MIDCOM COMMUNICATIONS INC, S-1, 1996-11-25

MIDCOM COMMUNICATIONS INC
S-1, 1996-11-25
TELEPHONE COMMUNICATIONS (NO RADIOTELEPHONE)

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 22, 1996

REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------

MIDCOM COMMUNICATIONS INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
WASHINGTON 4813 91-1438806
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>

1111 THIRD AVENUE
SEATTLE, WA 98101
(206) 628-8000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING
AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------

PAUL P. SENIO
VICE PRESIDENT AND GENERAL COUNSEL
MIDCOM COMMUNICATIONS INC.
1111 THIRD AVENUE
SEATTLE, WA 98101
(206) 628-4900
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
------------------------

COPIES TO:

THOMAS S. HODGE
MICHAEL A. SKINNER
HELLER, EHRMAN, WHITE & MCAULIFFE
6100 COLUMBIA CENTER, 701 FIFTH AVENUE
SEATTLE, WASHINGTON 98104
(206) 447-0900
------------------------

APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration statement number of the
earlier effective registration statement for the same offering. [ ]

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
------------------------

CALCULATION OF REGISTRATION FEE
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<TABLE>
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM
OFFERING PRICE AGGREGATE
TITLE OF EACH CLASS OF AMOUNT TO BE PER OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED SECURITY(1) PRICE(1) REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------
Common Stock, par value $.0001 per
share................................... 1,544,274 $9.69 $14,964,015 $4,534
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</TABLE>

(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457, based upon the average high and low prices of the
Company's common stock as reported on the Nasdaq National Market on November
20, 1996.
------------------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2

MIDCOM COMMUNICATIONS INC.

CROSS-REFERENCE SHEET
PURSUANT TO ITEM 501(B) OF REGULATION S-K

<TABLE>
<CAPTION>
FORM S-1 LOCATION OR HEADING
ITEM NUMBER AND CAPTION IN PROSPECTUS
--------------------------------------------------- ---------------------------------------
<S> <C> <C>
1. Forepart of the Registration Statement and
Outside Front Cover Page of Prospectus........... Outside Front Cover
2. Inside Front and Outside Back Cover Pages of
Prospectus....................................... Inside Front and Outside Back Cover
Pages
3. Summary Information and Risk Factors............... Prospectus Summary; Risk Factors
4. Use of Proceeds.................................... Prospectus Summary; Use of Proceeds
5. Determination of Offering Price.................... Outside Front Cover Page; Plan of
Distribution
6. Dilution........................................... Not Applicable
7. Selling Security Holders........................... Selling Securityholders
8. Plan of Distribution............................... Outside Front Cover Page; Plan of
Distribution
9. Description of Securities to Be Registered......... Outside Front Cover Page; Prospectus
Summary; Description of Capital Stock
10. Interests of Named Experts and Counsel............. Not Applicable
11. Information With Respect to the Registrant......... Outside Front Cover Page; Prospectus
Summary; Risk Factors;
Capitalization; Selected Financial
and Operating Data; Management's
Discussion and Analysis of Financial
Condition and Results of Operations;
Business; Management; Selling
Securityholders; Principal
Shareholders; Certain Transactions;
Description of Notes; Description of
Capital Stock; Description of Certain
Indebtedness; Shares Eligible for
Future Sale; Consolidated Financial
Statements
12. Disclosure of Commission Position on
Indemnification for Securities Act Liabilities... Not Applicable
</TABLE>
<PAGE> 3

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.

SUBJECT TO COMPLETION DATED NOVEMBER 22, 1996
PROSPECTUS

1,544,276 SHARES

MIDCOM COMMUNICATIONS INC.
COMMON STOCK
------------------------

THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 8.

------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

------------------------

This Prospectus relates to the public offer and sale of up to 1,544,274
shares (the "Securities") of common stock, par value $.0001 per share (the
"Common Stock"), of MIDCOM Communications Inc. ("Midcom" or the "Company") which
were privately offered by the Company in a series of unrelated transactions and
which may be offered from time to time for the account of the holders thereof
named herein (the "Selling Securityholders"). See "Selling Securityholders" and
"Plan of Distribution." Information concerning the Selling Securityholders may
change from time to time, which changes will be set forth in an accompanying
Prospectus Supplement.

The Common Stock is traded on the Nasdaq National Market ("Nasdaq") under
the symbol "MCCI." The closing sale price of the Common Stock reported on Nasdaq
on November 20, 1996 was $9.50 per share.

The Company has been advised by the Selling Securityholders that the
Selling Securityholders, acting as principals for their own account, directly or
through agents, dealers or underwriters to be designated from time to time, may
sell the Securities from time to time on terms to be determined at the time of
sale through customary brokerage channels, negotiated transactions or a
combination of these methods at fixed prices that may be changed, at market
prices then prevailing or at negotiated prices then obtainable. To the extent
required, the number of Securities to be sold, the names of the Selling
Securityholders, the purchase price, the public offering price, the name of any
agent, dealer or underwriter, the amount of expenses of the offering and any
applicable commission or discount with respect to a particular offer will be set
forth in an accompanying Prospectus Supplement or, if appropriate, a
post-effective amendment to the Registration Statement of which this Prospectus
is a part. Each of the Selling Securityholders reserves the right to accept and,
together with its agents from time to time, to reject in whole or in part any
proposed purchase of the Securities to be made directly or through agents. The
aggregate proceeds to the Selling Securityholders from the sale of the
Securities offered by the Selling Securityholders hereby will be the purchase
price of such Securities less any discounts or commissions. The Company will
receive no portion of the proceeds from the sale of the Securities offered
hereby and will bear certain expenses incident to their registration. See "Plan
of Distribution."

No person has been authorized to give any information or to make any
representation other than those contained in this Prospectus, and if given or
made, such information or representations must not be relied upon as having been
authorized by the Company. This Prospectus shall not constitute an offer to sell
or a solicitation of an offer to buy, nor shall there be any sale of, any of the
Securities to any person in any jurisdiction in which such an offer,
solicitation or sale would be unlawful. Neither the delivery of this Prospectus
nor any sale made hereunder shall under any circumstances create any implication
that the information contained herein is correct as of any time subsequent to
the date hereof.

------------------------

THE DATE OF THIS PROSPECTUS IS NOVEMBER , 1996.
<PAGE> 4

PROSPECTUS SUMMARY

The following summary should be read in conjunction with, and is qualified
in its entirety by, the more detailed information and financial statements,
including the notes thereto, appearing elsewhere in this Prospectus. Unless the
context indicates otherwise in this Prospectus (i) all references to "Midcom" or
the "Company" refer to MIDCOM Communications Inc. and its subsidiaries and (ii)
all references to Consolidated Financial Statements refer to the financial
statements of Midcom. This Prospectus contains certain forward-looking
statements which involve known and unknown risks, uncertainties and other
factors which may cause actual results, performance or achievements of the
Company or industry trends to differ materially from those expressed or implied
by such forward-looking statements. Such factors include, among others, those
discussed in "Risk Factors" and elsewhere in this Prospectus.

THE COMPANY

MIDCOM Communications Inc. 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 AT&T Corp. ("AT&T"), Sprint Corporation
("Sprint") and WorldCom, Inc. ("WorldCom"), to provide a broad array of
integrated long distance telecommunications services on a seamless and highly
reliable basis. Midcom's service offerings include basic "1 plus" and "800" long
distance, frame relay data transmission and wireless communications services, as
well as enhanced telecommunications services such as dedicated private lines
between customer locations, facsimile broadcast services, calling cards and
conference calling.

Midcom focuses on serving small to medium-sized businesses. The Company
estimates that during the second quarter of 1996 it invoiced approximately
125,000 customer locations per month, a significant majority of which were
located in the major metropolitan areas of California, Florida, Illinois, New
York, Ohio and Washington. The Company believes that the larger long distance
carriers, such as AT&T, Sprint, WorldCom and MCI Communications Corporation
("MCI"), tend to focus their sales and customer support efforts on residential
and large commercial customers and do not routinely provide significant pricing
discounts for small to medium-sized businesses. By purchasing large usage
volumes from the facilities-based carriers at wholesale prices, Midcom seeks to
offer its customers more favorable pricing than they could obtain from such
carriers directly. In addition, the Company believes that businesses in this
market segment do not typically have in-house telecommunications expertise and
therefore require more assistance with the assessment and management of their
telecommunications requirements. As a result, the Company believes that it is
able to differentiate its service offerings from the larger carriers in this
market segment on the basis of price, breadth of service offerings, customer
service and support and the ability to provide customized solutions to the
telecommunications requirements of its customers. See "Business -- Marketing and
Sales," "Business -- Competition" and "Business -- Customer Concentrations."

Midcom believes that the recently enacted Telecommunications Act of 1996
(the "Telecommunications Act") will substantially expand its market
opportunities. The Telecommunications Act removes substantial legal barriers to
competitive entry into the local telecommunications market and directs incumbent
local exchange carriers to allow competing telecommunications service providers
such as the Company to interconnect their facilities with the local exchange
networks, to lease network components on an unbundled basis and to resell local
telecommunications services. According to Federal Communications Commission
("FCC") and other industry estimates, in 1995 long distance providers reported
revenue of $72.4 billion while local telecommunications providers reported
revenue of $102.9 billion. See "Business -- Industry Background,"
"Business -- Regulation" and "Business -- Competition."

2
<PAGE> 5

installation of a new billing system. Problems encountered in this
implementation process contributed to the Company's operational difficulties. In
addition, certain reports generated by the new management information system
that were used to estimate unbilled revenue for the third quarter of 1995 failed
to fully reflect all discounts that were properly included in the bills
subsequently sent to the Company's customers. See "Business -- Information
Systems." Primarily as a result of this failure, reported revenue was overstated
for the third quarter of 1995 and the Company's Quarterly Report on Form 10-Q
for that period had to be amended to restate reported results. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Restatement of Results for the Third Quarter of 1995." In
addition, the Company's profitability was reduced as a result of the Company's
supply contract with AT&T which provided for higher rates than those provided by
competitive suppliers, although in October 1996 the Company and AT&T entered
into a new carrier supply contract which provides for more favorable rates. See
"Business -- Suppliers." These factors contributed to defaults under the
Company's Revolving Credit Facility (as defined below) and caused the Company's
auditors to include a going concern qualification in their report on the
Company's consolidated financial statements for the year ended December 31,
1995. The Company's auditors also identified certain material weaknesses in the
Company's internal financial controls. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Material Weaknesses" and
"Description of Certain Indebtedness."

In response to these developments, during the second and third quarters of
1996 Midcom recruited a new executive management team with extensive experience
and expertise in the telecommunications industry. In May 1996, the Company hired
William H. Oberlin as its President and Chief Executive Officer, appointed Mr.
Oberlin, Marvin C. Moses and John M. Zrno to its Board of Directors and engaged
Mr. Moses and Mr. Zrno as consultants. In October 1996, Mr. Zrno was appointed
as Chairman of the Board, effective December 2, 1996. These individuals formerly
held senior management positions at ALC Communications Corporation ("ALC"), a
leading provider of long distance and other services to small and medium-sized
businesses. During their tenure at ALC, ALC completed a successful turn-around
and experienced profitable growth. From the fiscal year ended December 31, 1991
through the 12 months ended June 30, 1995 (prior to ALC's merger into Frontier
Corporation), ALC's revenue increased from $346.9 million to $677.1 million and
net income increased from $5.3 million to $75.0 million. In addition, in July
1996 the Company appointed Daniel M. Dennis to the Company's Board of Directors.
Mr. Dennis has served in a number of management positions with MCI for over 23
years. See "Management."

The new executive management team has developed a restructuring, network
and marketing strategy which it plans to implement during 1996 and 1997 and
which is designed to address the operational challenges experienced by the
Company and increase internally generated sales and profitability. Principal
components of the Company's strategy include the following:

Continue to Build Management Team and Restructure Operations. Midcom
will continue to seek opportunities to augment management with individuals
who have telecommunications industry experience and expertise. From May to
September 1996, the Company appointed 10 individuals to key operational
management positions. These individuals have extensive experience in the
operation of a telecommunications company, including (i) network design,
implementation and operation, (ii) marketing and sales, (iii) management
information systems and (iv) bill processing and collection. Midcom
believes that the experience and depth of this management team will improve
the Company's ability to address its current operational challenges and to
pursue its transition from primarily a nonfacilities-based reseller of long
distance and other telecommunications services to a switchbased provider of
integrated telecommunications services. In addition, Midcom's management
team intends to focus on consolidating and integrating the Company's
multiple information and billing systems and other redundant functions of
certain acquired operations, enlarging and enhancing its information
system, improving its financial reporting and internal controls and
renegotiating its existing carrier supply agreements to obtain more
favorable terms.

Deploy Switching Facilities. At the end of the second quarter of
1996, Midcom owned and operated limited capacity switches in nine
locations. The Company intends to use a portion of the proceeds of a
convertible note offering completed in August 1996 to acquire and install
state-of-the-art high capacity switches, with local and long distance
functionality, in areas of the country where it has a

3
<PAGE> 6

sufficient volume of long distance traffic and where the regulatory
environment and market conditions will permit it to provide local service
at acceptable margins. The Company believes that, in the cities where it
intends to deploy switches, there will be significant local circuit
capacity at attractive rates available from incumbent local exchange
carriers, competitive local exchange carriers and 38GHz wireless providers.
Using its own switches will enable the Company to (i) direct customer call
traffic over multiple networks which is expected to minimize costs and
improve gross margin, (ii) switch local traffic, thereby increasing the
economic viability of entering the market for local telecommunications
services, (iii) shield proprietary information regarding its customers from
the underlying carriers, thereby increasing customer control, (iv)
facilitate access to call data records and (v) implement differentiating
features and billing enhancements without involving the underlying carrier.
See "Business -- Switching Facilities."

Reorganize and Expand Sales Efforts. To take full advantage of its
planned network of switching facilities and expanded product offerings,
Midcom is in the process of reorganizing its direct sales force into (i) a
national and key accounts group consisting of highly experienced sales
personnel focused on larger customers with sophisticated telecommunications
requirements and (ii) a general accounts group focused on smaller
customers. Both groups will be located in major metropolitan areas where
the Company believes it has significant market opportunities and can
compete effectively on the basis of price. The Company intends to implement
training programs and financial incentives designed to increase the
cross-selling efforts of its direct sales force and further integrate the
Company's broad array of service offerings. In addition to reorganizing its
sales efforts, the Company intends to increase the number of sales
representatives during 1996 and 1997 from approximately 35 at the end of
July 1996 to approximately 200. The Company will continue to supplement its
direct sales force with its existing network of resellers and distributors.
In addition, the Company intends to develop a new tier of distributors who
will be offered long-term financial incentives and who will be required,
within selected territories, to market and sell the Company's service
offerings exclusively. The Company believes that these long-term financial
incentives and exclusive marketing arrangements will result in improved
performance and increased loyalty to the Company and its service offerings.
See "Business -- Marketing and Sales."

Expand and Enhance Customer Support Efforts. Midcom intends to
support its expanded sales efforts and reduce customer attrition by
building an enhanced customer service and support operation. The Company
intends to increase its customer service and support staff during 1996 and
1997 from approximately 45 at the end of July 1996 to approximately 60.
This expanded operation will include (i) a staff of trained customer
service representatives available during normal business hours at a number
of integrated customer service centers, (ii) trained account
representatives assigned and dedicated to individual customers with
sophisticated telecommunications requirements and (iii) teams of technical
specialists available to develop customized solutions for a customer's
unique telecommunication needs. See "Business -- Customer Service."

Resell Local Services and Provide a Single-Source
Solution. Regulatory changes resulting from the Telecommunications Act
significantly expand the number and types of services Midcom is permitted
to offer. As a result, Midcom intends to offer its customers local dial
tone and a variety of other local telecommunications services primarily in
locations where it has a significant sales and marketing presence or where
it plans to deploy switching facilities. The Company believes that its
large and geographically concentrated customer base of small to
medium-sized businesses represents a significant potential market for these
additional services. These additional services will afford the Company the
opportunity to provide its customers with a single-source solution for
local, long distance, wireless and enhanced telecommunications services.
The Company believes that bundling these services will provide substantial
advantages to its customers, including lower overall costs and a higher
level of service due to a single source for ordering, installation,
customer service and account management. In addition, Midcom believes that
offering a single source for telecommunications services will permit the
Company to (i) increase sales by increasing its share of the
telecommunications expenditures of its customers and (ii) improve customer
control and retention by strengthening its relationships with its
customers. See "Business -- Industry Background," "Business -- Regulation"
and "Business -- Competition."

4
<PAGE> 7

Midcom believes that its new management team has the skills and experience
necessary to implement the foregoing strategy. However, management's ability to
implement the Company's strategy and achieve the intended positive results is
subject to a number of risks and uncertainties, and there can be no assurance
that the strategy will be successfully implemented or that the intended positive
results will be achieved. See "Risk Factors."

Midcom was incorporated in the State of Washington in 1989. Its executive
offices are located at 1111 Third Avenue, Seattle, Washington 98101, and its
telephone number is (206) 628-8000.

RISK FACTORS

Prospective investors are strongly cautioned that an investment in the
Securities offered hereby involves a very high degree of risk. The ability of
the Company's new management to halt the deterioration of the Company's results
of operations and financial condition and successfully implement its operating
strategy is subject to an unusual number of material risks and uncertainties.
Prospective investors should not dismiss the risk factors contained herein as
"boilerplate" or "customary" disclosure. The contingencies and other risks
discussed under the heading "Risk Factors" could affect the Company in ways not
presently anticipated by its management and thereby impair its ability to
continue as a going concern and materially affect the value of its debt and
equity securities, including the Securities offered hereby. A careful review and
understanding of each of the risk factors contained herein, as well as the other
information contained in this Prospectus, is essential for an investor seeking
to make an informed investment decision with respect to the Securities.

THE PRIVATE PLACEMENT

In August and September of 1996, the Company completed a private placement
(the "Private Placement") of $97,743,000 in aggregate principal amount of 8 1/4%
Convertible Subordinated Notes due 2003 (the "Notes") pursuant to a Purchase
Agreement, dated as of August 15, 1996 (the "Purchase Agreement"), among the
Company, PaineWebber Incorporated ("PaineWebber") and Wheat, First Securities,
Inc. ("Wheat, First," and together with PaineWebber the "Initial Purchasers").
The Notes were sold to qualified institutional buyers pursuant to Rule 144A of
the Securities Act of 1933 (the "Securities Act"), certain "accredited
investors" pursuant to Regulation D under the Securities Act, and certain
non-U.S. persons pursuant to Regulation S under the Securities Act.

The net proceeds to Midcom from the Private Placement were approximately
$94.2 million, after deducting the discount to the Initial Purchasers and
expenses. The Company used the net proceeds as follows: (i) $15.0 million to
repay in full a bridge loan (the "Bridge Loan") made by Transamerica Business
Credit Corporation ("Transamerica"), (ii) $19.0 million to repay in full the
revolving loans (the "Revolving Loans") under the Company's secured revolving
credit facility with Transamerica and certain other lenders (the "Revolving
Credit Facility"), (iii) $5.0 million to pay the first installment of an $8.8
million payment in connection with the satisfaction of past shortfalls and
reduction of the minimum commitment under the Company's carrier supply contract
with AT&T and (iv) $10.0 million to bring current a number of payment
obligations existing prior to the completion of the Private Placement. In
addition, the Company anticipates using approximately $22.0 million of the net
proceeds to acquire and install high capacity switches. The balance of the net
proceeds will be used for additional working capital, additional capital
expenditures and general corporate purposes.

Pursuant to a Registration Rights Agreement, dated as of August 22, 1996
(the "Registration Rights Agreement"), among the Company and the Initial
Purchasers, the Company has agreed to register the public offer and sale of the
Notes and the shares of Common Stock issuable upon conversion of the Notes (the
"Conversion Shares"). Pursuant to the Registration Rights Agreement, the Company
filed a shelf registration statement (the "Shelf Registration Statement") with
the Securities and Exchange Commission (the "Commission") on October 18, 1996
(file no. 333-14427) to register the public offer and sale of the Notes and the
Conversion Shares. The Company is required under the Registration Rights
Agreement to maintain the effectiveness of the Shelf Registration Statement for
a period of three years from the completion of the Private Placement or, if
shorter, when (i) all the Notes and Conversion Shares have been sold pursuant to
the Shelf Registration Statement or (ii) the date on which there ceases to be
outstanding any Notes or Conversion Shares. See "Description of
Notes -- Registration Rights; Liquidated Damages."

5
<PAGE> 8

SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA

The summary consolidated financial and operating data presented below is
qualified in its entirety by, and should be read in conjunction with, the
Company's Consolidated Financial Statements and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Prospectus. The following information as previously
reported has been restated to include Adval, Inc. and ADNET Telemanagement, Inc.
which were acquired in pooling of interests transactions on September 29, 1995
and December 29, 1995, respectively.

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------- -------------------
1993 1994 1995 1995 1996
------- -------- -------- -------- --------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenue................................................ $66,010 $111,699 $203,554 $147,409 $124,590
Gross profit........................................... 20,647 32,655 64,008 46,748 34,762
Depreciation and amortization.......................... 1,881 4,134 13,790 8,384 26,184
Settlement of contract dispute......................... -- -- -- -- 8,800
Restructuring charge(1)................................ -- -- -- -- 2,220
Loss on impairment of assets(2)........................ -- -- 11,830 -- 20,765
Operating income (loss)................................ 641 824 (23,673) (4,290) (71,255)
Net loss(3)............................................ (529) (3,029) (33,418) (11,936) (77,420)
Net loss per share(4).................................. $ (0.05) $ (0.31) $ (2.76) $ (1.02) $ (5.01)
Shares used in calculating per share data(4)........... 9,930 9,930 12,101 11,648 15,442
SUPPLEMENTAL OPERATING DATA:
EBITDA(5).............................................. $ 2,522 $ 4,958 $ 1,947 $ 4,094 $(13,286)
</TABLE>

<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
ACTUAL
------------------
<S> <C>
BALANCE SHEET DATA:
Cash................................................................................ $ 48,138
Total assets........................................................................ 106,764
Short-term obligations, including current portion of long-term obligations.......... 13,925
Long-term obligations, less current portion......................................... 99,632
Shareholders' equity................................................................ $(49,699)
</TABLE>

- ---------------
(1) Consists primarily of severance and lease cancellation charges relating to
restructuring of operations in March and April 1996.
(2) Consists of the following: (i) a $6.8 million write-down of the Company's
interest in its joint venture in Russia in 1995, and a $2.0 million
write-down in September 1996, (ii) a $2.5 million write-off in 1995 of the
Company's existing limited capacity switching equipment as a result of its
decision to deploy new, state-of-the-art high capacity switches, (iii) a
$2.5 million partial write-down of the Company's capitalized software
development costs for its management information system in 1995, (iv) a
$17.8 million write-down of intangible assets in June 1996, and (v) a $1.0
million write-down of microwave equipment in June 1996.
(3) Includes $2,992 of original issue discount and $1,075 of deferred financing
costs written off in the third and fourth quarters of 1995, respectively.
(4) Net loss per share is based on the number of shares as described in Note 1
of the Notes to Consolidated Financial Statements.
(5) As used herein, "EBITDA" is defined as operating income plus depreciation,
amortization, loss on impairment of assets, restructuring charge and
settlement of contract dispute. EBITDA is commonly used to measure
performance of telecommunications companies because of (i) the importance of
maintaining cash flows in excess of debt-service obligations due to the
capital and acquisition-intensive nature of the telecommunications industry
and (ii) the non-cash effect on earnings of generally high levels of both
amortization and depreciation expenses associated with capital equipment and
acquisitions common in this industry. EBITDA does not purport to represent
cash provided by operating activities as reflected in the Company's
consolidated statements of cash flows, is not a measure of financial
performance under generally accepted accounting principles and should not be
considered in isolation or as a substitute for measures of performance
prepared in accordance with generally accepted accounting principles. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

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<PAGE> 9

FORWARD-LOOKING STATEMENTS AND
THE PRIVATE SECURITIES LITIGATION REFORM ACT

Statements herein concerning expectations for the future constitute
forward-looking statements which are subject to a number of known and unknown
risks, uncertainties and other factors which might cause actual results to
differ materially from stated expectations. Forward-looking statements herein
include, but are not limited to, those concerning anticipated growth in sales,
services-per-customer ratio and profitability; deployment of a network of high
capacity local and long distance switching facilities; introduction of local and
other additional telecommunications services; geographic expansion; increases in
sales, customer service and other personnel; improvements in customer service;
sales through new sales channels; adequacy of available sources of working
capital to implement strategies; negotiation of more favorable carrier supply
contacts; and expectations for growth in the telecommunications industry.
Relevant risks and uncertainties include, but are not limited to, unanticipated
actions by competitors, regulatory or other obstacles which restrict the
Company's ability to implement local or other services, greater than expected
costs to open new offices, acquire switching equipment or execute other aspects
of the Company's growth strategy, greater than expected declines in sales,
inability to hire and retain key personnel, unfavorable determinations of
pending lawsuits or other disputes, inability to obtain more favorable pricing
and other terms from suppliers, inability to secure additional sources of
working capital if and when needed, inability to manage growth or integrate
acquired operations and regulatory changes. Additional risks and uncertainties
include those described in the Company's Interim Report on Form 8-K as filed
with the Commission on August 2, 1996, the Company's Annual Report on Form 10-K
for the year ended December 31, 1995 and those described from time to time in
the Company's other filings with the Commission, press releases and other
communications. Although the Company believes that all forward-looking
statements herein are reasonable, there can be no assurance that actual results,
achievements, performance or developments will not differ materially from those
expressed or implied by such forward-looking statements.

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<PAGE> 10

RISK FACTORS

Prospective investors are strongly cautioned that an investment in the
Securities offered hereby involves a very high degree of risk. The ability of
the Company's new management to halt the deterioration of the Company's results
of operations and financial condition and successfully implement its new
operating strategy is subject to an unusual number of material risks and
uncertainties. Prospective investors should not dismiss the risk factors set
forth below as "boilerplate" or "customary" disclosure. The contingencies and
other risks discussed below could affect the Company in ways not presently
anticipated by its management and thereby impair its ability to continue as a
going concern and materially affect the value of its debt and equity securities,
including the Securities offered hereby. A careful review and understanding of
each of the risk factors set forth below, as well as the other information
contained in this Prospectus, is essential for an investor seeking to make an
informed investment decision with respect to the Securities.

ABILITY TO CONTINUE AS A GOING CONCERN; DEFAULTS UNDER CREDIT FACILITY;
NEED FOR ADDITIONAL WORKING CAPITAL

As a result of Midcom's rapid growth, substantial operating losses, billing
and collection cycle, acquisition strategy and other factors, the Company has
required substantial external working capital. The Company's available sources
of working capital consist of cash flows from operations, approximately $48.1
million at September 30, 1996 in cash and short-term, investment grade,
interest-bearing securities, which funds represent the remaining net proceeds
from the Private Placement, and funds available under the Revolving Credit
Facility. Prior to completion of the Private Placement, the Company had for
several months experienced a severe working capital short-fall which required
the Company to seek extended payment terms from certain of its suppliers, delay
payments to many of its suppliers and other vendors, delay or cancel purchases
and take other steps to conserve operating capital. As a result, a number of
suppliers placed the Company on credit hold and/or initiated collection actions.
See "-- Dependence Upon Facilities-Based Carriers." Also, for several months
prior to the completion of the Private Placement, the Company was in default of
certain financial and other covenants under its Revolving Credit Facility,
although the lenders continued to permit borrowings under that facility. The
existence of defaults under the Revolving Credit Facility also constituted
defaults under certain of the Company's capital leases. The report of the
Company's independent auditors with respect to the Company's Consolidated
Financial Statements for the year ended December 31, 1995 states that the
Company's recurring operating losses, working capital deficiency and credit
agreement defaults raise substantial doubt about the Company's ability to
continue as a going concern. In connection with the completion of the Private
Placement and the application of the net proceeds therefrom to the repayment in
full of the Bridge Loan and the Revolving Loans, the lenders under the Revolving
Credit Facility waived all existing defaults and amended the financial covenants
under the Revolving Credit Facility to levels forecasted to be consistent with
Midcom's revised business plan. The Company's maximum borrowing availability
under the Revolving Credit Facility, as amended, is $43.0 million, subject to a
borrowing base equal to 85% of the Company's eligible accounts receivable less a
minimum excess availability requirement of $20.0 million for the months of
August 1996 through February 1997, declining in stages to $8.0 million for the
months of September through November 1997. As of September 30, 1996, Company's
borrowing base was less than the minimum excess availability and, accordingly,
the Company had no ability to borrow under the Revolving Credit Facility. There
can be no assurance that the Company will generate sufficient revenue to build a
borrowing base which would permit borrowings under the Revolving Credit Facility
in the future.

In addition to funds required for day to day operations, the Company's
principal working capital requirements include capital expenditures (including
those associated with the proposed installation of new switching facilities),
interest and principal payable under the Notes and other contingencies and
obligations described under "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources." The
Notes will mature on August 15, 2003. Interest on the Notes is payable
semi-annually on February 15 and August 15 of each year, commencing February 15,
1997, in the aggregate amount of approximately $4.0 million for each payment.

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<PAGE> 11

The exact amount and timing of the Company's capital requirements will be
determined by numerous factors, including the level of, and gross margin on,
future sales, the outcome of outstanding contingencies and disputes such as
pending lawsuits, payment terms achieved by the Company and the timing of
capital expenditures. There can be no assurance that cash balances, together
with funds available under the Revolving Credit Facility and cash flows from
operations will be sufficient to fully implement the Company's operating
strategy or meet its other capital requirements. Further, the Revolving Credit
Facility expires in November 1997, and there can be no assurance that the
Revolving Credit Facility will continue to be available to the Company, that the
Company will be able to renew the Revolving Credit Facility upon its expiration
or that the Company will be able to replace the Revolving Credit Facility on
terms that the Company finds acceptable. If (i) the Company experiences greater
than anticipated capital requirements, (ii) it is determined to be liable for,
or otherwise agrees to settle or compromise, any material claim against it,
(iii) it is unable to make future borrowings under the Revolving Credit Facility
for any reason or (iv) the Company's operating strategy fails to produce the
anticipated cash flows from operations, the Company may be required to refinance
all or a portion of its existing debt, sell assets or obtain additional equity
or debt financing. There can be no assurance that any such refinancing or asset
sales would be possible or that the Company will be able to obtain additional
equity or debt financing, if and when needed, on terms that the Company finds
acceptable. Any additional equity or debt financing may involve substantial
dilution to the interests of the Company's shareholders. The failure of the
Company to complete one or more of such alternatives or otherwise obtain
sufficient funds to satisfy its cash requirements could prevent the Company from
implementing its new operating strategy and, ultimately, could force the Company
to seek protection under the federal bankruptcy laws. Such events would
materially and adversely affect the value of the Company's debt and equity
securities. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."

RECENT LOSSES AND ANTICIPATED FUTURE LOSSES

The Company has experienced significant losses since its inception. Net
losses for 1994, 1995 and the nine months ended September 30, 1996 were
approximately $3.0 million, $33.4 million and $77.4 million, respectively. As a
result of customer attrition and other factors, the Company expects revenue to
continue to decline during 1996 and, perhaps, the first half of 1997. See
"-- Customer Attrition." In addition, the execution of the Company's operating
strategy will require the Company to substantially increase its investment in
sales, marketing, capital equipment, systems development and other areas. The
Company expects that a substantial portion of these expenditures will be made
before the Company realizes an increase in revenue or an improvement in gross
margin. The Company therefore expects that, during 1996 and at least the first
three quarters of 1997, operating costs will increase both in actual dollars and
as a percentage of revenue and net losses will continue. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Introduction."

MATERIAL WEAKNESSES IN INTERNAL FINANCIAL CONTROLS AND RESTATEMENTS OF FINANCIAL
RESULTS

In connection with the audit of Midcom's 1995 Consolidated Financial
Statements, Midcom's independent auditors identified two conditions which were
characterized as material weaknesses in its internal financial controls. One
material weakness identified by the auditors was the failure of the accounting
and finance systems to provide accurate information necessary to monitor the
Company's financial position, results of operations and liquidity, as
demonstrated by the restatement of the Company's third quarter results and the
difficulties in completing the 1995 year-end audit which resulted in numerous
material adjustments to preliminary fourth quarter results. Factors identified
as contributing to this weakness and requiring immediate attention included
insufficient staffing and systems to accommodate significant growth from
acquisitions, transitional difficulties associated with major new information
and billing systems, inadequate communication between senior management and the
finance department and demands associated with the Company's initial public
offering. The second material weakness identified by the auditors was the
Company's process of estimating unbilled receivables. With respect to this
material weakness, the auditors recommended that the Company review and revise,
as necessary, all policies and procedures with regard to its reconciliation of
unbilled receivables with actual billings to ensure that all unbilled amounts at
a reporting date represent

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<PAGE> 12

properly recorded revenue. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Material Weaknesses" and
"Business -- Information Systems."

It is the Company's practice, which is common in the long distance
industry, to include in reported revenue and accounts receivable an amount for
unbilled calls equal to an estimate of the amount that will be billed and
collected for calls occurring in that reporting period. During 1995, the Company
converted its customer billing function for those calls for which it provides
direct billing to a new billing system. The Company experienced difficulties in
implementing the new billing system which caused an increased number of calls to
be billed later than expected by the Company. See "Business -- Information
Systems." Also, in the process of reconciling unbilled accounts as of December
31, 1995 with amounts ultimately billed, the Company discovered that certain
reports generated by its new information management system that were used for
recognizing unbilled revenue for the third quarter of 1995 failed to fully
reflect all discounts that were properly included in the bills subsequently sent
to the Company's customers. Primarily as a result of this failure, reported
revenue was overstated for the third quarter of 1995 and the Company's Quarterly
Report on Form 10-Q for that period had to be amended to restate reported
results. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Restatement of Results for the Third Quarter of 1995."
The Company is in the process of enhancing this billing system and converting
and modifying the customer support portions of its information systems. See
"Business -- Information Systems." However, in light of the foregoing and other
weaknesses in the systems, the Company's financial statements for 1995 included
a $2.5 million partial write-down of its capitalized software development costs
for the management information system. In addition, the Company had previously
been required to restate its financial statements for the year ended December
31, 1994 after determining that revenue and accounts receivable had been
overstated by approximately $1.8 million net of reserves as a result of using
historical averages of unbilled calls as the basis for its revenue estimates, a
practice that the Company discontinued in the first quarter of 1995.

In light of the volume of financial data to be processed, the reliance upon
timely receipt of call data records from suppliers, the anticipated rate of
growth of the Company, the demands on key financial personnel, turnover in key
finance and accounting positions, the challenges associated with the integration
of acquired businesses and other factors, there can be no assurance that the
Company will not encounter additional billing delays, other internal control
weaknesses or other difficulties in future financial reporting.

DISPUTES AND LITIGATION

The Company, its Chairman of the Board of Directors and largest
shareholder, the Company's former President, Chief Executive Officer and a
director, and the Company's former Chief Financial Officer are named as
defendants in a securities action filed in the U.S. District Court for the
Western District of Washington (the "Complaint"). The Complaint purports to be
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"). An amended complaint
(the "Amended Complaint") was filed on July 8, 1996. The Amended Complaint
alleges, among other things, that the registration statement and prospectus
relating to the Company's initial public offering contained false and misleading
statements concerning the Company's billing software and financial condition.
The Amended Complaint further alleges that, throughout the Class Period, the
defendants inflated the price of the Common Stock by intentionally or recklessly
making material misrepresentations or omissions which deceived the public about
the Company's financial condition and prospects. The Amended Complaint alleges
claims under the Securities Act and the Securities Exchange Act of 1934 (the
"Exchange Act") as well as various state laws, and seeks damages in an unstated
amount. While the Company believes that it has substantive defenses to the
claims in the Amended Complaint and intends to vigorously defend this lawsuit,
it is unable to predict the outcome of this action. If determined adversely to
the Company, this lawsuit could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business -- Legal
Proceedings."

The Company was informed in May 1996 that the Commission was conducting an
informal inquiry regarding the Company's initial public offering and the
restatement of its 1995 third quarter results. The Company has voluntarily
provided the documents requested by the Commission. In addition, in November

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<PAGE> 13

1996, the Commission requested the Company's cooperation in interviewing certain
Company personnel. However, the Company has not been informed whether the
Commission intends to commence formal action against the Company or any of its
affiliates. The Company is, therefore, unable to predict the ultimate outcome of
the investigation. In the event that the Commission elects to initiate a formal
enforcement proceeding, the Company and its officers could be subject to civil
or criminal sanctions including monetary penalties and injunctive measures. Any
such enforcement proceeding could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Legal Proceedings."

In addition, by virtue of its rapid growth, acquisition activities and
large volume of business with suppliers, the Company is involved in litigation
or disputes with sellers of acquired operations, suppliers and other third
parties. See "Business -- Acquisitions, -- Suppliers, and -- Legal Proceedings."

Although the Company intends to defend its existing litigation and other
disputes vigorously, it is unable to predict the nature or timing of any
resolution of such matters. If the Company is determined to be liable for, or
otherwise agrees to settle or compromise, any claim, it would most likely be
required to make a payment in the form of cash, indebtedness or equity
securities. Depending on the size, type and timing of any such payment, it could
materially impair the Company's limited capital resources or significantly
dilute the Company's existing shareholders. See "-- Ability to Continue as a
Going Concern; Defaults Under Credit Facility; Need for Additional Working
Capital." In addition, the Company's pending litigation, investigations and
disputes could result in substantial legal costs to the Company and divert
management's attention from the other business affairs of the Company for
substantial periods of time.

MINIMUM VOLUME COMMITMENTS AND EXISTING SHORTFALLS

Midcom has entered into multiple-year supply contracts with AT&T, Sprint
and WorldCom and short-term contracts with a number of other suppliers for the
long distance telecommunication services provided to its customers. To obtain
favorable forward pricing from certain of its suppliers, the Company has
committed to purchase minimum volumes of a variety of long distance services
during stated periods whether or not such volumes are used or, in one case, to
pay a surcharge equal to a percentage of the Company's shortfall from a
specified quarterly minimum volume. For the final six months of 1996, these
commitments and maximum surcharge total approximately $53.2 million (including
approximately $37.2 million attributable to AT&T). As of September 30, 1996,
Midcom's minimum volume commitment under its supply contract with AT&T, its
largest supply contract, was $117.0 million. The Company estimates that, as of
September 30, 1996, it would have been in shortfall of its minimum commitments
to AT&T by approximately $27.6 million based on then-applicable contract
requirements. However, on October 31, 1996, the Company and AT&T executed a
Release and Settlement Agreement pursuant to which substantially all disputes
between the Company and AT&T have been resolved. Also on October 31, 1996, the
Company and AT&T executed a new carrier contract pursuant to which the Company's
minimum commitment to AT&T was reduced to $13.3 for the eighteen month period
immediately following execution of the contract. In addition, the new carrier
contract provides for more favorable pricing for certain network services
provided by AT&T. In consideration for the terms of the settlement and the new
rate structure, the Company is required to make two payments to AT&T in the
aggregate amount of $8.8 million. The first payment of $5.0 million was made on
November 6, 1996. The second payment of $3.8 million will be due within 30 days
of Midcom announcing quarterly gross revenue in excess of $75.0 million, or upon
completion of a change in control. Another major supplier has agreed to forebear
from exercising its rights to shortfalls incurred through April 30, 1996 which
would otherwise have required the Company to pay a surcharge and caused pricing
from this supplier to increase. This supplier has indicated that it will work
with Midcom to restate applicable minimums so that their attainment is more
realistic. There can be no assurance that these negotiations will be concluded
in a manner favorable to the Company or that the Company will be able to obtain
relief from its minimum contractual commitments in the future. If existing or
future shortfalls are not eliminated, the Company may be required to make
substantial payments without associated revenue from customers or the supplier
may terminate service and commence formal action against the Company. Such
payments are not presently contemplated in the Company's capital budgets and
would have a material adverse effect on the Company's business, financial
condition and results of operation. See "Business -- Suppliers."

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<PAGE> 14

Because of Midcom's commitments to purchase fixed volumes of use from
certain of its suppliers at predetermined rates, the Company could be adversely
affected if a supplier were to lower the rates it makes available to the
Company's target market without a corresponding reduction in the Company's
rates. Similarly, the Company could be adversely affected if its suppliers
failed to adjust their overall pricing, including prices to the Company, in
response to price reductions of other major carriers. See "Business --
Suppliers" and Note 14 of the Notes to Consolidated Financial Statements.

ABILITY TO IMPLEMENT OPERATING STRATEGY

The Company's new management team has developed an operating strategy which
will emphasize the installation of dedicated switching facilities to create a
Company network and the reorganization and expansion of the Company's existing
sales and customer support departments. See "Business -- Company Strategy." In
addition to the capital requirements associated with the new operating strategy,
the Company's ability to realize the full benefit of its operating strategy is
contingent upon its ability to (i) hire and retain sufficient numbers of new
sales personnel and (ii) overcome the logistical challenges of entering the
local telecommunications market. The Company plans to increase the number of
sales representatives during 1996 and 1997 from approximately 35 at the end of
July 1996 to approximately 200. There can be no assurance that the Company will
be able to hire and retain a sufficient number of experienced or otherwise
suitable employees to meet this goal. While the Company's new operating strategy
seeks to decrease the level of its sales force turnover, there can be no
assurance that its efforts to do so will be successful. See
"Business -- Marketing and Sales." Prior to reselling local services to its
customers, the Company must complete a number of operational, marketing and
regulatory tasks, including the negotiation of interconnect agreements with
local circuit providers, the development of a billing, provisioning and customer
service capability and the creation of a local marketing, pricing and sales
strategy. Failure to overcome these logistical challenges would have a material
adverse effect on the Company's ability to implement its strategy to enter the
local telecommunications market.

ABILITY TO MANAGE GROWTH

The Company intends to pursue substantial growth in connection with the
implementation of its operating strategy. This growth will place significant
demands on the Company's management and systems of financial and internal
controls and will require an increase in the capacity, efficiency and accuracy
of its billing and customer support systems. Moreover, this growth will require
an increase in the number of the Company's personnel, particularly sales,
customer service and technical personnel. The market for such personnel is
highly competitive and there can be no assurance that the Company will be able
to attract the personnel required by its operating strategy. Further, the
Company will be required to expand, train, motivate and manage its employee
base. This will require an increase in the level of responsibility for both
existing and new management personnel. There can be no assurance that the
management skills and systems currently in place, or to be implemented in
connection with the Company's new operating strategy, will be adequate or that
the Company will be able to assimilate its new employees successfully. Finally,
the Company has experienced a high level of turnover in its sales force. The
Company believes that this turnover is attributable to, among other things,
mobility and turnover common to the reseller segment of the industry, the
Company's recent operational difficulties and recent changes in senior
management. See "Business -- Marketing and Sales." Although one objective of the
Company's operating strategy is to decrease the level of turnover in its sales
force, there can be no assurance that this objective will be achieved. Failure
to attract and retain sufficient qualified personnel or to train, motivate and
manage such personnel, could have a material adverse effect on the Company's
business, financial condition and results of operations.

DEPENDENCE UPON NEW MANAGEMENT TEAM

Midcom's ability to implement its operating strategy is highly dependent
upon its ability to retain its new senior management team. These individuals are
generally in high demand and are often subject to competing employment
opportunities. Midcom believes that it will need to retain key management
personnel to meet the demands of its business. However, the Company's recent
performance may make the retention of key personnel more difficult. The loss of
William H. Oberlin, the Company's President and Chief Executive Officer and one
of the Company's directors, or the other key members of the management team
could have a

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<PAGE> 15

material adverse effect on the Company's business, financial condition and
results of operations. See "Management."

CUSTOMER ATTRITION

Midcom's revenue is affected by customer attrition, a problem inherent in
the long distance industry. The attrition experienced by the Company is
attributable to a variety of factors, including the Company's termination of
customers for non-payment and the marketing and sales initiatives of the
Company's competitors such as, among other things, national advertising
campaigns, telemarketing programs and the use of cash or other incentives. In
particular, the Company commonly experiences high initial customer attrition
from acquired customer bases as these customers are transitioned to the
Company's services and systems. Moreover, in the past, one of the Company's
selling points has been the ability to accommodate its customers who express a
preference for a particular underlying long distance carrier, such as AT&T. In
connection with the establishment of its own network of switching facilities,
the Company no longer plans to accommodate such customer preferences. The
Company expects that, as a result, certain of its existing customers will
discontinue or reduce their purchases from the Company following the
implementation of its network of switching facilities. This is expected to
contribute to anticipated declines in revenue and could also impair the
Company's ability to compete for customers. Although one of the objectives of
the Company's operating strategy is to reduce attrition, there can be no
assurance that this attrition will not remain at current levels or increase.
Failure to reduce attrition could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Customer Attrition."

RAPID TECHNOLOGICAL CHANGE

The telecommunications industry is characterized by rapidly evolving
technology. Midcom believes that its success will increasingly depend on its
ability to offer, on a timely basis, new services based on evolving technologies
and industry standards. Midcom intends to increase its efforts to develop new
services; however, there can be no assurance that the Company will have the
ability or resources to develop such new services, that new technologies
required for such services will be available to the Company on favorable terms
or that such services and technologies will enjoy market acceptance. Further,
there can be no assurance that the Company's competitors will not develop
products or services that are technologically superior to those used by the
Company or that achieve greater market acceptance. The development of any such
superior technology by the Company's competitors, or the inability of the
Company to successfully respond to such a development, could render Midcom's
existing products or services obsolete and could have a material adverse effect
on the Company's business, financial condition and results of operations.

ABILITY TO INTEGRATE ACQUIRED OPERATIONS

Midcom experienced rapid growth through the end of 1995. A significant
portion of this growth, particularly in 1995, was attributable to acquisitions
of customer bases and other telecommunications service providers. For a number
of reasons, the Company has not been able to fully consolidate and integrate the
sales and marketing, customer support, billing and other functions of certain
acquired operations. Pending such integration, the Company has maintained a
number of billing systems and other functions of certain acquired operations,
which has caused inefficiencies, additional operational complexity and expense
and greater risk of billing delays and financial reporting difficulties. The
Company believes that these integration problems have also increased customer
attrition and impaired the Company's efforts to cross-sell the disparate
products and services of certain of the acquired operations. The Company's
failure to fully integrate acquired operations with its own operations could
have a material adverse effect on the Company's business, financial condition
and results of operations. See "Business -- Acquisitions" and
"Business -- Information Services."

DEPENDENCE UPON INTEGRITY OF CALL DATA RECORDS

Midcom depends on the timeliness and accuracy of call data records provided
to it by facilities-based carriers supplying telecommunications services, and
there can be no assurance that accurate information will

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<PAGE> 16

consistently be provided by the carriers on a timely basis. Failure of the
Company to receive prompt and accurate call data records from its suppliers will
impair the Company's ability to bill its customers on a timely basis. Such
billing delays could impair the Company's ability to collect amounts owed by its
customers. Due to the multitude of billing rates and discounts which suppliers
must apply to the calls completed by the Company's customers, and due to routine
logistical issues such as the addition or termination of customers, the Company
regularly has disagreements with its suppliers concerning the amounts invoiced
for its customers' traffic. Since 1994, the Company has been paying its
suppliers according to its own calculation of the amounts owed as recorded on
the computer tapes provided by its suppliers. The Company's computations of
amounts owed are frequently less than the amount shown on the suppliers'
invoices. Accordingly, the suppliers may consider the Company to be in arrears
in its payments until the amount in dispute is resolved. Although these disputes
have generally been resolved on terms favorable to the Company, there can be no
assurance that this will continue to be the case. Future disputes which are not
resolved favorably to the Company could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Suppliers."

DEPENDENCE UPON FACILITIES-BASED CARRIERS

Midcom does not currently own a transmission network and, accordingly,
depends to a large extent on AT&T, Sprint, WorldCom and other facilities-based
carriers for actual transmission of customer calls and other services. Further,
the Company, like all other long distance providers, is dependent upon local
exchange carriers for call origination (carrying the call from the customer's
location to the long distance network of the interexchange carrier selected to
carry the call) and termination (carrying the call off the interexchange
carrier's network to the call's destination). The Company's ability to maintain
and expand its business depends, in part, on its ability to obtain
telecommunication services on favorable terms from facilities-based carriers and
the cooperation of both interexchange and local exchange carriers in initiating
and terminating service for its customers in a timely manner (the process of
initiating service for a customer is referred to as "provisioning"). FCC policy
currently requires all common carriers, including interexchange carriers, to
make their services available for resale and to refrain from imposing
unreasonable restrictions on such resale. Further, the Telecommunications Act
requires all incumbent local exchange carriers both to offer their services for
resale at wholesale rates and to allow access to unbundled network elements at
cost-based rates. The incumbent local exchange carriers are also required by the
Telecommunications Act to provide all interexchange carriers, including the
Company, with equal access for the origination and termination of long distance
calls. If any of these requirements were eliminated, the adverse impact on the
Company could be substantial. Access charges represent a substantial portion of
the Company's current cost of service. The FCC, however, has indicated that it
will initiate in the near future a comprehensive review of its access charge
structure, evaluating the embedded costs and subsidies that produce current
access charge levels. The FCC has also proposed to levy on interexchange
carriers a new per-call payphone usage fee for all toll-free and access code
calls originated from pay telephones. The level at which the FCC sets access
charges, universal service contributions and payphone use fees could have a
material adverse effect on the Company's business, financial condition and
results of operation. Moreover, implementation of a new access charge structure
and repricing of local transport could place many interexchange carriers,
including the Company, at a significant cost disadvantage relative to larger
competitors. See "Business -- Regulation."

In 1994, 1995 and the nine months ended September 30, 1996, AT&T, Sprint
and WorldCom were collectively responsible for carrying traffic representing
approximately 97%, 67% and 41% of the Company's revenue, respectively, and for
those periods no single carrier was responsible for carrying traffic
representing more than 46%, 31% and 17% of the Company's revenue, respectively.
In the past, the Company has, from time to time, been substantially in arrears
of its payment obligations to AT&T and other suppliers. Although the Company is
generally entitled to be given notice of defaults and an opportunity to cure
under the terms of its agreements with its interexchange suppliers before such
service can be terminated, and although the Company has the ability to transfer
its customers' traffic from one supplier to another, provisioning a customer
that is not serviced by a Midcom switch to an alternate supplier takes several
days. Accordingly, if a major supplier were to decline to continue to carry the
Company's traffic, due to non-payment or otherwise, without sufficient notice
for the Company to make alternate arrangements, there is a possibility that the
customers

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<PAGE> 17

serviced by that supplier would be temporarily without "1 plus" long distance
calling which could have a material adverse effect on the Company's business,
financial condition and results of operation. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business --
Suppliers."

COMPETITION

The long distance telecommunications industry is highly competitive.
Several of the Company's current and potential competitors have substantially
greater financial, technical, marketing and other resources than the Company,
and there can be no assurance that the Company will be competitive in this
environment. The Company's ability to compete may also be impaired by its
leveraged capital structure and limited capital resources.

The long distance telecommunications industry is significantly influenced
by the marketing and pricing activities of the major industry participants,
including AT&T, MCI, Sprint and WorldCom. While the Company believes that AT&T,
MCI and Sprint historically have chosen not to concentrate their direct sales
efforts on small to medium-sized businesses, these carriers control
approximately 85% of that market. Moreover, AT&T, MCI and Sprint have recently
introduced new service and pricing options that are attractive to smaller
commercial users, and there can be no assurance that they will not market to
these customers more aggressively in the future. AT&T and, as an interim
measure, the structurally separate interexchange affiliates of the seven
regional Bell operating companies have recently been reclassified as nondominant
carriers and, accordingly, have the same flexibility as the Company in meeting
competition by modifying rates and service offerings without pricing constraints
or extended waiting periods. These reclassifications may make it more difficult
for the Company to compete for long distance customers. See
"Business -- Regulation." In addition, a significant number of large regional
long distance carriers and new entrants in the industry compete directly with
the Company by concentrating their marketing and direct sales efforts on small
to medium-sized commercial users. Activities by competitors including, among
other things, national advertising campaigns, telemarketing programs and the use
of cash or other forms of incentives, contribute to significant customer
attrition in the long distance industry.

The Company contracts for call transmission over networks operated by
suppliers who may also be the Company's competitors. Both the interexchange
carriers and local exchange carriers providing transmission services for the
Company have access to information concerning the Company's customers for which
they provide the actual call transmission. Because these interexchange carriers
and local exchange carriers are potential competitors of the Company, they could
use information about the Company's customers, such as their calling volume and
patterns of use, to their advantage in attempts to gain such customers'
business. In addition, the Company's future success will depend, in part, on its
ability to continue to buy transmission services and access from these carriers
at a significant discount below the rates these carriers otherwise make
available to the Company's targeted customers.

Regulatory trends have had, and may have in the future, a significant
impact on competition in the telecommunications industry. See
"Business -- Regulation." As the result of the recently enacted
Telecommunications Act, the regional Bell operating companies are now permitted
to provide, and are providing or have announced their intention to provide, long
distance service originating (or in the case of "800" service, terminating)
outside their local service areas or offered in conjunction with other ancillary
services, including wireless services. Following application to and upon a
finding by the FCC that a regional Bell operating company faces facilities-based
competition and has satisfied a congressionally-mandated "competitive checklist"
of interconnection and access obligations, it will also be permitted to provide
long distance service within its local service area. The entry of these
well-capitalized and well-known entities into the long distance service market
could significantly alter the competitive environment in which the Company
operates.

The Telecommunications Act also removes all legal barriers to competitive
entry into the local telecommunications market and directs incumbent local
exchange carriers to allow competing telecommunications service providers such
as the Company to interconnect their facilities with the local exchange network,
to lease network components on an unbundled basis and to resell local
telecommunications services.

