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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                             ---------------------
                                   FORM 10-K
 
                 FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
          SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934.
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
 
                                       OR
 
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
   SECURITIES EXCHANGE ACT OF 1934.
 
        FOR THE TRANSITION PERIOD FROM                TO
 
                        COMMISSION FILE NUMBER 000-24581
                             ---------------------
                          CAPROCK COMMUNICATIONS CORP.
             (Exact name of registrant as specified in its charter)
 
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<S>                                            <C>
                    TEXAS                                        75-2765572
       (State or other jurisdiction of                        (I.R.S. Employer
        incorporation or organization)                      Identification no.)
15601 DALLAS PARKWAY, SUITE 700, DALLAS, TEXAS                     75248
   (Address of principal executive offices)                      (Zip Code)
</TABLE>
 
       Registrant's telephone number, including area code: (972) 982-9500
 
          Securities registered pursuant to Section 12(b) of the Act:
 
                                      None
 
          Securities registered pursuant to Section 12(g) of the Act:
 
                         COMMON STOCK, $0.01 PAR VALUE
 
                                (Title of Class)
                             ---------------------
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  Yes [X]     No [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  [ ]
 
     The aggregate market value of the voting stock (which consists solely of
shares of Common Stock) held by non-affiliates of the registrant as of March 15,
1999, computed by reference to the closing sale price of the registrant's Common
Stock on the Nasdaq National Market on such date, was approximately $52,400,000.
 
     The number of shares of the registrant's Common Stock outstanding as of
March 15, 1999 was 28,952,482.
 
                      DOCUMENTS INCORPORATED BY REFERENCE:
 
     Portions of the registrant's proxy statement for its 1999 Annual Meeting of
Stockholders to be held on or about May 3, 1999, which will be filed with the
Commission within 120 days after the end of the Registrant's fiscal year are
incorporated by reference into Part III of this Annual Report on Form 10-K.
 
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                               TABLE OF CONTENTS
 
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                                   PART I
Forward-Looking Statements.............................................    1
Item 1.    Business....................................................    1
Item 2.    Properties..................................................   19
Item 3.    Legal Proceedings...........................................   19
Item 4.    Submission of Matters to a Vote of Security Holders.........   19
 
                                   PART II
Item 5.    Market for the Registrant's Common Equity and Related
           Stockholder Matters.........................................   20
Item 6.    Selected Consolidated Financial Data........................   21
Item 7.    Management's Discussion and Analysis of Financial Condition
           and Results of Operations...................................   22
Item 7A.   Quantitative and Qualitative Disclosures about Market
           Risk........................................................   32
Item 8.    Financial Statements........................................   33
Item 9.    Changes in and Disagreements with Accountants on Accounting
           and Financial Disclosure....................................   33
 
                                  PART III
Item 10.   Directors and Executive Officers of the Registrant..........   33
Item 11.   Executive Compensation......................................   33
Item 12.   Security Ownership of Certain Beneficial Owners and
           Management..................................................   33
Item 13.   Certain Relationships and Related Transactions..............   33
 
                                   PART IV
Item 14.   Exhibits, Financial Statement Schedules and Reports on Form
           8-K.........................................................   33
Signatures.............................................................   40
Index to Consolidated Financial Statements.............................  F-1
</TABLE>
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                                     PART I
 
FORWARD-LOOKING STATEMENTS
 
     This Annual Report on Form 10-K includes forward-looking statements. We
have based these forward-looking statements on our current expectations and
projections about future events. These forward-looking statements are subject to
risks, uncertainties, and assumptions about CapRock, including:
 
     - our anticipated growth strategies,
 
     - anticipated trends in our business, including trends in technology and
       the growth of communications network products and services,
 
     - future expenditures for capital projects, and
 
     - our ability to continue to control costs and maintain quality.
 
     These statements may be found in the sections of this Form 10-K entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" and in this Form 10-K generally. Our actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including all the risks discussed
elsewhere in this Form 10-K and risks related to, among other things, building a
fiber network (including obtaining the necessary rights-of-way, permits and
regulatory approvals), supply and demand for data services, competition, the
need for additional capital, debt and interest payment obligations, restrictions
in our senior note indenture, rapid growth, dependence on local telephone
companies and long distance carriers, our information systems, retention of key
personnel, dependence on major customers, year 2000 problems, the continued
integration of our predecessor companies, service interruptions, potential
liability as an internet service provider and protection of our intellectual
property.
 
     We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
Because of these risks, uncertainties and assumptions, the forward-looking
events discussed in this Form 10-K might not occur.
 
ITEM 1. BUSINESS
 
BUSINESS OVERVIEW
 
     CapRock Communications Corp. ("CapRock") owns and operates a scalable
long-haul fiber network which upon completion is expected to cover approximately
5,500 route miles throughout the Southwest region, which includes Texas,
Louisiana, Arkansas, Oklahoma and New Mexico. This fiber network supports the
voice, data, bandwidth and dark fiber services we provide to our carrier and
retail customers. Our 1998 revenues were $121.8 million and earnings before
interest, taxes, depreciation and amortization ("EBITDA") (exclusive of merger
related expenses of $2.3 million) was $15.0 million. Over the past five years,
our revenues have grown at a compound annual growth rate of 55%.
 
     We intend to be the premier provider of carriers' carrier services and the
leading facilities-based integrated communications provider in the Southwest
region. To measure our progress, we classify our revenues in three categories:
carriers' carrier, integrated services and systems services. Our carriers'
carrier revenues include domestic and international long distance, bandwidth and
dark fiber services sold to telecommunications carriers and other wholesale
customers. Currently, we have over 100 carrier customers, including AT&T, MCI
WorldCom, Sprint Corporation and Qwest Communications, as well as many regional
independent companies such as Century Telephone Enterprises, Inc. and Lufkin
Conroe Telephone. Our integrated services revenues reflect our local, long
distance, Internet, data and private line products provided to over 5,000 small
and medium-sized businesses on a single bundled bill. Lastly, our systems
services revenues represent the voice and data systems and services we provide
primarily to the oil and gas industry offshore in and along the Gulf of Mexico.
 
     We are focused on the Southwest region because of this region's size and
attractive growth prospects and because we believe that as a region it is
currently underserved by other major telecommunications providers.
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We believe our ability to offer integrated telecommunication services along with
superior customer service will be particularly attractive to small and
medium-sized businesses that desire simple bundled plans from a single provider.
Many of the smaller markets within our region do not have telecommunications
alternatives to the incumbent local telephone company. We also believe that a
regional focus enables us to achieve certain economies of scale due to the
concentrated deployment of network assets, our sales and marketing efforts and
our management. By maximizing the amount of traffic that remains on our network,
we can maximize our gross profit margins and returns on invested capital.
 
     We intend to build the most extensive alternative fiber network in the
Southwest region, which will allow us to serve nearly every primary, secondary
and tertiary city within the region. Our fiber network is scalable, and we are
deploying a minimum of 96 fibers and two to three spare conduits along each
route. Each fiber is capable of supporting dense wave division multiplexing, and
each conduit is capable of housing a cable with hundreds of additional fibers.
In order to reduce the cost of fiber retained for our own use, we intend to sell
excess fiber to other carriers. We are currently in discussions for the sale of
fiber over segments of our network with over 25 carriers. Consistent with our
planned network deployment schedule, approximately 800 route miles of the
long-haul fiber network were substantially completed at year-end 1998. We
currently have another 1,870 route miles under construction and expect to have
approximately 3,000 route miles completed by the end of 1999, with the remainder
of the 5,500 route mile network expected to be completed by the end of 2000. We
recently entered into an agreement with Enron Communications to jointly build
approximately 1,050 miles of fiber network in Texas. We believe that this
agreement and any other similar agreements we may execute in the future may
enable us to significantly lower the overall cost of network construction as
well as accelerate its deployment.
 
     Our proximity to Mexico allows us to directly connect to the fiber networks
of multiple Mexican telecommunications carriers. Subject to compliance with
certain regulatory requirements, we are capable of providing dark fiber to these
carriers at several border crossings enabling them to close open fiber rings in
Mexico by using CapRock fiber on the U.S. side of the border. Additionally, our
direct connect agreements with foreign carriers position us to capture increased
levels of growing international traffic. See Note 18 to the Consolidated
Financial Statements of CapRock included in this Form 10-K.
 
     We are a Texas corporation. Our principal executive offices are located at
15601 Dallas Parkway, Suite 700, Dallas, Texas 75248, and our telephone number
is (972) 982-9500. We maintain a World Wide Web site at www.caprock.com. The
reference to our World Wide Web address does not constitute incorporation by
reference of the information contained at the site. In this Annual Report on
Form 10-K, the "Company," "CapRock," "we," "us," and "our" refer to CapRock
Communications Corp. and its subsidiaries, including IWL Communications, Inc.
("IWL Communications"), CapRock Telecommunications Corp. ("CapRock
Telecommunications") and CapRock Fiber Network Ltd. ("CapRock Fiber"), which are
our three predecessor companies, as well as CapRock Network Services, L.P.,
CapRock Telecommunications Leasing Corp. and CapRock Design Services, L.P.,
unless the context otherwise requires. CapRock and CapRock Communications are
trademarks of CapRock. All other trade names or trademarks appearing in this
Annual Report on Form 10-K are the property of their respective holders.
 
RECENT DEVELOPMENTS
 
     In August 1998, we completed a business combination transaction, which was
accounted for as a pooling of interests, pursuant to which CapRock
Telecommunications, CapRock Fiber, and IWL Communications, our predecessor
companies, combined to form our company as it exists today.
 
     In July 1998, as part of the business combination transaction, we sold
senior notes in the aggregate principal amount of $150 million. The indenture
for the offering of these senior notes, which we also entered into in July 1998,
contains numerous restrictive covenants that restrict and limit our operating
and financing activities.
 
     On March 19, 1999, we filed a registration statement on Form S-1 relating
to the proposed offering by us of 5,000,000 shares of our Common Stock and the
proposed offering by certain of our shareholders of 1,500,000 shares of Common
Stock. The offering will be an underwritten offering managed by Merrill
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Lynch & Co. A registration statement relating to these securities has been filed
with the Securities and Exchange Commission, but has not yet become effective.
These securities may not be sold, nor may offers to buy be accepted, prior to
the time the registration statement becomes effective, and an offering of the
shares will be made only by means of a prospectus meeting the requirements of
Section 10 of the Securities Act of 1933.
 
     No assurances can be made as to when, or if, the offering will be
completed. If completed, we estimate that the net proceeds that we will receive
from the sale of the Common Stock offered by us will be approximately
$78,000,000, after deducting the underwriting discounts and commissions and
estimated offering expenses and other related fees that we will pay. We will not
receive any of the proceeds from the sale of Common Stock by the selling
shareholders.
 
     We currently intend to use the net proceeds from the equity offering:
 
     - to fund additional capital expenditures for the construction and
       operation of our fiber optic network,
 
     - to fund the installation of voice and data switches, including the cost
       of colocations in the central offices of local telephone companies,
 
     - to open sales offices and add sales support and customer service
       personnel in markets throughout the Southwest region, and
 
     - for potential acquisitions, additional working capital and other general
       corporate purposes.
 
     The actual use of proceeds may vary significantly and will depend on a
number of factors. Accordingly, our management has broad discretion in the
allocation of the net proceeds. Pending such uses, the net proceeds of the
equity offering, if it is completed, will be invested in short-term, high grade
investment securities.
 
NETWORK BUILD OUT AND FINANCING PLAN
 
     By the end of the year 2000, we intend to build out our fiber optic network
to approximately 5,500 route miles throughout the Southwest region. We began
constructing and operating a regional fiber network in 1993. We completed
construction of the first 260 route miles of our fiber network in 1997, and at
the end of 1998, the first 800 route miles of our scalable, regional fiber
network were substantially completed, linking San Antonio, Laredo, McAllen,
Harlingen, Corpus Christi, Victoria and Houston, Texas. Over the past two years,
we have met substantially all of our milestones with respect to our construction
schedules and budgets. We currently have approximately 1,870 route miles under
construction and expect to have approximately 3,000 route miles completed by the
end of 1999, linking south Texas, San Antonio, Houston, Austin, Waco, Dallas,
Fort Worth, and Amarillo, Texas, Oklahoma City and Tulsa, Oklahoma, Little Rock,
Arkansas, and Monroe and New Orleans, Louisiana. We expect that the remainder of
the 5,500 route mile fiber network will be completed by the end of the year
2000. Given the increased demand for our fiber-based telecommunications services
over the past year, we increased our planned network build out from
approximately 4,300 route miles to approximately 5,500 route miles.
 
     We believe that our network, once completed, will be the most extensive
alternative fiber network in the Southwest region and will enable us to serve
nearly every primary, secondary and tertiary city in the region. Our network is
designed to be scalable and will have significant excess capacity to meet future
demand and flexibility to accommodate new fiber technology and electronics. We
are burying three to four conduits throughout our network. We are installing in
a conduit a minimum of 96 Lucent Truewave and single-mode fibers. Both Truewave
and single-mode fiber are capable of supporting dense wave division
multiplexing. We intend to retain on average 24 fiber strands throughout most of
our network. The routes of the network are primarily constructed on state
highway and county road rights-of-way, and are planned to be generally
geographically diverse from the existing fiber networks of AT&T, Sprint, MCI
WorldCom, and IXC. The fiber network will also interconnect with the fiber
networks of selected Mexican carriers at multiple border crossings.
 
     Through the continuing and successful integration of IWL Communications and
its personnel and network facilities, we have been able to continue developing
our fiber network and our switching facilities. In
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addition to our extensive fiber network, our network facilities also include
seven local and long distance switches (six which we own and one which we
manage), with another four local switches scheduled to be installed in the
second and third quarters of 1999. We plan to colocate our equipment in 20
central offices with incumbent local telephone companies (13 of which are
currently in process) for the provision of local services using unbundled
network elements ("UNEs") by the end of 1999. We also plan to purchase and
deploy in the second and third quarters of 1999 ten asynchronous transfer mode
("ATM") data switches to support our Internet, frame relay and ATM services.
 
     We estimate total gross capital expenditures of approximately $410 million
to complete our planned regional network build out, including fiber,
transmission electronics, voice and data switches and corporate capital
expenditures.
 
     To reduce the cost of fiber retained for our own use, we have sold in the
past, and intend to sell in the future, conduit and dark fiber to third parties.
In the past, we have jointly constructed segments with Teleport Communications
Inc., a competitive local phone company, and with TCI Communications Inc., a
cable television company, and we recently announced our agreement with Enron
Communications to jointly build approximately 1,050 miles of fiber network in
Texas. Through this joint build arrangement, we will connect Amarillo, Lubbock,
Dallas, Fort Worth, Waco, Bryan, Austin, San Marcos, San Antonio and Houston,
Texas. The partnership we formed with Enron Communications is installing four
conduits throughout the approximate 1,050 miles. We intend to jointly market 96
of the 192 fibers installed. Of the remaining 96 fibers, we will own 48 fibers
and Enron Communications will own 48 fibers. The joint build arrangement
provides several benefits, including reduction of construction costs,
accelerated acquisition of right of way and franchise agreements, the majority
of which are essentially in place, and the freeing up of resources to
potentially accelerate the build of the remaining portion of the network. This
agreement and any similar agreements we may execute in the future may enable us
to accelerate our construction schedule and accelerate the rate of deployment of
our network, which in turn may accelerate our need for additional capital. Each
city-pair segment of our fiber network is operational upon completion of
construction. Should network construction be slowed or postponed, our existing
network is still operational and our integrated services strategy can continue
essentially unchanged.
 
     By installing a large fiber count, advanced fiber capable of supporting
dense wave division multiplexing and spare conduits, the network will be
scalable and will have significant flexibility to add capacity to meet future
demand. The integrity and survivability of the network will be enhanced through
the design of multiple SONET rings, and its diverse location from existing
long-haul networks. The expanded network is expected to deliver the following
significant strategic and financial benefits to us: (1) substantial savings by
allowing us to move onto our own network a significant portion of the traffic
that we currently carry on circuits which we lease from other carriers; (2) high
capacity new routes allowing us to increase revenues by leasing additional
circuits to our customers, including high capacity circuits such as OC-3s,
OC-12s, and OC-48s; (3) lower underlying transmission and network operating
costs; (4) sufficient capacity to support increasing demand from Internet,
multimedia applications, frame relay and ATM; and (5) reduced capital costs
through sales and exchanges of excess fiber which we are including in our
network expansion specifically for that purpose.
 
