<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 16, 1998
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
COMMISSION FILE NUMBER: 333-49397
FOCAL COMMUNICATIONS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 36-4167094
(STATE OF INCORPORATION) (IRS EMPLOYER IDENTIFICATION NUMBER)
200 N. LASALLE STREET
SUITE 800
CHICAGO, IL 60601
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(312) 895-8400
(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 No [X]
The number of shares outstanding of the issuer's common stock, as of March
31, 1998:
<TABLE>
<S> <C>
Common stock ($.01 par value).............................. 100,307 shares
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
FOCAL COMMUNICATIONS CORPORATION
INDEX
<TABLE>
<S> <C>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Operations-Three months ended March 31, 1998
and 1997................................................................. 3
Consolidated Balance Sheets-March 31, 1998 and December 31, 1997.......... 4
Consolidated Statements of Cash Flows-Three months ended March 31, 1998
and 1997................................................................. 5
Condensed Notes to Unaudited Interim Consolidated Financial Statements.... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................... 9
PART II--OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................................... 12
SIGNATURES.................................................................. 13
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDING MARCH 31
----------------------
1998 1997
----------- ---------
<S> <C> <C>
REVENUES................................................ $ 5,102,448 $ --
Expenses:
Customer service and network operations............... 1,826,893 8,692
Selling, general and administrative................... 1,307,625 416,492
Depreciation and amortization......................... 890,871 7,337
Non-cash compensation expense......................... 325,000 325,000
----------- ---------
Total operating expenses............................ 4,350,389 757,521
----------- ---------
Operating Income (Loss)............................. 752,059 (757,521)
Other income (Expense):
Interest income....................................... 1,015,902 43,055
Interest expense...................................... (2,109,152) (135)
----------- ---------
(1,093,250) 42,920
----------- ---------
Net loss................................................ $ (341,191) $(714,601)
Accretion to redemption value of Class A common stock... -- (25,891)
Net loss applicable to common stockholders.............. $ (341,191) $(740,492)
=========== =========
Basic and diluted net loss per share of common stock.... $ (3.86) $ (8.87)
=========== =========
</TABLE>
3
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1998 AND DECEMBER 31, 1997
<TABLE>
<CAPTION>
MARCH 31, DECEMBER
ASSETS 1998 31, 1997
------ ------------ -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents......................... $152,758,944 $ 2,256,552
Accounts receivable, trade (net of allowance for
Doubtful accounts of $469,000 and $1,046,000 at
December 31, 1997 and March 31, 1998,
respectively).................................... 5,196,879 2,355,814
Related-party receivables......................... 120,349 34,883
Other current assets.............................. 328,631 90,559
------------ -----------
Total current assets............................ 158,404,803 4,737,808
FIXED ASSETS, at cost:.............................. 19,386,802 11,793,741
Less--Accumulated depreciation and Amortization... 1,260,951 616,967
------------ -----------
Fixed assets, net............................... 18,125,851 11,176,774
Other Non-Current Assets, net..................... 5,697,368 --
------------ -----------
$182,228,022 $15,914,582
============ ===========
<CAPTION>
MARCH 31, DECEMBER
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) 1998 31, 1997
---------------------------------------------- ------------ -----------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable.................................. $ 5,256,228 $ 1,502,479
Accrued liabilities............................... 497,404 367,890
Current maturities of long-term debt.............. -- 943,621
------------ -----------
Total current liabilities....................... 5,753,632 2,813,990
LONG-TERM DEBT, net of current maturities........... 152,093,513 2,593,265
OTHER NONCURRENT LIABILITIES........................ 269,222 179,481
REDEEMABLE COMMON STOCK:
Class A, $.01 par value, 85,567 shares authorized
and 80,307 issued and outstanding at December 31,
1997............................................. -- 12,403,218
STOCKHOLDERS' EQUITY (DEFICIT):
Common stock, Class A, $.01 par value, 85,567
shares authorized and 80,307 issued and
outstanding at March 31, 1998.................... 803 --
Common stock, Class B, $.01 par value; 35,000
shares authorized, 20,000 shares issued at
December 31, 1997 and March 31, 1998............. 200 200
Common stock, Class C, $.01 par value; 15,000
shares authorized, 14,711 shares issued at
December 31, 1997 and March 31, 1998............. 147 147
Additional paid-in capital........................ 31,298,850 5,096,435
