<PAGE>
As filed with the Securities and Exchange Commission on November 14, 2000
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 2000
Commission file number 333-49397
----------------
Focal Communications Corporation
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 36-4167094
(State of incorporation) (IRS Employer Identification Number)
</TABLE>
200 N. LaSalle Street
Suite 1100
Chicago, IL 60601
(Address of principal executive offices, including zip code)
(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 required 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 October
31, 2000:
Common stock ($.01 par value) 61,384,204 shares
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
INDEX
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)................................. 4
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 2000 and 1999................... 4
Condensed Consolidated Balance Sheets as of September 30, 2000
and December 31, 1999........................................... 5
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 2000 and 1999........................ 6
Condensed Notes to Interim Consolidated Financial Statements..... 7
Management's Discussion and Analysis of Financial Condition and
Item 2. Results of Operations .......................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk ...... 18
PART II--OTHER INFORMATION
Item 1. Legal Proceedings................................................ 19
Item 2. Changes in Securities and Use of Proceeds........................ 19
Item 3. Defaults Upon Senior Securities.................................. 19
Item 4. Submission of Matters to a Vote of Security Holders.............. 19
Item 5. Other Information................................................ 19
Item 6. Exhibits and Reports on Form 8-K................................. 19
SIGNATURES................................................................ 20
</TABLE>
2
<PAGE>
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
We make statements in this Report on Form 10-Q that are not historical
facts. These "forward-looking statements" can be identified by the use of
terminology such as "believes," "expects," "may," "will," "should" or
"anticipates" or comparable terminology. These forward-looking statements
include, among others, statements concerning:
. Our business strategy and competitive advantages
. Our anticipation of potential revenues from designated markets or
customers
. Statements regarding the growth of the communications services industry
and our business
. The market potential of our services and products
. Forecasts of when we will enter particular geographic markets or begin
offering particular services
. Our anticipated capital expenditures and funding requirements
. Anticipated regulatory developments
These statements are only predictions. You should be aware that these
forward-looking statements are subject to risks and uncertainties, including
financial, regulatory developments, industry growth and trend projections, that
could cause actual events or results to differ materially from those expressed
or implied by the statements. The most important factors that could affect
these statements or prevent us from achieving our stated goals include, but are
not limited to, our failure to:
. Successfully expand our operations into new geographic markets on a
timely and cost-effective basis
. Successfully introduce and expand our data and voice service offerings on
a timely and cost effective basis
. Design and install our Internet services infrastructure
. Respond to competitors in our existing and planned markets
. Execute and renew interconnection agreements with incumbent carriers on
terms satisfactory to us
. Enter into and maintain our agreements for transport facilities and
services, including Internet transit services
. Maintain acceptance of our services by new and existing customers
. Receive full and timely payments from customers
. Attract and retain talented employees
. Prevail in legal and regulatory proceedings regarding reciprocal
compensation for Internet-related calls
. Obtain and maintain any required governmental authorizations, franchises
and permits, all in a timely manner, at reasonable costs and on
satisfactory terms and conditions
. Respond effectively to regulatory, legislative and judicial developments,
including developments relating to reciprocal compensation
. Manage administrative, technical and operational issues presented by our
expansion plans
. Raise sufficient capital on acceptable terms and on a timely basis
. Successfully provision digital subscriber line, or DSL services
3
<PAGE>
Part I--Financial Information
Item 1. Financial Statements
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three and Nine Months Ended September 30, 2000 and 1999
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30 ended September 30
------------------------ ------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Data services............ $ 40,573 $ 26,339 $ 115,401 $ 70,550
Telecom services ........ 20,179 8,145 51,368 20,265
----------- ----------- ----------- -----------
Total revenues ........ 60,752 34,484 166,769 90,815
----------- ----------- ----------- -----------
EXPENSES:
Network Expenses ........ 23,947 8,400 63,648 17,837
Selling, general and
administrative.......... 42,082 20,301 111,532 48,804
Depreciation and
amortization............ 15,874 6,554 39,018 15,519
Non-cash compensation
expense ................ 1,630 3,352 4,675 5,723
----------- ----------- ----------- -----------
Total operating
expenses ............. 83,533 38,607 218,873 87,883
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) ... (22,781) (4,123) (52,104) 2,932
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest income ......... 4,817 2,240 17,056 4,760
Interest expense, net ... (13,151) (6,860) (39,919) (18,144)
Other income, net ....... -- -- 242 --
----------- ----------- ----------- -----------
Total other expense ... (8,334) (4,620) (22,621) (13,384)
----------- ----------- ----------- -----------
LOSS BEFORE INCOME TAXES .. (31,115) (8,743) (74,725) (10,452)
INCOME TAX BENEFIT
(EXPENSE) ................ 1,643 (2,091) 3,043 (2,399)
----------- ----------- ----------- -----------
NET LOSS................... $ (29,472) $ (10,834) $ (71,682) $ (12,851)
=========== =========== =========== ===========
BASIC AND DILUTED NET LOSS
PER SHARE OF COMMON STOCK
.......................... $ (0.49) $ (0.20) $ (1.19) $ (0.27)
=========== =========== =========== ===========
BASIC AND DILUTED WEIGHTED
AVERAGE NUMBER OF SHARES
OF COMMON STOCK
OUTSTANDING .............. 60,504,463 53,295,805 60,321,464 47,134,241
=========== =========== =========== ===========
</TABLE>
The accompanying condensed notes are an integral part of these condensed
consolidated financial statements.