15
<PAGE> 18

Moreover, the Telecommunications Act seeks to facilitate the development of
local telecommunications competition by requiring incumbent local exchange
carriers, among other things, to allow end users to retain their telephone
numbers when changing service providers and to place short-haul toll calls
without dialing lengthy access codes. In response to these regulatory changes,
MCI and AT&T have each announced plans to enter the local telecommunications
market, including MCI's announcement that it will invest more than $2.0 billion
in fiber optic rings and local switching equipment in major metropolitan markets
throughout the United States, and AT&T's announcement that it has filed
applications in all 50 states to provide local telecommunications services.

While the Telecommunications Act opens new markets to the Company, the
nature and value of the resultant business opportunities will be dependent in
large part upon subsequent regulatory interpretation of the statute's
requirements. The FCC has recently promulgated rules implementing the local
competition provisions of the Telecommunications Act; each state must now
individually adopt regulations applying the new national guidelines. The Company
anticipates that incumbent local exchange carriers will actively resist
competitive entry into the local telecommunications market and will seek to
undermine the operations and the service offerings of competitive providers,
leaving carriers such as the Company which are dependent on incumbent local
exchange carriers for network services vulnerable to anti-competitive abuses. No
assurance can be given that the local competition provision of the
Telecommunications Act will be implemented and enforced by federal and state
regulators in a manner which will permit the Company to successfully compete in
the local telecommunications market or that subsequent legislative and/or
judicial actions will not adversely impact the Company's ability to do so.
Moreover, federal and state regulators are likely to provide incumbent local
exchange carriers with increased pricing flexibility for their services as
competition in the local market increases. If incumbent local exchange carriers
are allowed by regulators to lower their rates substantially, engage in
excessive volume and term discount pricing practices for their customers, charge
excessive fees for network interconnection or access to unbundled network
elements or decline to make services available for resale at wholesale rates,
the ability of the Company to compete in the provision of local service could be
materially and adversely affected.

REGULATION

Federal and state regulations, regulatory actions and court decisions have
had, and may have in the future, both positive and negative effects on the
Company and its ability to compete. The Company is subject to regulation by the
FCC and by various state public service or public utility commissions as a
non-dominant or resale provider of long distance services. The Company is
required to file tariffs specifying the rates, terms and conditions of its
interstate and international services with the FCC and is required to file
tariffs or obtain other approvals in most of the states in which it operates.
Neither the FCC nor the relevant state utility commissions currently regulate
the Company's profit levels, but they often reserve the authority to do so. The
large majority of states require long distance service providers to apply for
authority to provide telecommunications services and to make filings regarding
their activities. The multiplicity of state regulations makes full compliance
with all such regulations a challenge for multistate providers such as the
Company. There can be no assurance that future regulatory, judicial and
legislative changes or other activities will not have a material adverse effect
on the Company or that regulators or third parties will not raise material
issues with regard to the Company's compliance with applicable laws and
regulations. The Company believes, however, that the trend has been, and will
continue to be, toward significant relaxation of federal and state regulation of
its operations and services.

Pursuant to the terms of the 1984 court decree which required AT&T to
divest its local exchange operations, the regional Bell operating companies were
prohibited from providing long distance telecommunications service between
certain defined geographic areas, known as Local Access Transport Areas or
"LATAs." However, the Telecommunications Act allows for immediate provision by
the regional Bell operating companies of long distance service outside their
respective local telephone service areas as well as long distance service
bundled with wireless, enhanced and certain other services. The
Telecommunications Act also provides a mechanism for eventual entry by the
regional Bell operating companies into the long

16
<PAGE> 19

distance market within their respective local service areas. The competition
faced by the Company will increase significantly as the regional Bell operating
companies expand their provision of inter-LATA services.

As a result of a 1994 court decision, the Company became obligated to
provide detailed rate schedules in all of its federal tariffs, and the Company
could possibly be liable for damages for following an FCC policy which did not
require the Company to file such detailed schedules of its domestic charges in
the past. The FCC has proposed to implement a policy of "mandatory detariffing"
for the domestic offerings of all non-dominant interexchange carriers, which, if
adopted, would not only absolve the Company, as well as its principal suppliers
and competition, from any obligation to file domestic interexchange tariffs, but
would affirmatively prohibit all such tariff filings. Also, AT&T and, as an
interim measure, the structurally separate interexchange affiliates of the
regional Bell operating companies have recently been reclassified as non-
dominant carriers and, accordingly, have the same flexibility as the Company in
meeting competition by modifying rates and service offerings without pricing
constraints or extended waiting periods. The reclassifications may make it more
difficult for the Company to compete for long distance customers. See
"Business -- Regulation."

SUBSTANTIAL LEVERAGE

The Company is highly leveraged. As of September 30, 1996, the Company's
total indebtedness and shareholders' deficit was $113.6 million and $49.7
million, respectively. The Company's ability to make scheduled payments of the
principal of, or interest on, its indebtedness will depend on its future
performance, which is subject to economic, financial, competitive and other
factors beyond its control.

REPURCHASE OF NOTES AT THE OPTION OF HOLDERS UPON A CHANGE OF CONTROL

In the event of a Change of Control (as defined herein), each holder of
Notes has the right to require that the Company repurchase the Notes in whole or
in part at a redemption price equal to 101% of the principal amount thereof,
plus accrued interest, if any, to the date of repurchase. See "Description of
Notes -- Repurchase of Notes at the Option of Holders Upon a Change of Control."
If a Change of Control were to occur, there can be no assurance that the Company
would have sufficient funds to pay such redemption price for all Notes tendered
by the holders thereof. See "Description of Notes -- Subordination." If the
Company is required to pay such redemption price, such payment may have a
material adverse effect on the Company's liquidity, results of operations and
financial condition. Moreover, the Company's repurchase obligation may have the
effect of delaying, deferring or preventing a change of control of the Company
and could limit the price that certain investors might be willing to pay in the
future for the Common Stock.

SHARES ELIGIBLE FOR FUTURE SALE

At July 31, 1996, the Company had outstanding 15,838,202 shares of Common
Stock (assuming no redemption of the shares owned by Ashok Rao; see "Certain
Transactions") of which 9,131,201 shares were "restricted securities" subject to
restrictions set forth in Rule 144 promulgated under the Securities Act. Of the
restricted securities, upon expiration of a lock-up agreement described below,
5,496,522 shares may be sold under Rule 144, 3,534,679 shares will be tradable
pursuant to Rule 144 upon the expiration of the applicable two-year holding
period and 100,000 shares, sold in a transaction exempt from registration under
Regulation S of the Securities Act, will be tradeable pursuant to Rule 144 upon
the expiration of a one-year holding period. These periods will expire between
December 31, 1996 and December 30, 1997. If a proposed amendment to Rule 144 is
adopted, however, the two-year holding period would be reduced to one year. In
addition, as of July 31, 1996, the Company had reserved for issuance 4,211,024
shares of Common Stock under its Amended and Restated 1993 Stock Option Plan
(the "Stock Option Plan") (assuming shareholder approval of an increase in
options available for grant) and 258,625 shares of Common Stock for issuance
under its 1995 Employee Stock Purchase Plan (the "Stock Purchase Plan"). Under
the Stock Option Plan, as of July 31, 1996, options to purchase 3,408,474 shares
of Common Stock were outstanding and options to purchase 212,240 shares of
Common Stock were exercisable. Also, at July 31, 1996, warrants to purchase
874,970 shares of Common Stock were outstanding, including a warrant to purchase
815,470 shares of

17
<PAGE> 20

Common Stock issued in connection with the Bridge Loan which expired upon the
completion of the Private Placement and the application of the net proceeds
therefrom to the repayment in full of the Bridge Loan.

The Selling Securityholders and certain other individuals and entities have
certain rights with respect to the registration under the Securities Act of the
public offer and sale of the Securities and other shares of Common Stock
acquired in connection with various unrelated acquisition and financing
transactions. At July 31, 1996, holders of approximately 9,832,946 shares of
Common Stock (including the Securities and shares held in escrow which are
deemed not to be issued, as described elsewhere in this Prospectus) were subject
to such registration rights. At July 31, 1996, holders of approximately
1,876,000 shares of Common Stock subject to such registration rights had the
right to require the Company to register the public offer and sale of their
shares under the Securities Act. Notwithstanding the registration rights of the
Selling Securityholders, the Company has voluntarily filed the Registration
Statement of which this Prospectus is a part in order to register under the
Securities Act the public offer and sale of the Securities. The Company intends
to maintain the effectiveness of the Registration Statement of which this
Prospectus is a part for a period of one year. In addition, pursuant to the
Registration Rights Agreement, the Company filed the Shelf Registration
Statement with the Commission on October 18, 1996 (file no. 333-14427) to
register the public offer and sale of the Notes and the Conversion Shares. If
the Notes are fully converted, approximately 6,938,276 shares of Common Stock
(not including an indeterminate number of shares that may be issued in
connection with certain anti-dilution and other provisions) will be eligible for
public offer and sale pursuant to the Shelf Registration Statement. The Company
is required under the Registration Rights Agreement to maintain the
effectiveness of the Shelf Registration Statement for a period of three years
from the completion of the Private Placement or, if shorter, when (i) all the
Notes and Conversion Shares have been sold pursuant to the Shelf Registration
Statement or (ii) the date on which there ceases to be outstanding any Notes or
Conversion Shares. See "Description of Capital Stock -- Registration Rights" and
"Description of Notes -- Registration Rights; Liquidated Damages."

Sales of substantial amounts of Common Stock in the public market under
Rule 144, pursuant to the exercise of registration rights or otherwise, and even
the potential for such sales, may have a material adverse effect on the
prevailing market price of the Common Stock and could impair the Company's
ability to raise capital through the sale of its equity securities.

CONTROL BY PRINCIPAL SHAREHOLDERS

At July 31, 1996, Midcom's directors and executive officers beneficially
owned or had the power to vote approximately 39.0% of the Common Stock. Although
such shareholders will not have the ability to control matters requiring
shareholder approval, they may have the ability to influence the affairs and
management of the Company and the elections of directors. This may have the
effect of delaying, deferring or preventing a change in control of the Company
and could limit the price that certain investors might be willing to pay in the
future for the Common Stock. See "Principal Shareholders."

ANTI-TAKEOVER CONSIDERATIONS

The Company is subject to the anti-takeover provisions of Chapter 23B.17 of
the Washington Business Corporation Act (the "WBCA") which prohibits, subject to
certain exceptions, a merger, sale of assets or liquidation of a corporation
involving a 20% shareholder unless determined to be at a fair price or approved
by disinterested directors or two-thirds of the disinterested shareholders. In
addition, Chapter 23B.19 of the WBCA prohibits a corporation registered under
the Exchange Act from engaging in certain significant transactions with a 10%
shareholder. Significant transactions include, among others, a merger with or
disposition of assets to the 10% shareholder. Further, the Company's Amended and
Restated Articles of Incorporation (the "Articles") require super-majority
shareholder approval of certain business combinations and provide for a
classified Board of Directors with staggered, three-year terms. Also, the
Company has the authority to issue up to 10 million shares of preferred stock in
one or more series and to fix the preferences and other rights thereof without
any further vote or action by the Company's shareholders. The issuance of
preferred stock, together with the effect of other anti-takeover provisions in
the Articles and under the WBCA, may have the effect of delaying, deferring or
preventing a change in control of the Company and could limit

18
<PAGE> 21

the price that certain investors might be willing to pay in the future for the
Common Stock. See "Description of Capital Stock -- Washington Law" and
"Description of Capital Stock -- Certain Provisions in Amended and Restated
Articles of Incorporation and Bylaws."

VOLATILITY OF STOCK PRICE

The market price of the Common Stock has been, and is likely to continue to
be, volatile. There can be no assurance that the market price of the Common
Stock will not fluctuate significantly from its current level. The market price
of the Common Stock could be subject to significant fluctuations in response to
a number of factors, such as actual or anticipated variations in the Company's
quarterly operating results, the introduction of new products by the Company or
its competitors, changes in other conditions or trends in the Company's
industry, changes in governmental regulations, changes in securities analysts'
estimates of the Company's, or its competitors' or industry's, future
performance or general market conditions. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." In addition, stock
markets have experienced extreme price and volume volatility in recent years,
which has had a substantial effect on the market prices of securities of many
smaller public companies for reasons frequently unrelated to the operating
performance of such companies. These broad market fluctuations may have a
material adverse effect on the market price of the Common Stock. See "Price
Range of Common Stock."

LIMITATIONS ON DIVIDENDS

Since its incorporation in 1989, the Company has not declared or paid cash
dividends on its Common Stock, and the Company anticipates that any future
earnings will be retained for investment in its business. Any payment of cash
dividends in the future will be at the discretion of the Company's Board of
Directors and will depend upon, among other things, the Company's earnings,
financial condition, capital requirements, extent of indebtedness and
contractual restrictions with respect to the payment of dividends. In addition,
the terms of the Revolving Credit Facility prohibit the payment of cash
dividends without the consent of the Company's lenders. See "Dividend Policy"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

19
<PAGE> 22

USE OF PROCEEDS

The Securities are offered by the Selling Securityholders and, accordingly,
the Company will not receive any of the proceeds from the sales thereof.

TRADING MARKET FOR SECURITIES

PRICE RANGE OF COMMON STOCK

Midcom's Common Stock has been quoted on the Nasdaq National Market since
July 6, 1995 under the symbol "MCCI." The stock prices below are the high and
low closing sales prices on the Nasdaq National Market for the periods
indicated.

<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
1995
Third Quarter (from July 6, 1995).................................... $16 3/4 $11 1/4
Fourth Quarter....................................................... 18 7/8 13 3/4
1996
First Quarter........................................................ $18 1/4 $ 7
Second Quarter....................................................... 15 1/4 6 1/2
Third Quarter........................................................ 16 10 1/4
Fourth Quarter (through November 20, 1996)........................... 14 3/16 9 1/2
</TABLE>

On November 20, 1996, the closing sale price reported by the Nasdaq
National Market for the Common Stock was $9.50. As of July 31, 1996, there were
approximately 129 holders of record of the Common Stock.

DIVIDEND POLICY

20
<PAGE> 23

CAPITALIZATION

The following table sets forth the cash, short-term obligations and
capitalization of the Company at September 30, 1996. This table should be read
in conjunction with the Consolidated Financial Statements and the notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" which are included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
---------------------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C>
Cash....................................................................... $ 48,138
=========
Short-term obligations, including current portion of long-term obligations:
Notes payable(1)......................................................... $ 10,963
Capital lease obligations................................................ 2,923
Other.................................................................... 39
---------
Total short-term obligations..................................... $ 13,925
=========
Long-term obligations, less current portion:
Convertible subordinated notes........................................... $ 97,743
Long-term debt........................................................... 800
Capital lease obligations................................................ 1,089
Other.................................................................... 5,948
---------
Total long-term obligations...................................... 105,580
---------
Shareholders' equity:
Preferred stock, 10,000,000 shares authorized; none issued and
outstanding........................................................... --
Common stock, $.0001 par value; 90,000,000 shares authorized; 15,773,558
shares issued and outstanding(2)...................................... 66,309
Accumulated deficit...................................................... (116,008)
---------
Total shareholders' equity....................................... (49,699)
---------
Total capitalization....................................................... $ 55,881
=========
</TABLE>

- ---------------
(1) Notes payable includes $9.0 million payable in connection with two customer
base acquisitions which may be paid in cash or by delivery of shares of
Common Stock, as the Company may elect; provided, however, that the
Revolving Credit Facility prohibits payment of this obligation in cash
without the lenders' prior written consent. See "Business -- Legal
Proceedings."

(2) Does not include (i) 4,110,272 shares reserved for issuance upon exercise of
options under the Stock Option Plan, of which options to purchase 3,330,995
shares were outstanding at September 30, 1996, (ii) 258,625 shares reserved
for issuance under the Stock Purchase Plan, (iii) 59,500 shares reserved for
issuance upon exercise of certain warrants issued to sellers of a customer
base acquired by the Company, (iv) up to 176,675 shares which, as of
September 30, 1996, were held in escrow or subject to issuance pursuant to
the Company's obligations under agreements entered into in connection with
several acquisitions completed in the second half of 1995, (v) 198,577
shares that the Company is required to issue in the event that the market
price of the Common Stock is below stated prices on designated true-up dates
and upon the occurrence of certain contingencies (based on the price of the
Common Stock on November 8, 1996 and assuming the maximum contingent shares
are issued) and (vi) shares that may be issued to Cherry Communications as
payment in lieu of a $9.0 million cash payment in connection with the
acquisition of a customer base. See "Description of Capital Stock" and
"Shares Eligible for Future Sale."

21
<PAGE> 24

SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA

The selected consolidated financial and operating data presented below with
respect to Midcom's consolidated statements of operations for each of the three
years in the period ended December 31, 1995, and with respect to Midcom's
consolidated balance sheets at December 31, 1994 and 1995, are derived from the
Consolidated Financial Statements included elsewhere in this Prospectus which
have been audited by Ernst & Young LLP, and such data are qualified by, and
should be read in conjunction with, such financial statements and the notes
related thereto. The selected consolidated financial and operating data
presented below with respect to Midcom's consolidated statements of operations
for the years ended December 31, 1991 and 1992, and with respect to Midcom's
consolidated balance sheets at December 31, 1991, 1992 and 1993, are derived
from consolidated financial statements which were also audited by Ernst & Young
LLP, and which are not included herein. The selected consolidated financial and
operating data presented below with respect to Midcom's consolidated statements
of operations for the nine months ended September 30, 1995 and 1996 and with
respect to Midcom's consolidated balance sheet at September 30, 1996 are derived
from unaudited interim consolidated financial statements which, in the opinion
of the Company's management, reflect all material adjustments consisting only of
normal recurring adjustments necessary for a fair presentation of such data.
Further, the selected consolidated financial and operating data set forth below
is qualified in its entirety by, and should be read in conjunction with,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The following information as previously reported has been restated
to include Adval, Inc. and ADNET Telemanagement, Inc. which were acquired in
pooling of interests transactions on September 29, 1995 and December 29, 1995,
respectively.

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------- -------------------
1991 1992 1993 1994 1995 1995 1996
------- ------- ------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenue....................... $10,895 $27,894 $66,010 $111,699 $203,554 $147,409 $124,590
Cost of revenue............... 1,690 14,817 45,363 79,044 139,546 100,661 89,828
------- ------- ------- -------- -------- -------- --------
</TABLE>

<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C>
Gross profit.................. 9,205 13,077 20,647 32,655 64,008 46,748 34,762
Selling, general and
administrative expense...... 8,871 11,246 18,125 27,697 62,061 42,654 48,048
Depreciation and
amortization................ 245 295 1,881 4,134 13,790 8,384 26,184
Settlement of contract
dispute..................... -- -- -- -- -- -- 8,800
Restructuring charge(1)....... -- -- -- -- -- -- 2,220
Loss on impairment of
assets(2)................... -- -- -- -- 11,830 -- 20,765
------- ------- ------- -------- -------- -------- --------
Operating income (loss)..... 89 1,536 641 824 (23,673) (4,290) (71,255)
Interest expense.............. 685 951 1,368 2,965 5,288 4,105 5,959
Other expense (income)........ 1,880 (65) (249) 871 390 531 206
------- ------- ------- -------- -------- -------- --------
Income (loss) before income
taxes and extraordinary
item..................... (2,476) 650 (478) (3,012) (29,351) (8,926) (77,420)
Provision (benefit) for income
taxes....................... (118) (4) 51 17 -- 18 --
------- ------- ------- -------- -------- -------- --------
Loss before extraordinary
item..................... (2,358) 654 (529) (3,029) (29,351) (8,944) (77,420)
Extraordinary item(3)......... -- -- -- -- (4,067) (2,992) --
------- ------- ------- -------- -------- -------- --------
Net income (loss)............. $(2,358) $ 654 $ (529) $ (3,029) $(33,418) $(11,936) $(77,420)
======= ======= ======= ======== ======== ======== ========
Per share amounts(4):
Income (loss) before
extraordinary item.......... $ (0.24) $ 0.07 $ (0.05) $ (0.31) $ (2.42) $ (0.77) $ (5.01)
Extraordinary item............ -- -- -- -- (0.34) (0.25) --
------- ------- ------- -------- -------- -------- --------
Net income (loss)........... $ (0.24) $ 0.07 $ (0.05) $ (0.31) $ (2.76) $ (1.02) $ (5.01)
======= ======= ======= ======== ======== ======== ========
Shares used in calculating per
share data.................. 9,930 9,930 9,930 9,930 12,101 11,648 15,442
</TABLE>

22
<PAGE> 25

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------- -------------------
1991 1992 1993 1994 1995 1995 1996
------- ------- ------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
SUPPLEMENTAL OPERATING DATA:
EBITDA(5)..................... $ 334 $ 1,831 $ 2,522 $ 4,958 $ 1,947 $ 4,094 $(13,286)
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1996
------- ------- ------- -------- -------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash............................... $ 447 $ 1,461 $ 808 $ 960 $ 1,083 $ 48,138
Total assets....................... 3,530 11,090 35,414 66,078 133,331 106,764
Short-term obligations,
including current portion of
long-term obligations........... 294 279 8,719 2,241 56,297 13,925
Long-term obligations, less
current portion................. 8,119 8,618 16,431 34,195 3,691 99,632
Redeemable preferred stock......... -- -- -- 8,597 -- --
Shareholders' equity (deficit)..... (6,479) (6,196) (6,565) (6,304) 23,799 (46,699)
</TABLE>

23
<PAGE> 26

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

Midcom was formed in 1989 and initially operated as an aggregator of long
distance telecommunications services. In 1991, Midcom shifted its focus from
aggregation to providing telecommunications services and, accordingly, began to
(i) enter into volume-based supply agreements with multiple underlying
facilities-based carriers, (ii) establish a knowledgeable direct sales force to
target small and medium-sized business customers, (iii) obtain the necessary
federal and state certifications to provide interstate, intrastate and
international service, (iv) build an infrastructure to bill and service a large
volume of customers and (v) develop enhanced and value-added products and
services to supplement its basic long distance service. Midcom does not provide
its telecommunications services through the operation of its own transmission
network. Rather, Midcom purchases large volumes of long distance services
utilizing transmission networks owned and operated by various other
interexchange carriers, and then resells those services to its customers.
Midcom, or one of its billing agents, receives monthly records from its
underlying carriers which detail the calls made by its customers, then rates the
calls and bills its customers.

Subsequent to its initial public offering in July 1995, Midcom completed
numerous acquisitions of businesses and customer bases. Although these
acquisitions contributed to substantial growth, they have placed significant
demands on management resources and have disrupted Midcom's normal business
operations. In particular, the Company has been unable to fully integrate the
sales and marketing, customer support, billing and other functions of certain
acquired operations which has increased the Company's overall cost structure and
has resulted in lower profitability and cash flows. See
"Business -- Acquisitions." During 1995, the Company was in the process of
implementing a new management information system, including the installation of
a new billing system. Problems encountered in this implementation process
contributed to the Company's operational difficulties. In addition, certain
reports generated by the new management information system that were used to
estimate unbilled revenue for the third quarter of 1995 failed to fully reflect
all discounts that were properly included in the bills subsequently sent to the
Company's customers. See "Business -- Information Systems." Primarily as a
result of this failure, reported revenue was overstated for the third quarter of
1995 and the Company's Quarterly Report on Form 10-Q for that period had to be
amended to restate reported results. See "-- Restatement of Results for the
Third Quarter of 1995." In addition, the Company's profitability was reduced as
a result of the Company's supply contract with AT&T which provided for higher
rates than those provided by competitive suppliers, although in October 1996 the
Company and AT&T entered into a new carrier supply contract which provides for
more favorable rates. See "Business -- Suppliers." These factors contributed to
defaults under the Revolving Credit Facility and caused the Company's auditors
to include a going concern qualification in their report on the Company's
financial statements for the year ended December 31, 1995. The Company's
auditors also identified certain material weaknesses in the Company's internal
financial controls. See "-- Material Weaknesses" and "Description of Certain
Indebtedness."

In response to these developments, during the second and third quarters of
1996 Midcom recruited a new executive management team with extensive experience
and expertise in the telecommunications industry. The new executive management
team has developed a restructuring, network and marketing strategy which it
plans to implement during 1996 and 1997 and which is designed to address the
Company's recent operational challenges and increase internally generated sales
and profitability. See "Business -- Company Strategy." As a result of customer
attrition and other factors, the Company expects that revenue is likely to
decline during the remainder of 1996 and, perhaps, the first half of 1997. In
addition, the execution of the Company's restructuring, network and marketing
strategy will require the Company to substantially increase its investment in
sales, marketing, capital equipment, systems development and other areas. The
Company expects that a substantial portion of these expenditures will be made
before the Company realizes an increase in revenue or an improvement in gross
margin. The Company therefore expects that, during 1996 and, perhaps, a portion
of 1997, operating costs will increase both in actual dollars and as a
percentage of revenue and net losses will continue. These expected trends will
have a material adverse impact on the Company's near

24
<PAGE> 27

term profitability and levels of cash flows. The Company expects that the net
proceeds of the Private Placement, funds available under the Revolving Credit
Facility and cash flows from operations will be sufficient to fund its capital
requirements during 1996 and 1997. However, there can be no assurance that the
Revolving Credit Facility will continue to be available to the Company or that
the net proceeds of the Private Placement together with funds available under
the Revolving Credit Facility and cash flows from operations will be sufficient
to fully implement the Company's operating strategy or meet its other capital
requirements. See "-- Liquidity and Capital Resources."

If Midcom successfully implements its operating strategy, it anticipates
that, over the long term, (i) revenue will increase as a result of its
reorganized and expanded direct sales efforts, the development of a new tier of
distributors and reduced customer attrition and (ii) operating expenses will
decrease as a result of deploying its network of switching facilities and
obtaining more favorable terms from its suppliers. As a result of these expected
trends, the Company expects that gross margin as a percentage of revenue will,
over the long term, be comparable to other telecommunications providers despite
an anticipated increase in costs associated with its larger sales force and
customer support efforts. Although the Company believes that its new management
team has the relevant skills and experience necessary to implement this
strategy, its ability to do so is subject to an unusual number of risks and
uncertainties, and there can be no assurance that this strategy will be
successfully implemented or that the intended positive results will be achieved.
See "Forward-Looking Statements and the Private Securities Litigation Reform
Act."

RECENT ACQUISITIONS

In 1994, Midcom acquired PacNet, Inc. ("PacNet") and certain assets of
American Telephone Network, Inc. ("ATN"). In 1995, Midcom acquired Adval, Inc.
("Adval"), Cel-Tech International Corp. ("Cel-Tech"), ADNET Telemanagement, Inc.
("Adnet") and certain assets of Communique Telecommunications, Inc.
("Communique"). With the exception of ATN, the consideration for these
acquisitions was paid primarily in the form of Common Stock and the assumption
of certain liabilities. The consideration for ATN was primarily in the form of
cash and the assumption of certain liabilities, financed principally through
working capital and borrowings under an expired revolving credit facility. In
addition to the acquisitions of businesses, the Company has made numerous
acquisitions of customer bases, including acquisitions of two significant
customer bases from Cherry Communications Incorporated ("Cherry Communications")
in September and November 1995. See "Business -- Acquisitions" and "Business --
Legal Proceedings."

To date, all business combinations have been accounted for using the
purchase method except for Adval and Adnet which have been accounted for as
pooling of interests transactions. The Company's consolidated financial
statements for the years ended December 31, 1994 and 1993 and the following
Management's Discussion and Analysis of Financial Condition and Results of
Operations for 1994 versus 1993 have been restated to reflect the inclusion of
the accounts and results of operations of Adval and Adnet in both of those
periods. Using the purchase method, the purchase price paid in excess of the
fair market value of the assets acquired is recorded as an intangible asset and
amortized generally over three years using the straight-line method. During the
second quarter of 1996, the Company wrote down certain acquired customer bases
and equipment and recorded a loss on impairment of assets of $18.8 million. A
total of $27.3 million of intangibles associated with acquisitions remained to
be amortized as of June 30, 1996. See Note 5 of the Notes to Consolidated
Financial Statements.

SUPPLIER RELATIONSHIPS

Midcom has entered into multiple-year contracts with AT&T, Sprint and
WorldCom and short-term contracts with a number of other suppliers for the long
distance telecommunication services provided to its customers. To obtain
favorable forward pricing from certain suppliers, the Company has committed to
purchase minimum volumes of a variety of long distance services during stated
periods whether or not such volumes are used or, in one case, to pay a surcharge
equal to a percentage of the Company's shortfall from a specified quarterly
minimum volume. For 1995, these commitments and maximum surcharge totaled
approximately $74.1 million, and for the final six months of 1996 they total
approximately $53.2 million (including approximately $37.2 million attributable
to AT&T). Under the Company's agreements with other

25
<PAGE> 28

suppliers, if certain volume levels are not achieved during stated periods,
pricing is adjusted going forward to levels justified by actual volumes.
Historically, the Company has directed its customers' traffic among its
suppliers in order to meet its minimum volume commitments. The allocation of
traffic among the Company's various suppliers could contribute to fluctuations
in gross margin between periods. As of September 30, 1996, Midcom's minimum
volume commitment under its supply contract with AT&T, its largest supply
contract, was $117.0 million. The Company estimates that, as of September 30,
1996, it would have been in shortfall of its minimum commitments to AT&T by
approximately $27.6 million based on then-applicable contract requirements.
However, on October 31, 1996, the Company and AT&T executed a Release and
Settlement Agreement pursuant to which substantially all disputes between the
Company and AT&T have been resolved. Also on October 31, 1996, the Company and
AT&T executed a new carrier contract pursuant to which the Company's minimum
commitment to AT&T was reduced to $13.3 for the eighteen month period
immediately following execution of the contract. In addition, the new carrier
contract provides for more favorable pricing for certain network services
provided by AT&T. In consideration for the terms of the settlement and the new
rate structure, the Company is required to make two payments to AT&T in the
aggregate amount of $8.8 million. The first payment of $5.0 million was made on
November 6, 1996. The second payment of $3.8 million will be due within 30 days
of Midcom announcing quarterly gross revenue in excess of $75.0 million, or upon
completion of a change in control. The Company believes that the renegotiation
of its carrier supply contracts is an important element to the Company's
restructuring strategy and will increase the Company's flexibility in utilizing
those suppliers while lowering its costs. There can be no assurance, however,
that the Company will be successful in its efforts to renegotiate the terms of
these agreements or that the Company will be able to obtain relief from minimum
contractual commitments in the future. If existing or future shortfalls are not
eliminated, the Company may be required to make substantial payments without
associated revenue from customers or the supplier may terminate service and
commence formal action against the Company. Such payments are not presently
contemplated in the Company's capital budgets and would have a material adverse
effect on the Company's business, financial condition and results of operation.
See "Business -- Switching Facilities," "Business -- Suppliers" and Note 14 of
the Notes to Consolidated Financial Statements.

ATTRITION

Midcom's revenue is affected by customer attrition, a problem inherent in
the long distance industry. The attrition experienced by the Company is
attributable to a variety of factors, including the Company's termination of
customers for non-payment and the marketing and sales initiatives of the
Company's competitors such as, among other things, national advertising
campaigns, telemarketing programs and the use of cash or other forms of
incentives. In particular, the Company commonly experiences high initial
customer attrition from acquired customer bases as these customers are
transitioned to the Company's services and systems. The Company believes that
this attrition occurs as a result of difficulties encountered in transitioning
acquired customer bases to the Company's services and systems, a process which
often prompts customers to consider competitive alternatives in the
telecommunications marketplace. Also, where the Company has not acquired the
sales channel associated with an acquired customer base, there is often a period
of increased exposure to competitors as the Company's sales force establishes a
relationship with its new customers. Moreover, one of the Company's selling
points in the past has been the ability to accommodate its customers who express
a preference for a particular underlying long distance carrier, such as AT&T. In
connection with the establishment of its own network of switching facilities,
the Company no longer plans to accommodate such customer preferences. The
Company expects that, as a result, certain of its existing customers will
discontinue or reduce their purchases from the Company following implementation
of its network of switching facilities. This is expected to contribute to
anticipated declines in revenue and could also impair the Company's ability to
compete for customers. See "Business -- Competition" and
"Business -- Acquisitions." The Company is aware of the significant impact
attrition has on its business. However, because of numerous acquisitions and
lack of historical data concerning its acquired customer bases, the Company has
found it difficult to measure customer attrition in a consistently meaningful
manner. As a consequence, the Company has not formulated a statistical basis for
measuring or reporting customer attrition.

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<PAGE> 29

MATERIAL WEAKNESSES

In connection with the audit of Midcom's 1995 Consolidated Financial
Statements, Midcom's independent auditors identified two conditions which were
characterized as material weaknesses in its internal financial controls. One
material weakness identified by the auditors was the failure of the Company's
accounting and finance systems to provide accurate information to monitor the
Company's financial position, results of operations and liquidity. Factors
identified as contributing to this weakness and requiring immediate attention
included insufficient staffing and systems to accommodate significant growth
from acquisitions, transitional difficulties associated with major new
information and billing systems, inadequate communication between senior
management and the finance department and demands associated with the Company's
initial public offering. The second material weakness identified by the auditors
was the Company's process of estimating unbilled receivables. With respect to
this material weakness, the auditors recommended that the Company review and
revise, as necessary, all policies and procedures with regard to its
reconciliation of unbilled receivables with actual billings to ensure that all
unbilled amounts at a reporting date represent properly recorded revenue. In
response to these recommendations, the Company has hired new finance and
accounting personnel, curtailed acquisitions and established a policy of billing
substantially all customer call traffic in a financial reporting period before
revenue for the period is reported. See "Business -- Information Systems."

RESTATEMENT OF RESULTS FOR THE THIRD QUARTER OF 1995

Midcom announced on March 4, 1996 that it would issue restated financial
statements for the third quarter and nine months ended September 30, 1995 that
would lower previously announced results. The restatement was primarily
attributable to an overrecognition of revenue and unbilled accounts receivable
which occurred during the conversion to a new billing system. In the process of
reconciling unbilled accounts as of December 31, 1995 with amounts ultimately
billed, the Company discovered that certain reports generated by its new
information management system that were used for recognizing unbilled revenue
did not fully reflect all discounts that were properly included in the bills
subsequently sent to the Company's customers. Primarily as a result of this
failure, the Company's Quarterly Report on Form 10-Q for the third quarter of
1995 was amended to report a $3.3 million reduction in revenue and a $4.5
million reduction in accounts receivable, consisting of a $3.8 million reduction
in unbilled accounts receivable and a $0.7 million increase in the allowance for
doubtful accounts. The amended 10-Q also reflects a reclassification of $1.2
million of customer adjustments to revenue to bad debt expense (included in
selling, general and administrative expenses on the statement of operations).
These adjustments resulted in the net loss for the quarter and nine months ended
September 30, 1995 being increased from $3.8 million and $8.0 million,
respectively, to $8.3 million and $12.5 million, respectively.

SEASONALITY

Due to its predominately commercial customer base, Midcom tends to
experience decreases in customer usage and revenue around national holidays and
traditional vacation periods. The Company anticipates revenue from existing
customers during the last two quarters of the year to be somewhat lower than
during the first two quarters. Historically, however, results have been affected
more significantly by acquisitions of customer bases and growth through
wholesale, direct and other sales channels than by seasonal factors.

27
<PAGE> 30

RESULTS OF OPERATIONS

Percentage of Revenue

The following table sets forth, for the periods indicated, the percentages
that certain items bear, except as noted, to total revenue:

<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------- ---------------
1993 1994 1995 1995 1996
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
REVENUE
Telecommunication Services....................... 89.4% 94.6% 99.1% 98.9% 99.3%
Aggregation...................................... 10.6 5.4 0.9 1.1 0.7
----- ----- ----- ----- -----
Total revenue............................ 100.0 100.0 100.0 100.0 100.0
COST OF REVENUE
Telecommunication Services(1).................... 76.8 74.8 69.2 68.3 72.1
Aggregation...................................... 0.0 0.0 0.0 0.0 0.0
----- ----- ----- ----- -----
Total cost of revenue.................... 68.7 70.8 68.5 68.3 72.1
Gross margin....................................... 31.3 29.2 31.5 31.7 27.9
Selling, general and administrative expenses....... 27.5 24.8 30.5 28.9 38.6
Depreciation and amortization...................... 2.8 3.7 6.8 5.7 21.0
Loss on impairment of assets, restructuring charge
and settlement of contract dispute............... -- -- 5.8 -- 25.5
----- ----- ----- ----- -----
Operating income (loss)............................ 1.0 0.7 (11.6) (2.9) (57.2)
Interest expense................................... (2.1) (2.6) (2.6) (2.8) (4.8)
Other income (expense)............................. 0.3 (0.8) (0.2) (0.4) (0.1)
----- ----- ----- ----- -----
Loss before extraordinary item..................... (0.8) (2.7) (14.4) (6.1) (62.1)
Extraordinary item................................. -- -- (2.0) (2.0) --
----- ----- ----- ----- -----
Net loss........................................... (0.8)% (2.7)% (16.4)% (8.1)% (62.1)%
===== ===== ===== ===== =====
SUPPLEMENTAL OPERATING DATA:
EBITDA(2).......................................... 3.8% 4.4% 1.0% 2.8% (10.7)%
</TABLE>

- ---------------
(1) Cost of telecommunications services is stated as a percentage of
telecommunication services revenue.

(2) As used herein, "EBITDA" is defined as operating income plus depreciation,
amortization, loss on impairment of assets, restructuring charge and
settlement of contract dispute.

Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995

Revenue. For the third quarter of 1996, the Company reported a 38.6%
decrease in revenue to $30.7 million from $50.0 million reported in the third
quarter of 1995. Year-to-date revenue of $124.6 million represents a 15.5%
decrease from the $147.4 million reported for the same period in 1995. Third
quarter 1996 revenue decreased $10.1 million from the second quarter 1996
revenue of $40.8 million due to customer attrition, the sale of its low-end fax
broadcasting business, and a dispute with Cherry Communications, the seller of
an acquired customer base. As a result of the litigation between Cherry
Communications and the Company, as of September 1, 1996, the Company
discontinued booking revenue generated by the customer bases acquired from
Cherry Communications which accounted for $2.6 million of revenue during the
third quarter of 1996 down from $7.9 million of revenue during the second
quarter of 1996. In addition, the bankruptcy of the seller of a customer base
acquired by the Company has adversely affected the Company's ability to generate
revenue from that customer base. The decrease in 1996 periods as compared to the
year earlier periods is attributable to the above factors and the Company
expects that during the remainder of 1996

28
<PAGE> 31

and, perhaps, a portion of 1997, revenue will continue to decline due to
customer attrition, seasonality and other factors.

Gross Margin. The Company's cost of revenue consists of the cost of
services provided by local and interexchange carriers. Gross margin was 27.5%
and 27.9% as a percent of total revenue for the third quarter and nine month
periods in 1996, respectively, versus 29.3% and 31.7%, respectively for the same
periods in 1995. The decline in gross margin is primarily attributable to
changes in the mix of customers. These factors were offset in part by
negotiation of price reductions with some of the Company's suppliers.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses consist primarily of payroll and related expenses for
administrative, customer support and marketing personnel, compensation costs for
direct sales personnel, commissions and other costs related to indirect
distribution and bad debt expense. Selling, general and administrative expenses
increased to $15.7 million for the third quarter of 1996 compared to $15.2
million for the same period in 1995. For the nine month period, selling, general
and administrative expenses increased $5.3 million to $48.0 million from $42.7
million in the same period of 1995. The increase is due to several factors,
including an increase in bad debt expense, an increase in legal, accounting and
other professional contractor fees, an increase in fees paid to third party
billing agents, and the addition of sales force personnel and related
recruiting, travel and training costs. These increases were offset, in part, by
reductions in commission expenses, and facilities-related costs. The Company
employed 452 and 428 persons on a full-time basis as of September 30, 1996 and
1995, respectively.

Depreciation. Depreciation expense increased to $1.7 million in the third
quarter of 1996 from $1.2 million in the same period of 1995. For the nine
months ended September 30, 1996, depreciation was $4.3 million versus $3.2
million in the same period of 1995. The increase is primarily attributable to
the depreciation of computer systems and equipment related to the Company's
billing and management information system which was placed into service in the
second quarter of 1995. The increase was partially offset by the reduction in
depreciation of telephone switching equipment due to the partial write-off of
such equipment in the fourth quarter of 1995.

Amortization. Amortization expense increased to $5.3 million in the third
quarter of 1996 from $2.2 million in the same period of 1995. Year-to-date
amortization was $21.9 million in 1996 versus $5.2 million for the same period
of 1995. In conjunction with the preparation of the first quarter financial
statements, the Company completed a review of its accounting policies and
practices, including those relating to intangible assets. Based on certain
changes in circumstances that occurred in the first quarter of 1996, including
turnover in personnel, reduction in sales force and continuing attrition of
acquired customer bases, the Company determined that effective January 1, 1996,
a reduction in the estimated useful life of acquired customer bases from 5 years
to 3 years was appropriate. The increase in amortization expense is a result of
the change in the estimated useful life and amortization of customer bases,
non-competition agreements and goodwill resulting from acquisitions completed in
the second half of 1995.

Charge Related to Settlement of Contract Dispute. On July 19, 1996, the
Company and AT&T executed a letter of intent to settle anticipated shortfalls of
minimum commitments under the Company's supply contract with AT&T as well as all
other pending disputes between the Company and AT&T and to negotiate a new
contract to the Company's minimum commitment to AT&T from approximately $117
million to $17 million. The letter of intent also provided for the payment by
the Company to AT&T of $8.8 million in two installments. The Company recorded a
charge of $8.8 million in the second quarter of 1996 with respect to this
settlement. Pursuant to the letter of intent, on October 31, 1996, the Company
and AT&T executed a Release and Settlement Agreement pursuant to which
substantially all disputes between the Company and AT&T have been resolved. Also
on October 31, 1996, the Company and AT&T executed a new carrier contract
pursuant to which the Company's minimum commitment to AT&T was reduced to $13.3
million to be used over the eighteen month period immediately following the
execution of the agreement. In addition, the new carrier contract provides for
more favorable pricing for certain network services provided by AT&T. In
consideration for the terms of the settlement and the new rate structure, the
Company is required to pay AT&T $8.8 million payable in two installments. The
first payment of $5.0 million was made on November 6, 1996, and the remaining
balance of $3.8 million will be due within 30 days of Midcom announcing
quarterly gross revenue in excess of $75.0 million, or upon completion of a
change in control.

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<PAGE> 32

Restructuring Charges. In March and April 1996, the Company made
announcements regarding changes in senior management and the restructuring of
its operations in order to reduce expenses to the level of available capital.
These actions included the layoff of certain employees and contractors and the
closure of six sales offices. As a result, the Company recorded a charge of $1.6
million during the first quarter 1996 and $0.6 million during the second quarter
of 1996, the major components of which relate to severance and lease
cancellation charges. Included in the restructuring charge is approximately $0.4
million relating to the extension of the time period to exercise outstanding
stock options. As of September 30, 1996, $1.0 million of this restructuring
charge remained in accrued liabilities to cover payments to be made in the
future.

Loss on Impairment of Assets. The Company periodically reviews the
carrying value of its long-term assets in accordance with Statement of
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of." To the extent that 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. In connection with such a review, the Company wrote-down certain
acquired customer bases, equipment, an investment in a joint venture, and
recorded a loss on long-term assets totaling $20.8 million during 1996.

Other Expenses. Interest expense for the quarter and nine months ended
September 30, 1996 increased over the same periods in 1995 primarily due to an
increase in average borrowings outstanding, an increase in average interest
rates, and $1.1 million in fees paid in connection with a temporary $15.0
million Bridge Loan. At September 30, and June 30, 1996, the Company had
outstanding interest-bearing obligations of $113.6 million and $58.0 million,
respectively, as compared to $58.1 million as of December 31, 1995. The increase
in debt at September 30, 1996 was primarily due to issuance of the Notes, net of
repayment of the Bridge Loan and the Revolving Loans.

The Company discontinued recording its share of the income or losses of a
Russian joint venture as of December 31, 1995, and during the third quarter of
1996 the remaining investment of $2.0 million was written off to loss on
impairment of assets.

Income Taxes. The Company has incurred losses for all periods presented.
No tax benefit has been recorded with respect to these losses due to the
uncertainty as to the utilization of Company's net operating loss carryforward.

Net Loss. The substantial increase in net loss in 1996 periods over the
corresponding periods in 1995 is attributable to the declines in gross margin,
the increases in operating expenses, the $20.8 million loss on impairment of
assets related to acquired customer bases equipment, an investment in a joint
venture, the restructuring charges and the settlement payments described above.

Year Ended December 31, 1995 Compared to Year Ended December 31, 1994

Revenue. Total revenue in 1995 increased 82.2% to $203.6 million from
$111.7 million in 1994. The increase is primarily attributable to incremental
telecommunications services revenue resulting from acquisitions and, to a lesser
extent, new sales through the Company's combined sales channels, offset by the
impact of attrition. Increased revenue also was partially offset by a 70.6%
decrease in aggregation fee revenue compared to 1994. The decline in aggregation
fees is due to the attrition of aggregation customers and the Company's efforts
to convert aggregation customers to other Midcom products. See "-- Liquidity and
Capital Resources."

Gross Margin. Cost of revenue grew 76.5% in 1995, primarily as a result of
the increase in revenue as discussed above. The gross margin percentage for 1995
increased to 31.5% versus 29.2% in 1994. Telecommunications services gross
margin increased to 30.8% in 1995, up from 25.2% in 1994. The higher gross
margin in

30
<PAGE> 33

1995 is attributable to several factors, including (i) acquisitions of customer
bases whose mix of customers generally result in higher average revenue per
minute and acquisitions of higher margin businesses, such as PacNet, (ii)
negotiation of price reductions with some of the Company's suppliers as a result
of increased traffic volume and (iii) an increase in traffic over the Company's
own switches, all of which were acquired or placed in service on or after
September 30, 1994. These factors were partially offset by an increase in
wholesale revenue as a percentage of total revenue, which carries a lower gross
margin percentage, a decline in aggregation fee revenue as a percentage of total
revenue, which has no cost of revenue, and the write-off of calls which were not
billed during the conversion to the Company's new billing system.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased as a percentage of total revenue from 24.8% in
1994 to 30.5% in 1995. The increase was due to several factors, including a
substantial increase in bad debt expense and other adjustments given to
customers largely attributable to delays in billing which occurred during the
conversion to the new billing system, higher commission rates associated with a
telemarketing program for lower volume customers, the addition of personnel and
other costs incurred in connection with conversion to the Company's new
information processing systems and costs to open sales offices, some of which
were closed in the first quarter of 1996. Midcom also incurred additional
expenses during 1995 in connection with the maintenance of duplicate billing and
information systems, including those of acquired businesses, and to a lesser
extent, additional personnel costs. The Company employed 457 and 366 persons on
a full-time basis as of December 31, 1995 and 1994, respectively.

Depreciation and Amortization. Depreciation and amortization expense
increased as a percentage of revenue during 1995. This increase reflects the
amortization of customer bases and goodwill, the depreciation of telephone
switching equipment resulting from acquisitions in the second half of 1994 and
throughout 1995 and the depreciation and amortization of significant continued
capital investment in computer equipment and software development used to
support internal systems. The Company expects depreciation and amortization
expenses to continue to increase due to the effect of recent acquisitions and
the development and placement into service of management information systems.

Loss on Impairment of Assets. The loss on impairment of assets consists of
the following: (i) a $6.8 million write-down of the Company's interest in the
joint venture in Russia to reflect the estimated current value of this
investment (see "Business -- Russian Joint Venture"), (ii) a $2.5 million
write-off of the Company's current telephone switching equipment as a result of
its decision to migrate to a different switching platform (see
"Business -- Switching Facilities") and (iii) a $2.5 million partial write-down
of the Company's capitalized software for its management information system due
to weaknesses identified in the system (see "Business -- Information Systems").

Interest Expense. Interest expense increased 78.4% to $5.3 million in 1995
from $3.0 million in 1994 primarily due to the increase in average borrowings
outstanding in 1995. At December 31, 1995, the Company had outstanding
interest-bearing obligations of $58.1 million, up from $36.3 million outstanding
as of December 31, 1994. The increase in debt was due to the funding of
acquisitions and the development of management information systems and purchase
of related equipment.

Extraordinary Item. In July 1995, the Company completed an initial public
offering which resulted in net proceeds of $54.2 million to the Company. The
Company used the proceeds to pay down various obligations, including $15.0
million in principal amount of certain subordinated notes. As a result of the
early extinguishment of these notes, the Company expensed as an extraordinary
item in the third quarter of 1995 the unamortized portion of original issue
discount which aggregated approximately $3.0 million. In addition, in the fourth
quarter of 1995, the Company obtained a new credit facility and paid off its
prior revolving credit facility. As a result, the Company was required to
write-off as an extraordinary item during the fourth quarter unamortized
deferred financing costs associated with its prior credit facility totaling
approximately $1.1 million.

Other Expense/Equity in Loss of Joint Venture. Other expense consists
mainly of finance charges and other nonoperating expenses. The Company's portion
of the loss generated by its Russian joint venture, Dal

31
<PAGE> 34

Telecom, was $52,000 in 1995, down from $458,000 in 1994, due mainly to improved
operating results of the joint venture.

Income Taxes. The Company has incurred losses for all periods presented.
No tax benefit has been recorded with respect to these losses due to the
Company's net operating loss carryforward which totalled approximately $19.1
million as of December 31, 1995.

Year Ended December 31, 1994 Compared to Year Ended December 31, 1993

Revenue. Total revenue in 1994 increased 69.2% to $111.7 million from
$66.0 million in 1993. This increase consisted primarily of a 78.9% increase in
revenue from telecommunications services, to $105.6 million from $59.0 million
in 1993, which was offset by a 12.7% decrease in revenue from aggregation fees.
The increase in telecommunications services revenue in 1994 is attributable to
increased sales from the Company's direct sales and field service
representatives and independent distributors, as well as revenue attributable to
acquired customer bases. In 1993 and early 1994, the Company significantly
increased the size of its sales force. Also, in late 1993 the Company increased
the number of its independent distributors, primarily through acquisitions. To a
lesser extent, 1994 revenue increased as a result of the expansion of the
Company's products and services and increased sales to resellers.

Gross Margin. The Company's gross margin declined in 1994 to 29.2% from
31.3% in 1993. The decline was largely attributable to the decrease in
aggregation fees, which has no cost of sales. Telecommunications services gross
margin increased from 23.2% in 1993 to 25.1% in 1994 in spite of declining
revenue per minute caused by increasingly competitive market conditions. The
revenue per minute decline also reflects the Company's increasing emphasis,
commencing in mid-1993, on term contracts (two or three years) which offered
lower rates in exchange for fixed-term commitments. Nevertheless, these factors
were offset by price reductions obtained from some of the Company's suppliers as
a result of the Company's increased volume of use. In addition, in the fourth
quarter of 1994 the Company commenced use of its own switches which also
benefited gross margin.

Selling, General and Administrative Expenses. From 1993 to 1994, the
Company's selling, general, and administrative expenses declined as a percentage
of revenue from 27.5% to 24.8%. The actual dollar increase was primarily a
result of growth, including growth through acquisitions. The 1994 increase is
also attributable to additional personnel and other costs incurred in connection
with the development and initial implementation of the Company's new information
processing systems and to operate and maintain switches. The percentage decline
in 1994 is also attributable to the fact that the Company did not pay any
consulting fees to shareholders, compared to shareholder consulting fees of
$1,025,000 paid in 1993 to Paul Pfleger, the Company's then sole shareholder. In
1993, Mr. Pfleger, as a director and the sole shareholder of the Company,
actively consulted with management of the Company by participating in major
decisions and regularly giving direction and guidance to the Company's senior
officers. The amount paid for these services was based primarily on the
Company's operating results. Midcom incurred additional expenses in 1994 due to
the cost of maintaining duplicate systems of acquired businesses pending full
integration of these acquisitions. The decline in selling, general and
administrative expenses as a percentage of revenue was attributable to improved
operating leverage. The Company employed 366 and 248 persons on a full-time
basis at the end of 1994 and 1993, respectively.

Depreciation and Amortization. From 1993 to 1994, depreciation and
amortization expense increased as a percentage of revenue from 2.8% to 3.7%.
This increase reflects the significant capital investment in internal systems
and the amortization of intangible assets associated with acquisitions.

Interest Expense. From 1993 to 1994, interest expense increased from $1.4
million to $3.0 million. This increase was primarily due to increased borrowings
and, to a lesser extent, an increase in overall interest rates. At December 31,
1993, the Company had outstanding interest-bearing obligations of approximately
$23.5 million, while at December 31, 1994, this amount had grown to $36.3
million. The increase in debt is primarily due to funding acquisitions and the
purchase of systems and equipment.

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Other Expense. Other expense in 1994 is mainly composed of the Company's
portion of the loss of its Russian joint venture. The Company's pro rata share
of the loss generated by its joint venture in Russia in 1994 was $365,000.
Additionally, the Company recorded a $93,000 incremental loss for the difference
between the Company's investment and its 50% allocable share of Dal Telecom's
net assets.

Income Taxes. Through December 31, 1993, the Company was an S corporation
for income tax purposes. Accordingly, the Company's income (losses) were
reported by the shareholders rather than by the Company. Effective with the
change from an S corporation to a C corporation, the Company recorded a tax
provision of $207,000, which was subsequently reversed due to losses incurred
during 1994.

LIQUIDITY AND CAPITAL RESOURCES

Historically, the Company has experienced rapid growth, which has required
substantial working capital to finance receivables, capital expenditures and
acquisitions and service indebtedness. Given the Company's billing and
collection cycle with its customers and suppliers, the Company generally pays
its underlying suppliers from thirty to forty-five days prior to the time it is
paid by its customers for the same services. The Company has financed its growth
with the proceeds from its July 1995 initial public offering, bank borrowings,
subordinated debt, capital leases, cash flow from operations, and the issuance
of Common Stock and assumption of indebtedness in connection with acquisitions
of businesses and customer bases.

The Company's cash balances were $48.1 million at September 30, 1996 versus
$1.1 million at December 31, 1995. Net cash used in operations was $6.6 million
for the first nine months of 1996 versus $992,000 generated by operations in the
same period of 1995. During the first nine months of 1996, the Company
experienced significant operating losses which resulted in a use of cash in
operating activities. The Company reduced its unbilled receivables balances from
$28.0 million as of December 31, 1995 to $9.9 million as of September 30, 1996.
This was primarily attributable to a reduction in the backlog of billings which
built up during the second half of 1995, and a reduction in the run rate of
monthly revenue.