Deferred compensation............................. (3,466,668) (3,791,667)
Accumulated deficit............................... (3,721,678) (3,380,487)
------------ -----------
Total stockholders' equity (deficit)............ 24,111,655 (2,075,372)
------------ -----------
$182,228,022 $15,914,582
============ ===========
</TABLE>
4
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THREE MONTHS ENDED
MARCH 31
------------------------
1998 1997
------------ ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................ $ (341,191) $ (714,601)
Adjustments to reconcile net loss to net cash
provided by (used in)
operating activities--
Depreciation and amortization..................... 890,871 7,337
Deferred lease costs.............................. 89,741 --
Deferred compensation expense..................... 325,000 325,000
Amortization of discount on Senior Discount Notes. 2,062,174 --
Provision for losses on accounts receivable....... 577,000 --
Changes in operating assets and liabilities--
Accounts receivable............................. (3,418,065) --
Related-party receivables....................... (85,466) (29,679)
Other assets.................................... (238,072) --
Accounts payable and accrued liabilities........ 3,883,263 (110,652)
------------ ----------
Net cash provided by (used in) operating
activities................................... 3,745,255 (522,595)
------------ ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................ (7,593,061) (2,244,385)
------------ ----------
Net cash used in investing activities......... (7,593,061) (2,244,385)
------------ ----------
CASH FLOW FROM FINANCING ACTIVITIES:
Net proceeds from issuance of long-term debt...... 144,083,351 --
Payments on bank credit facility and capital
leases........................................... (3,533,153) (486)
Proceeds from class A common capital
contributions.................................... 13,800,000 4,000,000
------------ ----------
Net cash provided by financing activities..... 154,350,198 3,999,514
------------ ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS........... 150,502,392 1,232,534
CASH AND CASH EQUIVALENTS, beginning of period...... 2,256,552 3,790,121
------------ ----------
CASH AND CASH EQUIVALENTS, end of period............ $152,758,944 $5,022,655
============ ==========
</TABLE>
5
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MARCH 31, 1998 AND DECEMBER 31, 1997
1. BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements reflect
all adjustments, consisting of normal recurring accruals, which management
believes are necessary to present fairly the financial position, results of
operations, and cash flows for Focal Communications Corporation and
subsidiaries (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 financial statements and the notes thereto
included in Amendment No. 4 to the Registration Statement on Form S-4 (File
No. 333-49397) filed by the Company with the Securities and Exchange
Commission on August 13, 1998 and Form 8-K filed on November 13, 1998 revising
the calculation of basic and diluted net loss per share of common stock
contained in the financial statements set forth in such Form S-4. The
consolidated balance sheet at December 31, 1997 was derived from 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:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER
1998 31, 1997
----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Communications Network........................ $11,125,470 $ 7,906,336
Construction in progress...................... 4,325,152 1,938,236
Computer Equipment............................ 1,211,371 941,237
Leasehold Improvements........................ 2,268,183 652,173
Furniture and fixtures........................ 437,337 355,759
Motor vehicles................................ 19,289 --
----------- -----------
$19,386,802 $11,793,741
=========== ===========
</TABLE>
3. DEBT
Long-term debt at December 31, 1997 and March 31, 1998 consist of the
following:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
(UNAUDITED)
<S> <C> <C>
Credit facility with bank, Maximum borrowing
level at $6,000,000.......................... $ -- $3,480,972
12.125% senior discount notes due 2008, net of
unamortized discount of $117,910,220......... 152,089,780 --
Capital leases on equipment with interest at
14.66%, $2,327 due Monthly through April,
2000......................................... 3,733 55,914
------------ ----------
152,093,513 3,536,886
Less--Current Maturities...................... -- 943,621
------------ ----------
$152,093,513 $2,593,265
============ ==========
</TABLE>
In February 1998 the Company completed its offering of $270 million stated
principal amount at maturity of its 12.125% senior discount notes due 2008
(the "Notes"), which resulted in gross proceeds of $150,027,606. The Notes
bear interest at the rate of 12.125% per annum (computed on a semiannual bond
equivalent basis). In
6
<PAGE>
the period prior to February 15, 2003, interest will accrue but will not be
payable in cash. From February 15, 2003, interest on the stated principal
amount at maturity of the Notes will be payable in cash semi-annually on
August 15 and February 15 of each year, beginning on August 15, 2003.
