
--------- ---------
Total liabilities, redeemable preferred stock and
stockholders' equity ................................. $ 263,266 $ 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 ................ -- -- 27,001 -- 223
Warrants and options exercised
for common stock ................ -- -- 394,451 1 446
10% Series B Convertible Preferred
Stock issued for cash ............ 5,277,779 46,500 -- -- --
Accrued preferred stock dividend ... -- -- -- -- --
Accretion of preferred stock
to redemption value .............. -- 1,349 -- -- --
Net loss ........................... -- -- -- -- --
---------- -------- ---------- ---- --------
BALANCE AT JUNE 30, 1999
(UNAUDITED) (as restated) ........ 5,277,779 $ 47,849 17,611,880 $ 18 $109,660
========== ======== ========== ==== ========
</TABLE>
<TABLE>
<CAPTION>
NOTES
RECEIVABLE FROM ACCUMULATED
STOCKHOLDERS FOR OTHER TOTAL
ACCUMULATED ISSUANCE OF COMPREHENSIVE STOCKHOLDERS'
DEFICIT COMMON STOCK INCOME EQUITY
----------- ---------------- ------------- -------------
<S> <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 .............. -- -- (1,133) (1,133)
Common stock issued ................ -- -- -- 223
Warrants and options exercised
for common stock ................ -- -- -- 447
10% Series B Convertible Preferred
Stock issued for cash ............ -- -- -- --
Accrued preferred stock dividend ... (729) -- -- (729)
Accretion of preferred stock
to redemption value .............. (1,349) -- -- (1,349)
Net loss ........................... (29,749) -- -- (29,749)
-------- ------- ------- --------
BALANCE AT JUNE 30, 1999
(UNAUDITED) (as restated) ........ $(76,219) $(2,173) $ (316) $ 30,970
======== ======= ======= ========
</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>
SIX MONTHS ENDED
JUNE 30,
------------------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss .......................................................... $(29,749) $(13,202)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization ................................... 7,666 1,990
Gain on sale of investments available-for-sale .................. (252) --
Amortization of debt discount ................................... 288 288
Amortization of deferred financing costs ........................ 411 446
Changes in assets and liabilities:
Increase in accounts receivable, net ......................... (4,620) (3,273)
Increase in prepaid expenses ................................. (162) (127)
Increase in other assets ..................................... (527) (8)
Increase in accounts payable - trade ......................... 2,559 1,980
Increase in accrued interest and other expenses .............. 3,441 1,747
-------- --------
Net cash used in operating activities ...................... (20,945) (10,159)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment, net of
payables ........................................................ (23,938) (28,599)
Decrease in accounts payable - property and equipment ............. (11,331) --
Purchase of investments held-to-maturity .......................... -- (41,609)
Purchase of investments available-for-sale ........................ (917) --
Sale of restricted investments .................................... 9,429 9,043
-------- --------
Net cash used in investing activities ...................... (26,757) (61,165)
-------- --------
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 .................................... 46,500 4,980
Payments on other long-term debt .................................. (98) (110)
Proceeds from issuance of common stock ............................ 670 785
Proceeds from issuance of common stock (IPO) ...................... -- 63,021
-------- --------
Net cash provided by financing activities .................. 47,072 68,543
-------- --------
Net decrease in cash ....................................... (630) (2,781)
Cash and cash equivalents at beginning of period .................... 11,886 45,054
-------- --------
Cash and cash equivalents at the end of period ...................... $ 11,256 $ 42,273
======== ========
Supplemental schedule of non-cash investing and financing activities:
Increase in property and equipment purchases included
in accounts/notes payable -- property and equipment ............. $ -- $ 7,217
======== ========
Stock issued for notes receivable ................................. $ -- $ 1,485
======== ========
Increase in accretion of preferred stock to redemption value ........ $ 1,349 $ --
======== ========
Other disclosures:
Cash paid for interest net of amounts capitalized ................. $ 9,188 $ 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.
The Company's previously reported financial statements for the three and
six months ended June 30, 1999 have been amended to reflect the above accretion
of anticipated redemption value with respect to the Series B Preferred Stock.