During the first nine months of 1996, the Company invested $1.7 million to
purchase property, plant and equipment compared to $6.6 million for the same
period the prior year. During the first nine months of 1995, the Company used
$10.5 million in business and customer base acquisitions and $2.5 million in
advances to a Russian joint venture. No similar investments were made during the
first nine months of 1996. For the first nine months of 1996, the Company
received $2.8 million in proceeds in connection with the exercise of stock
options and the purchase of shares under the Company's stock purchase plan,
compared to $329,000 received in connection with the exercise of stock options
during the first nine months of 1995. In addition, the Company received $54.0
million in net proceeds from its initial public offering in July 1995, paid $8.6
million to redeem outstanding preferred stock, and paid $287,000 to shareholders
of acquired companies.

The Company has experienced significant losses since its inception, with
net losses of approximately $3.0 million, $33.4 million and $77.4 million for
1994, 1995 and the nine months ended September 30, 1996, respectively. As a
result of these losses, the billing and collection cycle with its customers,
prior acquisition strategy and other factors, the Company has required
substantial external working capital.

In August and September of 1996, the Company completed the Private
Placement. See "Prospectus Summary -- The Private Placement." The net proceeds
to Midcom from the Private Placement were approximately $94.2 million, after
deducting the discount to the Initial Purchasers and expenses. The Company used
the net proceeds as follows: (i) $15.0 million to repay in full the Bridge Loan,
(ii) $19.0 million to repay in full the Revolving Loans, (iii) $5.0 million to
pay the first installment of an $8.8 million payment in connection with the
satisfaction of past shortfalls and settlement of other obligations under the
Company's carrier supply contract with AT&T and (iv) $10.0 million to bring
current a number of payment obligations existing prior to the completion of the
Private Placement. In addition, the Company anticipates using approximately
$22.0 million of the net proceeds to acquire and install high capacity switches.
The balance of the net proceeds has been and will be used for additional working
capital, additional capital expenditures and general corporate purposes.

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<PAGE> 36

Interest on the Notes will be paid semi-annually, on February 15 and August
15 of each year, commencing February 15, 1997, in the aggregate amount of
approximately $4.0 million per payment. Interest payments will adversely affect
the Company's liquidity. In addition, in the event of a "change of control" of
the Company, as defined in the indenture pursuant to which the Notes were issued
(the "Indenture"), holders of the Notes have the right to require the Company to
repurchase the Notes in whole or in part at a repurchase price equal to 101% of
the principal amount thereof, plus accrued interest, if any, to the date of
repurchase. If the Company is required to repurchase the Notes upon a change of
control, payment of the repurchase price could have a material adverse effect on
the Company's liquidity, results of operation and financial condition. Also, if
the Company is in default under the Indenture, holders of the Notes have the
right to demand immediate repayment of the Notes. If the Company were required
to repay the Notes upon default, such repayment could have a material adverse
effect on the Company's liquidity, results of operation and financial condition.

In connection with the resignation of Ashok Rao, the Company's former
President and Chief Executive Officer, the Company has elected to repurchase
885,360 shares of Common Stock held by Mr. Rao and certain trusts established by
Mr. Rao at a price equal to the fair market value of such Common Stock on the
date of Mr. Rao's resignation, as determined by arbitration, to be paid ratably
over a period of 36 months. The Company's election to repurchase such shares of
Common Stock will adversely affect the Company's liquidity. In addition, the
unpaid balance of a promissory note delivered to Cherry Communications
Incorporated ("Cherry Communications") in connection with the acquisitions of
two customer bases is approximately $10.2 million, of which $9.0 million may be
paid in cash or by delivery of Common Stock, as the Company may elect, and the
remaining $1.2 million is subject to certain hold-back arrangements. The
acquired customer bases have not generated 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 the second of the
two acquisitions, payment of invoices for carrier services for the acquired
bases (up to $11.4 million through September 30, 1996) and accrued customer
service charges through September 30, 1996 of $840,000. Negotiations between
Cherry Communications and the Company failed to produce a settlement of these
disputes and Cherry Communications has filed suit against the Company seeking to
recover alleged past due amounts. See "Business -- Legal Proceedings." The
Company was obligated to pay additional cash pursuant to a customer base
purchase agreement, based upon revenue levels for such customer base. In October
1996, $1.2 million was paid to satisfy this obligation. In addition, in the
event of the sale or transfer of the majority of the voting stock of Cel-Tech, a
payment of a maximum of $2.0 million would become payable to the former
shareholder.

The Company's available sources of working capital consist of cash flows
from operations, approximately $48.1 million at September 30, 1996 in cash and
short-term, investment grade, interest-bearing securities, which funds represent
the remaining net proceeds from the Private Placement, and possible borrowings
under the Revolving Credit Facility. Prior to completion of the Private
Placement, the Company had for several months experienced a severe working
capital short-fall which required the Company to seek extended payment terms
from certain of its suppliers, delay payments to many of its suppliers and other
vendors, delay or cancel purchases and take other steps to conserve operating
capital. As a result, a number of suppliers placed the Company on credit hold
and/or initiated collection actions. Also, for several months prior to
completion of the Private Placement, the Company was in default of certain
financial and other covenants under its Revolving Credit Facility, although the
lenders continued to permit borrowings under that facility. In addition, the
report of the Company's independent auditors with respect to the Company's
Consolidated Financial Statements for the year ended December 31, 1995 states
that the Company's recurring operating losses, working capital deficiency and
credit agreement defaults raise substantial doubt about the Company's ability to
continue as a going concern. The nature of this opinion itself constituted a
default under the Revolving Credit Facility. In connection with the completion
of the Private Placement and the application of the net proceeds therefrom to
the repayment in full of the Bridge Loan and the Revolving Loans, which
aggregated approximately $34.0 million, the lenders under the Revolving Credit
Facility waived all existing defaults and amended the financial covenants under
the Revolving Credit Facility to levels forecasted to be consistent with
Midcom's revised business plan. The Company's maximum borrowing availability
under the

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Revolving Credit Facility, as amended, is $43.0 million, subject to a borrowing
base equal to 85% of the Company's eligible accounts receivable less a minimum
excess availability requirement of $20.0 million for the months of August 1996
through February 1997, declining in stages to $8.0 million for the months of
September through November 1997. As of September 30, 1996, after giving effect
to the amendment, the Company's borrowing base was less than the minimum
borrowing base excess availability and, accordingly, the Company had no ability
to borrow under the Revolving Credit Facility. There can be no assurance that
the Company will generate sufficient revenue to build a borrowing base which
will permit borrowings under the Revolving Credit Facility in the future.

The Company estimates that it will require between $40.0 million and $50.0
million during 1996 and 1997 in order to fund (i) operating losses, (ii) working
capital requirements and (iii) capital expenditures, including an estimated
$22.0 million to acquire and install high capacity switches. The Company expects
that the remaining proceeds of the Private Placement, together with funds
available under the Revolving Credit Facility and cash flows from operations,
will be sufficient to fund these requirements during 1996 and 1997. However, the
exact amount and timing of these capital requirements will be determined by
numerous factors, including the level of, and gross margin on, future sales, the
outcome of outstanding contingencies and disputes such as pending lawsuits and
payment terms obtained from the Company's suppliers and the timing of capital
expenditures. The Revolving Credit Facility expires in November 1997 and there
can be no assurance that the Company will be able to renew the Revolving Credit
Facility upon its expiration or that it will be able to replace the Revolving
Credit Facility on terms that it finds acceptable. Further, there can be no
assurance that the net proceeds of the Private Placement together with funds
available under the Revolving Credit Facility and cash flows from operations
will be sufficient to fully implement the Company's operating strategy or meet
its other capital requirements. If (i) the Company experiences greater than
anticipated capital requirements, (ii) it is determined to be liable for, or
otherwise agrees to settle or compromise, any material claim against it, (iii)
it is unable to make future borrowings under the Revolving Credit Facility for
any reason or (iv) the Company's operating strategy fails to produce anticipated
cash flows from operations, the Company may be required to refinance all or a
portion of its existing debt, sell assets or obtain additional equity or debt
financing. There can be no assurance that any such refinancing or asset sales
would be possible or that the Company will be able to obtain additional equity
or debt financing, if and when needed, on terms that the Company finds
acceptable. Any additional equity or debt financing may involve substantial
dilution to the interests of the Company's shareholders as well as the holders
of the Notes. The failure of the Company to complete one or more of such
alternatives or otherwise obtain sufficient funds to satisfy its cash
requirements could prevent the Company from implementing its operating strategy
and, ultimately, could force the Company to seek protection under the federal
bankruptcy laws. Such events would materially and adversely affect the value of
the Company's debt and equity securities.

The report of the Company's independent auditors with respect to the
Company's consolidated financial statements for the year ended December 31, 1995
states that the Company's recurring operating losses, working capital deficiency
and past credit facility defaults raise substantial doubt about the Company's
ability to continue as a going concern. The Company's consolidated financial
statements have been prepared assuming that the Company will continue as a going
concern and do not include any adjustments that might result from the outcome of
this uncertainty.

ADOPTION OF ACCOUNTING STANDARDS

In October 1995, the Financial Accounting Standards Board issued Statement
No. 123, "Accounting for Stock-Based Compensation." This pronouncement
establishes accounting and reporting standards for stock-based employee
compensation plans, including stock purchase plans, stock options and stock
appreciation rights. This standard defines a fair value based method of
accounting for these equity instruments. This method measures compensation cost
based on the value of the award and recognizes that cost over the service
period. Companies may elect to adopt this standard or to continue accounting for
these types of equity instruments under current guidance, APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Companies which elect to continue
using the rules of APB Opinion No. 25 must make pro forma disclosures of net
income and earnings per share as if this new statement had been applied.
Effective January 1, 1996, the Company adopted Statement 123 and elected to
continue following the guidance of APB Opinion No. 25.

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BUSINESS

INDUSTRY BACKGROUND

The existing domestic long distance telecommunications industry was
principally shaped by a 1984 court decree (the "Decree") that required the
divesture by AT&T of its 22 Bell operating companies ("BOCs"), organized the
BOCs under seven regional Bell operating companies ("RBOCs") and divided the
country into some 200 Local Access Transport Areas or "LATAs." The incumbent
local exchange carriers ("ILECs"), which include the seven RBOCs as well as
independent local exchange carriers, were given the right to provide local
telephone service, local access service to long distance carriers and intra-LATA
long distance service (long distance service within LATAs), but the RBOCs were
prohibited from providing inter-LATA service (service between LATAs). The right
to provide inter-LATA service was given to AT&T and the other interexchange
carriers ("IXCs"). Conversely, IXCs were prohibited from providing local
telephone service.

A typical inter-LATA long distance telephone call begins with the local
exchange carrier ("LEC") transmitting the call by means of its local network to
a point of connection with an IXC. The IXC, through its switching and
transmission network, transmits the call to the LEC serving the area where the
recipient of the call is located, and the receiving LEC then completes the call
over its local facilities. For each long distance call, the originating LEC
charges an access fee. The IXC also charges a fee for its transmission of the
call, a portion of which consists of a terminating fee which is passed on to the
LEC which delivers the call. To encourage the development of competition in the
long distance market, the Decree required LECs to provide all IXCs with access
to local exchange services "equal in type, quality and price" to that provided
to AT&T. These so-called "equal access" and related provisions were intended to
prevent preferential treatment of AT&T and to level the access charges that the
LECs could charge IXCs, regardless of their volume of traffic. As a result of
the Decree, customers of all long distance companies were eventually allowed to
initiate their calls by utilizing simple "1 plus" dialing, rather than having to
dial longer access or identification numbers and codes.

The Telecommunications Act is expected to significantly alter the
telecommunications industry. The Decree has been lifted and all restrictions and
obligations associated with the Decree have been eliminated by the new
legislation. The seven RBOCs are now permitted to provide long distance service
originating (or in the case of "800" service, terminating) outside their local
service areas or offered in conjunction with other ancillary services, including
wireless services. Following application to the FCC, and upon a finding by the
FCC that an RBOC faces facilities-based competition and has satisfied a
congressionally-mandated "competitive checklist" of interconnection and access
obligations, an RBOC will be permitted to provide long distance service within
its local service area, although in so doing, it will be subject to a variety of
structural and nonstructural safeguards intended to minimize abuse of its market
power in these local service areas. Having opened the interexchange market to
RBOC entry, the Telecommunications Act also removes all legal barriers to
competitive entry by interexchange and other carriers into the local
telecommunications market and directs RBOCs to allow competing
telecommunications service providers such as the Company to interconnect their
facilities with the local exchange network, to acquire network components on an
unbundled basis and to resell local telecommunications services. Moreover, the
Telecommunications Act prevents IXCs that serve greater than five percent of
presubscribed access lines in the U.S. (which includes the nation's three
largest long distance providers) from jointly marketing their local and long
distance services until the RBOCs have been permitted to enter the long distance
market or for three years, whichever is sooner. This gives all other long
distance providers such as the Company a competitive advantage over the larger
long distance providers in the newly-opened local telecommunications market. As
a result of the Telecommunications Act, long distance carriers such as the
Company will face significant new competition in the long distance
telecommunications market, but will also be afforded significant new business
opportunities in the local telecommunications market. See "-- Competition" and
"-- Regulation."

Legislative, judicial and technological factors have helped to create the
foundation for smaller long distance providers to emerge as legitimate
alternatives to AT&T, MCI and Sprint for long distance telecommunication
services. The FCC has required that all IXCs allow the resale of their services,
and the Decree substantially eliminated different access arrangements as
distinguishing features among long distance

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<PAGE> 39

carriers. In recent years, national and regional network providers have
substantially upgraded the quality and capacity of their domestic long distance
networks, resulting in significant excess transmission capacity for voice and
data communications. The Company believes that, as a result of digital fiber
optic technology, excess capacity has been, and will continue to be, an
important factor in long distance telecommunications. As a consequence, not only
have smaller long distance service providers received legal protection to
compete with the network-based carriers, they also represent a source of traffic
to carriers with excess capacity.

THE COMPANY

Midcom 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 AT&T, Sprint and WorldCom, to provide a broad array of integrated long
distance telecommunications services on a seamless and highly reliable basis.
Midcom's service offerings include basic "1 plus" and "800" long distance, frame
relay data transmission and wireless services, as well as enhanced
telecommunications services such as dedicated private lines between customer
locations, facsimile broadcast services, calling cards and conference calling.

Midcom focuses on serving small to medium-sized businesses. The Company
estimates that during the second quarter of 1996 it invoiced approximately
125,000 customer locations, a significant majority of which were located in the
major metropolitan areas of California, Florida, Illinois, New York, Ohio and
Washington. The Company believes that the larger long distance carriers, such as
AT&T, Sprint, WorldCom and MCI, tend to focus their sales and customer support
efforts on residential and large commercial customers and do not routinely
provide significant pricing discounts for small to medium-sized businesses. By
purchasing large usage volumes from the facilities-based carriers at wholesale
prices, Midcom seeks to offer its customers more favorable pricing than they
could obtain from such carriers directly. In addition, the Company believes that
businesses in this market segment do not typically have in-house
telecommunications expertise and therefore require more assistance with the
assessment and management of their telecommunications requirements. As a result,
the Company believes that it is able to differentiate its service offerings from
the larger carriers in this market segment on the basis of price, breadth of
service offerings, customer service and support and the ability to provide
customized solutions to the telecommunications requirements of its customers.
See "-- Marketing and Sales," "-- Competition" and "-- Customer Concentrations."

COMPANY STRATEGY

During the second and third quarters of 1996, Midcom recruited a new
executive management team with extensive experience and expertise in the
telecommunications industry. In May 1996, the Company hired William H. Oberlin
as its President and Chief Executive Officer, appointed Mr. Oberlin, Marvin C.
Moses and John M. Zrno to its Board of Directors and engaged Mr. Moses and Mr.
Zrno as consultants. In October of 1996, Mr. Zrno was appointed as Chairman of
the Board effective December 2, 1996. These individuals formerly held senior
management positions at ALC Communications Corporation ("ALC"), a leading
provider of long distance and other services to small and medium-sized
businesses. During their tenure at ALC, ALC completed a successful turn-around
and experienced profitable growth. From the fiscal year ended December 31, 1991
through the 12 months ended June 30, 1995 (prior to ALC's merger into Frontier
Corporation), ALC's revenue increased from $346.9 million to $677.1 million and
net income increased from $5.3 million to $75.0 million. In addition, in July
1996 the Company appointed Daniel M. Dennis to the Company's Board of Directors.
Mr. Dennis has served in a number of management positions with MCI for over 23
years.

Midcom's new executive management team has developed a restructuring,
network and marketing strategy which it plans to implement during 1996 and 1997
and which is designed to address the operational challenges experienced by the
Company and increase internally generated sales and profitability. Principal
components of the Company's strategy are set forth below. Although the Company
believes that its new management team has the relevant skills and experience
necessary to implement this strategy, its ability to do so is subject to a
number of risks and uncertainties, and there can be no assurance that this
strategy will be successfully implemented or that the intended positive results
will be achieved. See "Risk Factors."

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Operational Restructuring Strategy

Continue to Build Management Team. Midcom will continue to seek
opportunities to augment management with individuals who have telecommunications
industry experience and expertise. From May to September 1996, the Company
appointed 10 individuals to key operational management positions. These
individuals have extensive experience in the operation of a telecommunications
company, including (i) network design, implementation and operation, (ii)
marketing and sales, (iii) management information systems and (iv) bill
processing and collection. Midcom believes that the experience and depth of this
management team will improve the Company's ability to address its current
operational challenges and to pursue its transition from primarily a
nonfacilities-based reseller of long distance and other telecommunications
services to a switch-based provider of integrated telecommunications services.

Integrate and Improve Information Systems. Midcom intends to focus on
consolidating and integrating the Company's multiple information and billing
systems and other redundant functions of certain acquired operations and
enlarging and enhancing the Company's information system and financial reporting
functions. The Company believes that these activities will (i) reduce the
overhead and maintenance costs associated with its management information
systems, (ii) improve the amount and type of information that can be accessed
about customers, sales and operations, (iii) increase the speed with which
information can be processed and (iv) reduce the Company's working capital
investment by shortening the time it takes for the Company to produce and
distribute customer bills. See "-- Information Systems."

Renegotiate Carrier Agreements. The Company currently resells network
switching and transport facilities of long distance carriers such as AT&T,
Sprint and WorldCom. Midcom believes its relationships with these carriers
enables it to provide customers a broad array of integrated long distance
telecommunications services on a seamless and highly reliable basis. Despite the
Company's successful resale of these network facilities, the Company's
profitability was reduced as a result of a supply contract with AT&T which
provided for higher rates than those obtained from alternative suppliers.
However, in October 1996 the Company and AT&T entered into a new carrier supply
contract which provides for more favorable rates. The Company believes the
successful renegotiation of its supply agreement with AT&T and its other
carriers will substantially improve the financial performance of the Company
while enabling the Company to continue to provide the same level of service to
its customers. See "-- Suppliers."

Network Strategy

At the end of July 1996, Midcom owned and operated limited capacity
switches in nine locations. The Company intends to use a portion of the proceeds
of the Private Placement to acquire and install state-of-the-art high capacity
switches, with local and long distance functionality, in areas of the country
where it has a sufficient volume of long distance traffic and where the
regulatory environment and market conditions will permit it to provide local
service at acceptable margins. The Company believes that, in the cities where it
intends to deploy switches, there will be significant local circuit capacity at
attractive rates available from competitive local exchange carriers ("CLECs"),
ILECs and 38GHz wireless providers. Using its own switches will enable the
Company to (i) direct customer call traffic over multiple networks which is
expected to minimize costs and improve gross margin, (ii) switch local traffic,
thereby increasing the economic viability of entering the market for local
telecommunication services, (iii) shield proprietary information regarding its
customers from the underlying carriers and thereby increase customer control,
(iv) facilitate access to call data records and (v) implement differentiating
features and billing enhancements without involving the underlying carrier. See
"-- Switching Facilities."

Marketing Strategy

Reorganize and Expand Sales Efforts. To take full advantage of its planned
switching facilities network and expanded product offerings, Midcom is in the
process of reorganizing its direct sales force into (i) a national and key
accounts group consisting of highly experienced sales personnel focused on
larger customers with sophisticated telecommunications requirements and (ii) a
general accounts group focused on smaller customers. Both groups will be located
in major metropolitan areas where the Company believes it has

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<PAGE> 41

significant market opportunities and can compete effectively on the basis of
price. The Company intends to implement training programs and financial
incentives designed to increase the cross-selling efforts of its direct sales
force and further integrate the Company's broad array of service offerings. In
addition to reorganizing its sales efforts, the Company intends to increase the
number of sales representatives during 1996 and 1997 from approximately 35 at
the end of July 1996 to approximately 200. The Company will continue to
supplement its direct sales force with its existing network of resellers and
distributors. In addition to its existing distributors, the Company intends to
develop a new tier of distributors who will be offered long-term financial
incentives and who will be required, within selected territories, to market and
sell the Company's service offerings exclusively. The Company believes that
these long-term financial incentives and exclusive marketing arrangements will
result in improved performance and increased loyalty to the Company and its
service offerings. See "-- Marketing and Sales."

Expand and Enhance Customer Support Efforts. Midcom intends to support its
expanded sales efforts and reduce customer attrition by building an enhanced
customer service and support operation. The Company intends to increase its
customer service and support staff during 1996 and 1997 from approximately 45 at
the end of July 1996 to approximately 60. This expanded operation will include
(i) a staff of trained customer service representatives available during normal
business hours at a number of integrated customer service centers, (ii) trained
account representatives assigned and dedicated to individual customers with
sophisticated telecommunications requirements and (iii) teams of technical
specialists available to develop customized solutions for a customer's
telecommunication needs. See "-- Customer Service."

Resell Local Services and Provide a Single-Source Solution. Regulatory
changes resulting from the Telecommunications Act significantly expand the
number and types of services Midcom is permitted to offer. As a result, Midcom
intends to offer its customers local dial tone and a variety of other local
telecommunications services primarily in locations where it has a significant
sales and marketing presence or where it plans to deploy switching facilities.
The Company believes that its large and geographically concentrated customer
base of small to medium-sized businesses represents a significant potential
market for these additional services. These additional services will afford the
Company the opportunity to provide its customers with a single-source solution
for local, long distance, wireless and enhanced telecommunications services. The
Company believes that bundling these services will provide substantial
advantages to its customers, including lower overall costs and a higher level of
service due to a single source for ordering, installation, customer service and
account management. In addition, Midcom believes that offering a single source
for telecommunications services will permit the Company to (i) leverage its
significant customer base and increase sales by increasing its share of the
telecommunications expenditures of its customers and (ii) improve customer
control and retention by strengthening its relationships with its customers. See
"-- Industry Background," "-- Regulation" and "-- Competition."

MARKETING AND SALES

Midcom markets its services nationwide through three distinct channels:
direct sales, independent distributors and, on a wholesale basis, other
resellers.

Direct Sales. Midcom believes that direct sales activities are more
effective than advertising for securing and maintaining the business of small to
medium-sized commercial customers. The Company believes that the face-to-face
customer contact afforded by its direct sales activities results in increased
customer loyalty, improves cross-selling opportunities and will ultimately have
a positive effect on revenue. Accordingly, direct sales activities comprise a
substantial portion of the Company's marketing and sales resources. To optimize
the Company's selling efforts, the Company intends to increase the number of
sales representatives during 1996 and 1997 from approximately 35 at the end of
July 1996 to approximately 200 and reorganize the direct sales force into the
following two groups:

National and Key Accounts. The national and key accounts group will
consist of highly experienced sales personnel and will concentrate sales
efforts on businesses with sophisticated telecommunications requirements.
Target customers for special accounts generally include those which require
dedicated access to the Company's long distance points of presence and a
high level of customer service and

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<PAGE> 42

support. In particular, the Company expects that these customers will
increasingly require support for data communication applications. Dedicated
account representatives will be assigned to each of these customers. In
addition, these customers will be supported by technical specialist teams
trained to provide customized solutions to their telecommunications
problems.

General Accounts. The general accounts group will concentrate sales
efforts on businesses with less sophisticated telecommunications
requirements. Typically, these customers do not require dedicated access to
the Company's long distance point of presence and utilize only basic "1
plus" and "800" long distance and cellular service and calling cards.
Moreover, although the Company will provide these customers access to its
customer service and support centers, it generally will not assign to them
a dedicated account representative.

Each of these groups will consist of approximately 50% of the Company's sales
force and will be geographically focused, concentrating on major metropolitan
areas where the Company has customer concentrations sufficient to support a
sales and marketing presence. Currently, the Company's direct sales force is
located in Atlanta, Charlotte, Chicago, Cleveland, Dallas, Detroit, Los Angeles,
New York, San Francisco and Seattle. In addition to these locations, the Company
plans to deploy its direct sales force in Boston, Long Island, New Haven, New
Jersey, Philadelphia, Washington, D.C. and other cities during 1996 and 1997.

In 1995 and the first half of 1996, Midcom experienced a high level of
turnover in its direct sales force which has had a negative impact on internally
generated sales. The Company believes this turnover is attributable to, among
other things, the intense competition for, and the mobility of, qualified sales
personnel endemic to the reseller segment of the telecommunications industry,
coupled with difficulties experienced with the Company's information systems and
changes in senior sales management. The Company intends to restructure the
commission arrangements and other financial incentives offered to its direct
sales force in order to increase the incentive of its direct sales force to
cross-sell the Company's telecommunications offerings and bundle high margin
services with lower margin services thereby improving the Company's sales levels
and gross margins. The Company believes that appropriate financial incentives,
along with the recent additions to the Company's management team and
improvements to the Company's information systems, will result in decreased
turnover in its direct sales force. However, there can be no assurance that
turnover in the Company's direct sales force will be reduced or that any of
these other objectives will be achieved.

Distributors. Midcom supplements its direct sales efforts by marketing
through independent distributors located throughout the country. The Company
enters into distributor agreements with, but is otherwise not affiliated with,
its distributors. The Company's existing distributor agreements generally grant
a non-exclusive right to solicit customers, require the distributor to maintain
a minimum quota and provide for commissions on business generated by the
distributor for the Company. The distributor network in existence in mid-1996
was not organized according to geographical area or service offerings.
Distributors maintain sales offices and sales staff at their own expense.
However, customers provided by distributors belong to the Company, are billed
directly by the Company or one of its billing agents and are in most instances
supported by the Company's customer service centers.

Midcom believes that distributors may have substantial telemarketing
programs, marketing resources and access to a large base of potential customers.
Accordingly, a key component of the Company's business strategy is to maintain
its existing distributors and to develop a new tier of distributors. During 1996
and 1997, the Company expects to engage approximately 30 new distributors,
primarily in cities where it currently does not have any significant marketing
presence. To improve performance and increase loyalty to the Company and its
service offerings, the new distributors will be offered long-term financial
incentives and will be required, within selected territories, to market and sell
the Company's service offerings exclusively. By making use of territorial
limitations, the Company intends to direct the marketing and sales efforts of
these new distributors in secondary cities which are outside the focus of the
Company's direct sales efforts. The Company expects these cities to include
Akron, Baltimore, Columbus, Denver, Houston, Kansas City, Memphis, Miami,
Milwaukee, Minneapolis, Nashville, New Orleans, Orlando, Philadelphia, Phoenix,
Pittsburgh, Portland, Raleigh, Salt Lake City, San Diego, St. Louis and
metropolitan areas of New Jersey and Connecticut.

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<PAGE> 43

Wholesale to Other Resellers. At the end of July 1996, Midcom offered
telecommunications services on a wholesale basis to approximately 20 small
resellers of long distance services. The Company does not have direct
relationships with the end users of the services purchased by its resellers.
Those customers are not billed by the Company and are not supported by the
Company's customer service centers. Although gross margins on sales to resellers
are generally lower than the Company's average, sales through this channel
enable the Company to (i) enter markets with minimal cost or risk where small
resellers have already built strong direct customer relationships, (ii) increase
the volume of services purchased by the Company from facilities-based carriers,
thereby obtaining higher volume discounts from those carriers, and (iii) spread
the costs of acquiring, installing and integrating the Company's switching
facilities over a larger revenue base.

CUSTOMER SERVICE

Midcom strives to provide superior customer service and believes that
personal contact with potential and existing customers is a significant factor
in customer acquisition and retention. The Company's goal is to have frequent
contact with prospects and customers both through its direct sales
representatives as well as its customer service representatives.

At the end of July 1996, Midcom's customer service and support staff
consisted of approximately 45 employees located at one of the Company's six
customer service centers. To support the planned expansion of Midcom's sales
efforts, Midcom intends to add approximately 15 customer service representatives
to its customer support staff during 1996 and 1997 and reorganize its customer
service and support efforts. This reorganization will involve consolidating and
integrating Midcom's service centers so that each is capable of supporting all
of Midcom's service offerings. Moreover, the Company's customer service
department will be organized into two groups, each with its own management and
reporting structure. One group will consist of customer service representatives
who will primarily respond to customer calls. The other group will consist of
account representatives who will be dedicated to the Company's special accounts
customers and will take proactive measures to pursue opportunities to cross-sell
the Company's various service offerings to such customers and address their
telecommunications needs before they arise. The account representatives will
also coordinate customer access to teams of technical specialists trained to
provide customized solutions to the customer's telecommunications problems. To
ensure that customer service representatives and account representatives have
the knowledge required to support the Company's broad range of service
offerings, Midcom intends to allocate a portion of its customer service
resources to training programs for its customer service staff. In addition,
Midcom intends to establish a small group of customer service and technical
specialists who are available exclusively to the direct sales representatives,
customer service representatives, account representatives and distributors. The
Company believes that these changes will improve the level of customer service
and support provided to its customers.

PRODUCTS AND SERVICES

At the end of July 1996, Midcom, primarily through contractual arrangements
with facilities based carriers, offered small to medium-sized businesses a wide
variety of telecommunications services including basic "1 plus" and "800" long
distance, frame relay data transmission, enhanced and other value-added services
and wireless communications services. The Company also plans to provide local
telecommunications services in the newly opened local telecommunications market,
and to develop new products and services. Each of these services is discussed
below.

Long Distance. Historically, substantially all of Midcom's revenue
has been generated by basic "1 plus" and "800" long distance services.
Midcom believes it has been successful as a provider of these basic
services because of the volume discounts it has been able to negotiate with
underlying carriers and its ability to direct customer call traffic over
the transmission networks of more than one carrier. As the Company expands
its network of switching facilities, it will increasingly have the ability
to choose among the transmission networks of different carriers to take
advantage of the most favorable rates to different destinations at
different times of the day.

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<PAGE> 44

Data Transmission. Through its wholly-owned subsidiary, PacNet,
Midcom offers data transmission services using its own frame relay switches
and a digital microwave and fiber optic transmission network connecting
over 40 cities in the Western United States. PacNet is a member of the UNI-
SPAN(@) consortium of frame relay data network providers. Members of the
UNI-SPAN(@) consortium are permitted to contract for access to frame relay
networks of other members at favorable rates. In addition to cost savings,
the consortium enables the Company to provide end-to-end connectivity to
its customers on a nationwide basis.

Private Line Services. Midcom provides data transmission service on
private line facilities on a point-to-point basis. This enables high volume
users to send and receive voice and data transmissions between locations on
a highly reliable and cost effective basis.

Enhanced and Other Services. Midcom offers a variety of enhanced and
other value-added services, including the following:

- Fax Broadcast and Fax Mailbox. Through its wholly owned subsidiary,
Adval, Midcom offers facsimile-related services that allow a user to
send a facsimile to many destinations simultaneously (Fax Broadcast)
and to store and retrieve facsimiles in a manner similar to electronic
mail (Fax Mailbox).

- Travel Cards. Midcom's travel cards offer low-cost long distance
service through various flat-rate pricing or per-call fees.

- Conference Calling. Midcom offers a full-featured teleconferencing
service that allows for connection of multiple locations
simultaneously.

- Custom Billing. Midcom provides many of its direct-billed customers
billing and management reports with a level of detail and features
that the major carriers generally provide only to their higher volume
customers. In addition, the Company's customers can choose to have one
centralized bill sent each month to their principal place of business
or individual bills sent to branch offices, with a master copy sent to
the principal place of business. The Company believes that its
value-added billing capability enables its customers to manage their
telecommunications costs more effectively, helps differentiate the
Company's services from services offered by the larger long distance
carriers and will continue to be an important factor in its ability to
successfully compete in its targeted market.

Wireless Services. At the end of July 1996, Midcom offered wireless
services in the Pacific Northwest through Cel-Tech, its wholly-owned
subsidiary. Outside the Pacific Northwest, there is a proliferation of
wireless opportunities that the Company intends to aggressively pursue in
order to provide wireless services in the other regions it serves. However,
the Company is not currently pursuing any specific wireless opportunity.

Local Service. Midcom is evaluating opportunities created by the
Telecommunications Act to offer local telecommunications services either on
a resale basis or over its proposed network of switching facilities. Prior
to offering the resale of local services to its customers, the Company must
complete a number of operational, market and regulatory tasks, including
the negotiation of interconnect agreements with local circuit providers,
the development of a billing, installation and customer service capability
and the creation of a marketing, pricing and sales strategy. Despite these
logistical challenges, the Company believes that introducing local services
will enable the Company to leverage its extensive customer base by
increasing the number of service offerings available to its customers. The
Company intends to offer local services in large cities where it has (i)
deployed high capacity switches, (ii) a significant customer concentration
and (iii) a sales and customer support presence. The Company believes that
targeting larger cities for local service will be advantageous due to the
availability of multiple local circuit capacity alternatives to the ILECs
and more favorable and less time consuming interconnection negotiations
with the ILECs.

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<PAGE> 45

New Services. Midcom intends to increase its efforts to develop new
telecommunications services based on evolving technologies and changing
industry standards. There can be no assurance, however, that the Company
will have the ability or resources to develop such new services, that new
technologies required for such services will be available to the Company on
favorable terms or that such services and technologies will enjoy market
acceptance.

Midcom markets its products under a number of registered and common law
service marks, including Infinity(@), Logicall(@), Simplicity(TM), ADNET(TM),
Cel-Tech(TM), Adval(TM), Midcom(@) and MIDCOM(@), as well as various registered
logos.

SWITCHING FACILITIES

A key element of the Company's operating strategy is to deploy a national
switching network. The Company believes that successful implementation of its
strategy to increase switching capacity will improve its ability to direct
customer call traffic among networks owned by other long distance carriers in
order to take advantage of the most favorable rates to different destinations at
different times of the day. This is expected to minimize costs and have a
positive impact on gross margin. In addition, deployment of switches is expected
to enable the Company to (i) switch local traffic, thereby increasing the
economic viability of entering the market for local telecommunications services,
(ii) shield proprietary information regarding its customers from the underlying
carriers, thereby increasing customer control, (iii) facilitate access to call
data records and (iv) implement differentiating features and billing
enhancements without involving the underlying carrier.

High Capacity Switches. The Company intends to acquire and install
state-of-the-art high capacity switches, with local and long distance
functionality, in areas of the country where it has a sufficient volume of long
distance traffic and where the regulatory environment and market conditions will
permit it to provide local service at acceptable margins. The Company believes
that, in the cities where it intends to deploy switches, there will be
significant local circuit capacity at attractive rates available from CLECs,
ILECs and 38GHz wireless providers. The Company currently anticipates acquiring
six switches which it presently plans to install in Atlanta, Chicago, Dallas,
Los Angeles, New York and Seattle. The Company estimates that it will take at
least until the third quarter of 1997 to purchase, install and fully integrate
these switches, at a cost of approximately $3 million per switch. The Company
anticipates employing at least three on-site technicians at each switch location
to provide switch service and support. In addition, the Company is exploring the
possibility of establishing a remote service center staffed with approximately
four technicians capable of monitoring and providing limited service and support
for each of its switches 24 hours a day, seven days a week. The Company
estimates that it will take at least four to five months to establish a remote
service center, at a cost of approximately $500,000 to $750,000. There can be no
assurance, however, that these switches will be acquired, installed or fully
operational, or that a remote service center will be installed and operational,
within anticipated deadlines and budgets, or that the Company will not encounter
technical, operational or other problems in the installation or operation of
this sophisticated switching and monitoring equipment.

US ONE Relationship. Pending implementation of its strategy to acquire,
install and integrate a national network of high capacity switches and to
supplement its network of existing limited capacity switches, the Company will
continue to explore alternatives to contracting with its long distance providers
for origination and termination of traffic. In this regard, the Company has
signed a non-binding letter of intent with US ONE Communications Corporation
("US ONE") whereby the Company would gain access to a nationwide network of high
capacity switches. Under the terms of this letter of intent, US ONE would
provide Midcom with both long distance origination and local dial tone service.
For a number of reasons, the Company believes that this arrangement would not be
as desirable to the Company as acquiring and installing its own switching
capacity. However, the Company believes that this arrangement has many
advantages over utilization of switching capacity owned by the major carriers,
including (i) significant savings on the cost of switched access, (ii)
additional switching capacity in smaller cities with lower population densities,
(iii) local origination and termination of calls in certain cities and (iv)
increased customer control by renting switching capacity from a non-competitor.
There can be no assurance, however, that a final agreement will be reached with
US ONE or that US ONE will acquire or install its network of switches according
to its expected schedule.

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Frame Relay Data Switches. In addition to voice switches, PacNet, a
wholly-owned subsidiary of the Company, currently offers data transmission
services using its own frame relay switches and a digital microwave and fiber
optic transmission network connecting over 40 cities in the Western United
States. PacNet is a member of the UNI-SPAN(@)consortium of frame relay data
network providers. Members of the UNI-SPAN(@) consortium are permitted to
contract for access to frame relay networks of other members at favorable rates.
In addition to cost savings, the consortium enables the Company to provide
end-to-end connectivity to its customers on a nationwide basis.

Limited Capacity Switches. At the end of July 1996, the Company owned and
operated limited capacity switches in nine locations, most of which were
acquired through acquisitions of other telecommunications service providers. As
a result of limitations inherent in these switches and the Company's plans to
install a state-of-the-art high capacity switch network, the Company has removed
these switches from service. The Company is currently exploring the possibility
of utilizing these limited capacity switches to complement the planned
deployment of high capacity switching facilities; however, there can be no
assurance that this will be feasible and, accordingly, the Company's financial
results for 1995 include a $2.5 million write-off of its existing limited
capacity switching equipment.

ACQUISITIONS

Midcom experienced rapid growth through the end of 1995. A significant
portion of this growth, particularly in 1995, was attributable to acquisitions
of customer bases and other telecommunications service providers. These
acquisitions were intended to (i) enhance Midcom's sales force capability, (ii)
broaden its service offerings, and (iii) increase its customer base and revenue.
The following table provides a chronology of significant acquisitions completed
by the Company during 1994 and 1995:

<TABLE>
<CAPTION>
BUSINESS DATE ACQUIRED INTENDED STRATEGIC VALUE
- ----------------------------------- --------------- -----------------------------------
<S> <C> <C>
American Telephone Network, Inc. September 1994 Switches; customer base
PacNet, Inc. December 1994 Private line and frame relay
network;
customer base
Communique Telecommunications, Inc. January 1995 Switches; customer base; billing
and
collection agreements
Cel-Tech International Corp. September 1995 Cellular and paging service
reseller
Adval, Inc. September 1995 Enhanced facsimile and related
services
ADNET Telemanagement, Inc. December 1995 Direct sales force
</TABLE>

The Company's acquisitions resulted in revenue growth and increased
customer concentrations in certain metropolitan areas which, in turn, increased
the Company's ability to control transmission routing for customers in those
areas in order to lower costs and improve gross margin. However, these
acquisitions have placed significant demands on management resources and have
disrupted the Company's normal business operations. For a number of reasons, the
Company is still in the process of consolidating and integrating the sales and
marketing, customer support, billing and other functions of certain acquired
operations. Pending such integration, the Company has maintained a number of
billing systems and other functions of certain acquired operations, which has
caused inefficiencies, additional operational complexity and expense and greater
risk of billing delays and financial reporting difficulties. Failure to
consolidate and integrate certain acquired operations has impaired the Company's
ability to cross-sell the various products and services offered by those
acquired operations. In addition, the Company commonly experiences high initial
customer attrition from acquired customer bases. The Company believes this
occurs as a result of difficulties encountered in transitioning acquired
customer bases to the Company's services and systems, a process which often
prompts customers to consider competitive alternatives in the telecommunications
marketplace. Also, where the Company has not acquired the sales channel
associated with an acquired customer base, there has often been a period of
enhanced exposure to competitors as the Company's sales force becomes familiar
with its newly acquired customers and establishes relationships with the
appropriate customer contacts. In addition to problems associated with
integration, consolidation and customer attrition, certain of the Company's

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<PAGE> 47

acquisitions have resulted in disputes between the Company and the sellers of
the acquired operations. See "-- Legal Proceedings."

The Company's current strategy is to generate growth primarily through
internal sales and marketing efforts, rather than through the acquisition of
customer bases or other telecommunication service providers. Although growth
through acquisitions is no longer central to the Company's growth strategy, the
Company will consider, on a selective basis, acquisitions which the Company
believes will contribute to its infrastructure, create synergies or which
otherwise have strategic value to the Company. There can be no assurance that
there will not be adverse consequences to the Company from its past or future
acquisitions. Further, there can be no assurance that the Company will be able
to identify attractive acquisition candidates in the future, that acquisitions
pursued by the Company will be completed, or that, if completed, such
acquisitions will be beneficial to the Company. The Company has no current
understanding, arrangement or agreement to make any acquisitions. Further, at
the date of this Prospectus, limitations imposed by the terms of the Revolving
Credit Facility, limitations of internal systems and other factors restrict the
Company's ability to make acquisitions. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

INFORMATION SYSTEMS

Telecommunication service providers generally must record and process
massive amounts of data quickly and accurately in order to bill customers in a
timely manner, verify billings from third party carriers, service customer
accounts, respond to customer inquiries and otherwise support operations. These
tasks require sophisticated, high capacity and reliable management information
and billing systems.

In late 1993, Midcom began the development of a proprietary information
system, referred to as "Keystone," designed to integrate its customer
information system, billing system and financial reporting system. The billing
module used in Keystone was designed to replace the Company's existing billing
system. The Company began using the Keystone billing module for a portion of its
customers in February 1995. Due to difficulties encountered during the
implementation of Keystone and required modifications to Midcom's customer data
base, which delayed full implementation of the Keystone billing module, the
Company continued to bill most of its customers under its prior billing system
until late April 1995. At that time, the Company completed the conversion to the
Keystone billing module.

The Company estimates that in 1995 the number of call data records
processed by the Company grew from approximately 20 million to as many as 35
million per month, each of which had to be identified with the appropriate
customer for proper billing. This growth was attributable in large part to
customers of acquired businesses and customer bases. Difficulties encountered
during the implementation of Keystone were compounded by this rapid growth and
contributed to operational difficulties. Partly as a result of these operational
difficulties, the Company is still in the process of consolidating and
integrating the sales and marketing, customer support, billing and other
functions of certain acquired operations. Pending such integration, the Company
has maintained a number of billing systems and other functions of certain
acquired operations. In addition, the Company contracts with several ILECs and
billing agencies which prepare bills for and collect accounts receivable from a
substantial number of the Company's customers. These factors have caused
operational inefficiencies, added complexity and expense to the billing and
financial reporting process and have increased the risk of billing delays and
financial reporting difficulties.

During the second, third and fourth quarters of 1995, difficulties in
implementing the new billing system caused an increased number of calls to be
billed later than expected by the Company. As a result, the Company's accounts
receivable increased at a faster rate than the increase in revenue. Delays in
billings also contributed to a significant increase in customer invoice
adjustments and bad debt expense in the fourth quarter of 1995. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." In addition, in the process of reconciling unbilled accounts as of
December 31, 1995 with amounts ultimately billed, the Company discovered that
certain reports generated by its new information management system for
recognizing unbilled revenue for the third quarter of 1995 failed to fully
reflect all discounts that were properly included in the bills subsequently sent
to the Company's customers. Primarily as a result of this failure, reported
revenue was overstated for the third quarter of 1995 and the Company's

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<PAGE> 48

Quarterly Report on Form 10-Q for that period had to be amended to restate
reported results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Restatement of Results for the Third
Quarter of 1995."

In connection with the audit of Midcom's 1995 Consolidated Financial
Statements, Midcom's independent auditors identified two conditions which were
characterized as material weaknesses in its internal financial controls. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Material Weaknesses." In response to the recommendations of the
Company's auditors, the Company has hired additional finance and accounting
personnel, curtailed acquisitions and established the policy of billing
substantially all customer call traffic in a financial reporting period before
revenue for the period is reported, thereby eliminating the need to estimate any
material portion of revenue. In addition, as part of the Company's operational
restructuring, the Company intends to increase the number of information systems
personnel from approximately 18 full-time employees and 7 independent
contractors at the end of August 1996 to approximately 35 full-time employees,
make necessary improvements to its management information system and focus on
consolidating and integrating the Company's multiple billing systems and other
redundant functions of certain acquired operations.

Although Midcom has experienced difficulties in the implementation of its
management information system, it is now able to provide many of its
direct-billed customers billing and management reports with a level of detail
and features that the major carriers generally provide only to their higher
volume users. The Company is currently able to collect numerous multiple call
data items for each phone call placed by a customer, including customer name,
call origination point, call destination point, billing code, minutes, date,
time and rate code. From this data, the Company can organize the customer's
monthly phone calls into a wide variety of report formats. These reports can
include: (i) state/international codes, (ii) date and hour distributions, (iii)
type of service ("1 plus", "800", etc.), (iv) frequently called numbers, area
codes, cities or states, (v) calling card summaries, (vi) graphic presentation
of data and (vii) color-coded long distance calling activity maps. In addition,
the Company's customers can choose to have one centralized bill sent each month
to their principal place of business or individual bills sent to branch offices,
with a master copy sent to the principal place of business. The Company believes
that its value-added billing capability enables its customers to manage their
telecommunications costs more effectively, helps differentiate the Company's
services from services offered by the larger long distance carriers and will
continue to be an important factor in its ability to successfully compete in its
targeted market.

SUPPLIERS

Midcom purchases from facilities-based carriers the long-distance
telecommunications services that it provides to its customers. The Company has
entered into multiple-year supply contracts with AT&T, Sprint and WorldCom for
long distance telecommunication services. In addition to its contracts with its
major suppliers, the Company has entered or otherwise acquired short-term
contracts with other suppliers, including Frontier Corporation, Ameritech
Operating Companies, Pacific Bell, U.S. West, NYNEX, BellSouth, Bell Atlantic,
Southwestern Bell, GTE Telephone Operating Companies, LCI International Telecom
Corp., Cherry Communications and MCI. In 1994, 1995 and through the nine months
ended September 30, 1996, approximately 97%, 67% and 41%, respectively, of
Midcom's revenue was attributable to traffic carried by AT&T, Sprint and
WorldCom, collectively, and for those periods no carrier was responsible for
carrying traffic representing more than 46%, 31% and 17%, respectively, of the
Company's revenue.

To obtain favorable forward pricing from certain of its suppliers, the
Company has committed to purchase minimum volumes of a variety of long distance
services during stated periods whether or not such volumes are used or, in one
case, to pay a surcharge equal to a percentage of the Company's shortfall from a
specified

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<PAGE> 49

quarterly minimum volume. For 1995, these commitments and maximum surcharge
totaled approximately $74.1 million, and for the final six months of 1996, they
total approximately $53.2 million (including approximately $37.2 million
attributable to AT&T). As of September 30, 1996, Midcom's minimum volume
commitment under its supply contract with AT&T, its largest supply contract, was
$117.0 million. The Company estimates that, as of September 30, 1996, it would
have been in shortfall of its minimum commitments to AT&T by approximately $27.6
million based on then-applicable contract requirements. However, on October 31,
1996, the Company and AT&T executed a Release and Settlement Agreement pursuant
to which substantially all disputes between the Company and AT&T have been
resolved. Also on October 31, 1996, the Company and AT&T executed a new carrier
contract pursuant to which the Company's minimum commitment to AT&T was reduced
to $13.3 for the eighteen month period immediately following execution of the
contract. In addition, the new carrier contract provides for more favorable
pricing for certain network services provided by AT&T. In consideration for the
terms of the settlement and the new rate structure, the Company is required to
make two payments to AT&T in the aggregate amount of $8.8 million. The first
payment of $5.0 million was made on November 6, 1996. The second payment of $3.8
million will be due within 30 days of Midcom announcing quarterly gross revenue
in excess of $75.0 million, or upon completion of a change in control. Another
major supplier has agreed to forebear from exercising its rights to shortfalls
incurred through April 30, 1996 which would otherwise have required the Company
to pay a surcharge and caused pricing from this supplier to increase. This
supplier has indicated that it will work with Midcom to restate applicable
minimums so that their attainment is more realistic. There can be no assurance
that these negotiations will be concluded in a manner favorable to the Company
or that the Company will be able to obtain relief from its minimum contractual
commitments in the future. If existing or future shortfalls are not eliminated,
the Company may be required to make substantial payments without associated
revenue from customers or the supplier may terminate service and commence formal
action against the Company. Such payments are not presently contemplated in the
Company's capital budgets and would have a material adverse effect on the
Company's business, financial condition and results of operation.

Because of Midcom's commitments to purchase fixed volumes of use from
certain of its suppliers at predetermined rates, the Company could be adversely
affected if a supplier were to lower the rates it makes available to the
Company's target market without a corresponding reduction in the Company's
rates. Similarly, the Company could be adversely affected if its suppliers
failed to adjust its overall pricing, including prices to the Company, in
response to price reductions of other major carriers. See Note 14 of the Notes
to Consolidated Financial Statements.

Each month, Midcom receives invoices from its suppliers. In those areas in
which the Company directs call traffic through its own switches, it receives
bills directly from the ILECs for access charges. Due to the multitude of
billing rates and discounts which suppliers must apply to calls completed by the
Company's customers, and due to routine logistical issues such as the addition
or termination of customers, the Company regularly has disagreements with its
suppliers concerning the sums invoiced for its customers' traffic. Since 1994,
the Company has been paying its suppliers according to its own calculation of
amounts owed as recorded on computer tapes provided by its suppliers. The
Company's computations of amounts owed are frequently less than the amount shown
on the suppliers' invoices. Accordingly, the suppliers may consider the Company
to be in arrears in its payments until the amount in dispute is resolved.
Although these disputes have generally been resolved on terms favorable to the
Company, there can be no assurance that this will continue to be the case. In
accordance with generally accepted accounting principles, the Company records as
an expense amounts in dispute that correspond to the aggregate amount that the
Company believes it will be required to pay and adjusts that amount as the
underlying disputes are resolved.

Midcom, like all other long distance providers, is dependent upon local
exchange carriers for call origination (carrying the call from the customer's
location to the long distance network of the IXC selected to carry the call) and
termination (carrying the call off the IXC's network to the call's destination).
FCC policy currently requires all common carriers, including IXCs, to make their
services available for resale and to refrain from imposing unreasonable
restrictions on such resale. The Telecommunications Act further requires all
ILECs both to offer their services for resale at wholesale rates and to allow
access to unbundled network elements at cost-based rates. ILECs are also
required by the Telecommunications Act to provide all IXCs,

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<PAGE> 50

including the Company, with equal access for the origination and termination of
long distance calls. If any of these requirements were eliminated, the adverse
impact on the Company could be substantial. Access charges represent a
substantial portion of the Company's current cost of service. The FCC, however,
has indicated that it will initiate in the near future a comprehensive review of
its access charge structure, evaluating the embedded costs and subsidies that
produce current access charge levels. The FCC has also proposed to levy on IXCs
a new per-call payphone usage fee for all toll-free and access code calls
originated from pay telephones. The level at which the FCC sets access charges,
universal service contributions and payphone use fees could have a material
adverse effect on the Company's business, financial condition and results of
operations. Moreover, implementation of a new access charge structure and
repricing of local transport could place many IXCs, including the Company, at a
significant cost disadvantage relative to larger competitors. See
"-- Regulation."

COMPETITION

The long distance telecommunications industry is highly competitive. Midcom
believes that the principal competitive factors in this industry include
pricing, customer service, network quality, value-added services and the
flexibility to adapt to changing market conditions. Several of the Company's
current and potential competitors have substantially greater financial,
technical, marketing and other resources than the Company, and there can be no
assurance that the Company will remain competitive in this environment. The
Company's ability to compete may also be impaired by its leveraged capital
structure and limited capital resources.

The long distance telecommunications industry is significantly influenced
by the marketing and pricing activities of the major industry participants,
including AT&T, MCI, Sprint and WorldCom. While the Company believes that AT&T,
MCI and Sprint historically have chosen not to concentrate their direct sales
efforts on small to medium-sized businesses, these carriers control
approximately 85% of that market. Moreover, AT&T, MCI and Sprint have recently
introduced new service and pricing options that are attractive to smaller
commercial users, and there can be no assurance that they will not market to
these customers more aggressively in the future. AT&T and, as an interim
measure, the structurally separate interexchange affiliates of the RBOCs have
recently been reclassified as non-dominant carriers and, accordingly, have the
same flexibility as the Company in meeting competition by modifying rates and
service offerings without pricing constraints or extended waiting periods. These
reclassifications may make it more difficult for the Company to compete for long
distance customers. See "-- Regulation." In addition, a significant number of
large regional long distance carriers and new entrants in the industry compete
directly with the Company by concentrating their marketing and direct sales
efforts on small to medium-sized commercial users. Activities by competitors
including, among other things, national advertising campaigns, telemarketing
programs and the use of cash or other forms of incentives, contribute to
significant customer attrition in the long distance industry.

