<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Quarterly Period Ended September 30, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission File Number 0-24581
CAPROCK COMMUNICATIONS CORP.
(Exact name of registrant as specified in its charter)
TEXAS 75-2765572
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
Two Galleria Tower
13455 Noel Road, Suite 1925
Dallas, Texas 75240
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (972) 982-9500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
COMMON STOCK, $0.01 PAR VALUE 28,933,168
(Title of Each Class) (Number of Shares Outstanding at October 31, 1998)
<PAGE>
CAPROCK COMMUNICATIONS CORP.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
INDEX
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C>
PART 1. FINANCIAL INFORMATION 3
Item 1. Financial Statements: 3
Consolidated Balance Sheets at September 30, 1998 and
December 31, 1997 3
Consolidated Statements of Operations for the Nine Months
and Three Months Ended September 30, 1997 and 1998 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1997 and 1998 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
PART 2. OTHER INFORMATION 23
Item 1. Legal Proceedings 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURE PAGE 25
</TABLE>
2
<PAGE>
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
------------ -------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,520,017 $ 8,508,285
Marketable securities - 107,292,200
Accounts receivable and unbilled services, less
allowance for doubtful accounts of $1,781,355
and $662,641 at December 31, 1997 and September
30, 1998, respectively 15,143,525 20,730,379
Income tax receivable - 1,784,265
Costs and estimated earnings in excess of billings - 2,085,561
Inventory 1,022,927 1,569,330
Prepaid expenses and other 1,022,319 1,565,243
Deferred income taxes 731,845 7,129
------------- -------------
Total current assets 21,440,633 143,542,392
Property, plant and equipment, net 27,340,599 47,359,515
Other assets 608,219 2,784,319
------------- -------------
Total assets $ 49,389,451 $ 193,686,226
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 8,116,424 $ 742,760
Accounts payable and accrued expenses 11,587,951 27,566,532
Accrued commitment and guarantor fees 406,010 -
Customer deposits 171,972 35,566
Current installments of obligations under capital leases 239,672 430,123
Billings in excess of costs and earnings 92,022 -
Income taxes payable 589,514 -
Unearned revenue 542,441 577,050
------------- -------------
Total current liabilities 21,746,006 29,352,031
Long-term debt, excluding current portion 12,338,341 -
Senior notes, net of unamortized debt issuance costs - 145,632,297
Deferred income taxes 851,307 1,650,631
Obligations under capital lease, excluding current
installments 367,493 -
------------- -------------
Total liabilities 35,303,147 176,634,959
Stockholders' equity:
Preferred stock, $.01 par value; 20,000,000 shares
authorized; none issued - -
Common stock, $.01 par value; 200,000,000 shares
authorized; issued and outstanding, 28,677,743
and 28,920,038 shares at December 31, 1997 and
September 30, 1998, respectively 286,777 289,200
Additional paid-in capital 8,810,627 10,481,499
Retained earnings 5,385,144 6,607,962
Currency translation adjustments - 19,506
Unearned compensation (396,244) (333,676)
Treasury stock, at cost - (13,224)
------------- -------------
Total stockholders' equity 14,086,304 17,051,267
------------- -------------
Total liabilities and stockholders' equity $ 49,389,451 $ 193,686,226
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements
3
<PAGE>
CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
----------------------------- -----------------------------
1997 1998 1997 1998
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues:
Carriers' carrier $ 30,184,831 $ 50,125,291 $ 11,282,177 $ 21,683,842
Integrated communications services 5,544,865 13,476,547 2,767,045 5,351,997
Systems services 16,034,257 23,102,542 4,989,357 8,248,493
Product resales 2,945,563 - - -
------------- ------------- ------------- -------------
Total revenues 54,709,516 86,704,380 19,038,579 35,284,332
Cost of services 36,425,547 60,011,068 12,929,591 25,975,705
Cost of product resales 2,347,060 - - -
------------- ------------- ------------- -------------
Gross profit 15,936,909 26,693,312 6,108,988 9,308,627
Operating expenses:
Selling, general and administrative 9,912,166 14,891,568 3,459,392 5,331,889
Merger related expenses - 2,312,973 - 2,312,973
Depreciation and amortization 2,250,193 3,582,345 830,883 1,331,977
------------- ------------- ------------- -------------
Total operating expenses 12,162,359 20,786,886 4,290,275 8,976,839
------------- ------------- ------------- -------------
Operating income 3,774,550 5,906,426 1,818,713 331,788
Interest expense (1,314,564) (5,087,815) (473,477) (4,159,090)
Interest income 72,505 1,583,850 69,895 1,574,501
Other income 222,111 145,076 112,152 40,152
------------- ------------- ------------- -------------
Income (loss) before income taxes 2,754,602 2,547,537 1,527,283 (2,212,649)
Income tax expense (benefit) 949,229 1,324,719 557,783 (562,599)
------------- ------------- ------------- -------------
Net income (loss) $ 1,805,373 $ 1,222,818 $ 969,500 $ (1,650,050)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Earnings (loss) per common share:
Basic $ 0.07 $ 0.04 $ 0.03 $ (0.06)
Diluted $ 0.06 $ 0.04 $ 0.03 $ (0.06)
Weighted average shares outstanding:
Basic 27,658,262 28,885,288 28,677,743 28,914,167
Diluted 28,106,387 29,425,872 29,156,978 28,914,167
</TABLE>
See accompanying notes to consolidated financial statements
4
<PAGE>
CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------
1997 1998
-------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,805,373 $ 1,222,818
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,250,193 3,582,345
Amortization of discount on notes payable 7,339 -
Gain on sale of assets (141,694) (49,413)
Deferred income taxes 711,168 1,524,040
Equity earnings of unconsolidated joint venture (80,445) (132,350)
Compensation expense related to stock
option grants - 62,568
Amortization of debt issuance costs, included in
interest expense - 91,759
Allowance for doubtful accounts 820,977 615,498
Changes in operating assets and liabilities:
Accounts receivable and unbilled services (5,076,311) (6,202,351)
Inventory 1,632,617 (546,404)
Costs and estimated earnings in excess of billings (98,914) (2,085,561)
Prepaid expenses and other (548,163) (950,467)
Accounts payable and accrued liabilities 2,293,024 15,436,165
Billings in excess of costs and estimated earnings 35,605 (92,022)
Income taxes payable (70,622) (2,373,779)
Unearned revenue (145,108) 34,609
------------- -------------
Net cash provided by operating activities 3,395,039 10,137,455
Cash flows from investing activities:
Purchases of property and equipment (10,164,940) (23,304,225)
Purchase of marketable securities - (107,292,200)
Proceeds from disposal of property and equipment 105,067 303,805
Investment in unconsolidated subsidiary 428,374 -
Purchase of ICEL - (609,822)
------------- -------------
Net cash used in investing activities (9,631,499) (130,902,442)
Cash flows from financing activities:
Proceeds from issuance of long-term debt 7,958,187 -
Proceeds from issuance of senior notes, net of debt issuance - 145,540,538
Principal payments on notes payable (2,581,419) (18,559,677)
Proceeds from line of credit 28,071,076 44,717,209
Principal payments on line of credit (28,845,671) (45,869,537)
Net change in bank overdraft (957,497) -
Purchase of treasury stock - (13,224)
Proceeds from issuace of common stock 7,299,375 95,482
Principal payments under capital lease obligations (157,117) (177,042)
------------- -------------
Net cash provided by financing activities 10,786,934 125,733,749
Effect of exchange rate on cash and cash equivalents - 19,506
------------- -------------
Net increase in cash and cash equivalents 4,550,474 4,988,268
Cash and cash equivalents at beginning of period 306,897 3,520,017
------------- -------------
Cash and cash equivalents at end of period $ 4,857,371 $ 8,508,285
------------- -------------
------------- -------------
Supplemental disclosure of cash flow information:
Cash paid for interest $ 1,285,629 $ 895,539
------------- -------------
------------- -------------
Cash paid for income taxes $ 164,000 $ 1,861,656
------------- -------------
------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements
5
<PAGE>
CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) BASIS OF PRESENTATION AND NATURE OF BUSINESS
The consolidated financial statements include CapRock Communications
Corp. ("CapRock" or the "Company") and its majority owned
subsidiaries. The Company was formed on February 3, 1998, to serve as
a holding company for the operations of CapRock Telecommunications
Corp., a Texas corporation ("Telecommunications"), CapRock Fiber
Network Ltd., a Texas limited partnership ("Partnership"), and IWL
Communications, Inc., a Texas corporation ("IWL"), and its wholly
owned subsidiaries upon the consummation of the business combination
of those companies (the "Combination"). All significant inter-company
transactions are eliminated in consolidation. The equity method is
used to account for unconsolidated investments in companies in which
the Company exercises significant influences over operating and
financial policies, but does not have a controlling interest. On
August 26, 1998, pursuant to the Agreement and Plan of Merger and Plan
of Exchange dated February 16, 1998, as amended (the "Merger
Agreement"), among the Company, Telecommunications, the Partnership,
IWL and certain other parties, the Company completed the Combination
(note 2).