The Notes are senior unsecured obligations of the Company ranking pari passu
in right of payment with all other existing and future senior indebtedness of
the Company, if any, and will rank senior in right of payment to all existing
and future subordinated indebtedness of the Company, if any. Holders of
secured indebtedness of the Company, however, will have claims that are prior
to the claims of the holders of the Notes with respect to the assets securing
such other indebtedness. The Notes will be effectively subordinated to all
existing and future indebtedness and other liabilities of the Company's
subsidiaries (including trade payables).
The Notes are redeemable, at the Company's option, in whole or in part, at
any time or from time to time, on or after February 15, 2003, at 106.063% of
their stated principal amount at maturity, plus accrued and unpaid Current
Interest, declining ratably to 100% of their stated principal amount at
maturity, plus accrued and unpaid Current Interest, on or after February 15,
2006. In addition, at any time and from time to time, prior to February 15,
2001, the Company may redeem in the aggregate up to 35% of the original
aggregate stated principal amount at maturity of the Notes with the proceeds
from one or more public equity offerings following which there is a public
market, at a redemption price (expressed as a percentage of accreted value on
the redemption date) of 112.125%, plus additional interest, if any; provided
that at least 65% of the original aggregate stated principal amount at
maturity of the Notes remains outstanding after each such redemption.
The Notes indenture contains certain covenants which, among other things,
restrict the ability of the Company and certain of its subsidiaries to incur
additional indebtedness (and, in the case of certain subsidiaries, issue
preferred stock), pay dividends or make distributions in respect of the
Company's or such subsidiaries' capital stock, make other restricted payments,
enter into sale and leaseback transactions, incur liens, cause encumbrances or
restrictions to exist on the ability of certain subsidiaries to pay dividends
or make distributions in respect of their capital stock, issue and sell
capital stock of certain subsidiaries, enter into transactions with
affiliates, sell assets, or amalgamate, consolidate, merge or sell or
otherwise dispose of all or substantially all of their property and assets.
These covenants are subject to important exceptions and qualifications.
4. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share". SFAS
No. 128 changed the methodology of calculating earnings per share and renamed
the two calculations to basic earnings per share and diluted earnings per
share. The Company adopted SFAS No. 128 in January 1998 and has retroactively
restated all periods presented. Basic earnings per common share are based on
the average quarterly weighted average number of shares of common stock
outstanding as discussed further in Note 8. Diluted earnings per common share
are adjusted for the assumed exercise of dilutive stock options. Under the
requirements of SFAS No. 128 the Company's basic and diluted weighted average
number of shares outstanding at March 31, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1998 1997
--------- ---------
<S> <C> <C>
Basic Weighted Average Number of Common Shares
Outstanding......................................... 88,307 83,461
Dilutive Stock Options and unvested Class B Common
Stock............................................... 13,304 16,000
------- ------
Dilutive Weighted Average Number of Common Shares
Outstanding......................................... 101,611 99,461
======= ======
</TABLE>
Dilutive weighted average common shares outstanding are anti-dilutive and
have been excluded from the loss per share calculation for the three month
period ended March 31, 1998 and 1997.
7
<PAGE>
5. COMMITMENTS AND CONTINGENCIES
Under the terms of various short- and long-term contracts, the Company is
obligated to pay office rents and rent for leasing fiber optic transmission
facilities. The Company is obligated to pay office rents with its operations
through 2012. The office rent contracts provide for certain scheduled
increases and for possible escalation of basic rentals based on a change in
the cost of living or on other factors. The Company expects to enter into
other contracts for additional office space, other facilities, equipment and
maintenance services in the future.
