<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
March 31, 1998
------------------------------------------------
Date of Report (Date of earliest event reported)
MC Liquidating Corporation
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(Exact name of registrant as specified in its charter)
Washington 000-26118 91-1438806
---------- ----------- ----------
(State or other (Commission (I.R.S. Employer
jurisdiction of File Number) Identification No.)
incorporation)
26899 Northwestern Highway, Suite 120, Southfield, MI 48034
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(Address of principal executive offices)
(248) 304-1780
----------------------------------------------------
(Registrant's telephone number, including area code)
MIDCOM Communications Inc.
--------------------------
(Former Name)
<PAGE>
Item 5. OTHER EVENTS
As previously reported, the Company and three of its wholly-owned
subsidiaries, PacNet Inc., Ad Val, Inc., and Cel-Tech International Corporation,
each filed a petition for relief under Chapter 11 of the Bankruptcy Code in the
Bankruptcy Court (consolidated under Case No. 97-59044-S) on November 7, 1997.
Since the Petition Date, the Company has continued as a debtor-in-possession
pursuant to the Bankruptcy Code. The Company is in the process of liquidating
its assets and winding up its operations and, as previously disclosed, has sold
all of its assets with the exception of certain conference call customer
accounts representing revenue of approximately $40,000 on a monthly basis and
the microwave network of the Company's wholly-owned subsidiary, PacNet Inc. The
Company has ceased virtually all operations other than those necessary to
preserve the value of remaining assets and is otherwise taking steps to maximize
assets available for satisfaction of creditor claims. The proceeds from the
sales of the Company's assets, net of transaction and administration costs, will
be applied to satisfaction of creditor claims in accordance with a plan of
reorganization which is being prepared for approval by the Bankruptcy Court. Net
proceeds will not be sufficient to satisfy in full unsecured creditors' claims,
including sums owed to holders of the Company's Convertible Subordinated Notes
due 2003. Nor will such proceeds be sufficient to provide any distribution in
liquidation to the holders of shares of the Company's common stock.
The Company intends to file with the Securities and Exchange Commission,
under cover of Form 8-K, copies of all monthly financial and operating reports
filed with the Bankruptcy Court pursuant to Bankruptcy Rule 2015 in lieu of
continuing to file annual and quarterly reports under the Securities Exchange
Act of 1934.
The Company's consolidated balance sheet as of December 31, 1997 and
related consolidated statements of operations, shareholders' deficit and cash
flows for year ended December 31, 1997 are filed as Exhibit 99.1 to this report.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(c) Exhibits.
99.1 Consolidated balance sheet as of December 31,
1997 and related consolidated statements of operations, shareholders' deficit
cash flows and notes to consolidated financial statements for the year ended
December 31, 1997.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned hereunto duly authorized.
Date: March 31, 1998 MC Liquidating Corporation
By: /s/ Paul P. Senio
-------------------------------
Paul P. Senio, Secretary, and
General Counsel
<PAGE>
EXHIBIT 99.1
INDEX TO FINANCIAL STATEMENTS
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Page
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MIDCOM COMMUNICATIONS, INC. CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED
DECEMBER 31, 1997
Report of Independent Certified Public Accountants.................................................... F-2
Consolidated Balance Sheet as of December 31, 1997.................................................... F-3
Consolidated Statement of Operations for the year ended December 31, 1997............................. F-4
Consolidated Statement of Shareholders' Deficit for the year ended December 31, 1997.................. F-5
Consolidated Statement of Cash Flows for the year ended December 31, 1997............................. F-6
Notes to Consolidated Financial Statements............................................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
MIDCOM Communications Inc.
We have audited the consolidated balance sheet of MIDCOM Communications
Inc. and subsidiaries (in reorganization under Chapter 11 of the United States
Bankruptcy Code since November 7, 1997, see Note A to the consolidated financial
statements) as of December 31, 1997, and the related consolidated statements of
operations, shareholders' deficit and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of MIDCOM
Communications Inc. and subsidiaries at December 31, 1997 and the consolidated
results of their operations and their consolidated cash flows for the year then
ended in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared on a going concern
basis, which contemplates continuity of the Company's operations and realization
of its assets and payments of its liabilities in the ordinary course of
business. On November 7, 1997, MIDCOM Communications Inc. and its subsidiaries
filed a voluntary petition for relief under Chapter 11 of the United States
Bankruptcy Code and is currently operating its business as a debtor-in-
possession under the supervision of the Bankruptcy Court. The Chapter 11 filing
was the result of the inability to obtain additional financing, continuing
operating losses, and cash flow problems. As more fully described in Note A, the
Company's ability to continue as a going concern would depend upon, among other
things, approval of a plan of reorganization by the Bankruptcy Court, a return
by the Company to profitability, and its ability to generate sufficient cash
from operations and other financing sources to support its business activities,
all of which are uncertain. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. Management's plans to finance
operating activities and further reorganize operations are described in Note A.
The accompanying consolidated financial statements do not reflect further
adjustments that may be required in connection with reorganizing the Company
under Chapter 11 of the United States Bankruptcy Code or as may otherwise result
from the outcome of this uncertainty.
GRANT THORNTON LLP
Detroit, Michigan
March 6, 1998
F-2
<PAGE>
MIDCOM COMMUNICATIONS INC.