4
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
As of September 30, 2000 and December 31, 1999
(Dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
------
CURRENT ASSETS:
Cash and cash equivalents ........................ $ 189,515 $178,142
Short-term investments ........................... 14,336 10,000
Accounts receivable, net of allowance for doubtful
accounts of $8,800 and $7,700 at September 30,
2000 and December 31, 1999, respectively ........ 52,545 27,247
Other current assets ............................. 8,490 4,543
--------- --------
Total current assets ........................... 264,886 219,932
--------- --------
PROPERTY, PLANT and EQUIPMENT, at cost ............. 453,006 224,470
Less--Accumulated depreciation and amortization .. (65,693) (28,169)
--------- --------
Property, Plant and Equipment, net ............... 387,313 196,301
OTHER NONCURRENT ASSETS ............................ 16,326 4,753
--------- --------
$ 668,525 $420,986
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable ................................. $ 34,165 $ 15,324
Accrued liabilities .............................. 15,864 7,560
Current maturities of long-term debt ............. 9,805 9,252
--------- --------
Total current liabilities ...................... 59,834 32,136
--------- --------
LONG-TERM DEBT, net of current maturities .......... 529,212 244,534
--------- --------
OTHER NONCURRENT LIABILITIES ....................... 2,499 1,829
--------- --------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 100,000,000 shares
authorized; 61,357,028 and 60,748,981 issued and
outstanding at September 30, 2000 and December
31, 1999, respectively........................... 614 607
Additional paid-in capital ....................... 183,060 177,535
Deferred compensation ............................ (1,276) (1,919)
Accumulated deficit .............................. (105,418) (33,736)
--------- --------
Total stockholders' equity ..................... 76,980 142,487
--------- --------
$ 668,525 $420,986
========= ========
</TABLE>
The accompanying condensed notes are an integral part of these condensed
consolidated financial statements.
5
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended September 30, 2000 and 1999
(Dollars in thousands)
<TABLE>
<CAPTION>
For the nine months
ended September 30
--------------------
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................... $ (71,682) $ (12,851)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities--
Depreciation and amortization........................ 39,018 15,519
Non-cash compensation expense........................ 4,675 5,723
Gain on sale of investment in affiliate.............. (199) --
Amortization of obligation under capital lease....... 1,720 531
Amortization of discount on senior notes............. 17,354 15,304
Provision for losses on accounts receivable ......... 5,982 4,911
Changes in operating assets and liabilities
Accounts receivable ............................... (31,280) (16,158)
Other current assets .............................. (3,947) (1,906)
Accounts payable and accrued liabilities .......... 27,145 4,556
Other noncurrent assets and liabilities, net ...... 759 682
--------- ---------
Net cash (used in) provided by operating
activities...................................... (10,455) 16,311
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................... (227,653) (94,222)
Change in short-term investments....................... (4,336) (14,353)
--------- ---------
Net cash used in investing activities............ (231,989) (108,575)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Deferred debt issuance costs........................... (13,840) (253)
Proceeds from issuance of long-term debt............... 273,020 31,712
Payments on long-term debt............................. (6,863) (3,696)
Net proceeds from the issuance of common stock ........ 1,500 138,145
--------- ---------
Net cash provided by financing activities ....... 253,817 165,908
--------- ---------
NET INCREASE IN CASH AND CASH EQUIVALENTS................ 11,373 73,644
CASH AND CASH EQUIVALENTS, beginning of period........... 178,142 126,041
--------- ---------
CASH AND CASH EQUIVALENTS, end of period................. $ 189,515 $ 199,685
========= =========
</TABLE>
The accompanying condensed notes are an integral part of these condensed
consolidated financial statements.
6
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share amounts)
1. Basis of Presentation
Except as otherwise required by the context, references in this Form 10-Q to
"Focal", "we", "us", or "our" refer to the combined businesses of Focal
Communications Corporation and all of its subsidiaries. The accompanying
interim condensed consolidated financial statements reflect all adjustments,
consisting of normal recurring accruals, which we believe are necessary to
present fairly the financial position, results of operations, and cash flows
for Focal for the respective periods presented. Certain information and
footnote disclosures normally included in the annual consolidated 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 interim condensed
consolidated financial statements should be read in conjunction with our Annual
Report on Form 10-K for the year ended December 31, 1999, filed on March 10,
2000. The consolidated balance sheet at December 31, 1999 included herein was
derived from our audited consolidated financial statements, but does not
include all disclosures required under generally accepted accounting
principles.
Certain amounts in the prior period's consolidated financial statements have
been reclassified to conform with the current period presentation.
2. Risks and Uncertainties
Reciprocal compensation payments are amounts paid by one carrier to send
traffic to another carrier's network. Reciprocal compensation is currently a
significant component of our total revenues. As a result of several trends in
our business and the current regulatory environment, we expect revenues from
reciprocal compensation to decline as a percentage of total revenues. A
reduction in or elimination of revenues attributable to reciprocal compensation
which is not offset by increases in other revenues generated by us may have a
material adverse effect on us and our results of operations.
3. Property, Plant and Equipment
Property, plant and equipment are stated at cost, which includes direct
costs and capitalized interest, and are depreciated once placed in service
using the straight line method.