The Company is a regional facilities-based integrated communications
provider offering local, long distance, Internet, data and private
line services to small and medium-sized businesses. The Company also
provides switched and dedicated access, regional and international
long distance, private lines and dark fiber to carrier customers. The
Company is in process of building a 5,500 mile advanced fiber network
throughout Texas, Louisiana, Oklahoma, Arkansas and New Mexico, which
it expects to be completed by the end of the year 2000.
The accompanying consolidated financial statements, which should be
read in conjunction with the supplemental consolidated financial
statements and footnotes included in the Company's Registration
Statement on Form S-4 (Registration No. 64699), first filed with the
Securities and Exchange Commission (the "SEC") on September 29, 1998
(the "Exchange Offer Registration Statement"), have been prepared in
accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of
management, all adjustments (consisting only of normal recurring
adjustments) considered necessary for a fair presentation have been
included. Accounting measurements at interim dates inherently involve
greater reliance on estimates than at year-end. The results of
operations for the nine months ended September 30, 1998 are not
necessarily indicative of the results to be expected for the entire
fiscal year ending December 31, 1998.
(b) CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS AVAILABLE FOR SALE
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. The
Company is restricted to invest the proceeds from the 12% Senior Notes
(note 5) in accordance with the terms of the indenture agreement.
Marketable securities consist of U.S government and other securities
with original maturities beyond three months. Marketable securities
are stated at cost and are adjusted for discount accretion and premium
amortization, which approximates fair value. The securities in the
portfolio consist of money market instruments, commercial paper and
government obligations, all of which are considered to be
6
<PAGE>
available for sale and have maturities of one year or less. The
Company's short-term investment objectives are safety, liquidity
and yield.
2) BUSINESS COMBINATION
On August 26, 1998, the Company completed the Combination pursuant to
the Merger Agreement. Accordingly, the Consolidated Balance Sheets as of
December 31, 1997 and as of September 30, 1998 (unaudited) and the
Consolidated Statements of Operations and Cash Flows for the nine months
ended September 30, 1997 and 1998 (unaudited) include
Telecommunications, Partnership and IWL as though these entities had
always been a part of CapRock.
In the Combination, Telecommunications merged with a subsidiary of the
Company, with Telecommunications surviving the merger as a wholly owned
subsidiary of the Company, and IWL merged with another subsidiary of the
Company, with IWL also surviving the merger as a wholly owned subsidiary
of the Company. All previously outstanding shares of IWL common stock
ceased to exist and each such share was converted into and became
exchangeable for one share of CapRock common stock, and all previously
outstanding shares of Telecommunications common stock ceased to exist,
and each such share was converted into and became exchangeable for
1.789030878 shares of CapRock common stock. In addition, in the
Combination each one percent (1%) of the Partnership interests issued
and outstanding was exchanged for 63,194.54 shares of CapRock common
stock, with the result that Telecommunications became the successor
general partner of the Partnership and the Company became the successor
limited partner of the Partnership. The Company issued 28,911,231
common shares in exchange for the outstanding common shares of
Telecommunications and IWL and the outstanding partnership interests in
the Partnership. Additionally, outstanding employee stock options and
warrants of IWL and Telecommunications were converted at the above
exchange ratios into options to purchase 828,385 shares of CapRock
common stock. The Combination constituted a tax-free reorganization and
was accounted for as a pooling of interests under Accounting Principles
Board Opinion No. 16.
In May 1998, IWL changed its fiscal year end to coincide with the fiscal
years of CapRock, Telecommunications and the Partnership. The
Consolidated Statement of Operations for the for the nine months ended
September 30, 1997 and 1998 combine the operating activity for all three
entities for these periods.
The transactions between Telecommunications, IWL and the Partnership
have been eliminated for all respective periods presented. Certain
reclassifications were made to IWL's financial statements to conform to
CapRock's presentations.
The results of operations for the separate companies and the combined
amounts presented in the Consolidated Financial Statements for periods
prior to the Combination follow:
<TABLE>
<CAPTION>
Nine Months Three Months Six Months
Ended Ended Ended
September 30, 1997 September 30, 1997 June 30, 1998
------------------ ------------------ -------------
<S> <C> <C> <C>
Net sales:
Telecommunications $ 33,282,788 $ 13,154,362 $ 32,223,086
Partnership 1,376,363 531,350 2,551,337
IWL 20,050,365 5,352,867 16,645,625
---------- --------- ------------
Combined $ 54,709,516 $ 19,038,579 $ 51,420,048
---------- --------- ------------
---------- --------- ------------
Net income
Telecommunications $ 1,167,600 $ 738,885 $ 1,785,274
Partnership 3,865 25,349 870,304
IWL 633,908 205,266 217,290
---------- --------- ------------
Combined $ 1,805,373 $ 969,500 $ 2,872,868
---------- --------- ------------
---------- --------- ------------
</TABLE>
7
<PAGE>
The Company recorded $2.3 million to operating expenses in the third quarter
of 1998 related to direct and other merger related costs.
3) EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128 (FAS 128), "Earnings Per Share". Statement 128 replaced the
previously reported primary and fully diluted earnings per share with basic
and diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effects of options, warrants, and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where necessary, restated to
conform to the Statement 128 requirements.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Nine Months Ended Three Months Ended
September 30, September 30,
- -------------------------------------------------------------------------------
1997 1998 1997 1998
- -------------------------------------------------------------------------------
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Numerator:
- -------------------------------------------------------------------------------
Net income (loss) $ 1,805 $ 1,223 $ 970 $(1,650)
- -------------------------------------------------------------------------------
Denominator:
- -------------------------------------------------------------------------------
Denominator for basic earnings
(loss) per share-weighted-
average shares outstanding 27,658 28,885 28,678 28,914
- -------------------------------------------------------------------------------
Effect of dilutive securities:
- -------------------------------------------------------------------------------
Employee stock options 448 541 479 --
- -------------------------------------------------------------------------------
Denominator for diluted earnings
(loss) per share 28,106 29,426 29,157 28,914
- -------------------------------------------------------------------------------
Basic earnings (loss) per share 0.07 0.04 0.03 (0.06)
- -------------------------------------------------------------------------------
Diluted earnings (loss) per share 0.06 0.04 0.03 (0.06)
- -------------------------------------------------------------------------------
</TABLE>
4) STATEMENT OF OPERATIONS RECLASSIFICATIONS
The Company has reclassified the revenue categories in the third quarter
ended September 30, 1998 in order to more closely align the revenue
categories with management, shareholder and the investment community
expectations and to present the results of operations in the most
meaningful manner. Certain other reclassifications were made to the
Statement of Operations in order to conform to the 1998 presentation. The
revenue categories are as follows:
CARRIERS' CARRIER:
Carriers' carrier revenue includes all carrier revenues generated from the
sale of domestic and international switched services, from the sale of T-1
and DS-3 broadband capacity and from the sale and lease of dark fiber. The
revenue generated from the international switched services are minutes of
long distance traffic terminating in foreign countries, but generated by
domestic U.S based long distance carriers. Such revenues are recognized
when the services are provided. The cost of revenues associated with these
services is based primarily on the direct costs associated with owned and
leased transmission capacity and the cost of transmitting and terminating
traffic on other carriers' facilities. Commissions paid to acquire
customer call traffic are expensed in the period when associated call
revenues are recognized.