     We also provide services to our oil and gas company customers through a
satellite network consisting of leases for access to multiple satellites, a
microwave network, two-way radio licenses and carrier agreements for long
distance service combined with a switch-based network. Our microwave network
includes a system that has been built by us onshore in the Southwest region and
extends offshore into the Gulf of Mexico. We believe that the fiber and
microwave network we have created to support our oil and gas industry customers
has excess capacity and can readily support integrated communications'
activities in secondary and tertiary markets along the Texas and Louisiana Gulf
Coast, where we expect less competition for customers than in the larger
markets. We intend to leverage our project management skill set and expertise by
supplying communications services to customers outside of the oil and gas
industry, particularly customers with operations located near our existing and
planned communications infrastructure.
 
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PRODUCTS AND SERVICES
 
Carriers' Carrier
 
     We intend to establish ourself as the premier carriers' carrier within the
Southwest region, providing voice, data, broadband and dark fiber services over
the most extensive advanced fiber optic network in the Southwest region. Our
principal carriers' carrier products are: long distance terminating access,
calling cards, dark fiber, and bandwidth provision. Our carrier customer base
includes more than 100 carriers, including AT&T, IXC, MCI WorldCom, Qwest and
Sprint, and including regional independents such as Century Telephone
Enterprises, Inc. and Lufkin Conroe Telephone. For the year ended December 31,
1998, revenues from services provided to MCI WorldCom accounted for more than
10% of our revenues.
 
     Long Distance Terminating Access. This service enables carrier customers to
terminate regional, domestic or international long distance calls through our
switches. We terminate calls over our own network and feature groups established
with incumbent local telephone companies or through other carriers providing
services to us. We sell these services on a per-call basis, charging by minutes
of use, or MOUs, with payment due monthly after services are rendered.
 
     Bandwidth Provision. We offer T-1, DS-3, OC-3, OC-12 and OC-48 capacity and
individual wavelength channels to our carrier customers. Carriers utilize the
broadband capacity to support their voice and data traffic requirements and to
provide diverse routing as backup in the event of a fiber cut along their
primary routes. Services are provided generally through one year contracts,
requiring fixed monthly payments, generally in advance.
 
     Dark Fiber. We lease and sell excess dark fiber to carrier customers over
our fiber network. We are burying three to four conduits and installing a cable
with a minimum of 96 fiber strands throughout our 5,500 route mile fiber
network. We intend to retain an average of 24 fibers for our own use and to
continue to lease or sell excess capacity to lower our net cost for fiber
retained for our own use. Dark fiber lease contracts are generally for a minimum
of ten years with multiple five year renewals at discounted rates. Dark fiber
sales are in the form of indefeasible right of use contracts for terms for 20
years and longer.
 
Integrated Services
 
     We intend to become the dominant integrated communications provider in the
Southwest region, offering local, long distance, Internet, data and private line
services to end-user customers on an integrated basis invoiced on a single,
bundled bill. We believe that our ability to provide integrated services, and to
invoice these services on a single, bundled bill enables us to (1) better
compete in and rapidly penetrate our targeted markets, (2) capture virtually all
of our existing and newly acquired customers' expenditures for
telecommunications services and equipment, (3) increase customer satisfaction,
and (4) maintain low customer churn.
 
     We offer (or, where indicated, intend to offer) the following products:
 
     Local. These services offer customers local switched and enhanced services.
We intend to continue to obtain local telephone services from incumbent local
telephone companies on a total service resale, or TSR, basis and as demand
economically justifies, to install local switches and migrate customers to our
network utilizing unbundled network elements leased from incumbent local
telephone companies for last mile local lines. We believe this approach
significantly boosts our gross margins, maximizes our return on invested
capital, and reduces the time required to enter new markets.
 
     One Plus Long Distance. This service offers customers the ability to make
outbound switched long distance calls by simply dialing a 1, plus the area code
and phone number. Customers can select us as their primary long distance
provider by placing an order with us. This service may be used for both domestic
and international calling.
 
     Long Distance Dedicated Service. This service is designed for larger users
with sufficient long distance traffic volume to warrant the use of dedicated
lines directly to the customer to originate calls. Instead of long distance
calls switched through the incumbent local exchange carrier ("ILEC"), this
service uses a dedicated
 
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line that directly connects the end user and our switch. This eliminates ILEC
originating access fees and reduces per minute rates to the user.
 
     Internet. We provide Internet services to approximately 800 customers. The
services include e-mail server, news server and hosting of customer web pages.
 
     Data. Frame relay and ATM data services are currently provided on a resale
basis. Our fiber network has been designed to provide a platform to support high
capacity, bandwidth-intensive products. We intend to migrate our data services
onto our own data and fiber networks as these networks are built out.
 
     Private Lines. This service provides customers dedicated broadband
capacity, typically T-1s and DS-3s. Private lines enable customers to connect
directly to their long distance carriers, bypassing the ILEC and thereby
reducing long distance rates. Private lines also enable customers to establish
virtual private wide area networks for data and voice transmissions between or
among multiple locations.
 
     Toll Free 800/888. This inbound service, where the receiving party pays for
the call, is accessed by dialing an 800/888 area code. This is used in a wide
variety of applications, many of which generate revenue for the user (such as
reservation centers or customer service centers).
 
     Calling Card. These traditional, basic telephone calling cards allow the
user to place calls from anywhere in the United States or Canada. Later in 1999,
we plan to expand our service to include Mexico. We also offer additional
features including conference calling and speed dialing.
 
     Prepaid Card. Prepaid cards allow a customer to purchase and pay in advance
for a card with a fixed amount of calling time. The card is then used as a
standard calling card from which time is deducted when used. Prepaid cards may
be purchased with enhanced features similar to those of calling cards and also
may be renewed by purchasing additional time.
 
System Services
 
     We intend to maintain our position as a major provider of
telecommunications services to remote installations, primarily in the Gulf of
Mexico. Our principal products are offshore voice and data services, as well as
the sale and installation of equipment to carry those services.
 
     Offshore Services. We provide offshore voice and data systems and services
to the oil and gas industry in the Gulf of Mexico. Satellite and microwave
transmission media are used depending on the type and location of the drilling
rig involved. Our communications systems are flexible and can be quickly
re-aligned as rigs move to new locations.
 
     Customer Premise Equipment. We currently sell and install telephone and
switchboard equipment to our offshore customers. We intend to add office
switchboard and private branch exchange equipment for our small and medium-sized
business customers. We intend to continue to build our relationships with local
customer premise equipment installation companies in all of our markets for the
purpose of selling and installing customer premise equipment not otherwise
provided by us.
 
SALES AND MARKETING
 
     Carriers' Carrier. We established a carrier services sales force in 1992.
We believe it competes effectively in this market based on a combination of
price, reliability, quality of service, route diversity, ease of ordering,
ability to obtain traffic information and superior customer service. We market
our carriers' carrier services primarily through eight direct sales personnel
and four support specialists located in our headquarters in Dallas. In general,
these sales professionals locate potential customers for our carrier services
through customer referrals, trade forums, trade shows and industry alliances.
 
     Integrated Services. We focus our sales efforts on small to medium-sized
businesses in the Southwest region primarily through two channels: our direct
sales force and our network of independent sales agents. Our direct sales force
and our authorized agents are trained to emphasize our customer-focused sales
efforts,
 
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superior customer service and product value. We reinforce building customer
relationships by tying a portion of each account executive's and agent's
compensation directly to the longevity of their customer accounts.
 
     As of February 28, 1999, our direct sales force consisted of 100 account
executives in Dallas, Fort Worth, Houston, San Antonio, Austin, and Victoria,
Texas, as well as Lafayette, Louisiana. We intend to hire and train
approximately 100 additional account executives by the end of 1999 and an
additional 100 account executives by the end of 2000.
 
     Our sales personnel call on prospective and existing business customers,
conduct analyses of business customers' telecommunications usage histories and
service needs, and demonstrate how our various service packages will improve a
customer's communications capabilities in a cost-effective manner. Sales
personnel identify potential business customers by several methods, including
customer referral, marketing research, personal telemarketing and through other
networking alliances such as endorsement agreements with trade associations and
local chambers of commerce. We recruit new account executives by emphasizing our
extensive and advanced fiber communications network, broad array of services
bundled on a single bill, superior customer service, attractive compensation and
commission plans, stock option programs and marketing support plans.
 
     We also have 115 sales agents located throughout Texas. Our agent program
was established in 1996, and consists primarily of independent telephone
equipment vendors authorized by us to market our products and services.
Authorized agents receive recurring commissions based on product, pricing,
volume of usage and customer retention. We have four agent managers who actively
recruit new agents. We intend to add an additional 65 agents in 1999.
 
     Our marketing strategy is built upon the belief that customers want to
reduce the number of providers, simplify the complexity and enhance the value of
their telecommunications needs. To address this strategy, we seek to be a single
source provider, offering the bulk of our customers' needs on single bills and
through single sales channels. We believe that our personalized attention to the
needs of our business customers, coupled with our ability to provide a fully
integrated bill, is appealing to both existing and prospective customers.
 
     Project Management and Offshore Services. We target domestic customers that
require turnkey system solutions and other telecommunications services. Our
sales force sells frequency bandwidth and call completion and system solutions,
which allows us to further develop our own telecommunications infrastructure.
 
CUSTOMER CARE AND SUPPORT
 
     We believe that our reputation has been built on outstanding customer care.
We strive to provide superior customer care and support for our customers and
believe that personal contact with our customers through knowledgeable, friendly
and efficient customer service representatives is a significant factor in
customer retention. We intend to significantly increase the number of our
customer service representatives as the number of direct and agent sales
representatives grows.
 
     To support our carriers' carrier and integrated services customers, we
operate a call center in Dallas, Texas staffed by our customer service
representatives, who have completed a certification and training program
provided by us. To enhance their effectiveness, we provide ongoing training to
all customer service representatives. Our customer service department uses
on-line, real-time automated systems that provide notes from all prior contacts
with the customer, provide a complete account and payment history for customers
billed by us and enable the customer service representatives to provision new
services and modify existing services on all of our products.
 
     We handle our provisioning, customer care, billing and traffic reporting
functions through a proprietary software platform developed by RiverRock
Systems, Ltd., a Texas limited partnership in which we have a 49% ownership
interest. The system has been designed to be both scalable and flexible in order
to support our expected future back office requirements. We believe that this
system provides us with a significant competitive advantage by allowing us to
creatively bundle and price various telecommunication services, to process large
order volumes, and to provide superior customer service when compared to the
incumbent local
 
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telephone companies using legacy systems and their competitors that outsource
back-office services or that do not have an advanced office support systems
platform. The RiverRock system is part of a larger back office organization
which enables us to: (1) minimize the time required to initiate services for new
customers, (2) provide customer bills, (3) respond quickly to customers' needs
and information requests, and (4) better monitor and analyze traffic, financial
and operating trends. We intend to continue to develop this system to meet
increasing demands for our services and to continue to provide our customers
with superior customer care.
 
     We also provide customer support for our offshore products and services
through our full-service support teams in Friendswood, Texas, Lafayette and New
Orleans, Louisiana, Moscow, Russia and Aberdeen, Scotland. Support services
include: (1) on-site maintenance, with over 50 technical specialists on call for
immediate dispatch when customers' communications systems require maintenance;
(2) a network operations center in Friendswood, Texas where our professionals
remotely monitor customers' communications systems throughout the Gulf of Mexico
and around the world seven days a week, 24 hours a day; (3) customer support for
our wireless products; (4) training programs designed to maximize the customers'
communications investment through classroom training at customers' sites and
multimedia video training tools; and (5) research and development for unique
applications where our engineers can custom design or modify hardware to improve
our performance within a particular system.
 
COMPETITION
 
     Overview. The communications services industry is highly competitive,
rapidly evolving and subject to constant technological change. In particular,
numerous companies offer long distance, local, Internet, data and bandwidth
services, and we expect competition to increase in the future. We compete in
these markets primarily on the basis of price, customer service and the ability
to provide a variety of communications products and services.
 
     Fiber Networks. We intend to expand our fiber optic network to
approximately 5,500 route miles throughout the Southwest region. We expect to
compete with numerous established and start-up national and regional fiber optic
networks owned by long distance carriers, ILECs and competitive local exchange
carriers ("CLECs") throughout the Southwest region. These competitors include
very large companies such as:
 
     - AT&T,
 
     - MCI WorldCom,
 
     - Sprint,
 
     - Level 3,
 
     - Williams,
 
     - SBC, and
 
     - Qwest.
 
Each of these companies has greater name recognition, financial, personnel,
technical and marketing resources than we have. We also anticipate that other
providers of local and long distance telecommunications services will plan and
construct fiber networks that could compete with our network. In addition to
long distance carriers and local telephone companies, entities potentially
capable of offering broadband services in competition with our existing and
planned network include:
 
     - other facilities-based communications service providers,
 
     - cable television companies,
 
     - electric utilities,
 
     - microwave carriers,
 
     - satellite carriers,
 
     - wireless telephone system operators, and
 
     - large companies who build private networks.
 
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<PAGE>   11
 
     Competing networks may also have advanced fiber and operating capabilities
similar to those of our network. Furthermore, we expect that some of our
competitors will compete in our geographic market and directly with us for many
of the same customers along a significant portion of the routes along which we
intend to operate.
 
     Domestic and International Long Distance. We provide long distance services
using our own facilities and by reselling the facilities of other carriers, both
in the United States and between the United States and other countries. The long
distance communications industry is intensely competitive and the marketing and
pricing decisions of the larger industry participants such as AT&T, MCI
WorldCom, and Sprint have a significant impact on us. In addition, significant
consolidation in the industry has created and will continue to create numerous
other entities with substantial resources to compete for long distance business.
Such entities include Excel Communications, Inc., Frontier Communications
Service, Inc. and Qwest. In addition, as a result of the Telecommunications Act
of 1996 (the "1996 Telecommunications Act"), we anticipate that the Federal
Communications Commission ("FCC") may permit the Regional Bell Operating
Companies (the "RBOCs") and GTE Operating Companies ("GTOCs") to enter the long
distance market in the future. These larger competitors have significantly
greater name recognition and greater personnel, financial, technical, network
and marketing resources. Many may also offer a broader portfolio of services and
have long standing relationships with customers targeted by us. Moreover, we
cannot guarantee that our competitors cannot negotiate contracts with suppliers
of telecommunications services to obtain conditions of service more favorable
than ours. Many of our competitors enjoy economies of scale that can result in a
lower cost structure for transmission and related terminating costs. Those
carriers could bring significant pricing pressure to bear on us.
 
     Customers frequently change long distance providers in response to lower
rates or promotional incentives by competitors. Prices for domestic and
international long distance calls have declined in recent years and we expect
them to continue to decrease further and more rapidly. Indeed, we expect
competition in all of our relevant markets to increase. This increased
competition could adversely affect our net revenue per minute and gross margins.
We cannot guarantee that we can compete effectively in the domestic or
international long distance markets.
 
     Local Exchange Service. Our business objective is to expand significantly
our operations to provide local services. Regulation permitting us to compete in
the local service market has only recently been enacted into law, following
enactment of the 1996 Telecommunications Act. The services we intend to offer
will compete with those offered by ILECs, such as BellSouth, Southwestern Bell
and the GTOCs, as well as very large long distance carriers, such as AT&T, MCI
WorldCom, and Sprint. The ILECs currently dominate the provision of local
services in their respective markets, and the ILECs and the very large long
distance carriers have greater name recognition and greater financial,
technical, network, marketing and personnel resources than we do. Those entities
also hold longer standing relationships with regulatory authorities at the
federal and state levels than we do. We may also face competition from other
current and potential market entrants, including:
 
     - other CLECs,
 
     - cable TV companies,
 
     - electric utilities,
 
     - ILECs operating outside their current local service areas,
 
     - other long distance carriers,
 
     - wireless telephone system owners,
 
     - microwave owners,
 
     - satellite carriers,
 
     - private networks built by large companies, and
 
     - start-up telecommunications ventures.
 
We cannot guarantee that we can compete effectively in the local service
markets.
 
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<PAGE>   12
 
     Internet Telephony. The FCC currently classifies Internet services as
enhanced services. As a result, federal and state common carrier regulations,
including long distance interstate and intra-state access fees, tariffing,
certification and rate regulation do not apply to the provision of Internet
services. Some Internet service providers, or ISPs, have recently announced
plans to use Internet protocol technologies ("IP Telephony") to introduce
domestic and international long distance services at rates 30% to 50% below
standard long distance rates. Although the FCC intends to review this issue, IP
Telephony could increase pressure on long-distance companies and other
communications companies to reduce prices and margins on domestic and
international long distance services. We cannot guarantee that either we or our
carrier customers will not experience substantial decreases in call volume,
pricing and/or margins due to IP Telephony. We also cannot guarantee that we can
offer telecommunications services to end users at prices that can compete with
the IP Telephony services offered by these new companies.
 