Property, plant and equipment consists of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Unaudited)
<S> <C> <C>
Building and
improvements............. $ 8,444 $ 8,365
Network Equipment......... 189,999 106,723
Computer equipment........ 26,409 11,646
Leasehold improvements.... 47,580 24,756
Furniture and fixtures.... 9,519 5,020
Motor vehicles............ 427 152
Construction in progress.. 149,711 46,891
Assets under capital
lease.................... 20,917 20,917
-------- --------
453,006 224,470
Less--Accumulated
depreciation and
amortization............. (65,693) (28,169)
-------- --------
Total................... $387,313 $196,301
======== ========
</TABLE>
7
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Unaudited)
<S> <C> <C>
12.125% senior discount notes due 2008, net of
unamortized discount of $65,971 and $83,184 at
September 30, 2000 and December 31, 1999,
respectively....................................... $ 204,029 $186,816
11.875% senior notes due 2010, net of unamortized
discount of $1,839 at September 30, 2000 and
December 31, 1999, respectively.................... 273,161 --
Secured equipment term loan, maximum borrowing level
at $50,000......................................... 37,725 44,214
Obligation under capital lease...................... 23,713 21,994
Term loan payable in monthly installments through
June 2001 at an interest rate of 6.5%.............. 389 762
--------- --------
539,017 253,786
Less--current maturities............................ (9,805) (9,252)
--------- --------
Total............................................. $ 529,212 $244,534
========= ========
</TABLE>
Aggregate maturities of long-term debt outstanding as of September 30, 2000,
are as follows:
<TABLE>
<S> <C>
2000............................................................. $ 2,389
2001............................................................. 9,912
2002............................................................. 10,638
2003............................................................. 11,728
2004............................................................. 3,447
Thereafter....................................................... 500,903
--------
Total.......................................................... $539,017
========
</TABLE>
On January 12, 2000, we received net proceeds of approximately $265,700 from
the issuance of our $275,000 11 7/8% senior notes due 2010 ("2000 Notes"). The
2000 Notes bear interest at a rate of 11.875% per annum payable in cash on July
15 and January 15, commencing July 15, 2000. The 2000 Notes are not secured by
any of our assets and rank equally in right of payment with all our
unsubordinated and unsecured indebtedness. The 2000 Notes are senior in right
of payment to all of our future subordinated indebtedness. We may elect to
redeem all or part of the 2000 Notes at any time from time to time, on or after
January 15, 2005 at specified redemption prices. In addition, at any time and
from time to time prior to January 15, 2003 we may redeem in the aggregate up
to 35% of the initially outstanding aggregate principal amount of the 2000
Notes with the proceeds from one or more registered underwritten primary public
offerings of common stock at a price of 111.875% of the principal amount of the
2000 Notes so long as at least 65% of the original aggregate principal amount
of the 2000 Notes remains outstanding after each redemption.
On August 25, 2000, we completed our $300,000 Senior Secured Credit Facility
(the Credit Facility). The Credit Facility consists of a seven year $150,000
revolving credit facility and a seven year $150,000 delayed draw term loan
facility. The Credit Facility will be available, subject to certain financial
and operating terms and conditions, and is intended to provide purchase money
financing for the construction, acquisition, or improvements of
telecommunications assets. The interest on amounts drawn is variable based on
our leverage
8
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
ratio, as defined in the Credit Facility. The initial commitment fee on the
unused portion of the Credit Facility is 1.5% and will step down based on
usage. We have not drawn down against the Credit Facility as of September 30,
2000.
5. Loss Per Share
We compute basic earnings per common share based on the weighted average
number of shares of common stock outstanding for the period. This calculation
excludes certain unvested shares of common stock held by our executives.
Diluted earnings per common share are adjusted for the assumed exercise of
dilutive stock options and unvested shares of common stock. Since the
adjustments required for the calculation of diluted weighted average common
shares outstanding are anti-dilutive for the three and nine months ended
September 30, 2000 and 1999, this calculation has been excluded from the net
loss per share calculation. Our basic and diluted weighted average number of
shares outstanding for the three and nine months ended September 30, 2000 and
1999 were as follows:
<TABLE>
<CAPTION>
Three Three Nine Nine
Months Ended Months Ended Months Ended Months Ended
September 30, September 30, September 30, September 30,
2000 1999 2000 1999
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Basic weighted average
number of common shares
outstanding............ 60,504,463 53,295,805 60,321,464 47,134,241
Dilutive stock options
and unvested common
shares................. 5,155,074 7,651,104 4,958,280 6,712,077
---------- ---------- ---------- ----------
Dilutive weighted
average number of
common shares
outstanding............ 65,659,537 60,946,909 65,279,744 53,846,318
---------- ---------- ---------- ----------
</TABLE>
6. Commitments and Contingencies
Under the terms of various short- and long-term contracts and agreements, we
are obligated to make payments for office rents and for leasing components of
our communications network through 2019. 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. We expect to enter into
other contracts for additional components of our network, office space, other
facilities, equipment and maintenance services.
A summary of such fixed commitments at September 30, 2000 is as follows:
<TABLE>
<CAPTION>
Year Amount
---- --------
<S> <C>
2000............................................................. $ 12,368
2001............................................................. 30,046
2002............................................................. 32,440
2003............................................................. 32,195
2004............................................................. 24,514
Thereafter....................................................... 110,318
--------
Total.......................................................... $241,881
========
</TABLE>
Rent expense under operating leases for office rent and for leasing
components of our network was approximately $3,435 and $8,237 and $1,310 and $
3,813 for the three and nine months ended September 30, 2000 and 1999,
respectively.
9
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Stock Options
We established the Focal Communications Corporation 1997 Non Qualified
Stock Option Plan (the "1997 Plan") effective February 27, 1997. The 1997 Plan
is administered by the compensation committee of our Board of Directors ("the
Board"). Options to purchase 6,927,650 shares were issued under the 1997 Plan
and no further options will be granted under the 1997 Plan.