8
<PAGE>
The Company accounts for long-term construction contracts relating to the
development of telecommunications networks for customers using the
percentage-of-completion method, which would include the sale of fiber
usage rights through indefeasible right to use contracts ("IRU") and the
related construction services associated with building the fiber network
specified in the IRU. Progress under the percentage-of-completion is
measured based upon costs incurred to date compared with total estimated
construction costs. Customers are billed based upon contractual
milestones.
INTEGRATED COMMUNICATIONS SERVICES:
Integrated communications services revenue includes all revenues generated
from the sale of telecommunications products to business and residential
customers. These products include local, long distance, Internet, data and
private line services. The Company records revenues for these
telecommunications services at the time of customer usage. The cost of
revenues associated with services is based primarily on the direct costs
associated with owned and leased transmission capacity and the cost of
transmitting and terminating traffic on other carriers' facilities. The
cost of revenues for local services also includes payments to local
exchange carriers and interexchange carriers for access and transport
charges. Commissions paid to acquire customer call traffic are expensed in
the period when associated call revenues are recognized.
SYSTEMS SERVICES:
Systems services revenue includes revenues generated from the design,
installation, leasing and sale of voice and data systems and products,
primarily to companies in the oil and gas industry. The revenues
associated with the leasing and sale of voice and data systems products are
recorded as the services are provided. The revenue associated with the
design and installation of voice and data systems products primarily
relates to communication system contracts involving the engineering and
integration of telecommunications systems and sales, service and
maintenance of telecommunications equipment. These contracts are typically
fixed price and such revenue is recognized based upon the percentage-of-
completion method, primarily based upon contract costs incurred to date
compared with total estimated contract costs.
PRODUCT RESALES:
In 1997, the Company provided services to a subsidiary of Shell, which
included the resale of a significant amount of Alcatel products. The
Company sold $2.9 million to the Shell subsidiary during the nine months
ended September 30, 1997, relating to Alcatel products and other
equipment and hardware. Although profitable, the sale of Alcatel
products to the Shell subsidiary reduced the Company's gross margins in
these periods. The Shell project was substantially completed in May
1997 and, therefore, is not expected to contribute in a material manner
to the Company's total sales in future periods.
5) PROCEEDS FROM SENIOR NOTES
In July 1998, the Company issued, through a private placement under the
Securities Act of 1933, as amended (the "Securities Act"), $150 million
aggregate principal amount of its 12% senior notes due July 15, 2008
(the "Senior Notes"), which closed on July 16, 1998. Interest on the
Senior Notes will be payable semi-annually in arrears on January 15 and
July 15 of each year, commencing on January 15, 1999, at the rate of 12%
per annum. The net proceeds from the offering of the Senior Notes were
used to repay all existing debt obligations of Telecommunications, the
Partnership and IWL (with the exception of one note bearing interest at
6.75% and an outstanding balance of $743,000 at September 30, 1998 and a
capital lease obligation with a balance of $430,000 at September 30,
1998), which were repaid on or before August 31, 1998. The proceeds
used for debt payoffs totaled $26.8 million. The remaining proceeds, net
of transaction expenses, will be used to fund additional capital
expenditures for the construction of the Company's fiber optic network,
switching equipment and other capital expenditures and to expand its
sales offices, for
9
<PAGE>
potential acquisitions and for general working capital purposes. The
funds will be invested in high-grade liquid securities classified as
available for sale. The Company filed the Exchange Offer Registration
Statement in September 1998 with the SEC for the registration of $150
million of principal amount of its Senior Notes due July 15, 2008 (the
"Exchange Notes") to be offered in exchange for the Senior Notes (the
"Exchange Offer"). The Exchange Offer Registration Statement was
declared effective by the SEC on October 13, 1998 and the Exchange Offer
was commenced. The Exchange Offer expires on November 13, 1998, unless
extended. The terms of the Exchange Notes will be identical in all
material respects to the terms of the Senior Notes except that the
Exchange Notes have been registered under the Securities Act.
The indenture (the "Indenture") governing the issuance of the Senior
Notes contains certain restrictive operating and financial covenants
including, among other things, covenants with respect to the following
matters: (i) limitation on additional indebtedness, (ii) limitation on
restricted payments, (iii) limitation on dividends and other payment
restrictions affecting restricted subsidiaries, (iv) limitation on
issuances and sales of capital stock of restricted subsidiaries, (v)
limitation on issuances of guarantees by restricted subsidiaries, (vi)
limitation on transactions with stockholders and affiliates, (vii)
limitation on liens, (viii) limitation on any sale lease-back
transactions, (ix) limitation on asset sales, and (x) periodic reports.
All of the covenants are subject to a number of important qualifications
and exceptions. These covenants may adversely affect the Company's
ability to finance its future operations or capital needs or to engage
in other business activities that may be in the best interests of the
Company.
(6) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, including assets acquired under capital
leases of $1,732,000 as of December 31, 1997 and September 30, 1998,
is comprised of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30,
USEFUL DECEMBER 31, 1998
LIVES 1997 -------------
---------- ------------ (UNAUDITED)
<S> <C> <C> <C>
Land -- $ 51,289 $ 162,853
Buildings 20-31 982,484 926,570
Leasehold improvements Lease Term 330,468 809,004
Office equipment, furniture and
other 5-7 4,264,606 8,357,234
Telecommunications network 5-20 13,501,993 18,906,518
Equipment for rent/lease 7-10 12,003,374 15,976,235
Construction in progress -- 4,373,499 13,466,583
---------- ----------
Total property, plant and
equipment 35,507,713 58,604,997
Less accumulated depreciation,
including amounts applicable
to assets acquired under
capital leases of $721,667
and $907,238 as of December
31, 1997, and September 30,
1998, respectively 8,167,114 11,245,482
---------- ----------
Net property, plant and equipment $27,340,599 $47,359,515
---------- ----------
---------- ----------
</TABLE>
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO OF CAPROCK
CONTAINED IN THE EXCHANGE OFFER REGISTRATION STATEMENT. THE COMPANY BELIEVES
THAT ALL NECESSARY ADJUSTMENTS (CONSISTING ONLY OF NORMAL RECURRING ADJUSTMENTS)
HAVE BEEN INCLUDED IN THE AMOUNTS STATED BELOW TO PRESENT FAIRLY THE FOLLOWING
QUARTERLY INFORMATION. ACCOUNTING MEASUREMENTS AT INTERIM DATES INHERENTLY
INVOLVE GREATER RELIANCE ON ESTIMATES THAN AT YEAR-END. THE INFORMATION IS NOT
NECESSARILY INDICATIVE OF FUTURE OPERATING RESULTS AND ARE NOT NECESSARILY
INDICATIVE OF RESULTS OF OPERATIONS FOR A FULL YEAR.
FORWARD LOOKING INFORMATION
Certain information contained herein contains forward-looking statements (as
defined in the Private Securities Litigation Reform Act of 1995) regarding
future events or the future financial performance of the Company, and are
subject to a number of risks and other factors which could cause the actual
results of the Company to differ materially from those contained in and
anticipated by the forward-looking statements. Among such factors are: industry
concentration and the Company's dependence on major customers, competition,
risks associated with international operations and entry into new markets,
government regulation, variability in operating results, general business and
economic conditions, customer acceptance of any demand for the Company's new
products, the Company's overall ability to design, test, and introduce new
products on a timely basis, reliance on third parties and other
telecommunication carriers, the Company's ability to manage change, dependence
on key personnel, dependence on information systems and changes in technology,
and possible service interruptions. The forward-looking statements contained
herein are necessarily dependent upon assumptions, estimates and data that may
be incorrect or imprecise. Accordingly, any forward-looking statements included
herein do not purport to be predictions of future events or circumstances and
may not be realized. Forward-looking statements contained herein include, but
are not limited to, forecasts, projections and statements relating to inflation,
future acquisitions and anticipated capital expenditures. All forecasts and
projections in this report are based on management's current expectations of the
Company's near term results, based on current information available pertaining
to the Company, including the aforementioned risk factors. Actual results could
differ materially.