A summary of such fixed commitments at March 31, 1998 is as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
---- -----------
<S> <C>
1998.......................................................... $ 835,465
1999.......................................................... 1,345,834
2000.......................................................... 1,364,727
2001.......................................................... 1,263,920
2002.......................................................... 1,300,429
Thereafter.................................................... 8,383,672
-----------
Total..................................................... $14,494,047
===========
</TABLE>
In the ordinary course of business, the Company is involved in various
regulatory matters, proceedings and claims.
The Company has recorded accounts receivable totaling $3.2 million as of
March 31, 1998, and revenues of $1.5 million for the three month period ended
March 31, 1998 from another carrier who is currently disputing its obligation
to the Company. This dispute was ruled on in favor of the Company by the
Illinois Commerce Commission ("ICC") in March of 1998. The other carrier has
appealed the ICC ruling, and a stay of payments due was granted in federal
district court pending consideration of the appeal. A federal court ruling is
expected in June.
6. STOCK OPTIONS
The Company established the Focal Communications Corporation 1997 Non-
Qualified Stock Option Plan (the "Plan") effective February 27, 1997. The Plan
is administered by the Company's Board of Directors (the "Board"). The Board
has sole and complete authority to select participants and grant options for
the Company's Class A common shares which shall not exceed 5,260 shares, as
defined. The Company has chosen to account for stock based compensation using
the intrinsic value method prescribed in Accounting Principals Board Opinion
("APB") No. 25, "Accounting for Stock Issued To Employees." Accordingly, no
compensation expense has been recorded for its stock option awards, but
rather, the Company has determined the pro forma net loss amount for the first
quarter of 1998 as if compensation expense had been recorded for options
granted during 1997 and the first quarter of 1998 under the fair value method
described in SFAS No. 123, "Accounting for Stock-Based Compensation."
The Company utilizes the Black-Scholes option pricing model to estimate the
fair value of options at the date of grant. Had the Company adopted SFAS No.
123, pro forma net loss applicable to common stockholders and pro forma basic
and diluted net loss per share of common stock would have been approximately
$(360,353) and $(4.08) for the quarter ended March 31, 1998.
The following summarizes option activity:
<TABLE>
<CAPTION>
SHARES
OF WEIGHTED
CLASS AVERAGE
A EXERCISE EXERCISE
COMMON PRICES PRICES
------ --------- --------
<S> <C> <C> <C>
Outstanding at December 31, 1997............... 1,222 $290-$320 $296.61
Granted during the three months ended March 31,
1998.......................................... 627 $ 335 $335.00
----- --------- -------
Outstanding at March 31, 1998.................. 1,849 $290-$335 $309.63
===== ========= =======
</TABLE>
8
<PAGE>
7. REDEEMABLE COMMON STOCK
On January 23, 1998, the Company amended the Stock Purchase Agreement. As a
result of the amendment, the redeemable Class A common stock was reclassified
into permanent equity. The amended Stock Purchase Agreement also allows
Institutional Investors (as defined therein) at any time and from time to time
on or after November 27, 2003, but not after the consummation of a public
offering of the Company's equity securities, to require the Company to
voluntarily liquidate the assets of the Company. Upon receipt of notice of the
required liquidation, the Company may elect to purchase all but not less than
all of the Institutional Investors' Class A common shares.
8. SUBSEQUENT EVENT
On August 13, 1998, Amendment No. 4 to the Company's Registration Statement
on Form S-4 was declared effective by the Securities and Exchange Commission.
In connection with this registration statement, the Company has given
retroactive effect to a change in accounting. This change in accounting was
due to the fact that the Class B common shares held by the founding executives
vest over the term of employment. Accordingly, compensation expense totalling
$5.2 million will be charged to income over the vesting period. Compensation
expense of $325,000 was retroactively recorded in the three months ended March
31, 1998, and 1997. Basic and diluted share counts were also adjusted to
eliminate unvested Class B common shares in accordance with this revised
accounting. The effects on previously reported operating results are presented
below:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31
--------------------------------
1997 1998
--------------- ---------------
PER PER
AMOUNT SHARE AMOUNT SHARE
-------- ----- -------- -----
<S> <C> <C> <C> <C>
Net loss, as previously reported........ (415,492) (4.18) (16,191) (0.16)
Non-cash compensation expense........... (325,000) (4.69) (325,000) (3.70)
-------- ----- -------- -----
Net loss, as revised.................... (740,492) (8.87) (341,191) (3.86)
======== ===== ======== =====
</TABLE>
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
General: Focal Communications Corporation and subsidiaries (the "Company")
began operations during 1996 and has operated in Chicago since May 1997 and
New York since January 1998, currently serving a total of 6 MSAs (metropolitan
statistical areas.) The Company plans to offer services in 37 additional MSAs
by the end of 1999, reaching a total of 43 MSAs in ten metropolitan markets.
