UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported) March 11, 1998
--------------------------
WINSTAR COMMUNICATIONS, INC.
-------------------------------------------------
(Exact Name of Registrant as Specified in Charter)
Delaware 1-10726 13-3585278
- ---------------------------- ------------ ------------------
(State or Other Jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
230 Park Avenue, New York, New York 10169
- ----------------------------------------- ------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (212) 584-4000
Not Applicable
-------------------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
<PAGE>
Item 5. Other Events
On March 11, 1998, WinStar Communications, Inc. ("WinStar") issued a
press release announcing that it intends to raise, in institutional private
placements under Rule 144A under the Securities Act of 1933, as amended, $350
million of debt securities and $150 million of convertible preferred stock. A
copy of such press release is annexed hereto as Exhibit 99.1.
The Registrant hereby files the financial statements listed on the
Index to Financial Statements on page F-1 annexed hereto.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
(a) Financial Statements of Businesses Acquired.
Not applicable.
(b) Pro Forma Financial Information.
Not applicable.
(c) Exhibits.
99.1 Press Release
2
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
Page
<S> <C>
WinStar Communications, Inc. and Subsidiaries Consolidated Financial Statements
Report of Independent Certified Public Accountants ................................................... F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997 ......................................... F-3
Consolidated Statements of Operations, Ten Months ended December 31, 1995 and the Years Ended
December 31, 1996 and 1997 ........................................................................ F-4
Consolidated Statements of Stockholders' Equity (Deficit), Ten Months Ended December 31, 1995, and the
Years Ended December 31, 1996 and 1997 ............................................................ F-5
Consolidated Statements of Cash Flows, Ten Months Ended December 31, 1995, and the Years Ended
December 31, 1996 and 1997 ........................................................................ F-8
Notes to Consolidated Financial Statements ........................................................... F-9
MIDCOM Communications, Inc. Consolidated Financial Statements as of and for the Year Ended
December 31, 1997
Report of Independent Certified Public Accountants ................................................ F-35
Consolidated Balance Sheet as of December 31, 1997 ................................................ F-36
Consolidated Statement of Operations for the year ended December 31, 1997 ......................... F-37
Consolidated Statement of Shareholders' Deficit for the year ended December 31, 1997 .............. F-38
Consolidated Statement of Cash Flows for the year ended December 31, 1997 ......................... F-39
Notes to Consolidated Financial Statements ........................................................ F-40
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
WinStar Communications, Inc.
We have audited the accompanying consolidated balance sheets of WinStar
Communications, Inc. and Subsidiaries as of December 31, 1996 and 1997, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for the ten months ended December 31, 1995 and the years ended
December 31, 1996 and 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of WinStar
Communications, Inc. and Subsidiaries as of December 31, 1996 and 1997 and the
consolidated results of their operations and their consolidated cash flows for
the ten months ended December 31, 1995 and the years ended December 31, 1996 and
1997, in conformity with generally accepted accounting principles.
GRANT THORNTON LLP
New York, New York
February 12, 1998
F-2
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
December 31, December 31,
1996 1997
ASSETS ------------ -----------
<S> <C> <C>
Current assets
Cash and cash equivalents ..................................................... $ 95,490 $402,359
Short term investments ........................................................ 26,997 16,903
-------- --------
Cash, cash equivalents and short term investments .......................... 122,487 419,262
Investments in equity securities .............................................. 688 --
Accounts receivable, net of allowance for doubtful accounts of $852 and $3,819,
respectively ............................................................... 13,150 30,328
Inventories ................................................................... 5,009 10,296
Prepaid expenses and other current assets ..................................... 15,969 8,985
Net assets of discontinued operations ......................................... 3,814 2,105
-------- --------
Total current assets ....................................................... 161,117 470,976
Property and equipment, net ...................................................... 62,572 284,835
Licenses, net .................................................................... 27,434 174,763
Intangible assets, net ........................................................... 12,955 14,293
Deferred financing costs, net .................................................... 10,535 27,463
Other assets ..................................................................... 4,176 4,071
-------- --------
Total assets ............................................................. $278,789 $976,401
======== =========
</TABLE>
<PAGE>
LIABILITIES AND STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
December 31, December 31,
1996 1997
------------- ------------
<S> <C> <C>
Current liabilities
Current portion of long-term debt ............................................. $ 19,901 $ 386
Accounts payable and accrued expenses ......................................... 29,442 97,714
Current portion of capitalized lease obligations .............................. 3,110 6,848
--------- ---------
Total current liabilities .................................................. 52,453 104,948
Capitalized lease obligations, less current portion .............................. 10,846 21,823
Long-term debt, less current portion ............................................. 265,161 768,469
Deferred income taxes ............................................................ -- 24,000
--------- ---------
Total liabilities .......................................................... 328,460 919,240
--------- ---------
Series C exchangeable redeemable preferred stock, liquidation preference of
$175,000 plus accumulated dividends ........................................... -- 175,553
Commitments and contingencies
Stockholders' equity (deficit)
Series A preferred stock issued and outstanding 3,910 shares at December 31,
1997 ....................................................................... -- 39
Common stock, par value $.01; authorized 200,000 shares, issued and outstanding
28,989 and 34,610, respectively ............................................ 290 346
Additional paid-in-capital .................................................... 75,436 255,741
Accumulated deficit ........................................................... (125,034) (374,518)
--------- ---------
(49,308) (118,392)
Unrealized loss on investments ................................................... (363) --
--------- ---------
Total stockholders' deficit ................................................ (49,671) (118,392)
--------- ----------
Total liabilities, exchangeable redeemable preferred stock and stockholders'
deficit.................................................................. $278,789 $976,401
========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
F-3
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
For the Ten
Months Ended For the Year Ended
December 31, December 31,
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Operating revenues
Telecommunications services-commercial ............... $ 130 $ 4,487 $ 29,796
Telecommunications services-residential .............. 13,007 29,482 8,481
Information services ................................. 2,648 14,650 41,354
--------- --------- ---------
Total operating revenues ................................ 15,785 48,619 79,631
--------- --------- ---------
Operating expenses
Cost of services and products ........................ 12,073 38,233 81,017
Selling, general and administrative expenses ......... 13,617 62,365 156,959
Depreciation and amortization ........................ 1,027 4,501 29,701
-------- --------- ---------
Total operating expenses ................................ 26,717 105,099 267,677
--------- --------- ---------
Operating loss .......................................... (10,932) (56,480) (188,046)
Other (expense) income
Interest expense ..................................... (7,186) (36,748) (77,257)
Interest income ...................................... 2,890 10,515 17,577
Other (expense) income ............................... (866) -- 2,219
--------- --------- ---------
Loss from continuing operations before income tax benefit (16,094) (82,713) (245,507)
Income tax benefit ...................................... -- -- 2,500
--------- --------- ---------
Loss from continuing operations ......................... (16,094) (82,713) (243,007)
Income (loss) from discontinued operations .............. 237 (1,010) (6,477)
--------- --------- ---------
Net loss ................................................ (15,857) (83,723) (249,484)
Preferred stock dividends ............................... -- -- (5,879)
--------- --------- ---------
Net loss applicable to common stockholders .............. $ (15,857) $ (83,723) $(255,363)
========== ========= ==========
Basic and diluted income (loss) per share:
From continuing operations ........................... $ (0.71) $ (2.96) $ (7.49)
From discontinued operations ......................... 0.01 (0.04) (0.19)
--------- --------- ---------
Net loss per share ...................................... $ (0.70) $ (3.00) $ (7.68)
========= ========== ==========
Weighted average shares outstanding ..................... 22,770 27,911 33,249
========= ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
F-4
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE TEN MONTHS ENDED DECEMBER 31, 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
Preferred Stock Treasury Stock
B E Common Stock Common Stock Preferred
Stock B Unreal-
Addi- Defer- ized Total
tional Accumu- red Loss on Stock-
Paid-in lated Compen- Invest- holders'
Shares Amount Shares Amount Shares Amount Capital Deficit Shares Amount Shares Amount sation ments Equity
------ ------ ------ ------ ------- ------ ------- ------- ------ ------ ------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT
FEBRUARY
28, 1995 0.73 $ 733 -- $- 20,147 $201 $ 42,583 $(25,238) -- $- -- $- $- $- $ 18,279
Issuances
of common
stock 4,447 45 10,639 10,684
Issuance
of preferred
stock 932 6,000 (360) 5,640
Conversions
of prefer-
red stock (0.15) (147) (932) (6,000) 684 7 6,140 --
Warrants and
common stock
equivalents
issued in
connection
with long-
term debt
and lease
financing 981 981
Conversion
of long-
term debt 539 5 3,410 3,415
Preferred
stock
dividend 0.11 103 (216) (113)
Issuance
of re-
stricted
stock 150 2 1,236 (1,238) --
Amortiza-
tion of
deferred
compen-
sation 138 138
WinStar
Private
Exchange
Transac-
tion 3,741 37 39,641 (2,507) (36,348)(0.69) (3,330) --
Unrealized
loss on
investments
in market-
able equity
securities (982) (982)
Other, net (433) (433)
Net loss (15,857) (15,857)
------ ------ ------ ------ ------ ------ ------- ------- ------- -------- ----- ------ ------ ----- --------
BALANCES AT
DECEMBER
31, 1995 0.69 $689 -- $- 29,708 $297 $103,837 $(41,311) (2,507)$(36,348)(0.69)$(3,330)$(1,100) $(982) $21,752
====== ====== ====== ===== ====== ====== ======== ========= ====== ========= ==== ======= ======== ====== =======
</TABLE>
See Notes to Consolidated Financial Statements
F-5
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
Treasury Stock
Preferred Preferred
Stock B Common Stock Common Stock Stock B
Unreal- Total
Additi- ized Stock-
tional Accumu- Deferred Gain/ holders'
Paid-in lated Compensa- (Loss) on Equity
Shares Amount Shares Amount Capital Deficit Shares Amount Shares Amount tion Investments (Deficit)
------ ------ ------ ------ -------- -------- ------- ------- ------ ------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT
DECEMBER
31, 1995 0.69 $689 29,708 $297 $103,837 $(41,311) (2,507) $(36,348) (0.69) $(3,330) $(1,100) $(982) $21,752
Issuances
of common
stock 1,383 14 9,619 9,633
Acquisition
of treasury
shares (150) (3,056) (3,056)
Retirement
of treasury
shares (0.69) (689) (2,657) (27) (42,018) 2,657 39,404 0.69 3,330 -
Amortiza-
tion of
deferred
compensa-
tion 1,100 1,100
Conversion
of long-
term debt 555 6 3,878 3,884
Fair value
of stock
options
granted to
nonemploy-
ees and
other, net 120 120
Unrealized
gain on
invest-
ments in
marketable
equity
securities 619 619
Net loss (83,723) (83,723)
------ ------ ------ ------ -------- -------- ------- ------- ------ ------- --------- ---------- ----------
BALANCES AT
DECEMBER
31, 1996 - $- 28,989 $290 $75,436 $(125,034) - $- - $- $- $ (363) $(49,671)
======= ====== ====== ====== ======= ========== ======= ======= ====== ======= ========= ========= =========
</TABLE>
See Notes to Consolidated Financial Statements
F-6
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
Preferred
Stock A Common Stock
Total
Additional Unrealized Stockholders'
Paid-in Accumulated Gain/ (Loss) Equity
Shares Amount Shares Amount Capital Deficit on Investments (Deficit)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT
DECEMBER 31, 1996 ....... -- $- $ 290 $ 75,436 $(125,034) $ (363) $ (49,671)
Issuances of common stock .. -- -- 1,218 12 8,769 -- -- 8,781
Issuances of common stock
for acquistions ......... -- -- 3,984 40 83,311 -- -- 83,351
Issuance of preferred
stock Series A .......... 4,000 40 -- -- 95,960 -- -- 96,000
Dividends declared on
Series A preferred stock -- -- -- -- (5,326) -- -- (5,326)
Issuances of Series A
preferred stock as
dividends in kind ....... 213 2 -- -- 5,324 -- -- 5,326
Dividends on Series C
preferred stock ......... -- -- -- -- (553) -- -- (553)
Conversion of Series A
preferred stock to
common stock ............ (303) (3) 420 4 (1) -- -- --
Series C preferred stock
issuance costs and other,
net ..................... -- -- -- -- (7,179) -- -- (7,179)
Unrealized gain on
investments in
marketable equity
securities .............. -- -- -- -- -- -- 363 363
Net loss ................... -- -- -- -- -- (249,484) -- (249,484)
--------- --------- --------- --------- --------- --------- --------------- -------------
BALANCES AT
DECEMBER 31, 1997 ....... 3,910 $ 39 34,610 $ 346 $ 255,741 $(374,518) $- $ (118,392)
========= ========= ========= ========= ========= ========== =============== ============
</TABLE>
See Notes to Consolidated Financial Statements
F-7
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
For the ten month
period ended For the year ended
December 31, December 31,
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities
Net loss .................................................................. $ (15,857) $ (83,723) $(249,484)
Adjustments to reconcile net loss to net cash used in operating activities:
Net (income) loss from discontinued operations ...................... (237) 1,010 6,477
Depreciation and amortization ....................................... 1,117 5,977 32,360
Deferred income tax benefit ......................................... -- -- (2,500)
Provision for doubtful accounts ..................................... 855 1,562 5,674
Equity in unconsolidated results of AGT ............................. 866 -- --
Non cash interest expense ........................................... 6,151 35,040 53,506
Decrease (increase) in operating assets:
Accounts receivable ............................................... (4,216) (3,838) (24,026)
Inventories ....................................................... (991) (1,897) (9,217)
Prepaid expenses and other current assets ......................... (2,342) (13,442) 510
Other assets ...................................................... (865) (1,940) (178)
Increase in accounts payable and accrued expenses ................... 4,911 9,795 50,306
Net assets provided by (used in) discontinued operations ............ 90 (1,481) (4,559)
Other, net .......................................................... 179 186 --
--------- --------- ---------
Net cash used in operating activities ..................................... (10,339) (52,751) (141,131)
--------- --------- ---------
Cash flows from investing activities:
Investments in and advances to AGT ........................................ (5,704) -- --
Decrease (increase) in short-term investments, net ........................ (73,594) 46,597 10,094
Decrease (increase) in other investments, net ............................. (7,497) 6,447 --
Purchase of property and equipment, net ................................... (8,138) (47,842) (213,356)
Acquisitions of licenses and other ........................................ -- (2,121) (40,190)
Other, net ................................................................ (499) (1,619) 2,494
--------- --------- ---------
Net cash (used in) provided by investing activities ....................... (95,432) 1,462 (240,958)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from (repayments) of long-term debt, net ......................... 224,200 (2,778) 410,585
Net proceeds from redeemable preferred stock .............................. -- -- 168,138
Net proceeds from equity transactions ..................................... 11,259 6,295 104,781
Proceeds from equipment lease financing ................................... 6,998 8,345 9,912
Payment of capital lease obligations ...................................... (676) (2,080) (4,141)
Other, net ................................................................ (898) (1,010) (317)
--------- --------- ---------
Net cash provided by financing activities ................................. 240,883 8,772 688,958
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ...................... 135,112 (42,517) 306,869
Cash and cash equivalents at beginning of period .......................... 2,895 138,007 95,490
--------- --------- ---------
Cash and cash equivalents at end of period ................................ 138,007 95,490 402,359
Short-term investments at end of period ................................... 73,595 26,997 16,903
--------- --------- ---------
Cash, cash equivalents and short-term investments at end of period ........ $ 211,602 $122,487 $419,262
========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
F-8
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1-Summary of Significant Accounting Policies
Consolidation
The consolidated financial statements include the accounts of WinStar
Communications, Inc. and its subsidiaries (collectively, "WinStar" or the
"Company"). All material intercompany transactions and accounts have been
eliminated in consolidation.