The effect of the amendment was to increase the net loss applicable to common
stockholders and basic and diluted loss per share of common stock as follows:
<TABLE>
<CAPTION>
For the three months ended June 30, 1999 Net loss applicable Basic and diluted
to common loss per share of
stockholders common stock
------------------- -----------------
<S> <C> <C>
As previously reported..................... $(16,266) $(0.93)
Accretion of Series B Preferred Stock...... (1,349) (0.08)
--------- -------
As amended................................. $(17,615) $(1.01)
========= =======
</TABLE>
<TABLE>
<CAPTION>
For the six months ended June 30, 1999 Net loss applicable Basic and diluted
to common loss per share of
stockholders common stock
------------------- -----------------
<S> <C> <C>
As previously reported..................... $(30,478) $(1.76)
Accretion of Series B Preferred Stock...... (1,349) (0.08)
--------- -------
As amended................................. $(31,827) $(1.84)
========= =======
</TABLE>
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
--------- ------------
(UNAUDITED)
<S> <C> <C>
Building and property ................... $ 5,158 $ 2,653
Switching equipment ..................... 104,620 57,045
Leasehold improvements .................. 844 740
Computer hardware and software .......... 3,033 2,218
Office equipment and vehicles ........... 1,303 901
--------- ---------
114,958 63,557
Less accumulated depreciation and
amortization .......................... (14,190) (6,555)
--------- ---------
100,768 57,002
Switching equipment under construction... 31,915 59,378
--------- ---------
Net property and equipment .... $ 132,683 $ 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 June 30, 1999
and December 31, 1998, the Company had a total for all vendors of approximately
$30.1 million and $15.4 million, respectively, of remaining purchase commitments
for purchases of switching and other telecommunications equipment.
(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 six month period ended June 30, 1999 and for the year
ended December 31, 1998, the Company has recognized in operating revenues
switched access revenues of approximately $6,896,000 and $7,378,000,
respectively. Included in accounts receivable in the
<PAGE> 8
accompanying balance sheets as of June 30, 1999 and December 31, 1998 are net
receivables from carrier access billings of approximately $8,142,000 and
$3,590,000, respectively.
(5) REDEEMABLE PREFERRED STOCK AND STOCKHOLDER'S 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 $46.5 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 2002. The holders of Series B Preferred Stock
will vote along with the common stock on an as-converted basis.
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 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.
The Company records a pro rata accretion of the Series B Preferred Stock
to its anticipated redemption value. Such accretion is based on the market value
of the common stock at the balance sheet date, not to exceed $27 per share based
on the Market Threshold. For the three and six months ended June 30, 1999,
the Company recorded accretion of $1.3 million which has been recorded as an
increase in redeemable preferred stock.
(6) SUBSEQUENT EVENTS
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 587,696 shares of common
stock for which the Company did not receive any proceeds. The underwriters have
an option to purchase an additional 838,134 shares of common stock at $25 per
share. The option expires August 20, 1999.
On July 16, 1999, the Federal Communications Commission released a
decision ordering AT&T to pay MGC $2.0 million plus interest for originating
switched access charges covering the time period from August 1998 through March
1999 per MGC's tariffed rates. The decision is subject to appeal by AT&T.
On July 29, 1999, MGC settled the antitrust lawsuit against Sprint
Corporation. Under the terms of the settlement, MGC and other CLECs will receive
a residential market entry incentive of up to $3.65 per residential line per
month for the term of the agreement, which expires June 30, 2002.
<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 costs 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. As
expected, both cost of operating revenues and selling, general and
administrative costs 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 - JUNE 30, 1999 VS. JUNE 30, 1998
Total operating revenues increased to $11.5 million for the quarter
ended June 30, 1999 as compared to $4.0 million for the quarter ended June 30,
1998. The 186% increase is a result of the increase in the number of lines in
service and increased long distance service revenue. We had 89,535 lines in
service at the end of the second quarter as compared to 26,667 lines in service
at June 30, 1998, a 236% increase.