As of March 31, 1998, the Company had 21,082 access lines sold, of which
14,528 were installed and in service. This compares to 13,411 lines sold and
7,394 lines installed as of December 31, 1997.
The Company's plan to expand into 37 additional MSAs requires significant
expenditures to fund operating losses and the purchase of capital equipment.
The Company believes it can lower its initial capital requirements and
generate a substantially greater return on invested capital by concentrating
its investment in switching and information, billing, and support systems,
while leasing transport facilities. This network investment strategy differs
from many other competitive local exchange carries (CLECs) who build and
maintain their own transport facilities.
The Company targets its services to telecommunications-intensive customers
and, as a result, expects to generate revenue per line in excess of the
industry average. In addition, the Company's cost structure is
9
<PAGE>
anticipated to be below the industry average. Consequently, the Company
expects to more rapidly generate positive operating cash flow from its new
networks as compared to other CLECs. Nevertheless, the simultaneous
development of a number of new networks may result in negative consolidated
operating cash flow.
Revenues: The Company's revenue is comprised of monthly recurring charges,
usage charges, and initial, non-recurring charges. Monthly recurring charges
include the fees paid by customers for lines in service, additional features
on those lines, and colocation space. Monthly recurring charges are derived
only from end user customers. Usage charges consist of fees paid by end users
for each call made, fees paid by the incumbent local exchange carrier (ILEC)
and other CLECs as reciprocal compensation (which results from the Company
terminating calls made by ILEC customers or other CLEC customers to Focal's
customers), and access charges paid by the interexchange carriers (IXCs) for
long distance traffic originated and terminated by the Company. Usage charges
are derived from both end user customers and from other carriers. Initial non-
recurring charges are paid by end users, if applicable, for the installation
of service by the Company.
A majority of the Company's revenue currently consists of reciprocal
compensation. This is the result of an imbalance of inbound and outbound
traffic due to the preponderance of inbound applications utilized by the
Company's customers. Such inbound applications include Focal Virtual Office
service which is used by Focal's corporate customers and Focal Multi-Exchange
Service which is used by Focal's Information Service Provider (ISP) customers.
The Company expects the proportion of revenue represented by reciprocal
compensation to decline over time as the percentage of lines sold for outbound
applications increases as each given market matures.
End user invoices are sent monthly with recurring charges being billed in
advance and usage charges being billed in arrears. Reciprocal compensation and
carrier access invoices are sent monthly to the appropriate ILECs and IXCs
according to industry standard practices and in industry standard formats.
Operating Expenses: The Company's operating expenses are categorized as
customer service and network operations; selling, general and administrative;
and depreciation and amortization expense. Settlement costs are a significant
portion of customer service and network operations expense and are comprised
of leased transport charges and reciprocal compensation payments. Leased
transport charges are the lease payments incurred by Focal for the fiber optic
transmission facilities used to connect the Company's customers to its switch
and to connect to the ILEC and other CLEC networks. The Company's strategy of
leasing rather than building its own fiber transport facilities results in the
Company's cost of service being a significant component of total costs. The
Company has to date been successful in negotiating lease agreements which
match the duration of its customer contracts, thereby allowing the Company to
avoid the risk of continuing expenses associated with transmission facilities
that are not being used by revenue generating customers. The Company pays
reciprocal compensation to ILECs and other CLECs for terminating calls made by
Focal's customers to customers of the ILEC or CLEC.
Other customer service and network operations expense consists of the costs
to operate the Company's network and the costs of providing customer care
activities. Major components include: wages, rent, power, equipment
maintenance, supplies, and contract employees.