     We also provide Internet services. We cannot guarantee that federal or
state regulators will not impose additional regulation on Internet services in
the future. We expect to compete by introducing IP Telephony shortly. The
Internet services market is highly competitive, in part because no substantial
barriers to entry exist. We expect that competition will continue to intensify.
Our competitors in this market include:
 
     - Internet service providers,
 
     - other telecommunications companies,
 
     - online services providers, and
 
     - Internet software providers.
 
Many of these competitors have greater personnel, financial, technical and
marketing resources than those available to us.
 
     Technological Advances. Dense wave division multiplexing, high-speed OC-192
transmission electronics, advanced fiber technology and packet switching are
converging to increase significantly the supply of domestic and international
transmission capacity. Rapid and on-going technological advances have brought
new product and service offerings similar to the services we provide. The
introduction of new products or emergence of new technologies may cause capacity
to greatly exceed demand, reducing the pricing of certain services we provide.
We cannot guarantee that we can satisfy future customer needs, that our
technologies will not become obsolete because of future technological
developments, or that we will not have to make significant additional capital
investments to upgrade or replace our system and equipment. We cannot predict
the impact of these technological changes on our operations. If we fail to keep
pace with advances, it could have a material adverse effect on our financial
condition, results of operations and cash flow.
 
     Offshore and Remote Telecommunications Services. Currently, we provide
telecommunications services to oil and gas customers in the Gulf of Mexico. In
the Gulf of Mexico, we compete directly principally with Autocomm Communications
Engineering Corp., Sola Communications, Inc., Datacom and Shell. Shell currently
provides competing services through its microwave network in the Gulf of Mexico
and has announced plans to become a full service telecommunications provider to
the oil and gas industry in the region. Although we believe that we compete
successfully in each of our markets today, we cannot guarantee that we can
continue to compete successfully in the future. We believe that most of our
larger competitors have generally not made it a priority to provide remote,
difficult-access telecommunications services. Should one or more of our
competitors decide to focus on such services, it could have a material adverse
effect on our financial condition, results of operations and cash flow.
 
EMPLOYEES
 
     As of February 28, 1999, we employed approximately 390 people, including
approximately 116 in sales and marketing, approximately 110 in engineering and
technical services and approximately 164 in management, customer care,
provisioning, administration and finance. At that date, we also had an agent
sales force numbering approximately 115 independent agents throughout Texas. We
use the services of independent contractors for construction of our fiber
network. None of our employees is represented by a labor union or is subject to
a collective bargaining agreement. We believe that we have good relations with
our employees.
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<PAGE>   13
 
REGULATION AND LICENSES
 
     The following summary of regulatory developments and legislation does not
purport to describe all present and proposed federal, state and local
regulations and legislation affecting the telecommunications industry. Other
existing federal, state and local legislation and regulations are currently the
subject of judicial proceedings, legislative hearings, and administrative
proposals which could change, in varying degrees, the manner in which this
industry operates. Neither the outcome of these proceedings, nor their impact
upon us or the telecommunications industry, can be predicted at this time. This
section also sets forth a brief description of regulatory and tariff issues
pertaining to our operations.
 
     We provide domestic and international services subject to varying degrees
of U.S. federal, state and local regulation, and regulation by foreign
authorities. In the United States, the 1934 Communications Act, as amended,
including as amended by the 1996 Telecommunications Act and the regulations
promulgated by the FCC thereunder, as well as the applicable laws and
regulations of the various states and state regulatory commissions all govern
the provision of telecommunications services. The FCC exercises jurisdiction
under Title II of the 1934 Communications Act over all facilities of, and
services offered by, telecommunications common carriers to the extent such
services involve jurisdictionally interstate common carrier communications,
including international communications originating from or terminating in the
United States. State regulatory authorities retain jurisdiction over
jurisdictionally intrastate communications. Under Title III of the 1934
Communications Act, the FCC also regulates the licensing and use of the radio
frequency spectrum. Local governments sometimes impose franchise or licensing
requirements on local service competitors and/or facilities companies. Services
we provide in other countries remain subject to the telecommunications laws and
regulations of those countries.
 
     The FCC and the state regulatory agencies impose and enforce regulatory
requirements applicable to our operations. The FCC and the state regulatory
agencies may address regulatory non-compliance with a variety of enforcement
mechanisms, including:
 
     - monetary forfeitures,
 
     - refund orders,
 
     - injunctive relief,
 
     - license conditions, and/or
 
     - license revocation.
 
     As a telecommunications carrier, we must also comply with the Federal
digital wiretapping administered by the U.S. Department of Justice and the FCC.
The telecommunications industry varies substantially from state to state and
continues to change rapidly. Moreover, as deregulation at the federal level
occurs, some states are reassessing the level and scope of regulation applicable
to carriers. Domestic or international regulators or third parties could raise
material issues with regard to compliance or non-compliance with applicable
regulations. Future regulatory, judicial or legislative activities could have a
material adverse effect on our financial condition, results of operations or
cash flow.
 
  U.S. Federal Regulation
 
     Local Service Regulation Under The 1996 Telecommunications Act. The 1996
Telecommunications Act, which amended the 1934 Communications Act, provided for
comprehensive reform of the United States' telecommunications laws. In passing
the 1996 Telecommunications Act, Congress sought to increase local competition
from newer competitors such as long distance carriers, cable TV companies and
public utility
 
                                       11
<PAGE>   14
 
companies. The 1996 Telecommunications Act specifically requires all local
exchange carriers, or LECs (including ILECs and CLECs):
 
     - not to prohibit or unduly restrict resale of their services,
 
     - to provide dialing parity, number portability and nondiscriminatory
       access to telephone numbers, operator services, directory assistance and
       directory listings,
 
     - to afford access to poles, ducts, conduits and rights-of-way, and
 
     - to establish reciprocal compensation arrangements for the transport and
       termination of telecommunications.
 
     In addition, ILECs must provide:
 
     - interconnection on certain terms and conditions,
 
     - unbundled network elements,
 
     - resold local services at wholesale rates,
 
     - reasonable public notice of any changes in the information needed for
       transmission and routing services over their communications facilities,
       and
 
     - physical colocation of equipment necessary for interconnection and access
       to unbundled network elements at the LECs' premises.
 
     Under the 1996 Telecommunications Act, Regional Bell Operating Companies,
or RBOCs, have the opportunity to provide out-of-region long distance and
certain cable TV services immediately and in-region long distance services after
the RBOCs meet certain conditions. Specifically, an RBOC can enter the market
for in-region long distance services within areas where the RBOC provides local
exchange service upon FCC approval based on a showing that facilities-based
competition and interconnection agreements meeting a 14-point checklist both
exist. Entry of RBOCs into the domestic and international long distance business
and the emergence of other new local competitors could subject us to substantial
competition and could have a material adverse effect on our financial condition,
results of operations and cash flow.
 
     On August 8, 1996, the FCC released the Interconnection Decision, which
established a framework of minimum, national rules enabling state commissions
and the FCC to begin implementing many of the local competition provisions of
the 1996 Telecommunications Act. Among other things, the Interconnection
Decision:
 
     - prescribed certain minimum points of interconnection,
 
     - adopted a minimum list of unbundled network elements that ILECs must make
       available to competitors, and
 
     - adopted a methodology for states to use when setting prices for unbundled
       network elements and for wholesale resale services.
 
     On January 25, 1999, the Supreme Court issued an opinion overturning prior
decisions issued by the U.S. Court of Appeals for the Eighth Circuit that had
vacated certain portions of the Interconnection Decision. The Supreme Court's
decision confirmed the FCC's authority to issue regulations implementing the
pricing and other provisions of the 1996 Telecommunications Act and reinstated
most of the challenged rules. However, the Supreme Court vacated a key FCC rule
that identified the network elements that incumbent LECs must unbundle. The
Eighth Circuit decisions and their recent reversal by the Supreme Court
perpetuate continuing uncertainty about the rules governing the pricing, terms
and conditions of interconnection agreements. During the pendency of the Eighth
Circuit proceedings, state public utilities commissions have continued to
conduct arbitrations, and to implement and enforce interconnection agreements.
However, the Supreme Court's recent ruling and further proceedings on remand may
affect the scope of the state
 
                                       12
<PAGE>   15
 
commissions' authority to conduct such proceedings or to implement or enforce
interconnection agreements. The U.S. Supreme Court's decision will likely result
in new or additional rules being promulgated by the FCC. Given the general
uncertainty surrounding the effect of the Eighth Circuit decisions and the
recent decision of the Supreme Court reversing them, we cannot guarantee that we
can continue to obtain or enforce acceptable interconnection terms or
interconnection terms consistent with our business plans.
 
     On August 7, 1998, the FCC released an Order denying requests by various
ILECs that the FCC use Section 706 of the 1996 Telecommunications Act to forbear
from regulating advanced telecommunications services. Instead, the FCC
determined that advanced services constitute telecommunications services and
that ILECs must comply with the unbundling and resale obligations and the
in-region inter-LATA restrictions of the 1996 Telecommunications Act in their
provision of advanced services. The FCC also proposed in a rulemaking to allow
ILECs to provide advanced services on an unregulated basis through separate
subsidiaries. We cannot predict the outcome of the FCC's proceeding. However, if
the FCC does forbear from regulating advanced telecommunications services, such
a decision would increase the ability of ILECs to compete against less
established carriers such as us.
 
     Domestic Interstate Services. The FCC considers domestic interstate common
carriers (including us) that do not have market power as "nondominant." The FCC
subjects nondominant carriers to minimal regulation. However, interstate
carriers offering services to the public must comply with the federal statutory
and regulatory requirements of common carriage under the 1934 Communications
Act. Among other things, interstate common carriers must offer service on a
non-discriminatory basis at just and reasonable rates. Nondominant carriers need
not obtain specific prior FCC approval to initiate or expand domestic interstate
services, although they must file a tariff with the FCC. Nondominant carriers
remain subject to the FCC's complaint jurisdiction. The FCC has issued an order
eliminating the requirement that nondominant carriers maintain tariffs for their
domestic interstate services on file at the FCC. Several carriers have appealed
the FCC's order to the U.S. Court of Appeals for the District of Columbia and
that court has stayed the FCC's order pending resolution of the appeal. If the
FCC order becomes effective, nondominant interexchange carriers will need to
find new means of providing notice to customers of prices, terms and conditions
on which they offer their interstate services. Elimination of tariffs will
require that we secure with each of our customers contractual agreements
containing the terms of the services offered. To the extent that disputes arise
over such contacts, carriers, including us, may no longer resort to the legal
doctrine that the terms of a filed tariff supersede individual contract
language.
 
     International Service Regulation. As a provider of international
telecommunications services, we must comply with the federal statutory and
regulatory requirements of common carriage under the 1934 Communications Act.
International common carriers must obtain authority from the FCC under Section
214 of the 1934 Communications Act and file a tariff containing the rates,
terms, and conditions applicable to their services before initiating their
international telecommunications services. We hold global authority from the FCC
to provide resale of switched services and private line services (where
permitted by the FCC) and to provide facilities-based services. We maintain an
international tariff on file with the FCC. International telecommunications
service providers must also file with the FCC:
 
     - copies of their contracts with other carriers,
 
     - foreign carrier agreements, and
 
     - various reports regarding their international revenue, traffic flows and
       use of international facilities.
 
     Carriers holding Section 214 authority must also comply with FCC rules
requiring, among other things, prior approval for transfers of control and
assignments.
 
     Authorized international carriers must also comply with the FCC's
international service regulations, including the International Settlements
Policy ("ISPY") which governs:
 
     - the payment settlements between U.S. common carriers and their foreign
       correspondents for terminating traffic over each other's networks,
 
                                       13
<PAGE>   16
 
     - the accounting rates for such settlements, and
 
     - the permissible deviations from these policies.
 
     The ISPY applies to both resale and facilities-based operations. To the
extent that we acquire or own facilities that permit us to carry international
traffic, the FCC may pay particular attention to our compliance with that
policy.
 
     The FCC enacted certain changes in its rules designed to permit alternative
arrangements outside of its ISPY as a means of encouraging competition and
lower, cost-based accounting rates. As a part of implementing the ISPY, the FCC
maintains a private line resale policy that prohibits carriers from reselling
international private leased circuits to provide switched services to or from a
country unless the FCC has found that the country affords U.S. carriers
equivalent resale opportunities to engage in similar activities in that country.
The FCC recently revised this and other policies to accommodate the 1997 WTO
Agreement on basic services, a compact that addresses market access, foreign
investment, and procompetitive regulatory principles in areas currently
generating a vast majority of the world's telecommunications revenue. Currently,
the FCC's rules permit U.S. carriers to provide switched service over
international leased lines or facilities-based private lines between the U.S.
and WTO countries where the local telecommunications provider generally charges
U.S. carriers at or below an FCC-determined rate for terminating the U.S.
carriers' traffic or equivalent resale opportunities are available.
 
     The FCC has adopted measures intended to overhaul the system of
international settlements by, among other things, establishing lower ceilings
("Benchmarks") for the rates that U.S. carriers will pay foreign carriers for
the termination of international services. The FCC's authority to establish such
Benchmarks was recently affirmed in federal court. Under the FCC's "Flexibility
Policy," the FCC will also permit alternative arrangements with foreign carriers
on a case by case basis. The FCC has recently proposed additional reforms to the
ISPY to eliminate or reduce unnecessary regulatory requirements governing
arrangements between U.S. and foreign carriers in competitive situations. The
FCC recently streamlined Section 214 license and related requirements. While
these rule changes may provide carriers with more flexibility to respond more
rapidly to changes in the global telecommunications market, they will also
likely increase the level of competition in the international telecommunications
marketplace.
 
     Wireless Services. We own and maintain a variety of telecommunications
infrastructures and we hold various FCC and international licenses to transmit
voice and data. We currently hold numerous FCC licenses to provide land mobile,
microwave and satellite communications services. See "-- Licenses."
 
     FCC licensees authorized to provide microwave, satellite earth station and
land mobile service must comply with under Title III of the 1934 Communications
Act and a variety of detailed licensing, operational and technical requirements
specific to each service. Among other requirements, licensees seeking to alter
the technical or operational configurations of their equipment or to continue
operating beyond the expiration date of the licenses must seek additional prior
authority from the FCC. We recently became aware that some of our earth station
operations do not strictly comply with the licenses we hold. We expect to file
applications to modify our FCC licenses to ensure that they fully reflect our
operations. FCC rules also contain various other requirements such as
restrictions on proposed transfers of control or assignments and required
compliance with relevant Federal Aviation Administration rules on wireless tower
construction and operation. The FCC generally retains the right to sanction a
carrier or revoke its authorizations if a carrier violates applicable laws or
regulations.
 
     The FCC continues to refine its wireless rules for each service area to
accommodate advances in technology, developing markets and new service
arrangements, to implement certain provisions of the 1996 Telecommunications
Act, and to eliminate confusing, outdated, redundant or otherwise burdensome
regulation. Opportunities to obtain new common carrier wireless licenses are
often limited by the FCC's auction process under which the FCC assigns wireless
licenses to the highest bidder.
 
     The 1934 Communications Act generally limits direct foreign ownership of
wireless licenses to 20%, but provides for indirect foreign ownership holdings
above 25% upon FCC approval. In its order implementing the
 
                                       14
<PAGE>   17
 
U.S. commitment under the WTO Agreement, the FCC established new rules that
effectively relax the foreign ownership limits for common carrier wireless
licenses. Specifically, the new rules allow for up to 100% indirect ownership of
wireless licenses by foreign interests from countries that have participated in
the WTO Agreement upon FCC review and approval.
 
     Access Charges. The cost of providing long distance and local exchange
services will be affected by changes in the "access charge" rates imposed by
ILECs on long-distance carriers for origination and termination of calls over
local facilities. The term "access service" describes the use of local exchange
facilities for the origination and termination of interexchange communications.
On May 8, 1997, the FCC released an order intended to reform the FCC's system of
interstate access charges to make that regime compatible with the
pro-competitive deregulatory framework of the 1996 Telecommunications Act. The
FCC's access reform order adopts various changes to federal policies governing
interstate access service pricing designed to move access charges, over time, to
more economically efficient levels and rate structures. Among other things, the
FCC:
 
     - modified rate structures for certain non-traffic sensitive access rate
       elements, moving some costs from a per-minute-of-use basis to flat-rate
       recovery, including one new flat rate element,
 
     - changed its structure for interstate transport services, and
 
     - affirmed interstate access charges do not apply to ISPs.
 