Cost of operating revenues for the quarter ended June 30, 1999 was $10.5
million as compared to $3.4 million for the quarter ended June 30, 1998. The
208% 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 quarter ended June 30, 1999, selling, general and administrative
expenses totaled $9.2 million; a 177% increase over the $3.3 million for the
quarter ended June 30,
<PAGE> 10
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 June 30, 1999, depreciation and amortization was
$4.2 million as compared to $1.1 million for the quarter ended June 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 June 30, 1999 totaled $5.7
million compared to $5.5 million for the quarter ended June 30, 1998. Interest
capitalized for the quarter ended June 30, 1999 increased to $1.1 million as
compared to $0.3 million for the quarter ended June 30, 1998. This increase 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 $1.4 million during the quarter ended June 30, 1999
compared to $2.3 million for the quarter ended June 30, 1998. The 40% decrease
is a result of the decrease in cash and investments since June 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 $15.5 million during second quarter 1999 and
$6.9 million during the second quarter 1998.
SIX MONTH PERIOD ENDED - JUNE 30, 1999 VS. JUNE 30, 1998
Total operating revenues increased to $19.9 million for the six months
ended June 30, 1999 as compared to $6.9 million for the six months ended June
30, 1998. The 190% increase is a result of the increase in the number of lines
in service and increased long distance service revenue.
Cost of operating revenues for the six months ended June 30, 1999 was
$19.0 million as compared to $5.8 million for the quarter ended June 30, 1998.
The 228% 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 six months ended June 30, 1999, selling, general and
administrative expenses totaled $16.9 million; a 187% increase over the $5.9
million for the six months ended June 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 six months ended June 30, 1999, depreciation and amortization
was $7.7 million as compared to $2.0 million for the six months ended June 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 six months ended June 30, 1999 and 1998
totaled $11.1 million. Interest capitalized for the six months ended June 30,
1999 increased to $1.9 million as compared to $0.2 million for the six months
ended June 30, 1998. This increase 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 $2.9 million during the six months ended June 30,
1999 compared to $4.5 million for the six months ended June 30, 1998. The 36%
decrease is a result of the decrease in cash and investments since June 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 $29.7 million and $13.2 million for the six
month periods ended June 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 June 30, 1999 were $8.7 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 $45.1 million
of capital expenditures expected during the last six months of 1999, which will
be funded 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.
From our inception through September 1997, we raised approximately $17.8
million from private sales of common stock.
In September 1997, we completed a $160.0 million offering of Senior
Secured Notes and warrants to purchase 862,923 shares of common stock (after
giving effect to anti-dilution adjustments). At the closing of the sale of the
Senior Secured Notes, we used approximately $56.8 million of the net proceeds
from the sale of the Senior Secured Notes to purchase a portfolio of securities
that has been pledged as security to cover the first six interest payments on
the Senior Secured Notes. In addition, we have granted the holders of the Senior
Secured Notes a security interest in a substantial portion of our
telecommunications equipment.
In November 1997 and January 1998, we issued an aggregate of 6,571,427
shares of Series A Convertible Preferred Stock at $3.50 per share for net
proceeds of $21.6 million.
We completed our initial public offering of common stock on May 15,
1998. We sold a total of 4,025,000 shares of common stock to the public and
received net proceeds of $63.0 million. In connection with our initial public
offering of our common stock, we reduced the number of authorized and
outstanding shares of our common stock by 40%. Our outstanding shares of
preferred stock were converted into 3,942,856 shares of common stock upon our
initial public offering.
In May 1999, we issued 5,277,779 shares of Series B Convertible
Preferred Stock at $9.00 per share for net proceeds of approximately $46.5
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. Our underwriters have an option to
purchase an additional 838,134 shares of common stock at $25 per share. The
option expires August 20, 1999.
In addition, we are currently negotiating a vendor facility to finance
at least $20 million of DSL equipment. We cannot assure you that we will be able
to obtain this vendor financing in a timely manner, on terms we consider
acceptable or at all.
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 third quarter 2000. 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.
<PAGE> 12
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 were completed in
June 1999. We will continue integration testing throughout the remainder of
1999. 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 currently in the process of developing 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.