OVERVIEW
COMPANY BACKGROUND. CapRock was formed on February 3, 1998 to combine the
businesses of Telecommunications, the Partnership and IWL. On August 26, 1998,
pursuant to the Merger Agreement, the Company completed the Combination of
Telecommunications, Partnership and IWL.
In the Combination, Telecommunications merged with a subsidiary of the
Company, with Telecommunications surviving the merger as a wholly owned
subsidiary of the Company, and IWL merged with another subsidiary of the
Company, with IWL also surviving the merger as a wholly owned subsidiary of
the Company. All previously outstanding shares of IWL common stock ceased to
exist and each such share was converted into and became exchangeable for one
share of CapRock common stock, and all previously outstanding shares of
Telecommunications common stock ceased to exist, and each such share was
converted into and became exchangeable for 1.789030878 shares of CapRock
common stock. In addition, in the Combination each one percent (1%) of the
Partnership interests issued and outstanding was exchanged for 63,194.54
shares of CapRock common stock, with the result that Telecommunications
became the successor general partner of the
11
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Partnership and the Company became the successor limited partner of the
Partnership. The Company issued 28,911,231 common shares in exchange for the
outstanding common shares of Telecommunications and IWL and the outstanding
partnership interests in the Partnership. Additionally, outstanding employee
stock options and warrants of IWL and Telecommunications were converted at
the above exchange ratios into options to purchase 828,385 shares of CapRock
common stock. The Combination constituted a tax-free reorganization and was
accounted for as a pooling of interests under Accounting Principles Board
Opinion No. 16.
Telecommunications and the Partnership are facilities-based providers of
telecommunications services to carriers and to small and medium-sized businesses
in Texas. CapRock believes that the Combination will enable it to accelerate
the implementation of its business plan and to achieve it business objectives by
enhancing its revenue opportunities, creating greater operational depth,
providing the opportunity to cross-sell its products, enabling it to capitalize
on international opportunities and reducing its capital expenditures.
REVENUE. CapRock intends to accelerate its revenue growth primarily by (i)
becoming the leading integrated communications provider ("ICP") in Texas,
Louisiana, Oklahoma, Arkansas and New Mexico, offering local, long distance,
data and private line services to end-customers, (ii) establishing itself as the
premier carriers' carrier in Texas, Louisiana, Oklahoma, Arkansas and New
Mexico, providing voice, data and broadband services over the most extensive
alternative fiber optic network in the such region and (iii) capitalizing on the
growing opportunities to provide international long distance on international
project services.
CapRock intends to roll out its ICP service offering initially by reselling
incumbent local exchange carrier ("ILEC") products, and intends to migrate its
customer base to its own network upon the installation of local switches.
CapRock expects that gross margins will increase as traffic is migrated to
CapRock's own facilities. CapRock intends to minimize customer turnover by
being the single source telecommunications and data services provider to its
customers, while offering a competitive mix of higher quality service and lower
costs than the ILECs. To grow its customer base, CapRock intends to rapidly
increase the size of its sales force and the number of its sales agents.
CapRock's carriers' carrier business currently provides domestic and
international long distance terminations as well as private line and dark fiber
services over its own network and the networks of other carriers. CapRock
intends to build out its fiber optic network to approximately 5,500 route miles
throughout Texas, Louisiana, Oklahoma, Arkansas and New Mexico by the end of the
year 2000. CapRock's network will also interconnect with the networks of
selected Mexican carriers at four border crossings, creating SONET (synchronous
optical network) ring connections between the United States and Mexico. CapRock
believes that its network build out will enable it to significantly increase its
revenues derived from the provision of carrier services.
RESULTS OF OPERATIONS
The Company has reclassifed the revenue categories in the third quarter of 1998
in order to more closely align the revenue categories with management,
shareholder and the investment community expectations and to present the results
of operations in the most meaningful manner. The following table represents the
various sources of revenue:
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
---------------------------- ---------------------------
1997 1998 1997 1998
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Revenues:
Carriers' carrier $ 30,184,831 $ 50,125,291 $ 11,282,177 $ 21,683,842
Integrated communications services 5,544,865 13,476,547 2,767,045 5,351,997
Systems services 16,034,257 23,102,542 4,989,357 8,248,493
---------------------------- ---------------------------
Total service revenue 51,763,953 86,704,380 19,038,579 35,284,332
Product resales 2,945,563 - - -
------------- ------------- ------------ -------------
Total revenues $ 54,709,516 $ 86,704,380 $ 19,038,579 $ 35,284,332
Gross margin %:
Gross margin - service revenue 29% 31% 32% 26%
Gross margin - product resales 20% N/A N/A N/A
</TABLE>
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<PAGE>
The following table sets forth for the periods indicated the Company's statement
of operations as a percentage of its operating revenues:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
1997 1998 1997 1998
------------ ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues 100% 100% 100% 100%
Cost of revenues 68 74 71 69
------------ ------------- ------------- -------------
Gross Profit 32 26 29 31
------------ ------------- ------------- -------------
Operating costs and expenses:
Selling, general and administrative 18 15 18 17
Merger related expenses 0 7 0 3
Depreciation and amortization 4 4 4 4
------------ ------------- ------------- -------------
Total operating costs and expenses 23 25 22 24
------------ ------------- ------------- -------------
Income (loss) from operations 10 1 7 7
Interest expense (2) (12) (2) (6)
Interest income 0 4 0 2
Other income (expense) 1 0 0 0
------------ ------------- ------------- -------------
Income (loss) before income taxes 8 (6) 5 3
Income taxes 3 (2) 2 2
------------ ------------- ------------- -------------
Net income (loss) 5 (5) 3 1
------------ ------------- ------------- -------------
------------ ------------- ------------- -------------
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
REVENUE. Total revenues increased $16.3 million, or 85%, from $19 million
during the three months ended September 30, 1997 to $35.3 million during the
three months ended September 30, 1998. The 85% increase was attributed to
increases of 92% in carriers' carrier, 93% in integrated communications services
and 65% in systems services revenue for the comparable periods.
Carriers' carrier revenue increased $10.4 million from $11.3 million during the
three months ended September 30, 1997 to $21.7 million during the three months
ended September 30, 1998. The 92% increase resulted primarily from the rapid
growth in domestic and international switched services sold to other carriers.
Integrated communications services revenue increased $2.6 million from $2.8
million during the three months ended September 30, 1997 to $5.4 million
during the three months ended September 30, 1998. The 93% increase is
attributed to growth in the number of business and residential customers and
local services.
Systems services revenue increased $3.3 million from $4.9 million during the
three months ended September 30, 1997 to $8.2 million during the three months
ended September 30, 1998. The 65% increase is attributed to growth associated
with the leasing and sale of voice and data systems products and projects
involving the engineering and integration of telecommunications systems and
sales, service and maintenance of telecommunications equipment.
OPERATING COSTS AND EXPENSES. Principal operating costs and expenses consist of
cost of revenues, selling, general and administrative ("SG&A"), and
depreciation.
Total operating costs and expenses increased $17.8 million, or 103%, from
$17.2 million during the three months ended September 30, 1997 to $35 million
during the three months ended September 30, 1998. Cost of revenues increased
$13 million, or 101%, from $13 million for the three months ended September
30, 1997 to $26 million during the three months ended September 30, 1998. The
growth in cost of revenues was primarily attributable to the continued growth
in switched services and network operations. The six-percentage point
decrease in gross margins from 32% to 26% was primarily attributable to the
mix of domestic and international revenues. The international and Mexico
revenues carry a lower gross margin percent, ranging historically from 10% to
18%. Revenue attributable to international and Mexico revenues increased
$9.5 million from $3.8 million for the three months ended September 30, 1997
to $13.3 million during the three months ended September 30, 1998. Gross
margins may vary in the future periods as a result of these and other
factors.