The Company contracts for call transmission over networks operated by
suppliers who may also be the Company's competitors. Both the IXCs and LECs
providing transmission services for the Company have access to information
concerning the Company's customers for which they provide the actual call
transmission. Because these IXCs and LECs are potential competitors of the
Company, they could use information about the Company's customers, such as their
calling volume and patterns of use, to their advantage in attempts to gain such
customers' business. The Telecommunications Act has strengthened the rules which
govern the privacy of customer proprietary information by expressly prohibiting
telecommunications carriers which receive proprietary information from resale
carriers for purposes of providing telecommunications services to those resale
carriers from using such information for their own marketing purposes. In
addition, the Company's future success will depend, in part, on its ability to
continue to buy transmission services and access from these carriers at a
significant discount below the rates these carriers otherwise make available to
the Company's targeted customers.

Regulatory trends have had, and may have in the future, a significant
impact on competition in the telecommunications industry. See "-- Regulation."
As a result of the recently enacted Telecommunications Act, the RBOCs are now
permitted to provide, and are providing or have announced their intention to
provide, long distance service originating (or in the case of "800" service,
terminating) outside their local service areas

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or offered in conjunction with other ancillary services, including wireless
services. Following application to and upon a finding by the FCC that an RBOC
faces facilities-based competition and has satisfied a congressionally-mandated
"competitive checklist" of interconnection and access obligations, an RBOC will
also be permitted to provide long distance service within its local service
area. The entry of these well-capitalized and well-known entities into the long
distance service market could significantly alter the competitive environment in
which the Company operates.

The Telecommunications Act also removes all legal barriers to competitive
entry into the local telecommunications market and directs ILECs to allow
competing telecommunications service providers such as the Company to
interconnect their facilities with the local exchange network, to acquire
network components on an unbundled basis and to resell local telecommunications
services. Moreover, the Telecommunications Act seeks to facilitate the
development of local telecommunications competition by requiring ILECs, among
other things, to allow end users to retain their telephone numbers when changing
service providers and to place short-haul toll calls without dialing lengthy
access codes. In response to these regulatory changes, MCI and AT&T have each
announced its intention to enter the local telecommunication market, including
MCI's announcement that it will invest more than $2.0 billion in fiber optic
rings and local switching equipment in major metropolitan markets throughout the
United States, and AT&T's announcement that it filed applications in all 50
states to provide local telecommunications services.

While the Telecommunications Act opens new markets to the Company, the
nature and value of the resultant business opportunities will be dependent in
large part upon subsequent regulatory interpretation of the statute's
requirements. The FCC has recently promulgated rules implementing the local
competition provisions of the Telecommunications Act; each state must now
individually adopt regulations applying the new national guidelines. The Company
anticipates that ILECs will actively resist competitive entry into the local
telecommunications market and will seek to undermine the operations and the
service offerings of competitive providers, leaving carriers such as the Company
which are dependent on ILECs for network services vulnerable to anti-competitive
abuses. No assurance can be given that the local competition provisions of the
Telecommunications Act will be implemented and enforced by federal and state
regulators in a manner which will permit the Company to successfully compete in
the local telecommunications market or that subsequent legislative and/or
judicial actions will not adversely impact the Company's ability to do so.
Moreover, federal and state regulators are likely to provide ILECs with
increased pricing flexibility for their services as competition in the local
market increases. If ILECs are allowed by regulators to lower their rates
substantially, engage in excessive volume and term discount pricing practices
for their customers, charge excessive fees for network interconnection or access
to unbundled network elements, or decline to make services available for resale
at wholesale rates, the ability of the Company to compete in the provision of
local service could be materially and adversely affected.

The Company believes it competes favorably in its targeted market segment,
principally due to its economies of scale, personalized service and enhanced
billing and reporting. The Company also believes that its success will
increasingly depend on its ability to offer on a timely basis new services based
on evolving technologies and industry standards. However, there can be no
assurance that new technologies or services will be made available to the
Company on favorable terms.

TELECOMMUNICATIONS ACT

On February 8, 1996, Congress enacted the Telecommunications Act, which
effected a sweeping overhaul of the Communications Act of 1934 (the
"Communications Act"). In particular, the Telecommunications Act substantially
amends Title II of the Communications Act, which governs telecommunications
common carriers. The Telecommunications Act was intended by Congress to open
telephone exchange service markets to full competition, to promote competitive
development of new service offerings, to expand public availability of
telecommunications services and to streamline regulation of the industry. The
Telecommunications Act makes all state and local barriers to competition
unlawful, prohibits state and local governments from enforcing any law, rule or
legal requirement that prohibits or has the effect of prohibiting any person
from providing interstate or intrastate telecommunications services and directs
the FCC to conduct rulemaking proceedings on local competition and other related
matters.

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Implementation of the provisions of the Telecommunications Act will be the
task of the FCC, the state public utility commissions and a joint federal-state
board. Much of the implementation of the Telecommunications Act must be
completed in numerous rulemaking proceedings with short statutory deadlines.
These proceedings are expected to address issues and proposals already before
the FCC in pending rulemaking proceedings affecting the long distance industry
as well as additional areas of telecommunications regulation not previously
addressed by the FCC and the states. States retain jurisdiction under the
Telecommunications Act to adopt laws necessary to preserve universal service,
protect public safety and welfare, ensure the continued quality of
telecommunications services and safeguard the rights of consumers.

Some specific provisions of the Telecommunications Act which are expected
to affect long distance service providers are summarized below:

Expanded Interconnection Obligations. The Telecommunications Act
establishes a general duty of all telecommunications carriers to interconnect
with other carriers, directly or indirectly. The Telecommunications Act also
contains a detailed list of requirements with respect to the interconnection
obligations of LECs. These interconnection obligations include resale, number
portability, dialing parity, access to rights-of-way and reciprocal
compensation.

ILECs have additional obligations including: to negotiate in good faith; to
provide for network interconnection at any technically feasible point on terms
that are reasonable and non-discriminatory; to provide non-discriminatory access
to facilities, equipment, features, functions and capabilities on an unbundled
basis; to offer for resale at wholesale rates any service that ILECs provide on
a retail basis; and to provide actual co-location of equipment necessary for
interconnection or access.

The Telecommunications Act establishes a framework for state commissions to
mediate and arbitrate negotiations between ILECs and carriers requesting
interconnection, services or network elements. The Telecommunications Act
establishes deadlines, policy guidelines for state commission decision making
and federal preemption in the event a state commission fails to act. While the
FCC has recently promulgated rules implementing these provisions of the
Telecommunications Act, the impact of these rules on the Company cannot be
determined at this time.

Provision of Interexchange Services. The Telecommunications Act eliminates
the previous prohibition on RBOC provision of interexchange services originating
(or in the case of "800" service, terminating) outside their local service areas
and all interexchange services associated with the provision of most commercial
mobile wireless services, including services originating within their local
service areas.

In addition, the Telecommunications Act allows RBOCs to provide landline
interexchange services in the states in which they provide landline local
exchange service; provided, however, that before engaging in landline long
distance services in a state in which it provides landline local exchange
service, an RBOC must (i) provide access and interconnection to one or more
unaffiliated competing facilities-based providers of telephone exchange service,
unless after 10 months after enactment of the Telecommunications Act no such
competing provider has requested such access and interconnection more than three
months before the RBOC has applied for authority and (ii) demonstrate to the FCC
its satisfaction of the Telecommunications Act's "competitive checklist."

The specific interconnection requirements contained in the "competitive
checklist," which the RBOCs must offer on a non-discriminatory basis, include
network interconnection and unbundled access to network elements, including
local loops, switching and transport; access to poles, ducts, conduits and
rights-of-way owned or controlled by them; access to emergency 911, directory
assistance, operator call completion and white pages; access to telephone
numbers, databases and signaling for call routing and completion; availability
of number portability; local dialing parity; reciprocal compensation
arrangements; and resale opportunities.

Review of Universal Service Requirements. The Telecommunications Act
contemplates that interstate telecommunications providers will "make an
equitable and non-discriminatory contribution" to support the cost of providing
universal service, although the FCC can grant exemptions in certain
circumstances. The FCC is in the process of promulgating rules to implement
these provisions of the Telecommunications Act, and the outcome of such
proceedings and its effect on the Company cannot be determined.

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Limitation on Joint Marketing of Local and Long Distance Services. Long
distance providers that serve greater than five percent of presubscribed access
lines in the United States (which includes the nation's three largest long
distance providers) are precluded from jointly marketing local and long distance
service until the RBOCs are permitted to enter the long distance market, or
three years from the date of enactment of the Telecommunications Act, whichever
is sooner.

Deregulation. The FCC is authorized to forebear from applying any
statutory or regulatory provision that is not necessary to keep
telecommunications rates and terms reasonable or to protect consumers. A state
may not apply a statutory or regulatory provision that the FCC decides to
forebear from applying. In addition, the FCC must review its telecommunications
regulations every two years and change any that are no longer necessary.

REGULATION

The terms and conditions under which Midcom provides communications
services are subject to government regulation. Federal laws and FCC regulations
apply to interstate telecommunications, while particular state regulatory
authorities have jurisdiction over telecommunications that originate and
terminate within the same state.

Federal

Midcom is classified by the FCC as a non-dominant carrier and therefore is
subject to relaxed regulation. Historically, the FCC has generally either
excused or presumed compliance by non-dominant carriers with many of the
statutory requirements and regulations to which dominant carriers are subject,
including most reporting, accounting and record keeping obligations. However, a
number of these requirements are imposed, at least in part, on non-dominant
carriers such as the Company whose annual operating revenues exceed $100
million. The FCC retains the jurisdiction to impose fines or other penalties on,
or to act upon complaints against, any common carrier, including non-dominant
carriers, for failure to comply with its statutory or regulatory obligations.
The FCC also has the authority to impose more stringent regulatory requirements
on the Company and change its regulatory classification. In the current
regulatory atmosphere; however, the Company believes that the FCC is unlikely to
do so. Non-dominant carriers are also subject to a variety of miscellaneous
regulations that, for instance, dictate the materials required to document and
the procedures necessary to verify a consumer's election to change its preferred
long distance telephone provider, mandate disclosure of rate and other data
associated with the provision of operator services and require contribution to a
variety of FCC-mandated funds and payment of various regulatory and other fees.
There has generally been increased enforcement activity by the FCC and the
states with respect to such regulations, particularly with respect to those
regulations governing the verification of consumer elections to change long
distance service providers.

Among domestic carriers, only the ILECs are classified as dominant
carriers, although ILECs currently would only be classified as dominant in their
provision of long distance telecommunications services if they were to provide
such services other than through structurally separate affiliates. As a
consequence, the FCC regulates many of their rates, charges and services to a
greater degree than the Company's, although the FCC is currently evaluating
proposals to streamline and otherwise relax its regulation of the ILECs. AT&T
and, as an interim measure, the structurally separate interexchange affiliates
of the RBOCs have recently been reclassified as non-dominant carriers and,
accordingly, have the same flexibility as the Company in meeting competition by
modifying rates and service offerings without pricing constraints or extended
waiting periods. The impact on the Company of the reclassification of AT&T and
the RBOC interexchange affiliates as non-dominant carriers cannot be determined
at this time, but it could make it more difficult for the Company to compete for
long distance customers.

With the passage of the Telecommunications Act, the RBOCs are now free to
offer local service outside their respective local telephone service areas as
well as local service bundled with wireless, enhanced and other ancillary
services. Following application to and upon a finding by the FCC that an RBOC
faces facilities-based competition and has satisfied a congressionally-mandated
"competitive checklist" of interconnection and

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access obligations, the RBOC will be permitted to provide long distance service
within its local service area, although in so doing, it will be subject to a
variety of structural and nonstructural safeguards intended to minimize abuse of
its market power in these local service areas. As a result of the removal of the
legal barriers to competitive entry into the local market, long distance
carriers like the Company will be allowed to compete with the RBOCs in the
provision of local service. It is impossible to predict the impact of RBOC entry
into the long distance telecommunications market on the Company's business and
prospects, but it could make it more difficult for the Company to compete for
long distance customers.

The Company has all necessary authority to provide domestic interstate
telecommunications services under current laws and regulations. The Company and
one or more of its subsidiaries have been granted authority by the FCC to
provide international telecommunications services through the resale of switched
services of U.S. facilities-based carriers. The FCC reserves the right to
condition, modify or revoke such international authority for violations of
federal law or rules, as well as to approve assignments and transfers of control
of such international authority.

Both domestic and international non-dominant carriers must maintain tariffs
on file with the FCC. Although the tariffs of non-dominant carriers, and the
rates and charges they specify, are subject to FCC review, they are presumed to
be lawful and are seldom contested. As a domestic non-dominant carrier, the
Company is permitted to make tariff filings on a single day's notice and without
cost support to justify specific rates. As an international non-dominant
carrier, the Company has always been required to include, and has included,
detailed rate schedules in its international tariffs, but, as a result of recent
FCC action, is now permitted to make tariff filings on a single day's notice.
Prior to a 1995 court decision, Southwestern Bell v. FCC, 43 F.3rd 1515 (D.C.
Cir. 1995), domestic non-dominant carriers were permitted by the FCC to file
tariffs with a "reasonable range of rates" instead of the detailed schedules of
individual charges required of dominant carriers. In reliance on the FCC's past
practice of allowing relaxed tariff-filing requirements for non-dominant
domestic carriers, the Company and most of its competitors did not maintain
detailed rate schedules for domestic offerings in their tariffs. Until the
two-year statute of limitation expires, the Company could be held liable for
damages for its failure to do so, although it believes that such an outcome is
highly unlikely and would not have a material adverse effect on the Company's
operations.

To date, the FCC has exercised its regulatory authority to set rates only
with respect to the rates of dominant carriers, and it has increasingly relaxed
its control in this area. Thus, the FCC does not regulate the rates of the
Company or any other long distance telecommunications provider, including AT&T,
although it would regulate the rates charged by any ILEC that elected to provide
interexchange services other than through a structurally separate affiliate.
While the FCC continues to cap the prices that dominant ILECs may charge to
originate and terminate interstate calls, it has afforded the ILECs a modicum of
geographically-restricted pricing flexibility when they face competition in a
given market. The FCC has indicated that it will initiate in the near future a
comprehensive review of its access charge structure, evaluating embedded costs
and subsidies that produce current access charge levels. The FCC is currently
conducting a rulemaking procedure to implement the universal service provisions
of the Telecommunications Act and will be determining in that proceeding the
contributions that telecommunications companies such as the Company will be
required to make to support universal service. The FCC also has recently
completed a rulemaking proceeding to implement the local competition provisions
of the Telecommunications Act. In that proceeding, the FCC has set forth
comprehensive national rules and guidelines for states and local competitors to
follow that, among other things, govern the interconnection obligations among
telecommunications carriers, including interconnection with the local exchange
network, and access to a minimum set of unbundled network elements, as required
by the Act. The FCC also has set forth pricing methodologies for both the FCC
and the states to follow in implementing the Telecommunications Act's
requirement that interconnection and access to unbundled network elements be
made available by ILECs at cost-based rates with a reasonable profit.

The FCC-styled "trilogy" of access charge reform, universal service and
local competition proceedings comprise the FCC's effort to respond to the
Telecommunications Act's goal of transitioning telecommunications markets to
full competition. The FCC does not expect this framework to be complete until
state public service commissions complete their own efforts to implement and
supplement the Telecommunications Act's provisions. Until the FCC's "trilogy" of
proceedings is completed, and until such state actions are taken, the

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impact of the FCC's actions on the Company's access arrangements or access
charge obligations, or more broadly, on the Company's operations in general,
cannot be determined at this time.

The Telecommunications Act grants the FCC authority to forebear from
applying any statutory requirement or regulation to classes of carriers or
services upon a determination that such application is unnecessary and no longer
in the public interest. Utilizing this newly-granted authority, the FCC has
already reduced, and has proposed further reductions in, its regulation of
non-dominant IXCs such as the Company. Among other things, the FCC has proposed
"mandatory detariffing" for the domestic offerings of non-dominant IXCs. This
proposed rule, if adopted, would not only relieve the Company of its obligation
to file tariffs applicable to its domestic interexchange offerings, but would
prohibit all non-dominant IXCs, including AT&T, MCI, Sprint and WorldCom, from
filing such tariffs. The magnitude of the impact on the Company of mandatory
detariffing of its principal suppliers and competitors cannot be determined at
this time, although such an action would, if adopted, render enforcement of the
FCC's resale and nondiscrimination requirements more difficult.

The microwave licenses held by the Company's subsidiary, PacNet, are
subject to FCC regulation and licensing. PacNet's licenses are for
point-to-point microwave systems operating in the Private Operational Fixed
Microwave Service ("OFS"). Such facilities must be constructed and operated in
strict conformance with their authorizing licenses and FCC rules and policies
and such licenses may not be modified, transferred or assigned without prior FCC
approval. OFS licenses may be cancelled or revoked, and fines and other non-
monetary penalties imposed on OFS licensees, for failure to comply with FCC
requirements. OFS licenses are granted for a fixed five-year term, with the
potential for renewal. The majority of PacNet's licenses expire in December 1997
and the balance expire in June 1999. The Company intends to seek renewal of the
microwave licenses for each of PacNet's stations and currently anticipates that
these licenses will be renewed in the ordinary course of business. Failure to
obtain renewal of microwave licenses upon expiration could adversely affect the
Company's profitability in providing data transmission services, although the
Company does not expect that this would affect the Company's other
telecommunication services. The Company does not expect the Telecommunications
Act to significantly impact the Company's microwave licenses.

State

The intrastate long distance telecommunications operations of Midcom are
also subject to various state laws and regulations, including initial
certification, registration and/or notification, as well as various tariffing
and reporting requirements. Currently, the Company is certified and tariffed,
where required, to provide intrastate service to customers throughout the United
States except in Alaska and Hawaii. The Company continuously monitors regulatory
developments in all 50 states and intends to obtain licenses wherever feasible.
The Company will require additional certifications in most, if not all, states
at such time as it elects to enter the local telecommunications market.

Midcom is currently subject to varying levels of regulation in the 48
states in which it provides intrastate telecommunications. The large majority of
the states require Midcom to apply for certification to provide
telecommunications services, or at least to register or to be found exempt from
regulation, before commencing intrastate service. At present, 34 states also
require Midcom to file and maintain detailed tariffs listing its rates for
intrastate service. Many states also impose various reporting requirements
and/or require prior approval for transfers of control of certified carriers,
assignments of carrier assets (including customer bases), carrier stock
offerings and/or incurrence by carriers of significant debt obligations.
Certificates of authority can generally be conditioned, modified, cancelled,
terminated or revoked by state regulatory authorities for failure to comply with
state law and/or the rules, regulations, and policies of the state regulatory
authorities. Fines and other penalties, including the return of all monies
received for intrastate traffic from residents of a state, may be imposed for
such violations. With two exceptions, the Company has secured approval for its
acquisitions of the capital stock, customer bases or other assets of other
telecommunications service providers. Requests for approval are currently
pending in Arkansas, California and Ohio with respect to the Company's
acquisition of a customer base from Cherry Communications and in Minnesota and
Ohio with respect to the Company's acquisition of a customer base from G.E.
Capital Communications Service Corporation. In both cases, the relevant states
have requested additional information from the parties selling the customer
bases, which has

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delayed the review process. The Company does not believe that failure to obtain
these pending approvals prior to completing the acquisitions will have a
material adverse effect on the Company's business, financial condition or
results of operation.

RUSSIAN JOINT VENTURE

In December 1993, Midcom contracted to acquire a 50% interest in Dal
Telecom, a provider of local, long distance, international and cellular
telecommunications services to several hundred customers in three of the four
largest cities in the Russian Far East. To acquire its interest in Dal Telecom,
Midcom committed to make a capital contribution of cash, equipment and services
of approximately $12.7 million. In March 1996, the Company and the joint venture
partner agreed to amend the terms of the joint venture to provide that the
Company had a 40% equity interest in the joint venture and that, upon payment of
an additional capital contribution of $3.5 million, the Company would have a 50%
equity interest in the joint venture. Upon final payment of such additional
capital contribution, under the terms of agreements with its joint venture
partner, Midcom would control 50% of the voting rights of the capital stock of
Dal Telecom and would be entitled to receive 50% of the profits of that entity.
However, the terms of the Revolving Credit Facility prohibit the Company from
making any additional capital contributions to the joint venture.

The Company's commitment to Dal Telecom has required significant amounts of
capital resources and management attention given the logistics of maintaining a
relationship in Russia. The Company now believes it is in its best interests to
dispose of its interest in the joint venture and focus on its domestic business.
As a consequence, in 1995 the Company initiated efforts to find a buyer for its
interest in Dal Telecom or to otherwise liquidate its position in the joint
venture. As a result of its inability to fund additional contributions to the
joint venture, the Company has written off its investment in Dal Telecom. There
can be no assurance that the Company will be successful in its efforts to sell
its interest in Dal Telecom. See Note 4 of the Notes to Consolidated Financial
Statements.

EMPLOYEES

As of September 30, 1996, the Company employed 452 persons on a full-time
basis. None of the Company's employees are members of a labor union or are
covered by a collective bargaining agreement.

PROPERTIES

As of September 30, 1996, the Company's headquarters in Seattle consisted
of approximately 69,800 square feet of office space under a lease that expires
on November 30, 2004 and that requires minimum annual lease payments in 1996 of
approximately $1.3 million. In addition, as of September 30, 1996, the Company
and its subsidiaries leased an aggregate of approximately 77,000 square feet of
space for 25 offices in 15 states. Management believes its present office
facilities, together with additional space available under expansion options,
are adequate for its operations for the foreseeable future and that similar
additional space can readily be obtained as needed.

CUSTOMER CONCENTRATIONS

The Company estimates that during the second quarter of 1996 it invoiced
approximately 125,000 customer locations. Certain Midcom customers receive
multiple billing invoices because they have multiple locations. At this time,
the Company is unable to aggregate the invoices of such customers to determine
an exact customer count. During 1994, 1995 and for the nine months ended
September 30, 1996, no one customer accounted for more than 5.0% of Midcom's
revenues. Midcom believes that the loss of any single customer would not have a
material adverse effect on its business, financial condition or results of
operations.

LEGAL PROCEEDINGS

Class Action Lawsuit. The Company, its 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 are named as
defendants in a securities action filed in the U.S. District Court for the

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Western District of Washington (the "Complaint"). The Complaint purports to be
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"). An amended complaint
(the "Amended Complaint") was filed on July 8, 1996. The Amended Complaint
alleges, among other things, that the registration statement and prospectus
relating to the Company's initial public offering contained false and misleading
statements concerning the Company's billing software and financial condition.
The Amended Complaint further alleges that, throughout the Class Period, the
defendants inflated the price of the Common Stock by intentionally or recklessly
making material misrepresentations or omissions which deceived the public about
the Company's financial condition and prospects. The Amended Complaint alleges
claims under the Securities Act and the Exchange Act as well as various state
laws, and seeks damages in an unstated amount. Defendants filed a motion to
dismiss on August 7, 1996 and filed a reply to plaintiffs' opposition on
September 18, 1996. Oral arguments were heard on November 1, 1996. All discovery
proceedings are stayed until defendants' motion to dismiss is acted on by the
Court. While the Company believes that it has substantive defenses to the claims
in the Amended Complaint and intends to vigorously defend this lawsuit, it is
unable to predict the outcome of this action.

SEC Investigation. The Company was informed in May 1996 that the
Commission was conducting an informal inquiry regarding the Company's initial
public offering and the restatement of its 1995 third quarter results. The
Company has voluntarily provided the documents requested by the Commission. In
addition, in November 1996, the Commission requested the Company's cooperation
in interviewing certain Company personnel. However, the Company has not been
informed whether or not the Commission intends to commence a formal action
against the Company or any of its affiliates. The Company is, therefore, unable
to predict the ultimate outcome of the investigation. In the event that the
Commission elects to initiate a formal enforcement proceeding, the Company and
its officers could be subject to civil or criminal sanctions including monetary
penalties and injunctive measures. Any such enforcement proceeding could have a
material adverse effect on the Company's business, financial condition and
results of operations.

Frontier Lawsuit. On August 19, 1996 the Company was served with a
complaint filed in the U.S. District Court for the Eastern District of Michigan
by Frontier Corporation ("Frontier"). This complaint names as defendants the
Company and eleven individuals, all of whom are former employees of Frontier who
resigned their positions with Frontier at various times in the last year. These
individuals include William H. Oberlin, the President and Chief Executive
Officer and a director of the Company, Charles I. Gragg III, the Vice
President-Marketing of the Company, and nine other employees of the Company. The
complaint alleges, among other things, that: (i) certain of the individual
defendants, with the acquiescence and active assistance of the Company, have
engaged in a systematic strategy to hire key employees and independent
contractors of Frontier in violation of various written agreements; (ii) the
individual defendants have used confidential information belonging to Frontier
in their new employment with Midcom in violation of written agreements and
fiduciary duties and (iii) Mr. Oberlin has breached fiduciary duties as a former
employee and officer of Frontier and breached obligations under an employment
agreement with Frontier. The complaint further alleges 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; (ii) Midcom has aided and abetted
Mr. Oberlin's alleged breaches of fiduciary duties and (iii) Midcom and the
other defendants have tortiously 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 the defendants hold all profits which Midcom earns as a
result of its hiring of the individual defendants 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 defendants 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 intends to vigorously defend this action. Based on the
Company's review of the allegations in the complaint and the underlying facts,
the Company believes that the ultimate outcome of this matter will not have a
material adverse effect on the Company's business, financial condition, results
of operations or liquidity.

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Adnet Lawsuit. On August 1, 1996, a lawsuit was filed in the Superior
Court of the State of California for the County of Orange against the Company,
the Company's former President and Chief Executive Officer and other defendants
to be named at a later date by David and Maria Wiegand, the former shareholders
of Adnet. The plaintiffs have agreed to dismiss this action without prejudice as
described below. Adnet was acquired by the Company on December 29, 1995 in
exchange for 453,250 shares of Common Stock, of which 45,325 shares (the "Adnet
Escrow Shares") were placed in escrow to be held until December 28, 1996 for
satisfaction of certain contingencies. Adnet provides long distance services to
medium-to-large businesses. The acquisition was accomplished through the merger
of Adnet into the Company and has been accounted for as a pooling of interests.
Mr. Wiegand was a vice president of the Company in charge of the continuing
operations of Adnet from the date Adnet was acquired by the Company until his
resignation on October 1, 1996. At the date of closing of this acquisition, the
last reported sale price for the Company's Common Stock as reported by Nasdaq
National Market was $18.25. During 1996 (through November 20, 1996), the Common
Stock has traded as low as $6.25 per share. The complaint alleged intentional
misrepresentations, intentional concealment of facts, negligent
misrepresentation, breach of contract, breach of implied covenant of good faith
and fair dealing and violation of California Securities Laws in connection with
the acquisition. The plaintiffs sought recovery of monetary damages in an amount
which the plaintiffs describe as "not yet ascertainable, but potentially [in
excess of] $10,000,000." The plaintiffs furthermore sought rescission of the
Merger Agreement, restoration of all consideration paid by the plaintiffs to the
Company pursuant to the Merger Agreement, an order enjoining the Company from
undertaking any acts which would further merge Adnet into the Company, and which
would prevent the plaintiffs from being accorded full relief upon rescission of
the Merger Agreement, punitive damages in an amount to be determined at trial
and attorneys' fees and other costs and expenses of suit.

The plaintiffs' claims are based in part on the restatement by the Company
of its financial results for the third quarter and the nine months ended
September 30, 1995 from those reported in its Quarterly Report on Form 10-Q for
the quarter ended September 30, 1995 as originally filed in November 1995. The
restated results, which were first announced in March 1996, reflected a $3.3
million reduction in revenue and $4.5 million reduction in accounts receivable
for the quarter and the nine months ended September 30, 1995. These and other
adjustments resulted in the Company's net loss for the quarter and the nine
months ended September 30, 1995 being increased from $3.8 million and $8.0
million, respectively, to $8.3 million and $12.5 million, respectively. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Restatement of Results for the Third Quarter of 1995." The Company
had represented in the Merger Agreement with Adnet that the financial statements
included in its filings with the Commission "fairly present the . . . financial
position of MIDCOM . . . as of the dates thereof and its . . . results of
operations and cash flow for the periods then ended . . . are correct and
complete in all respects."

On August 8, 1996 the Company and the plaintiffs entered into an agreement
whereby the plaintiffs agreed to dismiss the complaint without prejudice and not
to re-file the complaint before August 31, 1996, and the parties agreed to meet
before August 31, 1996 to pursue a negotiated settlement of the plaintiffs'
claims. In connection with execution of this agreement, the Company agreed to
release the Adnet Escrow Shares to the plaintiffs, following dismissal of the
complaint. Although as of the date of this Prospectus, the plaintiffs have not
re-filed their complaint, the parties have not negotiated a settlement to the
plaintiffs' claims. If the Company is unable to reach an agreement with the
plaintiffs to settle their claims, it is likely that the complaint will be
re-filed. Although the Company would vigorously defend this action, it cannot
predict the outcome of these claims.

Cherry Communications Lawsuit. In September and December 1995, the Company
acquired 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 Company is responsible for the underlying carrier costs associated
with the customer traffic acquired from Cherry Communications at a rate which
would yield to the Company a gross profit on such traffic at an

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<PAGE> 59

agreed rate. The purchase price payable with respect to Cherry I was a total of
$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 indemnity 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 placed in an escrow
account for satisfaction of indemnity claims or to cover shortfalls in revenue
from the $2.0 million monthly average. The parties later agreed that the Company
could pay up to $9.0 million of the Cherry II payments either in cash or by
delivery of shares of Common Stock, although the terms of the Revolving Credit
Facility prohibit the Company from paying any portion of this obligation in cash
without the lenders' prior written consent. Separately, the Company also agreed
to pay Cherry Communications $40,000 per month per customer base 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 service for the
acquired bases (up to $9.7 million through June 30, 1996) and accrued customer
service charges through June 30, 1996 of $720,000. 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 attorneys'
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 $40,000 per month for each month of customer service
Cherry Communications has provided to the Company under the September 1, 1995
Customer Base Purchase and Sale Agreement between Cherry Communications and the
Company (the "Cherry I Agreement"); and (iv) customer service charges of $40,000
per month for each month of customer service Cherry Communications has provided
to the Company under the Cherry II Agreement. 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 bases. 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
substantial offsets and counterclaims against 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 the
outcome of this lawsuit.

Cel-Tech Lawsuit. On April 30, 1996, a lawsuit was filed in the Superior
Court of the State of Washington, King County, against the Company and certain
of its officers and directors by the former owner of Cel-Tech seeking rescission
of his sale of Cel-Tech to the Company. The complaint alleged misrepresentation
of facts concerning the value of the Company's Common Stock and breach of
contract. In addition to rescission of the sale transaction, plaintiff sought
unspecified damages and an injunction placing Cel-Tech under the plaintiff's
control until resolution of the dispute. The Plaintiff has filed a second
amended complaint in order to seek damages in lieu of rescission. On October 28,
1996, the Court dismissed without prejudice the plaintiff's claim for rescission
under the Washington Securities Act; however, the case continues with respect to
the plaintiff's breach of contract and fraud claims. The Company believes there
is no merit to the allegations in the portion of the amended complaint which has
not been dismissed and plans to vigorously defend this lawsuit and to file a
motion for summary judgment on the remaining claims. However, the Company is
unable to predict the outcome of this lawsuit.

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<PAGE> 60

Discom Lawsuit. On July 2, 1993, a complaint was filed in the Superior
Court of the State of New Jersey, Bergen County, Law Division, by Discom
Corporation ("Discom") against the Company, Paul Pfleger, who is the largest
shareholder and Chairman of the Board of Directors, and Pamcom, Inc., a
corporation wholly owned by Mr. Pfleger ("Pamcom"), alleging unjustified
customer provisioning delays, customer rejections, improper changes in pricing
policies and failure to deal in good faith causing a breach of contract with a
third party beneficiary. Discom seeks compensatory damages of $3.0 million for
lost profits and lost commissions. Claims against Mr. Pfleger were dismissed on
jurisdictional grounds. The Company has filed counterclaims against Discom for
unfair competition and trademark infringement. Discom was a distributor of
aggregation services under a contract between AT&T and Midcom Consultants, Inc.
("Consultants"). In exchange for the right to place its own aggregation
customers under Consultant's contract with AT&T, the Company provided
provisioning, billing and other support services for all aggregation customers
under Consultant's aggregation contract, including Discom's customers. In
January 1995, the Company acquired certain of the assets and liabilities of
Consultants. Pamcom, Inc., the sole remaining co-defendant in this action, was
the sole shareholder of Consultants at the time of the alleged events that are
the subject of this action. On October 25, 1995, Discom filed notice for
arbitration in New York against Consultants alleging breach of the distributor
agreement between the parties. The Company moved to consolidate the pending
litigation between Discom and the Company with Discom's claim in arbitration
against Consultants. Pursuant to an order of the Superior Court, the entire case
has been transferred to arbitration in New York for disposition of the claims
and counterclaims. A hearing by a panel of arbitrators has been indefinitely
post-poned. The Superior Court proceeding has been stayed with jurisdiction
reserved solely to resolve any discovery disputes. The Company has deposited
$645,000 in an interest-bearing escrow account, which the Company believes
exceeds the total of all commissions payable to Discom from August 1, 1993
through December 31, 1995. Although the outcome of any litigation or arbitration
is uncertain, the Company believes that it has significant defenses to the
claims of Discom and intends to vigorously defend itself in this matter and
believes that the outcome of this matter will not have a material adverse effect
on the Company's business, financial condition, results of operations or
liquidity.

The Company is also party to other routine litigation incident 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.

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<PAGE> 61

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information as to the executive
officers and directors of the Company.

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
John M. Zrno.............................. 58 Chairman of the Board and Director
William H. Oberlin........................ 52 President, Chief Executive Officer and
Director
Robert L. Nitschke........................ 49 Executive Vice President of Operations
Robert J. Chamberlain..................... 43 Executive Vice President of Finance and
Administration, Chief Financial Officer,
Treasurer and Assistant Secretary
Jay T. Caldwell........................... 43 Senior Vice President of Revenue Management
Paul P. Senio............................. 64 Vice President, Secretary and General Counsel
Charles I. Gragg III...................... 38 Executive Vice President, Marketing
Thomas A. Marino.......................... 54 Vice President, Network Operations
Judith W. Johnson......................... 36 Vice President, Customer Service
Paul Pfleger.............................. 60 Director
John M. Orehek(1)(2)...................... 42 Director
Scott B. Perper(2)........................ 40 Director
Karl D. Guelich(1)........................ 54 Director
Marvin C. Moses(1)........................ 51 Director
Daniel M. Dennis(2)....................... 48 Director
</TABLE>

- ---------------

(1) Member of the Audit Committee.

(2) Member of the Compensation Committee.

John M. Zrno has served as a director of the Company and a consultant to
the Company since May 1996. In October 1996, he was appointed to serve as
Chairman of the Board of the Company, effective December 2, 1996. From August
1995 to October 1995, Mr. Zrno was Vice Chairman of Frontier Corporation and was
President, Chief Executive Officer and a director of ALC from August 1988 until
its merger with Frontier Corporation in August 1995.

William H. Oberlin has served as President, Chief Executive Officer and a
director of the Company since May 1996. Prior to joining the Company, Mr.
Oberlin was President and Chief Operating Officer of Frontier Corporation, a
long distance telecommunications provider, from August 1995 to November 1995 and
was Executive Vice President, Chief Operating Officer and a director of ALC
Communications Corporation, a long distance telecommunications provider ("ALC"),
from October 1988, July 1990 and July 1993, respectively, until its merger with
Frontier Corporation in August 1995.

Robert L. Nitschke has served as Executive Vice President of Operations
since October 1996 and Executive Vice President and Chief Operating Officer from
October 1995 to October 1996. Prior to joining the Company, Mr. Nitschke was
Vice President for U.S. Intelco Holdings, a telecommunications holding company,
and President of its subsidiary, USI-Gateway, Inc., a developer of products and
services for local number portability, from July 1995 to October 1995, and was
Vice President of Operations of its subsidiary, U.S. Intelco Network, a billing
aggregation and database and information services provider to local exchange
carriers, from September 1989 to July 1995.

Robert J. Chamberlain has served as Executive Vice President of Finance and
Administration, Treasurer and Assistant Secretary of the Company since October
1996. He has served as the Chief Financial Officer of the Company since April
1996. He served as Senior Vice President of Finance and Administration from
April 1996 to October 1996. He also served as a consultant to the Company,
advising on financial matters, from

59
<PAGE> 62

January 1995 to May 1995 and from January 1996 to April 1996. Prior to joining
the Company, Mr. Chamberlain was the Vice President of Finance and Operations
and Chief Financial Officer of ElseWare Corporation, a font technology software
developer, from January 1992 to December 1995. Prior to that, Mr. Chamberlain
was a partner at KPMG Peat Marwick.

Charles I. Gragg III has served as Executive Vice President, Marketing of
the Company since October 1996. He served as Vice President of Marketing of the
Company from June 1996 to October 1996. Prior to joining the Company, he was
Vice President of Retail Marketing at Detroit Edison, an electric utility, from
March 1996 to June 1996. From August 1995 to February 1996, Mr. Gragg was Vice
President of Marketing of Frontier Corporation and was Vice President of
Marketing of ALC from September 1991 until its merger with Frontier Corporation
in August 1995.

Jay T. Caldwell has served as Senior Vice President, Revenue Management of
the Company since May 1995. In that position, he is responsible for all revenue,
costing and carrier compliance functions for the Company. He also served as Vice
President -- Finance from October 1993 to October 1994 and Vice
President -- Revenue Management from November 1994 to May 1995. Prior to joining
the Company, Mr. Caldwell was corporate controller for Logic Modeling
Corporation, a manufacturer of microprocessor and electronic component
simulation tools, from September 1992 to October 1993, and Director of Finance
for Applied Microsystems Corporation, a manufacturer of microprocessor
diagnostic and emulation equipment, from January 1985 to September 1992.

Paul P. Senio has served as Secretary of the Company since 1989, becoming
General Counsel in January 1994. He served as Vice President from January 1994
to September 1994 and again from December 1995 to the present. He served as
Senior Vice President from September 1994 to December 1995. From 1984 to
December 1993, Mr. Senio served as General Counsel for Security Properties Inc.,
a real estate management company controlled by Paul Pfleger.

Thomas A. Marino has served as Vice President, Network Operations of the
Company since June 1996. Prior to joining the Company, from August 1995 to June
1996 he was Vice President of Network Operations and Engineering of Frontier
Corporation and was Vice President of Administration and Technical Services of
ALC from April 1992 until its merger with Frontier Corporation in August 1995.

Judith W. Johnson has served as Vice President, Customer Service of the
Company since June 1996. Prior to joining the Company, from October 1995 to June
1996 she was Vice President of Customer Service of Frontier Corporation. Ms.
Johnson was also Vice President of Client Services of Optel Systems, a software
developer, from November 1994 to October 1995 and was Senior Manager of Customer
Service of ALC, from February 1992 until November 1994.

Paul Pfleger has been Chairman of the Board of the Company since its
formation in 1989. In October 1996, Mr. Pfleger resigned as Chairman of the
Board of the Company effective December 2, 1996, at which time he will serve as
the Company's Vice Chairman. Mr. Pfleger served as acting President and Chief
Executive Officer of the Company from April 1996 to May 1996. Since 1969, Mr.
Pfleger has been actively involved in the real estate industry. He was a founder
and currently is Chairman of the Board of Directors of SP Investments, Inc. Mr.
Pfleger has been Chairman of the Board of Directors of Interfinancial Real
Estate Management Company ("IREMCO") since 1984 and has been its President since
April 1993. IREMCO is the General Partner of the following four limited
partnerships: Urban Improvement Fund Limited ("UIFL"); UIFL 1973; UIFL 1973-II;
and UIFL 1974. Shareholders party to the Shareholders' Agreement (as defined
below) have agreed to vote their shares to elect Mr. Pfleger to the Board of
Directors. The Shareholders' Agreement expires on June 7, 1999. See "Description
of Capital Stock -- Shareholders' Agreement."

John M. Orehek has served as a director of the Company since December 1992.
Mr. Orehek has served as President and Chief Executive Officer of SP Investments
Inc., an investment management company, from 1991 to the present. In addition,
Mr. Orehek has been a director of IREMCO since 1993. From 1987 to 1991, Mr.
Orehek was President of Hallmark Capital Partners, Ltd., a Seattle-based real
estate development corporation.

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<PAGE> 63

Scott B. Perper has served as a director of the Company since June 1994.
Mr. Perper has been a Senior Vice President of First Union Corporation, a bank
holding company, and First Union National Bank of North Carolina since January
1990, and an executive of First Union Capital Partners, the private equity and
mezzanine investment arm of First Union Corporation, since February 1989.

Karl D. Guelich has served as a director of the Company since November 1995
and served as a consultant to the Company from March 1996 to April 1996. Since
March 1993, Mr. Guelich has been in private practice as a certified public
accountant. From June 1964 to February 1993, Mr. Guelich was employed by Ernst &
Young LLP, where he served as the Area Managing Partner for the Pacific
Northwest offices headquartered in Seattle from October 1986 to November 1992.

Marvin C. Moses has served as a director of the Company and a consultant to
the Company since May 1996. From August 1995 to January 1996, Mr. Moses was
Executive Vice President and Chief Financial Officer and from January 1996 to
April 1996 Mr. Moses was Vice Chairman and Chief Financial Officer of Frontier
Corporation. He also was Chief Financial Officer and a director of ALC from
October 1988 and September 1989, respectively, until its merger with Frontier
Corporation in August 1995.

Daniel M. Dennis has served as a director of the Company since July 1996.
Mr. Dennis served in numerous executive positions since joining MCI in 1973, the
most recent being president of MCI Large Accounts, a division of MCI, from
February 1996 to August 1996. Although Mr. Dennis continues to serve as a
consultant to MCI, he has resigned from MCI effective August 1996.

BOARD OF DIRECTORS

Commencing with the annual meeting of the Company's shareholders held on
October 29, 1996, the Company's Board of Directors consists of three classes,
each of which is as nearly equal in number as possible. Class 1 directors have
an initial term of one year; Class 2 directors have an initial term of two
years; and Class 3 directors have an initial term of three years. Following the
initial term, each class will have a term of three years. At the annual meeting
of the Company's shareholders held on October 29, 1996, Messrs. Guelich and
Perper were elected as Class 1 directors, Messrs. Dennis, Moses and Orehek were
elected as Class 2 directors and Messrs. Oberlin, Pfleger and Zrno were elected
as Class 3 directors. All directors hold office until the annual meeting of
shareholders at which their term expires and until their successors have been
duly elected and qualified. Directors may be removed only for cause by holders
of a majority of the outstanding shares of Common Stock. Officers are elected
by, and serve at the discretion of, the Board of Directors.

The Company has established two standing committees of the Board of
Directors: an Audit Committee and a Compensation Committee. The Audit Committee
reviews the functions of the Company's management and independent auditors
pertaining to the Company's financial statements and performs such other related
duties and functions as are deemed appropriate by the Audit Committee and the
Board of Directors. The Compensation Committee makes recommendations to the
Board of Directors concerning the compensation of the Company's executive
officers and directors and administers the Company's Stock Option Plan and the
Stock Purchase Plan.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Compensation Committee of the Board of Directors consists of John M.
Orehek, Scott B. Perper and Daniel M. Dennis. None of these individuals has
served at any time as an officer or employee of the Company.

From time to time, the Company has engaged in certain transactions with
members of the Board of Directors and the Compensation Committee. See "Certain
Transactions."

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<PAGE> 64

EXECUTIVE COMPENSATION

The following table shows compensation paid by the Company for services
rendered during its fiscal years ended December 31, 1994 and 1995 to the Chief
Executive Officer during 1995 and to the executive officers of the Company
serving on December 31, 1995, whose salary and bonuses in 1995 made them the
three most highly compensated executive officers of the Company in 1995
(collectively, the "Named Executive Officers").

SUMMARY ANNUAL COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) OPTIONS(#)(1) COMPENSATION($)(2)
---------------------------------------------- ---- --------- ------------ ------------------
<S> <C> <C> <C> <C>
Ashok Rao(3).................................. 1995 $ 292,500 3,000 $ 7,830
President and Chief 1994 300,000 278,775 3,762
Executive Officer
Eric G. Peterson(4)........................... 1995 117,000 1,000 4,105
Executive Vice President 1994 118,667 1,663 4,521
and Treasurer
Jay T. Caldwell............................... 1995 97,500 15,750 3,207
Senior Vice President of 1994 100,000 5,478 17,289
Revenue Management
</TABLE>

- ---------------

(1) The 1994 amounts include immediately exercisable options granted in March
1995 in lieu of cash bonuses for 1994 to Messrs. Rao, Peterson and Caldwell
of 18,375, 1,663 and 1,103 shares of Common Stock, respectively. These
options are exercisable at $2.29 per share and expire on the tenth
anniversary of the date of grant.

(2) Represents payments under the Company's 401(k) plan and payments for term
life insurance premiums.

(3) Mr. Rao resigned as an officer of the Company effective April 1996.

(4) Mr. Peterson resigned as an officer of the Company effective May 1996.

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<PAGE> 65

STOCK OPTION GRANTS

The following table sets forth further information regarding grants of
options to purchase Common Stock made by the Company pursuant to the Company's
Stock Option Plan during the fiscal year ended December 31, 1995 to each of the
Named Executive Officers.

OPTION GRANTS IN 1995

<TABLE>
<CAPTION>
PERCENT POTENTIAL REALIZABLE VALUE
NUMBER OF OF TOTAL AT ASSUMED ANNUAL RATES OF
SECURITIES OPTIONS EXERCISE MARKET STOCK PRICE APPRECIATION
UNDERLYING GRANTED TO PRICE PER PRICE ON FOR OPTION TERM(4)
OPTIONS EMPLOYEES SHARE DATE OF EXPIRATION ------------------------------
NAME GRANTED(#)(1) IN 1995 ($/SH)(2) GRANT($)(3) DATE 0%($) 5%($) 10%($)
- ------------------------- ------------- ---------- --------- ----------- ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ashok Rao(5)............. 18,375 2.48% $ 2.29 $ 9.14 03/15/05 $125,869 $231,490 $393,534
3,000 0.40 15.75 15.75 07/26/05 -- 29,715 75,304
Eric G. Peterson(5)...... 1,663 0.22 2.29 9.14 03/15/05 11,392 20,951 35,616
1,000 0.13 15.75 15.75 07/26/05 -- 9,905 25,101
Jay T. Caldwell.......... 8,750 1.18 9.14 9.14 02/07/05 -- 50,296 127,460
1,103 0.15 2.29 9.14 03/15/05 7,556 13,896 23,623
6,000 0.81 10.50 11.00 07/06/05 3,000 44,507 108,187
1,000 0.13 15.75 15.75 07/26/05 -- 9,905 25,101
</TABLE>

- ---------------
(1) Generally under the Company's Stock Option Plan, twenty percent of the
options vest for each full year that the optionee renders services to the
Company after the date of grant. All of the grants listed, however, were
fully vested at the time of the grant, with the exception of the grants of
options for 8,750 and 6,000 shares to Mr. Caldwell. The vesting of options
may be accelerated at the discretion of the administrator of the Stock
Option Plan.

(2) The exercise price may be paid by delivery of already owned shares, subject
to certain conditions.

(3) The fair market value of the underlying Common Stock on the date of grant is
determined by the Board of Directors.

(4) Potential realizable value is based on the assumption that the fair market
value of the Common Stock appreciates at the annual rate shown (compounded
annually) from the date of grant until the end of the option term.
Disclosure of these assumed rates of appreciation are mandated by the rules
of the Securities and Exchange Commission and do not represent the Company's
estimate or projection of future Common Stock prices. The actual value
realized may be greater or less than the potential realizable value set
forth in the table.

(5) Messrs. Rao and Peterson resigned effective April and May 1996,
respectively.

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<PAGE> 66

The following table sets forth certain information regarding options to
purchase Common Stock held as of December 31, 1995 by each of the Named
Executive Officers. None of such executive officers exercised any options during
the year ended December 31, 1995.

AGGREGATED 1995 YEAR-END OPTIONS

<TABLE>
<CAPTION>
NUMBER OF SHARES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS
DECEMBER 31, 1995(#) AT DECEMBER 31, 1995($)(2)
-------------------------------- -----------------------------------
EXERCISABLE UNEXERCISABLE(1) EXERCISABLE UNEXERCISABLE
----------- ---------------- -------------- ----------------
<S> <C> <C> <C> <C>
Ashok Rao(3)........................ 125,535 156,240 $1,701,717 $2,101,427
Eric G. Peterson(3)................. 68,288 21,875 1,076,416 349,125
Jay T. Caldwell..................... 16,103 22,625 208,623 221,938
</TABLE>

- ---------------
(1) Future ability to exercise is subject to vesting and the optionee remaining
employed by the Company.

(2) Calculated on the basis of the closing price of the Company's Common Stock
on December 29, 1995 which was $18.25, less the exercise price. There is no
guarantee that if and when these options are exercised they will have this
value.

(3) Messrs. Rao and Peterson resigned effective April and May 1996,
respectively.

DIRECTOR COMPENSATION

At the time of the Company's initial public offering on July 6, 1995, the
Company's Stock Option Plan provided for the automatic grant of a Nonqualified
Option (as defined herein) to purchase 8,750 shares of Common Stock to
non-employee directors of the Company (with certain exclusions that were
eliminated as of November 1996) upon their election to the Board of Directors,
and an additional option to purchase 4,375 shares of Common Stock each
subsequent year, both at a price equal to the fair market value of the Company's
Common Stock on the date of grant. Such options vest at a rate of fifty percent
(50%) per year and expire ten (10) years after the date of grant. On July 25,
1996, the Board approved an amendment to the Stock Option Plan to revise the
provisions relating to automatic grants of options to purchase shares of the
Company's Common Stock to all non-employee directors. Pursuant to the Stock
Option Plan as amended, non-employee directors are each granted a Nonqualified
Option to purchase 50,000 shares of Common Stock upon initial election to the
Board of Directors at an exercise price equal to the fair market value of the
Common Stock on the date of the grant. Such options vest at a rate of twenty
percent (20%) per year and expire ten years after the date of grant. The July
1996 Board action also provided for the grant to each non-employee director then
serving on the Board of an option to purchase shares of Common Stock equal to
50,000 minus the number of shares subject to options granted to each
non-employee director under the Stock Option Plan prior to its amendment. The
vesting schedule of these additional option grants begins on November 9, 1995
with respect to Messrs. Pfleger, Orehek, and Perper and on the date of election
to the Board for all other non-employee directors at a rate of twenty percent
(20%) per year. These options were granted subject to approval by shareholders
of an increase in shares available for purchase under the Stock Option Plan
which approval was obtained at the annual shareholders meeting held on October
29, 1996.

On March 15, 1996, the Company entered into a consulting agreement with
Karl D. Guelich whereby Mr. Guelich assisted the Company with respect to
financial matters. The consulting agreement provided for monthly compensation of
$20,000. The consulting agreement terminated effective April 30, 1996. Mr.
Guelich was paid a total of $35,000 pursuant to this agreement.

The Company has entered into consulting agreements with Marvin C. Moses and
John M. Zrno pursuant to which Messrs. Moses and Zrno (collectively, the
"Consultants") have each agreed to provide consulting services to the Company
with respect to (a) identifying and assisting in the negotiation and closing of
new business acquisitions, (b) establishing investor and other strategic
relations, and (c) advising the Company's Board of Directors on critical
strategic financial matters. Under the consulting agreements, the Consultants
are to make themselves reasonably available to the Company's Board of Directors
and are to devote

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<PAGE> 67

approximately twenty-five percent (25%) of their time and efforts to the
Company's affairs. Pursuant to the consulting agreements, the Company is
required to pay each of the Consultants Nonqualified Options for the purchase of
253,681 shares of the Company's Common Stock pursuant to and in accordance with
the Company's Stock Option Plan. The options vest ratably over a five-year
period, with the first twenty percent (20%) installment vesting in May 1997, and
are exercisable for $8.00 per share. The consulting agreements each terminate
after a period of five years beginning on June 1, 1996, unless terminated
earlier in accordance with the terms thereof. The Company has the right to
terminate the consulting agreements at any time for cause, as defined therein.
The Company or either of the Consultants may terminate the consulting
agreements, or reduce the time required to be devoted to the Company thereunder,
at any time upon 30 days prior written notice, in which case the Consultant's
retainer and unvested stock options shall be reduced proportionately.

STOCK OPTION PLAN

The following summary of the Stock Option Plan is a brief description of
the material provisions of the Stock Option Plan and is qualified in its
entirety by the full text of the Stock Option Plan.

General. Pursuant to the Stock Option Plan, the Company may grant options
to purchase shares of Common Stock which qualify as "incentive stock options"
within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended ("Code") ("Incentive Options") or which do not so qualify ("Nonqualified
Options"). The Compensation Committee of the Board of Directors is currently the
Plan Administrator for the Stock Option Plan. Incentive Options may be granted
to any employee, including employees who are directors, and Nonqualified Options
may be granted to such persons as the Plan Administrator shall select, including
employees, consultants and directors of the Company. The Plan Administrator
determines the terms and conditions of options granted under the Stock Option
Plan, including the exercise price, provided that the exercise price for
Incentive Options must be equal to or greater than the fair market value of the
Common Stock on the date of grant.

Unless otherwise provided by the Plan Administrator, options granted under
the Stock Option Plan vest at a rate of twenty percent (20%) after the first
year and thereafter at twenty percent (20%) per year over a four-year period so
that all options are fully vested after five years. Outstanding options vest, at
the discretion of the Plan Administrator, upon the occurrence of the liquidation
or dissolution of the Company. Options are exercisable for a period of ten years
from the date of grant, except that Incentive Options granted to persons who own
more than ten percent of the Common Stock are exercisable only for a period of
five years from the date of grant. Options granted under the Stock Option Plan
are nontransferable other than by will or the laws of descent and distribution.
Notwithstanding a vesting schedule, the Stock Option Plan provides for the
immediate vesting of options that have been outstanding for at least six months
upon the occurrence of certain events. In general, such events include (i) the
purchase by any person of thirty percent (30%) or more of the Common Stock of
the Company pursuant to a tender offer or exchange offer made by any person
other than the Company, and (ii) the approval by the Company's shareholders of
any merger, consolidation, reorganization or other transaction providing for the
conversion or exchange of more than fifty percent (50%) of the outstanding
shares of Common Stock of the Company. Under certain circumstances, accelerated
vesting could have the effect of delaying, deferring or preventing unfriendly
offers or other efforts to obtain control of the Company and could thereby
deprive the shareholders of opportunities to receive a premium on their Common
Stock and could make removal of incumbent management more difficult. On the
other hand, accelerated vesting may induce any person seeking control of the
Company or business combination with the Company to negotiate on terms
acceptable to the Board of Directors. The Stock Option Plan was recently amended
to permit limited transfers of certain options pursuant to newly effective SEC
regulations.