<PAGE> 13
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The American Institute of Certified Public Accountants recently issued
Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities." SOP 98-5 requires start-up costs, as defined, to be expensed as
incurred and is effective for financial statements for fiscal years beginning
after December 15, 1998. We currently expense all start-up costs as incurred and
the application of SOP 98-5 will have no material impact on our financial
statements.
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.
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 party to numerous state and federal administrative proceedings.
In these proceedings, we are seeking to define and/or enforce ILEC performance
requirements related to:
o the cost and provisioning of unbundled network elements;
o the establishment of customer care and provisioning;
o the allocation of subsidies; and
o 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 June 30, 1999, we had outstanding receivables of approximately $8.1 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 have 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 to a federal appeals court. We are currently
negotiating with Sprint and MCI WorldCom and have submitted our dispute with MCI
WorldCom to arbitration. The final outcome of the disputes with AT&T, Sprint and
MCI WorldCom is 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. The outcome of these proceedings is uncertain, and
adverse results 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 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) The rights of the holders of our common stock have been affected
by the issuance of 5,277,779 shares of Series B Convertible Preferred Stock (the
"Series B Preferred Stock") in May 1999. The Series B Preferred Stock has the
following rights and preferences:
Dividends accrue at the rate of 10% per year, are cumulative and must be
paid before any dividends may be paid on our common stock. Beginning November
22, 1999, we may elect to terminate the accrual of dividends if our common stock
price per share exceeds $27.00 for 20 consecutive trading days. Except as
described below, accrued dividends will be paid in common stock at the time the
Series B Preferred Stock is converted into common stock if the dividends have
not been paid prior to that time.
On any matter submitted to our stockholders, holders of shares of Series
B Preferred Stock will be treated as if they hold the number of shares of common
stock into which their shares of Series B Preferred Stock could be converted and
will be allowed to vote those shares along with the holders of our common stock.
In addition, the holders of shares of Series B Preferred Stock will have the
right to approve any action to:
o Issue preferred stock ranking equal or senior to the Series B
Preferred Stock;
o Dispose of assets in excess of a fixed dollar amount, merge or
consolidate or sell our company;
<PAGE> 15
o Liquidate our company;
o Alter the terms of the Series B Preferred Stock;
o Pay dividends on common stock or other securities junior to the
Series B Preferred Stock;
o Enter into transaction with our affiliates other than
transactions covered by specified exceptions;
o Make acquisitions in excess of a fixed dollar amount;
o Incur additional debt in excess of fixed amounts;
o Make material changes to our business plan;
o Hire a chief executive officer;
o Organize subsidiaries or enter into joint ventures unless
specified conditions are met; and
o Issue additional common stock that would result in an increase
in the number of shares of common stock into which the Series B
Preferred Stock may be converted.
If we were to take one of these restricted actions without the approval
of the holders of the Series B Preferred Stock, the holders of the Series B
Preferred Stock may have the right to require us to seed a sale of our company.
To avoid having to sell our company in the event one of the restricted actions
described above is not approved, we have the right to redeem the Series B
Preferred Stock and such a sale is not effected within six months, then the
holders of the Series B Preferred Stock would be entitled to elect a majority of
our Board of Directors.
The approval rights described above will terminate if fewer than
1,759,260 shares of Series B Preferred Stock remain outstanding and the shares
of Series B Preferred Stock outstanding constitute less than 5% of the
outstanding common stock assuming conversion of all outstanding shares of Series
B Preferred Stock. Based on the number of shares of common stock currently
outstanding, 5% of the common stock would be approximately 1,398,000 shares.
The holders of Series B Preferred Stock have the right to nominate one
or more directors depending on the size of our Board of Directors and the
percentage of our 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 our Board and on the board of
each of our subsidiaries. The holders of the Series B Preferred Stock are
currently entitled to nominate one director since we have seven directors. Paul
J. Salem has been elected to the Board after being nominated by the holders of
the Series B Preferred Stock.
The right to nominate directors will terminate if fewer than 1,759,260
shares of the Series B Preferred Stock remain outstanding and the shares of
Series B Preferred Stock outstanding constitute less than 5% of the outstanding
common stock assuming conversion of all outstanding shares of Series B Preferred
Stock.