SG&A includes the cost of salaries, benefits, occupancy costs, commissions,
sales and marketing expenses and administrative expenses. SG&A increased $1.9
million, or 54%, from $3.5 million during the three months ended September 30,
1997 to $5.3 million during the three months ended September 30, 1998. The
increase resulted primarily from the expanded administrative and information
activities
13
<PAGE>
required to support the Company's growth, recruitment of additional personnel
and additional sales commission payments.
The Company recorded merger related expenses of $2.3 million during the three
months ended September 30, 1998, as compared to no such costs during the
corresponding period in 1997. The merger related costs relate to the
Combination of Telecommunications, Partnership and IWL, which was consummated on
August 26, 1998. The merger related costs consist of fees for investment
bankers, attorneys, accountants, financial printing and other related charges.
Depreciation and amortization expense increased $501,000, or 60%, from $831,000
during the three months ended September 30, 1997 to $1.3 million during the
three months ended September 30, 1998. This increase resulted primarily from
purchases of additional equipment and other fixed assets to accommodate
CapRocks' growth. CapRock expects that depreciation and amortization expense
will continue to increase in subsequent periods as CapRock continues to expand
its facilities.
INTEREST EXPENSE. Interest expense increased $3.7 million, or 778%, from
$473,000 during the three months ended September 30, 1997 to $4.2 million during
the three months ended September 30, 1998. The increase resulted from the
issuance of $150 million of the Senior Notes, which closed on July 16, 1998.
See "Liquidity and Capital Resources".
INTEREST INCOME. Interest income increased $1.5 million, or 2,153%, from
$70,000 during the three months ended September 30, 1997 to $1.6 million
during the three months ended September 30, 1998. The increase is attributed
to the interest and investment accretion associated with the marketable
securities invested as a result of the proceeds from the Senior Notes. See
"Liquidity and Capital Resources".
INCOME TAXES. Income tax expense decreased $1.1 million, or 201%, from
$558,000 during the three months ended September 30, 1997 as compared to an
income tax benefit of $563,000 during the three months ended September 30,
1998. This decrease was attributable to the impact of the net interest
expense from the Senior Notes and the merger related expenses. The decrease
was partially offset by the change in effective tax rate from 36% for the
three months ended September 30, 1997 to a tax benefit of 25% during the
three months ended September 30, 1998, primarily as a result of certain
non-deductible merger related costs.
NET INCOME (LOSS). Net income decreased $2.7 million from $1 million during
the three months ended September 30, 1997, as compared to a net loss of
approximately $1.7 million in the 1998 as a result of the factors discussed
above.
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
REVENUE. Total revenues increased $32 million, or 58%, from $54.7 million
during the nine months ended September 30, 1997 to $86.7 million during the
nine months ended September 30, 1998. The 58% increase was attributed to
increases of 66% in carriers' carrier, 143% in integrated communications
services and 44% in systems services revenue.
Carriers' carrier revenue increased $19.9 million from $30.2 million during the
nine months ended September 30, 1997 to $50.1 million during the nine months
ended September 30, 1998. The 66% increase resulted primarily from the rapid
growth in domestic and international switched services sold to other carriers.
14
<PAGE>
Integrated communications services revenue increased $8 million from $5.5
million during the nine months ended September 30, 1997 to $13.5 million
during the nine months ended September 30, 1998. The 143% increase is
attributed to growth in the number of business and residential customers and
local services.
Systems services revenue increased $7.1 million from $16 million during the nine
months ended September 30, 1997 to $23.1 million during the nine months ended
September 30, 1998. The 44% increase is attributed to growth associated with
the leasing and sale of voice and data systems products and projects involving
the engineering and integration of telecommunications systems and sales, service
and maintenance of telecommunications equipment.
Product resale revenue was $2.9 million for the nine months ended September 30,
1997 as compared to no product resales during the nine months ended September
30, 1998. The product resales to a single customer were substantially complete
in May 1997 and such revenues are not expected to contribute in a material
manner in future years.
OPERATING COSTS AND EXPENSES. Total operating costs and expenses increased
$29.9 million, or 59% from $50.9 million during the nine months ended
September 30, 1997 to $80.8 million during the nine months ended September
30, 1998. Cost of revenues increased $21.2 million, or 55%, from $38.8
million for the nine months ended September 30, 1997 to $60 million during
the nine months ended September 30, 1998. The growth in cost of revenues was
primarily attributable to the continued growth in switched services and
network operations. The two-percentage point increase in gross margins from
29% to 31% resulted from, among other things, favorable pricing attributable
to the higher traffic and new vendors and revenue associated with the sale of
dark fiber. The increase in the gross margin percent for the nine months
ended September 30, 1998 were partially offset by lower margins attributable
to the mix of international and Mexico revenues, which carry a lower gross
margin percent, ranging historically from 10% to 18%. Revenue attributable
to international and Mexico revenues increased $13.8 million from $9.2
million for the nine months ended September 30, 1997 to $23 million during
the nine months ended September 30, 1998. Gross margins may vary in the
future periods as a result of these factors and other factors.
SG&A includes the cost of salaries, benefits, occupancy costs, commissions,
sales and marketing expenses and administrative expenses. SG&A increased $5
million, or 50%, from $9.9 million during the nine months ended September 30,
1997 to $14.9 million during the nine months ended September 30, 1998. The
increase resulted primarily from the expanded administrative and information
activities required to support the Company's growth, recruitment of additional
personnel and additional sales commission payments.
The Company recorded merger related expenses of $2.3 million during the nine
months ended September 30, 1998, as compared to no such costs during the
corresponding period in 1997. The merger related costs relate to the Combination
of Telecommunications, Partnership and IWL, which was consummated on August 26,
1998. The merger related costs consist of fees for investment bankers,
attorneys, accountants, financial printing and other related charges.
Depreciation and amortization expense increased $1.3 million, or 59%, from $2.3
million during the nine months ended September 30, 1997 to $3.6 million during
the nine months ended September 30, 1998. This increase resulted primarily from
purchases of additional equipment and other fixed assets to accommodate
CapRocks' growth. CapRock expects that depreciation and amortization expense
will continue to increase in subsequent periods as CapRock continues to expand
its facilities.
15
<PAGE>
INTEREST EXPENSE. Interest expense increased $3.8 million, or 287%, from
$1.3 million during the nine months ended September 30, 1997 to $5.1 million
during the nine months ended September 30, 1998. The increase resulted from
the issuance of $150 million of its Senior Notes, which closed on July 16,
1998. See "Liquidity and Capital Resources".
INTEREST INCOME. Interest income increased $1.5 million, or 2,084%, from
$73,000 during the nine months ended September 30, 1997 to $1.6 million
during the nine months ended September 30, 1998. The increase is attributed
to the interest and investment accretion associated with the marketable
securities invested as a result of the proceeds from the Senior Notes. See
"Liquidity and Capital Resources".
INCOME TAXES. Income tax expense increased $375,000, or 40%, from $1
million during the nine months ended September 30, 1997 to $1.3 million during
the nine months ended September 30, 1998, which resulted in an effective tax
rates of 34% for the nine months ended September 30, 1997 and 52% during the
nine months ended September 30, 1998. The increase was primarily attributable
to a higher effective tax rate during the nine months ended September 30, 1998
as a result of certain non-deductible merger related costs.