(DEBTOR-IN-POSESSION)
Consolidated Balance Sheet
December 31, 1997
(In thousands, except share data)
ASSETS
Curent Assets
Cash and Cash equivalents........................................... $ 2,285
Accounts receivable, less allownace for
doubtful accounts of $7,100....................................... 20,661
Prepaid expenses and other current assets........................... 6,125
Total current assets........................................... 29,071
Furniture, equipment and leasehold
improvements, net................................................. 25,331
Intangible assets, less accumulated
amortization of $51,119........................................... 4,481
Other assets, net................................................... 681
Total assets................................................... $ 59,564
LIABILITIES AND SHAREHOLDERS' DEFICIT
Liabilities Not Subject to Compromise
Current Liabilities
Accounts payable.................................................. $ 3,997
Accrued expenses.................................................. 5,405
Notes payable..................................................... 32,332
Capital lease obligations......................................... 15,263
Total current liabilities...................................... 56,997
Liabilities Subject to Compromise................................... 175,886
Commitments and Contingencies....................................... --
Shareholders' Deficit
Preferred stock, $.0001 par value, 10,000,000 shares
authorized no shares issued and outstanding....................... --
Common stock, $.0001 par value, 90,000,000 shares
authorized, 16,193,546 shares issued and 16,183,186
shares outstanding................................. 68,623
Less 10,360 shares of treasury stock................................ (1,075)
Deferred stock option compensation.................................. (1,192)
Accumulated deficit................................................. (239,675)
Total shareholders' deficit.................................... (173,319)
Total liabilities and shareholders' deficit.................... $ 59,564
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
MIDCOM COMMUNICATIONS INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<S> <C>
For the year ended December 31, 1997
(In thousands, except share data)
Revenues...................................................................................... $ 98,283
Costs and expenses
Costs of revenue............................................................................. 72,440
Selling, general and administrative.......................................................... 103,172
Relocation of corporate headquarters......................................................... 5,200
Interest..................................................................................... 9,929
---------
190,741
Loss before reorganization items.......................................................... (92,458)
Reorganization items
Lease rejection claims....................................................................... 10,775
Professional fees and other.................................................................. 535
---------
Total reorganization items................................................................ 11,310
---------
Net loss...................................................................................... $(103,768)
Loss per share - basic and diluted............................................................ $(6.67)
Weighted average common shares outstanding.................................................... 15,568
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
MIDCOM COMMUNICATIONS INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT
FOR THE YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DEFERRED
STOCK TOTAL
PREFERRED COMMON TREASURY OPTION ACCUMULATED SHAREHOLDERS'
STOCK STOCK STOCK COMPENSATION DEFICIT DEFICIT
--------- ------- -------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997 $ - $68,330 $ - $(1,707) $(135,907) $ (69,284)
Issuance of shares of
common stock in
connection with
acquisitions in prior
years (Note D)........... - 276 - - - 276
Redemption of shares of
common stock(Note G)..... - - (6,544) - - (6,544)
Reissuance of redeemed
shares................... - - 5,469 - - 5,469
Issuance of shares for
employee stock purchase
plan..................... - 17 - - - 17
Compensation attributable
to stock options vesting. - - - 515 - 515
Net loss for the year..... - - - - (103,768) (103,768)
Balance at December 31,
1997..................... $ - $68,623 $ (1,075) $(1,192) $(239,675) $(173,319)
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
MIDCOM COMMUNICATIONS INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss..................................................................................... $(103,768)
Adjustments to reconcile net loss to net cash provided by operating activities
Depreciation............................................................................... 5,724
Amortization of intangible assets.......................................................... 11,444
Bad debt expense........................................................................... 6,347
Loss on abandonment of assets due to relocation............................................ 1,809
Loss on sale of assets..................................................................... 26
Changes in operating assets and liabilities
Increase in Accounts receivable........................................................... (10,039)
Increase in Prepaid expenses and other current assets..................................... (4,577)
Decrease in Other assets.................................................................. 3,171
Increase in Intangible Assets............................................................. (378)
Decrease in Accounts payable and accrued expenses......................................... (23,858)
Increase in liabilities subject to Compromise............................................. 175,886
Net cash provided by operating activities............................................... 61,787
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of furniture, equipment and leasehold improvements................................. (22,247)
Proceeds from sale of assets................................................................. 402
Net cash used in investing activities................................................... (21,845)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from notes payable.................................................................. 76,250
Repayment of notes payable................................................................... (43,918)
Proceeds from long-term obligations.......................................................... 13,954
Repayment of long-term obligations........................................................... (2,491)
Proceeds from common stock issued for stock purchase plan and stock options.................. 532
Net repurchase of common stock............................................................... (1,075)
Reclassification of long term obligations to liabilities subject to compromise............... (112,147)
Proceeds from sale of common stock........................................................... 276
Net Cash used in financing activities................................................... (68,619)
Net decrease in cash and cash equivalents..................................................... (28,677)
Cash and cash equivalents at the beginning of year............................................ 30,962
Cash and cash equivalents at the end of year.................................................. $ 2,285
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
MIDCOM COMMUNICATIONS INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE A - CHAPTER 11 PROCEEDINGS
On November 7, 1997, MIDCOM Communications, Inc. ("MIDCOM" or the
"Company") and its wholly-owned subsidiaries, PacNet Inc. ("PacNet"), Ad Val,
Inc. ("Adval") and Cel-Tech International Corp. ("Cel-Tech"), each filed a
petition (collectively, the "Petitions") for relief under Chapter 11 of Title 11
of the United States Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the Eastern District of Michigan (the "Bankruptcy Court"),
Case Nos. 97-59044-S, 59052-G, 59064-G and 59057-S, respectively, with such
cases to be jointly administered by the Bankruptcy Court under Case No. 97-
59044-S. The Company and its subsidiaries are currently operating their
respective businesses as debtors-in-possession pursuant to Section 1107(a) and
1108 of the Bankruptcy Code and are subject to the jurisdiction of the
Bankruptcy Court.
Under Chapter 11, certain claims against the Company in existence prior to
the filing of the petition for relief under federal bankruptcy law are stayed
while the Company continues business operations as debtor-in-possession. These
claims are reflected in the accompanying consolidated balance sheet as
"liabilities subject to compromise." In addition, the filing of a voluntary
petition under Chapter 11 was an event of default under all the Company's loan
agreements (see Note F).