We adopted the Focal Communications Corporation 1998 Equity and Performance
Incentive Plan (the "1998 Plan") on August 21, 1998. The total number of
shares available under the 1998 Plan shall not exceed 12,050,000 shares. The
Board and, with respect to non-executive employees, the stock option committee
of our Board of Directors, has sole and complete authority to select
participants and grant options, and other equity-based instruments for our
common stock.
On August 21, 1998, we also adopted the 1998 Equity Plan for Non-Employee
Directors of Focal Communications Corporation (the "1998 Non-Employee Plan").
The total number of shares available under the 1998 Non-Employee Plan shall
not exceed 150,000 shares. The Board has sole and complete authority to select
participants and grant options for our common stock, as defined in the 1998
Non-Employee Plan.
Under our stock option plans, the Board and stock option committee have
complete discretion in determining vesting periods and terms of each
participant's options granted. The options granted to participants under our
stock option plans typically vest at 25% on the first anniversary from grant
date, with vesting at 12.5% every six months for the remainder of vesting
years. The term of each option has a life of 10 years. In addition, the plans
provide for accelerated vesting upon certain events.
The following summarizes option activity:
<TABLE>
<CAPTION>
Weighted
Shares of Average
Common Exercise Exercise
Stock Prices Price
--------- ------------- --------
<S> <C> <C> <C>
Outstanding at December 31, 1999............ 6,353,820 $ 0.58-$25.00 $ 4.14
Activity for the nine months ended September
30, 2000:
Options Granted........................... 4,393,341 26.25- 45.06 33.33
Options Exercised......................... (633,047) 0.58- 4.32 2.53
Options Canceled.......................... (498,235) 0.67- 45.06 21.21
--------- ------------- ------
Outstanding at September 30, 2000......... 9,615,879 $0.58-$45.06 $16.70
========= ============= ======
</TABLE>
The following table summarizes information about fixed stock options
outstanding at September 30, 2000:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Options Contractual Exercise Options Exercise
Range of Exercise Prices Outstanding Life Price Exercisable Price
------------------------ ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
At December 31, 1999..... 6,353,820 8.7 $ 4.14 943,023 $ 2.12
========= === ====== ========= ======
$ 0.58-$ 4.51............ 5,200,913 8.0 3.01 1,441,980 2.53
$22.53-$27.04............ 955,218 9.1 25.89 -- --
$27.04-$31.54............ 1,846,875 9.7 29.87 24,436 29.85
$31.54-$36.05............ 375,300 9.7 32.46 -- --
$36.05-$45.06............ 1,237,573 9.4 41.19 674 44.50
--------- --- ------ --------- ------
At September 30, 2000.... 9,615,879 8.7 $16.70 1,467,090 $ 3.01
========= === ====== ========= ======
</TABLE>
10
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Segment Information
We are organized primarily on the basis of strategic geographic operating
segments that provide communications services in each respective geographic
region. All of our geographic operating segments have been aggregated into one
reportable segment as of and for the periods ended September 30, 2000 and 1999,
and as of December 31, 1999.
We view earnings before interest, income taxes, depreciation and
amortization ("EBITDA") as the primary current measure of profit and loss in
our industry segment. The following represents information about revenues,
EBITDA (which excludes non-cash compensation), total assets and capital
expenditures as of September 30, 2000 and December 31, 1999; and for the nine
months ended September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Nine Months Ended
---------------------------
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Data services revenue............................ $115,401 $ 70,550
Telecom services revenue......................... 51,368 20,265
-------- --------
Total revenues................................... 166,769 90,815
EBITDA........................................... $(13,510) $ 21,735
<CAPTION>
September 30, December 31,
2000 1999
------------- -------------
<S> <C> <C>
Total assets..................................... $401,562 $202,324
Capital expenditures............................. 227,653 128,550
======== ========
The following reconciles our total segment EBITDA to our consolidated net
loss before income taxes for the nine months ended September 30, 2000 and 1999:
<CAPTION>
Nine months Nine months
Ended Ended
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Total EBITDA for reportable segment.............. $(13,510) $ 21,735
Corporate EBITDA................................. 5,099 2,439
Depreciation and amortization.................... (39,018) (15,519)
Interest expense, net............................ (39,919) (18,144)
Interest income.................................. 17,056 4,760
Other income, net................................ 242 --
Non-cash compensation............................ (4,675) (5,723)
-------- --------
Net loss before income taxes................... $(74,725) $(10,452)
======== ========
</TABLE>
11
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following reconciles our total segment assets to our consolidated total
assets as of September 30, 2000 and December 31, 1999:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- -------------
<S> <C> <C>
Total assets for reportable segment............ $401,562 $202,324
Cash and short-term investments................ 203,851 188,142
Other current assets........................... 5,442 3,745
Property, plant and equipment, net............. 41,344 22,022
Other noncurrent assets........................ 16,326 4,753
-------- --------
Total consolidated assets.................... $668,525 $420,986
======== ========
We currently operate solely in the United States. We have no customers that
accounted for more than 10% of our revenues during the nine months ended
September 30, 2000 and 1999.
Our relationships with Ameritech/SBC and Bell Atlantic/Verizon are
mandatory, co-carrier relationships and are not that of a customer and
supplier. Nevertheless, these carriers are shown here due to their contribution
to our revenues for the nine months ended September 30, 2000 and 1999.