Nature of Business
The Company provides facilities-based voice and data telecommunications
services to businesses and other customers in major metropolitan areas
throughout the United States. WinStar's licenses provide the Company with the
largest amount of 38 GHz radio spectrum in the country, which allows the Company
to create a nationwide network on a cost efffective basis using its
fiber-quality digital capacity in the 38 GHz band to provide its customers with
a broad range of attractively priced services, and an alternative to the
incumbent local exchange carriers, other competitive local exchange carriers and
the interexchange carriers. Additionally, the Company produces, aggregates and
distributes information and entertainment content, some of which is distributed
as part of its telecommunications service offerings to different services in the
market place, as well as through traditional and new media outlets, including
television, video, cable, radio and the Internet. The Company's
telecommunications services are subject to varying degrees of federal, state and
local regulation.
To capitalize on opportunities in the telecommunications industry, the
Company is pursuing a rapid expansion of its telecommunications services, which
will require significant amounts of capital to finance capital expenditures and
anticipated operating losses. The Company may elect to slow the speed or narrow
the focus of this expansion in the event it is unable to raise sufficient
amounts of capital on acceptable terms.
Fiscal Year
The Company changed its fiscal year end from February 28 to December
31, effective January 1, 1996. Accordingly, these financial statements present
the ten-month transition period ended December 31, 1995, and the years ended
December 31, 1996 and 1997.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents. Cash
equivalents consist of money market fund investments, short-term certificates of
deposit, and commercial paper. Exclusive of cash in banks, cash equivalents at
December 31, 1996 and 1997 were $84.5 million and $395.3 million, respectively,
which approximate fair value.
Short-term Investments
Short-term investments are widely diversified and principally consist
of certificates of deposit and money market deposits, U.S. government or
government agency securities, commercial paper rated "A-1/P-1" or higher, and
municipal securities rated "A" or higher with an original maturity of greater
than three months and less than six months. Short-term investments are
considered held-to-maturity and are stated at amortized cost which approximates
fair value. As of December 31, 1996 and 1997, cash, cash equivalents and
short-term investments totaled $122.5 million and $419.3 million, respectively.
F-9
<PAGE>
Inventories
Inventories are composed of film inventories that include direct and
indirect production costs, which are amortized to expense in the proportion that
revenue recognized during the year for each film bears to the estimated total
revenue to be received from all sources under the individual film forecast
method. Management's estimate of forecasted revenues exceeds the unamortized
costs on an individual program basis. Such forecasted revenue is subject to
revision in future periods if warranted by changing market conditions.
Property and Equipment
Property and equipment is stated at cost. Depreciation and amortization
are generally computed using the straight-line method over the estimated useful
lives of the related assets.
The Company constructs certain of its own network systems and related
facilities. Certain internal costs directly related to the construction of such
facilities, including interest and salaries of certain employees, are
capitalized. Such costs amounted to approximately $4.1 million for the year
ended December 31, 1997, and were insignificant in prior years.
Costs incurred to develop software for internal use are capitalized as
incurred. Such costs amounted to $452,000, and $7,091,000 for the years ended
December 31, 1996 and 1997, respectively; and were insignificant in prior years.
The Company follows the policy of capitalizing interest expense as a
component of the cost of its telecommunications equipment constructed for its
own use.
Licenses and Intangible Assets
Licenses and intangible assets are being amortized by the straight-line
method over their estimated useful lives.
Goodwill represents the excess of cost over the fair value of assets
acquired. The Company's policy is to measure goodwill impairment by considering
a number of factors as of each balance sheet date including (i) current
operating results of the applicable business, (ii) projected future operating
results of the applicable business, (iii) the occurrence of any significant
regulatory changes which may have an impact on the continuity of the business,
and (iv) any other material factors that affect the continuity of the applicable
business. The amortization period for goodwill is determined on a case-by-case
basis for each acquisition from which goodwill arises based on a review of the
nature of the business acquired as well as the factors cited above (see Note 6).
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS
109"). Pursuant to SFAS 109, deferred income taxes are recognized for temporary
differences between financial statement and income tax bases of assets and
liabilities, loss carryforwards and tax credit carryforwards for which income
tax benefits are expected to be realized in future years. A valuation allowance
is established to reduce deferred tax assets if it is more likely than not that
all, or some portion, of such deferred tax assets will not be realized. The
effect on
F-10
<PAGE>
deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date.
Revenue Recognition
In the telecommunications segment, revenues are recorded upon placing
of calls or rendering of other related services. In the information services
segment, revenues from film productions are recognized when a program is
accepted by the licensee and is available for broadcast. Revenues from the
licensing of film productions are recognized when the license period begins and
the film is available for broadcast. Revenues from advertising sales are
recognized when the related advertising is broadcast.
Basic and Diluted Loss Per Share
Basic and diluted loss per share is calculated by dividing the net
loss, after consideration of preferred stock accretion and dividends, by the
weighted average number of shares of common stock outstanding during each
period. The adoption of Statement of Financial Accounting Standard No. 128,
"Earnings Per Share" had no material impact on the presentation of loss per
share for the periods presented. Stock options and warrants have been excluded
from the calculation of diluted loss per share as their effect would have been
antidilutive. (See Notes 13 and 14.)
Concentration of Credit Risk
Financial instruments which potentially subject the Company to
concentration of credit risk consist principally of trade receivables.
Concentration of credit risk with respect to these receivables is generally
diversified due to the large number of entities comprising the Company's
customer base and their dispersion across geographic areas. The Company
routinely addresses the financial strength of its customers and, as a
consequence, believes that its receivable credit risk exposure is limited. The
Company's short term investments and cash equivalents are potentially subject to
concentration of credit risk, but such risk is limited due to such amounts being
invested in investment grade securities.
Use of Estimates in Preparing Financial Statements
In preparing financial statements in conformity with generally accepted
accounting principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Reclassifications
Certain prior period amounts have been reclassified to conform to the
current period presentation.
F-11
<PAGE>
Note 2-Acquisitions
Acquisitions of Businesses
Milliwave Limited Partnership
On January 2, 1997, a subsidiary of the Company merged with the
corporate shareholders of Milliwave Limited Partnership ("Milliwave"), a large
holder of 38 GHz licenses in the United States, covering 160 million people in
more than 80 major markets. The merger consideration paid by the Company to the
shareholders of the corporate partners of Milliwave was $116.0 million ($40.7
million in cash and 3.6 million shares of the Company's common stock, which had
an aggregate market value of $75 million). The merger was treated as a
"purchase" for accounting purposes with the purchase price principally allocated
to licenses. In addition, approximately $26.5 million of deferred tax
liabilities were recorded in connection with the acquisition, with a
corresponding allocation to licenses, which will be amortized on a straight-line
basis over 40 years. Milliwave had minimal operations prior to its merger into
the Company. The accounts of Milliwave have been consolidated into the Company's
financial statements as of the date of acquisition.
Unaudited pro forma results of operations (in thousands, except per
share data), which reflect the combined operations of the Company and Milliwave
as if the merger occurred as of January 1, 1996, are as follows:
For the Year
Ended
December 31, 1996
------------------
Operating Revenues............................. $47,131
Net Loss....................................... $(91,898)
Net Loss Per Share............................. $(2.92)
Local Area Telecommunications, Inc.
In October 1996, a subsidiary of the Company acquired certain assets of
Local Area Telecommunications, Inc. ("Locate"), comprising its business as a
competitive access provider of local digital microwave distribution services and
facilities to large corporations and to interexchange and other common carriers.
The assets acquired included multiple 38 GHz licenses in the New York
metropolitan area. The purchase price for such assets was $17.5 million, which
was paid in the form of promissory notes, which were paid in 1997 (see Note 7).
The acquisition has been accounted for as a "purchase" for accounting purposes,
with the majority of the purchase price allocated to licenses, which will be
amortized on a straight-line basis over 40 years. The accounts of Locate have
been consolidated into the Company's financial statements as of the date of the
acquisition.
Avant-Garde Telecommunications, Inc.
Avant-Garde Telecommunications, Inc. ("Avant-Garde" or "AGT") was a
privately held company which held 38 GHz radio licenses granted by the FCC in
September 1993. Through July 17, 1995, the Company owned 49% of Avant-Garde,
which it acquired for $4.9 million, and accounted for its investment in
Avant-Garde under the equity method. For the period from March 1, 1995 to July
17, 1995, Avant-Garde had net losses of $1.8 million. On July 17, 1995, pursuant
to the terms of a merger agreement, the Company exchanged 1,275,000 restricted
shares of its common stock valued at $5.1 million for the 51% of Avant-Garde
that it did not already own. The acquisition of Avant-Garde has been treated as
a "purchase"
F-12
<PAGE>
for accounting purposes, with $12.6 million allocated to the licenses acquired,
which are being amortized on a straight-line basis over 40 years. The accounts
of Avant-Garde have been consolidated into the Company's financial statements as
of the date of the acquisition.
Other Acquisitions of Businesses
During 1997, the Company acquired certain other telecommunications and
information services companies which were not material.
Unaudited results of operations for acquisitions consummated through
December 31, 1997 other than Milliwave have not been included because they are
not material to the consolidated statement of operations of the Company.
During 1996, a subsidiary of the Company acquired 100% ownership or a
controlling interest in a number of companies engaged in the production and
distribution of entertainment content. These acquisitions were treated as
"purchases" for accounting purposes. The aggregate consideration for the
acquisitions was approximately $6.4 million, consisting of $4.1 million in cash,
$800,000 in notes payable and 100,605 shares of the Company's common stock or
share equivalents, valued at $1.5 million. The accounts of the acquired
companies have been consolidated with the Company's financial statements as of
the date of acquisitions.
Acquisition of Assets
In October 1997, a subsidiary of the Company purchased certain
telecommunication assets from US ONE Communications Corp., US ONE Communications
Services, Corp. and US ONE Communications of New York, Inc. (collectively, the
"Sellers") which were entities in bankruptcy under chapter 11 of the United
States Bankruptcy code. The aggregate purchase price was approximately $81.3
million, of which approximately $61.3 million was paid in cash at the closing
and $20.0 million is payable by WinStar in cash and/or shares of the common
stock of WinStar, at WinStar's discretion, on the effective date of the Sellers
confirmed plan of reorganization. Included in fixed assets are certain equipment
which the Company plans to sell within the near term.
Acquisition of Additional Licenses
During 1997, the Company executed agreements to acquire additional
38GHz licenses, subject to FCC approval. The total purchase price for the
licenses will be $55.0 million, payable in shares of Common Stock of the Company
or in certain instances, at the Company's election, cash, which will be payable
at the time of closing. During 1997, licenses acquired amounted to $10.4 million
of which $7.5 million was paid in common stock at the closing. The remaining
license acquisitions are expected to close within the next 12 months.
In connection with the acquisition of additional licenses, the Company
entered into service agreements whereby the Company supplied and installed
telecommunications equipment and provided related consulting services. Total
revenues recorded under such agreements were $4.2 million in 1997.
F-13
<PAGE>
Acquisitions Subsequent to December 31, 1997
GoodNet
On January 12, 1998, pursuant to an agreement between the Company and
Telesoft Corp., the Company acquired Telesoft's Internet services subsidiary,
("Goodnet"), for a purchase price of approximately $22.0 million, consisting of
$3.5 million cash and 732,784 shares of common stock of the Company valued at
$18.5 million. GoodNet is a national provider of Internet services, offering
high-capacity data communication services.
Midcom Communications, Inc.
Effective January 21, 1998 (the "Closing Date"), pursuant to an
agreement between the Company and MIDCOM Communications Inc. and its
subsidiaries (collectively, "Midcom"), the Company acquired substantially all of
Midcom's assets and businesses for a purchase price of approximately $92.0
million in cash. On December 23, 1997, $9.2 million of the purchase price was
placed in escrow. On the Closing Date, $48.5 milliion of the purchase price was
paid in cash to Midcom and its designees and $10.8 million of the purchase price
was placed in escrow along with the initial deposit of $9.2 million to secure
Midcom's obligations to indemnify the Company in certain circumstances. In
addition, $23.5 million of the purchase price was placed in escrow on the
Closing Date to secure Midcom's obligation to refund a portion of the purchase
price in the event of a post-closing adjustment of the purchase price under the
purchase agreement.
Midcom is an entity in bankruptcy under Chapter 11 of the U.S. Bankruptcy Code.
Midcom is a provider of long distance voice and data telecommunications
services primarily to small and medium-sized businesses, most of which are
located in major metropolitan areas of California, Florida, Illinois, New York,
Ohio and Washington.
Note 3-Investments in Marketable Equity Securities
The Company treats its investments in marketable securities as
available for sale securities. As such, they are carried at market value, with
the difference between the historical cost (which is determined on a FIFO basis)
and the market value reflected in unrealized gains or losses on marketable
equity securities, a component of stockholders' equity. During the year ended
December 31, 1996, proceeds of $6,400,000 were realized on the sale of
marketable securities, which were sold at carrying value. During the year ended
December 31, 1997, all such investments were sold, generating proceeds of
approximately $1,024,000 and a loss of approximately $27,000, which was
recognized in operations. At December 31, 1996 and 1997, unrealized losses of
$363,000 and $0 were carried in stockholders' equity.
Note 4-Inventories
Inventory is comprised of film inventories of $5,009,000 and
$10,296,000 at December 31, 1996 and 1997, respectively.
F-14
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 5-Property and Equipment
Property and equipment consist of the following:
<TABLE>
<CAPTION>
December 31, December 31, Estimated
1996 1997 Useful Life
---- ---- -----------
(in thousands)
<S> <C> <C> <C>
Telecommunications equipment and software.. $58,788 $293,728 5 to 10 years
Furniture, fixtures and other.............. 3,354 12,504 4 to 5 years
Leasehold improvements..................... 4,845 23,162 Lesser of life of the
--------- ---------- lease or life of the asset
66,987 329,394
Less accumulated depreciation
and amortization...................... (4,415) (44,559)
---------- -----------
$62,572 $284,835
========== ===========
</TABLE>
Note 6-Intangible Assets
Intangible assets consist of the following:
<TABLE>
<CAPTION>
December 31, December 31, Estimated
1996 1997 Useful Life
---- ---- -----------
(in thousands)
<S> <C> <C> <C>
Goodwill......................... $13,726 $17,865 5 to 20 years
Covenants not to compete and other.. 37 26 5 to 10 years
--------- ----------
13,763 17,891
Less accumulated amortization....... (808) (3,598)
---------- -----------
$12,955 $14,293
========== ===========
</TABLE>
Licenses, which are subject to renewal through February 2001, are
amortized over a 40-year period, in accordance with industry practice. As of
December 31, 1996 and 1997, the value of licenses was $27.4 million and $174.8
million, net of accumulated amortization of $820,000 and $4.9 million,
respectively.
Note 7-Long-Term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31, December 31,
1996 1997
(in thousands)
<S> <C> <C>
12- 1/2% Guaranteed Senior Secured Notes Due 2004, WEC........................................ $- $200,000
12- 1/2% Guaranteed Senior Secured Notes Due 2004, WEC II..................................... - 50,000
14% Senior Discount Notes Due 2005............................................................ 176,328 201,843
14- 1/2% Senior Deferred Interest Notes Due 2005.............................................. - 111,691
15% Senior Subordinated Deferred Interest Notes Due 2007...................................... - 103,542
14% Convertible Senior Subordinated Discount Notes Due 2005................................... 88,164 100,922
Other Notes Payable........................................................................... 20,570 857
------------- ----------
Total...................................................................................... 285,062 768,855
Less Current Portion.......................................................................... 19,901 386
------------- ----------
Total Long Term Debt.......................................................................... $265,161 $768,469
============= ==========
</TABLE>
F-15
<PAGE>
1995 Debt Placement
In October 1995, the Company completed a $225.0 million private
placement of debt securities with institutional investors (the "1995 Debt
Placement"). The transaction was structured as a units offering with two
components, $150.0 million of Senior Discount Notes due 2005 (the "Senior
Discount Notes"), and $75 million of Convertible Senior Subordinated Discount
Notes due 2005 (the "1995 Convertible Notes"), convertible at $20.625 (subject
to adjustment), a 10% premium over the closing price on October 18, 1995, the
day of pricing. Both securities accrue interest at 14% per annum, with no
interest payable during the first five years, and principal payable only at
maturity in October 2005. Commencing April, 2001, both securities require the
payment of interest only, in cash, until maturity. In addition, the 1995
Convertible Notes, including accretion thereon, will be automatically converted
during the initial five-year period if the market price of the Company's common
stock exceeds certain levels for thirty consecutive trading days, ranging from
$37.50 per share in the first year to $44.00 per share in the fifth year.