Pursuant to the Company's Stock Option Plan, Nonqualified Options are
automatically granted to non-employee directors of the Company, as described in
"Director Compensation" above.

There were an aggregate of 4,211,463 shares of Common Stock reserved for
issuance pursuant to the Stock Option Plan at August 23, 1996, subject to
adjustment for stock splits and similar changes in the Company's capitalization.
At August 23, 1996, options to purchase an aggregate of 3,401,286 shares of

65
<PAGE> 68

Common Stock were outstanding under the Stock Option Plan and a total of 782,249
shares of Common Stock remained available for grant. At August 23, 1996,
outstanding options were exercisable at prices ranging from $2.29 to $18.50 per
share. Shares subject to options granted under the Stock Option Plan that have
lapsed or terminated may again be subject to options granted under the Stock
Option Plan.

EMPLOYMENT AGREEMENTS

The Company has entered into an employment agreement with William H.
Oberlin, the Company's President and Chief Executive Officer. The agreement
provides for a monthly base salary of $25,000 per month as well as certain other
compensation, subject to annual review by the Board of Directors. The agreement
requires that the Board of Directors formulate and adopt a bonus plan for the
year ending December 31, 1996 on or before August 30, 1996. For each calendar
year effective with the year starting January 1, 1997, the bonus plan is to be
structured to pay out one hundred percent of Mr. Oberlin's base salary if the
Company meets targets set forth in its annual business plan, or a greater or
lesser percentage of the base salary in proportion to the amount by which the
Company exceeds or falls short of such targets. In connection with entering into
the agreement, the Company has granted Mr. Oberlin options to purchase 1,214,724
shares of Common Stock pursuant to the Stock Option Plan. The options vest
ratably over a five-year period, with the first twenty percent (20%) installment
vesting in May 1997, and are exercisable for $8.00 per share. In the event that
Mr. Oberlin's employment is terminated by the Board of Directors "without
cause," or if Mr. Oberlin voluntarily resigns within 180 days of a "change of
control" of the Company (as such terms are defined in the agreement), Mr.
Oberlin is entitled to two years severance. In the event that Mr. Oberlin's
employment is terminated by mutual agreement, or if Mr. Oberlin voluntarily
resigns under certain limited circumstances, Mr. Oberlin is entitled to 12
months severance. Severance equals the sum of (i) the annualized base salary at
the time of termination, and (ii) either the average annual bonuses for the
fiscal years preceding termination or, if no bonuses have been established or
paid for such period, the annualized base salary at the time of termination.
Severance is payable in equal monthly installments, without interest, commencing
on the last day of the month of termination. In the event that Mr. Oberlin is
entitled to severance, he will continue to receive medical, life, disability and
group term life insurance benefits (or the cash equivalent thereof), and options
granted to him under the Stock Option Plan will continue to vest, during the
applicable severance period as if his employment had not been terminated. In the
event of Mr. Oberlin's death, vesting of options otherwise vesting over the
two-year period following his death will be accelerated. The agreement also
contains a non-interference provision pursuant to which Mr. Oberlin has agreed,
for a period of six months after the termination of his employment, to preserve
the confidentiality of the Company's customer list, to refrain from actively
soliciting the Company's customers existing at the date of termination and to
refrain from soliciting or hiring the Company's executive or management level
employees.

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<PAGE> 69

SELLING SECURITYHOLDERS

The following table sets forth the name of each Selling Securityholder, the
aggregate number of shares of Common Stock beneficially owned by each Selling
Securityholder as of the date hereof and the aggregate number of shares of
Common Stock that each Selling Securityholder may offer and sell pursuant to
this Prospectus. Because the Selling Securityholders may sell all or a portion
of the Securities at any time and from time to time after the date hereof, no
estimate can be made of the number of shares of Common Stock that each Selling
Securityholder may retain upon completion of the offering pursuant to this
Prospectus. Information concerning the Selling Securityholders may change from
time to time and, to the extent required, will be set forth in an accompanying
Prospectus supplement or, if appropriate, a post-effective amendment to the
Registration Statement of which this Prospectus is a part. To the Company's
knowledge, none of the Selling Securityholders has any material relationship
with the Company except as set forth in the footnotes to the following table or
as described elsewhere in this Prospectus. The following table has been prepared
based upon information furnished to the Company by or on behalf of the Selling
Securityholders.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES TO BE OFFERED FOR THE
NAME OF SELLING SECURITYHOLDER PRIOR TO THIS OFFERING SELLING SECURITYHOLDERS' ACCOUNT
- --------------------------------------------- ------------------------- --------------------------------
<S> <C> <C>
Richard and Patricia Stroup(1)............... 113,750 113,750
Steven Tomsic(2)............................. 23,625 23,625
Darren Narans(2)............................. 12,250 12,250
Kevin Narans(2).............................. 23,625 23,625
Fidelity Communications Corporation(3)....... 20,893 20,893
Robert Brody(4).............................. 50,370 50,370
Arlene Brody(4).............................. 8,888 8,888
Claude Bernstein(4).......................... 19,752 19,752
Melody Bernstein(4).......................... 19,752 19,752
David Wiegand(5)............................. 453,250 453,250
Theodore Berns(6)............................ 50,000 50,000
Donald Dean(6)............................... 50,000 50,000
WorldCom, Inc.(6)............................ 50,000 50,000
First Union Corporation(7)................... 640,478 640,478
The Robinson-Humphrey Company, Inc.(7)....... 7,641 7,641
--------- ---------
TOTAL.............................. 1,544,274 1,544,274
========= =========
</TABLE>

- ---------------
(1) In December 1994, the Company issued to Richard and Patricia Stroup 113,750
shares of Common Stock valued at $11.43 per share in exchange for all of the
outstanding shares of stock of PacNet, Inc. In addition, the Company issued
to Richard W. Stroup an option to purchase 52,000 shares of Common Stock at
an exercise price of $5.71 per share. The Company has committed to register
these shares (but not the options or the shares issuable upon exercise
thereof) under the Securities Act under certain circumstances. See
"Description of Capital Stock -- Registration Rights." From December 1994
until January 1995, Richard W. Stroup served as a Senior Vice President of
the Company in charge of the Company's PacNet division.

(2) Effective April 1, 1995, the Company issued to Darren Narans, Kevin Narans
and Steven Tomsic, at that time the shareholders of Telnet Communications
Inc., warrants to purchase 12,250, 23,625, and 23,625 shares respectively,
of Common Stock exercisable for $7.44 per share. The Company has committed
to register the shares issuable upon exercise of the warrants (but not the
warrants) under the Securities Act under certain circumstances. See
"Description of Capital Stock -- Registration Rights."

(3) On August 31, 1995, the Company issued to Communications Services of
America, Inc. ("CSA") 27,100 shares of Common Stock plus additional
consideration in exchange for a substantially all of the assets of CSA. The
shares have been assigned to Fidelity Communication Corporation, an
affiliate of CSA. Prior to the effective date of this Registration
Statement, the Company will issue additional shares

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<PAGE> 70

as required by the acquisition documents to compensate for the decrease in
the value of the Company's stock since the closing of the acquisition. The
Company has committed to register these shares under the Securities Act
under certain circumstances. See "Description of Capital
Stock -- Registration Rights."

(4) On November 6, 1995, the Company issued to Robert Brody, Arlene Brody,
Claude Bernstein and Melody Bernstein, at that time the shareholders of
Fairfield County Telephone Corporation ("Fairfield"), 37,777, 6,666, 14,814
and 14,814 shares, respectively (74,071 shares in the aggregate), of Common
Stock in exchange for all of the outstanding capital stock of Fairfield. An
additional 24,691 shares were issued in connection with the acquisition and
deposited into escrow and are subject to redemption by the Company upon the
occurrence of certain events. For purposes of this table, 12,593, 2,222,
4,938 and 4,938 shares of the escrowed shares have been included in the
number of shares beneficially owned by Robert Brody, Arlene Brody, Claude
Bernstein and Melody Bernstein, respectively. Prior to the effective date of
this Registration Statement, the Company will issue additional shares as
required by the acquisition documents to compensate for the decrease in the
value of the Company's stock since the closing of the acquisition. The
Company has committed to register the foregoing shares under the Securities
Act under certain circumstances. See "Description of Capital
Stock -- Registration Rights."

(5) On December 29, 1995, the Company issued to David Wiegand 453,250 shares, of
Common Stock in exchange for substantially all of the assets of ADNET
Telemanagement, Inc. The Company has committed to register these shares
under the Securities Act under certain circumstances. See "Business -- Legal
Proceedings" and "Description of Capital Stock -- Registration Rights."

(6) On September 29, 1995, the Company issued to Theodore Berns, Donald Dean and
WorldCom, Inc., at the time the shareholders of AdVal, Inc. ("Adval"),
90,000, 90,000 and 45,000 shares, respectively (225,000 shares in the
aggregate), of Common Stock in exchange for all of the outstanding capital
stock of Adval. An additional 25,000 additional shares issued in connection
with the acquisition and deposited into escrow. These shares were released
to the three shareholders on a pro rata basis. The Company has committed to
register these shares under the Securities Act under certain circumstances.
See "Description of Capital Stock -- Registration Rights." Theodore Berns
and Donald Dean each previously sold 50,000 shares which are not included in
the above table. Donald Dean served as a Vice President of AdVal from
September 1995 until May 1996.

(7) On June 10, 1994, the Company issued to First Union Corporation a warrant to
purchase 1,493,059 shares of Nonvoting Common Stock, at an exercise price of
$0.0001 per share. Also on June 10, 1994, the Company issued to The
Robinson-Humphrey Company, Inc. a warrant to purchase 20,177 shares of
Common Stock, at an exercise price of $0.0001 per share. In connection with
the conclusion of that financing the Company paid a cash fee to
Robinson-Humphrey of $444,000. In conjunction with the closing of the
Company's initial public offering, the warrants were amended and exercised
resulting in the issuance of 640,478 shares of Common Stock to First Union
Corporation and 7,641 shares of Common Stock to The Robinson-Humphrey
Company, Inc. The Company has committed to register these shares under the
Securities Act under certain circumstances. See "Description of Capital
Stock -- Registration Rights." Scott B. Perper, one of the Company's
directors, is also an officer of First Union Corporation.

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<PAGE> 71

PRINCIPAL SHAREHOLDERS

The following table sets forth certain information regarding beneficial
ownership of Midcom's Common Stock, as of July 31, 1996, with respect to (i)
each shareholder known by Midcom to be the beneficial owner of more than five
percent of the outstanding shares of Common Stock, (ii) each director of Midcom,
(iii) Midcom's Chief Executive Officer and the other most highly compensated
executive officer in 1995 and (iv) all directors and executive officers as a
group. Except as otherwise indicated, the Company believes that the beneficial
owners of the Common Stock listed below have sole investment and voting power
with respect to such shares, subject to community property laws where
applicable. The following table does not include Common Stock issuable upon
conversion of Notes purchased by any of the foregoing individuals. See "Certain
Transactions."

<TABLE>
<CAPTION>
PERCENT OF
AMOUNT AND NATURE OF OUTSTANDING
NAME AND ADDRESS BENEFICIAL OWNERSHIP SHARES(1)
- ------------------------------------------------------------ -------------------- -----------
<S> <C> <C>
Black Creek Limited Partnership(2).......................... 5,659,964 35.7%
(Paul Pfleger)
1201 Third Avenue
Suite 5400
Seattle, WA 98101
US Online Communications L.L.C.(3).......................... 1,666,667 10.5
1201 Third Avenue
Suite 5400
Seattle, WA 98101
Ashok Rao................................................... 846,723(4) 5.3
5456 E. Mercer Way
Mercer Island, WA 98040
William H. Oberlin(6)....................................... 0 *
Jay T. Caldwell............................................. 19,928(5) *
John M. Orehek(7)........................................... 2,149,343 13.6
Scott B. Perper(8).......................................... 3,000 *
Karl D. Guelich............................................. 225 *
John M. Zrno(8)............................................. 0 *
Marvin C. Moses(10)......................................... 0 *
Daniel M. Dennis............................................ 0 *
All Executive Officers and Directors as a Group (15
persons).................................................. 6,194,368(11) 39.0%
</TABLE>

- ---------------
* Less than 1%

(1) This table is based upon information supplied by directors, officers and
principal shareholders. Percentage of ownership is based on 15,838,202
shares of Common Stock outstanding as of July 31, 1996. Beneficial
ownership is determined in accordance with the Rules of the Commission, and
includes voting and investment power with respect to the shares. Shares of
Common Stock subject to options or warrants which are currently exercisable
or exercisable within 60 days of July 31, 1996 are deemed outstanding when
computing the percentage ownership of the person holding such options, but
are not deemed outstanding for purposes of computing the percentage
ownership of any other person.

(2) Mr. Paul Pfleger, the Chairman of the Board of the Company until December
1996, and thereafter the Company's Vice Chairman, has sole voting and
investment power with respect to 3,993,297 shares by virtue of being the
President and sole director of the corporate general partner of this
limited partnership. Mr. Pfleger shares voting and investment power with
respect to 1,666,667 shares of Common Stock owned by US Online
Communications L.L.C. See footnote (3) below. Does not include 31,943
shares of Common Stock issuable upon conversion of $450,000 aggregate
principal of Notes purchased by Mr. Pfleger on August 22, 1996.

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<PAGE> 72

(3) Mr. Pfleger and Mr. Orehek are managers of US Online Communications L.L.C.
(formerly Communications Access L.L.C.) and share voting and investment
power over the shares held by this entity.

(4) Does not include 38,637 shares of Common Stock held in trusts for the
benefit of the children, two nieces and a nephew of Mr. Rao and one
unrelated person, over which Mr. Rao disclaims beneficial ownership. All
shares owned by Mr. Rao or the trusts will be repurchased by the Company in
connection with Mr. Rao's resignation as President, Chief Executive Officer
and Director of the Company. See "Certain Transactions."

(5) Represents options exercisable within 60 days of July 31, 1996.

(6) Does not include 188,110 shares of Common Stock issuable upon conversion of
$2,650,000 aggregate principal of Notes purchased by Mr. Oberlin on August
22, 1996.

(7) Mr. Orehek has sole voting and investment power with respect to 482,676
shares owned by Madrona Ridge Limited Partnership by virtue of being the
President and sole director of the corporate general partner of this
limited partnership and shares voting and investment power with respect to
1,666,667 shares held by US Online Communications L.L.C. See footnote (3)
above. Does not include 17,746 shares of Common Stock issuable upon
conversion of $250,000 aggregate principal of Notes purchased by Mr. Orehek
on August 22, 1996.

(8) Scott B. Perper is an officer of First Union Corporation. Does not include
640,484 shares of Common Stock held by First Union Corporation, as to which
Mr. Perper disclaims beneficial ownership.

(9) Does not include 28,393 shares of Common Stock issuable upon conversion of
$400,000 aggregate principal of Notes purchased by Mr. Zrno on August 22,
1996.

(10) Does not include 17,746 shares of Common Stock issuable upon conversion of
$250,000 aggregate principal of Notes purchased by Mr. Moses on August 22,
1996.

(11) Includes 48,503 shares subject to options exercisable within 60 days of
July 31, 1996. Does not include 283,938 shares of Common Stock issuable
upon conversion of Notes purchased on August 22, 1996.

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<PAGE> 73

CERTAIN TRANSACTIONS

In June 1994, the Company entered into a Senior Subordinated Note and
Warrant Agreement with, and completed the sale of $14.8 million principal amount
of senior subordinated notes (the "Subordinated Notes") to, First Union
Corporation ("First Union"). Following the sale of the Subordinated Notes, Scott
B. Perper, a Senior Vice President of First Union, was appointed to serve on the
Company's Board of Directors, and he continues to serve in that capacity. The
Company paid First Union a loan initiation fee of $375,000 in connection with
issuance of the Subordinated Notes. During 1995, the Company paid interest on
the Subordinated Notes to First Union in the amount of $782,575. The Company
prepaid the Subordinated Notes in full with the proceeds of its initial public
offering.

In connection with the issuance of the Subordinated Notes, the Company also
issued warrants to First Union to acquire up to 640,484 shares of Common Stock,
for a purchase price of $.0001 per share. In July 1995, First Union exercised
these warrants for a total of 640,484 shares of Common Stock. First Union has
certain preemptive rights to purchase additional shares of Common Stock offered
by the Company, subject to a number of exceptions. The Company has granted
certain registration rights under the Securities Act with respect to the shares
of Common Stock held by it. In addition, First Union has certain rights to
information concerning the Company until the shares of Common Stock held by it
constitute less than one percent of the outstanding Common Stock.

In August 1994, the Company entered into a revolving credit agreement with
First Union National Bank of North Carolina ("First Union Bank"), a subsidiary
of First Union, providing a line of credit of up to $25.0 million, for which
First Union Bank received a commitment fee of $43,750. In March 1995, this
facility was amended to increase the maximum amount of borrowings by $4.0
million to a total of $29.0 million, for which First Union Bank was paid an
additional commitment fee of $80,000. This additional amount was originally due
on June 30, 1995. In June 1995, First Union Bank agreed to extend the due date
for borrowings in excess of $25.0 million to July 20, 1995. Mr. Perper, a
director of the Company, is also a Senior Vice President of First Union Bank.
During 1995, the Company paid interest of $2,021,055 to First Union Bank in
connection with this revolving credit facility. The revolving credit facility
was paid in full and terminated on November 8, 1995.

In June 1994, the Company issued to Paul Pfleger 859,653 shares of Series A
Redeemable Preferred Stock in consideration of (i) the contribution to the
Company by Mr. Pfleger of two notes payable by the Company to Mr. Pfleger, net
of a receivable for the benefit of the Company from Mr. Pfleger in the amount of
$1,233,846 and (ii) the assumption by Mr. Pfleger of a note payable by the
Company by December 31, 2002 to Mr. McCaugherty in the amount of $4,864,795
which included accrued interest at the rate of 12% per annum. The two notes
payable by the Company which were contributed by Mr. Pfleger were for an
aggregate of $6,865,578, including accrued interest. The Company's receivable
from Mr. Pfleger arose from his assignment to the Company earlier in 1994 of his
right to receive payments later in 1994 from a third party, for which the
Company paid $1.2 million. Remaining principal and accrued interest under the
Company's notes payable to Mr. Pfleger, aggregating $1.9 million, were paid in
June 1994, and there were no related party notes outstanding as of December 31,
1994. In July 1995, the Company redeemed all of the shares of Series A
Redeemable Preferred Stock held by Mr. Pfleger for $8.6 million.

Paul Pfleger and Ashok Rao, formerly the Company's Chief Executive Officer,
President and a director, own 88% and 12%, respectively, of QuestWest Inc.
("QuestWest"), one of two general partners of Quest America L.P. ("Quest LP").
John M. Orehek is the sole limited partner of Quest LP. Messrs. Pfleger, Rao and
Orehek are directors and Messrs. Rao and Orehek are officers of QuestWest.
QuestWest holds an 84.995% interest in Quest LP, subject to reduction if Quest
LP meets certain earnings and sales targets. In December 1993, Quest LP entered
into a distribution agreement with the Company pursuant to which Quest LP is
entitled to receive commissions on sales for the Company at a rate equal to the
most favorable rate provided by the Company to any of its distributors. Quest LP
received $66,456 in net commissions on 1994 invoices. Effective March 6, 1995,
Messrs. Pfleger, Rao and Orehek granted the Company an option to purchase their
entire interests in QuestWest and Quest LP for an exercise price equal to the
total amount paid

71
<PAGE> 74

to acquire their respective interests, which then aggregated $823,170. The
parties terminated the option effective October 24, 1995.

In June 1995, Paul Pfleger and Ashok Rao agreed in writing to indemnify and
hold the Company harmless from any costs, expenses or other liabilities incurred
by the Company in connection with a claim asserted in June 1995 by an affiliate
of the co-general partner of Quest LP that he or an affiliated party is entitled
to purchase 3% of the Company's outstanding stock for $1 million. The Company
believes that no such right exists and that this claim is without merit.

In June 1994, the Company entered into an employment agreement with Ashok
Rao, then the President, Chief Executive Officer and a director of the Company.
In April 1996, Mr. Rao resigned from the Company. The Company and Mr. Rao are
currently negotiating a Resignation Agreement and General Release (the
"Resignation Agreement") to define the terms of Mr. Rao's resignation from the
Company. The terms of the Resignation Agreement are not finalized, but it likely
will include payments to Mr. Rao for 24 months, confirmation of non-competition
and confidentiality agreements signed by Mr. Rao upon joining the Company and
mutual releases of claims. In addition, pursuant to the terms of the
Shareholders' Agreement, the Company has called for the repurchase of all of the
shares of Common Stock owned by Mr. Rao and by certain trusts established by Mr.
Rao (the "Rao Shares"). Because the Company and Mr. Rao have been unable to
reach mutual agreement on the purchase price for the Rao Shares, pursuant to the
Shareholders' Agreement, the purchase price shall be the fair market value of
the Rao Shares as of the date of Mr. Rao's resignation as determined by
arbitration. The Company and Mr. Rao are in disagreement as to the effective
date of Mr. Rao's resignation and whether a restricted security discount should
be applied to the Rao Shares. The purchase price will be payable in 36 equal
monthly installments and will bear interest at a rate of 8% per annum. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Description of Capital
Stock -- Shareholders' Agreement." Under an agreement between Mr. Rao and Paul
Pfleger pursuant to which Mr. Rao purchased the Rao Shares from Mr. Pfleger, Mr.
Pfleger is entitled to receive payments aggregating approximately $2.2 million
out of proceeds received by Mr. Rao from the sale of the Rao Shares.

On March 15, 1996, the Company entered into a consulting agreement with
Karl D. Guelich, a director of the Company. See "Management -- Director
Compensation."

The Company has entered into an employment agreement with William H.
Oberlin, the Company's President and Chief Executive Officer. See
"Management -- Employment Agreements."

The Company has entered into consulting agreements with Marvin C. Moses and
John M. Zrno, each a director of the Company. See "Management -- Director
Compensation."

On April 4, 1996, the Company entered into an agreement with Tie
Communications, Inc. ("Tie"), appointing Tie as an independent distributor for
selling the Company's long distance services. Mr. Pfleger and Mr. Orehek
together own 95.2% of Tie. Through July 31, 1996, no commissions had been paid
to Tie pursuant to this agreement.

William H. Oberlin, John M. Zrno, Marvin C. Moses, Paul Pfleger and John M.
Orehek beneficially own $2,650,000, $400,000, $250,000, $450,000 and $250,000
principal amount of Notes, respectively. Mr. Oberlin is the Company's President
and Chief Executive Officer as well as a director. Mr. Zrno is Chairman of the
Company's Board of Directors effective December 1996. Mr. Pfleger is Chairman of
the Company's Board of Directors until December 1996, and thereafter will serve
as the Company's Vice Chairman. Messrs. Moses and Orehek are directors. The
foregoing individuals own the Notes on the same terms, and subject to the same
conditions, applicable to all other holders of the Notes.

DESCRIPTION OF NOTES

Set forth below is a summary of certain provisions of the Notes. The Notes
were issued pursuant to an indenture (the "Indenture") between the Company and
IBJ Schroder Bank & Trust Company, as trustee (the "Trustee"). The following
summary of the Notes, the Indenture and the Registration Rights Agreement does
not purport to be complete and is subject to, and is qualified in its entirety
by reference to, all of the

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<PAGE> 75

provisions of the Indenture and the Registration Rights Agreement, including the
definitions therein. The terms of the Notes include those stated in the
Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939 (the "Trust Indenture Act"). The definitions of certain
terms used in the following summary are set forth below under "-- Certain
Definitions." Capitalized terms used herein without definition have the meanings
ascribed to them in the Indenture.

As used in this Description of Notes, "the Company" refers to MIDCOM
Communications Inc., exclusive of its subsidiaries.

GENERAL

The Notes are unsecured, subordinated, general obligations of the Company,
and will mature on August 15, 2003. The Notes bear interest from the date of
issuance, or from the most recent date to which interest has been paid or
provided for, at the rate stated on the cover page hereof, payable in arrears on
February 15 and August 15 of each year commencing on February 15, 1997, to
holders of record on the immediately preceding February 1 and August 1. Interest
will be computed on the basis of a 360-day year comprised of twelve 30-day
months.

Principal, premium, if any, interest and Liquidated Damages, if any, on the
Notes will be payable at the office or agency of the Company maintained for such
purpose within The City of New York or, at the option of the Company, payment of
interest and Liquidated Damages, if any, may be made by check mailed to the
holders of the Notes ("Holders") at their respective addresses set forth in the
register of Holders of Notes; provided that all payments with respect to Notes
the Holders of which have given wire transfer instructions to the Company will
be required to be made by wire transfer of immediately available funds to the
accounts specified by the Holders thereof. Until otherwise designated by the
Company, the Company's office or agency in New York will be the office of the
Trustee maintained for such purpose.

The Notes have been issued in registered form, without coupons, and in
denominations of $1,000 and integral multiples thereof.

The Indenture does not contain any financial covenants or restrictions on
the payment of dividends, the incurrence of Senior Indebtedness or issuance or
repurchase of securities of the Company. The Indenture contains no covenants or
other provisions to afford protection to Holders of the Notes in the event of a
highly leveraged transaction or a change in control of the Company except to the
extent described under "-- Repurchase of Notes at the Option of Holders Upon a
Change of Control."

CONVERSION RIGHTS

The Holder of any Note has the right to convert such Note, or any portion
thereof which is an integral multiple of $1,000, into shares of Common Stock of
the Company at any time prior to maturity (unless earlier redeemed or
repurchased), initially at the conversion price stated on the cover page hereof
(which is equivalent to a conversion rate of 70.985 shares per $1,000 principal
amount of Notes), subject to adjustment as described below (the "Conversion
Price"). The right to convert Notes called for redemption will terminate at the
close of business on the Business Day immediately preceding the Redemption Date
(as defined below) (unless the Company defaults in making the payments due upon
redemption, in which case the conversion right shall not terminate until the
close of business on the date such default is cured and such Notes are
redeemed). A Note for which a Holder has delivered a notice exercising the
option of such Holder to require the Company to repurchase such Note may be
converted only if such notice is withdrawn by a written notice of withdrawal
delivered by such Holder to the Company (or an agent designated by the Company
for such purpose) prior to the close of business on the Repurchase Date (as
defined below) in accordance with the terms of the Indenture. The Notes are
convertible at the offices or agencies of the Company maintained for such
purposes in The City of New York.

The Conversion Price is subject to adjustment upon the occurrence of
certain events, including (i) the issuance of shares of Common Stock as a
dividend or distribution on the Common Stock; (ii) the subdivision, combination
or reclassification of the outstanding Common Stock; (iii) the issuance to all
or substantially all holders of Common Stock of rights, warrants or options to
subscribe for or purchase Common Stock (or securities convertible into Common
Stock) at a price per share less than the then current market price per

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share, as defined in the Indenture; (iv) the distribution of shares of Capital
Stock of the Company (other than Common Stock), evidences of indebtedness or
other assets (excluding dividends payable exclusively in cash) to all or
substantially all holders of Common Stock; (v) the distribution to all or
substantially all of the holders of Common Stock of rights or warrants to
subscribe for Capital Stock (other than Common Stock) at a price per share less
than the then current market price per share of such Capital Stock; (vi) the
issuance of Common Stock for a price per share less than the current market
price per share (determined as set forth below) on the date the Company fixes
the offering price of such additional shares (other than issuances of Common
Stock under certain employee benefit plans of the Company and certain other
issuances described in the Indenture); (vii) the distribution, by dividend or
otherwise, of cash (excluding any cash portion of a distribution resulting in an
adjustment pursuant to clause (iv) above) to all holders of Common Stock in an
aggregate amount that, combined together with (A) all other distributions of
cash that did not trigger a Conversion Price adjustment to all holders of Common
Stock within the 12 months preceding the date fixed for determining the
shareholders entitled to such distribution plus (B) any cash and the fair market
value of consideration that did not trigger a Conversion Price adjustment
payable in respect of any tender offer by the Company or any of its subsidiaries
for Common Stock (as described in clause (viii) below) consummated within the 12
months preceding the date fixed for determining the shareholders entitled to
such distribution, exceeds 15% of the product of the current market price per
share (determined as set forth below) on the date fixed for the determination of
shareholders entitled to receive such distribution times the number of shares of
Common Stock outstanding on such date; and (viii) the completion of a tender
offer made by the Company or any of its subsidiaries for Common Stock involving
an aggregate consideration that, together with (A) any cash and the fair market
value of any consideration that did not trigger a Conversion Price adjustment
paid or payable in respect of any previous tender offer by the Company or its
subsidiary for Common Stock consummated with the 12 months preceding the
consummation of such tender offer plus (B) the aggregate amount of any
distribution of cash that did not trigger a Conversion Price adjustment (as
described in clause (vii) above) to all holders of Common Stock within the 12
months preceding the consummation of such tender offer, exceeds 15% of the
product of the current market price per share (determined as set forth below)
immediately prior to the expiration of such offer times the number of shares of
Common Stock outstanding at the expiration of such offer. In the event of a
distribution to all or substantially all holders of Common Stock of rights to
subscribe for additional shares of the Company's Capital Stock (other than those
referred to in clause (iii) above), the Company may, instead of making an
adjustment in the Conversion Price, make proper provisions so that each holder
of a Note who converts such Note after the record date for such distribution and
prior to the expiration or redemption of such rights shall be entitled to
receive upon such conversion, in addition to shares of Common Stock, an
appropriate number of such rights. No adjustment of the Conversion Price will be
made until cumulative adjustments amount to one percent or more of the
Conversion Price as last adjusted.

If any Note is converted between the Record Date for the payment of
interest and the next succeeding Interest Payment Date, such Note must be
accompanied by funds equal to the interest payable on such succeeding Interest
Payment Date on the principal amount so converted (unless such Note shall have
been called for redemption, in which case no such payment shall be required),
and the interest on the principal amount of the Note being converted will be
paid on such next succeeding Interest Payment Date to the registered holder of
such Note on the immediately preceding Record Date, except as provided in the
Indenture. A Note converted on an Interest Payment Date need not be accompanied
by any payment, and the interest on the principal amount of the Note being
converted will be paid on such Interest Payment Date to the registered holder of
such Note on the immediately preceding Record Date. Subject to the aforesaid
right of the registered holder to receive interest, no payment or adjustment
will be made on conversion for interest accrued on the converted Note or for
dividends on the Common Stock issued on conversion. Fractional shares of Common
Stock shall not be issued upon conversion, but, in lieu thereof, the Company
will pay a cash adjustment based upon the market price of the Common Stock on
the first business day prior to the day of conversion, as provided in the
Indenture.

In the Indenture, the "current market price" per share of Common Stock on
any date shall be deemed to be the average of the Daily Market Prices for the
shorter of (i) 30 consecutive Business Days ending on the last full trading day
on the exchange or market referred to in determining such Daily Market Prices
prior to

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the time of determination or (ii) the period commencing on the date next
succeeding the first public announcement of the issuance of such rights or
warrants or such distribution through such last full trading day prior to the
time of determination.

In case of any consolidation or merger of the Company with or into any
other corporation, or in the case of any consolidation or merger of another
corporation into the Company in which the Company is the surviving corporation,
involving in either case a reclassification, conversion, exchange or
cancellation of shares of Common Stock, or any sale or transfer of all or
substantially all of the assets of the Company, the Holder of each Note shall,
after such consolidation, merger, sale or transfer, have the right to convert
such Note into the kind and amount of securities or other property, which may
include cash, which such Holder would have been entitled to receive upon such
consolidation, merger, sale or transfer if such Holder had held the Common Stock
issuable upon the conversion of such Note immediately prior to the effective
date of such consolidation, merger, sale or transfer.

OPTIONAL REDEMPTION BY THE COMPANY

The Notes are not redeemable at the Company's option prior to August 15,
2001. Thereafter, the Notes are subject to redemption at the option of the
Company, in whole or in part (in any integral multiple of $1,000), upon not less
than 30 nor more than 60 days' notice, at the following redemption prices
(expressed as percentages of principal amount), if redeemed during the 12-month
period beginning on August 15 of the years indicated:

<TABLE>
<CAPTION>
YEAR PERCENTAGE
------------------------------------------------------------------ ----------
<S> <C>
2001.............................................................. 101.179%
2002 and thereafter............................................... 100.000
</TABLE>

in each case together with accrued but unpaid interest and Liquidated Damages,
if any, to the redemption date (subject to the right of Holders of record on the
relevant record date to receive interest due on an Interest Payment Date that is
on or prior to the Redemption Date).

If less than all of the Notes are to be redeemed at any time, selection of
Notes for redemption will be made by the Trustee in compliance with the
requirements of the principal national securities exchange or national market
system, if any, on which the Notes are listed, or, if the Notes are not so
listed, on a pro rata basis, by lot or by such other method as the Trustee shall
deem fair and appropriate; provided that no Notes of $1,000 principal amount or
less shall be redeemed in part. Notice of any redemption will be sent, by
first-class mail, at least 30 days and not more than 60 days prior to the date
fixed for redemption, to the Holder of each Note to be redeemed to such Holder's
last address as then shown upon the registry books of the Registrar. The notice
of redemption must state the Redemption Date, the Redemption Price and the
amount of accrued interest to be paid. Any notice that relates to a Note to be
redeemed in part only must state the portion of the principal amount equal to
the unredeemed portion thereof and must state that on and after the Redemption
Date, upon surrender of such Note, a new Note or Notes in principal amount equal
to the unredeemed portion thereof will be issued. On and after the Redemption
Date, interest will cease to accrue on the Notes or portion thereof called for
redemption, unless the Company defaults in its obligations with respect thereto.

The Notes will not have the benefit of any sinking fund.

REPURCHASE OF NOTES AT THE OPTION OF HOLDERS UPON A CHANGE OF CONTROL

The Indenture provides that in the event that a Change of Control (as
defined below) has occurred, each Holder will have the right, at such Holder's
option, pursuant to an irrevocable and unconditional offer by the Company (the
"Repurchase Offer"), to require the Company to repurchase all or any part of
such Holder's Notes (provided, that the principal amount of such Notes must be
$1,000 or an integral multiple thereof) on the date (the "Repurchase Date") that
is no later than 60 days after the occurrence of such Change of Control at a
cash price equal to 101% of the principal amount thereof, together with accrued
and unpaid interest and Liquidated Damages, if any, to the Repurchase Date (the
"Repurchase Price"). The Repurchase Offer shall be made within 30 days following
a Change of Control and shall remain open for a period specified

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<PAGE> 78

by the Company but not less than 20 Business Days following its commencement
(the "Repurchase Offer Period"). Upon expiration of the Repurchase Offer Period,
the Company shall purchase all Notes tendered in response to the Repurchase
Offer in the manner described below. If required by applicable law, the
Repurchase Date and the Repurchase Offer Period may be extended to the extent
required; however, if so extended, it shall nevertheless constitute an Event of
Default if the Repurchase Date does not occur within 90 days of the Change of
Control.

The Indenture provides that a "Change of Control" will be deemed to have
occurred when: (i) any "person" or "group" (as such terms are used for purposes
of Sections 13(d) and 14(d) of the Exchange Act, whether or not applicable),
other than a Permitted Holder, is or becomes the "beneficial owner," directly or
indirectly, of shares representing more than 50% of the combined total voting
power of the then outstanding securities entitled to vote generally in elections
of directors of the Company ("Voting Stock"), (ii) the Company consolidates with
or merges into any other person or conveys, transfers or leases, whether
directly or indirectly, all or substantially all of its assets to any person, or
any other person merges into the Company, and, in the case of any such
transaction, the outstanding Common Stock of the Company is changed or exchanged
as a result, unless the shareholders of the Company immediately before such
transaction own, directly or indirectly immediately following such transaction,
at least a majority of the combined voting power of the outstanding voting
securities of the corporation resulting from such transaction in substantially
the same proportion inter se as their ownership of the Voting Stock immediately
before such transaction, (iii) at any time the Continuing Directors (as defined
below) do not constitute the majority of the Board of Directors of the Company
(or, if applicable, a successor corporation to the Company), or (iv) the Common
Stock of the Company (or other common stock into which the Notes are then
convertible) is neither listed for trading on a United States national
securities exchange or approved for trading on an established automatic
over-the-counter trading market in the United States. "Continuing Directors"
means, as of any date of determination, any member of the Board of Directors of
the Company who (i) was a member of the Board of Directors on the date of the
Indenture or (ii) was nominated for election or elected to such Board of
Directors with the approval of a majority of the Continuing Directors who were
members of the Board of Directors at the time of such nomination or election.

On or before the Repurchase Date, the Company will (i) accept for payment
Notes or portions thereof properly tendered pursuant to the Repurchase Offer,
(ii) deposit with the Paying Agent cash sufficient to pay the Repurchase Price
of all Notes so tendered and (iii) deliver to the Trustee Notes so accepted,
together with an Officers' Certificate listing the Notes or portions thereof
being purchased by the Company. The Paying Agent will promptly mail to the
Holders of Notes so accepted payment in an amount equal to the Repurchase Price
(together with accrued and unpaid interest), and the Trustee will promptly
authenticate and mail or deliver to such Holders a new Note or Notes equal in
principal amount to any unpurchased portion of the Notes surrendered. Any Notes
not so accepted will be promptly mailed or delivered by the Company to the
Holder thereof. The Company will publicly announce the results of the Repurchase
Offer on or as soon as practicable after the Repurchase Date.

The phrase "all or substantially all" off the assets of the Company is
likely to be interpreted by reference to applicable state law at the relevant
time, and will be dependent on the facts and circumstances existing at such
time. As a result, there may be a degree of uncertainty in ascertaining whether
a sale or transfer of "all or substantially all" of the assets of the Company
has occurred. In addition, no assurances can be given that the Company will be
able to acquire the Notes tendered upon the occurrence of a Change of Control.

For purposes of the definition of Change of Control, (i) the terms "person"
and "group" shall have the meaning used for purposes of Rules 13d-3 and 13d-5 of
the Exchange Act as in effect on the Issuance Date, whether or not applicable;
and (ii) the term "beneficial owner" shall have the meaning used in Rules 13d-3
and 13d-5 under the Exchange Act as in effect on the Issuance Date, whether or
not applicable, except that a "person" shall be deemed to have "beneficial
ownership" of all shares that any such person has the right to acquire, whether
such right is exercisable immediately or only after the passage of time or upon
the occurrence of certain events.

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<PAGE> 79

The Change of Control purchase feature of the Notes may make more difficult
or discourage a takeover of the Company, and, thus, the removal of incumbent
management. The Change of Control purchase feature resulted from negotiations
between the Company and the Initial Purchasers.

The provisions of the Indenture relating to a Change of Control may not
afford the Holders protection in the event of a highly leveraged transaction,
reorganization, restructuring, merger, spin-off or similar transaction that may
adversely affect Holders, if such transaction does not constitute a Change of
Control, as set forth above. In addition, the Company may not have sufficient
financial resources available to fulfill its obligation to repurchase the Notes
upon a Change of Control or to repurchase other debt securities of the Company
or its Subsidiaries providing similar rights to the holders thereof.

To the extent applicable and if required by law, the Company will comply
with Section 14 of the Exchange Act and the provisions of Regulation 14E and any
other tender offer rules under the Exchange Act and any other securities laws,
rules and regulations that may then be applicable to any offer by the Company to
purchase the Notes at the option of Holders upon a Change in Control.

The right to require the Company to repurchase Notes as a result of the
occurrence of a Change of Control could create an event of default under Senior
Indebtedness as a result of which any repurchase could, absent a waiver, be
blocked by the subordination provision of the Notes. See "-- Subordination."
Failure of the Company to repurchase the Notes when required would result in an
Event of Default with respect to the Notes whether or not such repurchase is
permitted by the subordination provisions.

SUBORDINATION

The payment of principal, premium, if any, interest and Liquidated Damages,
if any, on the Notes is subordinated in right of payment, as set forth in the
Indenture, to the prior payment in full of all Senior Indebtedness, whether
outstanding on the date of the Indenture or thereafter incurred. Upon any
distribution to the creditors of the Company in a liquidation or dissolution of
the Company or in a bankruptcy, reorganization, insolvency, receivership or
other similar proceeding relating to the Company or its property, an assignment
for the benefit of creditors or any marshalling of the Company's assets and
liabilities, the holders of the Senior Indebtedness will be entitled to receive
payment in full of all obligations in respect of such Senior Indebtedness before
the Holders will be entitled to receive any payment with respect to the Notes.

In the event of any acceleration of the Notes because of an Event of
Default, the holders of any Senior Indebtedness then outstanding would be
entitled to payment in full of all obligations in respect of such Senior
Indebtedness before the Holders are entitled to receive any payment or
distribution in respect of the Notes. The Indenture further requires that the
Company promptly notify holders of Senior Indebtedness if payment of the Notes
is accelerated because of an Event of Default.

The Company also may not make any payment upon or in respect of the Notes
if (i) a default in the payment of the principal of, premium, if any, interest,
rent or other Obligations in respect of Designated Senior Indebtedness occurs
and is continuing beyond any applicable period of grace or (ii) any other
default occurs and is continuing with respect to Designated Senior Indebtedness
that permits holders of the Designated Senior Indebtedness as to which such
default relates to accelerate its maturity and the Trustee receives a notice of
such default (a "Payment Blockage Notice") from the Company or other person
permitted to give such notice under the Indenture. Payments on the Notes may and
shall be resumed (a) in the case of a payment default, upon the date on which
such default is cured or waived and (b) in the case of a nonpayment default, the
earlier of the date on which such nonpayment default is cured or waived or 179
days after the date on which the applicable Payment Blockage Notice is received.
No new period of payment blockage may be commenced unless and until (i) 365 days
shall have elapsed since the effectiveness of the immediately prior Payment
Blockage Notice and (ii) all scheduled payments of principal, premium, if any,
and interest on the Notes that have come due have been paid in full in cash. No
nonpayment default that existed or was continuing on the date of delivery of any
Payment Blockage Notice to the Trustee shall be, or be made, the basis of a
subsequent Payment Blockage Notice.

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<PAGE> 80

By reason of the subordination provisions described above, in the event of
the Company's liquidation or insolvency, holders of Senior Indebtedness may
receive more, ratably, and Holders of the Notes may receive less, ratably, than
the other creditors of the Company. Such subordination will not prevent the
occurrences of any Event of Default under the Indenture.

The Notes are obligations exclusively of the Company. Since certain
operations of the Company are conducted through its Subsidiaries, the cash flow
and the consequent ability to service debt, including the Notes, of the Company,
are dependent upon the earnings of its Subsidiaries and the distribution of
those earnings to, or upon loans or other payments of funds by those
Subsidiaries to, the Company. The payment of dividends and the making of loans
and advances to the Company by its Subsidiaries may be subject to statutory or
contractual restrictions, are dependent upon the earnings of those Subsidiaries
and are subject to various business considerations.

Any right of the Company to receive assets of any of its Subsidiaries upon
their liquidation or reorganization (and the consequent right of the Holders of
the Notes to participate in those assets) will be effectively subordinated to
the claims of that Subsidiary's creditors (including trade creditors), except to
the extent that the Company is itself recognized as a creditor of such
Subsidiary, in which case the claims of the Company would still be subordinate
to any security interests in the assets of such Subsidiary and any indebtedness
of such Subsidiary senior to that held by the Company.

As of August 31, 1996, the Company had approximately $22,772,000 of
indebtedness outstanding that would have constituted Senior Indebtedness
(excluding liabilities of a type not required to be reflected as a liability on
the balance sheet of the Company in accordance with GAAP) and approximately
$1,088,000 of indebtedness outstanding and other obligations of Subsidiaries of
the Company (excluding intercompany liabilities and liabilities of a type not
required to be reflected as a liability on the balance sheet of such
Subsidiaries in accordance with GAAP) as to which the Notes would have been
structurally subordinated. The Indenture does not limit the amount of additional
indebtedness, including Senior Indebtedness, which the Company is permitted to
create, incur, assume or guarantee, nor does the Indenture limit the amount of
indebtedness and other liabilities which any Subsidiary is permitted to create,
incur, assume or guarantee.

In the event that, notwithstanding the foregoing, the Trustee or any Holder
receives any payment or distribution of assets of the Company of any kind in
contravention of any of the terms of the Indenture, whether in cash, property or
securities, including, without limitation by way of set-off or otherwise, in
respect of the Notes before all Senior Indebtedness is paid in full, then such
payment or distribution will be held by the recipient in trust for the benefit
of holders of Senior Indebtedness, and will be immediately paid over or
delivered to the holders of Senior Indebtedness or their representative or
representatives to the extent necessary to make payment in full of all Senior
Indebtedness remaining unpaid, after giving effect to any concurrent payment or
distribution, or provision therefor, to or for the holders of Senior
Indebtedness.

EVENTS OF DEFAULT AND REMEDIES

The Indenture provides that each of the following constitutes an Event of
Default: (i) default for 30 days in the payment when due of interest on, or
Liquidated Damages with respect to, the Notes (whether or not prohibited by the
subordination provisions of the Indenture); (ii) default in payment when due of
the principal of or premium, if any, on the Notes (whether or not prohibited by
the subordination provisions of the Indenture); (iii) failure by the Company to
comply with the provisions described under the caption "-- Repurchase of Notes
at the Option of Holders Upon a Change of Control"; (iv) failure by the Company
for 60 days after notice to comply with any of its other agreements in the
Indenture or the Notes; (v) default under any mortgage, indenture or instrument
under which there is issued or by which there is secured or evidenced any
indebtedness for money borrowed by the Company or any of its Subsidiaries (or
the payment of which is guaranteed by the Company or any of its Subsidiaries)
whether such indebtedness or guarantee now exists, or is created after the date
of the Indenture, which default (a) is caused by a failure to pay principal of
or premium, if any, or interest on such indebtedness prior to the expiration of
the grace period provided in such indebtedness on the date of such default (a
"Payment Default") or (b) results in the acceleration of such indebtedness prior
to its express maturity and, in each case, the principal amount of any such
indebtedness,

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<PAGE> 81

together with the principal amount of any other such indebtedness under which
there has been a Payment Default or the maturity of which has been so
accelerated, is an amount which, in the aggregate, is equal to or greater than
$10 million; (vi) failure by the Company or any of its Subsidiaries to pay final
judgments in an amount which, in the aggregate, exceeds $10 million and which
judgments are not paid, discharged, bonded or stayed within 60 days after their
entry; and (vii) certain events of bankruptcy or insolvency with respect to the
Company or any of its Significant Subsidiaries.

If any Event of Default occurs and is continuing, the Trustee or the
Holders of at least 25% in principal amount of the then outstanding Notes may
declare all the Notes to be due and payable immediately. Notwithstanding the
foregoing, in the case of an Event of Default arising from certain events of
bankruptcy or insolvency, with respect to the Company, any Significant
Subsidiary or any group of Subsidiaries that, taken together, would constitute a
Significant Subsidiary, all outstanding Notes will become due and payable
without further action or notice. Holders of the Notes may not enforce the
Indenture or the Notes except as provided in the Indenture. Subject to certain
limitations, Holders of a majority in principal amount of the then outstanding
Notes may direct the Trustee in its exercise of any trust or power. The Trustee
may withhold from Holders of the Notes notice of any continuing Default or Event
of Default (except a Default or Event of Default relating to the payment of
principal or interest) if it determines that withholding notice is in their
interest.

The Holders of a majority in aggregate principal amount of the Notes then
outstanding, by notice to the Trustee, may on behalf of all Holders waive any
existing Default or Event of Default and its consequences under the Indenture
except a continuing Default or Event of Default in the payment of interest on,
or the principal of, the Notes.

The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying such Default or Event of Default.

LIMITATION ON MERGER, SALE OR CONSOLIDATION

The Indenture provides that the Company may not consolidate or merge with
or into, or sell, assign, transfer, lease, convey or otherwise dispose of all or
substantially all of its properties or assets in one or more related
transactions, to another corporation, Person or entity unless (i) the Company is
the surviving corporation, Person or entity formed by or surviving any such
consolidation or merger (if other than the Company) or to which such sale,
assignment, transfer, lease, conveyance or other disposition shall have been
made is a corporation organized or existing under the laws of the United States,
any state thereof or the District of Columbia; (ii) the entity or Person formed
by or surviving any such consolidation or merger (if other than the Company) or
the entity or Person to which such sale, assignment, transfer, lease, conveyance
or other disposition shall have been made assumes all the obligations of the
Company under the Notes and the Indenture pursuant to a supplemental indenture
in a form reasonably satisfactory to the Trustee; and (iii) immediately after
such transaction no Default or Event of Default exists.

REPORTS

The Indenture provides that, whether or not required by the rules and
regulations of the Commission, so long as any Notes are outstanding, the Company
will furnish to the Holders (i) all quarterly and annual financial information
that would be required to be contained in a filing with the Commission on Forms
10-Q and 10-K if the Company were required to file such Forms, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and, with respect to the annual information only, an audit report
thereon by the Company's certified independent accountants and (ii) all current
reports that would be required to be filed with the Commission on Form 8-K if
the Company were required to file such reports. In addition, whether or not
required by the rules and regulations of the Commission, the Company will file a
copy of all such information and reports with the Commission for public
availability (unless the Commission will not accept such a filing). In addition,
the Company has agreed to furnish to the Holders or beneficial holders of the
Notes or the underlying Common Stock and prospective purchasers of the Notes or

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<PAGE> 82

the underlying Common Stock designated by the Holders of the Notes or the
underlying Common Stock, upon their request, the information required to be
delivered pursuant to Rule 144A(d)(4) under the Securities Act until such time
as such securities are no longer "restricted securities" within the meaning of
Rule 144 under the Securities Act.

NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND SHAREHOLDERS

No director, officer, employee, incorporator or shareholder of the Company,
as such, shall have any liability for any obligations of the Company under the
Notes or the Indenture or for any claim based on, in respect of, or by reason
of, such obligations or their creation. Each Holder, by accepting a Note, waives
and releases all such liability. The waiver and release are part of the
consideration for issuance of the Notes. Such waiver may not be effective to
waive liabilities under the federal securities laws and it is the view of the
Commission that such a waiver is against public policy.

TRANSFER AND EXCHANGE

A Holder may transfer or exchange Notes in accordance with the Indenture.
The Registrar and the Trustee may require a Holder, among other things, to
furnish appropriate endorsements and transfer documents and the Company may
require a Holder to pay any taxes and fees required by law or permitted by the
Indenture. The Company is not required to transfer or exchange any Note selected
for redemption. Also, the Company is not required to transfer or exchange any
Note for a period of 15 days before a selection of Notes to be redeemed.

The registered Holder of a Note is treated as the owner of the Note for all
purposes.

AMENDMENT, SUPPLEMENT AND WAIVER

Except as provided in the next two succeeding paragraphs, the Indenture or
the Notes may be amended or supplemented with the consent of the Holders of at
least a majority in principal amount of the Notes then outstanding (including,
without limitation, consents obtained in connection with a purchase of, or
tender offer or exchange offer for, the Notes), and any existing default or
compliance with any provision of the Indenture or the Notes may be waived with
the consent of the Holders of a majority in principal amount of the then
outstanding Notes (including consents obtained in connection with a tender offer
or exchange offer for Notes).

Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any Notes held by a non-consenting Holder): (i) reduce the
principal amount of Notes whose Holders must consent to an amendment, supplement
or waiver, (ii) reduce the principal of or change the fixed maturity of any Note
or alter the provisions with respect to the redemption of the Notes (other than
provisions relating to the covenants described above under the caption
"-- Repurchase of Notes at the Option of Holders Upon a Change of Control"),
(iii) reduce the rate of or change the time for payment of interest on any Note,
(iv) waive a Default or Event of Default in the payment of principal of or
premium, if any, or interest or Liquidated Damages, if any, on the Notes (except
a rescission of acceleration of the Notes by the Holders of at least a majority
in aggregate principal amount of the Notes and a waiver of the payment default
that resulted from such acceleration), (v) make any Note payable in money other
than that stated in the Notes, (vi) make any change in the provisions of the
Indenture relating to waivers of past Defaults or the rights of Holders of Notes
to receive payments of principal of, premium, if any, interest or Liquidated
Damages, if any, on the Notes, (vii) waive a redemption payment with respect to
any Note (other than a payment required by one of the covenants described above
under the caption "-- Repurchase of Notes at the Option of Holders Upon a Change
of Control") (viii) modify the conversion or subordination provisions of the
Indenture in a manner adverse to the Holders of the Notes or (ix) make any
change in the foregoing amendment and waiver provisions.

Notwithstanding the foregoing, without the consent of any Holder, the
Company and the Trustee may amend or supplement the Indenture or the Notes to
cure any ambiguity, defect or inconsistency, to provide for uncertificated Notes
in addition to or in place of certificated Notes, to provide for the assumption
of the

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Company's obligations to Holders in the case of a merger or consolidation, to
make any change that would provide any additional rights or benefits to the
Holders or that does not adversely affect the legal rights under the Indenture
of any such Holder, or to comply with requirements of the Commission in order to
effect or maintain the qualification of the Indenture under the Trust Indenture
Act.

CONCERNING THE TRUSTEE

The Indenture contains certain limitations on the rights of the Trustee,
should it become a creditor of the Company, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any such
claim as security or otherwise. The Trustee is permitted to engage in other
transactions; however, if it acquires any conflicting interest it must eliminate
such conflict within 90 days, apply to the Commission for permission to continue
or resign.