NET INCOME. Net income decreased $583,000, or 32%, from $1.8 million for the
nine months ended September 30, 1997 to $1.2 million during the nine months
ended September 30, 1998 as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
In July 1998, the Company issued, through a private placement under the
Securities Act, $150 million aggregate principal amount of its Senior Notes,
which closed on July 16, 1998. Interest on the Senior Notes will be payable
semi-annually in arrears on January 15 and July 15 of each year, commencing
on January 15, 1999, at the rate of 12% per annum. The net proceeds from the
offering of the Senior Notes were used to repay all existing debt obligations
of Telecommunications, the Partnership and IWL (with the exception of one
note bearing interest at 6.75% and an outstanding balance of $743,000 at
September 30, 1998 and a capital lease obligation with a balance of $430,000
at September 30, 1998), which were repaid on or before August 31, 1998. The
proceeds used for the debt payoffs totaled $26.8 million. The remaining
proceeds, net of transaction costs, will be used to fund additional capital
expenditures for the construction of the Company's fiber optic network,
switching equipment and other capital expenditures and to expand its sales
offices, for potential acquisitions and for general working capital purposes.
The funds will be invested in high-grade liquid securities classified as
available for sale. The Company filed the Exchange Offer Registration
Statement in September 1998 with the SEC for the registration of $150
million of principal amount of Exchange Notes to be offered in exchange for
the Senior Notes. The Exchange Offer Registration Statement was declared
effective by the SEC on October 13, 1998 and the Exchange Offer was
commenced. The Exchange Offer expires on November 13, 1998, unless extended.
The terms of the Exchange Notes will be identical in all material respects to
the terms of the Senior Notes except that the Exchange Notes have been
registered under the Securities Act of 1933.
The Indenture governing the issuance of the Senior Notes contains certain
restrictive operating and financial covenants including, among other things,
covenants with respect to the following matters: (i) limitation on additional
indebtedness, (ii) limitation on restricted payments, (iii) limitation on
dividends and other payment restrictions affecting restricted subsidiaries, (iv)
limitation on issuances and sales of capital stock of restricted subsidiaries,
(v) limitation on issuances of guarantees by restricted subsidiaries, (vi)
limitation on transactions with stockholders and affiliates, (vii) limitation on
liens, (viii) limitation on any sale lease-back transactions, (ix) limitation on
asset sales, and (x) periodic reports. All of the covenants are subject to a
number of important qualifications and exceptions. These covenants may
adversely affect the Company's ability to finance its future operations or
capital needs or to engage in other business activities that may be in the best
interests of the Company.
The Company's total assets increased $144.3 million, or 292%, from $49.4 million
at December 31, 1997 to $193.7 million at September 30, 1998. The increase is
attributed to internal growth, build out of the fiber optic network and the
receipt of the proceeds from the Senior Notes. The Company had cash and cash
equivalents of $3.5 million at December 31, 1997, as compared with $8.5 million
at September 30, 1998 and marketable securities available for sale of $107.3
million at September 30, 1998 as
16
<PAGE>
compared to no marketable securities at December 31, 1997. The Company had a
working capital deficit of $305,000 at December 31, 1997 as compared to
working capital of $114.2 million at September 30, 1998. The increase in the
working capital is attributed to the repayment of the Company's existing
notes (with the exception of one note bearing interest at 6.75% and an
outstanding balance of $743,000 at September 30, 1998 and a capital lease
obligation with a balance of $430,000 at September 30, 1998), which (other
than the Senior Notes) were repaid on or before August 31, 1998 with the
proceeds from the Senior Notes.
The Company's cash flow from operations was $3.4 million and $10.1 million
for the nine months ended September 30, 1997 and 1998, respectively, an
increase of $6.7 million, or 198% from 1997. The increase in cash flow from
operations was primarily attributed to overall growth and economies of scale
resulting from the internal growth. Additionally, accounts payable and
accrued expenses increased $15.5 million from $12.1 million at December 31,
1997 to $27.6 million at September 30, 1998. The increase was primarily
attributed to increased expenditures and amounts due to vendors relating to
the fiber optic network build out.
Cash used in investing activities for the nine months ended September 30, 1997
and 1998 were $9.6 million and $130.9 million, respectively. The increase in
the cash used in investing activities primarily relates to the investment of
$107.3 million of the proceeds from the Senior Notes in Available for Sale
Marketable Securities, the purchase of telecommunications equipment and costs
incurred with the build out of the fiber optic network. In January 1998, the
Company completed the acquisition of Integrated Communications and Engineering,
Ltd. ("ICEL"), a communications systems integrator and maintenance provider in
Aberdeen, Scotland. The Company paid a total purchase price of approximately
$2.2 million comprised of approximately $610,000 in cash and 207,266 shares of
the Company's common stock.
CapRock expects to require significant financing for capital expenditure and
working capital requirements. CapRock currently estimates that its aggregate
capital requirements will total approximately $35 to $40 million in the fourth
quarter of 1998 and approximately $160 million in 1999. CapRock expects to
make substantial capital expenditures thereafter. Capital expenditures will
be required to: (i) fund the construction and operation of the fiber optic
network; (ii) fund the installation of voice and data switches, and (iii)
open sales offices and add sales support and customer service personnel in
markets throughout Texas, Louisiana, Oklahoma, Arkansas and New Mexico.
CapRock may require additional capital in the future for new business
activities related to its current and planned businesses, or in the event it
decides to make additional acquisitions or enter into joint venture and
strategic alliances. Sources of additional capital may include cash flow
from operations, public or private equity, debt financings, bank debt, vendor
financings and indefeasible right to use contracts. In addition, the Company
may enter into joint construction agreements with carriers, thereby reducing
the capital expenditure requirements. There can be no assurance, however,
that CapRock will be successful in producing sufficient cash flow or raising
sufficient debt or equity capital to meet its strategic business objectives
or that such funds, if available, will be available on a timely basis and on
terms that are acceptable to CapRock and within limitations contained in
Caprock's financing arrangements. Failure to generate or raise sufficient
funds may require CapRock to delay or abandon some or all of its future
expansion plans.
NETWORK BUILD OUT AND FINANCING PLAN
17
<PAGE>
CapRock intends to build out its fiber optic network to approximately 5,500
route miles throughout Texas, Louisiana, Oklahoma, Arkansas and New Mexico by
the end of the year 2000. CapRock intends to use advanced fiber capable of
supporting dense wave division multiplexing with an OC-48 backbone scalable
to OC-192. CapRock intends to install 96 fiber strands and two spare conduits
throughout most of its fiber optic network. CapRock estimates total capital
expenditures of approximately $330 million to complete its fiber optic
network build out, including fiber, construction costs and network
electronics and approximately $80 million for switching equipment and other
capital expenditures through the year 2000. CapRock believes that the net
proceeds from the offering of the Senior Notes, together with cash flow from
operations, borrowings under credit facilities and bank debt, vendor
financings, sales of dark fiber and other sources of financing, will be
sufficient to fund its capital expenditures and working capital requirements
for a period ranging from the end of the second quarter of 1999 to the end of
the fourth quarter of 1999. Additional capital will be required after such
time to finance the fiber optic network build out. In addition, CapRock may
accelerate the rate of deployment of its fiber optic network, which in turn
may accelerate CapRock's need for additional capital. CapRock's actual
capital expenditures will also be affected, possibly materially, by various
factors, including the timing and actual cost of the deployment of the
CapRock's fiber optic network, the timing of cost of expansion into new
markets, the extent of competition and the pricing of telecommunications
services in its markets. Failure to generate or raise sufficient funds may
require CapRock to delay or abandon some or all of its future expansion plans.
CREDIT FACILITY
CapRock is currently negotiating with a several lenders to obtain a senior
credit facility in an amount that the Company believes will range from $50 to
$100 million. The final terms and conditions of the credit facility will depend
on negotiation of definitive documentation for the credit facility. There can
be no assurance, however, as to when or if CapRock will enter into the credit
facility or as to the amount or terms of the credit facility.
NEW ACCOUNTING PRONOUNCEMENTS
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
requires classification of items of other comprehensive income by nature in a
financial statement and a breakout of the accumulated balance of other
comprehensive income separately from retained earnings and additional paid in
capital in the equity section of a statement of financial position. Reporting
comprehensive income provides a measure of all changes in equity that result
from recognized transactions and other economic events of the period other
than transactions with owners in their capacity as owners. Adoption of this
statement did not have a material effect on the Company's consolidated
financial position or results of operation because there are no material
differences between net income and comprehensive income in the Company's
circumstances.