<CAPTION>
Nine months Nine months
Ended Ended
September 30, September 30,
2000 1999
------------- -------------
<S> <C> <C>
Revenue contribution from Ameritech/SBC........ $40,673 $43,362
Revenue contribution from Bell
Atlantic/Verizon.............................. $26,805 $18,293
</TABLE>
9. Subsequent Event
We established the Focal Communications Corporation 2000 Employee Stock
Purchase Plan ("the Plan") effective October 1, 2000. The Plan is intended to
give employees a convenient means of purchasing shares of Focal Common Stock
through payroll deductions. Each participating employee's contributions will be
used to purchase shares for the employee's share account as promptly as
practicable after each six month enrollment period. The cost per share will be
85% of the lower of the closing price of Focal's Common Stock on the Nasdaq
National Market on the first or last day of the six month enrollment period. We
have reserved 375,000 shares for issuance under the Plan.
12
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
General. Focal provides data and telecom services to large, communications-
intensive users in major cities. During the third quarter of 2000 we launched
service in Minneapolis, our 20th market. We have completed our original 20
market plan which encompasses a total of 49 metropolitan statistical areas, or
MSAs. We plan to have four additional markets turn up in 2001, which will allow
us to serve 24 markets, or 56 MSAs, by the end of 2001. As of September 30,
2000, we had sold 427,641 access lines, of which 365,016 were installed and in
service.
In April, we announced a suite of Internet infrastructure services designed
to improve Internet performance. These leading edge services include managed
high-speed Internet access, colocation and private peering services. In
preparation for the rollout of these services, we began the deployment of Focal
Internet eXchange platforms in a number of our markets. We recently launched
commercial service in our Chicago market during the third quarter and turned up
our second Internet eXchange in our Philadelphia market during October 2000. We
expect to launch additional Focal Internet eXchanges across our 24 planned
markets.
We expect our continued expansion to result in continued negative operating
cash flows and operating losses for a period of time. We expect to again
produce positive operating cash flows during 2001 once these trends stabilize
and operating activities in our newer markets are established and mature. If,
however, these trends do not stabilize or our operating activities are not
established or do not mature as expected, we may continue to sustain negative
operating cash flows and net losses.
Revenues. Data services revenue includes revenues from circuit switched
lines sold to ISP customers, DSL, private line, colocation, and Internet
infrastructure services. Telecom services revenue includes circuit switched
lines sold to corporate and VAR customers. Our data and telecom services
revenue is composed of monthly recurring charges, usage charges, and initial
non-recurring charges. Monthly recurring charges include the fees paid by our
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 ILEC and other CLECs as reciprocal compensation, and access
charges paid by the IXCs for long distance traffic that we originate and
terminate. Non-recurring revenues are typically derived from fees charged to
install new customer lines.
We earn reciprocal compensation revenue for calls made by customers of
another local exchange carrier to our customers. Conversely, we incur
reciprocal compensation expense to other local exchange carriers for calls by
our customers to their customers. We expect the proportion of revenues
represented by reciprocal compensation to decrease in the future as a result of
the expiration and subsequent renegotiation of our existing interconnection
agreements with the ILECs and the impact of recent and future regulatory
developments. A reduction in or elimination of reciprocal compensation revenues
that are not offset by increases in other revenues generated by us could have a
material adverse effect on us and our results of operations.
Operating Expenses. Our operating expenses are categorized as network
expenses, selling, general and administrative, depreciation and amortization,
and non-cash compensation expense. Network expenses as a percentage of total
revenues represented approximately 39% and 38% for the three and nine month
periods ended September 30, 2000, respectively. Network expenses are composed
of leased transport charges, the cost of leasing space in ILEC central offices
for collocating our transmission equipment, the costs of leasing our nationwide
Internet network, reciprocal compensation payments and the cost of completing
local and long distance calls. Leased transport charges are the lease payments
we make for the use of fiber transport facilities connecting our customers to
our switches and for our connection to the ILECs' and other CLECs' networks.
Our strategy of initially leasing rather than building our own fiber transport
facilities has resulted in our cost of service being a significant component of
total costs. To date, we have been successful in negotiating lease agreements
that match the duration of our customer contracts, thereby allowing us to avoid
the risk of incurring expenses associated with transport facilities that are
not being used by revenue generating customers.
13
<PAGE>
Historically, leasing rather than building our transport network has
resulted in capital expenditures which we believe are lower than those of CLECs
of similar size that own their fiber networks. Our capital expenditures have
been driven by customer service demands and projected near-term revenue streams
from our established markets. In addition, we believe that the percentage of
these "success-based" capital expenditures is higher than those of fiber-based
CLECs. In contrast, we incur network expenses for leased facilities that are
proportionately higher than those incurred by fiber-based CLECs. During 1999,
we entered into a number of agreements to own fiber transport capacity and are
operating our own fiber networks in seven of our markets with approximately
7,914 fiber miles in operation as of September 30, 2000. We expect to activate
our remaining transport networks in other markets by the end of 2000.
Selling, general and administrative expense ("SG&A") consists of network and
customer care personnel costs, 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. We expect our sales expense to be lower as a percentage of revenue
than that of our competitors because we have relatively high sales productivity
associated with our strategy of serving communications-intensive customers.
These customers generally utilize a large number of switched access lines
relative to the average business customer, resulting in more revenue per sale.
Further, fewer sales representatives are required to service the relatively
smaller number of communications-intensive customers in a given region.