In accordance with the terms of the 1995 Debt Placement, the Company
consummated an exchange offer in 1996 with respect to the Senior Discount Notes,
whereby these notes were exchanged for new notes which were identical in every
respect to the original Senior Discount Notes except that the new notes were
registered under the Securities Act of 1933.
1997 Debt Placements
In March 1997, the Company and WinStar Equipment Corp. ("WEC") issued
an aggregate of $300.0 million of notes in the March 1997 Debt Placement,
consisting of (i) $100.0 million of the 1997 Senior Deferred Interest Notes Due
2005 (the "1997 Senior Notes"), ranking pari passu with the 1995 Senior Discount
Notes, and (ii) $200.0 million of 1997 Guaranteed Senior Secured Notes Due 2004
(the "WEC Notes"). The Company also obtained a $150.0 million facility
("Facility") from affiliates of certain of the initial purchasers of the Notes.
In August 1997, WinStar Equipment II Corp. ("WEC II") issued, pursuant to the
Facility, $50.0 million of 1997 Guaranteed Senior Secured Notes Due 2004 (the
"WEC II Notes") and in October 1997, the Company utilized the remaining $100.0
million available under the Facility, issuing an aggregate of $100.0 million
principal amount of 1997 Senior Subordinated Deferred Interest Notes Due 2007
(the "October 1997 Notes").
The obligations of WEC and WEC II under the WEC Notes and the WEC II
Notes are unconditionally guaranteed by the Company and are secured by a
security interest in the equipment and other property purchased by WEC and WEC
II, as the case may be, with the proceeds thereof.
The WEC Notes bear interest at a rate of 12 1/2% per annum, payable on
March 15 and September 15, commencing September 15, 1997. The WEC Notes will
mature on March 15, 2004 and are redeemable on or after March 15, 2002, at the
option of the Company, in whole or in part, at certain specified prices.
Additionally, in the event that by March 18, 1999, the Company has not applied
the $200.0 million of proceeds from the sale of the WEC Notes to fund the
acquisition costs of Designated Equipment (as defined), the Company is required
to redeem the WEC Notes in an aggregate principal amount equal to such shortfall
at a redemption price of 112.5% of such principal amount, plus accrued interest,
if any, to the date of redemption.
The WEC II Notes bear interest at a rate of 12 1/2% per annum, payable
on March 15 and September 15, commencing September 15, 1997. The WEC II Notes
mature on March 15, 2004 and are redeemable on or after March 15, 2002, at the
option of the Company, in whole or in part, at certain specified prices.
Additionally, in the event that by August 8, 1999, the Company has not applied
the $50.0
F-16
<PAGE>
million of proceeds from the sale of the WEC Notes to fund the acquisition costs
of Designated Equipment, the Company is required to redeem the WEC II Notes in
an aggregate principal amount equal to such shortfall at a redemption price of
112.5% of such principal amount, plus accrued interest, if any, to the date of
redemption.
The 1997 Senior Notes are unsecured, senior indebtedness of the
Company, rank pari passu in right of payment with all existing and future senior
indebtedness of the Company, and are senior in right of payment to all existing
and future subordinated indebtedness of the Company. The 1997 Senior Notes bear
interest at a rate of 14 1/2%. Until October 15, 2000, interest on the 1997
Senior Notes will accrue and compound semiannually, but will not be payable in
cash. Interest on the Accumulated Amount (as defined in the 1997 Senior Notes
Indenture) of the 1997 Senior Notes as of October 15, 2000 will be payable
semiannually in cash on April 15 and October 15 of each year commencing April
15, 2001. The 1997 Senior Notes mature on October 15, 2005 and are redeemable on
or after October 15, 2000, at the option of the Company, in whole or in part, at
certain specified prices.
The October 1997 Notes are unsecured, senior subordinated obligations
of the Company, rank pari passu in right of payment with the 1995 Convertible
Notes and are junior in right of payment to all existing future senior
indebtedness of the Company. The October 1997 Notes bear interest at a rate of
15% per annum, and are payable on March 1 and September 1, commencing September
1, 2002. Until March 1, 2002, interest on the Notes will accrue and be
compounded semiannually on each Semi Annual Interest Accrual Date (as defined in
the Indenture relating to the October 1997 Notes), but will not be payable in
cash. Interest on the Accumulated Amount (as defined in the Indenture relating
to the October 1997 Notes) of the Notes as of March 1, 2002 will be payable
semiannually commencing September 1, 2002. The Notes will mature on March 1,
2007 and are redeemable on or after March 1, 2002, at the option of the Company,
in whole or in part, at certain specified prices.
The terms of the Indentures relating to the 1995 and 1997 Debt
Placements and the Certificates of Designation relating to certain of the
Company's Preferred Stock agreements (see Notes 12 and 13) contain covenants
placing certain restrictions on the ability of the Company to pay dividends or
make other restricted payments, incur additional indebtedness, issue guarantees,
sell assets, or enter into certain other specified transactions.
Other
On October 8, 1996, in connection with the purchase of Locate (see Note
2), the Company issued two promissory notes in the aggregate principal amount of
$17.5 million (the "Locate Notes") bearing interest at an annual rate of 8%.
Interest on the Locate Notes was payable on a quarterly basis. The Notes were
due on the earlier of April 8, 1997, or the day after the date on which the
shares into which the Notes may be converted have been registered pursuant to an
effective registration statement. During 1997, the Locate Notes including
accrued interest were paid in full. At December 31, 1996, the aggregate amount
of the Locate Notes, including accrued interest thereon, was $17.8 million.
In May 1995, a subsidiary of the Company issued $7.5 million of five
year collateralized convertible notes bearing interest at a rate of 7%, payable
semiannually, with all principal due and payable on May 24, 2000. On December
28, 1995, the note holders converted $3.75 million of the convertible notes and
accrued interest thereon into 539,255 shares of common stock of the Company, and
on November 24, 1996, converted the remaining outstanding notes of $3.75 million
principal amount plus accrued interest thereon into 554,880 shares of common
stock of the Company.
F-17
<PAGE>
Maturities of long-term debt at December 31, 1997, are as follows:
(in thousands)
1998................................................ $386
1999................................................ 277
2000................................................ 194
2001................................................ -
2002................................................ -
Thereafter.......................................... 767,998
----------------------
$768,855
======================
Note 8-Fair Value of Financial Instruments
The fair value of the Company's financial instruments classified as
current assets or liabilities, including cash and cash equivalents, short-term
investments, accounts and notes receivable, and accounts payable and accrued
expenses approximate carrying value, principally because of the short maturity
of these items. Marketable equity securities are stated at quoted market value.
The carrying amounts of the long-term debt payable to financial
institutions issued pursuant to two of the Company's subsidiaries' asset-based
lending agreements approximate fair value because the interest rates on these
agreements change with market interest rates.
The fair values of capitalized lease obligations approximate carrying
value based on their effective interest rates compared to current market rates.
Estimated fair values of the Company's Long Term Notes Payable,
Convertible Notes Payable, and Exchangeable Redeemable Preferred Stock which
were calculated based upon quoted market prices, are as follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997
----------------- ----------------
Carrying Carrying
Amount Fair Value Amount Fair Value
(in thousands)
<S> <C> <C> <C> <C>
14% Senior Discount Notes Due 2005 ........................ $176,328 $179,455 $201,843 $233,144
14% Convertible Senior Subordinated Discount Notes Due 2005 $ 88,164 $ 94,141 $100,922 $216,228
14 1/2% Senior Deferred Interest Notes Due 2005 ........... -- -- $111,691 $132,000
15% Senior Subordinated Deferred Interest Notes Due 2007 .. -- -- $103,542 $122,500
12 1/2% Guaranteed Senior Secured Notes Due 2004, WEC ..... -- -- $200,000 $224,500
12 1/2% Guaranteed Senior Secured Notes Due 2004, WEC II .. -- -- $ 50,000 $ 55,750
141/2% Series C Senior Cumulative Exchangeable Redeemable
Preferred Stock ........................................ -- -- $175,552 $177,675
</TABLE>
Note 9-Capital Lease Obligations
The Company leases telecommunications and other equipment through
various equipment lease financing facilities. Such leases have been accounted
for as capital leases.
F-18
<PAGE>
Future minimum lease payments on these capital leases are as follows:
<TABLE>
Year Ending December 31, (in thousands)
<S> <C>
1998.................................................................................. $9,941
1999.................................................................................. 9,758
2000.................................................................................. 8,321
2001.................................................................................. 5,313
2002.................................................................................. 1,834
Thereafter............................................................................ 194
----------------------
Total payments........................................................................ 35,361
Less amount representing interest..................................................... (6,690)
----------------------
Present value of minimum lease payments............................................... $28,671
=====================
</TABLE>
The carrying value of assets under capital leases was $15.9 million and
$28.0 million at December 31, 1996 and 1997 respectively, and is included in
property and equipment. Amortization of these assets is included in depreciation
expense.
Note 10-Commitments and Contingencies
a. Operating Leases
The Company's offices, manufacturing and warehousing facilities, along
with various equipment and roof access rights, are leased under operating leases
expiring in 1998 through 2012. Certain leases contain escalation clauses based
upon increases in the consumer price index.
Future minimum lease payments on noncancellable operating leases are as
follows:
<TABLE>
Year Ending December 31, (in thousands)
<S> <C>
1998.................................................................................. $13,800
1999.................................................................................. 13,600
2000.................................................................................. 13,200
2001.................................................................................. 12,800
2002.................................................................................. 12,400
Thereafter............................................................................ 80,500
----------------------
$146,300
======================
</TABLE>
Rent expense for the ten month period ended December 31, 1995 and the
years ended December 31, 1996 and 1997 were $1.0 million, $4.4 million and $11.6
million, respectively.
b. Employment Contracts
Amounts due under employment contracts are as follows:
<TABLE>
Year Ending December 31, (in thousands)
<S> <C>
1998.................................................................................. $2,485
1999.................................................................................. 1,728
2000.................................................................................. 479
----------------------
$4,692
======================
</TABLE>
F-19
<PAGE>
c. Litigation
The Company's residential long distance subsidiary, WinStar Gateway
Network, Inc., occasionally receives inquiries from state authorities arising
with respect to consumer complaints concerning the provision of
telecommunications services, including allegations of unauthorized switching of
long distance carriers and misleading marketing. The Company believes such
inquiries are common in the long distance industry and addresses such inquiries
in the ordinary course of business. In December 1996, the Federal Communications
Commission ("FCC") and WinStar Gateway Network, Inc. ("WGN") entered into a
consent decree which terminated an inquiry by the FCC into any alleged
violations of unauthorized carrier conversions through the use of contest
programs by certain of WGN's agents. The FCC cited WGN's efforts in identifying
the problems caused by these agents and its proactive response in implementing
self-directed remedial actions on its own as significant factors leading to the
consent decree in lieu of initiating a formal investigation. The Company entered
into assurances of voluntary compliance with the attorneys general of a number
of states and has also initiated negotiations with other state authorities to
resolve any claims by such authorities arising from the contest programs. The
Company does not believe that the resolution of these issues will have a
material adverse effect on the Company, its financial condition, or its results
of operations.
In June 1996, the Company commenced an action for declaratory judgment
against a former officer of WGN, who had notified the Company of his belief that
he was entitled to the issuance of certain shares of common stock of the Company
(or payment of the cash value thereof) under the terms of stock options granted
to him during his employment with WGN. He has based his beliefs on standard
antidilution language contained in his stock option agreement. Such language was
designed and intended to adjust the number of shares purchasable thereunder in
the event of a merger, capital restructuring or other similar event of the
Company. As WinStar Communications, Inc. has never been subject to a merger or
capital restructuring, the former officer was immediately notified of the
Company's belief that his claim was without merit in law or fact. To expedite
resolution of these issues, the Company currently is seeking declaratory
judgment that it has no obligation to the former officer.
In January 1998, a stockholder suit, purported to be a class action,
was commenced against the Company, its directors (and certain former directors)
and one non-director officer in the Delaware Chancery Court seeking among other
things, to invalidate certain portions of the Company's Stockholder Rights Plan,
adopted in July 1997 (the "Rights Plan") (see Note 12), and to recover
unspecified damages and attorneys' fees. The complaint alleges that certain
provisions of the Rights Plan, particularly the so-called "Continuing Directors"
provision, are not permitted under the Delaware General Corporation Law and the
Company's Certificate of Incorporation. The Company believes strongly that these
allegations are without merit and that the Rights Plan was properly adopted and
is valid in its entirety. The Company is reviewing its available alternatives
with regard to responding to this action.
The Company is also involved in miscellaneous claims, inquiries and
litigation arising in the ordinary course of business. The Company believes that
these matters, taken individually or in the aggregate, would not have a material
adverse impact on the Company's financial position or results of operations.
d. Other
In connection with the purchase of telecommunications equipment
including switches and radios, the Company enters into agreements with the
suppliers of such equipment. As of December 31, 1997, the Company's
noncancellable purchase commitments under these agreements were approximately
$31 million. In addition, the Company has guaranteed $3.0 million of debt of
Global Products.
F-20
<PAGE>
Note 11-Income Taxes
SFAS No. 109 requires the use of the liability method in accounting for
income taxes. Temporary differences and carryforwards that give rise to deferred
tax assets and liabilities are as follows:
December 31, December 31,
1996 1997
(in thousands)
Deferred tax assets:
Net operating loss carryforward ... $ 48,218 $ 134,550
Deferred interest expense ......... 10,417 21,636
Allowance for doubtful accounts ... 433 1,140
Deferred compensation ............. -- 748
Other ............................. 961 2,291
--------- ---------
Gross deferred tax assets ......... 60,029 160,365
Valuation allowance ............... (58,586) (119,874)
--------- ---------
Deferred tax asset net of allowance 1,443 40,491
--------- ---------
Deferred tax liabilities:
Depreciation ...................... (1,354) (5,998)
Amortization ...................... (89) (58,493)
--------- ---------
Gross deferred tax liabilities .... (1,443) (64,491)
--------- ----------
Net deferred tax asset (liability) ... $- $ (24,000)
========= ==========
The federal net operating loss carryforward at December 31, 1997 is
approximately $345.0 million. If not utilized, the net operating loss
carryforward will expire in various amounts through the year 2012.
Some of these losses are subject to utilization limitation under
Section 382 of the Internal Revenue Code. However, the Company believes that
substantially all of such losses will be available to offset future income.
SFAS No. 109 requires a valuation allowance against deferred tax assets
if, based on the weight of available evidence, it is more likely than not that
some or all of the deferred tax assets may not be realized. The valuation
allowances at December 31, 1996 and December 31, 1997, primarily pertain to
uncertainties with respect to future utilization of net operating loss
carryforwards.
On January 2, 1997, a net deferred tax liability of $26.5 million was
recorded in connection with the acquisition of Milliwave (see Note 2). This
deferred tax liability resulted from the temporary difference between the book
and tax basis of the acquired licenses, and related to the scheduled reversal of
the temporary differences through amortization in years 2018 through 2036 that
could not be offset by deferred tax assets existing at January 2, 1997, the date
of the Milliwave acquisition.
During 1997, the Company recognized a deferred income tax benefit of
$2.5 million relating to the Company's net loss carryforwards. The Company
recognizes income tax benefits to the extent of future reversals of existing
temporary differences.