     In response to claims that existing access charge levels are excessive, the
FCC stated that it would rely on market forces first to drive prices for
interstate access to competitive but that a "prescriptive" approach might be
considered if necessary. In the absence of competition, the FCC stated that it
might specify the nature and timing of changes to existing access rate levels.
The FCC has indicated that it will promulgate additional rules sometime in 1999
that may grant increased pricing flexibility to price cap LECs upon
demonstrations of increased competition (or potential competition) in relevant
markets. Price cap LECs include the RBOCs, GTE and certain independents that
must to establish rates only at or below a designated price ceiling. The Eighth
Circuit has affirmed the FCC's access reform order.
 
     Universal Service Charges. In 1997, the FCC released an order establishing
a significantly expanded federal universal service subsidy regime. Specifically,
the FCC established new universal service funds to support telecommunications
and information services provided to qualifying schools, libraries and rural
health care providers, and expanded the federal subsidies for local telephone
services provided to low-income consumers. The FCC collects money to fund this
expanded regime from interstate carriers and certain other entities. Our
payments for the schools and libraries and rural health care fund depend on
estimated quarterly intrastate, interstate and international gross end-user
telecommunications revenues. Contribution factors vary quarterly and the FCC
bills carriers on a monthly basis. Contribution factors for 1999 ranged from
3.08 to 3.19% for the high cost and low income funds (interstate and
international revenues); and 0.72 to 0.76% for the schools, libraries, and rural
health care funds (intrastate, interstate and international revenues). Because
the contribution factors do vary quarterly, we cannot currently accurately
determine the annualized impact on our annual performance. Several parties have
appealed the FCC's universal service order and those appeals remain pending
before the Fifth Circuit Court of Appeals.
 
     The FCC may also issue new regulations governing the treatment of calls to
ISPs for the purposes of universal service obligations. In a recent report to
Congress, the FCC clarified that carriers must consider revenues earned from the
transmission services supplied to ISPs when calculating universal service
obligations. The FCC plans to address in the future the contribution
obligations, if any, of ISPs using their own facilities and ISPs providing
phone-to-phone IP telephony. We cannot predict the outcome of these proceedings
or their potential effect on our operations.
 
     Internet Services. There are currently few U.S. laws or regulations which
specifically regulate communications or commerce over the Internet. One area in
which Congress did attempt to regulate information over the Internet involved
the dissemination of obscene or indecent materials. Certain provisions of the
1996 Telecommunications Act relating to indecent communication over the
Internet, generally referred to as the
 
                                       15
<PAGE>   18
 
Communications Decency Act, were found to be unconstitutional by the U.S.
Supreme Court in 1997. In October 1998, Congress enacted the Child Online
Protection Act, which requires that on-line material that is "harmful" to minors
be restricted. This law is currently being challenged in federal district court.
On February 1, 1999, a U.S. District Court judge issued a preliminary injunction
against enforcement of that Act.
 
     It is possible that in the future laws and regulations could be adopted
which address matters such as user privacy, copyrights, pricing and the
characteristics and quality of Internet services, among other areas.
Internet-related legislation and regulatory policies are continuing to develop
and we could be subject to increased regulation in the future. Laws or
regulations could be adopted in the future that may decrease the growth and
expansion of the Internet's use, increase our cost of doing business, or
otherwise adversely affect our business.
 
     In addition, in 1998 Congress passed the Digital Millennium Copyright Act.
That act provides ISPs that comply with its requirements numerous protections
from certain types of copyright liability. To the extent that we have not met
those requirements, third parties could seek recovery from us for copyright
infringements caused by our Internet customers.
 
     The law relating to the liability of ISPs for information carried on or
disseminated through their networks is currently unsettled. It is possible that
claims could be made against ISPs for defamation, negligence, copyright or
trademark infringement, or on other theories based on the nature and content of
the materials disseminated through their networks. We could be required to
implement measures to reduce our exposure to potential liability, which may
require, for instance, the expenditure of resources or the discontinuance or
modification of certain product or service offerings. Costs that may be incurred
as a result of contesting any claims relating to our services or the consequent
imposition of liability could have a material adverse effect on our financial
condition, results of operations and cash flow.
 
     The Eighth Circuit recently found that the FCC has a reasonable basis for
not requiring ISPs to pay access charges. In June 1997, every RBOC advised CLECs
that they did not consider calls in the same local calling area from RBOC served
customers to CLEC served ISPs, to be local calls under the interconnection
agreements between the RBOCs and the CLECs. The RBOCs also claimed that the FCC
exempted these calls from access charges, and therefore that CLECs could not
recover compensation for transporting and terminating such calls. As a result,
the RBOCs threatened to withhold, and in many cases did withhold, reciprocal
compensation for the transport and termination of such calls. To date, numerous
state commissions have ruled on this issue in the context of state commission
arbitration proceedings or enforcement proceedings. In every state, to date, the
state commission has determined that RBOCs must pay reciprocal compensation for
such calls. Various RBOCs have appealed these cases. We cannot predict the
outcome of these appeals.
 
     On February 26, 1999, the FCC determined that calls made to ISPs are
largely interstate in nature, and requested comments regarding how this traffic
should be regulated once existing interconnection agreements expire. However,
the FCC also determined that since federal law did not govern compensation for
this traffic when existing interconnection agreements were signed, the states
could determine whether carriers should pay reciprocal compensation for these
calls under existing agreements. There is a risk that state commissions which
previously considered this issue and ordered the payment of reciprocal
compensation could revisit this issue on their own volition or at the request of
an ILEC, and revise their prior decisions on this issue. To date, at least one
ILEC has filed suit seeking a refund from a carrier of reciprocal compensation
the ILEC has paid to that carrier.
 
  State Regulation
 
     Most states require carriers to obtain a certification or other
authorization before offering local exchange and long distance intrastate
services. These certifications generally require a showing that the carrier has
adequate financial, managerial and technical resources to offer the proposed
services in a manner consistent with the public interest. We hold long distance
authorization in most, but not all, of the states in which certificates are
required. In addition most states impose tariff requirements on carriers and
require that common carriers charge just and reasonable rates and not
discriminate among similarly situated customers.
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<PAGE>   19
 
Some states also require the filing of periodic reports, the payment of various
regulatory fees and surcharges, and compliance with service standards and
consumer protection rules. States also often require prior approvals or
notifications for certain transfers of assets (such as fiber optic cable or
other telecommunications facilities), customers, or ownership. States generally
retain the right to sanction a carrier or to revoke certifications if a carrier
violates relevant laws and/or regulations. If any state regulatory agency
concluded that we provide intrastate service without the appropriate authority,
that agency could initiate enforcement actions, potentially including the
imposition of fines, the disgorging of revenues, or the refusal to grant the
regulatory authority necessary for the future provision of intrastate
telecommunications services. We hold authority to provide interexchange and
competitive local exchange services in certain service areas in Arkansas,
Kansas, Louisiana, Oklahoma and Texas, and have authority to provide
interexchange service in at least 35 states.
 
     In addition, carriers providing intrastate services must comply with state
utility commission rules and policies with respect to ILEC and CLEC competition,
geographic build out, mandatory de-tariffing and other matters. Certain states
have adopted specific universal service funding obligations. Numerous other
states have also instituted proceedings to adopt state universal service funding
obligations rules. State commissions generally have authority to impose
sanctions on carriers ranging from fines to license revocation to address
non-compliance with the states' particular regulatory policies and requirements.
 
     State regulatory agencies also regulate access charges and other pricing
for telecommunications services within each state. The RBOCs and other LECs have
sought reductions in state regulatory requirements, including greater pricing
flexibility. If regulators allow variable pricing of access charges based on
volume, we could face a competitive disadvantage in competing against larger
long distance carriers. We also could face increased price competition from the
RBOCs and other LECs for local and long distance services. In addition, the
removal of former restrictions on long distance service offerings by the RBOCs
as a result of the 1996 Telecommunications Act could further increase
competition. We cannot predict what impact of such rule changes might have on
our operations.
 
  Local Government Authorizations
 
     We also own telecommunications facilities that may be subject to certain
local government requirements. In particular, facilities-based companies must
generally obtain street use and construction permits and licenses and/or
franchises to install and expand fiber optic networks using municipal rights of
way. While regulation of municipal rights of way generally remains a matter
under local jurisdiction, some states have enacted or are considering enacting
measures that affect the ability of local governments to impose certain types of
restrictions on franchisees or to require certain types of concessions from
carriers seeking franchise agreements.
 
     Termination of our existing franchise or license agreements before their
expiration dates or failure to renew those agreements and any resulting
requirement to remove facilities could have a material adverse effect on our
financial condition, results of operations and cash flow. In some municipalities
carriers must pay license or franchise fees based on a percentage of gross
revenues or on a per linear foot basis, as well as post performance bonds or
letters of credit. We cannot guarantee that we can retain existing franchises or
that franchise fees will remain at their current levels.
 
     The Texas Public Service Commission generally requires us to provide 911
service along with our CLEC offerings in Texas. As a condition to providing 911
service in the City of Dallas, the City of Dallas requires that service
providers obtain a municipal franchise, which, among other things:
 
     - requires the franchise holder to pay a 4% gross revenue fee based on
       operations in the City of Dallas,
 
     - permits use of certain conduit by the City of Dallas without charge, and
 
     - provides a single fiber pair in the franchisee's system for the City of
       Dallas' exclusive use.
 
     To date, we have not obtained a franchise. On May 26, 1998, we, along with
two other entities authorized to provide CLEC service in Texas, Golden Harbor of
Texas, Inc., and Westel, Inc., filed suit in the U.S. District Court for the
Northern District of Texas against the City of Dallas alleging that the
franchise
                                       17
<PAGE>   20
 
requirements imposed by the City of Dallas violates the 1996 Telecommunications
Act, particularly with respect to resellers of LEC services. The Texas court has
consolidated our action with a similar action brought by AT&T Communications of
the Southwest, Inc. ("AT&TSW"). Although AT&TSW has obtained a preliminary
injunction against the City of Dallas' imposition of certain conditions on its
franchise, we cannot guarantee that we will prevail in our pending lawsuit
against the City of Dallas.
 
  Foreign Regulation
 
     International telecommunications providers are subject to varying degrees
of regulation in each of the jurisdictions in which they provide service. Local
laws and regulations, and the interpretation of such laws and regulations,
differ significantly from country to country. To the extent that we provide, now
or in the future, services in non-U.S. countries, we must comply with the laws
and regulations of foreign countries. The nature and extent of
telecommunications regulation varies significantly from country to country and
may include requirements that reflect closed or limited market access and/or
requirements we may also face to obtain initial licensing, operational and rate
requirements in the relevant countries. For example, many countries, including
Mexico, have international settlements policies similar to the one imposed by
the U.S. Such policies and their enforcement vary between different countries.
To the extent that we provide service between the U.S. and other countries,
various international settlement policies may apply.
 
  Licenses
 
     We have received authorization, by virtue of state certification, tariff,
registration, or on a deregulated basis, to provide resold long distance
services in at least 35 states. In order to provide wireless mobile services, we
own various radio systems that provide two-way voice communications and have
obtained approximately 35 FCC licenses with approximately 300 frequency pairs.
These licenses have varying terms that expire and will require renewal. As each
license comes due for renewal, we will evaluate the need for such license and
elect to either renew the license or let it expire where, for example, we expect
no further need to use a particular license. These licenses allow us to provide
two-way wireless radio services along the Texas and Louisiana Gulf Coast and
offshore to oil and gas-related companies. Each frequency pair allows two-way
transmission and reception. We hold approximately 20 microwave FCC licenses
providing voice and data services along the Texas and Louisiana Gulf Coast and
offshore to drilling, production and related companies. We also hold and operate
seven Ku band and three C band fixed earth stations and hold FCC licenses that
allow us to locate very small aperture terminal, or VSAT, earth stations in
Texas and other U.S. locations. We expect to file applications to modify our FCC
earth station licenses to ensure that they reflect our current operations.
 
     We also operate as an FCC certificated Section 214 carrier to provide
resold switched telecommunications services. We have obtained broader common
carrier authority from the FCC to provide global resale of switched and private
line services as well as global facilities-based service.
 
     We currently provide international facilities-based private line service on
a private carrier basis into Bolivia, Bosnia, Croatia, Ecuador, Hungary and
Russia. As part of our plans to increase service offerings, we have obtained
authority to provide dedicated services in Louisiana and CLEC and long distance
services in Arkansas, Kansas, Louisiana, Oklahoma and Texas. In addition, we
have received approval to have pole attachment rights to existing or future
facilities of Entergy, BellSouth and the State of Louisiana. Pole attachment
rights allow us to attach our own fiber optic cable to other parties' respective
utility poles. In addition, we own installed fiber optic cable placed under
various public and private rights-of-ways.
 
  Digital Wiretapping
 
     The Communications Assistance to Law Enforcement Act ("CALEA"), enacted in
1994, requires telecommunications carriers to make available certain
telecommunications capabilities to U.S. law enforcement officials to permit
those authorities to continue to intercept communications involving advanced
technologies such as digital and wireless transmission communications. CALEA
imposes certain obligations on carriers to ensure that their equipment,
facilities and services will meet capability and capacity
 
                                       18
<PAGE>   21
 
requirements in order to provide law enforcement agencies the ability to
intercept wireline and wireless communications transmitted over those carrier's
networks. Courts may impose fines of up to $10,000 per day on telecommunications
carriers that fail to meet the required capability functions, as determined by
industry standards. Under procedures specified in CALEA, the U.S. Department of
Justice ("DOJ") recently filed a petition at the FCC challenging the technical
capability standard developed by the telecommunications industry. Because of the
disputed standard, several carriers sought an FCC extension of the October 25,
1998 capability compliance deadline. The FCC recently extended the compliance
date for the CALEA capability requirements to June 30, 2000 to permit
manufacturers sufficient time to develop CALEA compliant equipment. In the
meantime, we expect the FCC to issue shortly an order identifying the
capabilities carriers, such as us, will have to provide to law enforcement
officials in order to meet CALEA's requirements. Telecommunications carriers
must also meet CALEA capacity requirement mandating that by March 12, 2001,
carriers enable a specific number of simultaneous interceptions determined on a
geographic basis. We cannot predict the nature and extent of the impact the
CALEA requirements will have on us or on telecommunications carriers in general.
 
ITEM 2. PROPERTIES
 
     We own or lease buildings that contain approximately 180,000 square feet of
floor space. Our primary headquarters are located in Dallas, Texas. We entered
into a lease agreement effective March 1999 for our new corporate headquarters
and expect to occupy an additional approximately 30,000 square feet at the new
headquarters by the year 2000. We own an office building in Friendswood, Texas
and an office building in Lafayette, Louisiana, and we lease the remainder of
our office space.
 
     All of the fiber optic cable, fiber optic telecommunications equipment and
other properties and equipment used in the networks, are owned or leased by us.
We have entered into various franchise, rights of way and lease agreements for
network regeneration sites. These properties and agreements do not lend
themselves to description by character and location of principal units and are
not considered meaningful for this disclosure. Our principal facilities include:
 
<TABLE>
<CAPTION>
                                       APPROXIMATE
LOCATION                               SQUARE FEET                      DESCRIPTION
--------                               -----------                      -----------
<S>                                    <C>           <C>
Dallas, Texas........................    80,000      Corporate headquarters for administration, finance
                                                     and carrier sales functions, sales, switching and
                                                     customer support personnel
Houston, Texas.......................    24,000      Division headquarters for administration, finance
                                                     and sales functions
Friendswood, Texas...................    24,000      Engineering, network operations center,
                                                     administration, production and warehouse
Phoenix, Arizona.....................    10,300      Switching facility and sales functions
</TABLE>
 
     We consider our current facilities adequate for our current needs and
believe that suitable additional space will be available, as needed, to
accommodate further physical expansion of corporate operations and for
additional sales and service.
 
ITEM 3. LEGAL PROCEEDINGS
 
     We are a party to ordinary litigation incidental to our business from time
to time. Currently, we are not a party to any litigation that we expect would
have a material adverse effect on our results of operations, financial condition
or cash flow.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     None.
 