We record monthly non-cash compensation expense related to shares issued to
some of our executive officers in November 1996, in connection with the
September 30, 1998 amendments to vesting agreements with some of our executive
officers, in connection with stock options granted to employees, an outside
consultant, and directors during 1999, and shares issued to a director during
the first quarter of 1999. We will continue to record non-cash compensation
expense in future periods relating to these events through the third quarter of
2003.
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<PAGE>
Quarterly Results
The following table sets forth unaudited financial, operating and
statistical data for each of the specified quarters of 2000 and 1999. The
unaudited quarterly financial information has been prepared on the same basis
as our Consolidated Financial Statements and, in our opinion, contains all
normal recurring adjustments necessary to fairly state this information. The
operating results for any quarter are not necessarily indicative of results for
any future period.
<TABLE>
<CAPTION>
2000 1999
---------------------------- ------------------
Third Second First Fourth Third
Quarter Quarter Quarter Quarter Quarter
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Data Services Revenue ($
mil)....................... $ 40,573 $ 42,638 $ 32,190 $ 26,306 $ 26,339
Telecom Services Revenue ($
mil)....................... $ 20,179 $ 18,050 $ 13,139 $ 9,740 $ 8,145
Switched Lines Sold to
Date....................... 427,641 356,918 291,443 237,167 169,122
Switched Lines Installed to
Date....................... 365,016 298,983 238,697 181,103 137,033
Estimated Data Lines (% of
Installed Lines)........... 65% 68% 71% 72% 72%
Lines on Switch (%)......... 100% 100% 100% 100% 100%
ILEC Switches
Interconnected............. 1,823 1,677 1,447 1,209 948
ILEC Central Office
Colocations in Service or
Under Development.......... 275 270 223 221 201
ILEC Central Office
Colocations Market Ready... 127 -- -- -- --
Quarterly Minutes of Use
(mil)...................... 7,112 6,640 6,421 5,158 3,514
Markets in Operation........ 20 19 18 16 14
Markets Under Development... 4 5 6 4 6
MSAs Served................. 49 48 47 40 38
MSAs Under Development...... 7 8 9 10 12
Circuit Switches
Operational................ 19 16 14 12 10
Circuit Switches Under
Development................ 6 8 7 7 7
ATM Switches Deployed....... 22 16 6 2 --
Fiber Miles Operational..... 7,914 4,488 864 -- --
Focal Customer Colocation
Space in Service (Sqr.
Ft.)....................... 107,201 80,096 73,840 70,105 53,478
Focal Customer Colocation
Space Under Development
(Sqr. Ft.)................. 27,830 54,802 36,549 24,654 20,362
Capital Expenditures ($
mil)....................... $ 99 $ 77 $ 52 $ 34 $ 34
Employees................... 1,089 935 747 592 478
Sales Force(1).............. 180 166 124 116 105
</TABLE>
--------
(1) Quota bearing sales professionals. Does not include sales engineers or
customer support personnel.
Three Months Ended September 30, 2000 Compared to Three Months Ended September
30, 1999
Data services revenue increased 54% from the third quarter of 1999 to $40.6
million during the third quarter of 2000. Telecom services revenue increased
148% from the third quarter of 1999 to $20.2 million during the third quarter
of 2000. This increase in data and telecom services revenue is primarily due to
the generation of revenues from a number of new markets that went into
operation subsequent to the third quarter of 1999 and from an increase in
revenues from our more mature markets in the third quarter of 2000. In
addition, we installed 10,227 and 25,522 more data and telecom services lines,
respectively, during the third quarter of 2000 compared to the third quarter of
1999.
Network expense totaled $23.9 million for the third quarter of 2000 compared
to $8.4 million for the third quarter of 1999. This $15.5 million increase
resulted from our rapid expansion into six new markets and related costs for
leased facilities, and usage settlements. Our gross margin, which represents
total revenues less network expenses was approximately 61% and 76% for the
three months ended September 30, 2000 and 1999,
15
<PAGE>
respectively. This decrease in our gross margin between comparable periods is a
direct result of our effective reciprocal compensation per minute of use rate
having declined between periods. SG&A expenses increased by $21.8 million, from
$20.3 million during the three months ended September 30, 1999 to $42.1 million
during the third quarter of 2000. This increase is the result of our rapid
expansion into six new markets and the rollout of our Focal Internet eXchanges
platforms. In addition, our overall SG&A expenses increased between comparable
periods due to a corresponding increase in our employee base of 611 employees.
Depreciation and amortization increased from $6.6 million to $15.9 million
in the comparative three-month periods. This increase of $9.3 million is a
result of our expansion into an additional six new markets, to a total of 20
markets in operation as of September 30, 2000.
Interest income increased from $2.2 million in the third quarter of 1999, to
$4.8 million in the comparable period of 2000. This $2.6 million increase is
primarily due to the receipt of $265.7 million in net proceeds from our 11 7/8%
senior notes ("2000 Notes") offering completed in January 2000. Interest
expense increased from $6.9 million in the third quarter of 1999 to $13.1
million in the third quarter of 2000. This $6.2 million net increase is due to
an additional $9.2 million of interest expense charged relating to our
outstanding notes and Credit Facility which was partially offset by interest
capitalized during the third quarter of 2000 totaling $3.0 million.
Nine Months Ended September 30, 2000 Compared to Nine Months Ended September
30, 1999
Our data services revenue increased 64% for the nine months ended September
30, 2000 to $115.4 million. Telecom services revenue increased 153% to $51.4
million for the nine months ended September 30, 2000. This increase in our data
and telecom services revenue is primarily due to the generation of revenues
from a number of new markets that went into operation subsequent to the third
quarter of 1999 and from an increase in revenues from our more mature markets.