The Holders of a majority in principal amount of the then outstanding Notes
have the right to direct the time, method and place of conducting any proceeding
for exercising any remedy available to the Trustee, subject to certain
exceptions. The Indenture provides that in case an Event of Default shall occur
(which shall not be cured), the Trustee will be required, in the exercise of its
power, to use the degree of care of a prudent man in the conduct of his own
affairs. Subject to such provisions, the Trustee is under no obligation to
exercise any of its rights or powers under the Indenture at the request of any
Holder, unless such Holder shall have offered to the Trustee security and
indemnity satisfactory to it against any loss, liability or expense.

BOOK-ENTRY, DELIVERY AND FORM

The Notes sold within the United States to qualified institutional buyers
("Qualified Institutional Buyers") have been issued in the form of a Rule 144A
Global Note. The Rule 144A Global Note has been deposited with, or on behalf of,
The Depository Trust Company ("DTC") and registered in the name of DTC or its
nominee (the "Global Note Holder"). Except as set forth below, the Rule 144A
Global Note may be transferred, in whole and not in part, only to DTC or another
nominee of DTC. Investors may hold their beneficial interests in the Rule 144A
Global Note directly through DTC if they are Participants (as described below)
in such system or indirectly through organizations that are Participants in such
system.

The Notes originally sold to "accredited investors" (as defined in Rule
501(a)(l), (2), (3), (4) or (7) under the Securities Act and referred to as
"Accredited Investors") who are not Qualified Institutional Buyers have been
issued and registered in certificated form without coupons and bear a legend
containing restrictions on transfers (the "Certificated Notes"). Certificated
Notes are not eligible to be exchanged for an interest in a Global Note.

The Notes sold outside of the United States in reliance on Regulation S
under the Securities Act are represented by a Regulation S Permanent Global
Note. The Regulation S Permanent Global Note will be deposited with a custodian
and will be registered in the name of a nominee of DTC. Cedel Bank, societe
anonyme ("Cedel Bank"), and the Euroclear System ("Euroclear") will hold
beneficial interests in the Regulation S Permanent Global Note on behalf of
their participants through their respective depositaries, which in turn will
hold such beneficial interests in the Regulation S Permanent Global Note in
participants' securities accounts in the depositaries' names on the books of
DTC. In addition, Notes sold outside of the United States in reliance on
Regulation S under the Securities Act may, to the extent permitted by Regulation
S, be issued and registered in certificated form without coupons and will bear a
legend containing restrictions on transfers (the "Regulation S Certificated
Notes"). Any such Regulation S Certificated Notes will be subject to limitations
on any further transfer or exchange in a manner consistent with the requirements
of Regulation S.

A beneficial interest in the Regulation S Permanent Global Note may be
transferred to a person who takes delivery in the form of an interest in the
Rule 144A Global Note only upon receipt by the Trustee of a written
certification from the transferor in the form required by the Indenture to the
effect that such transfer is being made (i)(a) to a person whom the transferor
reasonably believes is a Qualified Institutional Buyer in a transaction meeting
the requirements of Rule 144A or (b) pursuant to another exemption from the
registration requirements under the Securities Act (in which case such
certificate must be accompanied by an

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opinion of counsel regarding the availability of such exemption) and (ii) in
accordance with all applicable securities laws of any state of the United States
or any other jurisdiction. Beneficial interests in the Rule 144A Global Note may
be transferred to a person who takes delivery in the form of an interest in the
Regulation S Permanent Global Note, whether before, on or after the 40-day
restricted period, only upon receipt by the Trustee of a written certification
from the transferor in the form required by the Indenture to the effect that
such transfer is being made in accordance with Regulation S. Any beneficial
interest in one of the Global Notes that is transferred to a person who takes
delivery in the form of an interest in another Global Note will, upon transfer,
cease to be an interest in such Global Note and become an interest in such other
Global Note and, accordingly, will thereafter be subject to all transfer
restrictions and other procedures applicable to beneficial interests in such
other Global Note for as long as it remains such an interest.

Because of time-zone differences, the securities accounts of Euroclear or
Cedel Bank participants (each, a "Member Organization") purchasing an interest
in a Global Note from a Participant that is not a Member Organization will be
credited during the securities settlement processing day (which must be a
business day for Euroclear or Cedel Bank, as the case may be) immediately
following the DTC settlement date. Transactions in interests in a Global Note
settled during any securities settlement processing day will be reported to the
relevant Member Organization on the same day. Cash received in Euroclear or
Cedel Bank as a result of sales of interests in a Global Note by or through a
Member Organization to a Participant that is not a Member Organization will be
received with value on the DTC settlement date, but will not be available in the
relevant Euroclear or Cedel Bank cash account until the business day following
settlement at DTC. The Notes are eligible for trading in the Private Offerings,
Resales and Trading through Automated Linkages ("PORTAL") Market, the National
Association of Securities Dealers' screen-based automated market for trading of
securities eligible for resale under Rule 144A.

Subject to compliance with the transfer restrictions applicable to the
Global Notes described above and in the Indenture, cross-market transfers
between holders of interests in the Rule 144A Global Note, on the one hand, and
direct or indirect account holders at a Member Organization holding interests in
the Regulation S Permanent Global Note, on the other, will be effected through
the DTC in accordance with its rules and the rules of Euroclear or Cedel Bank,
as applicable. Such cross-market transactions will require, among other things,
delivery of instructions by such Member Organization to Euroclear or Cedel Bank,
as the case may be, in accordance with the rules and procedures and within
deadlines (Brussels time) established in Euroclear or Cedel Bank, as the case
may be. If the transaction complies with all relevant requirements, Euroclear or
Cedel Bank, as the case may be, will then deliver instructions to its depositary
to take action to effect final settlement on its behalf.

DTC is a limited-purpose trust company that was created to hold securities
for its participating organizations (collectively, the "Participants") and to
facilitate the clearance and settlement of transactions in such securities
between Participants through electronic book-entry changes in accounts thereof.
DTC's Participants include securities brokers and dealers (including the Initial
Purchasers), banks and trust companies, clearing corporations and certain other
organizations. Access to DTC's system is also available to other entities such
as banks, brokers, dealers and trust companies (collectively, the "Indirect
Participants") that clear through or maintain a custodial relationship with a
Participant, either directly or indirectly. Persons who are not Participants may
beneficially own securities held by or on behalf of DTC only through
Participants or Indirect Participants.

The Company expects that pursuant to procedures established by DTC (i) upon
the issuance of the Rule 144A Global Notes, or the Regulation S Permanent Global
Notes (each, a "Global Note" and together, the "Global Notes"), DTC will credit
the accounts of Participants designated by the Initial Purchaser with portions
of the principal amount of the Global Notes and (ii) ownership of the Notes
evidenced by the Global Notes will be shown on, and the transfer of ownership
thereof will be effected only through, records maintained by DTC (with respect
to the interests of the Participants), Participants and Indirect Participants.
Prospective purchasers are advised that the laws of some states require that
certain persons take physical delivery in definitive form of securities that
they own. Consequently, the ability to transfer Notes evidenced by the Global
Notes will be limited to such extent. For certain other restrictions on the
transferability of the Notes, see "Notice to Investors."

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So long as the Global Note Holder is the registered owner of any Notes, the
Global Note Holder will be considered the sole Holder under the Indenture of any
Notes evidenced by the Global Notes. Beneficial owners of Notes evidenced by the
Global Notes are considered the owners or holders thereof under the Indenture
for any purpose, including with respect to the giving of any directions,
instructions or approvals to the Trustee thereunder. Neither the Company nor the
Trustee has any responsibility or liability for any aspect of the records of DTC
or for maintaining, supervising or reviewing any records of DTC relating to the
Notes.

Payments in respect of the principal of, premium, if any, interest and
Liquidated Damages, if any, on any Notes registered in the name of the Global
Note Holder on the applicable Record Date are payable by the Trustee to or at
the direction of the Global Note Holder in its capacity as the registered holder
under the Indenture. Under the terms of the Indenture, the Company and the
Trustee may treat the persons in whose names Notes, including the Global Notes,
are registered as the owners thereof for the purpose of receiving such payments.
Consequently, neither the Company nor the Trustee has or will have any
responsibility or liability for the payment of such amounts to beneficial owners
of Notes (including principal, premium, if any, interest and Liquidated Damages,
if any). The Company believes, however, that it is currently the policy of DTC
to immediately credit the accounts of the relevant Participants with such
payments, in amounts proportionate to their respective holdings of beneficial
interests in the relevant security as shown on the records of DTC. Payments by
Participants and Indirect Participants to the beneficial owners of Notes will be
governed by standing instructions and customary practice and will be the
responsibility of Participants or Indirect Participants.

CERTIFICATED SECURITIES

Subject to certain conditions, any person having a beneficial interest in
the Global Notes may, upon request to the Trustee, exchange such beneficial
interest for Notes evidenced by registered, definitive Certificated Notes. Upon
any such issuance, the Trustee is required to register such Certificated Notes
in the name of, and cause the same to be delivered to, such person or persons
(or the nominee of any thereof). All such Certificated Notes would be subject to
the legend requirements described herein under "Notice to Investors." In
addition, if (i) the Company notifies the Trustee in writing that DTC is no
longer willing or able to act as a depositary and the Company is unable to
locate a qualified successor within 90 days or (ii) the Company, at its option,
notifies the Trustee in writing that it elects to cause the issuance of Notes in
the form of Certificated Notes under the Indenture, then, upon surrender by the
Global Note Holder of its Global Notes, Notes in such form will be issued to
each person that the Global Note Holder and DTC identify as being the beneficial
owner of the related Notes.

Neither the Company nor the Trustee will be liable for any delay by the
Global Note Holder or DTC in identifying the beneficial owners of Notes and the
Company and the Trustee may conclusively rely on, and will be protected in
relying on, instructions from the Global Note Holder or DTC for all purposes.

REGISTRATION RIGHTS; LIQUIDATED DAMAGES

Pursuant to the Registration Rights Agreement, the Company has agreed for
the benefit of the Holders, that (i) it will, at its cost, within 60 days after
the closing of the Private Placement (the "Closing"), file a shelf registration
statement with the Commission with respect to resales of the Notes and the
Conversion Shares, (ii) it will use its best efforts to cause such registration
statement to be declared effective by the Commission within 150 days after the
Closing, and (iii) it will use its best efforts to keep such registration
statement continuously effective under the Securities Act until, subject to
certain exceptions specified in the Registration Rights Agreement, the third
anniversary of the date of the Closing. Pursuant to the Registration Rights
Agreement, the Company filed the Shelf Registration Statement with the
Commission on October 18, 1996 (file no. 333-14427) to register the public offer
and sale of the Notes and the Conversion Shares. The Company will be permitted
to suspend use of the prospectus that is part of the Shelf Registration
Statement during certain periods of time and in certain circumstances relating
to pending corporate developments and public filings with the Commission and
similar events. If (a) the Company had failed to file the Shelf Registration
Statement required by the Registration Rights Agreement on or before the date
specified for such filing, (b) such Shelf Registration Statement is not declared
effective by the Commission on or prior to the

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date specified for such effectiveness (the "Effectiveness Target Date") or (c)
the Shelf Registration Statement is declared effective but thereafter ceases to
be effective or usable in connection with resales of Transfer Restricted
Securities (as defined below) during the periods specified in the Registration
Rights Agreement (each such event referred to in clauses (a) through (c) above a
"Registration Default"), then the Company will pay damages ("Liquidated
Damages") to each Holder, with respect to the first 90-day period immediately
following the occurrence of such Registration Default in an amount equal to $.05
per week per $1,000 aggregate principal amount of the Notes held by such Holder.
The amount of the Liquidated Damages will increase by an additional $.05 per
week per $1,000 aggregate principal amount of the Notes held by each Holder with
respect to each subsequent 90-day period until all Registration Defaults have
been cured, up to a maximum amount of Liquidated Damages of $.25 per week per
$1,000 aggregate principal amount of the Notes held by each Holder. All accrued
Liquidated Damages will be paid by the Company on each Interest Payment Date in
cash. Such payment will be made to the Holder of the Global Notes by wire
transfer of immediately available funds or by federal funds check and to Holders
of Certificated Notes, if any, by wire transfer to the accounts specified by
them or by mailing checks to their registered addresses if no such accounts have
been specified. Following the cure of all Registration Defaults, the accrual of
Liquidated Damages will cease.

For purposes of the foregoing, "Transfer Restricted Securities" means the
Notes and the Conversion Shares until (i) the date on which such Notes or
Conversion Shares have been effectively registered under the Securities Act and
disposed of in accordance with the Shelf Registration Statement, (ii) the date
on which such Notes or Conversion Shares are distributed to the public pursuant
to Rule 144 under the Securities Act (or any similar provision then in effect)
or are saleable pursuant to Rule 144(k) under the Securities Act and all legends
relating to transfer restrictions have been removed or (iii) the date on which
such Notes or Conversion Shares cease to be outstanding.

Holders of Notes will be required to deliver information to be used in
connection with the Shelf Registration Statement within the time periods set
forth in the Registration Rights Agreement in order to have their Notes or the
Common Stock issuable upon exercise thereof included in the Shelf Registration
Statement and benefit from the provisions regarding Liquidated Damages set forth
above.

If the Company determines that it is permissible to do so under applicable
law, in lieu of filing or maintaining the effectiveness of the shelf
registration statement with respect to the Notes, the Company may, at its
option, file with the Commission a registration statement with respect to an
issue of notes identical in all material respects to the Notes (the "New Notes")
except as to transfer restrictions and, upon such registration statement
becoming effective, offer the holders of the Notes the opportunity to exchange
their Notes for the New Notes. The Company has not determined that any such
registered exchange offer is permissible under applicable law, and there can be
no assurance that it will do so in the future.

The Company will provide to each registered holder of the Notes or the
Conversion Shares, who is named in the prospectus and who so requests in
writing, copies of the prospectus which will be a part of the Shelf Registration
Statement, notify each such holder when the Shelf Registration Statement for the
Notes or the Conversion Shares has become effective and take certain other
actions as are required to permit unrestricted resales of the Notes or the
Conversion Shares. A holder of Notes or the Conversion Shares that sells such
securities pursuant to a Shelf Registration Statement generally will be required
to be named as a selling security holder in the related prospectus and to
deliver a prospectus to purchasers, will be subject to certain of the civil
liability provisions under the Securities Act in connection with such sales and
will be bound by the provisions of the Registration Rights Agreement which are
applicable to such a holder (including certain indemnification and contribution
rights and obligations).

SAME-DAY SETTLEMENT AND PAYMENT

The Indenture will require that payments in respect of the Notes
represented by the Global Note (including principal, premium, if any, interest
and Liquidated Damages, if any) be made by wire transfer of immediately
available funds to the accounts specified by the Global Note Holder. With
respect to Certificated Notes, the Company will make all payments of principal,
premium, if any, interest and Liquidated Damages,

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if any, by wire transfer of immediately available funds to the accounts
specified by the Holders thereof or, if no such account is specified, by mailing
a check to each such Holder's registered address. Secondary trading in long-term
notes and debentures of corporate issuers is generally settled in clearing-house
or next-day funds. In contrast, the Notes represented by the Global Note are
eligible to trade in the PORTAL Market and to trade in the DTC's Same-Day Funds
Settlement System, and any permitted secondary market trading activity in such
Notes is, therefore, required by DTC to be settled in immediately available
funds. The Company expects that secondary trading in the Certificated Notes will
also be settled in immediately available funds.

CERTAIN DEFINITIONS

Set forth below are certain defined terms used in the Indenture and the
Registration Rights Agreement. Reference is made to the Indenture and the
Registration Rights Agreement for a full disclosure of all such terms, as well
as any other capitalized terms used herein for which no definition is provided.

"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, shall mean
the possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of such Person, whether through the
ownership of voting securities, by agreement or otherwise.

"Capital Stock" means (i) in the case of a corporation, corporate stock,
(ii) in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock, (iii) in the case of a partnership, partnership interests
(whether general or limited) and (iv) any other interest or participation that
confers on a Person the right to receive a share of the profits and losses of,
or distributions of assets of, the issuing Person.

"Credit Agreement" means that certain Credit Agreement, dated as of
November 8, 1995, by and among the Company, PacNet Inc., Advanced Network
Design, AdVal, Inc., Cel-Tech International Corp. and Transamerica Business
Credit Corporation, as agent for the lenders, as amended, providing for up to
$43 million of revolving credit borrowings, including any related notes,
guarantees, collateral documents, instruments and agreements executed in
connection therewith, and in each case as amended, modified, renewed, refunded,
replaced or refinanced from time to time.

"Default" means any event that is, or with the passage of time or the
giving of notice or both would be, an Event of Default.

"Designated Senior Indebtedness" means any particular Senior Indebtedness
having an outstanding principal amount or commitment in excess of $10 million
with respect to which the instrument creating or evidencing the same or the
assumption or guarantee thereof (or related agreements or documents to which the
Company is a party) expressly provides that such Indebtedness shall be
"Designated Senior Indebtedness" for purposes of the Indenture (provided that
such instrument, agreement or other document may place limitations and
conditions on the right of such Senior Indebtedness to exercise the rights of
Designated Senior Indebtedness.)

"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as have been approved by a significant segment of the accounting
profession, which are in effect from time to time.

"Global Notes" means the Rule 144A Global Note, the Regulation S Temporary
Global Note and the Regulation S Permanent Global Note.

"Indebtedness" means, with respect to any person, all obligations, whether
or not contingent, of such person (i)(a) for borrowed money (including, but not
limited to, any indebtedness secured by a security interest, mortgage or other
lien on the assets of the Company which is (1) given to secure all or part of
the

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purchase price of property subject thereto, whether given to the vendor of such
property or to another, or (2) existing on property at the time of acquisition
thereof), (b) evidenced by a note, debenture, bond or other written instrument,
(c) under a lease required to be capitalized on the balance sheet of the lessee
under GAAP, (d) in respect of letters of credit, bank guarantees or bankers'
acceptances (including reimbursement obligations with respect to any of the
foregoing), (e) with respect to Indebtedness secured by a mortgage, pledge,
lien, encumbrance, charge or adverse claim affecting title or resulting in an
encumbrance to which the property or assets of such person are subject, whether
or not the obligation secured thereby shall have been assumed by or shall
otherwise be such person's legal liability, (f) in respect of the balance of
deferred and unpaid purchase price of any property or assets or (g) under
interest rate or currency swap agreements, cap, floor and collar agreements,
spot and forward contracts and similar agreements and arrangements; (ii) with
respect to any obligation of others of the type described in the preceding
clause (i) or under clause (iii) below assumed by or guaranteed in any manner by
such person, contingent or otherwise (and, without duplication, the obligations
of such person under any such assumptions, guarantees or other such
arrangements); and (iii) any and all deferrals, renewals, extensions,
refinancings and refundings of, or amendments, modifications or supplements to,
any of the foregoing.

"Issuance Date" means the date on which the Notes are originally issued and
authenticated under the Indenture.

"Obligations" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.

"Permitted Designee" means (i) a spouse or child of a Permitted Holder,
(ii) trusts for the benefit of a Permitted Holder or a spouse or child of a
Permitted Holder, (iii) in the event of death or incompetence of a Permitted
Holder, his estate, heirs, executor, administrator, committee or other personal
representative or (iv) any Affiliate of a Permitted Holder.

"Permitted Holders" means Paul Pfleger, John M. Orehek and their Permitted
Designees.

"person" or "Person" means any individual, corporation, limited liability
company, partnership, joint venture, association, joint stock company, trust,
unincorporated organization or government or any agency or political subdivision
thereof.

"Regulation S" means Regulation S promulgated under the Securities Act.

"Regulation S Permanent Global Note" means a permanent global note that is
deposited with and registered in the name of the Depositary or its nominee,
representing a series of Notes sold in reliance on Regulation S.

"Rule 144A" means Rule 144A promulgated under the Securities Act.

"Rule 144A Global Note" means a permanent global note that is deposited
with and registered in the name of the Depositary or its nominee, representing a
series of Notes sold in reliance on Rule 144A.

"Senior Indebtedness" means the principal of, premium, if any, and interest
on, rent under, and any other amounts payable on or in respect of the Credit
Agreement and any other Indebtedness of the Company (including, without
limitation, any Obligations in respect of such Indebtedness and, in the case of
Designated Senior Indebtedness, any interest accruing after the filing of a
petition by or against the Company under any Bankruptcy Law, whether or not
allowed as a claim after such filing in any proceeding under such Bankruptcy
Law), whether outstanding on the date of this Indenture or thereafter created,
incurred, assumed, guaranteed or in effect guaranteed by the Company (including
all deferrals, renewals, extensions or refundings of, or amendments,
modifications or supplements to the foregoing); provided, however, that Senior
Indebtedness does not include (v) Indebtedness evidenced by the Notes, (w) any
liability for federal, state, local or other taxes owed or owing by the Company,
(x) Indebtedness of the Company to any of its Subsidiaries, (y) trade payables
of the Company, and (z) any particular Indebtedness in which the instrument
creating or evidencing the same or the assumption or guarantee thereof (or
related agreements or documents to which the Company is a party) expressly
provides that such Indebtedness shall not be senior in right of payment to, or
is pari passu with, or is subordinated or junior to, the Notes.

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"Significant Subsidiary" means any subsidiary of the Company that would be
a "significant subsidiary" as defined in Article 1, Rule 1-02 of Regulation S-X,
promulgated pursuant to the Securities Act and the Exchange Act, as such
Regulation is in effect on the date of the Indenture.

"Subsidiary" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total voting
power of shares of Capital Stock entitled (without regard to the occurrence of
any contingency) to vote in the election of directors, managers or trustees
thereof is at the time owned or controlled, directly or indirectly, by such
Person or one or more of the other Subsidiaries of that Person (or a combination
thereof) and (ii) any partnership (a) the sole general partner or the managing
general partner of which is such Person or a Subsidiary of such Person or (b)
the only general partners of which are such Person or of one or more
Subsidiaries of such Person (or any combination thereof).

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DESCRIPTION OF CAPITAL STOCK

The Company's Articles provide for authorized capital of 100,000,000
shares, consisting of 90,000,000 shares of Common Stock and 10,000,000 shares of
Preferred Stock, par value $.0001 per share ("Preferred Stock").

COMMON STOCK

As of July 31, 1996, there were 15,838,202 outstanding shares of Common
Stock. As of July 31, the Common Stock was held of record by 129 persons or
entities. Holders of the Common Stock are entitled to cast one vote for each
share held of record on all matters acted upon at any meeting of the Company's
shareholders. Holders of Common Stock are entitled to receive ratably such
dividends if, as and when declared by the Board of Directors out of funds
legally available therefor, subject to preferences that may be applicable to any
outstanding Preferred Stock. There are no cumulative voting rights, the absence
of which will, in effect, allow the holders of a majority of the outstanding
shares of the Common Stock to elect all of the directors then standing for
election. The absence of cumulative voting rights could have the effect of
delaying, deferring or preventing a change in control of Midcom. In the event of
any liquidation, dissolution or winding up of Midcom, each holder of Common
Stock will be entitled to participate, subject to the rights of any outstanding
Preferred Stock, ratably in all assets of Midcom remaining after payment of
liabilities. Holders of Common Stock have no preemptive or conversion rights.
All outstanding shares of Common Stock are, and all shares of Common Stock
issuable upon conversion of the Notes will be, fully paid and non-assessable.

PREFERRED STOCK

The Board of Directors has the authority to issue 10,000,000 shares of
Preferred Stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof including dividend rights, conversion
rights, voting rights, redemption rights, liquidation preferences and the number
of shares constituting any series, without any further vote or action by the
shareholders. The issuance of Preferred Stock with voting and conversion rights
may adversely affect the voting power of the holders of Common Stock. In
addition, because the terms of such Preferred Stock may be fixed by the Board of
Directors without shareholder action, the Preferred Stock could be designated
and issued quickly in the event Midcom requires additional equity capital. The
Preferred Stock could also be designated and issued with terms calculated to
defeat a proposed take-over of Midcom, or with terms that may have the effect of
delaying, deferring or preventing a change of control of Midcom. Under certain
circumstances, this could have the effect of decreasing the market price of the
Common Stock.

WARRANTS

Midcom has outstanding three warrants to purchase a total of 59,500 shares
of Common Stock, exercisable through March 28, 1999 at an exercise price of
$7.44 per share, which price is subject to adjustment to prevent dilution. The
warrants were issued in connection with the Company's acquisition of certain
assets of Telnet Communications, Inc., and the Company is obligated to register
the shares underlying these warrants. See "-- Registration Rights."

ESCROW SHARES AND CONTINGENT SHARES

In connection with its acquisition of certain businesses and customer
bases, Midcom has the obligation to issue or release from escrow up to 151,675
additional shares of Common Stock. Midcom has an obligation to issue or release
these shares upon the occurrence of certain contingencies, including, among
others, attainment of specified revenue levels for the acquired customer base,
adjustment of liabilities assumed and receivables purchased, and satisfaction of
general representations and warranties.

In connection with its acquisition of certain businesses and customer
bases, Midcom is obligated to issue additional shares of Common Stock in the
event that the market price of the Common Stock is below stated prices on
designated true-up dates and upon the occurrence of certain other contingencies.
Based on the price of the Common Stock on November 8, 1996 and assuming the
maximum contingent shares are issued, an

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additional 198,577 shares of Common Stock would be issuable as a result of these
obligations. The contingency periods range from six months to two years.

SHAREHOLDERS AGREEMENTS

Midcom has entered into a Shareholders' Agreement dated June 7, 1994 (the
"Shareholders' Agreement") with Paul Pfleger, Ashok Rao, John M. Orehek, and
Trusts for the benefit of each of Siddhartha Rao, Kavita Rao, Divya Rao and
Anjali Rao (collectively the "Founding Shareholders"). The Shareholders'
Agreement provides that Midcom and the Founding Shareholders have a right of
first refusal if Mr. Orehek or Mr. Rao wish to sell their shares and have a
right to purchase Mr. Rao's shares in the event he resigns from the Company.
Following Mr. Rao's resignation as President, Chief Executive Officer and a
director in April 1996, the Company called for the redemption of Mr. Rao's
shares and the shares owned by four trusts to which he had transferred a portion
of his shares. The terms of the redemption will be determined through
arbitration. See "Certain Transactions." Pursuant to the Shareholders'
Agreement, the Founding Shareholders have agreed to vote their shares to elect
Mr. Pfleger and Mr. Rao to the Company's Board of Directors. As part of Mr.
Rao's Resignation Agreement, the Shareholders' Agreement will be amended to
remove the requirement that the Founding Shareholders vote to elect Mr. Rao to
the Company's Board of Directors. See "Certain Transactions." If, during the
term of the Shareholders' Agreement, Midcom proposes to register any of its
Common Stock under the Securities Act, the Founding Shareholders may require
Midcom to include in such registration shares of Common Stock owned by them,
subject to certain conditions and limitations. See "-- Registration Rights." The
term of the Shareholders' Agreement expires on June 7, 1999. In connection with
a transfer of their Common Stock, Messrs. Pfleger and Orehek have each
transferred his rights and obligations under the Shareholders' Agreement to a
limited partnership of which he is a beneficial owner. The two limited
partnerships have further transferred certain shares of Common Stock to a
limited liability company that also assumed the rights and obligations under the
Shareholders' Agreement. See "Principal Shareholders."

REGISTRATION RIGHTS

Under the terms of the Registration Rights Agreement dated as of June 10,
1994 between Midcom, First Union and The Robinson-Humphrey Company, Inc.
("Robinson-Humphrey"), if Midcom proposes to register any of its securities
within five years of its initial public offering, First Union and
Robinson-Humphrey may require Midcom, at its sole expense, to include in such
registration any shares of Common Stock owned by them, subject to certain
conditions and limitations. First Union and Robinson-Humphrey may, prior to the
third anniversary of Midcom's initial public offering, demand that Midcom
register their shares up to two times on Form S-1 or Form S-2 and an unlimited
number of times on Form S-3. Midcom will not be obligated to effect any demand
registration within six months after the effective date of a previous demand
registration or a registration in which First Union or Robinson-Humphrey was
entitled to include its shares. In addition, so long as any shares issued to
First Union or Robinson-Humphrey upon exercise of certain warrants remain
outstanding, subject to certain exceptions, the Company shall not, without the
prior written consent of the holders of a majority of such shares: (i) make any
amendment to the Company's Articles or Bylaws, or file any resolution of the
Board of Directors with the Washington Secretary of State containing any
provisions which could adversely affect or otherwise impair the rights of the
holders of such shares; or (ii) enter into, or permit any subsidiary to enter
into, related party transactions. At any time after June 1, 2000, the Company
has the right to purchase all (but not less than all) of the shares issued to
First Union or Robinson-Humphrey upon exercise of their warrants in accordance
with an agreed formula.

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Under the terms of the Shareholders' Agreement if, during the term thereof,
Midcom proposes to register any of its Common Stock under the Securities Act,
the Founding Shareholders may require Midcom to include in such registration
shares of Common Stock owned by them, subject to certain conditions and
limitations. All expenses incurred in connection with such registration shall be
borne by Midcom except for the Founding Shareholders' legal fees and any
additional expenses that Midcom would not incur but for the registration of the
Founding Shareholders' shares. See "-- Shareholders' Agreement."

Under the terms of a Registration Rights Agreement dated as of December 30,
1994 between Midcom and Richard W. Stroup, if Midcom proposes to register its
Common Stock under the Securities Act at any time prior to December 31, 1996,
Mr. Stroup may require Midcom, at its sole expense, to include in such
registration any shares of Common Stock owned by him that he acquired in
connection with Midcom's acquisition of PacNet, subject to certain conditions
and limitations.

Under the terms of a registration rights agreement between Midcom and three
individuals who were the shareholders of Telnet Communications, Inc. and now
hold warrants to purchase a total of 59,500 shares of Common Stock, subject to
possible adjustment, if Midcom proposes to register Common Stock under the
Securities Act for its own account pursuant to an underwritten offering at any
time prior to April 1, 2000, each of these individuals may require Midcom, at
its sole expense, to include in such registration any shares of Common Stock
owned by him. In addition, these individuals may each demand that Midcom
register his shares one time on Form S-3, which rights expire on March 28, 1999.

Under the terms of a registration rights agreement between the Company and
Communication Services of America ("CSA"), if the Company proposes to register
Common Stock under the Securities Act for its own account pursuant to an
underwritten offering at any time prior to August 31, 1998, CSA may require the
Company, at its sole expense, to include in such registration any shares of
Common Stock owned by CSA, subject to certain conditions and limitations. In
addition, CSA may demand that the Company register CSA's shares one time on Form
S-3, provided that such shares would have an aggregate expected selling price of
at least $100,000.

Under the terms of a registration rights agreement between the Company and
Cherry Communications, Cherry Communications may demand that the Company
register any shares of Common Stock acquired by Cherry Communications in
connection with the Company's purchase from Cherry Communications of certain
customer bases on two occasions on Form S-3, provided that such shares would
have an aggregate expected selling price of at least $300,000.

Under the terms of a registration rights agreement among the Company,
Theodore Berns, Donald Dean and WorldCom (each a "Rights Holder"), Rights
Holders holding a majority of the shares of Common Stock held by all Rights
Holders may demand that the Company register the shares on up to two occasions
on Form S-3, provided that the shares would have an aggregate expected selling
price of at least $300,000.

Under the terms of a registration rights agreement between the Company and
Richard E. John, if the Company proposes to register Common Stock under the
Securities Act for its own account pursuant to an underwritten offering or to
register the Common Stock of another pursuant to a demand registration at any
time prior to August 31, 1998, Mr. John may require the Company, at its sole
expense, to include in such registration any shares of Common Stock owned by him
that he acquired in connection with the Company's acquisition of Cel-Tech,
subject to certain conditions and limitations. In addition, Mr. John may demand
that the Company register his shares one time on Form S-3, provided that such
shares would have an aggregate expected selling price of at least $200,000.

Under the terms of a registration rights agreement among the Company and
four individuals who were shareholders of Fairfield County Telephone Corporation
("Fairfield"), each such individual may demand, on up to three occasions, that
the Company register on Form S-3 any shares of Common Stock owned by him or her
that he or she acquired in connection with the Company's acquisition of
Fairfield, provided that such shares would have an aggregate expected selling
price of at least $300,000.

Under the terms of a registration rights agreement among the Company and
two individuals who were shareholders of Adnet, if the Company proposes to
register Common Stock under the Securities Act at any

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time prior to December 31, 1998, such individuals may require the Company, at
its sole expense, to include in such registration any shares of Common Stock
owned by them that were acquired in connection with the Company's acquisition of
Adnet, subject to certain conditions and limitations. In addition, such
individuals may demand that the Company register their shares on up to two
occasions on Form S-3, provided that such shares would have an aggregate
expected selling price of at least $300,000.

Notwithstanding the foregoing registration rights, the Company has
voluntarily filed the Registration Statement of which this Prospectus is a part
in order to register under the Securities Act the public offer and sale of the
Securities. The Company currently intends to maintain the effectiveness of the
Registration Statement of which this Prospectus is a part for a period of one
year, although it is not required to do so. See "Selling Securityholders" and
"Plan of Distribution."

In addition, pursuant to the Registration Rights Agreement, the Company has
agreed to register the public offer and sale of the Notes and the Conversion
Shares. Pursuant to the Registration Rights Agreement, the Company filed the
Shelf Registration Statement with the Commission on October 18, 1996 (file no.
333-14427) to register the public offer and sale of the Notes and the Conversion
Shares. The Company is required under the Registration Rights Agreement to
maintain the effectiveness of the Shelf Registration Statement for a period of
three years from the completion of the Private Placement or, if shorter, when
(i) all the Notes and Conversion Shares have been sold pursuant to the Shelf
Registration Statement or (ii) the date on which there ceases to be outstanding
any Notes or Conversion Shares. See "Description of Notes -- Registration
Rights; Liquidated Damages."

WASHINGTON LAW

Washington law contains certain provisions that may have the effect of
delaying or discouraging a hostile takeover of the Company. Chapter 23B.17 of
the Washington Business Corporation Act (the "WBCA") prohibits, subject to
certain exceptions, a merger, sale of assets or liquidation of a corporation
involving an "Interested Shareholder" (defined generally as a person or
affiliated group of persons acting in concert or under common control who
beneficially own 20% or more of the corporation's outstanding voting securities)
unless determined to be at a "fair price" or otherwise approved by a majority of
the Company's disinterested directors or the holders of two-thirds of the votes
of each voting group entitled to vote separately on the transaction, excluding
the votes of the Interested Shareholder. In addition, Chapter 23B.19 of the WBCA
prohibits a corporation having a class of securities registered pursuant to
Section 12 of the Exchange Act, with certain exceptions, from engaging in
certain significant business transactions with a person or group of persons
acting in concert or under common control who beneficially acquires 10% or more
of the corporation's outstanding voting securities for a period of five years
after such acquisition. The prohibited transactions include, among others, a
merger with, disposition of assets to, or issuance or redemption of stock to or
from, such person or group of persons, or allowing such person or group of
persons to receive a disproportionate benefit as a shareholder. Notwithstanding
the foregoing, an otherwise prohibited transaction may be consummated if such
transaction is approved by a majority of the members of the board of directors
prior to the date that the third parties became Interested Shareholders. These
provisions could have the effect of delaying, deterring or preventing a change
in control of the Company which, under certain circumstances, could have the
effect of decreasing the market price of the Common Stock.

CERTAIN PROVISIONS IN AMENDED AND RESTATED ARTICLES OF INCORPORATION AND BYLAWS

The WBCA permits amendment of the Articles with the approval of the holders
of a majority of the shares entitled to vote. The holders of outstanding shares
of a class may vote as a class on a proposed amendment if the amendment would
change the number of authorized shares or alter or change the powers,
preferences or special rights of such class. Holders of the same series of stock
have identical voting rights.

The Articles provide that special meetings of the shareholders may be
called by the Chairman of the Board, the President, the Board of Directors or
holders of not less than 30% of the outstanding shares entitled to vote at the
meeting. The Articles provide that certain business combinations, such as a
merger or share exchange with another corporation or the sale of a substantial
part of the Company's assets, must be approved

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by the holders of not less than two-thirds of the outstanding Common Stock and
any other class of stock entitled to vote thereon voting as a single class, and
the affirmative vote of a majority of each outstanding series or class, voting
as a separate class; provided, however, that if certain continuing members of
the Company's Board of Directors approve such business combination, it may be
approved by not less than a majority of the holders of outstanding Common Stock
and any other class of stock entitled to vote thereon voting as a single class
and the affirmative vote of a majority of each outstanding series or class,
voting as a separate class.

Pursuant to the Articles, commencing on the next annual meeting of the
Company's shareholders, the Company's Board of Directors is to be divided into
three classes having staggered, three-year terms. See "Management -- Board of
Directors."

The Company's Bylaws may be amended or repealed by the Board of Directors
or by the vote of holders of not less than two-thirds of the outstanding Common
Stock and any other stock entitled to vote thereon.

It is possible that the provisions described above could have the effect of
delaying, deterring or preventing a change in control or management of the
Company which, under certain circumstances, could have the effect of decreasing
the market value of the Common Stock.

LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS OF THE COMPANY

As permitted by Section 23B.08.320 of the WBCA, Article 14 of the Company's
Articles eliminates in certain circumstances the personal liability of the
Company's directors to the Company or its shareholders for monetary damages
resulting from breaches of their fiduciary duty. This provision does not
eliminate the liability of directors for (i) acts or omissions that involve
intentional misconduct or a knowing violation of law, (ii) improper declarations
of dividends, or (iii) transactions from which a director derived an improper
personal benefit.

The Company's Bylaws require the Company to indemnify its directors and
officers to the fullest extent permitted by Washington law, including under
circumstances in which indemnification is otherwise discretionary. The Company
maintains officers' and directors' liability insurance of $1 million for members
of its Board of Directors and key employees.

TRANSFER AGENT AND REGISTRAR

The transfer agent for the Common Stock is ChaseMellon Shareholder
Services. The registrar for the Notes is IBJ Schroder Bank & Trust Company.

DESCRIPTION OF CERTAIN INDEBTEDNESS

The Company obtained the Revolving Credit Facility on November 8, 1995. The
facility originally provided for Revolving Loans of up to $50.0 million, subject
to a borrowing base limitation of 85% of eligible accounts receivable and other
financial ratios. In March 1996, the maximum amount available was reduced to
$43.0 million in connection with the withdrawal of one of the participating
lenders. On March 28, 1996, Transamerica, one of the lenders under the Revolving
Credit Facility, provided the Bridge Loan of $15.0 million in consideration of a
loan fee of $500,000. The Bridge Loan was repaid in full upon completion of the
Private Placement. Although the Bridge Loan was originally due in full on April
27, 1996, the Company had the right to extend the due date for additional 30-day
periods upon payment of an additional fee of $200,000 for each such extension,
with final payment of the Bridge Loan due by September 24, 1996. Four 30-day
extensions were exercised by the Company prior to the completion of the Private
Placement and the repayment in full of the Bridge Loan. Transamerica also
received a warrant to purchase shares of the Company's Common Stock in an
initial amount of 815,470 shares, subject to adjustment in connection with a
variety of dilutive events, at an exercise price of $.0001 per share. The
warrant expired upon repayment in full of the Bridge Loan. The Revolving Loans
are collateralized by substantially all of the assets of the Company and its
subsidiaries (including the pledge of all outstanding stock of such
subsidiaries) and bear interest at the

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higher of three lenders' prime rates plus 0.5% per annum or the LIBOR rate plus
2.5% per annum. The Revolving Credit Facility expires on November 8, 1997.

Under the terms of the Revolving Credit Facility, the Company is required
to meet certain operating and financial covenant requirements and is subject to
a number of negative covenants which place limitations on, among other things,
investments (including a preclusion on any further cash investments in the
Company's Russian joint venture) and additional debt and changes in the
Company's capital structure. Other covenants preclude payment of cash dividends
except in certain limited circumstances and require the Company to obtain the
lenders' written consent prior to making any acquisition. The Company was in
default of a number of the financial covenants contained in the Revolving Credit
Facility during 1996. Also, the going concern qualification included in the
Company's independent auditors report with respect to the Company's 1995
Consolidated Financial Statements constituted an additional default under the
Revolving Credit Facility. In connection with the completion of the Private
Placement and the application of the net proceeds therefrom to the repayment in
full of the Bridge Loan and the Revolving Loans, the lenders waived all existing
defaults under the Revolving Credit Facility and amended the financial covenants
contained in the Revolving Credit Facility to, among other things, reduce the
minimum EBITDA financial covenant to a level forecasted to be consistent with
the Company's revised business plan and eliminate the minimum fixed charge ratio
of EBITDA to interest expense financial covenants. The amendment also requires
that the Company maintain minimum excess availability in an initial amount of
$20.0 million for the months of August 1996 through February 1997, declining in
stages to $8.0 million for the months of September through November 1997. As of
September 30, 1996, the Company's borrowing base was less than the minimum
excess availability and, accordingly, the Company had no ability to borrow under
the Revolving Credit Facility. The Company's borrowing base will fluctuate from
day to day based on the timing of cash collections and payments. However, there
can be no assurance that the Company will generate sufficient revenue to build a
borrowing base which would permit borrowings under the Revolving Credit Facility
in the future. Further, there can be no assurance that the Company will not be
in violation in the future of its obligations under the Revolving Credit
Facility or that borrowings under this facility will continue to be available.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."

SHARES ELIGIBLE FOR FUTURE SALE

At July 31, 1996, the Company had outstanding 15,838,202 shares of Common
Stock (assuming no redemption of the shares owned by Ashok Rao; see "Certain
Transactions") of which 9,131,201 shares were "restricted securities" subject to
restrictions set forth in Rule 144 promulgated under the Securities Act. Of the
restricted securities, 3,534,679 shares are tradeable under Rule 144 (subject to
volume and manner of sales restrictions), 3,534,685 shares will be tradable
pursuant to Rule 144 upon the expiration of the applicable two-year holding
period and 100,000 shares, sold in a transaction exempt from registration
pursuant to Regulation S of the Securities Act, will be tradable pursuant to
Rule 144 upon the expiration of a one-year holding period. Of the restricted
shares, 151,675 shares are held in escrow or are to be issued pursuant to the
Company's obligations under agreements entered into in connection with several
acquisitions completed in the second half of 1995. Also, in connection with
certain acquisitions, the Company is required to issue shares of Common Stock as
additional consideration (i) in the event that the market price of the Common
Stock is below stated prices on designated true-up dates, and (ii) upon the
occurrence of certain contingencies. Based on the price of the Common Stock on
November 8, 1996, and assuming the maximum contingent shares are issued, the
Company would be required to issue 198,577 shares of Common Stock. Also, in
connection with the acquisition of a customer base from Cherry Communications,
the Company may elect to issue shares of Common Stock in lieu of a cash payment
of $9.0 million. See "Management's Discussion and Analysis -- Liquidity and
Capital Resources" and "Description of Capital Stock."

The Company has reserved for issuance 4,211,024 shares of Common Stock
under its Stock Option Plan and 258,625 shares of Common Stock for issuance
under its Stock Purchase Plan. Under the Stock Option Plan, as of July 31, 1996
options to purchase 3,408,474 shares of Common Stock are outstanding and options
to purchase 212,240 shares of Common Stock are exercisable. Shares issued under
the Stock Option Plan and

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the Stock Purchase Plan are freely tradable in the open market, subject, in the
case of affiliates, to the volume, manner of sale, notice and public information
requirements of Rule 144.

At July 31, 1996, warrants to purchase 874,970 shares of Common Stock were
outstanding, including a warrant to purchase 815,470 shares of Common Stock
issued in connection with the Bridge Loan, which warrant expired upon the
completion of the Private Placement and the application of the net proceeds
therefrom to the repayment in full of the Bridge Loan. See "Description of
Certain Indebtedness."

The Selling Securityholders and certain other individuals and entities have
certain rights with respect to the registration under the Securities Act of the
public offer and sale of the Securities and other shares of Common Stock
acquired in connection with various unrelated acquisition and financing
transactions. At July 31, 1996, holders of approximately 9,832,946 shares of
Common Stock (including the Securities and shares held in escrow which are
deemed not to be issued, as described elsewhere in this Prospectus) were subject
to such registration rights. At July 31, 1996, holders of approximately
1,876,000 shares of Common Stock subject to such registration rights had the
right to require the Company to register the public offer and sale of their
shares under the Securities Act. Notwithstanding the registration rights of the
Selling Securityholders, the Company has voluntarily filed the Registration
Statement of which this Prospectus is a part in order to register under the
Securities Act the public offer and sale of the Securities. The Company intends
to maintain the effectiveness of the Registration Statement of which this
Prospectus is a part for a period of one year. In addition, pursuant to the
Registration Rights Agreement, the Company filed the Shelf Registration
Statement with the Commission on October 18, 1996 (file no. 333-14427) to
register the public offer and sale of the Notes and the Conversion Shares. If
the Notes are fully converted, approximately 6,938,279 shares of Common Stock
(not including an indeterminate number of shares that may be issued in
connection with certain anti-dilution and other provisions) will be eligible for
public offer and sale pursuant to the Shelf Registration Statement. The Company
is required under the Registration Rights Agreement to maintain the
effectiveness of the Shelf Registration Statement for a period of three years
from the completion of the Private Placement or, if shorter, when (i) all the
Notes and Conversion Shares have been sold pursuant to the Shelf Registration
Statement or (ii) the date on which there ceases to be outstanding any Notes or
Conversion Shares. See "Description of Capital Stock -- Registration Rights" and
"Description of Notes -- Registration Rights; Liquidated Damages."

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated), who has beneficially owned restricted securities
within the meaning of Rule 144 ("Restricted Shares") for at least two years,
including the holding period of any prior owner except an affiliate, is entitled
to sell within any three-month period a number of shares that does not exceed
the greater of (i) 1% of the then outstanding shares of the Company's Common
Stock and (ii) the average weekly trading volume of the Common Stock in the
over-the-counter market during the four calendar weeks preceding the date on
which notice of the sale is filed with the Commission. Sales under Rule 144 are
also subject to certain manner of sale provisions, notice requirements and the
availability of current public information about the Company. Any person (or
persons whose shares are aggregated) who is not deemed to have been an
"affiliate" of the Company at any time during the 90 days preceding a sale, and
who owns Restricted Shares that were purchased from the Company (or any
affiliate) at least three years previously, will be entitled to sell such shares
under Rule 144(k) without regard to the volume limitations, manner of sale
provisions, public information requirements or notice requirements. If a
proposed amendment to Rule 144 is adopted, the two- and three-year holding
period requirements described above would be reduced to one and two years,
respectively.

No prediction can be made as to the effect, if any, that future sales of
shares, the availability of shares for future sale, or the registration of
substantial amounts of currently restricted shares will have on the market price
of the Common Stock prevailing from time to time. Sales of substantial amounts
of Common Stock in the public market, under Rule 144, pursuant to the exercise
of registration rights or otherwise, and even the potential for such sales,
could have a material adverse effect on the prevailing market price of the
Common Stock and impair the Company's ability to raise capital through the sale
of its equity securities.

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PLAN OF DISTRIBUTION

The Selling Securityholders may sell all or a portion of the Securities
offered hereby from time to time while the Registration Statement of which this
Prospectus is a part remains effective. The Company has been advised by the
Selling Securityholders that the Securities may be sold on terms to be
determined at the times of such sales through customary brokerage channels,
negotiated transactions or a combination of these methods, at fixed prices that
may be changed, at market prices then prevailing or at negotiated prices then
obtainable. There is no assurance that the Selling Securityholders will sell any
or all of the Securities offered pursuant to this Prospectus. Each of the
Selling Securityholders reserves the right to accept and, together with its
agents from time to time, to reject in whole or in part any proposed purchase of
the Securities to be made directly or through agents. The Company will receive
no portion of the proceeds from the sale of Securities offered hereby. The
aggregate proceeds to the Selling Securityholders from the sale of the
Securities offered by the Selling Securityholders hereby will be the purchase
price of such Securities less any discounts or commissions.

The Company has been advised by the Selling Securityholders that the
Selling Securityholders, acting as principals for their own account, may sell
Securities from time to time directly to purchasers or through agents, dealers
or underwriters to be designated by the Selling Securityholders from time to
time who may receive compensation in the form of underwriting discounts,
commissions or concessions from the Selling Securityholders and the purchasers
of the Securities for whom they may act as agent. The Selling Securityholders
and any agents, broker-dealers or underwriters that participate with the Selling
Securityholders in the distribution of the Securities may be deemed to be
"underwriters" within the meaning of the Securities Act, in which event any
discounts, commissions or concessions received by such broker-dealers, agents or
underwriters and any profit on the resale of the Securities purchased by them
may be deemed to be underwriting discounts or commissions under the Securities
Act.

A Selling Securityholder may elect to engage a broker or dealer to effect
sales of the Securities in one or more of the following transactions: (a) block
trades in which the broker or dealer so engaged will attempt to sell the
Securities as agent but may position and resell a portion of the block as
principal to facilitate the transaction, (b) purchases by a broker or dealer as
principal and resale by such broker or dealer for its account pursuant to this
Prospectus, and (c) ordinary brokerage transactions and transactions in which
the broker solicits purchasers. In effecting sales, brokers and dealers engaged
by a Selling Securityholder may arrange for other brokers or dealers to
participate. Broker-dealers may agree with the Selling Securityholders to sell a
specified number of such Securities at a stipulated price, and, to the extent
such brokerdealer is unable to do so acting as agent for a Selling
Securityholder, to purchase as principal any unsold Securities at the price
required to fulfill the broker-dealer commitment to such Selling Securityholder.
Broker-dealers who acquire Securities as principal may thereafter resell such
Securities from time to time in transactions (which may involve crosses and
block transactions and sales to and through other broker-dealers, including
transactions of the nature described above) in the over-the-counter market or
otherwise at prices and on terms then prevailing at the time of sale, at prices
then related to the then-current market price or in negotiated transactions and,
in connection with such resales, may pay to or receive from the purchasers of
such Securities commissions as described above. To the extent required, the
number of Securities to be sold, the names of the Selling Securityholders, the
purchase price, the name of any agent, dealer or underwriter, any applicable
commissions and any other material information with respect to a particular
offer will be set forth in an accompanying Prospectus Supplement or, if
appropriate, a post-effective amendment to the Registration Statement of which
this Prospectus is a part.

The Securities originally issued by the Company contained legends as to
their restricted transferability. These legends will not be necessary with
respect to any Securities sold pursuant to, and during the effectiveness of, the
Registration Statement of which this Prospectus is a part. Upon the transfer by
the Selling Securityholders of any of the Securities, new certificates
representing such Securities will be issued to the transferee, free of any such
legends.

To comply with the securities laws of certain states, if applicable, the
Securities will be sold in such states only through registered or licensed
brokers or dealers. In addition, in certain states the Securities may not be

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offered or sold unless they have been registered or qualified for sale in such
state or an exemption from the registration or qualification requirement is
available and is complied with.

Under the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
any person engaged in the distribution of the Securities may not simultaneously
bid for or purchase securities of the same class for a period of two business
days prior to the commencement of such distribution. In addition, and without
limiting the foregoing, the Selling Securityholders will be subject to
applicable provisions of the Exchange Act and the rules and regulations
thereunder, including without limitation Rules 10b-2, 10b-6 and 10b-7, in
connection with the transactions in the Securities during the effectiveness of
the Registration Statement of which this Prospectus is a part. The foregoing may
affect the marketability of the Common Stock and any market making activities
with respect to the Common Stock.

Each of the Selling Securityholders has certain registration rights with
respect to the Securities owned by such Selling Securityholder. See "Description
of Capital Stock -- Registration Rights." Notwithstanding such rights, the
Company has voluntarily filed the Registration Statement of which this
Prospectus is a part. The Company currently intends to maintain the
effectiveness of such Registration Statement for a period of one year or until
such earlier time as all the Securities have been sold pursuant hereto or are no
longer outstanding, although it is not required to do so. The Company will bear
all expenses relating to this registration, other than underwriting discounts
and commissions and fees and disbursements of counsel to the Selling
Securityholders.

LEGAL MATTERS

Certain legal matters with respect to the Securities offered hereby will be
passed upon for Midcom by Heller, Ehrman, White & McAuliffe, Seattle,
Washington.

EXPERTS

The Consolidated Financial Statements of Midcom at December 31, 1994 and
1995 and for each of the three years in the period ended December 31, 1995
appearing in this Prospectus and the Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein, and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.

AVAILABLE INFORMATION

The Company has filed the Registration Statement with the Commission under
the Securities Act with respect to the Securities offered hereby. This
Prospectus, which constitutes a part of the Registration Statement, does not
contain all the information set forth in the Registration Statement and the
exhibits and schedules thereto, certain parts of which have been omitted in
accordance with the rules and regulations of the Commission. For further
information with respect to the Company and the Securities offered hereby,
reference is made to the Registration Statement and the exhibits and schedules
thereto. Statements contained in this Prospectus regarding the contents of any
contract or other document are not necessarily complete and in each instance
reference is hereby made to the copy of such contract to document filed as an
exhibit to the Registration Statement. Copies of the Registration Statement and
the exhibits and scheduled thereto may be inspected, without charge, at the
principal office of the Commission located at 450 Fifth Street, N.W.,
Washington, D.C. 20549, the New York Regional Office located at 7 World Trade
Center, Suite 1300, New York, New York 10048, and the Chicago Regional Office
located at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661, or obtained upon payment of prescribed rates from the Public
Reference Section of the Commission at its principal office in Washington, D.C.

The Company is subject to the informational requirements of the Exchange
Act, and in accordance therewith files periodic reports, proxy materials and
other information with the Commission. Such reports, proxy materials and other
information may be inspected and copied at the public reference facilities

96
<PAGE> 99

maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Washington,
D.C. 20549, and at the following regional offices of the Commission: Seven World
Trade Center, 13th Floor, New York, New York 10048 and 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661. Copies may also be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, at prescribed rates. Such reports, proxy materials and other information
may also be inspected at the National Association of Securities Dealers, Inc.,
at 1735 K Street, N.W. Washington, D.C. 20006. In addition, the Commission
maintains a World Wide Web site on the Internet at http://www.sec.gov that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.

97
<PAGE> 100

(This page intentionally left blank)
<PAGE> 101

MIDCOM COMMUNICATIONS INC.