                                       19
<PAGE>   22
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
STOCK PRICES
 
     Our Common Stock, par value $.01 per share, has traded on the Nasdaq
National Market under the symbol "CPRK" since August 27, 1998, the day after the
business combination of our predecessor companies was completed. The following
table sets forth, for the periods indicated, the range of high and low sales
prices for our common stock as reported on the Nasdaq National Market.
 
<TABLE>
<CAPTION>
                                                              PRICE RANGE OF
                                                               COMMON STOCK
                                                              --------------
                                                               HIGH     LOW
                                                              ------   -----
<S>                                                           <C>      <C>
1998:
  Third Quarter (beginning on August 27, 1998)..............  $10.00   $6.38
  Fourth Quarter............................................  $ 8.75   $4.75
1999:
  First Quarter (through March 18, 1999)....................  $19.00   $7.25
</TABLE>
 
     On March 18, 1999, the last reported closing sales price of the common
stock was $16.875 per share. As of March 18, 1999, there were approximately 60
shareholders of record of our Common Stock.
 
DIVIDEND POLICY
 
     Since our company became a public company, we have not paid cash dividends
on our Common Stock. We currently anticipate that all of our earnings will be
retained for development of our business and do not anticipate paying any cash
dividends in the foreseeable future.
 
     Any future determination as to the payment of dividends will be made in the
discretion of our Board of Directors and will depend upon our operating results,
financial condition, capital requirements, general business conditions and such
other factors as the Board of Directors deems relevant.
 
     Information pertaining to working capital restrictions and other
limitations upon the payment of dividends is incorporated herein from Item
7 -- Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources.
 
RECENT SALES OF UNREGISTERED SECURITIES
 
     None.
 
                                       20
<PAGE>   23
 
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
 
    The following table sets forth our summary financial data as of and for the
years ended December 31, 1994, 1995, 1996, 1997 and 1998. The business
combination among our predecessor companies was completed on August 26, 1998 and
was accounted for as a pooling of interests. Accordingly, the Consolidated
Financial Statements include our three predecessor companies (i.e., CapRock
Telecommunications, CapRock Fiber and IWL Communications) as though these
entities were always a part of CapRock.
 
    In May 1998, IWL Communications changed its fiscal year end to coincide with
the fiscal years of CapRock, CapRock Telecommunications and CapRock Fiber. The
Consolidated Statement of Operations for the year ended December 31, 1996
combines the operating activity of IWL Communications for the year ended June
30, 1996 with the operating activity of CapRock Telecommunications and CapRock
Fiber for the year ended December 31, 1996. The net income of IWL Communications
in the amount of approximately $260,000 for the six month period ended December
31, 1996 was excluded from the Consolidated Statement of Operations for the year
ended December 31, 1996 as a result of the non-conforming year ends for such
period. This amount was included as an adjustment to retained earnings in the
Consolidated Statement of Stockholders' Equity and Comprehensive Income in 1997.
IWL Communications' cash flow for this period was added to the 1997 beginning
balance in the Consolidated Statement of Cash Flows.
 
<TABLE>
<CAPTION>
                                                                   AS OF AND FOR THE YEAR ENDED DECEMBER 31,
                                                              ----------------------------------------------------
                                                               1994       1995       1996       1997        1998
                                                              -------    -------    -------    -------    --------
                                                                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                           <C>        <C>        <C>        <C>        <C>
STATEMENT OF OPERATIONS DATA:
Revenues....................................................  $21,159    $29,407    $50,970    $75,349    $121,774
Cost of services and product resales........................   15,295     21,185     39,357     52,471      83,221
                                                              -------    -------    -------    -------    --------
        Gross profit........................................    5,864      8,222     11,613     22,878      38,553
Operating expenses:
  Selling, general and administrative.......................    5,565      7,326      8,983     14,074      23,528
  Merger related expenses...................................       --         --         --         --       2,313
  Depreciation and amortization.............................      631      1,186      1,536      3,346       4,887
                                                              -------    -------    -------    -------    --------
        Total operating expenses............................    6,196      8,512     10,519     17,420      30,728
                                                              -------    -------    -------    -------    --------
Operating income (loss).....................................     (332)      (290)     1,094      5,458       7,825
Interest expense, net.......................................     (224)      (484)      (585)    (1,603)     (6,441)
Other income................................................      256        151         42        220         106
                                                              -------    -------    -------    -------    --------
Income (loss) before income taxes and extraordinary item....     (300)      (623)       551      4,075       1,490
Income taxes................................................       77         48        227      1,513       1,267
                                                              -------    -------    -------    -------    --------
Income (loss) before extraordinary item.....................     (377)      (671)       324      2,562         223
Extraordinary item -- extinguishment of debt................       --        645         --         --          --
                                                              -------    -------    -------    -------    --------
        Net income (loss)...................................  $  (377)   $   (26)   $   324    $ 2,562    $    223
                                                              =======    =======    =======    =======    ========
Pro forma net income (loss):
  Income (loss) before income taxes and extraordinary
    item....................................................  $  (300)   $  (623)   $   551    $ 4,075    $  1,490
  Pro forma income taxes, as if CapRock Fiber were a C
    corporation.............................................     (131)      (211)       143      1,475       1,267
                                                              -------    -------    -------    -------    --------
  Income (loss) before extraordinary item...................     (169)      (412)       408      2,600         223
  Extraordinary item, net of taxes..........................       --        397         --         --          --
                                                              -------    -------    -------    -------    --------
        Pro forma net income (loss).........................  $  (169)   $   (15)   $   408    $ 2,600    $    223
                                                              =======    =======    =======    =======    ========
Historical and pro forma income (loss) per common share:
  Income (loss) before extraordinary item...................  $ (0.01)   $ (.002)   $  0.01    $  0.09    $   0.01
  Extraordinary item, net of tax............................       --       .002         --         --          --
                                                              -------    -------    -------    -------    --------
  Basic and diluted.........................................  $ (0.01)   $    --    $  0.01    $  0.09    $   0.01
                                                              =======    =======    =======    =======    ========
Weighted average shares outstanding:
  Basic.....................................................   25,715     25,926     27,146     27,984      28,899
  Diluted...................................................   25,715     25,936     27,156     28,481      30,028
OPERATING DATA:
EBITDA(1)...................................................  $   299    $   896    $ 2,630    $ 8,804    $ 15,025
Cash flows provided by (used in) operations.................     (593)       827        781      4,112       7,125
Cash flows used in investing activities.....................   (1,366)    (1,919)    (9,350)   (12,987)   (134,350)
Cash flows provided by financing activities.................    2,324        903      8,605     12,113     123,989
Capital expenditures........................................   (1,822)    (2,282)   (10,212)   (13,630)    (36,855)
BALANCE SHEET DATA:
Working capital (deficit)...................................  $  (441)   $  (797)   $(2,153)   $  (305)   $102,489
Property, plant and equipment, net..........................    2,935      6,705     15,901     27,341      59,607
Total assets................................................    9,596     13,198     28,522     49,389     191,966
Long-term debt and capital lease obligations................    1,221      2,443     13,254     21,062     145,187
Stockholders' equity........................................    2,829      3,552      3,886     14,086      16,062
</TABLE>
 
---------------
 
(1) EBITDA consists of earnings before interest, income taxes, depreciation and
    amortization and merger related expenses. EBITDA is a measure commonly used
    in the communications industry to analyze companies on the basis of
    operating performance. EBITDA is not a measure of financial performance
    under generally accepted accounting principles and should not be considered
    as an alternative to net income as a measure of performance nor as an
    alternative to cash flow as a measure of liquidity.
 
                                       21
<PAGE>   24
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
     The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements and Notes thereto included in this Form
10-K. See "Item 8 -- Financial Statements." This information is not necessarily
indicative of future operating results. Except for the historical information
contained below, the matters discussed in this section are forward-looking
statements that involve a number of risks and uncertainties. Our actual
liquidity needs, capital resources and operating results may differ materially
from the discussion shown below in these forward-looking statements.
 
OVERVIEW
 
     We own and operate a scalable long-haul fiber network which upon completion
is expected to cover approximately 5,500 route miles throughout the Southwest
region, which includes Texas, Louisiana, Arkansas, Oklahoma and New Mexico. This
fiber network supports the voice, data, bandwidth and dark fiber services we
provide to our carrier and retail customers.
 
     In August 1998, we announced that we had completed a business combination
transaction in which our predecessor companies combined to form our company as
it exists today. The combination was accounted for as a pooling of interests.
Accordingly, our consolidated results include our three predecessor companies
(i.e., CapRock Telecommunications, CapRock Fiber and IWL Communications) as
though these entities had always been a part of CapRock.
 
     We intend to be the premier provider of carriers' carrier services and the
leading facilities-based integrated communications provider in the Southwest
region. To measure our progress, we classify our revenues in three categories:
carriers' carrier, integrated services and systems services. Our carriers'
carrier revenues include domestic and international long distance, bandwidth and
dark fiber services sold to telecommunications carriers and other wholesale
customers. Currently, we have over 100 carrier customers, including AT&T, MCI
WorldCom, Sprint Corporation and Qwest Communications, as well as many regional
independent companies such as Century Telephone Enterprises, Inc. and Lufkin
Conroe Telephone. Our integrated services revenues reflect our local, long
distance, Internet, data and private line products provided to over 5,000 small
and medium-sized businesses on a single bundled bill. Lastly, our systems
services revenues represent the voice and data systems and services we provide
primarily to the oil and gas industry offshore in and along the Gulf of Mexico.
 
     Our proximity to Mexico allows us to directly connect to the fiber networks
of multiple Mexican telecommunications carriers. Subject to compliance with
certain regulatory requirements, we are capable of providing dark fiber to these
carriers at several border crossings enabling them to close open fiber rings in
Mexico by using CapRock fiber on the U.S. side of the border. Additionally, our
direct connect agreements with foreign carriers position us to capture increased
levels of growing international traffic.
 
     In addition, we recently announced our joint build agreement with Enron
Communications, Inc. to jointly build approximately 1,050 miles of fiber network
in Texas. Through this joint build arrangement, we will connect Amarillo,
Lubbock, Dallas, Fort Worth, Waco, Bryan, Austin, San Marcos, San Antonio and
Houston, Texas. The build plan includes four conduits to be placed throughout
the approximately 1,050 miles, with one and one-quarter conduits to be owned and
funded directly by us, one and one-quarter to be owned and funded by Enron
Communications and one and one-half to be owned and funded by a limited
partnership formed by us and Enron Communications. Our agreements with Enron
Communications provide that the partnership will install 192 fibers in the first
conduit and will sell 96 of the 192 fibers to be installed. Of the remaining 96
fibers, we will own 48 fibers and Enron Communications will own 48 fibers. The
joint build arrangement provides several benefits, including reduction of
construction costs, accelerated acquisition of right of way and franchise
agreements, the majority of which are essentially in place, and the freeing up
of resources to potentially accelerate the build of the remaining portion of the
network.
 
                                       22
<PAGE>   25
 
RESULTS OF OPERATIONS
 
     CapRock recognizes revenue from the following sources: carriers' carrier,
integrated services, system services and product resales.
 
     Carriers' Carrier. Carriers' carrier revenue includes all carrier revenues
generated from the sale of domestic and international switched services, from
the sale of T-1 and DS-3 broadband capacity and from the sale and lease of dark
fiber. The revenue generated from the international switched services represent
minutes of long distance traffic terminating in foreign countries, but generated
by domestic U.S.-based long distance carriers. Such revenues are recognized when
the services are provided. The cost of revenues associated with these services
is based primarily on the direct costs associated with owned and leased
transmission capacity and the cost of transmitting and terminating traffic on
other carriers' facilities. Commissions paid to sales representatives or agents
to acquire customer call traffic are expensed in the period when associated call
revenues are recognized.
 
     We account for long-term construction contracts relating to the development
of telecommunications networks for customers using the percentage-of-completion
method, which would include the sale of fiber through indefeasible right to use
contracts, or IRUs, and the related construction services associated with
building the fiber network specified in the IRUs. Our revenues from IRUs will be
generated from the amount of fiber we build on our network in excess of that
which we intend to retain for our own use. As a result, we expect that revenues
from IRUs will diminish over time as our supply of excess fiber is sold.
Progress under the percentage-of-completion method is measured based upon costs
incurred to date compared with total estimated construction costs. Customers are
billed based upon contractual milestones.
 
     Integrated Services. Integrated communications services revenue includes
all revenues generated from the sale of telecommunications products to business
and residential customers. These products include local, long distance,
Internet, data and private line services.
 
     Systems Services. Systems services revenue includes revenues generated from
the design, installation, leasing and sale of voice and data systems and
products, primarily to companies in the oil and gas industry.
 
     Product Resales. In 1997, CapRock provided services to a subsidiary of
Shell, which included the resale of a significant amount of Alcatel products.
The Shell project was substantially completed in May 1997 and, therefore, is not
expected to contribute in a material manner to CapRock's total sales in future
years.
 
     The following table represents the various sources of revenue:
 
<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31,
                                                 ----------------------------
                                                  1996      1997       1998
                                                 -------   -------   --------
                                                    (DOLLARS IN THOUSANDS)
<S>                                              <C>       <C>       <C>
Revenues:
  Carriers' carrier............................  $22,405   $41,805   $ 72,165
  Integrated services..........................    1,980     8,640     17,978
  Systems services.............................   16,031    21,959     31,631
                                                 -------   -------   --------
          Total service revenue................   40,416    72,404    121,774
  Product resales..............................   10,554     2,945         --
                                                 -------   -------   --------
          Total revenues.......................  $50,970   $75,349   $121,774
                                                 =======   =======   ========
Gross margin percent:
  Gross margin -- service revenue..............       27%       31%        32%
                                                 =======   =======   ========
  Gross margin -- product resales..............        8%       20%        --%
                                                 =======   =======   ========
  Gross margin -- total........................       23%       30%        32%
                                                 =======   =======   ========
</TABLE>
 
                                       23
<PAGE>   26
 
     The following table sets forth for the periods indicated CapRock's
statement of operations as a percentage of its operating revenues:
 
<TABLE>
<CAPTION>
                                                          FOR THE YEAR ENDED
                                                             DECEMBER 31,
                                                        ----------------------
                                                        1996     1997     1998
                                                        ----     ----     ----
<S>                                                     <C>      <C>      <C>
Revenues..............................................  100%     100%     100%
Cost of services......................................   58%      67%      68%
Cost of product resales...............................   19%       3%      --%
                                                        ---      ---      ---
Gross profit..........................................   23%      30%      32%
Operating expenses:
  Selling, general and administrative.................   18%      19%      19%
  Merger related expenses.............................   --%      --%       2%
  Depreciation and amortization.......................    3%       4%       4%
                                                        ---      ---      ---
Total operating expenses..............................   21%      23%      25%
                                                        ---      ---      ---
Operating income......................................    2%       7%       6%
Interest expense......................................   (1)%     (2)%     (8)%
Interest income.......................................   --%      --%       2%
Other income..........................................   --%      --%      --%
                                                        ---      ---      ---
Income before income taxes............................    1%       5%       1%
Income tax expense....................................   --%       2%       1%
                                                        ---      ---      ---
Net income............................................    1%       3%      --%
                                                        ===      ===      ===
</TABLE>
 
YEAR ENDED 1997 COMPARED TO 1998
 
     Revenues. Total revenues increased $46.5 million, or 62%, from $75.3
million in 1997 to $121.8 million in 1998. The 62% increase was attributable to
increases of 73% in carriers' carrier, 108% in integrated services and 44% in
systems services revenue.
 
     Carriers' carrier revenue increased $30.4 million from $41.8 million in
1997 to $72.2 million in 1998. The 73% increase resulted primarily from the
rapid growth in domestic and international switched services sold to other
carriers and as a result of $9.5 million in IRUs in 1998; no such revenue from
IRUs was recorded before 1998.
 
     Integrated services revenue increased $9.3 million from $8.6 million in
1997 to $18.0 million in 1998. The 108% increase was attributable to growth in
the number of business customers both from increased penetration in our existing
markets and from the deployment of our network into new markets.
 
     Systems services revenue increased $9.7 million from $22.0 million in 1997
to $31.6 million in 1998. The 44% increase was attributable to growth associated
with the leasing and sale of voice and data systems products and projects
involving the engineering and integration of telecommunications systems and
sales, service and maintenance of telecommunications equipment.
 
     Product resale revenue was $2.9 million in 1997 as compared to no product
resales in 1998. The product resales to a single customer were substantially
complete in May 1997 and such revenues are not expected to contribute in a
material manner in future years.
 