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes
standards for the manner in which business enterprises are to report information
about operating statements in its annual statements and requires those
enterprises to report selected information regarding operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. SFAS 131 is effective for fiscal years beginning after December 15,
1997. Financial statement disclosures for prior periods are required to be
restated. The Company is in the process of evaluating the disclosure
requirements. The adoption of SFAS 131 will not have an
18
<PAGE>
impact on the Company's results of operation, financial position or cash flows
and any effect will be limited to the presentation of its disclosures.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activity" ("SFAS 133") which requires that all
derivatives be recognized in the statement of financial position as either
assets or liabilities and measured at fair value. In addition, all hedging
relationships must be designated, reassessed and documented pursuant to the
provisions of SFAS No. 133. SFAS 133 is effective for fiscal years beginning
after June 15, 1999. The adoption of SFAS 133 will not have an impact on the
Company's results of operations, financial position or cash flow.
CONTINGENCIES
The Company is party to ordinary litigation incidental to its business, none of
which is expected to have a material adverse effect on the results of
operations, financial condition or cash flow.
YEAR 2000
The Year 2000 problem, is the inability of a meaningful portion of the
world's computers, software applications and embedded semiconductor chips to
cope with the change of the year from 1999 to 2000. This issue can be traced
to the infancy of computing, when computer data and programs were designed to
save disk space by truncating the date field to just six digits (two for the
day, two for the month and two for the year). Therefore, information
applications automatically assumed that the two-digit year field represented
a year within the 1900's. As a result of this, systems could fail to operate
or fail to produce correct results when dates roll over to year 2000.
ASSESSMENT
The Year 2000 problem affects computers, software, and other equipment used,
operated, or maintained by the Company for itself and its customers. The
Company has substantially completed the process of assessing the potential
impact of, and the costs of remediating the Year 2000 problem for its internal
systems, facilities systems and equipment.
The Company's business is substantially dependent upon the operation of
computer systems, and as such, the Company has established a Year 2000
committee made up of leaders from the operational areas of the Company to
assess the areas which could be affected by the Year 2000 problem. The
committee has the involvement of senior management and the Board of Directors
and its objectives are a top priority. The Company has undertaken various
initiatives intended to ensure that its computer equipment and software will
function properly with respect to dates in the Year 2000 and thereafter. The
term "computer equipment and software" includes systems that are commonly
thought of as IT (Information Technology) systems, including accounting, data
processing, telephone/PBX systems, scanning equipment and other miscellaneous
systems, as well as systems that are not commonly thought of as IT systems,
such as alarm systems, fax machines or other miscellaneous systems. Both IT
and non-IT systems may contain embedded technology, which complicates the
Company's Year 2000 assessment, remediation and testing efforts. Based upon
its identification and assessment efforts to date, the Company believes that
certain of the computer equipment and software it currently uses will require
replacement or modification. In addition, in the ordinary course of
replacing computer equipment and software, the Company attempts to obtain
replacements that are Year 2000 compliant. The Company currently estimates
that the Year 2000 identification, assessment, remediation and testing
efforts will be substantially complete by June 30, 1999 and that such efforts
will be completed prior to any currently anticipated impact on its computer
19
<PAGE>
equipment and software. The Company estimates that as of September 30, 1998, it
had completed approximately 50% of the initiatives that it believes will be
necessary to fully address potential Year 2000 issues relating to its computer
equipment and software. The projects comprising the remaining 50% of the
initiative are in process and are expected to be completed on or about June
30, 1999.
<TABLE>
<CAPTION>
Year 2000 Initiative Time Frame
- -------------------- ------------
<S> <C>
Identification and assessment regarding IT system issues 2/98 - 1/99
Remediation and testing regarding critical system issues 6/98 - 3/99
Identification, assessment, remediation and testing regarding desktop
and individual system issues 6/98 - 2/99
Identification and assessment regarding non-IT system issues 8/98 - 12/98
Remediation and testing regarding non-IT systems 11/98 - 6/99
</TABLE>
The Company has mailed letters to its significant vendors, service providers
and customers with whom the Company's systems electronically interface to
determine the extent to which such interfaces and system processes are
vulnerable to Year 2000 issues and whether the products and services with
such entities are Year 2000 compliant. As of September 30, 1998, the Company
has received correspondence from approximately 25% of these third parties. A
follow up mailing to significant vendors is scheduled for December 1, 1998,
with responses due by December 31, 1998.
The Company has currently identified costs of replacing or remediating
non-compliant systems at approximately $300,000 and anticipates other costs
not to exceed $250,000 (although no costs have been incurred to date). Such
expenditures will be funded from operating cash flow and represent less than
1% of 1999 projected capital expenditures.
The Company has evaluated its systems and has identified the following systems
and functions as mission critical:
- - Switching Systems
- - Network Operations and Fiber
- - Satellite/Microwave Transmission Equipment
- - Billing Systems
- - Supply Chain (vendor provider of switched services)
SWITCHING SYSTEMS:
Switching equipment is utilized to connect calls to their destination, while
performing other advanced features and recording call record information for
future billing. The switch opens or closes circuits or selects the paths or
circuits to be used for the transmission of information. The Company
currently owns four switches, two of which are physically located in Dallas,
Texas, one in Houston, Texas and one in Phoenix, Arizona. The Company has
completed the assessment of switching equipment and has identified certain
non-compliant features, which can be remediated through software upgrades.
The upgrades are currently being developed by the respective manufacturer of
the switches. All of the software upgrades are scheduled to be complete
during the November 1998 to March 1999 timeframe. The Company anticipates
that the testing procedures relating to the switching equipment will be
complete by the end of the first quarter of 1999. The Company has the
ability to re-route traffic from one switch to another if one switch were to
fail from Year 2000 related issues.
20
<PAGE>
NETWORK OPERATIONS AND FIBER:
The Company currently owns and operates a 260-route mile fiber optic network,
which was completed in January 1997. The network is currently being expanded
to 5,500 route miles (which it expects to be completed by the end of the year
2000). The fiber optic network is designed to be scalable and will include
network-advanced fiber which is capable of supporting dense wave division
multiplexing with an OC-48 backbone scaleable to OC-192. The fiber optic
network will include electronic equipment, which regenerates and transports
the voice, data and other information. A detailed assessment of the network
operations and fiber equipment has been performed and no significant
non-compliant issues have been identified.
SATELLITE/MICROWAVE TRANSMISSION EQUIPMENT AND SATELLITE SERVICE PROVIDERS:
The Company utilizes satellite service providers to provide communications
services to certain customers in remote locations. The Company has sent
correspondence to each of the three vendors supplying the satellite services.
One of the vendors has responded and indicated that the testing, modification
and replacement of equipment, if necessary, are scheduled to be complete by
December 31, 1998. The Company is pursuing commitments from vendors
regarding the assessment and testing procedures regarding these satellites.
BILLING SYSTEMS:
The Company handles its provisioning, customer care, convergent billing and
traffic reporting functions on a proprietary software platform currently
being developed by RiverRock Systems, Ltd., a Texas limited partnership, in
which the Company is a limited partner. These operations support systems
("OSS") and other back office systems are used to enter, schedule and track a
customer's order from the point of sale to the installation and testing of
service. The systems also include or interface with trouble management,
inventory, billing, collection and customer service systems. The system is
scalable and flexible to support the Company's expected future back office
requirements.
The Company believes that substantially all of the hardware, database
platform and operating systems impacting the billing system function are Year
2000 compliant.
SUPPLY CHAIN (VENDOR PROVIDER OF SWITCH SERVICES):
The Company is dependent upon a number of telecommunications carriers during
the process of initiating and terminating calls to end-users. The Company
has sent correspondence to each of the significant suppliers and has received
approximately 25% of the responses from such suppliers. The Company has
scheduled a second mailing to such suppliers as of December 1, 1998 with
responses due back by December 31, 1998. Based upon the Company's current
assessment and responses from vendors, the Company believes that the risks
associated with Year 2000 relating to domestic traffic and terminations are
not significant. The Company is in process of evaluating the impact of Year
2000 as it relates to the termination of traffic in international locations,
and specifically third world and developing countries.