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Auditors........................................................ F-2
Consolidated Balance Sheets as of December 31, 1994 and 1995, and September 30, 1996
(unaudited)......................................................................... F-3
Consolidated Statements of Operations for the years ended December 31, 1993, 1994 and
1995, and the nine months ended September 30, 1995 and 1996 (unaudited)............. F-4
Consolidated Statements of Shareholders' Equity (Deficit) for the years ended December
31, 1993, 1994 and 1995, and the nine months ended September 30, 1996 (unaudited)... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994 and
1995, and the nine months ended September 30, 1995 and 1996 (unaudited)............. F-6
Notes to Consolidated Financial Statements............................................ F-8
</TABLE>

F-1
<PAGE> 102

REPORT OF INDEPENDENT AUDITORS

The Shareholders and Board of Directors
MIDCOM Communications Inc.

We have audited the accompanying consolidated balance sheets of MIDCOM
Communications Inc. as of December 31, 1994 and 1995, and the related
consolidated statements of operations, shareholders' equity (deficit), and cash
flows for each of the three years in the period ended December 31, 1995. 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
MIDCOM Communications Inc. at December 31, 1994 and 1995, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1995, in conformity with generally accepted accounting
principles.

The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 1, the
Company has incurred recurring operating losses and has a working capital
deficiency. In addition, the Company is in default with regard to certain loan
agreements with its lenders. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 1. The financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.

ERNST & YOUNG LLP

Seattle, Washington
March 29, 1996

F-2
<PAGE> 103

MIDCOM COMMUNICATIONS INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
------- --------
SEPTEMBER 30,
1996
-------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash.................................................... $ 960 $ 1,083 $ 48,138
Accounts receivable, less allowance for doubtful
accounts of $2,872, $10,581 and $8,026 in 1994, 1995
and 1996............................................. 28,702 51,814 20,266
Due from related parties................................ 640 502 71
Notes receivable........................................ 476 86 --
Prepaid expenses and other current assets............... 1,621 2,424 2,266
------- -------- ---------
Total current assets............................ 32,399 55,909 70,741
Investments in and advances to joint venture............ 5,643 2,000 --
Plant and equipment, net................................ 12,983 13,719 10,130
Intangible assets, less accumulated amortization of
$3,514, $12,812 and $34,646 in 1994, 1995 and 1996... 13,278 60,781 22,098
Other assets and deferred charges, net.................. 1,775 922 3,795
------- -------- ---------
Total assets.................................... $66,078 $133,331 $ 106,764
======= ======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable........................................ $ 5,145 $ 7,397 $ 6,222
Carrier accounts payable................................ 19,336 32,534 21,437
Accrued expenses........................................ 2,801 9,570 9,256
Notes payable........................................... 1,627 14,576 10,963
Current portion of long-term obligations................ 614 41,721 2,962
Deferred income......................................... 67 43 43
------- -------- ---------
Total current liabilities....................... 29,590 105,841 50,883
Long-term debt, less current portion...................... 32,070 827 800
Capital lease obligations, less current portion........... 1,952 1,017 1,089
Convertible subordinated notes payable.................... -- -- 97,743
Deferred income........................................... 173 130 97
Other long-term liabilities............................... -- 1,717 5,851
Commitments and contingencies
Preferred stock, 10,000,000 shares authorized for all
Series, $.0001 par value, 859,653 shares designated
as Series A Redeemable Preferred, all of which were
issued and outstanding in 1994....................... 8,597 -- --
Shareholders' equity (deficit):
Common stock, $.0001 par value (stated at amounts paid
in); 90,000,000 shares authorized, 8,125,000,
15,129,000 and 15,773,558 shares issued and
outstanding in 1994, 1995 and 1996................... (2,691) 62,400 66,831
Deferred compensation..................................... (34) (13) (522)
Accumulated deficit....................................... (3,579) (38,588) (116,008)
------- -------- ---------
Total shareholders' equity (deficit)............ (6,304) 23,799 (49,699)
------- -------- ---------
Total liabilities and shareholders' equity
(deficit)..................................... $66,078 $133,331 $ 106,764
======= ======== =========
</TABLE>

See accompanying notes.

F-3
<PAGE> 104

MIDCOM COMMUNICATIONS INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- --------------------
1993 1994 1995 1995 1996
------- -------- -------- -------- --------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Revenue.................................. $66,010 $111,699 $203,554 $147,409 $124,590
Cost of revenue.......................... 45,363 79,044 139,546 100,661 89,828
------- -------- -------- -------- --------
Gross profit............................. 20,647 32,655 64,008 46,748 34,762
Operating expenses:
Selling, general and administrative.... 18,125 27,697 62,061 42,654 48,048
Depreciation........................... 644 1,477 4,481 3,180 4,327
Amortization........................... 1,237 2,657 9,309 5,204 21,857
Settlement of contract dispute......... -- -- -- -- 8,800
Restructuring charge................... -- -- -- -- 2,220
Loss on impairment of assets........... -- -- 11,830 -- 20,765
------- -------- -------- -------- --------
Total operating expenses................. 20,006 31,831 87,681 51,038 106,017
------- -------- -------- -------- --------
Operating income (loss).................. 641 824 (23,673) (4,290) (71,255)
Equity in loss of joint venture.......... -- (458) (52) (279) --
Other income (expense)................... 249 (413) (338) (252) (206)
Interest expense......................... (304) (2,531) (5,288) (4,105) (5,959)
Interest expense -- shareholders......... (1,064) (434) -- -- --
------- -------- -------- -------- --------
Loss before income taxes and
extraordinary item..................... (478) (3,012) (29,351) (8,926) (77,420)
Income tax expense....................... (51) (17) -- (18) --
------- -------- -------- -------- --------
Loss before extraordinary item........... (529) (3,029) (29,351) (8,944) (77,420)
Extraordinary item: loss on early
redemption of debt..................... -- -- (4,067) (2,992) --
------- -------- -------- -------- --------
Net loss............................... $ (529) $ (3,029) $(33,418) $(11,936) $(77,420)
======= ======== ======== ======== ========
Per share amounts:
Loss before extraordinary item........... $ (0.05) $ (0.31) $ (2.42) $ (.77) $ (5.01)
Extraordinary item....................... -- -- (0.34) (.25) --
------- -------- -------- -------- --------
Net loss............................... $ (0.05) $ (0.31) $ (2.76) $ (1.02) $ (5.01)
======= ======== ======== ======== ========
Shares used in calculating per share
data................................... 9,930 9,930 12,101 11,648 15,442
======= ======== ======== ======== ========
</TABLE>

See accompanying notes.

F-4
<PAGE> 105

MIDCOM COMMUNICATIONS INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
TOTAL
SHAREHOLDERS'
NUMBER COMMON DEFERRED ACCUMULATED EQUITY
OF SHARES STOCK COMPENSATION DEFICIT (DEFICIT)
--------- ------- ------------ ----------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1993............... 7,786 $ 154 $ -- $ (6,350) $ (6,196)
Issuance of compensatory stock
options............................. -- 146 (146) -- --
Issuance of common stock............... 225 202 -- -- 202
Compensation attributable to stock
options vesting..................... -- -- 42 -- 42
Distributions by acquired company...... -- -- -- (84) (84)
Net loss for the year.................. -- -- -- (529) (529)
------ ------- ----- --------- --------
Balance at December 31, 1993............. 8,011 502 (104) (6,963) (6,565)
Conversion from S corporation to C
corporation......................... -- (7,679) -- 7,679 --
Stock issued in acquisition............ 114 1,040 -- -- 1,040
Compensation attributable to stock
options vesting..................... -- -- 20 -- 20
Stock option forfeitures............... -- (54) 50 -- (4)
Issuance of common stock warrant....... -- 3,500 -- -- 3,500
Distributions by acquired company...... -- -- -- (1,266) (1,266)
Net loss for the year.................. -- -- -- (3,029) (3,029)
------ ------- ----- --------- --------
Balance at December 31, 1994............. 8,125 (2,691) (34) (3,579) (6,304)
Issuance of compensatory stock
options............................. -- 268 -- -- 268
Stock issued in acquisitions........... 500 4,757 -- -- 4,757
Compensation attributable to stock
options vesting..................... -- -- 21 -- 21
Stock issued in initial public
offering............................ 5,456 54,182 -- -- 54,182
Stock issued in customer base
acquisitions........................ 331 5,120 -- -- 5,120
Stock issued for exercise of stock
options and warrants and employee
stock purchase plan................. 717 442 -- -- 442
Distributions by acquired company...... -- -- -- (1,269) (1,269)
Conversion of acquired company from S
corporation to C corporation........... -- 322 -- (322) --
Net loss for the year.................. -- -- -- (33,418) (33,418)
------ ------- ----- --------- --------
Balance at December 31, 1995............. 15,129 62,400 (13) (38,588) 23,799
Additional shares issued in
acquisitions (unaudited)............ 82 513 -- -- 513
Compensation attributable to stock
options vesting (unaudited)......... -- 420 160 -- 580
Issuance of compensatory stock options
(unaudited)......................... -- 669 (669) -- --
Stock issued for exercise of stock
options and employee stock purchase
plan (unaudited).................... 563 2,829 -- -- 2,829
Net loss for the period (unaudited).... -- -- -- (77,420) (77,420)
------ ------- ----- --------- --------
Balance at September 30, 1996
(unaudited)............................ 15,774 $66,831 $ (522) $(116,008) $ (49,699)
====== ======= ===== ========= ========
</TABLE>

See accompanying notes.

F-5
<PAGE> 106

MIDCOM COMMUNICATIONS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------ -------------------
1993 1994 1995 1995 1996
-------- -------- -------- -------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Reconciliation of net loss to net cash provided
by (used in) operating activities:
Net loss..................................... $ (529) $ (3,029) $(33,418) $(11,936) $(77,420)
Depreciation................................. 644 1,477 4,481 3,180 4,327
Amortization of intangibles.................. 1,237 2,657 9,309 5,204 21,857
Amortization of deferred financing costs..... -- 483 620 322 389
Loss on impairment of assets................. -- -- 11,830 -- 20,765
Loss on sale of assets....................... -- -- -- -- 53
Settlement of contract dispute............... -- -- -- -- 8,800
Equity in loss of joint venture.............. -- 458 52 279 --
Compensation attributable to stock options... 42 16 289 279 580
Noncompetition payments...................... (300) (250) -- -- --
Extraordinary item........................... -- -- 4,067 2,992 --
Changes in operating assets and liabilities:
Accounts receivable.......................... (10,361) (9,811) (17,784) (20,740) 18,956
Due from related parties..................... 336 (606) 138 562 431
Notes receivable............................. (128) (348) 390 (77) 86
Prepaid expenses and other current assets.... 24 (1,201) (719) (2,250) 58
Other assets................................. (64) 11 (142) 219 323
Accounts payable and accrued expenses........ 2,414 4,062 (3,559) 2,250 (3,121)
Carrier accounts payable..................... 5,429 8,236 16,638 19,876 (16,097)
Deferred income.............................. 2,912 (3,229) (67) (51) (76)
Other long-term liabilities.................. 168 (202) 1,717 677 12,646
Accrued interest payable..................... 384 (869) 228 206 852
-------- -------- -------- -------- --------
Net cash provided by (used in) operating
activities................................... 2,208 (2,145) (5,930) 992 (6,591)
INVESTING ACTIVITIES
Purchases of plant and equipment............... (1,614) (4,187) (6,884) (6,648) (1,729)
Net assets acquired in business and customer
base acquisitions............................ (9,282) (5,089) (11,407) (10,458) --
Investment in and advances to joint venture.... (1,911) (4,190) (2,625) (2,524) --
Proceeds from sale of customer base............ -- -- -- -- 692
Other, net..................................... -- -- -- -- (19)
Loan to related party.......................... -- (1,234) -- -- --
-------- -------- -------- -------- --------
Net cash used in investing activities.......... (12,807) (14,700) (20,916) (19,630) (1,056)
FINANCING ACTIVITIES
Proceeds of loans from related parties......... 5,292 -- -- -- --
Repayment of loans from related parties........ (798) (3,617) -- -- --
Proceeds from notes payable.................... 6,411 3,485 -- -- 333
Repayment of notes payable..................... -- (10,592) (21,628) (12,153) (3,946)
</TABLE>

F-6
<PAGE> 107

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
1993 1994 1995 1995 1996
-------- -------- -------- -------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Proceeds from long-term debt................... -- 34,350 69,205 8,695 15,000
Proceeds from common stock issued for stock
purchase plan and stock options.............. -- -- 442 329 2,828
Issuance of common stock....................... -- -- 54,182 53,986 --
Preferred stock redemption..................... -- -- (8,597) (8,597) --
Repayment of long-term debt.................... (875) (3,851) (64,841) (22,695) (53,687)
Proceeds from issuance of convertible
subordinated notes payable................... -- -- -- -- 97,743
Distributions to shareholders of acquired
companies.................................... (84) (1,266) (1,269) (287) --
Deferred financing costs....................... -- (1,512) (525) (80) (3,569)
-------- -------- -------- -------- --------
Net cash provided by financing activities...... 9,946 16,997 26,969 19,198 54,702
-------- -------- -------- -------- --------
Net increase (decrease) in cash................ (653) 152 123 560 47,055
Cash at the beginning of period................ 1,461 808 960 960 1,083
-------- -------- -------- -------- --------
Cash at the end of period...................... $ 808 $ 960 $ 1,083 $ 1,520 $ 48,138
======== ======== ======== ======== ========
</TABLE>

See accompanying notes.

F-7
<PAGE> 108

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(INFORMATION AS OF SEPTEMBER 30, 1996 AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1995 AND 1996 IS UNAUDITED)

1. NATURE OF OPERATIONS AND GOING CONCERN

MIDCOM Communications Inc. and Subsidiaries (Midcom or Company) provides
long distance voice and frame relay data communication services, wireless
communication services, and enhanced telecommunication services such as
facsimile broadcast, conference calling and calling cards, primarily as a
nonfacilities-based reseller. The Company's customers are primarily small to
medium-sized commercial businesses, wholesalers and certain significant
customers located throughout the United States.

Going Concern and Liquidity

The Company incurred operating losses during each of the three years ended
December 31, 1995 and, as of September 30, 1996, had an accumulated deficit of
approximately $116.0. The report of the Company's independent auditors with
respect to the Company's Consolidated Financial Statements for the year ended
December 31, 1995 states that the Company's recurring operating losses, working
capital deficiency and past credit facility defaults raise substantial doubt
about the Company's ability to continue as a going concern. The Company's
condensed consolidated financial statements have been prepared assuming that the
Company will continue as a going concern and do not include any adjustments that
might result from the outcome of this uncertainty. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."

Risks and Uncertainties

The Company is also subject to certain other significant risks and
uncertainties that may affect the amounts reported in the financial statements.
These significant risks and uncertainties include limits on acquisitions due to
the current financial condition, impairment of assets, litigation and
commitments with certain suppliers. Additional information concerning these
risks and uncertainties is included in the notes to the consolidated financial
statements.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts of
MIDCOM Communications Inc. and its wholly-owned subsidiaries, PacNet Inc.
(PacNet), Cel-Tech International Corp. (Cel-Tech), AdVal, Inc. (AdVal) and
Advanced Network Design (AND) (collectively referred to as the "Company"). All
significant intercompany accounts and transactions have been eliminated. AdVal
and Adnet Telemanagement, Inc. (Adnet), the parent company of AND, were acquired
on September 29, 1995 and December 29, 1995, respectively, in transactions that
were accounted for as pooling of interests. As a result, the consolidated
financial statements for all periods prior to the acquisitions have been
restated to include the accounts and results of operations of AdVal and Adnet
and its wholly-owned subsidiary.

The Company's investment in Dal Telecom International (Dal Telecom), a
Russian corporate joint venture, is accounted for on the equity method, adjusted
to estimated fair value, in accordance with generally accepted accounting
principles. The Company recorded its pro rata share of Dal Telecom's income or
loss one month in arrears (see Note 4).

F-8
<PAGE> 109

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Interim Financial Information

The financial information at September 30, 1996 and for the nine months
ended September 30, 1995 and 1996 is unaudited, but includes all adjustments
(consisting only of normal recurring adjustments) that the Company considers
necessary for a fair presentation of the financial position at such date and the
operating results and cash flows for those periods. Operating results for the
September 30, 1996 period are not necessarily indicative of the results that may
be expected for the entire year.

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 and
expenses during the reporting periods. Actual results could differ from those
estimates.

Revenue Recognition

Resale and transmission revenue and related costs are recognized in the
period the customer utilizes the Company's service. Aggregation fees are
recognized by the Company based upon notification of customers' participation in
the AT&T program. At December 31, 1994, 1995, and September 30, 1996, unbilled
resale revenue totaled $13,373, $27,985 and $9,930, respectively.

Concentration of Credit Risk

The Company's financial instruments consist of cash, accounts and notes
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. The Company continually
evaluates the creditworthiness 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.

Deferred Financing Costs

Financing costs are capitalized and amortized over the term of the related
debt on a straight-line basis which approximates the effective-interest method.
Included in other assets at December 31, 1995 and September 30, 1996 are
deferred financing costs of $510 and $3,705, respectively (net of accumulated
amortization of $15 and $389, respectively).

F-9
<PAGE> 110

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Plant and Equipment

Plant and equipment are stated at cost. The direct employee costs and
outside consultant costs related to development of the Company's management
information systems were capitalized (see Note 3). Depreciation and
amortization, which includes amortization of assets recorded under capital
leases, are computed using the straight-line method over the following useful
lives:

<TABLE>
<S> <C>
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
</TABLE>

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 five years (three years effective January 1, 1996) using the
straight-line method. Amounts are also allocated to noncompete agreements,
goodwill and a reseller agreement, as applicable, which are amortized using the
straight-line method over terms ranging from 18 months to 25 years.

In conjunction with the preparation of its financial statements for the
first quarter of 1996, the Company completed a review of its accounting policies
and practices, including those relating to intangible assets. Based on certain
changes in circumstances that occurred in the first quarter, including turnover
in personnel, reduction in sales force and continuing attrition of acquired
customer bases, the Company determined that effective January 1, 1996, a
reduction in the estimated life of acquired customer bases from 5 years to 3
years was appropriate.

Income Taxes

Prior to January 1, 1994, Midcom was taxed as an S corporation. As an S
corporation, all earnings or losses of Midcom were taxed directly to the
shareholders. Effective January 1, 1994, Midcom became subject to income taxes
directly as a C corporation.

The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes," which
requires that deferred income taxes be provided based on the estimated future
tax effects of differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes.

Foreign Currency Translation

The Company's Russian joint venture, Dal Telecom, operates in a highly
inflationary country, and therefore, a combination of current and historical
rates is used in translating assets and liabilities. The related exchange
adjustments are included in net loss. Operating results are translated at the
average rates during the period.

Restructuring Charge

In March and April 1996, the Company made announcements regarding changes
in senior management and the restructuring of its operations in order to reduce
expenses to the level of available capital. These actions included the layoff of
certain employees and contractors and closure of six sales offices. As a result,
the Company recorded a charge of $1,600 during the first quarter of 1996 and
$600 during the second quarter of 1996, the major components of which relate to
severance and lease cancellation charges. Included in the first

F-10
<PAGE> 111

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

quarter restructuring charge is approximately $400 relating to the extension of
the time period to exercise certain outstanding stock options. As of September
30, 1996, approximately $1,024 of this restructuring charge remained in accrued
liabilities.

Net Loss Per Share

Net loss per share is based on the weighted average number of common and
equivalent shares outstanding using the treasury stock method and the number of
shares issued in the Company's initial public offering whose net proceeds were
used to redeem the Series A Redeemable Preferred Stock. Common stock equivalents
are excluded from the calculation of net loss per share due to their
antidilutive effect, except that pursuant to Securities and Exchange Commission
(SEC) requirements, common and equivalent shares issued during the 12-month
period prior to the initial public offering have been included in the
calculation as if they were outstanding for all periods prior to the completion
of the Company's initial public offering using the treasury stock method.

Accounting for Long-Lived Assets

Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which was issued
in March 1995, requires impairment losses to be recorded on certain longlived
assets used in operations or expected to be disposed of. The Company adopted
Statement 121 in the fourth quarter of 1995.

Reclassifications

Certain reclassifications have been made to the prior years' financial
statements to conform with the current year presentation.

3. PLANT AND EQUIPMENT

Major classes of plant and equipment, including assets under capital
leases, consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------- SEPTEMBER 30,
1994 1995 1996
------- ------- -------------
<S> <C> <C> <C>
Buildings and towers............................... $ 764 $ 787 $ 405
Transmission equipment............................. 2,772 3,747 3,369
Data processing systems and equipment.............. 6,260 11,120 11,314
Switches........................................... 1,487 -- 117
Furniture, equipment and leasehold improvements.... 4,552 4,663 5,839
-------- -------- --------
15,835 20,317 21,044
Accumulated depreciation and amortization.......... (2,852) (6,598) (10,914)
-------- -------- --------
$12,983 $13,719 $ 10,130
======== ======== ========
</TABLE>

The gross amount of plant and equipment recorded under capital leases was
$2,685 at December 31, 1994 and $6,073 at December 31, 1995 and September 30,
1996.

Included in plant and equipment 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
over five years. As a result of billing problems encountered after the system
was placed in service, the Company evaluated the system during the fourth
quarter of 1995 and determined that the system would require additional
enhancements to meet its initial design objectives and that its value

F-11
<PAGE> 112

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

had been impaired. As a result, the Company reduced the unamortized costs from
$4,471 to $2,000 and in 1995 recorded a $2,471 loss on impairment of the asset.

Included in plant and equipment are switches, the majority of which were
acquired through acquisitions of other telecommunications service providers.
During the fourth quarter of 1995, the Company determined that it intended to
replace these limited capacity switches with newer switches with increased
functionality and capacity through sharing or reseller arrangements with
operators of switches. As a result of this decision, the Company wrote off its
existing switches and recorded in 1995 a $2,544 loss on impairment of these
assets.

4. INVESTMENT IN AND ADVANCES TO JOINT VENTURE

In December 1993, Midcom advanced $1,911 to Dal Telecom, to be used in
building a long distance telephone network in the Russian Far East. In January
1994, Midcom formed a 50/50 joint venture with the Russian owner of Dal Telecom
to continue this activity and committed to invest a total of $15,000 to acquire
its 50% interest in the joint venture. This amount was subsequently reduced to
$12,700. Midcom converted the advance outstanding at December 31, 1993 to an
investment in the joint venture and during 1994 and 1995, invested an additional
$4,190 and $2,625, respectively.

Summarized financial data for Dal Telecom follows:

<TABLE>
<CAPTION>
NOVEMBER 30, 1995
-----------------
<S> <C>
Current assets............................................... $ 2,708
Noncurrent assets............................................ 9,567
Current liabilities.......................................... 352
Noncurrent liabilities....................................... 668
Equity....................................................... 11,255
</TABLE>

<TABLE>
<CAPTION>
12 MONTHS ENDED
NOVEMBER 30, 1995
-----------------
<S> <C>
Revenue...................................................... $ 3,821
Gross profit................................................. 1,902
Translation loss............................................. (127)
Net income (loss)............................................ 135
</TABLE>

Substantially all of the assets of Dal Telecom are located in Russia. The
Company has obtained insurance against political and expropriation risks of up
to 90% of the Company's invested capital in the joint venture through a U.S.
Government sponsored agency.

As of December 31, 1995, the Company was required to invest an additional
$3,100 in order to maintain its 50% interest in Dal Telecom, although there is
currently no fixed schedule for providing these funds. The Russian joint venture
partner disputes the amount remaining to be contributed by Midcom for a variety
of tax, accounting and other reasons. In May 1996, the Company and the joint
venture partner agreed to amend the terms of the joint venture to provide that
the Company had a 40% interest in the joint venture and that, upon payment of an
additional capital contribution of $3,500, the Company would have a 50% equity
interest in the joint venture.

The Company's commitment to the Russian joint venture has required
significant amounts of capital resources and management attention given the
logistics of maintaining a relationship in Russia. Given the Company's current
financial condition, it is unable to fund any additional contributions to the
joint venture. The Company now believes it is in its best interests to focus on
its domestic business and, as a consequence, is actively seeking to sell its
interest in Dal Telecom during 1996. As result of this decision, the Company
wrote down its investment in Dal Telecom to $2,000, which was the Company's
estimate of the net recoverable value of its investment in Dal Telecom, and
recorded a $6,870 loss on impairment of the asset. This estimate was

F-12
<PAGE> 113

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

based on market information currently available to the Company and certain
assumptions about the future operations of Dal Telecom, over which the Company
has limited control. In September 1996, the Company wrote off the remaining $2.0
million carrying value to impairment of asset.

At December 31, 1995, prior to the write-down of its investment, the
difference between the Company's investment and 50% of the equity in Dal
Telecom's net assets was $2,210. The difference relates to the Company's
investment in the joint venture and was being amortized over 20 years. During
1995 and 1994, $120 and $93 was amortized, respectively, and is included in
equity in loss of joint venture in the consolidated statements of operations. As
a result of the write-down described above, this difference has been eliminated.

5. BUSINESS COMBINATIONS

In September 1995, the Company acquired all of the outstanding stock of
AdVal in exchange for 250,000 shares of common stock valued at $3,750. In
December 1995, the Company acquired all of the outstanding stock of Adnet and
its wholly-owned subsidiary, Advanced Network Design, in exchange for 453,250
shares of common stock valued at $8,272. These transactions have been accounted
for as pooling of interests and, accordingly, the consolidated financial
statements for all periods presented have been restated to include the accounts
and results of operations of AdVal and Adnet.

Net revenue, extraordinary items and net income (loss) of the separate
companies were as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, MIDCOM ADVAL ADNET COMBINED
-------------------------------------------- -------- ------ ------ --------
<S> <C> <C> <C> <C>
1993:
Net revenue............................... $ 56,623 $ 733 $8,654 $ 66,010
Net income (loss)......................... (840) 51 260 (529)
1994:
Net revenue............................... $ 99,815 $3,282 $8,602 $111,699
Net income (loss)......................... (3,984) (313) 1,268 (3,029)
1995:
Net revenue............................... $191,990 $3,102 $8,462 $203,554
Extraordinary loss........................ (4,067) -- -- (4,067)
Net income (loss)......................... (34,274) (69) 925 (33,418)
</TABLE>

During 1994 and 1995, the Company also completed a series of acquisitions
from other telecommunications companies offering services similar to those
offered by the Company. Certain of these acquisitions included the purchase of
substantially all of the operating assets of the acquiree, including customer
bases, and in other situations only specific customer bases. The asset
acquisitions have been accounted for using the purchase method, with the excess
of the purchase price over the net tangible assets acquired being allocated to

F-13
<PAGE> 114

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

acquired customer bases, non-compete agreements and goodwill. Revenue generated
from the acquired customer bases are included in the accompanying statements of
operations from the dates of the acquisitions.

Summary information concerning the acquisitions is as follows:

<TABLE>
<CAPTION>
TOTAL GROSS
PURCHASE INTANGIBLE
SELLING COMPANY ACQUISITION DATE PRICE ASSETS
------------------------------------------- ------------------- ------- --------
<S> <C> <C> <C>
Balance at December 31, 1993............... $10,788 $ 8,882
Business acquisitions:
American Telephone Network Inc. (ATN).... September 30, 1994 2,030 509
PacNet, Inc. (PacNet).................... December 30, 1994 4,816 439
Customer base acquisitions................. Various 6,962 6,962
------- --------
Balance at December 31, 1994............... 24,596 16,792
Communique Telecommunications, Inc. January 20, 1995 14,829 11,265
(Communique)..........................
Concord Network, Inc. (Concord).......... January 31, 1995 1,292 613
Cel-Tech International Corp. September 12, 1995 4,587 4,155
(Cel-Tech)............................
Customer base acquisitions................. Various 43,323 40,768
------- --------
Balance at December 31, 1995............... 88,627 73,593
Customer base acquisitions................. 971 971
Customer base disposition.................. -- (55)
Loss on impairment of assets............... -- (17,765)
------- --------
Balance at September 30, 1996.............. $89,598 $ 56,744
======= ========
</TABLE>

The above purchases have generally been financed through borrowings under
the Company's lines of credit, issuance of debt and stock (see Notes 6 and 7)
and assumption of liabilities.

Components of intangible assets at December 31, 1995 and September 30, 1996
and their respective estimated useful lives were as follows:

<TABLE>
<CAPTION>
ESTIMATED
DECEMBER 31, SEPTEMBER 30, USEFUL
1995 1996 LIFE
------------ ------------- ------------
<S> <C> <C> <C>
Customer bases............................... $ 66,855 $49,823 3 years
Non-compete agreements....................... 3,195 3,195 2 to 4 years
Reseller license............................. 1,695 1,695 10 years
Goodwill..................................... 1,848 2,031 25 years
------- -------
$ 73,593 $56,744
======= =======
</TABLE>

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. Substantially all of the
Company's intangible assets consist of acquired customer bases which are subject
to attrition. The estimated useful lives of these customer bases are based on
attrition rates considered standard in the industry. If the Company's actual
attrition rates were to exceed these estimates, or other unfavorable changes in
business conditions were to occur, the value of the related customer bases would
be impaired and future operating results would be adversely affected.

Based on certain changes in circumstances that occurred in 1996, including
turnover in personnel, reduction in sales force and continuing attrition of
acquired customer bases, the Company determined that

F-14
<PAGE> 115

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

effective January 1, 1996, a reduction in the estimated useful life of acquired
customer bases from 5 years to 3 years was appropriate. Additionally, to the
extent that 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. In connection with such a review, the Company wrote down
certain acquired customer bases and recorded a loss on impairment of assets
totaling $17,765 during the second quarter of 1996.

The following condensed pro forma information presents the results of
operations of Midcom as if the acquisitions of ATN, PacNet, Communique, Concord
and Cel-Tech had occurred on January 1, 1995 and 1994, respectively.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
----------------------
1994 1995
-------- --------
<S> <C> <C>
Revenue....................................................... $169,718 $205,494
Net loss...................................................... (1,873) (33,364)
Pro forma loss per share...................................... (0.19) (2.76)
</TABLE>

The pro forma results do not necessarily represent results which would have
occurred if the acquisitions had taken place on the dates indicated nor are they
necessarily indicative of the results of future operations.

In connection with the Communique acquisition, 371,875 shares of common
stock were held in escrow and subsequently sold as part of the Company's initial
public offering in July 1995 (see Note 16). The net proceeds of $3,800 from the
sale of these shares were held in escrow pending the results of an arbitration
hearing. On March 13, 1996, the arbitration decision was received, pursuant to
which the Company received approximately $352.

In connection with several of the other transactions described above, the
Company has an obligation to issue or release from escrow up to a maximum of
151,675 additional shares of its common stock representing an aggregate value,
based on the Company's stock price on November 8, 1996, of approximately $1.6
million, upon the satisfaction of certain contingencies. Such contingencies
include, among other things, maintenance of specified revenue levels, adjustment
of liabilities assumed and receivables purchased, and satisfaction of general
representations and warranties. The contingency periods range from six months to
two years. The Company was also obligated to pay additional cash in connection
with a customer base purchase agreement upon the maintenance of specified
revenue levels. In October 1996, $1.2 million was paid to satisfy this
obligation. In addition, in the event of the sale or other transfer of the
majority of the voting stock of Cel-Tech, a payment of a maximum of $2,000 would
become payable to the former shareholder.

In accordance with applicable accounting standards, the common stock or
other consideration issuable under the contingency arrangements has not been
included in the determination of purchase price, nor have the shares been
considered outstanding for purposes of earnings per share calculations.
Additional consideration will be recorded when the outcome of a contingency is
determined.

The Company is also obligated in certain cases to issue additional shares
of its Common Stock in the event that the market price of such stock, when the
shares become registerable, is less than the price at the acquisition dates.
Based on the Company's stock price on November 8, 1996, approximately 198,577
additional shares would be issuable as a result of these obligations.

6. NOTES PAYABLE

At December 31, 1994 and 1995 and September 30, 1996, the Company had $680
in 8% per annum subordinated convertible demand notes outstanding held by the
three sellers of Telnet, secured by a personal guarantee of the principal
shareholder of the Company. Interest was payable monthly on these notes and they
were convertible, at the option of the holders, into 0.1% per $100 of principal
debt of the Company's common stock. Effective April 1, 1995, the notes and
associated agreements were amended as follows: (i) the

F-15
<PAGE> 116

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

convertibility option was eliminated, (ii) if not paid sooner upon 30-day
demand, the maturity date was set at March 28, 1999, (iii) interest was set at a
prime plus 2%, but in no event lower than 9% or greater than 13% per annum, and
(iv) the three note holders were granted warrants to purchase up to a total of
59,500 shares of common stock at an exercise price of $7.44 per share, subject
to adjustments in the exercise price related to dilutive or anti-dilutive
activities. The warrants expire on March 28, 1999.

At December 31, 1994, the Company had notes payable of $947 which were
secured by certain assets of the Company and were repaid in full in 1995.

In connection with the acquisition of Communique in January 1995, and the
extension of a payable to one carrier in March 1995, the Company issued notes
payable to three carriers aggregating $8.5 million with interest ranging from
10% to 12%. The notes were paid in full in July 1995 with the proceeds from the
Company's initial public offering.

In connection with a customer base purchase agreement, the Company had a
noninterest-bearing obligation totaling $12.0 million as of December 31, 1995.
The unsecured obligation required monthly payments of $3.0 million from January
through April 1996, payable in cash or common stock. The Company paid $3.0
million to the seller in January 1996 and is currently in negotiations with the
seller to satisfy the remaining payment obligation, including possibly selling
back a portion of the customer bases originally acquired. There can be no
assurance that the Company will be successful in selling back these customer
bases or that, if sold, it would not incur a material loss on such disposition.
The Company is currently prohibited from paying this obligation in cash without
the prior written consent of its primary lender. Based on the Company's stock
price on November 8, 1996, the Company would be required to issue 491,715 shares
of its common stock to satisfy this obligation.

At December 31, 1995, the Company had an additional note payable of
approximately $2,000 to a seller of certain customer bases. The note was
non-interest bearing and was payable in varying installments in 1996. In
connection with the issuance of this note, the Company issued a warrant to
acquire $2,000 of the Company's common stock. In the event of non-payment of the
note, the exercise price is cancellation of the note, the principal amount of
which is subject to adjustment, and the number of shares to be issued upon
exercise of the warrant equals $2,000 divided by the then current market price
of the Company's common stock. The warrant would expire on April 30, 1997.

7. LONG-TERM OBLIGATIONS

Long-term obligations consisted of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------- SEPTEMBER 30,
1994 1995 1996
------- ------- -------------
<S> <C> <C> <C>
25,000 Senior Revolving Credit Facility with First Union
National Bank of North Carolina. Interest was generally
payable at the Company's option at either the Bank's prime
rate plus 1% or LIBOR plus 2.57%. Applicable interest rates
on outstanding advances at December 31, 1994 ranged from
7.625% to 8.75%. This facility was secured by substantially
all of the Company's assets and was paid in full November,
1995......................................................... $19,350 $ -- $ --
Senior Revolving Credit Facility with Transamerica Business
Credit. Interest is generally payable at the Company's option
at either LIBOR plus 2.50% or .5% plus the higher of the
Prime Rate or the latest published annualized rate for 90-day
dealer commercial paper. Applicable interest rate on
outstanding advances at December 31, 1995 was 9%. The balance
is due November 7, 1997. This facility is secured by
substantially all of the Company's assets.................... -- 37,428 --
</TABLE>

F-16
<PAGE> 117

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1994 1995 1996
------- -------
<S> <C> <C> <C>
Bridge loan with Transamerica Business Credit, renewable in 30
day extensions with final payment due September 24, 1996. The
loan bears interest at 12% and is secured by substantially
all of the Company's assets.................................. -- -- --
10% Senior Subordinated Notes Payable. Interest paid quarterly.
The note was repaid in full in July 1995..................... 15,000 -- --
Unsecured seller notes payable, interest at 5% to 8%, principal
and interest are payable in quarterly installments through
May 31, 1997................................................. 386 89 37
Note payable to bank, secured by certain property and
equipment, interest at the bank's prime rate plus 1%. Paid in
full in January 1996......................................... -- 240 --
Convertible subordinated notes payable, maturing on August 15,
2003, interest at 8 1/4%, interest payable in semi-annual
payments. Convertible into common stock at the option of the
holder at any time prior to maturity......................... -- -- 97,743
Note payable secured by assets acquired, interest payable
quarterly at the prime rate plus 1%. Balance due in full
September 30, 1998........................................... 800 800 800
Notes payable to equipment vendors, secured by related
equipment, interest at 9.5% to 15%, principal and interest
payments due in monthly installments through November 1,
1996......................................................... 159 79 1
------- -------
35,695 38,636 98,581
Less original issue discount on 10% Senior Subordinated Notes
Payable...................................................... 3,247 -- --
------- -------
32,448 38,636 98,581
Less current portion........................................... 378 37,809 38
------- -------
$32,070 $ 827 $98,543
======= =======
</TABLE>

The $25,000 Senior Revolving Credit Facility and the Senior Subordinated
Note agreements contained covenants which, among other matters, restricted the
ability of the Company to pay dividends, incur additional indebtedness, and
repurchase stock, and required the Company to maintain certain financial
covenants.

In connection with the issuance of the Senior Subordinated Notes Payable in
the amounts of $14,800 and $200 to First Union Corporation and the
Robinson-Humphrey Company, Inc., respectively, the Company issued detachable
warrants to the note holders to purchase common stock of the Company for $.0001
per share. The number of shares of common stock issuable upon exercise of the
warrants was dependent upon the completion of a public offering or other defined
events ("Liquidity Event(s)"). On July 6, 1995, the Company successfully
completed an initial public offering of its stock and 648,119 shares of common
stock were issued upon exercise of the warrants. The Company repaid the Senior
Subordinated Notes with proceeds from the initial public offering and recorded
as an extraordinary item in the third quarter a $2,992 loss on write-off of
unamortized original issue discount.

During 1995, the $25,000 Senior Revolving Credit Facility was amended to
increase the maximum borrowing by $4,000 (total of $29,000). Interest was
payable on the additional amount at the prime rate plus 2.5% and this amount was
repaid with proceeds from the Company's initial public offering of its stock.

In November 1995, the Company obtained a new Senior Revolving Credit
Facility (Facility), which provided for borrowings of up to $50,000 subject to a
limitation of 85% of eligible receivables and other financial covenants. The
Company was not in compliance with some of these covenants as of December 31,
1995. The agreement was further amended in March 1996 to reduce the overall
commitment by the lender from $50,000 to $43,000. As of June 30, 1996, the
Company was again in default of certain covenants under its Senior Revolving
Credit Facility and as a result, all borrowings under this Facility are
classified as current in

F-17
<PAGE> 118

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the accompanying consolidated financial statements. The default on this Facility
also creates a default under the bridge loan described below.

Concurrent with obtaining the new Senior Revolving Credit Facility, the
Company terminated its prior credit facility and recorded, as an extraordinary
item in the fourth quarter, a $1,075 loss on write-off of deferred financing
costs.

Principal maturities of long-term debt at December 31, 1995 were as
follows:

<TABLE>
<S> <C>
1996............................................................... $37,809
1997............................................................... 27
1998............................................................... 800
-------
Total.................................................... $38,636
=======
</TABLE>

On March 28, 1996, the Company obtained a bridge loan of $15,000 from the
principal lender of its Facility. The bridge loan is secured by substantially
all of the Company's assets, bears interest at 12% and was originally due on
April 27, 1996. The Company paid an initial loan fee of $500 and has the right
to extend the due date of the loan for 30-day periods upon payment of an
additional fee of $200 for each 30-day extension, with final payment due by
September 24, 1996. This bridge loan was repaid in August 1996. The Company also
gave the lender a warrant to purchase 815,470 shares of the Company's common
stock for nominal consideration; this warrant was cancelled upon repayment of
the bridge loan in August 1996. The number of shares that can be purchased is
subject to adjustment for certain defined dilutive events.

8. ISSUANCE OF CONVERTIBLE SUBORDINATED NOTES PAYABLE

In August and September of 1996, the Company completed a private placement
(the "Private Placement") of approximately $97.7 million in aggregate principal
amount of 8 1/4% Convertible Subordinated Notes due 2003 (the "Notes") pursuant
to a Purchase Agreement, dated as of August 15, 1996 (the "Purchase Agreement"),
among the Company, PaineWebber Incorporated ("PaineWebber") and Wheat, First
Securities, Inc. ("Wheat, First," and together with PaineWebber the "Initial
Purchasers"). Interest on the Notes will be paid semi-annually, on February 15
and August 15 of each year, commencing February 15, 1997. The Notes are
convertible into shares of the Company's common stock, at a conversion price of
$14.0875 per share (equivalent to a conversion rate of 70.985 shares per $1,000
principal amount of Notes), subject to adjustment in certain events.

The net proceeds to Midcom from the Private Placement were approximately
$94.2 million, after deducting the discount to the Initial Purchasers and
expenses. The Company used the net proceeds as follows: (i) $15.0 million to
repay in full a bridge loan made by Transamerica Business Credit Corporation
("Transamerica"), (ii) $19.0 million to repay in full the revolving loans (the
"Revolving Loans") under the Company's secured revolving credit facility with
Transamerica and certain other lenders, (iii) $5.0 million to pay the first
installment of an $8.8 million payment in connection with the satisfaction of
past shortfalls and settlement of other obligations under the Company's carrier
supply contract with AT&T and (iv) $10.0 million to bring current a number of
payment obligations existing prior to the completion of the Private Placement.
In addition, the Company anticipates using approximately $22.0 million of the
net proceeds to acquire and install high capacity switches. The balance of the
net proceeds has been and will be used for additional working capital,
additional capital expenditures and general corporate purposes.

The Notes were sold to qualified institutional buyers pursuant to
Securities and Exchange commission Rule 144A under the Securities Act of 1933
(the "Securities Act"), certain "accredited investors" pursuant to Regulation D
under the Securities Act, and certain non-U.S. persons pursuant to Regulation S
under the Securities Act. The Notes have not been registered under the
Securities Act and may not be offered or sold in the United States absent
registration under the Securities Act or an exemption from such registration

F-18
<PAGE> 119

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

requirements. However, pursuant to a Registration Rights Agreement, dated as of
August 22, 1996 (the "Registration Rights Agreement"), among the Company and the
Initial Purchasers, the Company has agreed to register the public offer and sale
of the Notes and the shares of Common Stock issuable upon conversion of the
Notes (the "Conversion Shares"). Pursuant to the Registration Rights Agreement,
the Company filed a shelf registration statement (the "Shelf Registration
Statement") with the Commission on October 18, 1996 to register the public offer
and sale of the Notes and the Conversion Shares. The Company is required under
the Registration Rights Agreement to maintain the effectiveness of the Shelf
Registration Statement for a period of three years from the completion of the
Private Placement or, if shorter, when (i) all the Notes and Conversion Shares
have been sold pursuant to the Shelf Registration Statement or (ii) the date on
which there ceases to be outstanding any Notes or Conversion Shares.

9. PREFERRED STOCK

During 1994, the Company's Board of Directors approved the issuance of a
new Series of preferred stock and issued 859,653 shares to retire shareholder
notes payable (see Note 12). The preferred stock was nonvoting, was not entitled
to dividends and had a preference in liquidation of $10 per share. The preferred
stock was redeemed at $10 per share in July 1995 with proceeds from the
Company's initial public offering.

10. COMMON STOCK

Prior to its initial public offering, the Company had authorized voting and
nonvoting common stock. Nonvoting common stock was convertible into an equal
number of shares of common stock upon the occurrence of certain events,
including the public sale of securities of the Company or a change in control of
the Company. In all other respects, the two classes have the same rights and
privileges. Concurrent with the closing of the Company's initial public
offering, all authorized nonvoting common stock converted by its terms to common
stock.

At December 31, 1995 and September 30, 1996, common stock was reserved for
the following:

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------ -------------
<S> <C> <C>
Conversion of convertible subordinated notes payable....... -- 6,938,279
Exercise and future grant of stock options................. 1,672,730 4,110,272
Employee stock purchase plan............................... 260,071 258,625
Exercise of outstanding warrants........................... 59,500 59,500
--------- ---------
Total common stock reserved...................... 1,992,301 11,366,676
========= =========
</TABLE>

11. STOCK OPTION PLAN

The Company has a stock option plan and, as of December 31, 1995, the plan
provided for the granting of nonqualified and incentive stock options to
purchase up to 1,739,063 shares of common stock. In May 1996, the Company
authorized an additional 3,000,000 shares of common stock for the Company's
stock option plan,which was approved by the Company's shareholders at the Annual
Meeting of Shareholders in October 1996. Options granted become exercisable over
vesting periods of up to five years at exercise prices determined by the Board
of Directors, generally expire ten years from the date of grant and are
dependent upon continuous employment.

F-19
<PAGE> 120

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of activity under the stock option plan is as follows:

<TABLE>
<CAPTION>
SHARES EXERCISE PRICE
--------- --------------
<S> <C> <C>
Options outstanding at December 31, 1993.................. 484,805 $2.29 - $ 5.71
Granted................................................. 663,139 $2.29 - $ 9.14
Canceled................................................ (117,460) $2.29 - $ 9.14
---------
Options outstanding at December 31, 1994.................. 1,030,484 $2.29 - $ 9.14
Granted................................................. 740,954 $1.00 - $18.50
Canceled................................................ (365,619) $2.29 - $15.75
Exercises............................................... (66,333) $2.29 - $18.50
---------
Options outstanding at December 31, 1995.................. 1,339,486 $1.00 - $18.50
Granted................................................. 2,806,361 $3.12 - $15.50
Canceled................................................ (252,394) $2.29 - $18.50
Exercises............................................... (561,501) $2.29 - $ 9.14
---------
Options outstanding at September 30, 1996................. 3,331,952 $2.29 - $18.50
=========
</TABLE>

Stock options have generally been granted at or in excess of the estimated
fair value as determined by the Board of Directors, at the date of grant.
However, certain options have been granted at less than the estimated fair
value, in which case compensation expense is recognized over the vesting period
based on the excess of the fair value of the stock at the date of grant over the
exercise price.

At December 31, 1995 and September 30, 1996, options to purchase 585,427
and 163,743 shares of Common Stock were fully vested and exercisable.

12. INCOME TAXES

Until January 1, 1994, Midcom was treated as an S corporation for income
tax purposes. Accordingly, Midcom's income (losses) were taxed directly to the
shareholders rather than to Midcom. When Midcom made the conversion to a C
corporation, a net deferred tax liability of $207 was recorded. However, this
amount was offset by losses during the balance of the year and, accordingly, no
provision for income taxes was required.

F-20
<PAGE> 121

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Significant components of the Company's deferred tax liabilities and assets
as of December 31, 1994 and 1995 are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
------- --------
<S> <C> <C>
Deferred tax assets:
Sales reserves and allowances................................. $ 469 $ 1,326
Intangible tax amortization different than financial
accounting amortization.................................... 200 1,832
Provisions not currently deductible........................... 370 1,343
Losses and write-down of foreign joint venture................ 184 2,953
Net operating loss carryforwards.............................. 1,435 7,648
Other......................................................... 87 69
------- --------
Total deferred tax assets............................. 2,745 15,171
Valuation allowance for deferred tax assets..................... (316) (13,017)
------- --------
2,429 2,154
Deferred tax liabilities:
Systems development expensed for tax.......................... (719) (995)
Tax depreciation different than financial accounting
depreciation............................................... (590) (396)
Cash to accrual change........................................ (1,120) (763)
------- --------
Total deferred tax liabilities........................ (2,429) (2,154)
------- --------
Net deferred tax liabilities.......................... $ -- $ --
======= ========
</TABLE>

On January 1, 1994, when the Company became a C corporation, a valuation
allowance on deferred tax assets was not required due to the net deferred tax
liability position. At December 31, 1994, the valuation allowance of $316 was
established for the deferred tax assets in excess of deferred tax liabilities.
At December 31, 1995, the valuation allowance was increased to $13,017 for
deferred tax assets in excess of deferred tax liabilities.

At December 31, 1995, the Company had net operating loss carryforwards for
federal income tax purposes of $19.1 million, which are available to offset
future federal taxable income, if any, through 2010.

The provisions for income taxes differed from "expected" income tax benefit
as follows:

<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1994 1995
--------------- ----------------
<S> <C> <C> <C> <C>
Computed expected federal tax benefit........... $(1,030) (34)% $(11,362) (34)%
State taxes, net of federal benefit............. (182) (6) (2,005) (6)
Deferred taxes associated with Midcom S
corporation to C corporation conversion,
January 1, 1994............................... 207 7 -- --
Deferred tax asset realization related to
acquisitions.................................. 507 17 -- --
Change in valuation allowance for net deferred
tax assets.................................... 316 10 12,701 38
Nondeductible expenses.......................... 182 6 142 1
Other........................................... -- -- 524 1
------- --- -------- ---
$ -- --% $ -- --%
======= === ======== ===
</TABLE>

F-21
<PAGE> 122

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. RELATED-PARTY TRANSACTIONS

At December 31, 1993, the Company had notes payable to certain shareholders
and officers totaling $13,448, including accrued interest of $1,277. The notes
accrued interest at rates ranging from 12% to 18% per annum. In 1994, $9,831 of
the notes and accrued interest was repaid by offsetting a shareholder note
receivable of $1,234 and issuing 859,653 shares of redeemable preferred stock.
The remaining notes and related accrued interest were paid in full in June 1994.

During 1993, the Company charged to expense $1,025 for business consulting
services provided by shareholders. Such charges were based, in part, on
available earnings and approved by the Company's Board of Directors. The
consulting arrangement was terminated effective January 1, 1994.

Mid-Com Consultants, Inc. (Consultants) is a long distance
telecommunications distributor owned indirectly by the Company's majority
shareholder. Prior to March 1994, Consultants owned certain AT&T contracts which
the Company utilized in its aggregation business in exchange for the Company
providing various billing, collection and operational support services to
Consultants. No value has been assigned to the exchange of these services in the
financial statements as the amounts are not material. At December 31, 1994, the
Company was owed approximately $137 for cash forwarded to Consultants in advance
of actual collections, which was paid to the Company in 1995.

At December 31, 1994, the Company also had a receivable from ATN of $465
for expenses paid by the Company on behalf of ATN which was collected in 1995.

The former President and the largest shareholder of the Company jointly own
QuestWest Inc. QuestWest Inc., in turn, holds approximately an 85% interest in
Quest America Limited Partnership (Quest LP). In December 1993, the Company
entered into a distribution agreement with Quest LP that entitles Quest LP to a
sales commission from the Company at a rate equal to the most favorable rate
available to other comparable Company distributors. In October 1995 the
President and the largest shareholder sold their interest in Quest LP to a third
party and the most favorable rate clause in the distribution agreement was
eliminated. During 1995 and 1994, Quest LP received $295 and $66, respectively,
in net commissions.

In March 1995, the Company was granted an option to purchase 100% of the
stock of QuestWest Inc. through March 2000. The option price will be equal to
the amount the shareholders have currently invested in QuestWest Inc. plus 9.0%
per annum, reduced by the pro rata amount of any distributions made by Quest LP
to QuestWest Inc. This option was canceled in October 1995.

At December 31, 1995 and September 30, 1996, the Company had loans
outstanding to certain employees of $502 and $71, respectively.

14. 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 ("Retirement Plan") with its affiliate SP Investments
Inc. ("SPII"). Effective February 1, 1996, SPII withdrew from the Retirement
Plan and the Company will continue to maintain the Retirement Plan on the same
terms.

The Retirement Plan contains profit sharing and 401(k) components. Under
the 401(k) portion of the Retirement Plan, each eligible employee may elect to
contribute up to 15% of his or her pre-tax gross earnings subject to annual
limits. Under the profit sharing portion of the Retirement Plan, the Company
makes annual matching contributions equal to 50% of the participant's
contributions up to 6% of his or her compensation. In general, a participant is
100% vested in his or her own contributions and vests in the Company matching
and

F-22
<PAGE> 123

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

discretionary contributions at 20% for each full year of service. The Company
reserves the right to amend the Retirement Plan at any time.

PacNet, a wholly owned subsidiary of the Company, had a 401(k) Profit
Sharing Plan (the "PacNet Plan") with profit sharing and 401(k) components.
Under the 401(k) portion of the PacNet Plan, each eligible employee could elect
to contribute up to 5% of his or her pre-tax gross earnings subject to annual
limits. Under the profit sharing portion of the PacNet Plan, PacNet made annual
mandatory contributions equal to 100% of the participant's contributions and
could make additional discretionary contribution of 5% of the employee's gross
earnings. In general, a participant was 100% vested in his or her own
contributions and in PacNet's matching contributions. In May 1995, the Company's
Board of Directors voted to combine the Retirement Plan and the PacNet Plan
under the terms and conditions of the Retirement Plan, effective July 1, 1995.

Contributions to all salary deferral and profit sharing plans are subject
to statutory limitations regarding maximum contributions. Contribution expense
was $54, $156 and $253 for the years ended December 31, 1993, 1994 and 1995,
respectively, and $146 for the nine months ended September 30, 1996.

Employee Stock Purchase Plan

In December 1994, the Company established an Employee Stock Purchase Plan
(the "Purchase Plan") which is meant to qualify under Section 423 of the
Internal Revenue Code. The Purchase Plan became effective upon the successful
completion of the Company's initial public offering of common stock. Under the
Purchase Plan, the Company reserved up to 262,500 shares of common stock for
purchase by employees who meet certain eligibility requirements. Eligible
employees may contribute up to 10% of their compensation to the Purchase Plan to
purchase shares at 95% of the fair market value of the stock on the first or the
last day of each six-month offering period, as defined in the Purchase Plan. The
Purchase Plan establishes a maximum number of shares a participant may purchase
during any period. This maximum number of shares is determined by dividing
$12,500 by the fair market value of a share of common stock on the first day of
the offering period. The offering periods generally begin January 1 and July 1,
and the first offering period was September 1, 1995 to December 31, 1995. During
this initial period and for the period ended June 1996, 3,875 shares were
purchased at an average price of $14.26 per share.