     Costs of Services and Product Resales. Cost of services increased $30.7
million, or 59%, from $52.5 million in 1997 to $83.2 million in 1998. The growth
in cost of services was primarily attributable to the continued growth in all
three revenue categories. The 2 percentage point increase in gross margin from
30% to 32% resulted primarily from favorable pricing attributable to the higher
traffic and new vendors and the sale of dark fiber. The increase in the gross
margin in 1998 was partially offset by lower margins attributable to Mexico and
other international traffic, which carry a lower gross margin percentage. Gross
margins may vary in future periods as a result of these and other factors.
 
                                       24
<PAGE>   27
 
     Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A") includes salaries, benefits, occupancy costs,
commissions, sales and marketing expenses and administrative expenses. SG&A
increased $9.4 million, or 67%, from $14.1 million in 1997 to $23.5 million in
1998. The increase resulted primarily from the additional personnel required to
support CapRock's growth, advertising to increase name recognition and brand
awareness, and additional sales commission payments.
 
     CapRock recorded merger related expenses of $2.3 million in 1998, as
compared to no such costs in 1997. The merger related costs relate to the
business combination of CapRock Telecommunications, CapRock Fiber and IWL
Communications, our predecessor companies. This combination was consummated on
August 26, 1998. The merger related expenses consist of fees for investment
bankers, attorneys, accountants, financial printing and other related charges.
 
     Depreciation and amortization expense increased $1.5 million, or 46%, from
$3.3 million in 1997 to $4.9 million in 1998. This increase resulted primarily
from purchases of additional equipment and other fixed assets to accommodate
CapRock's growth. CapRock expects that depreciation and amortization expense
will continue to increase in subsequent periods as CapRock continues to expand
its facilities.
 
     Interest Expense. Interest expense increased $7.8 million from $1.7 million
in 1997 to $9.5 million in 1998. The increase resulted from interest expense
related to its senior notes. See "-- Liquidity and Capital Resources."
 
     Interest Income. Interest income increased $2.9 million from $133,000 in
1997 to $3.0 million in 1998. The increase was attributable to the interest and
investment accretion associated with the marketable securities purchased with
the proceeds from the senior notes. See " -- Liquidity and Capital Resources."
 
     Income Taxes. Income tax expense of $1.5 million in 1997 was comparable to
the income tax expense of $1.3 million in 1998. The effective tax rate was 37%
in 1997 as compared to 85% in 1998. The increase in the effective tax rate was
primarily attributable to certain non-deductible merger related expenses in the
amount of approximately $1.8 million.
 
     Net Income. Net income decreased $2.3 million, or 91%, from $2.6 million in
1997 to $223,000 in 1998 as a result of the factors discussed above.
 
YEAR ENDED 1996 COMPARED TO 1997
 
     Revenues. Total revenues increased $24.3 million from $51.0 million in 1996
to $75.3 million in 1997. The 48% increase was due to increases in revenues from
both domestic and international switched services and to growth in switched
services provided to small and medium-sized businesses and to consumers as a
result of the continued expansion of CapRock's direct and agent sales. The 48%
increase was attributable to increases of 87% in carriers' carrier, 336% in
integrated services and 37% in systems services revenue. Product resale revenue
was $10.6 million in 1996, as compared to $2.9 million in 1997. The product
resales were substantially complete in May 1997 and these revenues are not
expected to contribute in a material manner in future years after 1997.
 
     Carriers' carrier revenue increased $19.4 million from $22.4 million in
1996 to $41.8 million in 1997. The 87% increase resulted primarily from the
rapid growth in domestic and international switched services sold to the other
carriers.
 
     Integrated services revenue increased $6.7 million from $2.0 million in
1996 to $8.6 million in 1997. The 336% increase was attributable to growth in
the number of business customers.
 
     Systems services revenue increased $6.0 million from $16.0 million in 1996
to $22.0 million in 1997. The 37% increase was attributable to growth associated
with the leasing and sale of voice and data systems products and projects
involving the engineering and integration of telecommunications systems and
sales, services and maintenance of telecommunication equipment.
 
     Costs of Services and Product Resales. Cost of services increased $13.1
million from $39.4 million in 1996 to $52.5 million in 1997. The growth in cost
of services was primarily attributable to the continued
 
                                       25
<PAGE>   28
 
growth in all three revenue categories. The 7 percentage point increase in gross
margin from 23% to 30% resulted primarily from favorable pricing attributable to
the higher traffic and new vendors, as well as a more favorable mix of
international and domestic traffic. Additionally, the total margin increase was
partially attributable to the completion of the product resales to a single
customer in 1997. Gross margins may vary in the future periods as a result of
these factors.
 
     Selling, General and Administrative Expenses. SG&A includes the cost of
salaries, benefits, occupancy costs, commissions, sales and marketing expenses
and administrative expenses. SG&A increased $5.1 million from $9.0 million in
1996 to $14.1 million in 1997. The increase resulted from additional personnel
needed to support CapRock's growth, additional sales commission payments and
from increases in travel and advertising expenses.
 
     Depreciation and amortization expense increased $1.8 million from $1.5
million in 1996 to $3.3 million in 1997. This increase resulted primarily from
purchases of additional equipment and other fixed assets to accommodate
CapRock's growth. CapRock expects that depreciation and amortization expense
will continue to increase in subsequent periods as CapRock continues to expand
its facilities.
 
     Interest Expense. Interest expense was approximately $631,000 in 1996, as
compared to $1.7 million in 1997.
 
     Income Taxes. Income tax expense increased $1.3 million from $227,000 in
1996 to $1.5 million in 1997. This increase was attributable to the improved
profitability of CapRock.
 
     Net Income. Net income increased $2.2 million from $324,000 in 1996 to
approximately $2.6 million in 1997 as a result of the factors discussed above.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     CapRock's total assets increased $142.6 million, or 289%, from $49.4
million at December 31, 1997 to $192.0 million at December 31, 1998. The
increase was attributable to internal growth, build out of the fiber optic
network and the receipt of the proceeds from the senior notes issued July 1998.
CapRock had cash and cash equivalents of $3.5 million at December 31, 1997, as
compared with $294,000 at December 31, 1998 and marketable securities of $97.0
million at December 31, 1998 as compared to no marketable securities at December
31, 1997. CapRock had a working capital deficit of $305,000 at December 31, 1997
as compared to working capital of $102.5 million at December 31, 1998. The
increase in the working capital was attributable to the issuance of the senior
notes and the repayment of CapRock's existing notes, which were repaid using a
portion of the proceeds from the senior notes.
 
     CapRock's cash flow from operations in 1997 and 1998 was $4.1 million and
$7.1 million, respectively. The increase of $3.0 million, or 73%, was primarily
attributable to overall growth. Additionally, accounts payable and accrued
expenses increased $15.0 million from $11.9 million at December 31, 1997 to
$26.9 million at December 31, 1998. The increase was primarily attributable to
increased expenditures and amounts due to vendors relating to the fiber optic
network build out.
 
     Cash used in investing activities in 1997 and 1998 was $13.0 million and
$134.3 million, respectively. The increase of $121.4 million, or 935%, primarily
relates to the net investment in marketable securities of $97.0 million from the
proceeds of the senior notes, the purchase of telecommunications equipment and
costs incurred with the build out of the fiber optic network.
 
     In January 1998, CapRock completed the acquisition of Integrated
Communications and Engineering, Ltd., a communications systems integrator and
maintenance provider in Aberdeen, Scotland. CapRock paid a total purchase price
of approximately $2.2 million comprised of approximately $610,000 in cash and
207,266 shares of CapRock's Common Stock.
 
     In July 1998, CapRock issued $150.0 million aggregate principal amount of
its senior notes. Interest on the senior notes is payable semi-annually in
arrears on January 15 and July 15 of each year, commencing January 15, 1999, at
the rate of 12% per year. A portion of the net proceeds from the offering of the
senior
 
                                       26
<PAGE>   29
 
notes was used to repay all existing debt obligations of CapRock
Telecommunications, CapRock Fiber and IWL Communications, our predecessor
companies. The proceeds used for the debt payoffs totaled $26.8 million. The
remaining proceeds, net of transaction costs, have been, or will be, used to
fund additional capital expenditures for the construction of CapRock's fiber
optic network, switching equipment and other capital expenditures to expand its
sales offices, for potential acquisitions and for general working capital
purposes. The funds are invested in high-grade liquid securities classified as
available for sale. The indenture governing the issuance of the senior notes
contains certain restrictive operating and financial covenants, including
restrictive covenants relating to borrowing additional money, paying dividends
or making other distributions to our shareholders, limiting the ability of
subsidiaries to make payments to us, making certain investments, creating
certain liens on our assets, selling certain assets and using the proceeds from
those sales for certain purposes, entering into transactions with affiliates,
and engaging in certain mergers or consolidations. All of the covenants are
subject to a number of important qualifications and exceptions. These covenants
may adversely affect CapRock's ability to finance its future operations or
capital needs or to engage in other business activities that may be in the best
interests of CapRock.
 
     CapRock expects to require significant financing for future capital
expenditure and working capital requirements. By the end of the year 2000,
CapRock intends to build out its fiber optic network to approximately 5,500
route miles throughout the Southwest region. CapRock intends to use advanced
fiber capable of supporting dense wave division multiplexing with an OC-48
backbone scalable to OC-192, and intends to install 96 fibers throughout most of
its network and intends to retain on average 24 fiber strands. CapRock is
burying three to four conduits throughout its network. CapRock currently
estimates that its aggregate capital requirements will total approximately $250
million for 1999 and approximately $160 million for 2000, including expenditures
to be made under the joint build arrangement with Enron Communications. CapRock
expects to make substantial capital expenditures thereafter. Capital
expenditures will be required to (1) fund the construction and operation of the
fiber optic network, including the portion to be constructed through the joint
build arrangement with Enron Communications; (2) fund the installation of voice
and data switches, and (3) open sales offices and add sales support and customer
service personnel in markets throughout Texas, Louisiana, Oklahoma, Arkansas and
New Mexico.
 
     CapRock believes that its cash and marketable securities, cash flow from
operations and sales of dark fiber, together with either the expected net
proceeds from the secondary equity offering or the bank credit facility that it
is currently negotiating, will be sufficient to fund its capital expenditures
and working capital requirements for at least the next 12 months. More
specifically, with CapRock's cash and marketable securities, cash flow from
operations, and the expected net proceeds from the secondary equity offering,
the planned completion of the network through the end of 1999 will be fully
funded, and CapRock believes that those sources of capital together with vendor
financings, borrowings under the credit facility that it is currently
negotiating, and anticipated sales of dark fiber will be sufficient to fully
fund completion of the network as planned. However, no assurances can be made as
to when or whether the secondary equity offering or the credit facility will be
completed. If CapRock is unable to complete either the equity offering or the
credit facility, or both, CapRock will seek alternate sources of financing and,
if Caprock is unable to obtain them, CapRock may have to curtail or delay the
build out of its fiber network and its level of capital expenditures. CapRock is
currently cash flow positive, with EBITDA of $8.8 million in 1997 and EBITDA of
$15.0 million in 1998 (exclusive of merger related expenses).
 
     CapRock may require additional capital in the future for new business
activities related to its current and planned businesses, or in the event it
decides to make additional acquisitions or enter into joint venture and
strategic alliances. Sources of additional capital may include cash flow from
operations, public or private equity and debt financings, bank debt, vendor
financings and indefeasible right to use contracts. In addition, CapRock may
enter into joint construction agreements with carriers, thereby reducing its
capital expenditure requirements. However, we cannot assure you that CapRock
will be successful in producing sufficient cash flow or raising sufficient debt
or equity capital to meet its strategic business objectives or that such funds,
if available, will be available on a timely basis and on terms that are
acceptable to CapRock. If CapRock is unable to obtain such capital, the build
out of portions of its expanded network may be significantly delayed, curtailed
or abandoned. In addition, CapRock may accelerate the rate of deployment of its
network, which in
 
                                       27
<PAGE>   30
 
turn may accelerate CapRock's need for additional capital. CapRock's actual
capital requirements will also be affected, possibly materially, by various
factors, including the timing and actual cost of the deployment of CapRock's
network, the timing and cost of expansion into new markets, the extent of
competition and the pricing of dark fiber and telecommunications services in its
markets.
 
     On March 22, 1999, CapRock announced that it had filed a Registration
Statement on Form S-1 on Friday March 19, 1999 pursuant to which it was
proposing to offer 5 million shares of Common Stock and that certain of its
selling shareholders were proposing to offer another 1.5 million shares of
Common Stock. The offering is being managed by Merrill Lynch & Co. The
Registration Statement for the proposed offering has not yet been declared
effective, and no assurances can be made that the offering will be completed.
See "Item 1 -- Business -- Secondary Equity Offering."
 
CREDIT FACILITY
 
     CapRock is currently negotiating with a bank to obtain a senior credit
facility in the amount of $100 million. The final terms and conditions of the
credit facility will depend on negotiation of definitive documentation for the
credit facility, however the credit facility is expected to have a five-year
term and is expected to contain standard and customary restrictive covenants,
including financial covenants. As our network build out proceeds and our
customer base expands, we will consider refinancing a portion of our borrowings
under the credit facility with long-term indebtedness.
 
NEW ACCOUNTING PRONOUNCEMENTS
 
     On January 1, 1998, CapRock adopted Statement of Accounting Standard No.
130 ("SFAS No. 130"), "Reporting Comprehensive Income." SFAS No. 130 establishes
standards for reporting and presentation of comprehensive income and its
components in a full set of financial statements. Comprehensive income consists
of net income and currency translation adjustments and is presented in the
consolidated statements of stockholders' equity and comprehensive income. This
Statement requires changes in disclosure only and it does not affect results of
operations or financial position. Prior year financial statements have been
reclassified to conform to the requirements of SFAS No. 130.
 
     In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
which CapRock adopted in 1998. CapRock identified operating segments based upon
how management allocated resources and assesses performance. SFAS No. 131
requires changes in disclosure only and does not affect results of operations or
financial position. Prior year comparative information has been restated to
conform to the requirements of SFAS No. 131.
 
     In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activity" ("SFAS 133") which requires that all
derivatives be recognized in the statement of financial position as either
assets or liabilities and measured at fair value. In addition, all hedging
relationships must be designated, reassessed and documented pursuant to the
provisions of SFAS No. 133. SFAS 133 is effective for fiscal years beginning
after June 15, 1999. The adoption of SFAS 133 will not have an impact on
CapRock's results of operations, financial position or cash flow.
 
CONTINGENCIES
 
     CapRock is party to ordinary litigation incidental to its business. No
currently pending litigation is expected to have a material adverse effect on
our results of operations, financial condition or cash flow.
 
                                       28
<PAGE>   31
 
YEAR 2000
 
     The year 2000 problem is the inability of a meaningful portion of the
world's computers, software applications and embedded semiconductor chips to
cope with the change of the year from 1999 to 2000. This issue can be traced to
the infancy of computing, when computer data and programs were designed to save
disk space by truncating the date field to just six digits (two for the day, two
for the month and two for the year). Therefore, information applications
automatically assumed that the two-digit year field represented a year within
the 1900's. As a result of this, systems could fail to operate or fail to
produce correct results when dates roll over to the year 2000.
 
STATE OF READINESS
 
     The year 2000 problem affects computers, software, and other equipment
used, operated, or maintained by CapRock for itself and its customers. CapRock
has substantially completed the process of assessing the potential impact of,
and the costs of remediating, the year 2000 problem for its internal systems,
facilities systems and equipment.
 
     CapRock's business depends upon the operation of computer systems. CapRock
has established a year 2000 committee made up of leaders from the operational
areas of CapRock to assess CapRock's year 2000 problem. The committee has the
involvement of senior management and the Board of Directors and its objectives
are a top priority. CapRock has undertaken various initiatives intended to
provide computer equipment and software that will function properly with respect
to dates in the year 2000 and thereafter. Computer equipment and software
include systems that are commonly thought of as Information Technology, or IT,
systems, including accounting, data processing, telephone/PBX systems, scanning
equipment and other miscellaneous systems, as well as systems that are not
commonly thought of as IT systems, such as alarm systems, fax machines or other
miscellaneous systems. Based upon its identification and assessment efforts to
date, CapRock believes that certain computer equipment and software it currently
uses will require replacement or modification. In addition, in the ordinary
course of replacing computer equipment and software, CapRock will obtain
replacements that are warranted to be year 2000 compliant. CapRock currently
estimates that the year 2000 identification, assessment, remediation and testing
efforts will be substantially complete by June 30, 1999 and that such efforts
will be completed before any currently anticipated impact on its computer
equipment and software. CapRock has substantially completed the identification
and assessment process. CapRock estimates that it currently has completed
approximately 70% of the initiatives that it believes will be necessary to
address potential year 2000 issues relating to its computer equipment and
software. The projects comprising the remaining 30% of the initiative are in
process and are expected to be completed on or about June 30, 1999.
 