Upon our liquidation, the holders of the Series B Preferred Stock are
entitled to receive their liquidation amount before any amounts may be paid to
holders of our common stock or junior securities. The liquidation amount will be
the greater of (a) $9.00 per share plus accrued and unpaid dividends or (b) the
amount the holders of Series B Preferred Stock would have received if the Series
B Preferred Stock had been converted into common stock. The holders of the
Series B Preferred Stock have the right to elect that a sale of our company be
treated as a liquidation for these purposes. If the liquidation or sale occurs
before May 4, 2002, the accrued dividends will not be paid to the extent the
holders of Series B Preferred Stock will receive more than $22.50 per share.
A holder of shares of Series B Preferred Stock may convert those shares
into common stock at any time. Initially, each share of Series B Preferred Stock
may be converted into one share of common stock. The number of shares of common
stock into which each share of Series B Preferred Stock can be converted may be
adjusted as a result of stock splits, stock dividends and other issuances of
additional stock.
After the earlier of May 24, 2000 or the date on which the holders of
Series B Preferred Stock exercise their demand registration rights, which are
described below, we have the right to require the conversion of the Series B
Preferred Stock if our common stock price exceeds $27.00 per share for 20
consecutive trading days. If we require conversion before May 4, 2002, no
accrued dividends will be paid.
<PAGE> 16
The holders of Series B Preferred Stock have the right to require us to
redeem the Series B Preferred Stock after May 4, 2005 or upon a sale of our
company. The redemption price will be equal to the greater of:
o $9.00 per share plus accrued and unpaid dividends; or
o the value of the common stock into which the Series B Preferred
Stock is then convertible.
If we fail to redeem all shares of Series B Preferred Stock within six
months of the date specified by the holders of the Series B Preferred Stock,
then the holders of the Series B Preferred Stock will have the right to elect a
majority of our Board of Directors.
The holders of Series B Preferred Stock have demand and piggyback
registration rights, although a demand registration may not be initiated by the
holders of the Series B Preferred Stock before May 4, 2000, unless our stock
price exceeds $27.00 per share for 20 consecutive trading days.
(c) During second quarter 1999, we issued 259,826 shares of common
stock pursuant to the exercise of warrants acquired in a private placement. As
the warrants were exercised on a cashless basis, we did not receive any proceeds
from the issuance. 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 3(a)(9) of the Securities
Act of 1933.
In May, 1999, we issued 5,277,779 shares of Series B Convertible
Preferred Stock at $9.00 per share to five investors for total consideration of
$47.5 million. Net proceeds to us were approximately $46.5 million. The offer
and sale of shares of Series B Preferred Stock were made without any public
solicitation; the stock certificates bear restrictive legends; and appropriate
stop transfer instructions 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.
(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 June 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 June 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Stockholders was held on Friday May 21, 1999.
At the meeting, Jack Hancock, Thomas Neustaetter and Paul J. Salem were elected
to serve on our Board of Directors for a three-year term expiring in 2002. Each
director received the vote of all 12,603,299 shares of stock represented at the
meeting. The terms of Timothy P. Flynn, Maurice J. Gallagher, Jr., David
Kronfeld and Nield J. Montgomery as directors also continued after the meeting.
At the meeting, the stockholders also approved an amendment of our Stock Option
Plan to increase the number of shares issuable under such Plan from 2,640,000
shares to 4,640,000 shares by the vote of 9,453,352 shares for, 886,014 shares
voting against and 35,400 shares abstaining.
<PAGE> 17
ITEM 6. 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) No reports on Form 8-K were filed during the second quarter 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this amendment to be signed on its behalf of the
undersigned, thereunto duly authorized.
MGC COMMUNICATIONS, INC.
Date: February 3, 2000 /s/ Maurice J. Gallagher, Jr.
------------------------------------
Maurice J. Gallagher, Jr.
Chairman of the Board
Date: February 3, 2000 /s/ Linda M. Sunbury
------------------------------------
Linda M. Sunbury
Principal Accounting Officer
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