Note 12-Stockholders' Equity
Common Stock
The authorized common stock of WinStar was increased during 1997 from
75.0 million shares to 200.0 million shares, $.01 par value. The holders of
common stock of WinStar are entitled to one vote for each
F-21
<PAGE>
share held of record on all matters submitted to a vote of stockholders.
Although the Company has no present intention of paying any cash dividends (and
is currently restricted from doing so under its indentures), holders of the
common stock are entitled to receive ratably such dividends as may be declared
by the Board of Directors out of funds legally available therefor. In the event
of a liquidation or dissolution of WinStar, holders of the common stock are
entitled to share ratably in all assets remaining after payment of all
liabilities and the liquidation preferences of preferred shares. Holders of
common stock have no preemptive rights and have no rights to convert their
common stock into any other securities. There are no redemption or sinking fund
provisions applicable to the common stock.
Preferred Stock
The authorized capital stock of the Company includes 15 million shares
of "Blank Check" preferred stock, which may be issued from time to time in one
or more series upon authorization by the Company's Board of Directors. The Board
of Directors, without further approval of the stockholders, is authorized to fix
the rights and terms, conversion rights, voting rights, redemption rights and
terms, liquidation preferences and any other rights, preferences, privileges and
restrictions applicable to each series of preferred stock.
Series A
On February 11, 1997, the Company sold 4.0 million shares of 6% Series
A cumulative convertible preferred stock, par value $0.01, and 1.6 million
warrants to purchase common stock of the Company, par value $0.01, for gross
proceeds of $100.0 million. The preferred stock earns a 6% annual dividend,
payable quarterly in kind, and matures on February 11, 2002.
Two million shares of preferred stock became convertible beginning on
August 11, 1997, and certain of these shares were converted at prices ranging
from $16.75 per share to $18.86 per share, while the remainder became
convertible on February 11, 1998. All remaining outstanding shares are
convertible at $25 per share. On February 11, 2002, any preferred stock still
outstanding will be automatically converted into shares of the Company's common
stock, unless the Company elects to pay, in lieu of conversion, the equivalent
value in cash.
The warrants are exerciseable at $25 per share, and expire on February
11, 2002. The Company has the right to call the warrants after February 11,
2000, if the Company's common stock price has exceeded $40 on each of the
previous twenty trading days.
Rights to Purchase Series B Preferred Stock
Under a Rights Agreement dated as of July 2, 1997, between the Company
and Continental Stock Transfer & Trust Company, as Rights Agent, which was
adopted by the Board of Directors of the Company on July 2, 1997, holders of
Common Stock of the Company received, as a dividend, preferred stock purchase
rights (the "Rights") at the rate of one Right for each share of Common Stock
held as of the close of business on July 14, 1997. One Right will also attach to
each share of Common Stock issued thereafter. Currently the Rights are not
separate from the Common Stock and are not exercisable, and the Rights will only
separate from the Common Stock and become exercisable if a person or group
acquires 10% or more of the Company's outstanding Common Stock (an "Acquiring
Person") or launches a tender or exchange offer that would result in ownership
of 10% or more the Company's outstanding common Stock. Each Right that is not
owned by an Acquiring Person entitles the holder of the right to buy one one-
F-22
<PAGE>
thousandth of one share (a "Unit") of Series B Preferred Stock which will be
issued by the Company. If any person becomes an Acquiring Person, or if an
Acquiring Person engages in certain transactions involving conflicts of interest
or in a business combination in which the Company's Common Stock remains
outstanding, then the Rights Plan provides that each Right, other than any Right
held by the Acquiring Person, entitles the holder to purchase, for $70, Units
with a market value of $140. However, if the Company is involved in a business
combination in which the Company itself is not the survivor, or if the Company
sells 50% or more of its assets or earning power to another person, then the
Rights Plan provides that each Right entitled the holder to purchase, for $70,
shares of the common stock of the Acquiring Person's ultimate parent having a
market value of $140.
At any time until ten days following the date on which a person
acquires 10% or more of the Company's Common Stock the Company may redeem all
(but not less than all) of the Rights for $0.0001 per Right. The Rights expire
in ten years. The Series B Preferred Stock will be junior, with respect to
dividends and liquidation rights, to any other series of preferred stock of the
Company. the Series B Preferred Stock has dividend and liquidation preferences
over the Common Stock of the Company.
Series E Preferred Stock
In April 1995, the Company completed a private placement of 932,040
shares of Series E Convertible Preferred Stock ("Preferred Stock E") at a price
of $6.4375 per share, for gross proceeds of $6 million. Preferred Stock E
holders were entitled to dividends at the rate of 9% per annum, payable
quarterly beginning on June 30, 1995. During the ten month period ended December
31, 1995, the entire 932,040 shares of Preferred Stock E were converted into
634,228 shares of common stock.
Note 13-Redeemable Series C Preferred Stock
On December 22, 1997, the Company issued 175,000 shares of Series C
Senior Cumulative Exchangeable Preferred Stock due 2007 ("Series C Exchangeable
Preferred Stock"), for gross proceeds of $175.0 million. The Company agreed to
exchange the preferred stock for new preferred stock identical in every respect
except that it would be registered under the Securities Act of 1933. During
February 1998, the new preferred stock was registered.
Each share of Series C Exchangeable Preferred Stock has a liquidation
preference of $1,000 ("Liquidation Preference"). Dividends on the Series C
Exchangeable Preferred Stock accrue from December 22, 1997 at the rate per share
of 14 1/4% of the Accumulated Amount (as defined) per annum, compounded
semiannually on each June 15 and December 15, but will not be payable in cash,
except as set forth in the next sentence. Commencing on the first June 15 or
December 15 (each a "Dividend Payment Date") which is at least six months after
the later of December 15, 2002, and the Specified Debt Satisfaction Date (as
defined) (the "Cash Payment Date"), dividends on the Series C Exchangeable
Preferred Stock will be payable in cash as a rate per annum equal to 14 1/4% of
the Accumulated Amount as of the Dividend Payment Date preceding such date. In
the event that the Specified Debt Satisfaction Date shall not have occurred
before December 15, 2002, the rate otherwise applicable to the Series C
Exchangeable Preferred Stock shall be increased by 150 basis points from
December 15, 2002, until the Dividend Payment Date falling on or after the
Specified Debt Satisfaction Date.
As of December 31, 1997 dividends totalling approximately $553,000 have been
accrued.
F-23
<PAGE>
WINSTAR COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 13-Redeemable Series C Preferred Stock
The Series C Exchangeable Preferred Stock is not redeemable prior to
December 15, 2002. On or after December 15, 2002, the Series C Exchangeable
Preferred Stock is redeemable at the option of the Company, in whole or in part,
at specified redemption prices plus accumulated and unpaid dividends, if any, to
the date of redemption. The Company is required to redeem the Series C
Exchangeable Preferred Stock at the Liquidation Preference thereof, plus
accumulated and unpaid dividends, if any, on December 15, 2007, out of any funds
legally available therefor.
The Series C Exchangeable Preferred Stock ranks (i) senior to all
existing and future Junior Stock (as defined) including the Series A Preferred
Stock; (ii) on a Parity basis with all existing and future Parity Stock; and
(iii) junior to all Senior Stock (as defined). In addition the Series C
Exchangeable Preferred Stock is junior in right of payment to all indebtedness
of the Company and its subsidiaries.
On any scheduled Dividend Payment Date following the Specified Debt
Satisfaction Date, the Company may, at is option, exchange all but not less than
all of the share of Series C Exchangeable Preferred Stock then outstanding for
14 1/4% Senior Subordinated Deferred Interest Notes Due 2007 ("Exchange
Debentures") in an aggregate Accumulated Amount equal to the aggregate
Accumulated Amount of the shares of Series C Exchangeable Preferred Stock
outstanding at the time of such exchange, plus accumulated and unpaid dividends
to the date of exchange. The issuance of the Exchange Debentures upon each
exchange will be registered under the Securities Act pursuant to a Registration
Statement. Until the Cash Payment Date, interest on the outstanding Exchange
Debentures if any, will accrue at a rate of 14 1/4% of the Accumulated Amount
per annum and will be compounded semiannually on each June 15 and December 15
(each an "Interest Payment Date") but will not be payable in cash except as set
forth in the next sentence. Commencing on the first Interest Payment Date
following the later of the Exchange Date (as defined) or the Cash Payment Date,
interest will be payable in cash at a rate per annum equal to 14 1/4% of the
Accumulated Amount as of the Exchange Date. The Exchange Debentures, if issued,
will be unsecured, senior subordinated obligations of the Company, subordinated
in right of payment to all Senior Indebtedness (as defined) of the Company and
to all indebtedness and other liabilities (including trade payables) of the
Company's subsidiaries, and will rank pari passu with the Company's existing
1997 Senior Subordinated Notes and the Company's Convertible Notes.
Note 14-Stock Options and Stock Purchase Warrants
The Company has three stock option plans, the 1990 Plan, the 1992
Performance Equity Plan ("1992 Plan"), and the 1995 Performance Equity Plan
("1995 Plan"). The 1990 Plan is a non-qualified common stock incentive plan, as
amended, pursuant to which options to purchase an aggregate of 150,000 shares of
common stock may be granted to key employees of the Company as selected by the
Board of Directors. The exercise price for shares covered by options granted
pursuant to this plan will not be less than the fair market value of the shares
on the date of the grant. The 1992 Plan authorizes the granting of awards up to
1.5 million shares of common stock to the Company's key employees, officers,
directors and consultants. Awards consist of stock options (both non- qualified
options and options intended to qualify as "incentive" stock options under the
Internal Revenue Code), restricted stock awards, deferred stock awards, stock
appreciation rights and other stock-based awards. The plan provides for
automatic issuance of 10,000 stock options annually to each director on January
13, at the fair market value at that date, subject to availability. The 1995
Plan authorizes the granting of awards of up to 7.5 million shares of the
Company's common stock to the Company's key employees, officers, directors and
consultants. The 1995 Plan is similar to the 1992 Plan, except that the 1995
Plan does not provide for annual automatic annual director grants. The
F-24
<PAGE>
Company has also granted options to certain individuals outside the three plans.
The options are exercisable over a period ranging from immediately to five
years, depending on option terms.
The following table summarizes option activity for the ten months ended
December 31, 1995 and the years ended December 31, 1996 and 1997:
Weighted Average
Number of Options Exercise Price
----------------- ----------------
(in thousands)
Balance, February 28, 1995 6,149 $ 3.85
Granted ............... 3,896 $ 9.13
Exercised ............. (2,092) $ 2.35
Canceled .............. (708) $ 3.21
----------------- -----------
Balance, December 31, 1995 7,245 $ 6.90
Granted ............... 4,057 $ 18.55
Exercised ............. (921) $ 6.00
Canceled .............. (669) $ 12.72
----------------- -----------
Balance, December 31, 1996 9,712 $ 11.43
Granted ............... 3,905 $ 15.62
Exercised ............. (1,214) $ 7.14
Canceled .............. (752) $ 16.18
------------------- -----------
Balance, December 31, 1997 11,651 $ 13.27
================== ===========
As of December 31, 1997, options outstanding for 5.2 million shares
were exercisable at prices ranging from $1.50 to $31.13, and the weighted
remaining contractual life was 4.9 years.
The following table summarizes option data as of December 31, 1997:
<TABLE>
<CAPTION>
Number
Outstanding Weighted Number Weighted
as Average Weighted Exerciseable as Average
of 12/31/97 Remaining Average of 12/31/97 Exercise
Range of Exercise Prices (in thousands) Contractual Life Exercise Price (in thousands) Price
------------------------ -------------- ---------------- -------------- -------------- -----
<S> <C> <C> <C> <C> <C>
$1.50- $7.00 2,541 2.83 $4.75 2,490 $4.72
$7.31-$12.00 2,759 5.46 $9.88 950 $8.14
$12.13-$16.81 2,481 5.21 $15.15 721 $15.02
$16.88-$20.38 2,571 5.95 $18.33 663 $18.40
$20.38-$31.13 1,299 5.17 $23.55 384 $22.24
-------- -------
$1.50-$31.13 11,651 4.91 $13.27 5,208 $9.81
======== ======= ======
</TABLE>
Compensation cost charged to operations, which the Company records for
options granted to non- employees, was $0, $150,000 and $0 in the ten months
ended December 31, 1995 and the years ended December 31, 1996 and 1997,
respectively.
The Company measures compensation in accordance with the provisions of
APB Opinion No. 25 in accounting for its stock compensation plans. Accordingly,
no compensation cost has been recorded for options granted to employees or
directors in the ten months ended December 31, 1995 or the years ended December
31, 1996 or 1997. The fair value of each option granted has been estimated on
the grant date
F-25
<PAGE>
using the Black-Scholes Option Valuation Model. The following assumptions were
made in estimating fair value:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Dividend Yield......................................................................... 0% 0% 0%
Risk-Free Interest Rate................................................................ 6.0% 6.0% 6.0%
Expected Life after Vesting Period
- Directors and Officers............................................................ 2.0 Years 2.0 Years 2.0 Years
- Others............................................................................ 0.5 Years 0.5 Years 0.5 Years
Expected Volatility.................................................................... 66.88% 66.88% 66.88%
</TABLE>
Had compensation cost been determined under FASB Statement No. 123, net
loss and loss per share would have been increased as follows:
<TABLE>
<CAPTION>
Ten Months Year Year
Ended Ended Ended
December 31, December 31, December 31,
1995 1996 1997
---------- ---------- ----------
(in thousands)
<S> <C> <C> <C>
Net Loss Applicable to Common Stockholders
As reported............................................................. $(15,857) $(83,723) $(255,363)
Pro forma for FASB No. 123.............................................. $(21,795) $(98,765) (272,497)
Loss Per Share-Basic and Diluted
As reported............................................................. $(0.70) $(3.00) $(7.68)
Pro forma for FASB No. 123.............................................. $(0.96) $(3.54) (8.20)
</TABLE>
The weighted average fair value of options granted during the years
ended December 31, 1996 and 1997 was $18.78 and $15.63 per share, respectively.
During the initial phase-in period of FASB Statement No. 123, such
compensation expense may not be representative of the future effects of applying
this statement.
Warrants to purchase the Company's common stock were issued as follows
(warrants in thousands):
<TABLE>
<CAPTION>
Warrants Price/Share Warrants Price/Share Warrants Price/Share
-------- ----------- -------- ----------- --------- -----------
10 Months Ended Year Ended Year Ended
December 31, 1995 December 31, 1996 December 31, 1997
----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Beginning Balance............. - - 400 $12.00-$13.00 400 $12.00-$13.00
Warrants Issued............... 400 $12.00-$13.00 - - 1,600 $25.00
Warrants Exercised............ - - - - - -
Warrants Expired.............. - - - - - -
------------ --------- -------- -------------
Ending Balance................ 400 $12.00-$13.00 400 $12.00-$13.00 2,000 $12.00-$25.00
============ ========= ======== ==============
</TABLE>
Note 15-Related Party Transactions
Services Agreements
In connection with the Company's merger with Milliwave, the Company
entered into a Services Agreement with Milliwave in June 1996. Under the
Services Agreement, a subsidiary of the Company
F-26
<PAGE>
installed radio links and managed Milliwave's communications network. Total fees
under the Services Agreement and equipment sales paid by Milliwave to the
Company were $1.5 million through December 31, 1996.
In connection with the Company' purchase of certain assets of Locate,
the Company entered into a Services Agreement with Locate in April 1996. Under
the Agreement, the Company provided consulting services to Locate regarding the
operation of Locate's business. During the year ended December 31, 1996, Locate
paid the Company approximately $352,000 under the Services Agreement.