The Company has arranged for debtor-in-possession financing (the "Foothill
DIP Facility") from Foothill Capital Corporation. In connection with the
Foothill DIP Financing, the Company incurred a loan fee of $250,000. The
Foothill DIP Facility consists of a revolving credit facility with borrowing
availability of up to $8.5 million, subject to the Company's satisfaction of
various terms and conditions. The Foothill DIP Facility bears interest at prime
plus 4% on receivable based advances and 18% on overadvances and expired on
January 15, 1998. The financing was paid on January 22, 1998. There can be no
assurance that the Company will not require additional debt or equity financing
in the future, and there can be no assurance that any such additional debt or
equity financing, if needed, would be available to the Company on acceptable
terms or at all.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles applicable to a company
on a "going concern" basis, which, except as otherwise noted, contemplates the
realization of assets and the liquidation of liabilities in the ordinary course
of business; however, as a result of the Chapter 11 proceedings, and
circumstances relating to this event, including the Company's leveraged
financial structure and its operating losses, such realization of assets and
liquidation of liabilities are subject to significant uncertainties. The Company
has experienced significant net losses in the past few years. During the Chapter
11 proceedings, the Company has incurred and will continue to incur substantial
reorganization costs.
F-7
<PAGE>
The Company's ability to continue as a going concern is dependent upon the
confirmation of a plan of reorganization, future profitable operations and the
ability to comply with the terms of any debtor-in-possession credit facility and
the ability to generate sufficient cash from operations and financing
arrangements to meet obligations. These conditions raise substantial doubt about
the Company's ability to continue as a going concern.
A plan of reorganization, as finally approved by the Bankruptcy Court,
could materially change the currently recorded amounts of assets and
liabilities. These financial statements do not reflect further adjustments to
the carrying value of assets and the amounts and classifications of liabilities
or shareholders' deficit that might be necessary as a consequence of the
bankruptcy proceedings. Events completed in relation to the Company's ongoing
restructuring include the sale of the assets and business of MIDCOM and its
wholly owned subsidiaries, PacNet, Cel-Tech and AdVal. The sale of MIDCOM,
PacNet and Cel-Tech was completed on January 21, 1998 and the sale of the assets
and business of AdVal was completed on February 25, 1998. Proceeds for these
sales totaled approximately $98.6 million. This is subject to adjustment if the
Company fails to maintain specified revenue levels or breaches general
representations and warranties as defined in the sales agreement.
Under the Bankruptcy Code, the Company may elect to assume or reject real
estate leases, employment contracts, personal property leases, service contract
and other unexpired executory pre-petition contracts, subject to Bankruptcy
Court approval. Certain leases and contracts have been rejected in connection
with the Chapter 11 proceedings. Obligations related to these rejected items
have been included in liabilities subject to compromise. The ultimate amount of
such claims is subject to adjustment based on the finalization of a
reorganization plan. Accordingly, the Company cannot presently determine the
ultimate liability which may result from the filing of claims for any contracts
which have been or may subsequently be rejected in the Chapter 11 proceedings.
The Court established March 17, 1998 (the "Bar Date") as the deadline for
filing proofs of claim in the Chapter 11 proceedings. The Company has notified
all known claimants for the purposes of identifying all pre-petition claims
against the Company.
The principal categories of claims classified as liabilities subject to
compromise are identified below (in thousands). All amounts below may be subject
to further adjustment depending on Bankruptcy Court action, further developments
with respects to disputed claims, determination as to the value of any
collateral securing claims, or other events. Additional claims may arise
resulting from rejection of additional executory contracts or unexpired leases
by the Company.
<TABLE>
<S> <C>
Notes payable............................................. $113,740
Accounts payable.......................................... 42,593
Carrier accounts payable.................................. 6,313
Lease termination claims.................................. 11,267
Other..................................................... 1,973
--------
Total liabilities subject to compromise................... $175,886
</TABLE>
F-8
<PAGE>
There are approximately 424 scheduled liabilities and filed proofs of claim
against the Company. The aggregate amount of those claims which specified
amounts was approximately $22.9 million as of March 6, 1998. Included among the
claims filed have been claims of unspecified amounts. The ultimate amount of and
settlement terms for such liabilities will be subject to an approved plan of
reorganization and, accordingly, are not presently determinable. Therefore, no
provision has been made for the differences between the amounts filed with the
court and the balances reflected in the accompanying consolidated financial
statements.
NOTE B - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
The Company provides long distance voice and data telecommunications
services. As primarily a nonfacilities-based reseller, MIDCOM principally
utilizes the network switching and transport facilities of Tier I long distance
carriers such as Sprint Corporation ("Sprint"), WorldCom, Inc. ('WorldCom") and
AT&T Corp. ("AT&T") to provide a broad array of telecommunications services.
MIDCOM's service offerings include basic "1 plus" and "800" long distance voice,
frame relay data transmission services, wireless services, dedicated private
lines between customer locations and enhanced telecommunications services such
as facsimile broadcast services and conference calling. The Company's customers
are primarily small to medium-sized commercial businesses throughout the United
States.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of MIDCOM and
its wholly-owned subsidiaries, PacNet, Cel-Tech and AdVal. All significant
intercompany accounts and transactions have been eliminated in consolidation.
FINANCIAL REPORTING FOR BANKRUPTCY PROCEEDINGS
The American Institute of Certified Public Accountants Statement of
Position 90-7, "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code" ("SOP 90-7"), provides guidance for financial reporting by
entities that have filed petitions with the Bankruptcy Court and expect to
reorganize under Chapter 11 of the Bankruptcy Code.
Under SOP 90-7, the financial statements of an entity in a Chapter 11
reorganization proceeding should distinguish transactions and events that are
directly associated with the reorganization from those of the operations of the
ongoing business as it evolves. Accordingly, SOP 90-7 requires the following
financial reporting/accounting treatments in respect to each of the consolidated
financial statements.
CONSOLIDATED BALANCE SHEET
The consolidated balance sheet separately classifies pre-petition and post-
petition liabilities. A further distinction is made between pre-petition
liabilities subject to compromise (generally unsecured and undersecured claims)
and those not subject to compromise (fully secured claims). Pre-petition
liabilities are reported on the basis of the expected amount of such allowed
claims, as opposed to the amounts for which those allowed claims may be settled.
Under an approved final plan of
F-9
<PAGE>
reorganization those claims may be settled at amounts substantially less than
their allowed amounts.