In addition, we installed 44,451 and 54,440 more data and telecom services
lines, respectively, during the first nine months of 2000 compared to the first
nine months of 1999.
Network expense totaled $63.6 million for the nine months ended September
30, 2000 compared to $17.8 million for the nine months ended September 30,
1999. This $45.8 million increase resulted from our rapid expansion into six
new markets and related costs for network expenses, SG&A and other operating
expenses. Our gross margin was approximately 62% and 80% for the nine months
ended September 30, 2000 and 1999, respectively. This decrease in our gross
margin between comparable periods is a direct result of our effective
reciprocal compensation per minute of use rate having declined between periods.
Our gross margin was 60% for the nine months ended September 30, 2000 after
excluding a second quarter adjustment for the recognition of $1.5 million in
telecom services revenue and $4.9 million in data services revenue for deferred
carrier settlements. SG&A expenses increased by $62.7 million, from $48.8
million during the nine months ended September 30, 1999 to $111.5 million
during the nine month ended September 30, 2000. This increase is the result of
our rapid expansion into six new markets and the rollout of our Focal Internet
eXchange platforms. In addition, our overall SG&A expenses increased between
comparable periods due to a corresponding increase in our employee base of 611
employees.
Depreciation and amortization increased from $15.5 million to $39.0 million
in the comparative nine-month periods. This increase of $23.5 million is a
result of our expansion into an additional six new markets, to a total of 20
markets in operation as of September 30, 2000.
Interest income increased from $4.8 million for the nine months ended
September 30, 1999, to $17.1 million in the comparable period of 2000. This
$12.3 million increase is primarily due to the receipt of $265.7 million in net
proceeds from our 11 7/8% senior notes ("2000 Notes") offering completed in
January 2000. Interest expense increased from $18.1 million in the nine months
ended September 30, 1999 to $40.0 million for the nine months ended September
30, 2000. This $21.9 million net increase is due to an additional $25.8 million
of interest expense charged relating to our outstanding notes and Credit
Facility and $2.2 million of interest expense related to our secured equipment
term loan and our capital lease obligation for dark fiber transport capacity,
which was partially offset by interest capitalized during the nine month period
ended September 30, 2000 totaling $6.1 million.
16
<PAGE>
Liquidity and Capital Resources
Our current business plan anticipates that we expand our existing networks
and services, expand into four new markets in 2001, deploy our own fiber
capacity in a majority of our markets, construct 36 Focal Internet eXchange
platforms across our 24 planned markets, construct expanded colocation centers,
and fund operating losses. We will require significant capital to fund this
plan including the purchase and installation of voice and data switches,
routers, equipment, infrastructure and fiber facilities and/or long-term rights
to use fiber transport capacity. The implementation of this plan requires
significant capital expenditures, a substantial portion of which will be
incurred before significant related revenues from our new markets are expected
to be realized. These expenditures, together with associated early operating
expenses, may result in our having substantial negative operating cash flow and
substantial net operating losses for the foreseeable future, including the
remainder of 2000 and 2001. Although we believe that our cost estimates and the
scope and timing of our build-out are reasonable, we cannot assure you that
actual costs or the timing of the expenditures, or that the scope and timing of
our build-out, will be consistent with current estimates.
Our capital expenditures were approximately $227.7 million for the nine
months ended September 30, 2000 primarily reflecting capital spending for the
build-out of our additional markets and the roll-out of new services. We
estimate that our capital expenditures in connection with our current business
plan will be approximately $300 million for 2000 and approximately $150-$300
million in 2001. These estimated capital expenditures are expected to be made
primarily for the build-out of additional markets, the construction of Focal
Internet eXchange platforms, the expansion of our existing markets, the roll-
out of new services, including managed high-speed Internet access, colocation
and peering services, and the activation of local dark fiber transport capacity
in a number of our markets. We estimate that the majority of our total
expenditures through 2001 will be for network expansion, rather than for
operating losses.
Net cash used in operating activities for the nine months ended September
30, 2000 was $10.5 million, a decrease of $26.8 million from the same period in
1999. This decrease is primarily the result of an increased net loss of $58.8
million which was partially offset by a $22.6 million increase in accounts
payable and accrued liabilities and a $23.5 million increase in depreciation.
Net cash used in investing activities was $232.0 million for the nine months
ended September 30, 2000 compared to $108.6 million for the comparable period
in 1999. This increase of $123.4 million is primarily the result of our
expansion into six new markets and the build-out of our Focal Internet eXchange
platforms, which resulted in capital expenditures that exceeded the nine months
ended September 30, 1999 by $133.4 million. Net cash provided by financing
activities for the nine months ended September 30, 2000 was $253.8 million, an
increase of $87.9 million for the comparable period of 1999. This increase is
primarily due to the $265.7 million in net proceeds received from the issuance
of our 2000 Notes.
On February 18, 1998, we received $150 million in gross proceeds from the
sale of our 1998 Notes. The 1998 Notes will accrete to an aggregate stated
principal amount of $270 million by February 15, 2003. As of September 30,
2000, the principal amount of the 1998 Notes had accreted to approximately
$204.0 million. No interest is payable on the 1998 Notes prior to August 15,
2003. Thereafter, cash interest will be payable semiannually on August 15 and
February 15 of each year. On August 2, 1999, we raised net proceeds of
approximately $137 million in our initial public offering in which we sold
11,442,500 shares of our common stock at a price of $13 per share, which
includes the underwriter's exercise of their over-allotment option to purchase
1,492,500 common shares at $13 per share. On January 12, 2000, we received
approximately $265.7 million in net proceeds from our 2000 Notes offering. The
2000 Notes interest payment dates are July 15 and January 15, commencing July
15, 2000. During July 2000, we paid $16.6 million in interest to the 2000 Note
holders.