Selling, general and administrative expenses consist of sales force
compensation and promotional expenses as well as the cost of corporate
activities related to regulatory, finance, human resources, legal, executive,
and other administrative activities.
The Company records non-cash compensation expense each quarter as a result
of having given retroactive effect to a change in accounting related to
certain shares issued to the Company's founders in November 1996. This change
in accounting is further described in Note 8 to the financial statements
contained herein.
The Company's strategy of leasing, rather than building, its transport
network results in capital expenditures which are proportionately lower than
most fiber-based CLECs. In addition, the proportion of capital expenditures
10
<PAGE>
which are "success-based" are higher than most fiber-based CLECs. In contrast,
the Company incurs operating expenses for leased facilities, which are
proportionately higher than fiber-based CLECs. The margin impact of these
higher, anticipated operating expenses is expected to be mitigated, in part,
by a higher revenue per line, which the Company anticipates as a result of its
focus on telecommunications-intensive users.
RESULTS OF OPERATIONS
Although the Company began operations on May 31, 1996, the Company did not
generate any revenue until May of 1997, therefore, any comparison of operating
results between three months ended March 31, 1997 and three months ended March
31, 1998 would not be meaningful.
THREE MONTHS ENDED MARCH 31, 1998
During the three months ended March 31, 1998, the Company generated
$5,102,448 in operating revenues. Customer service and network operations
expense totaled $1,826,893, and selling, general and administrative expense
during the period was $1,307,625. Customer service and network operations
expenses consisted primarily of leased transport charges, payroll and rent
costs. Selling, general and administrative expenses were largely comprised of
payroll and legal and accounting costs.
Depreciation and amortization expense during the period was $890,871,
resulting primarily from network assets placed in service in the Company's
operational markets. In addition, a portion of the amount is attributable to
the amortization of expenses incurred from the Company's offering of
$270,000,000 stated principal amount at maturity of 12.125% senior discount
notes due 2008. The offering was consummated on February 18, 1998 and the
Company received $150,027,606 in gross proceeds. Non-cash compensation expense
was $325,000. Non-cash compensation expense relates to the Class B common
shares held by the founding executives which vest over the term of employment.
Interest income for the three months ended March 31, 1998 was $1,015,902 and
interest expense was $2,109,152. The Company's net loss for the period totaled
$341,191. This loss was largely due to increased interest expense accrued by
the Company as a result of the completion of its senior discount note
offering.
For the three months ended March 31, 1998, the Company's Chicago operating
subsidiary had 11,535 access lines in service and generated revenues of
$4,781,132. The subsidiary recorded positive EBITDA, (earnings before
interest, taxes, depreciation and amortization) of $2,834,462, which includes
a pro-rata allocation of central operations and corporate expenses. EBITDA is
not a substitute for net income or cash flow as determined in accordance with
generally accepted accounting principles. The Company believes EBITDA is
commonly used by investors to analyze and compare companies in the
telecommunications industry.
THREE MONTHS ENDED MARCH 31, 1997
During the three months ended March 31, 1997, the Company did not generate
operating revenue due to the fact that service did not commence until May
1997. Customer service and network operations expenses were $8,692. Selling,
general and administrative expenses were $416,492, resulting primarily from
payroll costs. Depreciation and amortization expense was $7,337 for the three
months ended March 31, 1997. Non-cash compensation expense was $325,000. Non-
cash compensation expense relates to the Class B common shares held by the
founding executives which vest over the term of employment. The Company earned
$43,055 in interest income and paid a negligible amount of interest expense.
For the three months ended March 31, 1997, the Company had a net loss of
$714,601, resulting from the incurrence of operating expenses for the initial
development of the Company's business.
LIQUIDITY AND CAPITAL RESOURCES
The Company's existing operations have required, and its planned operations
will require, significant capital to fund the purchase and installation of
telecommunications switches, equipment, infrastructure, and the operating
losses expected during the start-up phase of each new market. Capital
expenditures were $7,593,061
11
<PAGE>
for the three months ended March 31, 1998 and $2,244,385 for the three months
ended March 31, 1997. The Company expects total capital expenditures for the
year ended December 31, 1998 to be approximately $50 million. Total capital
expenditures for the buildout of the ten city plan are currently estimated to
be $110 million. Prior to the completion of the senior discount note offering,
the Company funded a substantial portion of its capital expenditures through
the private sale of equity securities. In November 1996, the Company entered
into a stock purchase agreement which provided for the contribution over time
of approximately $26.1 million of equity funding by a group of investors. As
of February 13, 1998, the equity investors have contributed the entire $26.1
million to the Company. In addition, in 1997, the Company's Illinois
subsidiary borrowed approximately $3.5 million under a bank credit facility.