When a liability subject to compromise becomes an allowed claim and that
claim differs from the net carrying amount of the liability, the net carrying
amount is adjusted to the amount of the allowed claim. The resulting gain or
loss is classified as a reorganization item in the consolidated statement of
operations.
CONSOLIDATED STATEMENTS OF OPERATIONS
Pursuant to SOP 90-7, revenues and expenses, realized gains and losses, and
provisions for losses resulting from the reorganization of the business are
reported in the consolidated statement of operations separately as
reorganization items. Professional fees are expensed as incurred. Interest
expense is reported only to the extent that it will be paid during the
proceeding or that it is probable that it will be an allowed claim.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Reorganization items are reported separately within the operating,
investing and financing categories of the consolidated statement of cash flows.
CASH AND CASH EQUIVALENTS
All short-term investments with a maturity of three months or less at the
date of purchase are considered to be cash equivalents.
REVENUE RECOGNITION
Resale and transmission revenue and related costs are recognized in the
period the customer utilizes the Company's service. At December 31, 1997, net
unbilled resale revenue totaled approximately $6 million.
FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The Company's financial instruments consist of cash and cash equivalents,
accounts receivable, accounts and carrier accounts payable, notes payable and
long-term obligations. The fair value of the financial instruments, except long-
term obligations, approximates their recorded value based on the short-term
maturity of the instruments. The fair value of the long-term obligations
approximates their recorded value based on the current rates offered to the
Company for similar debt of the same maturities. The Company does not have
financial instruments with off-balance-sheet risk.
Financial instruments that potentially subject the Company to
concentrations of credit risk are accounts receivable. Concentration of credit
risk with respect to receivables are limited due to diversity in geographic
locations of customers as well as diversity of industries. The Company
continually evaluates the credit worthiness of its customers; however, it
generally does not require collateral. The Company's allowance for doubtful
accounts is based on historical trends, current market conditions and other
relevant factors.
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
F-10
<PAGE>
Furniture, equipment and leasehold improvements are stated at cost.
Maintenance and repairs are expensed as incurred. When properties are retired or
otherwise disposed of, gains and losses are reflected in the consolidated
statement of operations. Depreciation and amortization, which includes
amortization 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 three years using the straight-line method. Amounts are also
allocated to noncompete agreements and goodwill as applicable, which are
amortized using the straight-line method over terms ranging from 18 months to 25
years.
The Company periodically reviews the carrying value of its intangible
assets whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. To the extent the estimated future cash inflows
attributable to the asset, less estimated future cash outflows, is less than the
carrying amount, an impairment loss is recognized.
NET LOSS PER SHARE
During 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share", which is effective for financial statements issued after December 15,
1997. The new standard eliminates primary and fully diluted earnings per share
and requires presentation of basic and diluted earnings per share together with
disclosure of how the per share amounts were computed. Basic earnings per share
excludes dilution and is computed by dividing loss available to common
shareholders by the weighted-average common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised and converted
into common stock or resulted in the issuance of common stock that then share in
the loss of the entity. The Company adopted this pronouncement at December 31,
1997. Common stock equivalents have been excluded from the calculation of net
loss per share due to their antidilutive effect.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
F-11
<PAGE>
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue expenses
during the reporting periods. Actual results could differ from those estimates.
STOCK BASED COMPENSATION
In 1996, the Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation". SFAS 123 establishes financial accounting and reporting standards
for stock-based employee compensation plans. It defines a fair value based
method of accounting for an employee stock option or similar equity instrument
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans and include the cost in the statement of
operations as compensation expense. However, it also allows an entity to
continue to measure compensation cost for those plans using the intrinsic value
based method of accounting prescribed by Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees. The Company has
elected to account for compensation cost for stock option plans in accordance
with APB Opinion No. 25.
NEW PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting of Comprehensive
Income", which establishes standards for reporting and display of comprehensive
income and its components (revenues, expense, gains, and losses) in a full set
of financial statements. This statement also requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This statement is effective
for fiscal years beginning after December 15, 1997. Earlier application is
permitted. Reclassification of financial statements for earlier periods provided
for comparative purposes is required. The Company does not anticipate that
adoption of SFAS 130 will have a material effect on the consolidated financial
statements.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information", which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. This statement also establishes standards for related disclosures
about products and services, geographic areas, and major customers. This
statement requires the reporting of financial and descriptive information about
an enterprise's reportable operating segments. This statement is effective for
financial statements for periods beginning after December 15, 1997. In the
initial year of adoption, comparative information for earlier years is to be
restated. The Company does not anticipate that the adoption of SFAS 131 will
have a material effect on the consolidated financial statements.
NOTE C - FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Major classes of furniture, equipment and leasehold improvements, including
assets under capital leases, as of December 31, 1997 consist of the following
(in thousands):
F-12
<PAGE>
<TABLE>
<S> <C>
Buildings and towers.......................................... $ 6,757
Transmission equipment........................................ 129
Data processing systems and equipment......................... 7,503
Switches...................................................... 16,667
Furniture, equipment and leasehold improvements............... 8,538
-------
39,594
Less accumulated depreciation................................. 14,263
-------
$25,331
</TABLE>
The gross amount of furniture, equipment and leasehold improvements
recorded under capital leases was $19.2 million at December 31, 1997.
Included in furniture, equipment and leasehold improvements are unamortized
development costs related to the Company's proprietary management information
system. This system was placed in service in May 1995 and is being amortized on
a straight-line basis.
NOTE D - ACQUISITIONS
On August 15, 1997 the Company entered into merger agreements with Phoenix
Network, Inc. ("Phoenix") and Trans National Communications ("TNC"). On November
10, 1997 the Company announced that these agreements with Phoenix and TNC had
been terminated. On October 31, 1997, Phoenix notified the Company of its intent
to terminate the merger agreement, effective November 5, 1997, due to alleged
material breaches by the Company, including the Company's termination of its
agreement with Sprint and the deterioration of the Company's financial
condition. In addition, on November 6, 1997, TNC notified the Company of its
intent to terminate its purchase agreements with Phoenix that Phoenix had
assigned to the Company.