Private Exchange Transaction
On November 29, 1995, the Company acquired, in exchange for the
issuance of 3,741,224 shares of its common stock ("Private Exchange"),
substantially all of the assets of WinStar Companies, whose assets consisted of
(i) all the outstanding capital stock of WinStar Services and WinStar Venture,
two wholly owned subsidiaries of WinStar Companies, and (ii) 389,580 shares of
the Company's common stock owned by WinStar Companies. The sole assets of
WinStar Services and WinStar Venture were 2,117,183 shares of the Company's
common stock and other securities of the Company that were exercisable or
convertible into 1,429,633 shares of the Company's common stock. Accordingly,
the Company issued 3,741,224 shares of the Company's common stock and, in
exchange, acquired 3,936,396 shares of common stock and common stock
equivalents. All of the Company's common stock and certain of the common stock
equivalents received in the Private Exchange were included in Treasury Stock at
December 31, 1995 and were retired in 1996. WinStar Companies, WinStar Services
and WinStar Venture had no liabilities at the time of the closing of the Private
Exchange other than a liability previously assumed by the Company or liabilities
for which the Company is being indemnified. No claims for any liabilities have
been received by the Company.
The new shares of the Company's common stock issued in the Private
Exchange represented that number of shares which had an aggregate market value
based upon the average of the closing sale price of the Company's common stock
on the 30 trading days preceding November 15, 1995, the date as of which the
exchange agreement regarding the above-described transaction was executed, equal
to the market value of the Company's common stock (i) transferred by WinStar
Companies to the Company, (ii) owned by WinStar Services and WinStar Venture and
(iii) underlying certain other securities of the Company owned by WinStar
Services and WinStar Venture which were convertible into or exercisable for
shares of the Company's common stock, less the aggregate exercise price of such
latter securities.
The stockholders of WinStar Companies included several of the Company's
current executive officers one of whom is also a director. Simultaneously with
the Private Exchange, WinStar Companies was dissolved and the new shares issued
in the Private Exchange were issued directly to the stockholders of WinStar
Companies in proportion to their equity ownership of WinStar Companies.
The Private Exchange was considered and approved by a special committee
of independent and disinterested directors of the Company and an opinion from an
independent investment banking firm that the Private Exchange was fair to the
Company and its stockholders was obtained in connection with the Private
Exchange.
F-27
<PAGE>
Agreement with ITC Group, Inc.
In May 1994, the Company, WinStar Wireless, Inc. ("WWI") and ITC Group,
Inc. ("ITC"), a telecommunications consulting firm, entered into a two-year
agreement pursuant to which ITC advised the Company on the operations of its
telecommunications business. ITC, together with the management and employees of
WWI, developed and implemented a two-year operating plan for the Company's
wireless telecommunications business. Pursuant to the terms of the consulting
agreement, ITC made its consultants available to the Company and its
subsidiaries. The Company paid ITC an annual base consulting fee of $700,000 for
the services of a core management team, as well as supplemental fees at agreed
upon rates for additional consulting services rendered by ITC as necessary from
time to time. Under the terms of the agreement, ITC provided up to 12
consultants at any given time. From March 1995 through September 1995, ITC was
paid $1 million in fees and expenses in connection with the consulting
agreement, and the Company granted options to purchase an aggregate of 500,000
shares of its common stock for $4.41 per share to certain consultants of ITC.
Effective September 5, 1995, ITC's President became President and Chief
Operating Officer of the Company and certain core management personnel
previously provided by ITC also became employees. Concurrently, ITC ceased
providing services to the Company under the consulting agreement, and the
Company's obligation to pay any future compensation to ITC under such agreement
was terminated.
Note 16-Supplemental Cash Flow Information
Cash paid for interest during the ten months ended December 31, 1995,
and the years ended December 31, 1996 and 1997 was $1.3 million, $2.1 million
and $26.0 million, respectively. During the years ended December 31, 1996 and
1997, the Company capitalized $300,000 and $4.2 million of interest incurred in
connection with the buildout of its telecommunications network respectively. No
interest was capitalized in the ten months ended December 31, 1995.
During the ten months ended December 31, 1995, the Company completed
the following material noncash transactions: (i) the conversion of $3.75 million
of convertible notes plus accrued interest thereon; (ii) the conversion of all
shares of Preferred Stock Series E; (iii) the acquisition of approximately $7.5
million in property and equipment through various capitalized leases; (iv) the
Private Exchange transaction (see Note 14); (v) the settlement of the Company's
placement expenses from the gross proceeds of the Debt Placement; and (vi) the
acquisition of Avant-Garde.
During the year ended December 31, 1996, the Company completed the
following material noncash transactions: (i) the conversion of $3.75 million of
convertible notes plus accrued interest; (ii) the acquisition of $8.6 million in
property and equipment through various capitalized leases; (iii) the issuance of
100,605 shares and share equivalents, with a value of $1.5 million, and $800,000
in notes payable in connection with certain acquisitions (see Note 2); (iv) the
issuance of $17.5 million in notes payable for the acquisition of Locate; and
(v) the acceptance of 150,000 shares of the Company's common stock for payment
of stock options exercised. Depreciation and amortization includes amortization
of deferred compensation.
During the year ended December 31, 1997, the Company completed the
following material noncash transactions: (i) dividends-in-kind on the Series A
Preferred Stock for the aggregate amount of $5.3 million; (ii) the acquisition
of $8.9 million in property and equipment through various capitalized leases;
(iii) the issuance of 337,648 shares of common stock with a value of $7.5
million in connection with the
F-28
<PAGE>
acquisition of licenses; (iv) The issuance of 3,594,620 shares of Common Stock
with a value of approximately $75 million in connection with the acquisition of
Milliwave Limited Partnership.
Note 17-Advertising Costs
Advertising costs are charged to operations when the advertising first
takes place. Advertising expense for the ten months ended December 31, 1995, and
the years ended December 31, 1996 and 1997 was approximately $500,000, $4.3
million and $11.0 million, respectively.
Note 18-Business Segments
The Company's continuing business segments are telecommunications and
information services. The following table is a summary of the ten months ended
December 31, 1995 and the years ended December 31, 1996 and 1997:
<TABLE>
<CAPTION>
Total
Continuing Consolidated Discontinued
Telecommuni- Information Business General Continuing Operation-
cations Services Segments Corporate Operations Merchandising
------------- ------------- ----------- ----------- ------------ -------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
For the ten months
ended December
31, 1995
Net sales................ $13,137 $2,648 $15,785 $- $15,785
Operating income
(loss)................ $(7,288) $217 $(7,071) $(3,861) $(10,932) $237
EBITDA................... $(6,358) $241 $(6,117) $(3,758) $(9,875)
Depreciation and
amortization.......... $930 $24 $954 $104 $1,058
Capital expenditures..... $7,458 $14 $7,472 $651 $8,123
Identifiable assets at
December 31, 1995..... $36,998 $20,195 $57,193 $217,711 $274,904 $3,321
For the year ended
December 31, 1996
Net sales................ $33,969 $14,650 $48,619 $- $48,619
Operating loss........... $(43,698) $(1,409) $(45,107) $(11,373) $(56,480) $(1,010)
EBITDA................... $(39,206) $(890) $(40,096) $(9,796) $(49,892)
Depreciation and
amortization.......... $3,831 $469 $4,300 $202 $4,502
Capital expenditures..... $46,632 $701 $47,333 $509 $47,842
Identifiable assets at
December 31, 1996..... $101,380 $30,133 $131,513 $143,462 $274,975 $3,814
For the year ended
December 31, 1997
Net sales................ $38,277 $41,354 $79,631 - $79,631
Operating loss........... $(153,139) $(4,092) $(157,231) $(30,815) $(188,046) $(6,477)
EBITDA................... $(128,637) $(2,786) $(131,423) $(26,922) $(158,345)
Depreciation and
amortization.......... $24,502 $1,306 $25,808 $3,893 $29,701
Capital expenditures..... $219,979 $612 $220,591 $1,709 $222,300
Identifiable assets at
December 31, 1997..... $399,111 $30,376 $429,487 $544,809 $974,296 $2,105
</TABLE>
- -----------
EBITDA represents operating income (loss) plus interest, taxes, depreciation and
amortization.
F-29
<PAGE>
Note 19-Quarterly Results of Operations (Unaudited)
The unaudited quarterly financial data for 1996 and 1997 for the
Company is as follows:
<TABLE>
<CAPTION>
Quarter Ended 1996
(Unaudited)
March 31 June 30 September 30 December 31
---------- -------- ------------- -----------
(in thousands)
<S> <C> <C> <C> <C>
Telecommunications services ................ $ 10,217 $ 10,356 $ 7,384 $ 6,012
Information services ....................... 771 2,652 4,056 7,171
-------- -------- -------- --------
Total operating revenues ...................... 10,988 13,008 11,440 13,183
-------- -------- -------- --------
Operating expenses
Cost of services and products .............. 6,678 9,175 9,250 13,130
Selling, general and administrative expenses 8,845 14,401 15,816 23,303
Depreciation and amortization .............. 492 679 1,158 2,172
-------- -------- -------- --------
Total operating expenses ................ 16,015 24,255 26,244 38,605
-------- -------- -------- --------
Operating loss ................................ (5,027) (11,247) (14,784) (25,422)
Other (expense) income
Interest expense ........................... (8,643) (9,007) (9,045) (10,053)
Interest income ............................ 3,108 2,664 2,570 2,173
-------- -------- -------- --------
Loss from continuing operations ............... (10,562) (17,590) (21,259) (33,302)
Discontinued operations ....................... (137) (526) 47 (394)
-------- -------- -------- --------
Net loss ...................................... $(10,699) $(18,116) $(21,212) $(33,696)
========= ========= ========= =========
Basic and diluted net income (loss) per share:
From continuing operations.................... $(0.39) $(0.63) $(0.76) $(1.17)
From discontinued operations.................. (0.00) (0.02) 0.01 (0.01)
---------- ---------- ------------- -------------
Net loss per share............................ $(0.39) $(0.65) $(0.75) $(1.18)
========== ========= ============= =============
</TABLE>
F-30
<PAGE>
<TABLE>
<CAPTION>
Quarter Ended 1997
(Unaudited)
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
(in thousands)
<S> <C> <C> <C> <C>
Operating revenues
Telecommunications services .......................... $ 7,763 $ 7,678 $ 9,169 $ 14,367
Information services ................................. 6,014 8,662 11,017 15,661
-------- -------- -------- --------
Total operating revenues ................................ 13,077 16,340 20,186 30,028
-------- -------- -------- --------
Operating expenses
Cost of services and products ........................ 12,959 15,908 19,621 32,529
Selling, general and administrative expenses ......... 29,553 39,228 41,135 47,043
Depreciation and amortization ........................ 3,501 4,896 7,077 14,227
-------- -------- -------- --------
Total operating expenses .......................... 46,013 60,032 67,833 93,799
-------- -------- -------- --------
Operating loss .......................................... (32,936) (43,692) (47,647) (63,771)
Other (expense) income
Interest (expense) ................................... (10,798) (20,194) (22,082) (24,183)
Interest income ...................................... 2,235 5,090 3,727 6,525
Other income ............................................ -- -- 2,219 --
-------- -------- -------- --------
Loss from continuing operations before income tax benefit (41,499) (58,796) (63,783) (81,429)
Income tax benefit ...................................... -- -- -- 2,500
-------- -------- -------- --------
Loss from continuing operations ......................... (41,499) (58,796) (63,783) (78,929)
Loss from discontinued operations ....................... (477) -- (1,500) (4,500)
-------- --------- --------- ---------
Net loss ................................................ $(41,976) $(58,796) $ 65,283) (83,429)
========= ========= ========= =========
Basic and diluted net loss per share
From continuing operations .............................. $ (1.27) $ (1.85) $ (1.97) $ (2.37)
From discontinued operations ............................ (0.02) -- (0.04) (0.13)
-------- -------- -------- --------
Net loss per share ...................................... $ (1.29) $ (1.85) $ (2.01) $ (2.50)
========= ========= ========= =========
</TABLE>
The financial data presented above reflects certain reclassifications
from the amounts presented in the Company's filings on form 10-Q for the periods
ending March 31, June 30 and September 30, 1996. The reclassifications
principally relate to the breakout of revenues by operating segment and the
reclassification of certain telecommunication network costs from the selling,
general and administrative caption to the cost of services and products caption.
Note 20-Discontinued Operation-WinStar Global Products, Inc.
On May 13, 1997, a formal plan of disposal for the Company's consumer
products subsidiary, Global Products, was approved by the Board of Directors,
and it is anticipated that the disposal will be completed within the next 12
months. The disposal of Global Products has been accounted for as a discontinued
operation and, accordingly, its net assets have been segregated from continuing
operations in the accompanying consolidated balance sheets, and its operating
results are segregated and reported as discontinued operations in the
accompanying consolidated statements of operations and cash flows.
F-31
<PAGE>
Information relating to the discontinued operations of Global Products is as
follows (in thousands of dollars):
<TABLE>
<CAPTION>
For the Ten For the Year For the Year
Months Ended Ended Ended
December 31, December 31, December 31,
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Operating revenues......................................................... $13,986 $19,429 $15,665
------------------ ------------------ ---------------
Cost of services and products.............................................. 8,833 13,903 17,534
Selling, general & administrative.......................................... 4,289 5,323 8,393
Depreciation and amortization.............................................. 183 245 464
------------------ ------------------ ---------------
Total operating expenses................................................... $13,305 $19,471 26,391
------------------ ------------------ ---------------
Operating income (loss).................................................... 681 (42) (10,726)
Interest expense, net...................................................... (444) (968) (854)
------------------ ------------------ --------------
Net income (loss).......................................................... $237 $(1,010) $(11,580)
================== ================== ==============
</TABLE>
<TABLE>
<CAPTION>
December 31, December 31,
1996 1997
<S> <C> <C>
Assets:
Accounts receivable, net...................................................................... $4,499 $4,383
Inventories................................................................................... 8,606 4,663
Other assets.................................................................................. 2,143 1,268
------------------ ---------------
Total Assets.......................................................................... 15,248 10,314
------------------ ---------------
Liabilities:
Current liabilities........................................................................... 3,102 3,570
Other liabilities............................................................................. 8,332 9,951
------------------ ---------------
Total liabilities..................................................................... 11,434 13,521
------------------ ---------------
Net assets (deficit).................................................................. $3,814 $(3,207)
================== ===============
</TABLE>
During the year ended December 31, 1997, the Company reduced the
carrying amount of its investment to $2,105,000 and recorded a loss on
discontinued operations of $6,477,000.
Note 21- Condensed Financial Information of WinStar Equipment Corp.
and WinStar Equipment II Corp.
The Company's wholly-owned subsidiaries, WEC and WEC II, each of which
is a special purpose corporation which was formed to facilitate the financing
and purchase of telecommunications equipment and related property ("Designated
Equipment"), received $200.0 million and $50.0 million in gross proceeds,
respectively, from the issuance and sale of 12.5% Guaranteed Senior Secured
Notes in placements of debt in March and August of 1997, respectively (see Note
7). The use of the proceeds of the Guaranteed Senior Secured Notes are to be
used to purchase designated equipment and, if such equipment is not purchased
within a specified period, WEC and WEC II must apply unused proceeds thereof to
redeem the WEC and WEC II Notes, respectively. Both the interest and principal
of the WEC Notes are guaranteed by the Company.
F-32
<PAGE>
WEC and WEC II have no independent operations other than to purchase
designated equipment to lease same to the Company's other telecommunications
subsidiaries. Given this operating environment, it is unlikely, in the opinion
of management, that WEC or WEC II will generate sufficient income, after the
payment of interest on the WEC and WEC II Notes, to pay dividends or make other
distributions to the Company.