On August 25, 2000, we completed our $300 million Senior Secured Credit
Facility (the Credit Facility). The Credit Facility consists of a seven year
$150 million revolving credit facility and a seven year $150 million delayed
draw term loan facility. The Credit Facility will be available, subject to
certain financial and operating terms and conditions, and is intended to
provide purchase money financing for the construction, acquisition, or
improvements of telecommunications assets. The interest on amounts drawn is
variable based on our leverage
17
<PAGE>
ratio, as defined in our Credit Facility. The initial commitment fee on the
unused portion of the Credit Facility is 1.5% and will step down based on
usage. We have not drawn down against the Credit Facility as of September 30,
2000.
We have historically incurred net losses and have an accumulated deficit of
$105.4 million as of September 30, 2000. The aggregate net proceeds totaling
approximately $602.7 million that we received from the offering of our 1998
Notes, the August 1999 equity offering, the 2000 Notes and certain other
financings, have funded a large portion of our operating losses and capital
expenditures through September 30, 2000. We expect that our existing cash and
investment balances, Credit Facility, flexible "smart-build" success-based
operating plans, and future cash flows (expected to be provided from ongoing
operations) will be sufficient to fund our operations and capital expenditure
requirements through the first quarter of 2002. Our expectations of our future
capital requirements and cash flows from operations are based on current
estimates. If our plans or assumptions change or prove to be inaccurate, we may
be required to seek additional sources of capital, seek additional capital
sooner than currently anticipated, or modify our expansion plans.
The discussions under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contain forward-looking statements. These
statements are subject to a number of risks and uncertainties that could cause
actual results to differ substantially from our projections. See "Information
Regarding Forward-looking Statements" on page 3 of this report.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to minimal market risks. We manage sensitivity of our results
of operations to these risks by maintaining a conservative investment
portfolio, which primarily consists of debt securities, typically maturing
within one year, and entering into long-term debt obligations with appropriate
pricing and terms. We do not hold or issue derivative, derivative commodity or
other financial instruments for trading purposes. Financial instruments held
for other than trading purposes do not impose a material market risk on us.
We are exposed to interest rate risk, as additional debt financing is
periodically needed due to the large operating losses and capital expenditures
associated with establishing and expanding our network coverage. The interest
rate that we will be able to obtain on debt financing will depend on market
conditions at that time, and may differ from the rates we have secured on our
current debt.
While all of our long-term debt bears fixed interest rates, the fair market
value of our fixed rate long-term debt is sensitive to changes in interest
rates. We have no cash flow or earnings exposure due to market interest rate
changes for our fixed long-term debt obligations. The table below provides
additional information about our 1998 Notes and 2000 Notes. For additional
information about our long-term debt obligations, see our condensed
consolidated financial statements and accompanying notes related thereto
appearing elsewhere in this report.
<TABLE>
<CAPTION>
As of September 30,
2000
----------------------
Fixed Average
-------- -------------
Expected Maturity Debt Interest Rate
----------------- -------- -------------
<S> <C> <C>
2000.................................................. $ -- --
2001.................................................. -- --
2002.................................................. -- --
2003.................................................. -- --
2004.................................................. -- --
Thereafter............................................ 545,000 12%
-------- ---
$545,000 12%
======== ===
Fair Market Value..................................... $354,950
========
</TABLE>
18
<PAGE>
PART II--OTHER INFORMATION
Item 1. Legal and Administrative Proceedings
With the exception of the matters discussed in our Annual Report on Form 10-
K for the year ended December 31, 1999, filed on March 10, 2000 we are not
aware of any material litigation against us. In the ordinary course of our
business, we are involved in a number of regulatory proceedings before various
state commissions and the FCC.
Item 2. Changes in Securities and Use of Proceeds
Not Applicable.
Item 3. Defaults Upon Senior Securities
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not Applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
4.1 Form of Non-Qualified Stock Option Agreement for Filed herewith
Certain Members of Senior Management
4.2 Amendment No. 2 to Registration Agreement Filed herewith
4.3 Tag Along Agreement Filed Herewith
10.1 $300 million Senior Secured Credit Facility Agreement Filed herewith
27.1 Financial Data Schedule # Filed herewith
</TABLE>
#Management contract or compensatory plan
(b) Reports on Form 8-K
None
19
<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
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ ROBERT C. TAYLOR, JR President, Chief Executive November 14, 2000
. ____________________________________ Officer and (Authorized
Robert C. Taylor, JR. Officer)
/s/ JOSEPH A. BEATTY Executive Vice President, November 14, 2000
______________________________________ Chief Financial Officer
Joseph A. Beatty and (Principal Financial
Officer)
/s/ GREGORY J. SWANSON Controller (Principal November 14, 2000
______________________________________ Accounting Officer)
</TABLE> Gregory J. Swanson
20
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------- --------
<C> <S> <C>
4.1 Form of Non-Qualified Stock Option Agreement for Filed Herewith
Certain Members of Certain Members of Senior
Management
4.2 Amendment No. 2 to Registration Agreement Filed Herewith
4.3 Tag Along Agreement Filed Herewith
10.1 $300 Million Senior Secured Credit Facility Agreement Filed Herewith
27.1 Financial Data Schedule Filed herewith
</TABLE>
21