On January 27, 1997, in connection with a customer base acquisition
completed on July 31, 1995, the Company issued to the assignee of Communications
Services of America, Inc. ("CSA") 10,522 shares of common stock valued at $10.38
per share, and in April 1997, the Company issued an additional 18,536 shares to
compensate the former CSA shareholders for the decrease in value of the common
stock since the closing of the acquisitions.
On January 22, 1997, in connection with a customer base acquisition
completed in September 30, 1995, the Company issued to the shareholders of
Fairfield County Telephone Corporation ("Fairfield") 38,711 shares of common
stock valued at $10.25, and in April 1997 the Company issued an additional
59,631 shares to compensate the former Fairfield shareholders for the decrease
in value of the common stock since the closing of the acquisition.
In January 1997, the Company issued to Richard John 9,457 shares of common
stock valued $9.38 per share, and in August 1997, the Company issued to Richard
John 50,000 shares of common stock valued at $8.56 per share in connection with
the acquisition of Cel-Tech International Corp.
F-13
<PAGE>
NOTE E - OBLIGATIONS
As a result of the Chapter 11 filings (See Note A) the Company has
defaulted under the Foothill Credit Facility, the Company's equipment lease
facilities, the Indenture relating to the Company's $97.7 million aggregate
principal amount of 8 1/4% subordinated convertible notes due 2003 and the note
payable to Ashok Rao in connection with the redemption of certain shares of
common stock (See Note H). Accordingly, except for the Foothill Credit Facility
all long-term obligations have been classified as liabilities subject to
compromise in the accompanying consolidated balance sheet.
NOTE F - DEBTOR-IN-POSSESSION FINANCING
The Company has arranged for debtor-in-possession financing (the "Foothill
DIP Facility) from Foothill. In connection with the Foothill DIP Financing, the
Company incurred a loan fee of $250,000. The Foothill DIP Facility consists of a
revolving credit facility with borrowing availability of up to $8.5 million,
subject to the Company's satisfaction of various terms and conditions, bears
interest at prime plus 4% on receivable based advances and 18% on overadvances
and expired on January 15, 1998. The financing was paid on January 22, 1998.
NOTE G - STOCK REPURCHASE
In connection with the resignation of Ashok Rao, the Company's former
President and Chief Executive Officer, the Company redeemed, in April 1997,
885,360 shares of Common Stock held by Mr. Rao and certain trusts established by
Mr. Rao at a price of $6.80 per share (plus interest at 8% from April 1996), to
be paid in equal monthly installments over a period of 36 months, beginning May
1997.
NOTE H - COMMON STOCK
At December 31, 1997, common stock was reserved for the following:
<TABLE>
<S> <C>
Conversion of the notes................................. 6,938,279
Exercise and future grant of stock options.............. 5,010,064
Employee stock purchase plan............................ 252,911
Exercise of outstanding warrants........................ 276,500
----------
Total common stock reserved......................... 12,477,754
</TABLE>
F-14
<PAGE>
MIDCOM COMMUNICATIONS INC.
(DEBTOR-IN-POSSESSION)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE I - STOCK OPTION PLAN
The Company has a stock option plan which provides for the granting of
nonqualified and incentive stock options to purchase up to 5,010,064 shares of
common stock. Options granted become exercisable over vesting periods of up to
five years at exercise prices determined by the Board of Directors, and
generally expire ten years from the date of grant.
Stock options have generally been granted at the fair market value at the
date of grant. However, a limited number of options have been granted at less
than the fair market value, in which case compensation expense has been
recognized over the vesting period based on the excess of the fair market value
stock at the date of grant over the exercise price.
During the year ended December 31, 1997 1,408,820 options were granted. At
December 31, 1997 4,483,509 options were outstanding and 526,555 options were
available for future grant. Because of the Chapter 11 proceedings and since any
claims of option holders are subordinated to the claims of other creditors,
management does not believe that presentation of additional information with
respect to these options is meaningful.
NOTE J - INCOME TAXES
Components of the Company's deferred tax liabilities and assets as of
December 31, 1997 are as follows (in thousands);
<TABLE>
<S> <C>
Deferred tax assets
Allowance for doubtful accounts........................................................ $ 2,543
Accrued compensation costs............................................................. 655
Provisions not currently deductible.................................................... 6,009
Accrued restructuring costs............................................................ 373
Contract settlement.................................................................... 1,520
Tax depreciation different than financial accounting depreciation...................... 2,545
Intangible tax amortization different than financial statement amortization............ 22,173
Losses and write-down of foreign joint venture......................................... 3,769
Net operating loss carryforwards....................................................... 60,411
Total deferred tax assets.............................................................. 99,998
Valuation allowance.................................................................... 99,607
$ 391
Deferred tax liabilities
Cash to accrual change................................................................. (391)
Total deferred tax liabilities......................................................... (391)
</TABLE>
F-15
<PAGE>
<TABLE>
<S> <C>
Net deferred tax liabilities........................................................... $ -
</TABLE>
The Company has net operating loss carryforwards for federal income tax
purposes available to offset future federal taxable income, if any, of
approximately $151 million which expire in 2009-2013.
The provision for income taxes differ from the "expected" income tax
benefit as follows (in thousands):
<TABLE>
<S> <C>
Computed expected federal tax benefit............................. $(35,281)
State taxes, net of federal benefit............................... (4,109)
Change in valuation allowance for net deferred tax assets......... 46,105
Other............................................................. (6,715)
$ -
</TABLE>
NOTE K - RELATED PARTY TRANSACTIONS
Effective May 1996, the Company entered into an employment agreement with
William H. Oberlin, the Company's President and Chief Executive Officer. The
agreement provides for a base salary of $25,000 per month and an annual bonus to
be determined each year by the Company's Board of Directors based on certain
quantitative and qualitative targets set forth in the Company's annual business
plan. In connection with entering into the agreement, the Company granted Mr.