<TABLE>
<CAPTION>
YEAR 2000 INITIATIVE                                           TIME FRAME
--------------------                                           ----------
<S>                                                            <C>
Identification and assessment regarding IT system issues....    Completed
Remediation and testing regarding critical system issues....    6/98-3/99
Identification, assessment, remediation and testing
  regarding desktop and individual system issues............    6/98-6/99
Identification and assessment regarding non-IT system
  issues....................................................    8/98-4/99
Remediation and testing regarding non-IT systems............   11/98-6/99
</TABLE>
 
     CapRock has mailed questionnaires to its significant vendors, service
providers and customers with whom CapRock's systems electronically interface to
determine the extent to which such interfaces and system processes are
vulnerable to year 2000 issues and whether the products and services of such
entities are year 2000 compliant. Substantially all of the parties have
responded to the request and no significant matters were noted from these
responses. However, the information contained in a number of the responses was
generic in nature and did not specifically address the stage of their year 2000
initiatives. CapRock will continue seeking alternate vendors in advance of
December 31, 1999 in the event satisfactory responses are not received.
 
                                       29
<PAGE>   32
 
     CapRock has evaluated its systems and has identified the following systems
and functions as mission critical:
 
     - switching systems,
 
     - network operations and fiber,
 
     - satellite/microwave transmission equipment and satellite service
       providers,
 
     - billing and call record collection systems, and
 
     - supply chain (vendor provider of switched services).
 
  Switching Systems:
 
     Switching equipment is used to connect calls to their destination, while
performing other advanced features and recording call record information for
future billing. The switch opens or closes circuits or selects the paths or
circuits to be used for the transmission of information. CapRock currently owns
six switches, three of which are physically located in Dallas, Texas (two are
calling card platforms), two in Houston, Texas and one in Phoenix, Arizona.
CapRock also manages a switch in Jersey City, New Jersey. CapRock has completed
the assessment and certain test procedures relating to the switching equipment
and has identified certain non-compliant features, which can be remediated
through software upgrades. The upgrades are currently available by the
respective manufacturer of the switches. All of the software upgrades are
scheduled to be installed by March 31, 1999.
 
     By March 31, 1999, CapRock anticipates that the remainder of the testing
procedures for the switching equipment will be substantially complete for all
switches which are currently operational. The switches which have not been
placed in service will be subject to integrated test procedures prior to being
placed in service. The test will incorporate the call collection processes and
the interfaces with the billing system. The test will involve simulating date
changes with the switch, such that the call records will be processed, rated and
properly captured in the billing system as a billable transaction.
 
     The test procedures will consist of the following:
 
     - process flow analysis,
 
     - documentation of overall integrated test strategy,
 
     - documentation and test case plans at an individual component level,
 
     - committee agreement regarding the test plan,
 
     - execution of the integrated test plan, and
 
     - documentation regarding the results of test procedures.
 
  Network Operations and Fiber:
 
     CapRock currently owns and operates an 800-route mile fiber optic network,
which was substantially completed by December 31, 1998. Approximately 260 route
miles were completed and placed in service in January 1997. The network is
currently being expanded to 5,500 route miles (which CapRock expects to be
completed by the end of the year 2000). The fiber optic network is designed to
be scalable and will include network-advanced fiber, which is capable of
supporting dense wave division multiplexing with an OC-48 backbone scalable to
OC-192. The fiber optic network will include electronic equipment, which
regenerates and transports the voice, data and other information. A detailed
assessment of the network operations and fiber equipment has been performed and
no significant non-compliant issues have been identified.
 
  Satellite/Microwave Transmission Equipment and Satellite Service Providers:
 
     CapRock utilizes satellite service providers to provide communications
services to certain customers in remote locations. CapRock has sent
correspondence to each of the three vendors supplying the satellite services.
Each of the satellite service providers has responded. None of them noted any
significant non-
 
                                       30
<PAGE>   33
 
compliant issues. CapRock is continuing to pursue additional information and
test data from these providers and will seek new providers, if necessary.
 
  Billing and Call Record Collection Systems:
 
     CapRock handles its provisioning, customer care, billing and traffic
reporting functions on a proprietary software platform developed by RiverRock
Systems, Ltd., a Texas limited partnership in which CapRock has a 49% ownership
interest. These operations support systems, or OSS systems, and other back
office systems are used to enter, schedule and track a customer's order from the
point of sale to the installation and testing of service. The systems also
include or interface with trouble management, inventory, billing, collection and
customer service systems. The test procedures relating to the billing system and
call record collection processes will be performed in conjunction with the
switching equipment test procedures and are anticipated to be substantially
complete by March 31, 1999.
 
     CapRock believes that substantially all of the hardware, database platform
and operating systems impacting the billing system function will not be
materially affected by Year 2000 issues.
 
  Supply Chain (Vendor Provider of Switch Services):
 
     CapRock is dependent upon a number of telecommunications carriers during
the process of initiating and terminating calls to end-users. CapRock has sent
correspondence to each of the significant suppliers regarding their year 2000
status and has received substantially all of the responses from such suppliers.
However, the information contained in a number of the responses was generic in
nature and did not specifically address the stage of their year 2000
initiatives. CapRock will seek alternate suppliers in advance of December 31,
1999 in the event satisfactory responses are not received.
 
     Based upon CapRock's current assessment and responses from vendors, CapRock
believes that the risks associated with the year 2000 problem relating to
domestic traffic and terminations are not significant. CapRock is in the process
of evaluating the impact of year 2000 as it relates to the termination of
traffic in international locations, and specifically third world and developing
countries.
 
  Non-IT Systems
 
     CapRock continues to evaluate non-information technology systems. Based on
current results and other factors, CapRock does not anticipate finding any
material embedded system issues in its non-IT systems.
 
COSTS
 
     CapRock anticipates that costs of replacing or remediating non-compliant
systems will not exceed $500,000 (remediation costs incurred to date have been
immaterial). Such expenditures represent less than 1% of 1999 projected capital
expenditures, and will be funded out of cash flow from operations.
 
RISKS
 
     CapRock has begun, but not yet completed, a comprehensive analysis of the
problems and costs, including loss of revenues, that would be reasonably likely
to result from the failure by CapRock or certain third parties to complete the
efforts necessary to achieve year 2000 compliance on a timely basis.
 
     CapRock has not yet completed its identification of the most likely worst
case scenario. However, CapRock believes that the most reasonably likely worst
case scenario would involve loss of revenues relating to traffic terminating in
certain developing third world countries, which have not adequately prepared for
the year 2000. CapRock relies upon certain vendors to supply international
services and the possibility exists that some of the traffic in these developing
third world countries may not be able to be completed. The estimated loss of
revenue, if any, has not been determined, and we may not be able to identify the
amount of any loss by the year 2000. Depending on the systems affected, the
failure of any contingency plans developed by CapRock, if implemented, could
have a material adverse effect on CapRock's financial condition and results of
operations.
 
                                       31
<PAGE>   34
 
CONTINGENCY PLANS
 
     The contingency plans include a proactive analysis of countries that are
actively pursuing year 2000 remediation. CapRock is using outside consultants to
assist with an analysis of countries that are not actively pursuing year 2000
compliance and remediation. Contingency plans include identifying these
countries noted with substantial risk and potentially redirecting the sales and
marketing efforts to other countries less likely to be affected by year 2000
problems.
 
     CapRock is still formulating contingency plans relating to the use of the
satellite service providers. CapRock continues to actively pursue receiving test
data and procedures from these service providers regarding year 2000 compliance.
CapRock will consider utilizing other service providers if the current service
providers cannot demonstrate compliance to CapRock's satisfaction by June 30,
1999.
 
     CapRock is still formulating contingency plans regarding significant
suppliers of telecommunication services, which may suffer a year 2000-related
failure. CapRock utilizes a number of different service providers and the
contingency plan will include re-routing traffic from a vendor which has
experienced a year 2000 systems failure to one or more other vendors.
 
DISCLAIMER
 
     The discussion of CapRock's efforts, and management's expectations,
relating to year 2000 compliance are forward-looking statements and the dates on
which CapRock believes it will complete such efforts are based upon management's
best estimates. These estimates were derived using numerous assumptions
regarding future events, including the continued availability of certain
resources and other factors. We cannot assure you that these estimates will
prove to be accurate, and our actual results could differ materially from those
currently anticipated. Specific factors that could cause such material
differences include, but are not limited to the availability and cost of
personnel trained in year 2000 issues, the ability to identify, assess,
remediate and test all relevant computer codes and embedded technology and
similar uncertainties. In addition, variability of definitions of "compliance
with year 2000" relating to products and services sold by CapRock may lead to
claims whose impact on CapRock is currently not estimable. We cannot assure you
that the aggregate cost of defending and resolving such claims, if any, will not
materially adversely affect our results of operations.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
     CapRock is exposed to market risk from changes in marketable securities
(which consist of money market and commercial paper). At December 31, 1998,
marketable securities of CapRock were recorded at a fair value of approximately
$97 million, with an overall weighted average return of approximately 5% and an
overall weighted average life of less than 1 year. The marketable securities
held by CapRock have exposure to price risk, which is estimated as the potential
loss in fair value due to a hypothetical change of 50 basis points (10% of
CapRock's overall average return on marketable securities) in quoted market
prices. This hypothetical change would have an immaterial effect on the recorded
value of the marketable securities.
 
     CapRock is not exposed to material future earnings or cash flow
fluctuations from changes in interest rates on long-term debt since 100% of its
long-term debt is at a fixed rate of December 31, 1998. The fair value of
CapRock's long-term debt at December 31, 1998 was estimated to be $144 million
based on the overall rate of the long-term debt of 12% and an overall maturity
of 9.5 years compared to terms and rates currently available in long-term
financing markets. Market risk is estimated as the potential decrease in fair
value of CapRock's long-term debt resulting from a hypothetical increase of 120
basis points in interest rates (ten percent of CapRock's overall borrowing
rate). Such an increase in interest rates would result in approximately a $5.1
million decrease in fair value of CapRock's long-term debt. To date, CapRock has
not entered into any derivative financial instruments to manage interest rate
risk and is currently not evaluating the future use of any such financial
instruments.
 
     CapRock conducts business in Aberdeen, Scotland, through a wholly owned
subsidiary. However, the business transacted by this subsidiary is in the local
functional currency. Therefore, CapRock does not
 
                                       32
<PAGE>   35
 
currently have any exposure to foreign currency transaction gains or losses. All
other business transactions are in U.S. dollars. To date, CapRock has not
entered into any derivative financial instrument to manage foreign currency risk
and is currently not evaluating the future use of any such financial
instruments.
 
ITEM 8. FINANCIAL STATEMENTS
 
     Information called for by this item is set forth in the Company's
Consolidated Financial Statements contained in this Form 10-K. The Company's
Consolidated Financial Statements begin at page F-1 hereunder.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
     None.
                                    PART III
 
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     The presentation of Directors and Executive Officers of the Registrant
appears in the Registrant's Proxy Statement for the 1999 Annual Meeting of
Shareholders ("Proxy Statement") which is incorporated by reference herein.
 
ITEM 11.  EXECUTIVE COMPENSATION
 
     The presentation of Executive Compensation of the Registrant appears in the
Proxy Statement which is incorporated by reference herein.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     The presentation of the Security Ownership of Certain Beneficial Owners and
Management of the Registrant appears in the Proxy Statement which is
incorporated by reference herein.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     The presentation of Certain Relationships and Related Transactions of the
Registrant appears in the Proxy Statement which is incorporated by reference
herein.
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
<TABLE>
<C>                      <S>
      (a)(1)             -- Financial Statements.
                         The financial statements filed as a part of this Annual
                            Report on Form 10-K are listed in the "Index to
                            Consolidated Financial Statements" on page F-1 hereof.
         (2)             -- Financial Statement Schedules.
                         The financial statement schedules for which provision is
                            made in the applicable accounting regulations of the
                            Securities and Exchange Commission are not required under
                            the related instructions or are inapplicable and
                            therefore have been omitted.
</TABLE>
 
                                       33
<PAGE>   36
<TABLE>
<C>                      <S>
         (3)             -- Exhibits.
                         The following exhibits are filed as a part of this Annual
                            Report on Form 10-K.
</TABLE>
 
<TABLE>
<C>                      <S>
          2.1            -- Agreement and Plan of Merger and Plan of Exchange, dated
                            as of February 16, 1998, by and among the Registrant, IWL
                            Communications, Incorporated ("IWL"), IWL Acquisition
                            Corp., CapRock Communications Corp. (n/k/a CapRock
                            Telecommunications Corp. ("CapRock Telecommunications")),
                            CapRock Acquisition Corp., and CapRock Fiber Network,
                            Ltd. ("CapRock Fiber" and collectively, the "Parties").
                            The schedules to the Agreement and Plan of Merger and
                            Plan of Exchange and the appendices thereto have been
                            omitted. The Registrant will furnish supplementally to
                            the Securities and Exchange Commission any of the
                            schedules or appendices upon request. (Incorporated by
                            reference to Exhibit 2.1 to the Registration Statement on
                            Form S-4, as amended, of the Registrant, File No.
                            333-57365.)
          2.2            -- First Amendment to Agreement and Plan of Merger and Plan
                            of Exchange, dated as of April 30, 1998, by and among the
                            Parties. (Incorporated by reference to Exhibit 2.2 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
          2.3            -- Second Amendment to Agreement and Plan of Merger and Plan
                            of Exchange, dated as of June 19, 1998, by and among the
                            Parties. (Incorporated by reference to Exhibit 2.3 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
          2.4            -- Third Amendment to Agreement and Plan of Merger and Plan
                            of Exchange, dated as of July 8, 1998, by and among the
                            Parties. (Incorporated by reference to Exhibit 2.4 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
          3.1            -- Articles of Incorporation of the Registrant.
                            (Incorporated by reference to Exhibit 3.1 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
          3.2            -- Bylaws of the Registrant. (Incorporated by reference to
                            Exhibit 3.2 to the Registration Statement on Form S-4, as
                            amended, of the Registrant, File No. 333-64699.)
          4.1            -- Specimen Certificate for the Common Stock of the
                            Registrant (Incorporated by reference to Exhibit 4.3 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.
          4.2            -- Indenture dated as of July 16, 1998, among the
                            Registrant, CapRock Telecommunications, CapRock Fiber,
                            IWL and PNC Bank, National Association, Trustee.
                            (Incorporated by reference to Exhibit 4.1 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-64699.)
          4.3            -- Registration Rights Agreement dated July 16, 1998, among
                            the Registrant, CapRock Telecommunications, CapRock
                            Fiber, and Merrill Lynch, Pierce, Fenner & Smith
                            Incorporated, Donaldson, Lufkin & Jenrette Securities
                            Corporation and BancOne Capital Markets, Inc.
                            (Incorporated by reference to Exhibit 4.2 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-64699.)
          4.4            -- Form of Warrant Agreement between IWL and Cruttenden Roth
                            Incorporated. (Incorporated by reference to Exhibit 1.2
                            to the Registration Statement on Form S-1 of IWL, as
                            amended, File No. 333-22801.)
</TABLE>
 