14. COMMITMENTS AND CONTINGENCIES

Leases

The Company leases its office space and certain equipment under terms of
noncancelable operating leases, which expire on various dates through 2004. The
Company also leases equipment under various capital leases expiring on various
dates through 2002. The leases generally require that the Company pay certain
maintenance, insurance and other operating expenses. Rent expense under
operating leases for the years ended December 31, 1993, 1994 and 1995 was
$1,163, $566 and $2,535, respectively, and $2,169 for the nine months ended
September 30, 1996.

F-23
<PAGE> 124

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At December 31, 1995, minimum future lease payments under capital leases
and noncancelable operating leases with initial or remaining terms of one year
or more are as follows:

<TABLE>
<CAPTION>
CAPITAL OPERATING
YEARS ENDING DECEMBER 31, LEASES LEASES
---------------------------------------------------------------- ------ -------
<S> <C> <C>
1996............................................................ $1,542 $ 2,099
1997............................................................ 1,644 1,723
1998............................................................ 1,015 1,537
1999............................................................ 789 1,447
Thereafter...................................................... 1,282 5,515
------ -------
Total minimum future lease payments........................ 6,272 $12,321
=======
Less interest................................................... 1,343
------
Present value of future minimum lease payments.................. 4,929
Less current portion............................................ 3,912
------
$1,017
======
</TABLE>

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 some 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
others, if certain volume levels are not achieved during stated periods, pricing
is adjusted going forward to levels justified by current volumes.

Total future minimum usage commitments are as follows:

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
PERIODS ENDING DECEMBER 31, 1995 1996
--------------------------------------------------------- ------------ -------------
<S> <C> <C>
1996..................................................... $126,000 $ 53,000
1997..................................................... 111,000 77,000
1998..................................................... 77,000 78,000
-------- --------
Total.......................................... $314,000 $ 208,000
======== ========
</TABLE>

As of September 30, 1996, Midcom's minimum volume commitment under its
supply contract with AT&T Corp. ("AT&T"), its largest supply contract, was
$117.0 million. The Company estimated that, as of September 30, 1996, it would
have been in shortfall of its minimum commitments to AT&T by approximately $27.6
million based on then-applicable contract requirements. However, on October 31,
1996, the Company and AT&T executed a Release and Settlement Agreement pursuant
to which substantially all disputes between the Company and AT&T have been
resolved. Also on October 31, 1996, the Company and AT&T executed a new carrier
contract pursuant to which the Company's minimum commitment to AT&T was reduced
to $13.3 million for the eighteen month period immediately following execution
of the agreement. In addition, the new carrier contract provides for more
favorable pricing for certain network services provided by AT&T. In
consideration for the terms of the settlement and the new rate structure, the
Company is required to pay AT&T $8.8 million payable in two installments. The
first payment of $5.0 million was made on November 6, 1996, and the remaining
balance of $3.8 million will be due within 30 days of Midcom announcing
quarterly gross revenue in excess of $75.0 million, or upon completion of a
change in control.

During the years ended December 31, 1993, 1994 and 1995, the Company relied
on three carriers to carry traffic representing approximately 98%, 97% and 67%
of the Company's revenue, respectively. The Company has the ability to transfer
its customers' traffic from one supplier to another in the event a supplier
declines to

F-24
<PAGE> 125

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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.

Acquisitions

In connection with several business or customer base acquisition
agreements, the Company is obligated to issue additional consideration upon the
satisfaction of certain contingencies (see Note 5).

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 recent 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 two-year 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, if adopted, would relieve the
Company of its obligation to file tariffs applicable to its domestic
interexchange offerings.

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
adverse effect on the results of operations or financial condition of the
Company.

DISPUTES AND LITIGATION

Class Action Lawsuit. The Company, its 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 are named as
defendants in a securities action filed in the U.S. District Court for the
Western District of Washington (the "Complaint"). The Complaint purports to be
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"). An amended complaint
(the "Amended Complaint") was filed on July 8, 1996. The Amended Complaint
alleges, among other things, that the registration statement and prospectus
relating to the Company's initial public offering contained false and misleading
statements concerning the Company's billing software and financial condition.
The Amended Complaint further alleges that, throughout the Class Period, the
defendants inflated the price of the Common Stock by intentionally or recklessly
making material misrepresentations or omissions which deceived the

F-25
<PAGE> 126

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

public about the Company's financial condition and prospects. The Amended
Complaint alleges claims under the Securities Act and the Exchange Act as well
as various state laws, and seeks damages in an unstated amount. Defendants filed
a motion to dismiss on August 7, 1996 and filed a reply to plaintiffs'
opposition on September 18, 1996. Oral arguments were heard on November 1, 1996.
All discovery proceedings are stayed until defendants' motion to dismiss is
acted on by the Court. While the Company believes that it has substantive
defenses to the claims in the Amended Complaint and intends to vigorously defend
this lawsuit, it is unable to predict the outcome of this action.

Frontier Lawsuit. On August 19, 1996 the Company was served with a
complaint filed in the U.S. District Court for the Eastern District of Michigan
by Frontier Corporation ("Frontier"). This complaint names as defendants the
Company and eleven individuals, all of whom are former employees of Frontier.
These individuals include William H. Oberlin, the President and Chief Executive
Officer and a director of the Company, Charles I. Gragg III, the Executive Vice
President of Marketing of the Company, and nine other employees of the Company.
The complaint alleges, among other things, that: (i) certain of the individual
defendants, with the acquiescence and active assistance of the Company, have
engaged in a systematic strategy to hire key employees and independent
contractors of Frontier in violation of various written agreements; (ii) the
individual defendants have used confidential information belonging to Frontier
in their new employment with Midcom in violation of written agreements and
fiduciary duties and (iii) Mr. Oberlin has breached fiduciary duties as a former
employee and officer of Frontier and breached obligations under an employment
agreement with Frontier. The complaint further alleges 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; (ii) Midcom has aided and abetted
Mr. Oberlin's alleged breaches of fiduciary duties and (iii) Midcom and the
other defendants have 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 the defendants hold all profits which Midcom earns as a
result of its hiring of the individual defendants 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 defendants 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 intends to vigorously defend this action. Based on the
Company's review of the allegations in the complaint and the underlying facts,
the Company believes that the ultimate outcome of this matter will not have a
material adverse effect on the Company's business, financial condition, results
of operations or liquidity.

F-26
<PAGE> 127

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

by the Company on December 29, 1995 in exchange for 453,250 shares of Common
Stock, of which 45,325 shares (the "Adnet Escrow Shares") were placed in escrow
to be held until December 28, 1996 for satisfaction of certain contingencies.
Adnet provides long distance services to medium-to-large businesses. The
acquisition was accomplished through the merger of Adnet into the Company and
has been accounted for as a pooling of interests. On October 1, 1996, Mr.
Wiegand resigned as vice president of the Company. He had been in charge of the
operations of the Adnet division since its acquisition by Midcom. At the date of
closing of this acquisition, the last reported sale price for the Company's
Common Stock as reported by Nasdaq National Market was $18.25. During 1996
(through November 20, 1996), the Common Stock has traded as low as $6.25 per
share. The complaint alleged intentional misrepresentations, intentional
concealment of facts, negligent misrepresentation, breach of contract, breach of
implied covenant of good faith and fair dealing and violation of California
Securities Laws in connection with the acquisition. The plaintiffs sought
recovery of monetary damages in an amount which the plaintiffs describe as "not
yet ascertainable, but potentially [in excess of] $10,000,000." The plaintiffs
furthermore sought rescission of the Merger Agreement, restoration of all
consideration paid by the plaintiffs to the Company pursuant to the Merger
Agreement, an order enjoining the Company from undertaking any acts which would
further merge Adnet into the Company, and which would prevent the plaintiffs
from being accorded full relief upon rescission of the Merger Agreement,
punitive damages in an amount to be determined at trial and attorneys' fees and
other costs and expenses of suit.

The plaintiffs' claims are based in part on the restatement by the Company
of its financial results for the third quarter and the nine months ended
September 30, 1995 from those reported in its Quarterly Report on Form 10-Q for
the quarter ended September 30, 1995 as originally filed in November 1995. The
restated results, which were first announced in March 1996, reflected a $3.3
million reduction in revenue and $4.5 million reduction in accounts receivable
for the quarter and the nine months ended September 30, 1995. These and other
adjustments resulted in the Company's net loss for the quarter and the nine
months ended September 30, 1995 being increased from $3.8 million and $8.0
million, respectively, to $8.3 million and $12.5 million, respectively. The
Company had represented in the Merger Agreement with Adnet that the financial
statements included in its filings with the Commission "fairly present the . . .
financial position of MIDCOM . . . as of the dates thereof and its . . . results
of operations and cash flow for the periods then ended . . . are correct and
complete in all respects."

On August 8, 1996 the Company and the plaintiffs entered into an agreement
whereby the plaintiffs agreed to dismiss the complaint without prejudice and not
to re-file the complaint before August 31, 1996, and the parties agreed to meet
before August 31, 1996 to pursue a negotiated settlement of the plaintiffs'
claims. In connection with the execution of this agreement, the Company agreed
to release the Adnet Escrow Shares to the plaintiffs. Although as of the date of
this Quarterly Report, the plaintiffs have not re-filed their complaint, the
parties have not negotiated a settlement to the plaintiffs' claims. If the
Company is unable to reach an agreement with the plaintiffs to settle their
claims, it is likely that the complaint will be re-filed. Although the Company
would vigorously defend this action, it cannot predict the outcome of these
claims.

Cherry Communications Lawsuit. In September and December 1995, the Company
acquired two significant customer bases from Cherry Communications Incorporated
("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 Company is responsible for the
underlying carrier costs associated with the customer traffic acquired from
Cherry Communications at a rate which would yield to the Company a gross profit
on such traffic at an agreed rate. The purchase price payable with respect to
Cherry I was a total of $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
indemnity

F-27
<PAGE> 128

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 placed
in an escrow account for satisfaction of indemnity claims or to cover shortfalls
in revenue from the $2.0 million monthly average. The parties later agreed that
the Company could pay up to $9.0 million of the Cherry II payments either in
cash or by delivery of shares of Common Stock, although the terms of the
Revolving Credit Facility, as described below, prohibit the Company from paying
any portion of this obligation in cash without the lenders' prior written
consent. Separately, the Company also agreed to pay Cherry Communications
$40,000 per month per customer base 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 service for the acquired bases (up to $11.4
million through September 30, 1996) and accrued customer service charges through
September 30, 1996 of $840,000. Negotiations between Cherry Communications and
the Company failed to produce a settlement of these disputes.

F-28
<PAGE> 129

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

for summary judgment with respect to the amended complaint and to otherwise
vigorously defend this lawsuit. However, the Company is unable to predict the
outcome of this lawsuit.

Although the outcome of any litigation is uncertain, the Company believes
that it has significant defenses to such claims and intends to vigorously defend
itself in these matters, and also believes that the outcome of these matters
will not have a material adverse effect on the Company's financial condition,
results of operations or liquidity.

F-29
<PAGE> 130

MIDCOM COMMUNICATIONS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

<TABLE>
<CAPTION>
NINE MONTHS
ENDING
YEAR ENDING DECEMBER 31, SEPTEMBER 30,
----------------------------- -----------------
1993 1994 1995 1995 1996
------ ------ ------- ------ ------
<S> <C> <C> <C> <C> <C>
Noncash investing and financing activities:
Application of related-party accounts
receivable to related-party accounts
payable................................. $ -- $1,234 $ -- $ -- $ --
Conversion of amounts due to related
parties to redeemable preferred stock... -- 8,597 -- -- --
Issuance of notes payable and assumption of
liabilities for acquisitions of customer
bases................................... 3,557 5,154 42,591 36,750 487
Capital lease obligation for equipment..... 239 2,207 1,892 66 --
Issuance of notes payable for equipment.... 255 -- 310 310 --
Issuance of common stock warrants in
connection with financing............... -- 3,500 -- -- --
Issuance of common stock for
acquisitions............................ 202 1,040 9,877 2,776 513
Issuance of note payable for settlement of
carrier accounts payable................ -- -- 3,500 3,500 8,800
Cash paid for interest....................... 1,215 1,453 4,128 3,250 5,729
Cash paid for income taxes................... 21 131 25 -- --
</TABLE>

16. INITIAL PUBLIC OFFERING

On July 6, 1995, the Company completed the initial public offering of
shares of its common stock at $11.00 per share, which resulted in net proceeds
of approximately $54,182 to the Company after deducting the expenses of the
offering. The net proceeds were used to repay indebtedness and redeem all of the
outstanding Series A Redeemable Preferred Stock.

17. NEW ACCOUNTING STANDARD

In October 1995, the Financial Accounting Standards Board issued Statement
No. 123, Accounting for Stock-Based Compensation. This pronouncement establishes
accounting and reporting standards for stock-based employee compensation plans,
including: stock purchase plans, stock options and stock appreciation rights.
This standard defines a fair valuebased method of accounting for these equity
instruments. This method measures compensation cost based on the value of the
award and recognizes that cost over the service period. Companies may elect to
adopt this standard or to continue accounting for these types of equity
instruments under current guidance, APB Opinion No. 25, Accounting for Stock
Issued to Employees. Companies which elect to continue using the rules of APB
Opinion No. 25 must make pro forma disclosures of net income and earnings per
share as if this new Statement had been applied. Effective January 1, 1996, the
Company adopted Statement No. 123 and elected to continue following the guidance
of APB Opinion No. 25.

F-30
<PAGE> 131

MIDCOM COMMUNICATIONS INC.

INDEX TO FINANCIAL
STATEMENT SCHEDULES

YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors on Financial Statement
Schedule......................................................................... II-14
Schedule II. Valuation and Qualifying Accounts..................................... II-15
</TABLE>

S-1
<PAGE> 132

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS ON FINANCIAL
STATEMENT SCHEDULE

The Shareholders and Board of Directors
MIDCOM Communications Inc.

We have audited the consolidated financial statements of MIDCOM
Communications Inc. as of December 31, 1995 and 1994, and for each of the three
years in the period ended December 31, 1995, and have issued our report thereon
dated March 29, 1996 (included elsewhere in this Registration Statement). Our
audits also included the financial statement schedule listed in Item 16(b) of
this Registration Statement. This schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP

Seattle, Washington
March 29, 1996

S-2
<PAGE> 133

SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS

<TABLE>
<CAPTION>
ADDITIONS
---------------------------
BALANCE AT CHARGED TO CHARGED TO
BEGINNING COSTS AND OTHER ACCOUNTS DEDUCTIONS BALANCE AT END
DESCRIPTION OF PERIOD EXPENSES -- DESCRIBE -- DESCRIBE OF PERIOD
- ------------------------------------- ------------ ---------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1993
Reserve and allowances deducted from
assets accounts
Allowance for doubtful accounts.... $1,168 $ 940 $ 318(1) $(1,259)(3) $ 1,167
YEAR ENDED DECEMBER 31, 1994
Reserve and allowances deducted from
assets accounts
Allowance for doubtful accounts.... $1,167 $1,505 $1,948(1) $(1,748)(3) $ 2,872
YEAR ENDED DECEMBER 31, 1995
Reserve and allowances deducted from
assets accounts
Allowance for doubtful accounts.... $2,872 $9,874 $2,832(1) $(9,403)(3) $ 10,581
$4,406(2)
</TABLE>

- ---------------
(1) Receivable reserves associated with business and customer base
acquisitions.

(2) Amounts primarily charged against revenues.

(3) Amounts written off, net of recoveries.

S-3
<PAGE> 134

- ------------------------------------------------------
- ------------------------------------------------------

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED OR INCORPORATED BY
REFERENCE IN THIS PROSPECTUS IN CONNECTION WITH THE OFFERING COVERED BY THIS
PROSPECTUS. IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE INITIAL PURCHASERS.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF ANY
OFFER TO BUY THE NOTES IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS NOT
LAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN
IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS
SET FORTH IN THIS PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF.

------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 2
Forward-looking Statements and the
Private Securities Litigation Reform
Act................................. 7
Risk Factors.......................... 8
Use of Proceeds....................... 20
Trading Market for Securities......... 20
Dividend Policy....................... 20
Capitalization........................ 21
Selected Consolidated Financial and
Operating Data...................... 22
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 24
Business.............................. 36
Management............................ 59
Selling Securityholders............... 67
Principal Shareholders................ 69
Certain Transactions.................. 71
Description of Notes.................. 72
Description of Capital Stock.......... 88
Description of Certain Indebtedness... 92
Shares Eligible for Future Sale....... 93
Plan of Distribution.................. 95
Legal Matters......................... 96
Experts............................... 96
Available Information................. 96
Index to Financial Statements......... F-1
</TABLE>

- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------

1,544,274 SHARES

MIDCOM
COMMUNICATIONS INC.

COMMON STOCK
--------------------

PROSPECTUS
--------------------

NOVEMBER , 1996

- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 135

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Registrant in connection
with the issuance and distribution of the securities being registered. All the
amounts shown are estimated, except the Securities and Exchange Commission
registration fee, the NASD filing fee and the Nasdaq National Market(@) listing
fee.

<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee......................... $4,534
NASD Filing Fee............................................................. *
Nasdaq National Market@ Listing Fee......................................... *
Blue Sky Fees and Expenses (includes fees and expenses of counsel).......... *
Transfer Agent and Registrar Fees........................................... *
Accounting Fees and Expenses................................................ *
Legal Fees and Expenses..................................................... *
Printing, Engraving and Delivery Expenses................................... *
Insurance Coverage Acquired for the Offering................................ *
Miscellaneous............................................................... *
------
Total............................................................. $ *
======
</TABLE>

- ---------------

* To be filed by amendment.

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.

Sections 23B.08.500 through 23B.08.600 of the Washington Business
Corporation Act (the "WBCA") authorize a corporation to indemnify its directors,
officers, employees and agents against certain liabilities they may incur in
such capacities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"), provided they acted in good faith and in a
manner reasonably believed to be in or not opposed to the best interests of the
corporation. The Registrant's Bylaws (Exhibit 3.2 hereto) require the Registrant
to indemnify its officers and directors to the fullest extent permitted by
Washington law.

Section 23B.08.320 of the WBCA authorizes a corporation to limit or
eliminate its directors' liability to the corporation or its shareholders for
monetary damages for breaches of fiduciary duties, other than for (1) acts or
omissions that involve intentional misconduct or a knowing violation of law, (2)
improper declaration of dividends, or (3) transactions from which a director
derives an improper personal benefit. The Registrant's Amended and Restated
Articles of Incorporation (Exhibit 3.1 hereto) contain provisions limiting the
liability of the directors to the Registrant and to its shareholders to the
fullest extent permitted by Washington law.

The above discussion of the WBCA and the Registrant's Bylaws and Amended
and Restated Articles of Incorporation is not intended to be exhaustive and is
qualified in its entirety by such statute, the Bylaws and the Amended and
Restated Articles of Incorporation, respectively.

The Registrant maintains officers' and directors' liability insurance of on
its directors and officers.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

On August 22, 1996 and September 6, 1996, the Company completed sales of
$97,743,000 in aggregate principal amount of 8 1/4% Convertible Subordinate
Notes due 2003. PaineWebber Incorporated and Wheat, First Securities, Inc. acted
as the Initial Purchasers and resold the notes to qualified institutional buyers
pursuant to Rule 144A promulgated under the Securities Act, to accredited
investors under Regulation D promulgated under the Securities Act, and to
non-U.S. persons pursuant to Regulation S promulgated under the Securities Act.
The Company believes these transactions are exempt from registration pursuant to

II-1
<PAGE> 136

Rule 144A, Regulation D and Regulation S promulgate under Securities Act as
transactions not involving a public offering. The Company filed a Form D and an
Amended Form D to perfect an exemption from registration under Rule 506, as
promulgated under Section 4(2) of the Securities Act, with respect to the sales
of the notes to the Initial Purchasers. The Company has committed to register
the notes, and the shares of the Company's common stock issuable upon conversion
of the notes, for public offer and sale under the Securities Act. On October 18,
1996, the Company filed a Registration Statement on Form S-1 (Reg. No.
333-14427) relating to the public offer and sale of the notes and the shares of
the Company's common stock issuable upon conversion of the notes.

On December 29, 1995, the Company issued to David Wiegand 453,240 shares of
Common Stock in exchange for substantially all of the assets of ADNET
Telemanagement, Inc. The Company believes that the issuance of the shares was
exempt from the registration by virtue of Section 4(2) of the Securities Act as
a transaction not involving a public offering. The Company has committed to
register these shares under the Securities Act under certain circumstances.

On November 6, 1995, the Company issued to four individuals who were
shareholders of Fairfield County Telephone Corporation ("Fairfield") 98,762
shares of Common Stock, including 24,691 shares that were deposited into escrow
and are subject to possible redemption by the Company in exchange for all of the
outstanding capital stock of Fairfield. The Company believes that the issuance
of these shares was exempt from the registration by virtue of Section 4(2) of
the Securities Act as a transaction not involving a public offering. The Company
has committed to register these shares under the Securities Act under certain
circumstances.

In September 1995, the Company issued to GE Capital Communications
Services, Inc. ("GE Capital") a warrant to purchase shares of Common Stock with
an aggregate value of $2,000,000 plus additional consideration in exchange for a
portion of GE Capital's customer base. The Company believes that the issuance of
the warrant was exempt from the registration by virtue of Section 4(2) of the
Securities Act as a transaction not involving a public offering. The warrant
expired upon repayment in full of the note payable to GE Capital in the third
quarter of 1996.

On September 29, 1995, the Company issued to the shareholders of AdVal,
Inc. ("Adval") 250,000 shares of Common Stock in exchange for all of the
outstanding capital stock of Adval. The Company believes that the issuance of
these shares was exempt from the registration by virtue of Section 4(2) of the
Securities Act as a transaction not involving a public offering. The Company has
committed to register these shares under the Securities Act under certain
circumstances.

On September 1, 1995, the Company issued to Cherry Communications
Incorporated ("Cherry Communications") 317,460 shares of Common Stock plus
additional consideration in exchange for certain assets of Cherry
Communications. The Company believes that the issuance of these shares was
exempt from the registration by virtue of Section 4(2) of the Securities Act as
a transaction not involving a public offering. The Company has committed to
register these shares under the Securities Act under certain circumstances.

On August 31, 1995, the Company issued to Communications Services of
America, Inc. ("CSA") 20,893 shares of Common Stock plus additional
consideration in exchange for a portion of substantially all of the assets of
CSA. The Company believes that the issuance of these shares was exempt from the
registration by virtue of Section 4(2) of the Securities Act as a transaction
not involving a public offering. The Company has committed to register these
shares under the Securities Act under certain circumstances.

On August 19, 1995, the Company issued to Richard E. John 141,935 shares of
Common Stock in exchange for all of the outstanding capital stock of Cel-Tech
International Corp. ("Cel-Tech"). The Company believes that the issuance of
these shares was exempt from the registration by virtue of Section 4(2) of the
Securities Act as a transaction not involving a public offering. The Company has
committed to register these shares under the Securities Act under certain
circumstances.

Effective April 1, 1995, the Company issued to Darren Narins, Kevin Narins
and Steven Tomsic, at the time the shareholders of Telnet Communications Inc.,
warrants to purchase 59,500 shares of Common Stock exercisable for $7.44 per
share. The Company believes that the issuance of these warrants was exempt from

II-2
<PAGE> 137

registration by virtue of Section 4(2) of the Securities Act as transactions not
involving a public offering. The Company has committed to register the shares
issuable upon exercise of the warrants (but not the warrants) under the
Securities Act under certain circumstances.

On January 20, 1995, the Company issued to Communique Telecommunications,
Inc. ("Communique") 371,875 shares of Common Stock plus additional consideration
in exchange for certain assets of Communique. The Company believes that the
issuance of these shares was exempt from the registration by virtue of Section
4(2) of the Securities Act as a transaction not involving a public offering.

In December 1994, the Company issued to Richard W. Stroup 113,750 shares of
Common Stock in exchange for all of the outstanding shares of stock of PacNet,
Inc. In addition, the Company issued to Richard W. Stroup an option to purchase
52,000 shares of Common Stock at an exercise price of $5.71 per share. The
Company believes that the issuance of these shares and the option were exempt
from registration by virtue of Section 4(2) of the Securities Act as a
transaction not involving a public offering. The Company has committed to
register the shares (but not the options or the shares issuable upon exercise
thereof) under the Securities Act under certain circumstances.

On June 10, 1994, the Company issued to Paul Pfleger, a director and the
Company's Chairman of the Board until December 1996, and thereafter the
Company's Vice Chairman, 859,653 shares of Series A Preferred Stock in
consideration for the assignment by Mr. Pfleger to the Company of notes and
receivables in the aggregate amount of $3,731,729 and the assumption by Mr.
Pfleger of the Company's indebtedness to a third party evidenced by a note in
the original principal amount of $4 million, bearing interest at a rate of 12%
per annum and maturing December 31, 2002. The Company believes that the issuance
of the shares was exempt from registration by virtue of Section 4(2) of the
Securities Act. These shares were redeemed by the Company in connection with the
closing of the Company's initial public offering.

On June 10, 1994, the Company issued to First Union Corporation a warrant
to purchase 1,493,059 shares of Nonvoting Common Stock, at an exercise price of
$0.0001 per share. The Company believes that the issuance of the warrant was
exempt from registration by virtue of Section 4(2) of the Securities Act as a
transaction not involving a public offering and filed a Form D to perfect an
exemption from registration under Rule 506, as promulgated under Section 4(2).
In conjunction with the closing of the Company's initial public offering, the
warrants were amended and exercised resulting in the issuance of 640,478 shares
of Common Stock. The Company has committed to register these shares under the
Securities Act under certain circumstances.

On June 10, 1994, the Company issued to The Robinson-Humphrey Company, Inc.
a warrant to purchase 20,177 shares of Common Stock, at an exercise price of
$0.0001 per share. In connection with the conclusion of that financing the
Company paid a cash fee to Robinson-Humphrey of $444,000. The Company believes
that the issuance of the warrant was exempt from registration by virtue of
Section 4(2) of the Securities Act as a transaction not involving a public
offering and filed a Form D to perfect an exemption from registration under Rule
506, as promulgated under Section 4(2). In conjunction with the closing of the
Company's initial public offering, the warrants were amended and exercised
resulting in the issuance of 7,641 shares of Common Stock. The Company has
committed to register these shares under the Securities Act under certain
circumstances.

II-3
<PAGE> 138

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

A. EXHIBITS.

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
(REFERENCED TO
ITEM 601 OF
REGULATION S-K) EXHIBIT DESCRIPTION
- --------------- ----------------------------------------------------------------------------
<C> <S>
3.1 Articles of Incorporation.(6)
3.2 Bylaws.(1)
4.1 Form of Common Stock Certificate.(1)
4.2 See Exhibits numbered 3.1 and 3.2 for provisions of the Articles of
Incorporation and Bylaws of the Company defining the rights of the holders
of Common Stock.
4.3 Purchase Agreement dated August 15, 1996 among the Company, PaineWebber
Incorporated and Wheat, First Securities, Inc.(7)
4.4 Indenture dated as of August 22, 1996 between the Company and IBJ Schroder
Bank & Trust Company.(7)
4.5 Registration Rights Agreement dated as of August 22, 1996 by and among the
Company, PaineWebber Incorporated and Wheat, First Securities, Inc.(7)
*5.1 Opinion of Heller Ehrman White & McAuliffe.
10.1 Senior Subordinated Note and Warrant Purchase Agreement dated as of June 10,
1994 by and among the Company, First Union Corporation and The
Robinson-Humphrey Company, Inc.(1)
10.6 Warrant Agreement dated as of June 10, 1996 by and among the Company, First
Union Corporation and The Robinson-Humphrey Company, Inc.(1)
10.7 Registration Rights Agreement dated as of June 10, 1994 by and among the
Company, First Union Corporation and The Robinson-Humphrey Company, Inc.(1)
10.17 Agreement of Formation and Activities of Russian-American Joint Stock
Venture "Dal Telekom International" dated as of December 5, 1993, by and
among the Company, DalREO, the joint stock company Rostelekom and the state
enterprise Rossvyazinform in the cities of Khabarovsk, Blagoveschensk and
Petropavlovsk-Kamchatski, as amended; Addendum to Agreement Regarding
Reorganization of Dal Telecom International dated as of December 5, 1993, by
and between the Company and DalREO; Amendment to the Agreement on the Joint
Venture between the Company and DalREO dated July 13, 1994; Second Amendment
to the Agreement on the Joint Venture between the Company and DalREO dated
December 19, 1994; Proxy with regard to Voting of Shares of Dal Telecom
International dated December 5, 1993.(1)
10.21 Shareholders Agreement dated as of June 7, 1994 by and among Paul Pfleger,
Ashok Rao, the trust for the benefit of Siddhartha Rao, the trust for the
benefit of Kavita Rao, the trust for the benefit of Divya Rao, the trust for
the benefit of Anjali Rao, John M. Orehek, and the Company.(1)
10.23 Registration Rights Agreement dated as of December 30, 1994 by and between
the Company and Richard W. Stroup.(1)
10.25 1993 Stock Option Plan, adopted by the Board of Directors on December 30,
1993 and the shareholders on December 29, 1994, as amended by the Board of
Directors on February 21, 1994, March 28, 1994, January 19, 1995 and March
21, 1995, such amendments being approved by the shareholders on October 7,
1994 and March 30, 1995, and further amended by the Board of Directors on
April 25, 1995, July 26, 1995, November 9, 1995 and July 25, 1996, such
amendments being approved by the shareholders on October 29, 1996.(8)
10.26 1995 Employee Stock Purchase Plan adopted by the Board of Directors and the
shareholders on December 9, 1994.(1)
10.27 Employment Agreement dated as of June 7, 1994 by and between the Company and
Ashok Rao.(1)
10.30 Reseller Service Agreement dated as of December 31, 1992 by and between West
Coast Telecommunications, Inc. and the Company.(1)
10.34 Software License and Services Agreement dated as of October 26, 1993 by and
between ORACLE Corporation and the Company.(1)
</TABLE>

II-4
<PAGE> 139

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
(REFERENCED TO
ITEM 601 OF
REGULATION S-K) EXHIBIT DESCRIPTION
- --------------- ----------------------------------------------------------------------------
<C> <S>
10.35 Service Agreement, as amended, dated as of February 7, 1995 by and between
the Company and Oracle Corporation.(1)
10.36 One Plus Billing and Information Management Services Volume Purchase
Agreement dated March 4, 1995 by and between Zero Plus Dialing, Inc. d/b/a
U.S. Billing and the Company.(1)
10.42 Distributor Agreement dated as of December 28, 1993 by and between the
Company and Quest America L.P. Confidential treatment was requested for
portions of this exhibit and was granted on July 6, 1995, by an order of the
Securities and Exchange Commission under File No. 33-90814.(1)
10.50 Agreement and Plan of Reorganization dated as of November 8, 1994 by and
among the Company, P.N. Acquisition Corporation, PacNet, Inc. and Richard W.
Stroup.(1)
10.51 Agreement for the purchase of Mid-Com Consultants' Aggregation Customer Base
and Aggregation Plans by Mid-Com Communications, Inc. dated as of January 3,
1995 by and between the Company and Mid-Com Consultants, Inc.(1)
10.52 Asset Purchase Agreement dated as of January 20, 1995 by and between the
Company and Communique Telecommunications, Inc.(1)
10.60 1111 Third Avenue Lease Agreement dated as of March 8, 1994. (1)
10.61 Agreement of Sublease dated January 1, 1994 by and between Bank of New
Zealand and the Company.(1)
10.62 Real Estate Sub-Lease dated as of October 1, 1994 by and between Digital
Telecommunications, Inc. and the Company.(1)
10.66 Option Agreement dated March 6, 1995 by and among Paul H. Pfleger, Ashok
Rao, John M. Orehek and the Company.(1)
10.67 Release and Settlement Agreement dated January 1995. Confidential treatment
was requested for portions of this exhibit and was granted on July 6, 1995,
by an order of the Securities and Exchange Commission under File No.
33-90814.(1)
10.73 Overseas Private Investment Corporation Contract of Insurance against
Business Income Loss.(1)
10.74 Overseas Private Investment Corporation Contract of Insurance against
Expropriation Political Violence.(1)
10.75 Letter Agreement dated May 12, 1995 between First Union Corporation and the
Company.(1)
10.78 Registration Rights Agreement dated as of April 1, 1995 by and among the
Company and Darren Narans, Kevin Narans and Steven Tomsic.(1)
10.79 Stock Purchase Warrant issued on April 1, 1995 by the Company to Darren
Narans granting Darren Narans the right to purchase from the Company 12,250
shares of the Company's Common Stock.(1)
10.80 Stock Purchase Warrant issued on April 1, 1995 by the Company to Kevin
Narans granting Kevin Narans the right to purchase from the Company 23,625
shares of the Company's Common Stock.(1)
10.81 Stock Purchase Warrant issued on April 1, 1995 by the Company to Steven
Tomsic granting Steven Tomsic the right to purchase from the Company 23,625
shares of the Company's Common Stock.(1)
10.83 Letter Agreement dated June 6, 1995 between First Union Corporation, The
Robinson-Humphrey Company, Inc. and the Company.(1)
10.85 Indemnification and Hold Harmless Agreement dated June 29, 1995 by and among
the Company, Paul H. Pfleger, Black Creek Limited Partnership and Ashok
Rao.(1)
10.86 Carrier Transport Switched Services Agreement dated June 14, 1995 by and
between Sprint Communications Company L.P. and the Company, amended November
1, 1995. Confidential treatment was requested for portions of this exhibit
and was granted on July 6, 1995, by an order of the Securities and Exchange
Commission under File No. 33-90814.(6)
</TABLE>

II-5
<PAGE> 140

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
(REFERENCED TO
ITEM 601 OF
REGULATION S-K) EXHIBIT DESCRIPTION
- --------------- ----------------------------------------------------------------------------
<C> <S>
10.87 Telecommunications Services Agreement dated March 27, 1996 by and between
Worldcom Network Service, Inc. d/b/a WilTel and the Company. Confidential
treatment was requested for portions of this exhibit and was granted by the
SEC on March 31, 1996, by an order of the Securities and Exchange Commission
under File No. 0-26118.(6)
10.88 Customer Base Purchase and Sale Agreement dated as of September 1, 1995
between Cherry Communications Incorporated and the Company.(2)
10.89 Master Equipment Lease Agreement dated as of September 12, 1995 between
Keycorp Leasing Ltd. and the Company.(3)
10.90 Agreement and Plan of Reorganization dated as of September 29, 1995 among
the Company, AV Acquisition Corporation, AdVal, Inc., AdVal Data
Corporation, Theodore D. Berns and Donald D. Dean.(4)
10.91 Credit Agreement dated as of November 8, 1995 among the Company, PacNet,
AdVal, Cel-Tech (the "Borrowers") and Transamerica Business Credit
Corporation, as agent.(6)
10.92 Revolving Note dated December 20, 1995 in the amount of $30,000,000 made by
the Borrowers to the order of Transamerica Business Credit Corporation.(6)
10.93 Revolving Note dated December 20, 1995 in the amount of $7,000,000 made by
the Borrowers to the order of Keybank of Washington.(6)
10.94 Revolving Note dated December 20, 1995 in the amount of $13,000,000 made by
the Borrowers to the order of Nationsbank of Georgia, N.A.(6)
10.95 Stock Pledge Agreement dated as of November 8, 1995 made by the Company in
favor of Transamerica Business Credit Corporation, as agent.(6)
10.96 Security Agreement dated as of November 8, 1995 made by the Borrowers in
favor of Transamerica Business Credit Corporation, as agent.(6)
10.97 Letter Agreement dated March 6, 1996 between the Borrowers and Transamerica
Business Credit Corporation, as agent.(6)
10.98 Letter Agreement dated March 18, 1996 between the Borrowers and Transamerica
Business Credit Corporation, as agent.(6)
10.99 First Amendment to Credit Agreement dated March 28, 1996 between the
Borrowers and Transamerica Business Credit Corporation, as agent.(6)
10.100 Promissory Note dated March 28, 1996 in the amount of $15,000,000 made by
the Company to the order of Transamerica Business Credit Corporation.(6)
10.103 Agreement and Plan of Reorganization dated December 29, 1995 among the
Company, AdNet Telemanagement, Inc., David Wiegand and Maria Wiegand.(5)
10.104 Contract Tariff No. 969 effective February 15, 1996 between the Company and
AT&T Corp.(6)
10.105 Second Amendment to Credit Agreement dated July 26, 1996 among the Company,
PacNet, AdVal, Cel-Tech, Advanced Network Design and Transamerica Business
Credit Corporation, as agent.(10)
10.106 Third Amendment to Credit Agreement dated August 21, 1996 between the
Company, PacNet, AdVal, Cel-Tech and Advanced Network Design and
Transamerica Business Credit Corporation.(11)
10.107 Customer Base Purchase and Sale Agreement dated as of November 1, 1995
between Cherry Communications Incorporated.(9)
10.108 Distributor Agreement dated April 4, 1996 between the Company and Tie
Communications, Inc.(12)
10.109 Employment Agreement dated May 24, 1996 between the Company and William H.
Oberlin.(13)
10.110 Consulting Agreement dated May 24, 1996 between the Company and John M.
Zrno.(14)
</TABLE>

II-6
<PAGE> 141

<TABLE>
<CAPTION>
EXHIBIT
NUMBER
(REFERENCED TO
ITEM 601 OF
REGULATION S-K) EXHIBIT DESCRIPTION
- --------------- ----------------------------------------------------------------------------
<C> <S>
10.111 Consulting Agreement dated May 24, 1996 between the Company and Marvin C.
Moses.(15)
11.1 Statement re: computation of per share earnings.(6)
21.1 List of significant subsidiaries of the Company.(6)
23.1 Consent of Ernst & Young LLP (See page II-12).
23.2 Consent of Heller Ehrman White & McAuliffe (included in Exhibit 5.1).
24.1 Power of Attorney (See page II-11).
*25.1 Form T-1 Statement of Eligibility and Qualification of the Trustee under the
Trust Indenture Act of 1939.
</TABLE>

- ---------------
* To be filed by amendment.

(1) Exhibit is incorporated by reference to an identically numbered exhibit to
the Company's Registration Statement on Form S-1, file no. 33-90814.

(2) Exhibit is incorporated by reference to Exhibit 2.3 filed with the
Company's Current Report on Form 8-K filed with the Commission on December
18, 1995.

(3) Exhibit is incorporated by reference to Exhibit 10.1 filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1995.

(4) Exhibit is incorporated by reference to Exhibit 2.1 filed with the
Company's Current Report on Form 8-K filed with the Commission on October
13, 1995.

(5) Exhibit is incorporated by reference to Exhibit 2.1 filed with the
Company's Current Report on Form 8-K filed with the Commission on January
11, 1996.

(6) Exhibit is incorporated by reference to identically numbered exhibits filed
with the Company's Annual Report on Form 10-K for the year ended December
31, 1995.

(7) Exhibit is incorporated by reference to an identically numbered exhibit to
the Company's Registration Statement on Form S-1, file no. 333-14427.

(8) Exhibit is incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-8, file no. 333-15703.

(9) Exhibit is incorporated by reference to Exhibit 2.4 filed with the
Company's Current Report on Form 8-K filed with the Commission on December
18, 1995.

(10) Exhibit is incorporated by reference to Exhibit 10.1, filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.

(11) Exhibit is incorporated by reference to Exhibit 10.2, filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.

(12) Exhibit is incorporated by reference to Exhibit 10.3, filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.

(13) Exhibit is incorporated by reference to Exhibit 10.4, filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.

(14) Exhibit is incorporated by reference to Exhibit 10.5, filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.

(15) Exhibit is incorporated by reference to Exhibit 10.6, filed with the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.

B. FINANCIAL STATEMENTS.

Consolidated Financial Statements filed as part of this Registration
Statement are listed in the Index to the Financial Statements on page F-1.

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<PAGE> 142

C. FINANCIAL STATEMENT SCHEDULES.

Consolidated Financial Statement Schedules filed as part of this
Registration Statement are listed in the Index to the Financial Statement
Schedules on page S-1. All other schedules have been omitted because the
information is not required or is not applicable, or because the information
required is included in the Consolidated Financial Statements or the Notes
thereto included elsewhere in this Registration Statement.

ITEM 17. UNDERTAKINGS.

(a) Rule 415 Offering.

The undersigned Registrant hereby undertakes:

(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:

(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;

(ii) To reflect in the prospectus any facts or events arising after
the effective date of this Registration Statement (or the most recent
post-effective amendment thereof), which, individually or in the
aggregate, represent a fundamental change in the information set forth
in this Registration Statement;

(iii) To include any material information with respect to the plan
of distribution not previously disclosed in this Registration Statement
or any material change to such information in this Registration
Statement;

(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities as that time shall be deemed
to be the initial bona fide offering thereof;

(3) To remove from registration by means of post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.

(b) Indemnification for Liabilities

Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.

The undersigned Registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.

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<PAGE> 143

(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.

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<PAGE> 144

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Seattle, State of
Washington, on October 29, 1996.

MIDCOM COMMUNICATIONS INC.

By: /s/ ROBERT J. CHAMBERLAIN

---------------------------------------------------------------------------
Robert J. Chamberlain
Executive Vice President
Chief Financial Officer

POWER OF ATTORNEY

Each person whose individual signature appears below hereby authorizes and
appoints Robert J. Chamberlain and Paul P. Senio, and each of them, with full
power of substitution and full power to act without the other, as his true and
lawful attorney-in-fact and agent to act in his name, place and stead and to
execute in the name and on behalf of each person, individually and in each
capacity stated below, and to file, any and all amendments to this registration
statement, and to file the same, including any and all post-effective amendments
and any registration statement relating to the same offering as this
registration statement that is to be effective upon filing pursuant to Rule
462(b) under the Securities Act of 1933, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that said attorneys-in-fact, or their
substitute or substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities indicated below on the 29th day of October, 1996.

<TABLE>
<CAPTION>
SIGNATURE TITLE
- --------------------------------------------- ---------------------------------------------
<S> <C>
/s/ WILLIAM H. OBERLIN President, Chief Executive Officer and
- --------------------------------------------- Director
William H. Oberlin (Principal Executive Officer)

/s/ ROBERT J. CHAMBERLAIN Executive Vice President and Chief Financial
- --------------------------------------------- Officer (Principal Accounting and
Robert J. Chamberlain Financial Officer)

/s/ PAUL H. PFLEGER Director
- ---------------------------------------------
Paul H. Pfleger

/s/ JOHN M. OREHEK Director
- ---------------------------------------------
John M. Orehek

/s/ SCOTT B. PERPER Director
- ---------------------------------------------
Scott B. Perper

/s/ KARL D. GUELICH Director
- ---------------------------------------------
Karl D. Guelich

/s/ JOHN M. ZRNO Director
- ---------------------------------------------
John M. Zrno
</TABLE>

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<PAGE> 145

<TABLE>
<CAPTION>
SIGNATURE TITLE
- --------------------------------------------- ---------------------------------------------
<S> <C>
/s/ MARVIN C. MOSES Director
- ---------------------------------------------
Marvin C. Moses

/s/ DANIEL M. DENNIS Director
- ---------------------------------------------
Daniel M. Dennis
</TABLE>

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<PAGE> 146

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the reference to our firm under the captions "Selected
Consolidated Financial and Operating Data" and "Experts" and to the use of our
reports dated March 29, 1996, in the Registration Statement (Form S-1) and
related Prospectus of MIDCOM Communications Inc. for the registration of
1,544,274 shares of its common stock, par value $.0001 per share.

Seattle, Washington
November 19, 1996 ERNST & YOUNG LLP

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<PAGE> 147

MIDCOM COMMUNICATIONS INC.

INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER PAGINATION BY
(REFERENCED TO SEQUENTIAL
ITEM 601 OF NUMBERING
REGULATION S-K) EXHIBIT DESCRIPTION SYSTEM
- --------------- ------------------------------------------------------------------- -------------
<C> <S> <C>
3.1 Articles of Incorporation. (6)
3.2 Bylaws. (1)
4.1 Form of Common Stock Certificate. (1)
4.2 See Exhibits numbered 3.1 and 3.2 for provisions of the Articles of
Incorporation and Bylaws of the Company defining the rights of the
holders of Common Stock.
4.3 Purchase Agreement dated August 15, 1996 among the Company,
PaineWebber Incorporated and Wheat, First Securities, Inc. (7)
4.4 Indenture dated as of August 22, 1996 between the Company and IBJ
Schroder Bank & Trust Company. (7)
4.5 Registration Rights Agreement dated as of August 22, 1996 by and
among the Company, PaineWebber Incorporated and Wheat, First
Securities, Inc. (7)
*5.1 Opinion of Heller Ehrman White & McAuliffe.
10.1 Senior Subordinated Note and Warrant Purchase Agreement dated as of
June 10, 1994 by and among the Company, First Union Corporation and
The Robinson-Humphrey Company, Inc. (1)
10.6 Warrant Agreement dated as of June 10, 1996 by and among the
Company, First Union Corporation and The Robinson-Humphrey Company,
Inc. (1)
10.7 Registration Rights Agreement dated as of June 10, 1994 by and
among the Company, First Union Corporation and The
Robinson-Humphrey Company, Inc. (1)
10.17 Agreement of Formation and Activities of Russian-American Joint
Stock Venture "Dal Telekom International" dated as of December 5,
1993, by and among the Company, DalREO, the joint stock company
Rostelekom and the state enterprise Rossvyazinform in the cities of
Khabarovsk, Blagoveschensk and Petropavlovsk-Kamchatski, as
amended; Addendum to Agreement Regarding Reorganization of Dal
Telecom International dated as of December 5, 1993, by and between
the Company and DalREO; Amendment to the Agreement on the Joint
Venture between the Company and DalREO dated July 13, 1994; Second
Amendment to the Agreement on the Joint Venture between the Company
and DalREO dated December 19, 1994; Proxy with regard to Voting of
Shares of Dal Telecom International dated December 5, 1993. (1)
10.21 Shareholders Agreement dated as of June 7, 1994 by and among Paul
Pfleger, Ashok Rao, the trust for the benefit of Siddhartha Rao,
the trust for the benefit of Kavita Rao, the trust for the benefit
of Divya Rao, the trust for the benefit of Anjali Rao, John M.
Orehek, and the Company. (1)
10.23 Registration Rights Agreement dated as of December 30, 1994 by and
between the Company and Richard W. Stroup. (1)
10.25 1993 Stock Option Plan, adopted by the Board of Directors on
December 30, 1993 and the shareholders on December 29, 1994, as
amended by the Board of Directors on February 21, 1994, March 28,
1994, January 19, 1995 and March 21, 1995, such amendments being
approved by the shareholders on October 7, 1994 and March 30, 1995,
and further amended by the Board of Directors on April 25, 1995,
July 26, 1995, November 9, 1995 and July 25, 1996, such amendments
being approved by the shareholders on October 19, 1996. (8)
10.26 1995 Employee Stock Purchase Plan adopted by the Board of Directors
and the shareholders on December 9, 1994. (1)
</TABLE>
<PAGE> 148

<TABLE>
<CAPTION>
EXHIBIT
NUMBER PAGINATION BY
(REFERENCED TO SEQUENTIAL
ITEM 601 OF NUMBERING
REGULATION S-K) EXHIBIT DESCRIPTION SYSTEM
- --------------- ------------------------------------------------------------------- -------------
<C> <S> <C>
10.27 Employment Agreement dated as of June 7, 1994 by and between the
Company and Ashok Rao. (1)
10.30 Reseller Service Agreement dated as of December 31, 1992 by and
between West Coast Telecommunications, Inc. and the Company. (1)
10.34 Software License and Services Agreement dated as of October 26,
1993 by and between ORACLE Corporation and the Company. (1)
10.35 Service Agreement, as amended, dated as of February 7, 1995 by and
between the Company and Oracle Corporation. (1)
10.36 One Plus Billing and Information Management Services Volume
Purchase Agreement dated March 4, 1995 by and between Zero Plus
Dialing, Inc. d/b/a U.S. Billing and the Company. (1)
10.42 Distributor Agreement dated as of December 28, 1993 by and between
the Company and Quest America L.P. Confidential treatment was
requested for portions of this exhibit and was granted on July 6,
1995, by an order of the Securities and Exchange Commission under
File No. 33-90814. (1)
10.50 Agreement and Plan of Reorganization dated as of November 8, 1994
by and among the Company, P.N. Acquisition Corporation, PacNet,
Inc. and Richard W. Stroup. (1)
10.51 Agreement for the purchase of Mid-Com Consultants' Aggregation
Customer Base and Aggregation Plans by Mid-Com Communications, Inc.
dated as of January 3, 1995 by and between the Company and Mid-Com
Consultants, Inc. (1)
10.52 Asset Purchase Agreement dated as of January 20, 1995 by and
between the Company and Communique Telecommunications, Inc. (1)
10.60 1111 Third Avenue Lease Agreement dated as of March 8, 1994. (1)
10.61 Agreement of Sublease dated January 1, 1994 by and between Bank of
New Zealand and the Company. (1)
10.62 Real Estate Sub-Lease dated as of October 1, 1994 by and between
Digital Telecommunications, Inc. and the Company. (1)
10.66 Option Agreement dated March 6, 1995 by and among Paul H. Pfleger,
Ashok Rao, John M. Orehek and the Company. (1)
10.67 Release and Settlement Agreement dated January 1995. Confidential
treatment was requested for portions of this exhibit and was
granted on July 6, 1995, by an order of the Securities and Exchange
Commission under File No. 33-90814. (1)
10.73 Overseas Private Investment Corporation Contract of Insurance
against Business Income Loss. (1)
10.74 Overseas Private Investment Corporation Contract of Insurance
against Expropriation Political Violence. (1)
10.75 Letter Agreement dated May 12, 1995 between First Union Corporation
and the Company. (1)
10.78 Registration Rights Agreement dated as of April 1, 1995 by and
among the Company and Darren Narans, Kevin Narans and Steven
Tomsic. (1)
10.79 Stock Purchase Warrant issued on April 1, 1995 by the Company to
Darren Narans granting Darren Narans the right to purchase from the
Company 12,250 shares of the Company's Common Stock. (1)
10.80 Stock Purchase Warrant issued on April 1, 1995 by the Company to
Kevin Narans granting Kevin Narans the right to purchase from the
Company 23,625 shares of the Company's Common Stock. (1)
10.81 Stock Purchase Warrant issued on April 1, 1995 by the Company to
Steven Tomsic granting Steven Tomsic the right to purchase from the
Company 23,625 shares of the Company's Common Stock. (1)
</TABLE>
<PAGE> 149

<TABLE>
<CAPTION>
EXHIBIT
NUMBER PAGINATION BY
(REFERENCED TO SEQUENTIAL
ITEM 601 OF NUMBERING
REGULATION S-K) EXHIBIT DESCRIPTION SYSTEM
- --------------- ------------------------------------------------------------------- -------------
<C> <S> <C>
10.83 Letter Agreement dated June 6, 1995 between First Union
Corporation, The Robinson-Humphrey Company, Inc. and the Company.
(1)
10.85 Indemnification and Hold Harmless Agreement dated June 29, 1995 by
and among the Company, Paul H. Pfleger, Black Creek Limited
Partnership and Ashok Rao. (1)
10.86 Carrier Transport Switched Services Agreement dated June 14, 1995
by and between Sprint Communications Company L.P. and the Company,
amended November 1, 1995. Confidential treatment was requested for
portions of this exhibit and was granted on July 6, 1995, by an
order of the Securities and Exchange Commission under File No.
33-90814. (6)
10.87 Telecommunications Services Agreement dated March 27, 1996 by and
between Worldcom Network Service, Inc. d/b/a WilTel and the
Company. Confidential treatment was requested for portions of this
exhibit and was granted by the SEC on March 31, 1996, by an order
of the Securities and Exchange Commission under File No. 0-26118.
(6)
10.88 Customer Base Purchase and Sale Agreement dated as of September 1,
1995 between Cherry Communications Incorporated and the Company.
(2)
10.89 Master Equipment Lease Agreement dated as of September 12, 1995
between Keycorp Leasing Ltd. and the Company. (3)
10.90 Agreement and Plan of Reorganization dated as of September 29, 1995
among the Company, AV Acquisition Corporation, AdVal, Inc., AdVal
Data Corporation, Theodore D. Berns and Donald D. Dean. (4)
10.91 Credit Agreement dated as of November 8, 1995 among the Company,
PacNet, AdVal, Cel-Tech (the "Borrowers") and Transamerica Business
Credit Corporation, as agent. (6)
10.92 Revolving Note dated December 20, 1995 in the amount of $30,000,000
made by the Borrowers to the order of Transamerica Business Credit
Corporation. (6)
10.93 Revolving Note dated December 20, 1995 in the amount of $7,000,000
made by the Borrowers to the order of Keybank of Washington. (6)
10.94 Revolving Note dated December 20, 1995 in the amount of $13,000,000
made by the Borrowers to the order of Nationsbank of Georgia, N.A.
(6)
10.95 Stock Pledge Agreement dated as of November 8, 1995 made by the
Company in favor of Transamerica Business Credit Corporation, as
agent. (6)
10.96 Security Agreement dated as of November 8, 1995 made by the
Borrowers in favor of Transamerica Business Credit Corporation, as
agent. (6)
10.97 Letter Agreement dated March 6, 1996 between the Borrowers and
Transamerica Business Credit Corporation, as agent. (6)
10.98 Letter Agreement dated March 18, 1996 between the Borrowers and
Transamerica Business Credit Corporation, as agent. (6)
10.99 First Amendment to Credit Agreement dated March 28, 1996 between
the Borrowers and Transamerica Business Credit Corporation, as
agent. (6)
10.100 Promissory Note dated March 28, 1996 in the amount of $15,000,000
made by the Company to the order of Transamerica Business Credit
Corporation. (6)
10.103 Agreement and Plan of Reorganization dated December 29, 1995 among
the Company, AdNet Telemanagement, Inc., David Wiegand and Maria
Wiegand. (5)
10.104 Contract Tariff No. 969 effective February 15, 1996 between the
Company and AT&T Corp. (6)
</TABLE>
<PAGE> 150