CONTINGENCY PLANS
The Company has begun, but not yet completed, a comprehensive analysis of
problems and costs (including loss of revenues) that would be reasonably likely
to result from the failure by the Company
21
<PAGE>
and certain third parties to complete efforts necessary to achieve Year 2000
compliance on a timely basis.
The Company has not yet completed its identification of the most likely worst
case scenario. However, the Company believes that worst case scenarios could
involve loss of revenues relating to traffic terminating in certain
developing/third world countries, which have not adequately prepared for the
Year 2000. The Company relies upon certain vendors to supply international
services and the possibility exists that some of the traffic in these
developing/third world countries may not be able to be completed. The
estimated loss of revenue, if any, has not and may not be able to be
identified by the Year 2000. Depending on the systems affected, the failure
of any contingency plans developed by the Company, if implemented, could have
a material adverse effect on the Company's financial condition and results of
operations.
DISCLAIMER
The discussion of the Company's efforts, and management's expectations,
relating to Year 2000 compliance are forward-looking statements and the dates
on which the Company believes it will complete such efforts are based upon
management's best estimates, which were derived using numerous assumptions
regarding future events, including the continued availability of certain
resources and other factors. There can be no assurance that these estimates
will prove to be accurate and the actual results could differ materially from
those currently anticipated. Specific factors that could cause such material
differences include, but are not limited to, the availability and cost of
personnel trained in Year 2000 issues, the ability to identify, assess,
remediate and test all relevant computer codes and embedded technology and
similar uncertainties. In addition, variability of definitions of
"compliance with Year 2000" relating to products and services sold by the
Company may lead to claims whose impact on the Company is currently not
estimable. No assurance can be given that the aggregate cost of defending
and resolving such claims, if any, will not materially adversely affect the
Company's results of operations.
22
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
PART 2. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information pertaining to this item is incorporated herein from Part 1.
Financial Information (Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Opertions - Contingenices).
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Telecommunications and IWL each held a special meeting of shareholders on
August 24, 1998 in connection with the Combination. Holders of common stock of
Telecommunications and IWL voted at the respective special meetings on the
following matters which were set forth in the Joint Proxy Statement/Prospectus
dated July 20, 1998 relating to the Combination.
(a) To approve the Agreement and Plan of Merger and Plan of Exchange and
the transactions contemplated thereby.
<TABLE>
<CAPTION>
VOTES: TELECOMMUNICATIONS IWL
<S> <C> <C>
For:...................... 10,398,954 2,806,811
Against:.................. 0 3,900
Abstain:.................. 0 1,800
Broker non-votes*......... N/A ----
</TABLE>
(b) To approve the CapRock Communications Corp. 1998 Equity Incentive
Plan.
<TABLE>
<CAPTION>
VOTES: TELECOMMUNICATIONS IWL
<S> <C> <C>
For:..................... 10,398,954 2,695,601
Against:................. 0 113,800
Abstain:................. 0 3,110
Broker non-votes*........ N/A ----
</TABLE>
(c) To approve the CapRock Communications Corp. 1998 Director Stock Option
Plan.
<TABLE>
<CAPTION>
VOTES: TELECOMMUNICATIONS IWL
<S> <C> <C>
For:..................... 10,398,954 2,791,341
Against:................. 0 17,370
Abstain:................. 0 3,800
Broker non-votes*........ N/A ----
</TABLE>
- -----------------
* Broker non-votes occur when a broker holding stock in street name does not
vote these shares.
In addition, as contemplated by the Combination, all of the general and
limited partnership interests in the Partnership were tendered to and
accepted by the Company for shares of its Common Stock and, in connection
therewith, each of the former partners of the Partnership approved the
Combination and the adoption by the Company of its 1998 Equity Incentive Plan
and its 1998 Director Stock Option Plan.
23
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<S> <C>
2.1 First Amendment to Agreement and Plan of Merger and Plan of
Exchange, dated as of April 30, 1998, by and among the Company,
CapRock, Telecommunications, the Partnership, IWL Acquisition
Corp., and CapRock Acquisition Corp. (collectively, the "Parties").
(Incorporated by reference to Exhibit 2.2 to the Registration
Statement on Form S-4, as amended, SEC Registration No. 333-57365)
(the "Merger Form S-4")).
2.2 Second Amendment to Agreement and Plan of Merger and Plan of
Exchange, dated as of June 20, 1998, by and among the Parties
(incorporated by reference to Exhibit 2.3 to the Merger Form S-4).
3.1 Amended and Restated Articles of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Merger Form S-4).
3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2 to
the Registration Statement on Form S-4, as amended, SEC Registration
No. 333-64699) (the "Exchange Offer Form S-4")).
4.1 Specimen certificate for the Common Stock of the Company
(incorporated by reference to Exhibit 4.3 to the Merger Form S-4).
4.2 Indenture dated as of July 16, 1998, among CapRock Communications
Corp., CapRock Telecommunications Corp., CapRock Fiber Network, Ltd.,
IWL (defined below), and PNC Bank, National Association, Trustee
(Incorporated by reference to Exhibit 4.1 to the Exchange Offer
Form S-4).
4.3 Registration Rights Agreement dated July 16, 1998, among CapRock
Communications Corp., CapRock Telecommunications Corp., CapRock
Fiber Network, Ltd., and Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Donaldson, Lufkin & Jenrette Securities Corporation
and BancOne Capital Markets, Inc. (Incorporated by reference to
Exhibit 4.2 to the Exchange Offer Form S-4).
4.4 Form of Warrant Agreement between IWL and Cruttenden Roth
Incorporated. (Incorporated by reference to Exhibit 1.2 to the IWL
Communications, Incorporated ("IWL") Registration Statement on
Form S-1, as amended, SEC Registration No. 333-22801.)
4.5 Registration Rights Agreement dated January 22, 1998 between IWL
and Nera Limited. (Incorporated by reference to Exhibit 4.5 to the
Merger Form S-4.)
4.6 Registration Rights Agreement dated January 22, 1998 by and among
IWL, Thomas Norman Blair and Margaret Helen Blair. (Incorporated by
reference to Exhibit 4.6 to the Merger Form S-4.)
+27.1 Financial Data Schedule.
(b) Reports on Form 8-K
Current Report on Form 8-K dated August 26, 1998 regarding the
completion of the Combination.
</TABLE>
- ----------------------
+ Filed herewith.
24
<PAGE>
CAPROCK COMMUNICATIONS CORP.
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.
CAPROCK COMMUNICATIONS CORP.
Date: November 13, 1998 By: /s/ Matthew M. Kingsley
---------------------------------------
Matthew M. Kingsley
Corporate Controller (Duly Authorized
Officer and Chief Accounting Officer)
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED
FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 1998 (UNAUDITED) AND FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 8,508
<SECURITIES> 107,292
<RECEIVABLES> 20,730
<ALLOWANCES> (663)
<INVENTORY> 1,569
<CURRENT-ASSETS> 143,542
<PP&E> 47,360
<DEPRECIATION> (11,245)
<TOTAL-ASSETS> 193,686
<CURRENT-LIABILITIES> 29,352
<BONDS> 145,632
0
0
<COMMON> 289
<OTHER-SE> 16,762
<TOTAL-LIABILITY-AND-EQUITY> 193,686
<SALES> 86,704
<TOTAL-REVENUES> 86,704
<CGS> 60,011
<TOTAL-COSTS> 80,798
<OTHER-EXPENSES> (1,729)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,088
<INCOME-PRETAX> 2,548
<INCOME-TAX> 1,325
<INCOME-CONTINUING> 1,223
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,223
<EPS-PRIMARY> 0.04
<EPS-DILUTED> 0.04
</TABLE>