Oberlin options to purchase up to 1,214,714 shares of Common Stock pursuant to
the Company's Stock Option Plan. The options vest ratably over a five-year
period. Mr. Oberlin is entitled to receive up to two years severance (reduced to
one year severance in certain circumstances) in the event of termination.
Severance generally equals the sum of the annualized base salary at the time of
termination and the average annual bonuses for the fiscal years preceding
termination. The agreement also contains a non-interference provision pursuant
to which, for a period of six months following termination of employment,
Mr. Oberlin has agreed to, among other things, preserve the
confidentiality of the Company's customer list and refrain from actively
soliciting the Company's customers existing at the date of termination. This
agreement was terminated in January 1998.
Effective May 1996, the Company entered into consulting agreements with
Marvin C. Moses and John M. Zrno, each a director of the Company, pursuant to
which Messrs. Moses and Zrno have agreed to provide consulting services to the
Company with respect to acquisitions, investor and other strategic relations and
strategic financial matters. Pursuant to the agreements, the Company is required
to pay each of these individuals a retainer of $8,333 per month. In addition, in
connection with the agreements, the Company has granted to each of these
individuals options
F-16
<PAGE>
for the purchase of 253,681 shares of Common Stock pursuant to the Company's
Stock Option Plan. The options vest ratably over a five-year period. The
agreements terminate after a period of five years beginning on June 1, 1996,
unless terminated earlier in accordance with the terms thereof. The agreements
may be terminated by either party at any time upon 30 days prior written notice.
These agreements were terminated in January 1998.
In June 1994, the Company entered into an employment agreement with Ashok
Rao, the former President and Chief Executive Officer of the Company. The
agreement provided for a base salary of $25,000 per month. Mr. Rao resigned from
the Company in April 1996. In connection with Rao's resignation, the Company has
elected to repurchase 885,360 shares of Common Stock held by Mr. Rao and certain
trusts established by Mr. Rao (the "Rao Shares"). See Note H.
NOTE L - EMPLOYEE BENEFIT PLANS
401(K) SALARY DEFERRAL AND PROFIT SHARING PLAN
Prior to February 1, 1996, the Company maintained a 401(k) Salary Deferral
and Profit Sharing Plan with its affiliate SP Investments Inc. ("SPII").
Effective February 1, 1996, SPII withdrew from the Retirement Plan. The Company
maintains a voluntary defined contribution profit sharing plans covering all
eligible employees as defined in the plan documents. Participating employees may
elect to defer and contribute a stated percentage of their compensation to the
plan, not to exceed the dollar amount set by law. The Company matches 50% of
each employee's contribution up to a maximum of the first 6% of each employee's
compensation.
The Company's matching contributions to the plan were approximately
$448,000.
EMPLOYEE STOCK PURCHASE PLAN
In December 1994, the Company established an Employee Stock Purchase Plan
which became effective upon the successful completion of the Company's initial
public offering of common stock. The Company's plan provides that eligible
employees may contribute up to 10% of their base earnings toward the semi-annual
purchase of the Company's common stock. The employee's purchase price is 95% of
the lesser of the fair market value of the stock on the first business day or
the last business day of the semi-annual offering period. The total number of
shares issuable under the plan is 262,500. There were 3,380 shares issued under
the plan during 1997. The Plan was dissolved in November 1997.
NOTE M - COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases office space and certain equipment under terms of
noncancelable operating leases, which expire on various dates through 2005. The
leases generally require that the Company pay certain maintenance, insurance and
other operating expenses. Rent expense under operating leases was approximately
$4.8 million.
F-17
<PAGE>
At December 31, 1997, minimum future lease payments under noncancelable
operating leases are as follows (in thousands):
<TABLE>
<S> <C>
1998....................................................... 1,498
1999....................................................... 1,538
2000....................................................... 1,382
2001....................................................... 1,118
2002....................................................... 767
Thereafter................................................. 551
$6,854
</TABLE>
Amounts due on leases which have been rejected in connection with the
Chapter 11 filing have been excluded from the table above.
COMMITMENTS WITH PROVIDERS
Under the terms of carrier contracts executed with AT&T and other carriers,
the Company has made commitments to maintain or achieve certain volume levels in
order to obtain special forward pricing. Under certain of these contracts, the
Company guarantees to sell a certain amount of long distance volume within a
certain time period or purchase all or a portion of any unused volume. Under
other contracts, if certain volume levels are not achieved during stated
periods, pricing is adjusted going forward to levels justified by current
volumes.
At December 31, 1997, minimum future usage commitments are as follows:
<TABLE>
<S> <C>
1998....................................................... 3,287
1999....................................................... -
2000....................................................... 75,000
$78,287
</TABLE>
At December 31, 1997, the Company has achieved or reserved for all of its
required volume commitments. There can be no assurance that the minimum usage
communications will be achieved in the future, and if such commitments are not
achieved future operating results could be adversely affected.
During the year ended December 31, 1997, the Company relied on three
carriers to carry traffic representing approximately 78%, of the Company's
revenue. The Company has the ability to transfer its customers' traffic from one
supplier to another in the event a supplier declines to continue to carry the
Company's traffic. However, such transfers could result in disruption of service
to the customers, with a subsequent loss of revenue which would adversely affect
operating results.
REGULATION
F-18
<PAGE>
Federal
The Company has all necessary authority to provide domestic interstate and
international telecommunications services under current FCC regulations. MIDCOM
has filed both domestic and international tariffs with the FCC, and PacNet has,
and is only required to file, international tariffs. Pursuant to a 1995 court
decision, detailed rate schedules now must be filed in lieu of the "reasonable
range of rates" tariff previously accepted by the FCC. In reliance on the FCC's
past practice of allowing relaxed range of rates tariffs for non-dominant
carriers, MIDCOM and most of its competitors did not maintain detailed rate
schedules. Until the statute of limitations expires, MIDCOM could be held liable
for damages for its failure to maintain detailed rate schedules, although it
believes that such an outcome is highly unlikely and would not have a material
adverse effect on it. Pursuant to authority granted to it in the 1996
Telecommunications Act, the FCC is considering "mandatory detariffing" for
domestic non-dominant carriers. This proposal (which has been stayed by an order
of the federal district court in Washington, D.C.) would relieve the Company of
its obligation to file tariffs applicable to its domestic interexchange
offerings.