The Company used a portion of the net proceeds from the senior discount note
offering to prepay this indebtedness and cancel the facility.
On February 18, 1998, the Company received gross proceeds of $150,027,606
from the completion of its 12.125% senior discount note offering. The notes
will accrete to an aggregate stated principal amount of $270,000,000 by
February 15, 2003. No interest will be payable on the Notes prior to August
15, 2003. Thereafter, interest will be payable semiannually on August 15 and
February 15 of each year.
The Company has incurred net losses since inception. A portion of the prior
equity investments and debt proceeds have been used to fund the Company's
negative cash flow and net losses. Management believes the Company may produce
negative operating cash flow on a consolidated basis as it completes the
buildout of its ten city plan. There can be no assurance the Company will
realize positive consolidated operating cash flow in subsequent periods. Until
sufficient cash flow is generated, the Company will continue to rely on cash
on hand and outside capital to meet its cash requirements.
The Company expects its available cash, including the net proceeds from the
sale of its senior discount notes, will be sufficient to fund its capital
requirements through 1999. However, if the Company's expansion occurs more
rapidly than currently anticipated or if its operating results are below
expectations, the Company may require additional capital. The Company may
decide to raise additional capital before such time. The Company may secure
additional funding through the sale of public or private debt and/or equity
securities or enter into a future bank credit facility. There can be no
assurance, however, that the Company will be successful in raising sufficient
additional capital on terms that it will consider acceptable or that the
Company's operations will produce positive consolidated cash flow in
sufficient amounts to meet its debt obligations. Failure to raise and generate
sufficient funds may require the Company to delay or abandon some of its
planned future expansion or expenditures, which could have a material adverse
effect on the Company's growth and its ability to compete in the
telecommunications industry.
The foregoing discussion contains forward-looking statements. The company's
future performance is subject to numerous risks and uncertainties that could
cause actual results to deviate substantially from those discussed in these
forward-looking statements. Factors that could impact the variability of
future results include: the outcome of legal and regulatory proceedings
regarding reciprocal compensation for Internet-related calls; successful
execution of the company's expansion activities into new geographic markets on
a timely and cost-effective basis; the pace at which new competitors enter the
company's existing and planned markets; competitive responses of the incumbent
local exchange carriers; execution of interconnection agreements with
incumbent local exchange carriers on terms satisfactory to the company;
maintenance of the company's supply agreements for transmission facilities;
continued acceptance of the company's services by new and existing customers;
and the ability to attract and retain talented employees. Investors are
encourged to examine the company's SEC filing on form S-4, which more fully
describes the risks and uncertainties associated with the company's business.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b.) Reports on Form 8-K
The Company did not file any current reports on Form 8-K during the
quarter ended March 31, 1998.
12
<PAGE>
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 BY THE
UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Focal Communications Corporation
Date: November 16, 1998 /s/ Robert C. Taylor, Jr.
_____________________________________
Robert C. Taylor, Jr., President and
Chief Executive Officer (Authorized
Officer)
Date: November 16, 1998 /s/ Joseph A. Beatty
_____________________________________
Joseph A. Beatty, Executive Vice
President and Chief Financial
Officer (Principal Financial
Officer)
Date: November 16, 1998 /s/ Robert M. Junkroski
_____________________________________
Robert M. Junkroski, Controller
(Principal Accounting Officer)
13
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<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> MAR-31-1998 MAR-31-1997
<CASH> 152,758,944 5,022,655
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<DEPRECIATION> 1,260,951 (8,486)
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0 0
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<INTEREST-EXPENSE> 1,093,250 (42,920)
<INCOME-PRETAX> (341,191) (714,601)
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<INCOME-CONTINUING> (341,191) (714,601)
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