Summary financial information of WEC and WEC II, which are included in
the consolidated financial statements of the Company, are as follows (in
thousands):
Balance sheet information at December 31, 1997:
WEC WEC II
--------- ---------
Current assets ...... $ 144,004 $ 48,394
Long-term assets .... 71,424 2,660
Current liabilities . (25,601) (2,432)
Long-term liabilities (200,000) (50,000)
--------- --------
Stockholders' deficit (10,173) (1,378)
========== ==========
Statements of operations information for WEC for the period from its
inception through December 31, 1997, and for WEC II for the period from its
inception through December 31, 1997, are as follows (in thousands):
<TABLE>
<CAPTION>
WEC WEC II
Period from Period from
March 13, 1997 August 8, 1997
(Inception) to (Inception) to
December 31, December 31,
1997 1997
<S> <C> <C>
Rental revenues from other WinStar subsidiaries.................. $854 $-
Interest income from other WinStar subsidiaries.................. 1,207 -
Interest income-investments...................................... 7,765 1,105
Selling, general and administrative expenses..................... (1,470) -
Interest expense................................................. (18,529) (2,483)
--------------------- ---------------------
Net loss......................................................... $(10,173) $(1,378)
===================== ====================
--------------------- ---------------------
</TABLE>
Separate financial statements concerning WEC or WEC II are not
presented because management of the Company has determined that such information
would not provided any material information that is not already presented in the
condensed consolidated financial statements of the Company.
Note 22-Employee Benefit Programs
The Company has a defined contribution 401K Plan for substantially all
full time employees. The Company makes a 25% matching contribution up to 6% of
participant's compensation, subject to certain limitations. The Company
contribution vests over a five year period. Company contributions to date have
not been significant.
F-33
<PAGE>
Note 23-New Accounting Pronouncements
The Financial Accounting Standards Board released Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130),
governing the reporting and display of comprehensive income and its components,
and Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information" (SFAS No. 131), requiring
that all public businesses report financial and descriptive information about
their reportable operating segments. The Company will implement SFAS 130 and
SFAS 131 as required in 1998. The impact of adopting SFAS No. 130 is not
expected to be material to the consolidated financial statements or notes to
consolidated financial statements. Management is currently evaluating the effect
of SFAS No. 131 on consolidated financial statement disclosures.
F-34
<PAGE>
Report of Independent Certified Public Accountants
Board of Directors
MIDCOM Communications Inc.
We have audited the consolidated balance sheet of MIDCOM Communications
Inc. and subsidiaries (in reorganization under Chapter 11 of the United States
Bankruptcy Code since November 7, 1997, see Note A to the consolidated financial
statements) as of December 31, 1997, and the related consolidated statements of
operations, shareholders' deficit and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of MIDCOM
Communications Inc. and subsidiaries at December 31, 1997 and the consolidated
results of their operations and their consolidated cash flows for the year then
ended in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared on a going
concern basis, which contemplates continuity of the Company's operations and
realization of its assets and payments of its liabilities in the ordinary course
of business. On November 7, 1997, MIDCOM Communications Inc. and its
subsidiaries filed a voluntary petition for relief under Chapter 11 of the
United States Bankruptcy Code and is currently operating its business as a
debtor-in-possession under the supervision of the Bankruptcy Court. The Chapter
11 filing was the result of the inability to obtain additional financing,
continuing operating losses, and cash flow problems. As more fully described in
Note A, the Company's ability to continue as a going concern would depend upon,
among other things, approval of a plan of reorganization by the Bankruptcy
Court, a return by the Company to profitability, and its ability to generate
sufficient cash from operations and other financing sources to support its
business activities, all of which are uncertain. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans to finance operating activities and further reorganize
operations are described in Note A. The accompanying consolidated financial
statements do not reflect further adjustments that may be required in connection
with reorganizing the Company under Chapter 11 of the United States Bankruptcy
Code or as may otherwise result from the outcome of this uncertainty.
GRANT THORNTON LLP
Detroit, Michigan
March 6, 1998
F-35
<PAGE>
MIDCOM Communications Inc.
(Debtor-In-Possession)
Consolidated Balance Sheet
December 31, 1997
(In thousands, except share data)
<TABLE>
ASSETS
<S> <C>
Current Assets
Cash and cash equivalents .................................... $ 2,285
Accounts receivable, less allowance for doubtful accounts of
$7,100 ...................................................... 20,661
Prepaid expenses and other current assets .................... 6,125
-------
Total current assets ................................. 29,071
Furniture, equipment and leasehold improvements, net ......... 25,331
Intangible assets, less accumulated amortization of $51,119 .. 4,481
Other assets, net ............................................ 681
-------
Total assets ......................................... $59,564
=======
LIABILITIES AND SHAREHOLDERS' DEFICIT
Liabilities Not Subject to Compromise
Current Liabilities
Accounts payable ...................................... $ 3,997
Accrued expenses ...................................... 5,405
Notes payable ......................................... 32,332
Capital lease obligations ............................. 15,263
---------
Total current liabilities ........................... 56,997
Liabilities Subject to Compromise ........................... 175,886
Commitments and Contingencies ............................... --
Shareholders' Deficit
Preferred stock, $.0001 par value, 10,000,000 shares
authorized no shares issued and outstanding .............. --
Common stock, $.0001 par value, 90,000,000 shares authorized,
16,193,546 shares issued and 16,066,567 shares
outstanding .............................................. 68,623
Less 126,979 shares of treasury stock ....................... (1,075)
Deferred stock option compensation .......................... (1,192)
Accumulated deficit ......................................... (239,675)
---------
Total shareholders' deficit ......................... (173,319)
---------
Total liabilities and shareholders' deficit ......... $ 59,564
=========
</TABLE>
The accompanying notes are an integral part of
these financial statements.
F-36
<PAGE>
MIDCOM Communications Inc.
(Debtor-In-Possession)
Consolidated Statement of Operations
For the year ended December 31, 1997
(In thousands, except share data)
Revenues ........................................... $ 98,283
Costs and expenses
Costs of revenue ................................ 72,440
Selling, general and administrative ............. 103,172
Relocation of corporate headquarters ............ 5,200
Interest ........................................ 9,929
---------
190,741
---------
Loss before reorganization items ........... (92,458)
Reorganization items
Lease rejection claims .......................... 10,775
Professional fees and other ..................... 535
---------
Total reorganization items ................. 11,310
---------
Net loss ........................................... $(103,768)
==========
Loss per share - basic and diluted ................. $ (6.67)
==========
Weighted average common shares outstanding 15,568
==========
The accompanying notes are an integral part of
these financial statements.
F-37
<PAGE>
MIDCOM Communications Inc.
(Debtor-In-Possession)
Consolidated Statement of Shareholders' Deficit
For the year ended December 31,
(In thousands, except share data)
<TABLE>
<CAPTION>
Deferred
Stock Total
Preferred Common Treasury Option Accumulated Shareholders'
Stock Stock Stock Compensation Deficit Deficit
--------- -------- -------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997....... $- $68,330 $- $(1,707) $(135,907) $(69,284)
Issuance of shares of common
stock in connection with
acquisitions in prior years
(Note D)...................... - 276 - - - 276
Redemption of shares of
common stock(Note G).......... - - (6,544) - - (6,544)
Reissuance of redeemed shares.... - - 5,469 - - 5,469
Issuance of shares for
employee stock purchase
plan.......................... - 17 - - - 17
Compensation attributable to
stock options vesting......... - - - 515 - 515
Net loss for the year............ - - - - (103,768) (103,768)
-------------- ----------- ------------ ------------------ ---------------- ------------
Balance at December 31, 1997..... $- $68,623 $(1,075) $(1,192) $(239,675) $(173,319)
============== =========== ============ ================== ================ =============
</TABLE>
The accompanying notes are an integral part of
these financial statements.
F-38
<PAGE>
MIDCOM Communications Inc.
(Debtor-In-Possession)
Consolidated Statement of Cash Flows
For the year ended December 31, 1997
(In thousands)
<TABLE>
<CAPTION>
Cash Flows From Operating Activities
<S> <C>
Net loss.................................................................................................... $(103,768)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation............................................................................................. 5,724
Amortization of intangible assets........................................................................ 11,444
Bad debt expense......................................................................................... 6,347
Loss on abandonment of assets due to relocation.......................................................... 1,809
Loss on sale of assets................................................................................... 26
Changes in operating assets and liabilities
Increase in Accounts receivable.......................................................................... (10,039)
Increase in Prepaid expenses and other current assets.................................................. (4,577)
Decrease in Other assets............................................................................... 3,171
Increase in Intangible Assets.......................................................................... (378)
Decrease in Accounts payable and accrued expenses...................................................... (23,858)
Increase in liabilities subject to Compromise.......................................................... 175,886
------------
Net cash provided by operating activities........................................................... 61,787
Cash Flows From Investing Activities
Purchases of furniture, equipment and leasehold improvements................................................ (22,247)
Proceeds from sale of assets................................................................................ 402
------------
Net cash used in investing activities............................................................... (21,845)
Cash Flows From Financing Activities
Proceeds from notes payable................................................................................. 76,250
Repayment of notes payable.................................................................................. (43,918)
Proceeds from long-term obligations......................................................................... 13,954
Repayment of long-term obligations.......................................................................... (2,491)
Proceeds from common stock issued for stock purchase plan and stock options................................. 532
Net repurchase of common stock.............................................................................. (1,075)
Reclassification of long term obligations to liabilities subject to compromise.............................. (112,147)
Proceeds from sale of common stock.......................................................................... 276
------------
Net Cash used in financing activities............................................................... (68,619)
------------
Net decrease in cash and cash equivalents (28,677)
Cash and cash equivalents at the beginning of year 30,962
------------
Cash and cash equivalents at the end of year.................................................................. $2,285
============
</TABLE>
The accompanying notes are an integral part of
these financial statements.
F-39
<PAGE>
MIDCOM Communications Inc.
(Debtor-In-Possession)
Notes to Consolidated Financial Statements
December 31, 1997
Note A-Chapter 11 Proceedings
On November 7, 1997, MIDCOM Communications, Inc. ("MIDCOM" or the
"Company") and its wholly-owned subsidiaries, PacNet Inc. ("PacNet"), Ad Val,
Inc. ("Adval") and Cel-Tech International Corp. ("Cel-Tech"), each filed a
petition (collectively, the "Petitions") for relief under Chapter 11 of Title 11
of the United States Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the Eastern District of Michigan (the "Bankruptcy Court"),
Case Nos. 97-59044-S, 59052-G, 59064-G and 59057-S, respectively, with such
cases to be jointly administered by the Bankruptcy Court under Case No.
97-59044-S. The Company and its subsidiaries are currently operating their
respective businesses as debtors-in-possession pursuant to Section 1107(a) and
1108 of the Bankruptcy Code and are subject to the jurisdiction of the
Bankruptcy Court.
Under Chapter 11, certain claims against the Company in existence prior
to the filing of the petition for relief under federal bankruptcy law are stayed
while the Company continues business operations as debtor-in-possession. These
claims are reflected in the accompanying consolidated balance sheet as
"liabilities subject to compromise." In addition, the filing of a voluntary
petition under Chapter 11 was an event of default under all the Company's loan
agreements (see Note F).
The Company has arranged for debtor-in-possession financing (the
"Foothill DIP Facility") from Foothill Capital Corporation. In connection with
the Foothill DIP Financing, the Company incurred a loan fee of $250,000. The
Foothill DIP Facility consists of a revolving credit facility with borrowing
availability of up to $8.5 million, subject to the Company's satisfaction of
various terms and conditions. The Foothill DIP Facility bears interest at prime
plus 4% on receivable based advances and 18% on overadvances and expired on
January 15, 1998. The financing was paid on January 22, 1998. There can be no
assurance that the Company will not require additional debt or equity financing
in the future, and there can be no assurance that any such additional debt or
equity financing, if needed, would be available to the Company on acceptable
terms or at all.
The accompanying consolidated financial statements have been prepared
in accordance with generally accepted accounting principles applicable to a
company on a "going concern" basis, which, except as otherwise noted,
contemplates the realization of assets and the liquidation of liabilities in the
ordinary course of business; however, as a result of the Chapter 11 proceedings,
and circumstances relating to this event, including the Company's leveraged
financial structure and its operating losses, such realization of assets and
liquidation of liabilities are subject to significant uncertainties. The Company
has experienced significant net losses in the past few years. During the Chapter
11 proceedings, the Company has incurred and will continue to incur substantial
reorganization costs.
The Company's ability to continue as a going concern is dependent upon
the confirmation of a plan or reorganization, future profitable operations and
the ability to comply with the terms of any debtor-in-possession credit facility
and the ability to generate sufficient cash from operations and financing
arrangements to meet obligations. These conditions raise substantial doubt about
the Company's ability to continue as a going concern.
A plan of reorganization, as finally approved by the Bankruptcy Court,
could materially change the currently recorded amounts of assets and
liabilities. These financial statements do not reflect further adjustments to
the carrying value of assets and the amounts and classifications of liabilities
or shareholders' deficit that might be necessary as a consequence of the
bankruptcy proceedings. Events completed in
F-40
<PAGE>
relation to the Company's ongoing restructuring include the sale of the assets
and business of MIDCOM and its wholly owned subsidiaries, PacNet, Cel-Tech and
AdVal. The sale of MIDCOM, PacNet and Cel-Tech was completed on January 21, 1998
and the sale of the assets and business of AdVal was completed on February 25,
1998. Proceeds for these sales totalled approximately $98.6 million. This is
subject to adjustment if the Company fails to maintain specified revenue levels
or breaches general representations and warranties as defined in the sales
agreement.
Under the Bankruptcy Code, the Company may elect to assume or reject
real estate leases, employment contracts, personal property leases, service
contract and other unexpired executory pre-petition contracts, subject to
Bankruptcy Court approval. Certain leases and contracts have been rejected in
connection with the Chapter 11 proceedings. Obligations related to these
rejected items have been included in liabilities subject to compromise. The
ultimate amount of such claims is subject to adjustment based on the
finalization of a reorganization plan. Accordingly, the Company cannot presently
determine the ultimate liability which may result from the filing of claims for
any contracts which have been or may subsequently be rejected in the Chapter 11
proceedings.
The Court established March 17, 1998 (the "Bar Date") as the deadline
for filing proofs of claim in the Chapter 11 proceedings. The Company has
notified all known claimants for the purposes of identifying all pre-petition
claims against the Company.
The principal categories of claims classified as liabilities subject to
compromise are identified below (in thousands). All amounts below may be subject
to further adjustment depending on Bankruptcy Court action, further developments
with respects to disputed claims, determination as to the value of any
collateral securing claims, or other events. Additional claims may arise
resulting from rejection of additional executory contracts or unexpired leases
by the Company.
<TABLE>
<S> <C>
Notes payable........................................................... $113,740
Accounts payable........................................................ 42,593
Carrier accounts payable................................................ 6,313
Lease termination claims................................................ 11,267
Other................................................................... 1,973
------------
Total liabilities subject to compromise................................. $175,886
============
</TABLE>
There are approximately 424 scheduled liabilities and filed proofs of
claim against the Company. The aggregate amount of those claims which specified
amounts was approximately $22.9 million as of March 6, 1998. Included among the
claims filed have been claims of unspecified amounts. The ultimate amount of and
settlement terms for such liabilities will be subject to an approved plan of
reorganization and, accordingly, are not presently determinable. Therefore, no
provision has been made for the differences between the amounts filed with the
court and the balances reflected in the accompanying consolidated financial
statements.
F-41
<PAGE>
Note B-Nature of Operations and Significant Accounting Policies
The Company provides long distance voice and data telecommunications
services. As primarily a nonfacilities-based reseller, MIDCOM principally
utilizes the network switching and transport facilities of Tier I long distance
carriers such as Sprint Corporation ("Sprint"), WorldCom, Inc. ('WorldCom") and
AT&T Corp. ("AT&T") to provide a broad array of telecommunications services.
MIDCOM's service offerings include basic "1 plus" and "800" long distance voice,
frame relay data transmission services, wireless services, dedicated private
lines between customer locations and enhanced telecommunications services such
as facsimile broadcast services and conference calling. The Company's customers
are primarily small to medium-sized commercial businesses throughout the United
States.