State
The intrastate long distance operations of MIDCOM are also subject to
various state laws. The majority of states require certification or
registration, which the Company has secured in 47 states and Washington, D.C.
Many states require tariff filings as well.
In certain states, approval for transfers of control and acquisitions of
customer bases must be obtained. MIDCOM has been successful in obtaining all
necessary regulatory approvals to date, although revisions of tariffs,
authorities and approvals are being made on a continuing basis, and many such
requests are pending at any one time.
Some states may assess penalties on long distance service providers for
traffic sold prior to tariff approval or the state's consent to an acquisition.
Such states may require refunds to be made to customers. It is the opinion of
management that such penalties and refunds, if any, would not have a material
effect on the results of operations or financial condition of the Company.
DISPUTES AND LITIGATIONS
Sprint Settlement
The Company has had a series of ongoing disputes relating to service and
billing with Sprint, one of its primary suppliers. For this and other reasons,
on September 18, 1997, the Company discontinued its payments to Sprint and, on
October 10, 1997, the Company received a notice of default from Sprint. On
October 29, 1997, the Company entered into a settlement with Sprint whereby it
agreed to pay Sprint $1,250,000 on October 31, 1997, November 7, 1997 and
November 14, 1997; $4,000,000 on November 21, 1997; and thereafter, so long as
Sprint continues to provide service to the Company, weekly payments equal to the
lesser of $2,000,000 or the current amount outstanding. Sprint and the Company
agreed to arbitrate the Company's claims against Sprint up to an aggregate of
$5,000,000 and the parties agreed that the Company would transition its traffic
to its own or
F-19
<PAGE>
other networks over the ninety day period ending January 29, 1998. There is
uncertainty as to whether or not the settlement applies to the Bankruptcy
estate.
Class Action Lawsuit
The Company, its Vice Chairman of the Board of Directors and largest
shareholder, the Company's former President, Chief Executive Officer and
Director and the Company's former Chief Financial Officer were named as
defendants in a securities action filed in the U.S. District Court for the
Western District of Washington (the "Complaint"). The Complaint was filed on
behalf of a class of purchasers of the Company's common stock during the period
beginning on July 6, 1995, the date of the Company's initial public offering,
and ending on March 4, 1996 (the "Class Period"). In April 1997, the Board of
Directors of the Company unanimously approved the terms of a settlement of all
claims against the Company and all of the individual defendants. The settlement,
which is subject to Court approval and which admits no liability or fault,
provides for the payment of $1.0 million in cash by the Company's insurance
carrier, and the issuance of approximately 420,000 shares of the Company's
common stock, subject to adjustments depending upon the fair market value of the
stock on the date that the settlement is approved by the Court. In light of the
bankruptcy filing the status of the settlement is uncertain.
SEC Investigation
The Company was informed in May 1996 that the Securities and Exchange
Commission ("SEC") was conducting an informal inquiry regarding the Company. In
May 1997 the Company learned that a formal order of investigation had been
entered by the SEC. The Company believes that the focus of the investigation is
on (i) the accuracy of disclosures in certain documents filed by the Company
with the SEC; (ii) whether the Company had maintained adequate books and records
and had adequate internal controls; and (iii) whether records had been
falsified. The Company has voluntarily provided documents requested by the
Commission, is in the process of furnishing additional requested documents, and
has cooperated with the Commission in scheduling interviews with certain former
Company personnel. The Company is unable to predict the ultimate outcome of the
investigation. The Company and certain of its former employees could be subject
to civil or criminal sanctions including monetary penalties and injunctive
measures.
Frontier Lawsuits
On August 19, 1996 the Company was served with a complaint filed in U.S.
District Court for the Eastern District of Michigan by Frontier Corporation
("Frontier"). The complaint named as defendants the Company and eleven
individuals, all of whom are former employees of Frontier who resigned their
positions with Frontier. Frontier agreed to dismiss all of the individual
defendants in the case except William H. Oberlin, the Company's President and
CEO. Moreover, in September 1997, the Court dismissed certain causes of action
in the context of a summary judgment hearing. The surviving claims are that (i)
MIDCOM is in violation of a non-disclosure agreement between Frontier and MIDCOM
by virtue of its alleged use of confidential information of Frontier obtained
through employees hired from Frontier and otherwise; and (ii) MIDCOM and Mr.
Oberlin tortuously interfered in Frontier's contractual relationships with
various Frontier employees and contractors. The complaint seeks: (i) that the
defendants be preliminarily and permanently enjoined from breaching
F-20
<PAGE>
their respective agreements with Frontier, (ii) that MIDCOM be enjoined from
aiding and abetting certain alleged breaches of fiduciary duties; (iii) an order
that MIDCOM hold all profits which it earns as a result of its hiring of the
individual defendant and other Frontier employees as constructive trustees for
the benefit of Frontier; (iv) an accounting of all profits realized by Midcom as
a result of its hiring of the defendant and other Frontier employees; (v) a
declaratory judgment on its various claims; (vi) damages in an unspecified
amount; (vii) Frontier's costs, including reasonable attorney's fees, incurred
in bringing the action; and (viii) other appropriate relief. The Company has
recently filed a motion to dismiss the action and it awaits a hearing on this
motion.
An affiliate of Frontier has also filed a complaint in the same U.S.
Federal District Court claiming $515,000 for unpaid amounts under a supply
agreement. The Company believes this claim to be without substantial merit and
is vigorously defending it. The Company's motion to dismiss on statute of
limitations grounds was granted in part and remaining matters have been
transferred to the FCC as a matter of primary jurisdiction. On November 6, 1997,
the Company and Frontier agreed to enter into a settlement pursuant to which
Frontier would dismiss all claims against the Company and Mr. Oberlin. The
settlement would provide, among other things, that, over the next three years,
MIDCOM will transfer approximately $40.5 million of long distance traffic to
Frontier and Frontier will transfer approximately $20.25 million of long
distance traffic to Midcom. There is some uncertainty as to whether the
settlement creates a pre-petition or post-petition claim, which is to be decided
by the U.S. Federal District Court.