Basis of Presentation
The consolidated financial statements include the accounts of MIDCOM
and its wholly-owned subsidiaries, PacNet, Cel-Tech and AdVal. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Financial Reporting for Bankruptcy Proceedings
The American Institute of Certified Public Accountants Statement of
Position 90-7, "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code" ("SOP 90-7"), provides guidance for financial reporting by
entities that have filed petitions with the Bankruptcy Court and expect to
reorganize under Chapter 11 of the Bankruptcy Code.
Under SOP 90-7, the financial statements of an entity in a Chapter 11
reorganization proceeding should distinguish transactions and events that are
directly associated with the reorganization from those of the operations of the
ongoing business as it evolves. Accordingly, SOP 90-7 requires the following
financial reporting/accounting treatments in respect to each of the consolidated
financial statements.
Consolidated Balance Sheet
The consolidated balance sheet separately classifies pre-petition and
post- petition liabilities. A further distinction is made between pre-petition
liabilities subject to compromise (generally unsecured and undersecured claims)
and those not subject to compromise (fully secured claims). Pre-petition
liabilities are reported on the basis of the expected amount of such allowed
claims, as opposed to the amounts for which those allowed claims may be settled.
Under an approved final plan of reorganization those claims may be settled at
amounts substantially less than their allowed amounts.
When a liability subject to compromise becomes an allowed claim and
that claim differs from the net carrying amount of the liability, the net
carrying amount is adjusted to the amount of the allowed claim. The resulting
gain or loss is classified as a reorganization item in the consolidated
statement of operations.
Consolidated Statements of Operations
Pursuant to SOP 90-7, revenues and expenses, realized gains and losses, and
provisions for losses resulting from the reorganization of the business are
reported in the consolidated statement of operations separately as
reorganization items. Professional fees are expensed as incurred. Interest
expense is reported
F-42
<PAGE>
only to the extent that it will be paid during the proceeding or that it is
probable that it will be an allowed claim.
Consolidated Statements of Cash Flows
Reorganization items are reported separately within the operating,
investing and financing categories of the consolidated statement of cash flows.
Cash and Cash Equivalents
All short-term investments with a maturity of three months or less at
the date of purchase are considered to be cash equivalents.
Revenue Recognition
Resale and transmission revenue and related costs are recognized in the
period the customer utilizes the Company's service. At December 31, 1997, net
unbilled resale revenue totaled approximately $6 million.
Financial Instruments and Concentration of Credit Risk
The Company's financial instruments consist of cash and cash
equivalents, accounts receivable, accounts and carrier accounts payable, notes
payable and long-term obligations. The fair value of the financial instruments,
except long-term obligations, approximates their recorded value based on the
short-term maturity of the instruments. The fair value of the long-term
obligations approximates their recorded value based on the current rates offered
to the Company for similar debt of the same maturities. The Company does not
have financial instruments with off-balance-sheet risk.
Financial instruments that potentially subject the Company to
concentrations of credit risk are accounts receivable. Concentration of credit
risk with respect to receivables are limited due to diversity in geographic
locations of customers as well as diversity of industries. The Company
continually evaluates the credit worthiness of its customers; however, it
generally does not require collateral. The Company's allowance for doubtful
accounts is based on historical trends, current market conditions and other
relevant factors.
Furniture, Equipment and Leasehold Improvements
Furniture, equipment and leasehold improvements are stated at cost.
Maintenance and repairs are expensed as incurred. When properties are retired or
otherwise disposed of, gains and losses are reflected in the consolidated
statement of operations. Depreciation and amortization, which includes
amortization
F-43
<PAGE>
of assets recorded under capital leases, are computed using the straight-line
method over the following useful lives.
Buildings and towers .......................... 30 years
Transmission equipment ........................ 12 to 15 years
Data processing systems and equipment ......... 3 to 5 years
Switches ...................................... 5 to 7 years
Furniture, equipment and leasehold improvements 3 to 7 years
Intangible Assets
Intangible assets represent the excess of the purchase price over the
estimated fair value of identifiable assets acquired in business and customer
base acquisitions. Amounts are allocated primarily to customer bases which are
amortized over three years using the straight-line method. Amounts are also
allocated to noncompete agreements and goodwill as applicable, which are
amortized using the straight-line method over terms ranging from 18 months to 25
years.
The Company periodically reviews the carrying value of its intangible
assets whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. To the extent the estimated future cash inflows
attributable to the asset, less estimated future cash outflows, is less than the
carrying amount, an impairment loss is recognized.
Net Loss Per Share
During 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share", which is effective for financial statements issued after December
15, 1997. The new standard eliminates primary and fully diluted earnings per
share and requires presentation of basic and diluted earnings per share together
with disclosure of how the per share amounts were computed. Basic earnings per
share excludes dilution and is computed by dividing loss available to common
shareholders by the weighted-average common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised and converted
into common stock or resulted in the issuance of common stock that then share in
the loss of the entity. The Company adopted this pronouncement at December 31,
1997. Common stock equivalents have been excluded from the calculation of net
loss per share due to their antidilutive effect.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue expenses
during the reporting periods. Actual results could differ from those estimates.
F-44
<PAGE>
Stock Based Compensation
In 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation". SFAS 123 establishes financial accounting and reporting standards
for stock-based employee compensation plans. It defines a fair value based
method of accounting for an employee stock option or similar equity instrument
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans and include the cost in the statement of
operations as compensation expense. However, it also allows an entity to
continue to measure compensation cost for those plans using the intrinsic value
based method of accounting prescribed by Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees. The Company has
elected to account for compensation cost for stock option plans in accordance
with APB Opinion No. 25.
New Pronouncements
In June 1997, the FASB issued SFAS No. 130, "Reporting of Comprehensive
Income", which establishes standards for reporting and display of comprehensive
income and its components (revenues, expense, gains, and losses) in a full set
of financial statements. This statement also requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This statement is effective
for fiscal years beginning after December 15, 1997. Earlier application is
permitted. Reclassification of financial statements for earlier periods provided
for comparative purposes is required. The Company does not anticipate that
adoption of SFAS 130 will have a material effect on the consolidated financial
statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information", which establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. This statement also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
This statement requires the reporting of financial and descriptive information
about an enterprise's reportable operating segments. This statement is effective
for financial statements for periods beginning after December 15, 1997. In the
initial year of adoption, comparative information for earlier years is to be
restated. The Company does not anticipate that the adoption of SFAS 131 will
have a material effect on the consolidated financial statements.
F-45
<PAGE>
Note C-Furniture, Equipment and Leasehold Improvements
Major classes of furniture, equipment and leasehold improvements,
including assets under capital leases, as of December 31, 1997 consist of the
following (in thousands):
Buildings and towers .......................... $ 6,757
Transmission equipment ........................ 129
Data processing systems and equipment ......... 7,503
Switches ...................................... 16,667
Furniture, equipment and leasehold improvements 8,538
-------
39,594
Less accumulated depreciation............... 14,263
-------
$25,331
=======
The gross amount of furniture, equipment and leasehold improvements
recorded under capital leases was $19.2 million at December 31, 1997.
Included in furniture, equipment and leasehold improvements are
unamortized development costs related to the Company's proprietary management
information system. This system was placed in service in May 1995 and is being
amortized on a straight-line basis.
Note D-Acquisitions
On August 15, 1997 the Company entered into merger agreements with
Phoenix Network, Inc. ("Phoenix") and Trans National Communications ("TNC"). On
November 10, 1997 the Company announced that these agreements with Phoenix and
TNC had been terminated. On October 31, 1997, Phoenix notified the Company of
its intent to terminate the merger agreement, effective November 5, 1997, due to
alleged material breaches by the Company, including the Company's termination of
its agreement with Sprint and the deterioration of the Company's financial
condition. In addition, on November 6, 1997, TNC notified the Company of its
intent to terminate its purchase agreements with Phoenix that Phoenix had
assigned to the Company.
On January 27, 1997, in connection with a customer base acquisition
completed on July 31, 1995, the Company issued to the assignee of Communications
Services of America, Inc. ("CSA") 10,522 shares of common stock valued at $10.38
per share, and in April 1997, the Company issued an additional 18,536 shares to
compensate the former CSA shareholders for the decrease in value of the common
stock since the closing of the acquisitions.
On January 22, 1997, in connection with a customer base acquisition
completed in September 30, 1995, the Company issued to the shareholders of
Fairfield County Telephone Corporation ("Fairfield") 38,711 shares of common
stock valued at $10.25, and in April 1997 the Company issued an additional
59,631 shares to compensate the former Fairfield shareholders for the decrease
in value of the common stock since the closing of the acquisition.
F-46
<PAGE>
In January 1997, the Company issued to Richard John 9,457 shares of
common stock valued $9.38 per share, and in August 1997, the Company issued to
Richard John 50,000 shares of common stock valued at $8.56 per share in
connection with the acquisition of Cel-Tech International Corp.
Note E-Obligations
As a result of the Chapter 11 filings (See Note A) the Company has
defaulted under the Foothill Credit Facility, the Company's equipment lease
facilities, the Indenture relating to the Company's $97.7 million aggregate
principal amount of 8 1/4% subordinated convertible notes due 2003 and the note
payable to Ashok Rao in connection with the redemption of certain shares of
common stock (See Note H). Accordingly, except for the Foothill Credit Facility
all long-term obligations have been classified as liabilities subject to
compromise in the accompanying consolidated balance sheet.
Note F-Debtor-In-Possession Financing
The Company has arranged for debtor-in-possession financing (the
"Foothill DIP Facility) from Foothill. In connection with the Foothill DIP
Financing, the Company incurred a loan fee of $250,000. The Foothill DIP
Facility consists of a revolving credit facility with borrowing availability of
up to $8.5 million, subject to the Company's satisfaction of various terms and
conditions, bears interest at prime plus 4% on receivable based advances and 18%
on overadvances and expired on January 15, 1998. The financing was paid on
January 22, 1998.
Note G-Stock Repurchase
In connection with the resignation of Ashok Rao, the Company's former
President and Chief Executive Officer, the Company redeemed, in April 1997,
885,360 shares of Common Stock held by Mr. Rao and certain trusts established by
Mr. Rao at a price of $6.80 per share (plus interest at 8% from April 1996), to
be paid in equal monthly installments over a period of 36 months, beginning May
1997.
Note H-Common Stock
At December 31, 1997, common stock was reserved for the following:
Conversion of the notes .................. 6,938,279
Exercise and future grant of stock options 5,010,064
Employee stock purchase plan ............. 252,911
Exercise of outstanding warrants ......... 276,500
----------
Total common stock reserved ........... 12,477,754
==========
F-47
<PAGE>
MIDCOM Communications Inc.
(Debtor-In-Possession)
Notes to Consolidated Financial Statements
December 31, 1997
Note I-Stock Option Plan
The Company has a stock option plan which provides for the granting of
nonqualified and incentive stock options to purchase up to 5,010,064 shares of
common stock. Options granted become exercisable over vesting periods of up to
five years at exercise prices determined by the Board of Directors, and
generally expire ten years from the date of grant.
Stock options have generally been granted at the fair market value at
the date of grant. However, a limited number of options have been granted at
less than the fair market value, in which case compensation expense has been
recognized over the vesting period based on the excess of the fair market value
stock at the date of grant over the exercise price.
During the year ended December 31, 1997 1,408,820 options were granted.
At December 31, 1997 4,483,509 options were outstanding and 526,555 options were
available for future grant. Because of the Chapter 11 proceedings and since any
claims of option holders are subordinated to the claims of other creditors,
management does not believe that presentation of additional information with
respect to these options is meaningful.
Note J-Income Taxes
Components of the Company's deferred tax liabilities and assets as of
December 31, 1997 are as follows (in thousands);
<TABLE>
Deferred tax assets
<S> <C>
Allowance for doubtful accounts ........................................... $ 2,543
Accrued compensation costs ................................................ 655
Provisions not currently deductible ....................................... 6,009
Accrued restructuring costs ............................................... 373
Contract settlement ....................................................... 1,520
Tax depreciation different than financial accounting depreciation ......... 2,545
Intangible tax amortization different than financial statement amortization 22,173
Losses and write-down of foreign joint venture ............................ 3,769
Net operating loss carryforwards .......................................... 60,411
--------
Total deferred tax assets ................................................. 99,998
Valuation allowance ....................................................... 99,607
--------
$ 391
========
Deferred tax liabilities
Cash to accrual change .................................................... (391)
--------
Total deferred tax liabilities ............................................ (391)
--------
Net deferred tax liabilities .............................................. $-
=========
</TABLE>
The Company has net operating loss carryforwards for federal income tax
purposes available to offset future federal taxable income, if any, of
approximately $151 million which expire in 2009-2013.
F-48
<PAGE>
The provision for income taxes differ from the "expected" income tax
benefit as follows (in thousands):
Computed expected federal tax benefit ................... $(35,281)
State taxes, net of federal benefit ..................... (4,109)
Change in valuation allowance for net deferred tax assets 46,105
Other ................................................... (6,715)
--------
$-
========
Note K-Related Party Transactions
Effective May 1996, the Company entered into an employment agreement
with William H. Oberlin, the Company's President and Chief Executive Officer.
The agreement provides for a base salary of $25,000 per month and an annual
bonus to be determined each year by the Company's Board of Directors based on
certain quantitative and qualitative targets set forth in the Company's annual
business plan. In connection with entering into the agreement, the Company
granted Mr. Oberlin options to purchase up to 1,214,714 shares of Common Stock
pursuant to the Company's Stock Option Plan. The options vest ratably over a
five-year period. Mr. Oberlin is entitled to receive up to two years severance
(reduced to one year severance in certain circumstances) in the event of
termination. Severance generally equals the sum of the annualized base salary at
the time of termination and the average annual bonuses for the fiscal years
preceding termination. The agreement also contains a non-interference provision
pursuant to which, for a period of six months following termination of
employment,
Mr. Oberlin has agreed to, among other things, preserve the
confidentiality of the Company's customer list and refrain from actively
soliciting the Company's customers existing at the date of termination. This
agreement was terminated in January 1998.
Effective May 1996, the Company entered into consulting agreements with
Marvin C. Moses and John M. Zrno, each a director of the Company,
pursuant to which Messrs. Moses and Zrno have agreed to provide consulting
services to the Company with respect to acquisitions, investor and other
strategic relations and strategic financial matters. Pursuant to the agreements,
the Company is required to pay each of these individuals a retainer of $8,333
per month. In addition, in connection with the agreements, the Company has
granted to each of these individuals options for the purchase of 253,681 shares
of Common Stock pursuant to the Company's Stock Option Plan. The options vest
ratably over a five-year period. The agreements terminate after a period of five
years beginning on June 1, 1996, unless terminated earlier in accordance with
the terms thereof. The agreements may be terminated by either party at any time
upon 30 days prior written notice. These agreements were terminated in January
1998.
In June 1994, the Company entered into an employment agreement with
Ashok Rao, the former President and Chief Executive Officer of the Company. The
agreement provided for a base salary of $25,000 per month. Mr. Rao resigned from
the Company in April 1996. In connection with Rao's resignation, the Company has
elected to repurchase 885,360 shares of Common Stock held by Mr. Rao and certain
trusts established by Mr. Rao (the "Rao Shares"). See Note H.
F-49
<PAGE>
Note L-Employee Benefit Plans
401(k) Salary Deferral and Profit Sharing Plan
Prior to February 1, 1996, the Company maintained a 401(k) Salary
Deferral and Profit Sharing Plan with its affiliate SP Investments Inc.
("SPII"). Effective February 1, 1996, SPII withdrew from the Retirement Plan.
The Company maintains a voluntary defined contribution profit sharing plans
covering all eligible employees as defined in the plan documents. Participating
employees may elect to defer and contribute a stated percentage of their
compensation to the plan, not to exceed the dollar amount set by law. The
Company matches 50% of each employee's contribution up to a maximum of the first
6% of each employee's compensation.
The Company's matching contributions to the plan were approximately
$448,000.
Employee Stock Purchase Plan
In December 1994, the Company established an Employee Stock Purchase
Plan which became effective upon the successful completion of the Company's
initial public offering of common stock. The Company's plan provides that
eligible employees may contribute up to 10% of their base earnings toward the
semi-annual purchase of the Company's common stock. The employee's purchase
price is 95% of the lesser of the fair market value of the stock on the first
business day or the last business day of the semi-annual offering period. The
total number of shares issuable under the plan is 262,500. There were 3,380
shares issued under the plan during 1997. The Plan was dissolved in November
1997.
Note M-Commitments and Contingencies
Leases
The Company leases office space and certain equipment under terms of
noncancelable operating leases, which expire on various dates through 2005. The
leases generally require that the Company pay certain maintenance, insurance and
other operating expenses. Rent expense under operating leases was approximately
$4.8 million.
At December 31, 1997, minimum future lease payments under noncancelable
operating leases are as follows (in thousands):
1998 1,498
1999 1,538
2000 1,382
2001 1,118
2002 767
Thereafter 551
----------
$6,854
==========
F-50
<PAGE>
Amounts due on leases which have been rejected in connection with the
Chapter 11 filing have been excluded from the table above.
Commitments with Providers
Under the terms of carrier contracts executed with AT&T and other
carriers, the Company has made commitments to maintain or achieve certain volume
levels in order to obtain special forward pricing. Under certain of these
contracts, the Company guarantees to sell a certain amount of long distance
volume within a certain time period or purchase all or a portion of any unused
volume. Under other contracts, if certain volume levels are not achieved during
stated periods, pricing is adjusted going forward to levels justified by current
volumes.
At December 31, 1997, minimum future usage commitments are as follows:
1998 3,287
1999 -
2000 75,000
--------
$78,287
========
At December 31, 1997, the Company has achieved or reserved for all of
its required volume commitments. There can be no assurance that the minimum
usage communications will be achieved in the future, and if such commitments are
not achieved future operating results could be adversely affected.
During the year ended December 31, 1997, the Company relied on three
carriers to carry traffic representing approximately 78%, of the Company's
revenue. The Company has the ability to transfer its customers' traffic from one
supplier to another in the event a supplier declines to continue to carry the
Company's traffic. However, such transfers could result in disruption of service
to the customers, with a subsequent loss of revenue which would adversely affect
operating results.
Regulation
Federal
The Company has all necessary authority to provide domestic interstate
and international telecommunications services under current FCC regulations.
MIDCOM has filed both domestic and international tariffs with the FCC, and
PacNet has, and is only required to file, international tariffs. Pursuant to a
1995 court decision, detailed rate schedules now must be filed in lieu of the
"reasonable range of rates" tariff previously accepted by the FCC. In reliance
on the FCC's past practice of allowing relaxed range of rates tariffs for
non-dominant carriers, MIDCOM and most of its competitors did not maintain
detailed rate schedules. Until the statute of limitations expires, MIDCOM could
be held liable for damages for its failure to maintain detailed rate schedules,
although it believes that such an outcome is highly unlikely and would not have
a material adverse effect on it. Pursuant to authority granted to it in the 1996
Telecommunications Act, the FCC is considering "mandatory detariffing" for
domestic non-dominant carriers. This proposal (which has been stayed by an order
of the federal district court in Washington, D.C.) would relieve the Company of
its obligation to file tariffs applicable to its domestic interexchange
offerings.
F-51
<PAGE>
State
The intrastate long distance operations of MIDCOM are also subject to
various state laws. The majority of states require certification or
registration, which the Company has secured in 47 states and Washington, D.C.
Many states require tariff filings as well.
In certain states, approval for transfers of control and acquisitions
of customer bases must be obtained. MIDCOM has been successful in obtaining all
necessary regulatory approvals to date, although revisions of tariffs,
authorities and approvals are being made on a continuing basis, and many such
requests are pending at any one time.
Some states may assess penalties on long distance service providers for
traffic sold prior to tariff approval or the state's consent to an acquisition.
Such states may require refunds to be made to customers. It is the opinion of
management that such penalties and refunds, if any, would not have a material
effect on the results of operations or financial condition of the Company.
Disputes and Litigations
Sprint Settlement
The Company has had a series of ongoing disputes relating to service
and billing with Sprint, one of its primary suppliers. For this and other
reasons, on September 18, 1997, the Company discontinued its payments to Sprint
and, on October 10, 1997, the Company received a notice of default from Sprint.
On October 29, 1997, the Company entered into a settlement with Sprint whereby
it agreed to pay Sprint $1,250,000 on October 31, 1997, November 7, 1997 and
November 14, 1997; $4,000,000 on November 21, 1997; and thereafter, so long as
Sprint continues to provide service to the Company, weekly payments equal to the
lesser of $2,000,000 or the current amount outstanding. Sprint and the Company
agreed to arbitrate the Company's claims against Sprint up to an aggregate of
$5,000,000 and the parties agreed that the Company would transition its traffic
to its own or other networks over the ninety day period ending January 29, 1998.
Class Action Lawsuit
The Company, its Vice Chairman of the Board of Directors and largest
shareholder, the Company's former President, Chief Executive Officer and
Director and the Company's former Chief Financial Officer were named as
defendants in a securities action filed in the U.S. District Court for the
Western District of Washington (the "Complaint"). The Complaint was filed on
behalf of a class of purchasers of the Company's common stock during the period
beginning on July 6, 1995, the date of the Company's initial public offering,
and ending on March 4, 1996 (the "Class Period"). In April 1997, the Board of
Directors of the Company unanimously approved the terms of a settlement of all
claims against the Company and all of the individual defendants. The settlement,
which is subject to Court approval and which admits no liability or fault,
provides for the payment of $1.0 million in cash by the Company's insurance
carrier, and the issuance of approximately 420,000 shares of the Company's
common stock, subject to adjustments depending upon the fair market value of the
stock on the date that the settlement is approved by the Court.
F-52
<PAGE>
SEC Investigation
The Company was informed in May 1996 that the Securities and Exchange
Commission ("SEC") was conducting an informal inquiry regarding the Company. In
May 1997 the Company learned that a formal order of investigation had been
entered by the SEC. The Company believes that the focus of the investigation is
on (i) the accuracy of disclosures in certain documents filed by the Company
with the SEC; (ii) whether the Company had maintained adequate books and records
and had adequate internal controls; and (iii) whether records had been
falsified. The Company has voluntarily provided documents requested by the
Commission, is in the process of furnishing additional requested documents, and
has cooperated with the Commission in scheduling interviews with certain former
Company personnel. The Company is unable to predict the ultimate outcome of the
investigation. The Company and certain of its former employees could be subject
to civil or criminal sanctions including monetary penalties and injunctive
measures. If imposed on the Company, such penalties and injunctive measures
could have a material adverse effect on the Company's business, financial
condition and results of operation.
Frontier Lawsuits
On August 19, 1996 the Company was served with a complaint filed in
U.S. District Court for the Eastern District of Michigan by Frontier Corporation
("Frontier"). The complaint named as defendants the Company and eleven
individuals, all of whom are former employees of Frontier who resigned their
positions with Frontier. Frontier agreed to dismiss all of the individual
defendants in the case except William H. Oberlin, the Company's President and
CEO. Moreover, in September 1997, the Court dismissed certain causes of action
in the context of a summary judgment hearing. The surviving claims are that (i)
MIDCOM is in violation of a non-disclosure agreement between Frontier and MIDCOM
by virtue of its alleged use of confidential information of Frontier obtained
through employees hired from Frontier and otherwise; and (ii) MIDCOM and Mr.
Oberlin tortuously interfered in Frontier's contractual relationships with
various Frontier employees and contractors. The complaint seeks: (i) that the
defendants be preliminarily and permanently enjoined from breaching their
respective agreements with Frontier, (ii) that MIDCOM be enjoined from aiding
and abetting certain alleged breaches of fiduciary duties; (iii) an order that
MIDCOM hold all profits which it earns as a result of its hiring of the
individual defendant and other Frontier employees as constructive trustees for
the benefit of Frontier; (iv) an accounting of all profits realized by Midcom as
a result of its hiring of the defendant and other Frontier employees; (v) a
declaratory judgment on its various claims; (vi) damages in an unspecified
amount; (vii) Frontier's costs, including reasonable attorney's fees, incurred
in bringing the action; and (viii) other appropriate relief. The Company has
recently filed a motion to dismiss the action and it awaits a hearing on this
motion.
An affiliate of Frontier has also filed a complaint in the same U.S.
Federal District Court claiming $515,000 for unpaid amounts under a supply
agreement. The Company believes this claim to be without substantial merit and
is vigorously defending it. The Company's motion to dismiss on statute of
limitations grounds was granted in part and remaining matters have been
transferred to the FCC as a matter of primary jurisdiction. On November 6, 1997,
the Company and Frontier agreed to enter into a settlement pursuant to which
Frontier would dismiss all claims against the Company and Mr. Oberlin. The
settlement would provide, among other things, that, over the next three years,
MIDCOM will transfer approximately $40.5 million of long distance traffic to
Frontier and Frontier will transfer approximately $20.25 million of
F-53
<PAGE>
long distance traffic to Midcom. There is some uncertainty as to whether the
settlement creates a pre-petition or post-petition claim, which is to be decided
by the U.S. Federal District Court.
Cherry Communications Lawsuit
In September and December 1995, the Company purchased two significant
customer bases from Cherry Communications. The first transaction ("Cherry I")
provided for the purchase of long distance customer accounts having monthly
revenue for the three months preceding the date of closing of $2.0 million, net
of taxes, customer credits and bad debt. The second transaction ("Cherry II")
provided for the purchase of long distance customer accounts having monthly
revenue which were to average $2.0 million per month over the 12 months
following the transaction, net of taxes, customer credits and bad debt. The
purchase price payable with respect to Cherry I was $10.5 million, of which $5.5
million was paid in cash and the balance was paid by the delivery of 317,460
shares of common stock (subject to a possible increase in such number based on
the future value of the common stock), of which 126,984 shares are held in
escrow to be applied to indemnify claims or to cover shortfalls in revenue from
the $2.0 million monthly average. The purchase price for Cherry II was $18.0
million, of which $7.0 million has been paid in cash. Additional installments of
$3.4 million were due in February, March and April of 1996, of which $400,000 of
each installment was to be paid either in cash or by delivery of shares of
common stock. Separately, the Company also agreed to pay Cherry Communications
for servicing customer accounts on behalf of the Company. The acquired customer
bases have not generated the required minimum revenue levels and Cherry
Communications has failed to remit to the Company collections received by Cherry
Communications from a portion of the acquired customers. Accordingly, the
Company has withheld the final three installment payments for Cherry II (a total
of $9.0 million excluding escrowed sums), payment of invoices for carrier
services for the acquired bases (up to $11.0 million) and accrued customer
service charges of $840,000. Negotiations between Cherry Communications and the
Company failed to produce a settlement of these disputes.
Cherry Communications filed a lawsuit against the Company in the United
States District Court for the Northern District of Illinois, Eastern Division.
In its first Amended Complaint filed on July 18, 1996, Cherry Communications
seeks recovery of (i) approximately $7.2 million plus interest and attorney's
fees alleged to be due and owing under a Rebiller/Reseller Agreement for
Switched Services between Cherry Communications and the Company, (ii)
approximately $9.0 million plus interest and attorney's fees alleged to be due
and owing under the November 1, 1995 Customer Base Purchase and Sale Agreement
between Cherry Communications and the Company (the "Cherry II Agreement"), and a
Promissory Note executed in connection with the Cherry II Agreement, (iii)
customer service charges of $840,000. It is the position of the Company that
Cherry Communications has breached its obligations under the Cherry I Agreement
and the Cherry II Agreement by among other breaches (i) failing to sell MIDCOM
customer bases having the average monthly revenues required by the customer base
agreements, and (ii) failing to remit to MIDCOM monies collected from the
customer accounts. It is also the position of the Company that, as a result of
Cherry Communication's breaches of the Cherry I Agreement and the Cherry II
Agreement, as amended by certain addenda, that the Company has offsets and
counterclaims against Cherry Communications in excess of the sums it has
withheld from Cherry Communications. The Company is attempting to negotiate a
resolution of the disputes. In the event that a settlement is not reached, the
Company intends to vigorously defend the lawsuit filed by Cherry Communications.
However, the Company is unable to predict
F-54
<PAGE>
the outcome of this lawsuit. As a result of this litigation, as of September 1,
1996, the Company discontinued booking revenue generated by the customer bases
purchased from Cherry Communications. In October 1997, Cherry Communications
filed a petition for relief under Chapter 11 of the Bankruptcy Code.
Discom Arbitration
Discom Corporation ("Discom"), a former distributor of the Company, in
an arbitration proceeding in New York against the Company has filed to increase
the amount of its claim against the Company to approximately $8.0 million
purportedly based upon a lost profit and damage analysis of its expert. The
Company has not yet had an opportunity to depose Discom's expert, but
preliminary indications are that the evaluation is seriously flawed and that the
Company's own expert testimony will more accurately reflect the maximum possible
damage claim of $250,000 to $500,000, which amount has been escrowed by the
Company. The Company disputes that any amounts are owed to Discom and it is
vigorously defending the case.
Other Litigation
The Company is also party to other routine litigation incidental to its
business and to which its property is subject. The Company's management believes
the ultimate resolution of these matters will not have a material adverse effect
on the Company's business, financial condition or results of operations.
Note N-Supplemental Disclosure of Cash Flow Information
(In Thousands)
Cash paid for interest $9,353
Cash paid for income taxes $-
Note O-Relocation of Corporate Headquarters
In May 1997, the Company announced its intention to relocate its
corporate headquarter functions based in Seattle, Washington to Southfield,
Michigan, where the Company's Chief Executive Officer and other key executives
maintained offices. During 1997, the Company completed the relocation of various
corporate support functions, including human resources, legal, finance and
information services, affecting approximately 130 employees, to temporary office
space in Southfield.
Note P-Other Information
On November 7, 1997, the common stock of the Company was de-listed from
the Nasdaq Stock Market effective November 17, 1997. As a result of being
de-listed from the Nasdaq Stock Market, the liquidity of the common stock is
significantly diminished. This event will materially and adversely affect the
Company's ability to obtain financing through the sale of common stock or
securities convertible into common stock and, ultimately, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
F-55
<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 hereunto duly authorized.
Dated: March 11, 1998 WINSTAR COMMUNICATIONS, INC.
----------------------------
(Registrant)
/s/ Frederic E. Rubin
----------------------------
Frederic E. Rubin
Vice President and Treasurer
3
<PAGE>
EXHIBIT INDEX
Exhibit Number Description
- ----------------- -----------------
99.1 Press Release
4
<PAGE>
EXHIBIT 99.1
Contacts:
Financial Community Press
Frank Jepson Beth-Ellen Keyes
SVP, Investor Relations (212)-584-4098
(212)-584-4021
WINSTAR TO RAISE $500 MILLION IN INSTITUTIONAL PRIVATE
PLACEMENTS
NEW YORK - MARCH 11, 1998, WINSTAR COMMUNICATIONS, INC. (NASDAQ-WCII) announced
today that it intends to raise $500 million in Notes and Preferred Stock through
Rule 144A institutional private placements. The offerings will be in the form of
$200 million of Senior Subordinated Notes, $150 million of Senior Subordinated
Deferred Interest Notes and $150 million of Senior Cumulative Convertible
Preferred Stock. The Company intends to use the net proceeds of the offerings to
expand its telecommunications operations and for general corporate purposes.
WinStar Communications, Inc. is a national local communications Company, serving
business customers, long distance carriers, fiber-based competitive access
providers, mobile communications companies, local telephone companies, and other
customers with broadband local communications needs. The Company provides its
Wireless Fiber(sm) services using its licenses in the 38 GHz spectrum. The
Company also provides long distance, Internet and information services.
WinStar is a registered trademark, and Wireless Fiber is a service mark of
WinStar Communications, Inc.
5
<PAGE>