Cherry Communications Lawsuit
In September and December 1995, the Company purchased two significant
customer bases from Cherry Communications. The first transaction ("Cherry I")
provided for the purchase of long distance customer accounts having monthly
revenue for the three months preceding the date of closing of $2.0 million, net
of taxes, customer credits and bad debt. The second transaction ("Cherry II")
provided for the purchase of long distance customer accounts having monthly
revenue which were to average $2.0 million per month over the 12 months
following the transaction, net of taxes, customer credits and bad debt. The
purchase price payable with respect to Cherry I was $10.5 million, of which $5.5
million was paid in cash and the balance was paid by the delivery of 317,460
shares of common stock (subject to a possible increase in such number based on
the future value of the common stock), of which 126,984 shares are held in
escrow to be applied to indemnify claims or to cover shortfalls in revenue from
the $2.0 million monthly average. The purchase price for Cherry II was $18.0
million, of which $7.0 million has been paid in cash. Additional installments of
$3.4 million were due in February, March and April of 1996, of which $400,000 of
each installment was to be paid either in cash or by delivery of shares of
common stock. Separately, the Company also agreed to pay Cherry Communications
for servicing customer accounts on behalf of the Company. The acquired customer
bases have not generated the required minimum revenue levels and Cherry
Communications has failed to remit to the Company collections received by Cherry
Communications from a portion of the acquired customers. Accordingly, the
Company has withheld the final three installment payments for Cherry II (a total
of $9.0 million excluding escrowed sums), payment of invoices for carrier
services for the acquired bases (up to $11.0 million) and accrued customer
service charges of $840,000. Negotiations between Cherry Communications and the
Company failed to produce a settlement of these disputes.
F-21
<PAGE>
Cherry Communications filed a lawsuit against the Company in the United
States District Court for the Northern District of Illinois, Eastern Division.
In its first Amended Complaint filed on July 18, 1996, Cherry Communications
seeks recovery of (i) approximately $7.2 million plus interest and attorney's
fees alleged to be due and owing under a Rebiller/Reseller Agreement for
Switched Services between Cherry Communications and the Company, (ii)
approximately $9.0 million plus interest and attorney's fees alleged to be due
and owing under the November 1, 1995 Customer Base Purchase and Sale Agreement
between Cherry Communications and the Company (the "Cherry II Agreement"), and a
Promissory Note executed in connection with the Cherry II Agreement, (iii)
customer service charges of $840,000. It is the position of the Company that
Cherry Communications has breached its obligations under the Cherry I Agreement
and the Cherry II Agreement by among other breaches (i) failing to sell MIDCOM
customer bases having the average monthly revenues required by the customer base
agreements, and (ii) failing to remit to MIDCOM monies collected from the
customer accounts. It is also the position of the Company that, as a result of
Cherry Communication's breaches of the Cherry I Agreement and the Cherry II
Agreement, as amended by certain addenda, that the Company has offsets and
counterclaims against Cherry Communications in excess of the sums it has
withheld from Cherry Communications. The Company is attempting to negotiate a
resolution of the disputes. In the event that a settlement is not reached, the
Company intends to vigorously defend the lawsuit filed by Cherry Communications.
However, the Company is unable to predict the outcome of this lawsuit. As a
result of this litigation, as of September 1, 1996, the Company discontinued
booking revenue generated by the customer bases purchased from Cherry
Communications. In October 1997, Cherry Communications filed a petition for
relief under Chapter 11 of the Bankruptcy Code. As a result of the bankruptcy
filings by both corporations, the court dismissed all claims and counter claims
without prejudice. The Company filed a claim for $36 million in the Cherry
Bankruptcy.
Discom Arbitration
Discom Corporation ("Discom"), a former distributor of the Company, in an
arbitration proceeding in New York against the Company has filed to increase the
amount of its claim against the Company to approximately $8.0 million
purportedly based upon a lost profit and damage analysis of its expert. The
Company has not yet had an opportunity to depose Discom's expert, but
preliminary indications are that the evaluation is seriously flawed and that the
Company's own expert testimony will more accurately reflect the maximum possible
damage claim of $250,000 to $500,000, which amount has been escrowed by the
Company. The Company disputes that any amounts are owed to Discom and it is
vigorously defending the case. All evidence has been heard by the arbitration
panel.
Other Litigation
The Company is also party to other routine litigation incidental to its
business and to which its property is subject. The Company's management believes
the ultimate resolution of these matters will not have a material adverse effect
on the Company's business, financial condition or results of operations.
NOTE N - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
(In Thousands)
--------------
<S> <C>
Cash paid for interest.................................. $9,353
</TABLE>
F-22
<PAGE>
<TABLE>
<S> <C>
Cash paid for income taxes.............................. $ -
</TABLE>
NOTE O - RELOCATION OF CORPORATE HEADQUARTERS
In May 1997, the Company announced its intention to relocate its corporate
headquarter functions based in Seattle, Washington to Southfield, Michigan,
where the Company's Chief Executive Officer and other key executives maintained
offices. During 1997, the Company completed the relocation of various corporate
support functions, including human resources, legal, finance and information
services, affecting approximately 130 employees, to temporary office space in
Southfield.
NOTE P - OTHER INFORMATION
On November 7, 1997, the common stock of the Company was de-listed from the
Nasdaq Stock Market effective November 17, 1997. As a result of being de-listed
from the Nasdaq Stock Market, the liquidity of the common stock is significantly
diminished. This event will materially and adversely affect the Company's
ability to obtain financing through the sale of common stock or securities
convertible into common stock and, ultimately, could have a material adverse
effect on the Company's business, financial condition and results of operations.
F-23