                                       34
<PAGE>   37
<TABLE>
<C>                      <S>
          4.5            -- Registration Rights Agreement dated January 22, 1998
                            between IWL and Nera Limited. (Incorporated by reference
                            to Exhibit 4.5 to the Registration Statement on Form S-4,
                            as amended, of the Registrant, File No. 333-57365.)
          4.6            -- Registration Rights Agreement dated January 22, 1998 by
                            and among IWL, Thomas Norman Blair and Margaret Helen
                            Blair. (Incorporated by reference to Exhibit 4.6 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
         10.1            -- CapRock Communications Corp. 1998 Equity Incentive Plan.
                            (Incorporated by reference to Exhibit 10.1 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
         10.2            -- CapRock Communications Corp. 1998 Director Stock Option
                            Plan. (Incorporated by reference to Exhibit 10.2 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
         10.3            -- Employment Agreement between the Registrant and Ignatius
                            W. Leonards. (Incorporated by reference to Exhibit 10.5
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.4            -- Employment Agreement between the Registrant and Byron M.
                            Allen. (Incorporated by reference to Exhibit 10.6 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
         10.5            -- Employment Agreement between the Registrant and Errol
                            Olivier. (Incorporated by reference to Exhibit 10.7 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.6            -- Employment Agreement between the Registrant and Richard
                            H. Roberson. (Incorporated by reference to Exhibit 10.8
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.7            -- Employment Agreement between the Registrant and Bryan
                            Olivier. (Incorporated by reference to Exhibit 10.9 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.8            -- Employment Agreement between the Registrant and Jere W.
                            Thompson, Jr. (Incorporated by reference to Exhibit 10.10
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.9            -- Employment Agreement between the Registrant and Scott L.
                            Roberts. (Incorporated by reference to Exhibit 10.11 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.10           -- Employment Agreement between the Registrant and Timothy
                            W. Rogers. (Incorporated by reference to Exhibit 10.12 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.11           -- Employment Agreement between the Registrant and Timothy
                            M. Terrell. (Incorporated by reference to Exhibit 10.13
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.12           -- Employment Agreement between the Registrant and Kevin W.
                            McAleer. (Incorporated by reference to Exhibit 10.14 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.13           -- Office Lease Agreement dated May 22, 1996, by and between
                            Ellington Field, Ltd., a Texas limited partnership, and
                            IWL. (Incorporated by reference to Exhibit 10.5 to the
                            IWL Registration Statement on Form S-1, as amended, File
                            No. 333-22801.)
</TABLE>
 
                                       35
<PAGE>   38
<TABLE>
<C>                      <S>
         10.14           -- Satellite Information Network Service Agreement dated May
                            1, 1994, by and between IWL and the Information
                            Telegraphy Agency of Russia ITAR-TASS.# (Incorporated by
                            reference to Exhibit 10.9 to the Registration Statement
                            on Form S-1, as amended, of IWL, File No. 333-22801.)
         10.15           -- Reseller Agreement dated December 31, 1996, by and
                            between Alcatel Network Systems, Inc. and IWL.
                            (Incorporated by reference to Exhibit 10.10 to the
                            Registration Statement on Form S-1, as amended, of IWL,
                            File No. 333-22801.)#
         10.16           -- Form of Service Agreement.
         10.17           -- Lease Agreement dated November 18, 1996, by and between
                            IWL and CLG, Inc. (Incorporated by reference to Exhibit
                            10.13 to the Registration Statement on Form S-1, as
                            amended, of IWL, File No. 333-22801.)
         10.18           -- Promissory Note dated September 20, 1996 payable by IWL
                            to First Bank and Trust, Cleveland, Texas. (Incorporated
                            by reference to Exhibit 10.15 to the Registration
                            Statement on Form S-1, as amended, of IWL, File No.
                            333-22801.)
         10.19           -- Loan Agreement and Security Agreement dated December 20,
                            1995 between IWL and Marine Midland Business Loans, Inc.
                            (Incorporated by reference to Exhibit 10.16 to the
                            Registration Statement on Form S-1, as amended, of IWL,
                            File No. 333-22801.)
         10.20           -- Second Amendment to Loan and Security Agreement dated as
                            of May 7, 1997, between IWL and Marine Midland Business
                            Loans, Inc. (Incorporated by reference to Exhibit 10.9 to
                            the Registration Statement on Form S-1, as amended, of
                            IWL, File No. 333-22801.)
         10.21           -- Letter Agreement dated February 28, 1997, by and between
                            IWL and Marine Midland Bank as successor-in-interest to
                            Marine Midland Business Loans, Inc. (Incorporated by
                            reference to the Registration Statement on Form S-1, as
                            amended, of IWL, File No. 333-22801.)
         10.22           -- Credit Agreement, dated August 1, 1997, executed by and
                            between IWL and Bank One, Texas, N.A. ("Bank One").
                            (Incorporated by reference to Exhibit 10.22 to the Form
                            10K for the year ending June 30, 1997 of IWL, File No.
                            0-22293.)
         10.23           -- Promissory Note, dated August 1, 1997, in the principal
                            amount of $822,000.00, executed by IWL, and made payable
                            to Bank One. (Incorporated by reference to Exhibit 10.23
                            to the Form 10K of IWL for the year ending June 30, 1997,
                            File No. 0-22293.)
         10.24           -- Promissory Note, dated August 1, 1997, in the principal
                            amount of $605,000.00, executed by IWL, and made payable
                            to Bank One. (Incorporated by reference to Exhibit 10.24
                            to the Form 10-K of IWL for the year ending June 30,
                            1997, File No. 0-22293.)
         10.25           -- Collateral Assignment and Security Agreement, dated
                            August 1, 1997, executed by IWL, as assignor, and Bank
                            One, as assignee. (Incorporated by reference to Exhibit
                            10.25 to the Form 10K of IWL for the year ending June 30,
                            1997, File No. 0-22293.)
         10.26           -- Revolving Credit Agreement, dated August 1, 1997,
                            executed by and between IWL and Bank One. (Incorporated
                            by reference to Exhibit 10.26 to the Form 10K of IWL for
                            the year ending June 30, 1997, File No. 0-22293.)
         10.27           -- Promissory Note, dated August 1, 1997, in the principal
                            amount of $5,000,000.00, executed by IWL, and made
                            payable to Bank One. (Incorporated by reference to
                            Exhibit 10.27 to the Form 10K of IWL for the year ending
                            June 30, 1997, File No. 0-22293.)
</TABLE>
 
                                       36
<PAGE>   39
<TABLE>
<C>                      <S>
         10.28           -- Security Agreement, dated August 1, 1997, executed by
                            IWL, as debtor, and Bank One, as secured party.
                            (Incorporated by reference to Exhibit 10.28 to the Form
                            10K of IWL for the year ending June 30, 1997, File No.
                            0-22293.)
         10.29           -- Amended and Restated Credit Agreement, dated August 28,
                            1997, executed by and between IWL and Bank One.
                            (Incorporated by reference to Exhibit 10.29 to the Form
                            10K of IWL for the year ending June 30, 1997, File No.
                            0-22293.)
         10.30           -- Promissory Note, dated August 28, 1997, in the principal
                            amount of $1,055,000.00, executed by IWL, and made
                            payable to Bank One. (Incorporated by reference to
                            Exhibit 10.30 to the Form 10K of IWL for the year ending
                            June 30, 1997, File No. 0-22293.)
         10.31           -- Telecommunications Equipment Lease Agreement dated as of
                            June 1, 1997 between IWL and Diamond Offshore Company.
                            (Incorporated by reference to Exhibit 10.4 to the Form
                            10K of IWL for the year ending June 30, 1997, File No.
                            0-22293.)#
         10.32           -- Sublease dated November 22, 1994 by and between CapRock
                            Telecommunications and Arkwright Mutual Insurance
                            Company. (Incorporated by reference to Exhibit 10.35 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.33           -- Loan and Security Agreement dated March 14, 1996 by and
                            between CapRock Telecommunications and Bank One, as
                            amended. (Incorporated by reference to Exhibit 10.36 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.34           -- Sixth Renewal Extension $2,500,000 Promissory Note dated
                            December 31, 1997 payable by CapRock Telecommunications
                            to Bank One. (Incorporated by reference to Exhibit 10.37
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.35           -- Form of CapRock Communications Corp. Commercial
                            Application. (Incorporated by reference to Exhibit 10.41
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.36           -- Form of CapRock Communications Corp. Commercial Agent
                            Application. (Incorporated by reference to Exhibit 10.42
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
         10.37           -- Unlimited Guaranty dated March 9, 1996 by Jere W.
                            Thompson, Jr. for the benefit of Bank One. (Incorporated
                            by reference to Exhibit 10.43 to the Registration
                            Statement on Form S-4, as amended, of the Registrant,
                            File No. 333-57365.)
         10.38           -- Loan Agreement dated July 1, 1996 by and between CapRock
                            Fiber and Bank One. (Incorporated by reference to Exhibit
                            10.44 to the Registration Statement on Form S-4, as
                            amended, of the Registrant, File No. 333-57365.)
         10.39           -- $10,000,000 Promissory Note dated July 1, 1996 by and
                            between CapRock Fiber and Bank One. (Incorporated by
                            reference to Exhibit 10.45 to the Registration Statement
                            on Form S-4, as amended, of the Registrant, File No.
                            333-57365.)
         10.40           -- Guaranty dated July 1, 1996 by CapRock Systems, Inc. in
                            favor of Bank One. (Incorporated by reference to Exhibit
                            10.46 to the Registration Statement on Form S-4, as
                            amended, of the Registrant, File No. 333-57365.)
         10.41           -- Guaranty dated July 1, 1996 by Mark Langdale in favor of
                            Bank One. (Incorporated by reference to Exhibit 10.47 to
                            the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
</TABLE>
 
                                       37
<PAGE>   40
<TABLE>
<C>                      <S>
         10.42           -- Guaranty dated July 1, 1996 by Jere W. Thompson, Jr. in
                            favor of Bank One. (Incorporated by reference to Exhibit
                            10.48 to the Registration Statement on Form S-4, as
                            amended, of the Registrant, File No. 333-57365.)
         10.43           -- Form of Note Purchase Agreement by and among the
                            Registrant and various initial purchasers. (Incorporated
                            by reference to Exhibit 10.49 to the Registration
                            Statement on Form S-4, as amended, of the Registrant,
                            File No. 333-57365.)
         10.44           -- Form of Contribution Agreement by the General Partner of
                            CapRock Fiber. (Incorporated by reference to Exhibit
                            10.50 to the Registration Statement on Form S-4, as
                            amended, of the Registrant, File No. 333-57365.)
         10.45           -- First Amendment to Loan Agreement dated July 1, 1996 by
                            and between CapRock Fiber and Bank One. (Incorporated by
                            reference to Exhibit 10.51 to the Registration Statement
                            on Form S-4, as amended, of the Registrant, File No.
                            333-57365.)
         10.46           -- Second Amendment to Loan Agreement dated April 29, 1998
                            by and between CapRock Fiber and Bank One. (Incorporated
                            by reference to Exhibit 10.52 to the Registration
                            Statement on Form S-4, as amended, of the Registrant,
                            File No. 333-57365.)
         10.47           -- License Agreement dated June 16, 1998 by and between
                            CapRock Telecommunications and RiverRock Systems, Ltd.
                            (Incorporated by reference to Exhibit 10.53 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
         10.48           -- Modification Agreement dated as of June 17, 1998 by and
                            between IWL and Bank One. (Incorporated by reference to
                            Exhibit 10.54 to the Registration Statement on Form S-4,
                            as amended, of the Registrant, File No. 333-57365.)
         10.49           -- Promissory Note dated June 17, 1998 executed by IWL
                            payable to the order of Bank One, in the principal amount
                            of $4,000,000.00. (Incorporated by reference to Exhibit
                            10.55 to the Registration Statement on Form S-4, as
                            amended, of the Registrant, File No. 333-57365.)
         10.50           -- Eighth Amendment to Loan and Security Agreement dated as
                            of June 18, 1998 by and between CapRock
                            Telecommunications and Bank One. (Incorporated by
                            reference to Exhibit 10.56 to the Registration Statement
                            on Form S-4, as amended, of the Registrant, File No.
                            333-57365.)
         10.51           -- Renewal and Extension Promissory Note dated as June 18,
                            1998 executed by CapRock Telecommunications payable to
                            the order of Bank One, in the principal amount of
                            $7,000,000.00. (Incorporated by reference to Exhibit
                            10.57 to the Registration Statement on Form S-4, as
                            amended, of the Registrant, File No. 333-57365.)
         10.52           -- Intercompany Promissory Note dated as of June 18, 1998
                            originally executed by CapRock Fiber payable to the order
                            of CapRock Telecommunications in the principal amount of
                            $2,500,000.00 and endorsed by CapRock Telecommunications
                            in favor of Bank One. (Incorporated by reference to
                            Exhibit 10.58 to the Registration Statement on Form S-4,
                            as amended, of the Registrant, File No. 333-57365.)
         10.53           -- Ninth Amendment to Loan and Security Agreement dated as
                            July 9, 1998 by and between CapRock Telecommunications
                            and Bank One. (Incorporated by reference to Exhibit 10.59
                            to the Registration Statement on Form S-4, as amended, of
                            the Registrant, File No. 333-57365.)
</TABLE>
 
                                       38
<PAGE>   41
<TABLE>
<C>                      <S>
         10.54           -- Third Amendment to Loan Agreement dated as of June 18,
                            1998 by and between CapRock Fiber and Bank One.
                            (Incorporated by reference to Exhibit 10.60 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
         10.55           -- Fourth Amendment to Loan Agreement dated as of July 9,
                            1998 by and between CapRock Fiber and Bank One.
                            (Incorporated by reference to Exhibit 10.61 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-57365.)
         10.56           -- Form of Escrow Agreement. (Incorporated by reference to
                            Exhibit 10.62 to the Registration Statement on Form S-4,
                            as amended, of the Registrant, File No. 333-57365.)
         10.57           -- Form of Exchange Agent Agreement by and between the
                            Registrant and PNC Bank, National Association.
                            (Incorporated by reference to Exhibit 10.57 to the
                            Registration Statement on Form S-4, as amended, of the
                            Registrant, File No. 333-64699.)
         10.58           -- Addison Circle One Office Lease Agreement between
                            Champion Addison One Limited Partnership, a limited
                            partnership, as Landlord and the Registrant, as Tenant.
                            (Incorporated by reference to Exhibit 10.58 to the
                            Registration Statement on Form S-1 of the Registrant,
                            File No. 333-74735.)
         10.59           -- Form of Carrier Agreement.
         16.1            -- Letter re: Change in Accountants. (Incorporated by
                            reference to Exhibit 16.1 to the Registration Statement
                            on Form S-4, as amended, of the Registrant, File No.
                            333-57365.)
         21.1            -- Subsidiaries of the Registrant.
         23.1            -- Consent of KPMG LLP.
         27.1            -- Financial Data Schedule for 1996 and 1998. (Incorporated
                            by reference to Exhibit 27.1 to the Registration
                            Statement on Form S-1 of the Registrant, File No.
                            333-74735.)
         27.2            -- Amended Financial Data Schedule for 1997. (Incorporated
                            by reference to Exhibit 27.2 to the Registration
                            Statement on Form S-1 of the Registrant, File No.
                            333-74735.)
</TABLE>
 
---------------
 
# Confidential treatment was granted.
 
     (b) Reports on Form 8-K
 
     No current reports on Form 8-K were filed during the fourth quarter of
1998.
 
                                       39
<PAGE>   42
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized on March 24, 1999.
 
                                            CAPROCK COMMUNICATIONS CORP.
 
                                            By:  /s/ JERE W. THOMPSON, JR.
                                              ----------------------------------
                                                    Jere W. Thompson, Jr.
                                                   Chief Executive Officer
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated and on the dates indicated below.
 
<TABLE>
<CAPTION>
                      SIGNATURE                                        TITLE                        DATE
                      ---------                                        -----                        ----
<C>                                                    <S>                                    <C>
 
              /s/ JERE W. THOMPSON, JR.                Chief Executive Officer, Chairman of    March 24, 1999
-----------------------------------------------------    the Board, and Director (Principal
                Jere W. Thompson, Jr.                    Executive Officer)
 
                /s/ KEVIN W. MCALEER                   Senior Vice President and Chief         March 24, 1999
-----------------------------------------------------    Financial Officer (Principal
                  Kevin W. McAleer                       Financial Officer)
 
              /s/ IGNATIUS W. LEONARDS                 President, Vice Chairman of the         March 24, 1999
-----------------------------------------------------    Board, and Director
                Ignatius W. Leonards
 
                /s/ TIMOTHY W. ROGERS                  Executive Vice President and Director   March 24, 1999
-----------------------------------------------------
                  Timothy W. Rogers
 
                 /s/ BYRON M. ALLEN                    Executive Vice President and Director   March 24, 1999
-----------------------------------------------------
                   Byron M. Allen
 
               /s/ MATTHEW M. KINGSLEY                 Corporate Controller (Principal         March 24, 1999
-----------------------------------------------------    Accounting Officer)
                 Matthew M. Kingsley
 
                  /s/ MARK LANGDALE                    Director                                March 24, 1999
-----------------------------------------------------
                    Mark Langdale
 
             /s/ CHRISTOPHER J. AMENSON                Director                                March 24, 1999
-----------------------------------------------------
               Christopher J. Amenson
 
                 /s/ JOHN R. HARRIS                    Director                                March 24, 1999
-----------------------------------------------------
                   John R. Harris
</TABLE>
 
                                       40
<PAGE>   43
 
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                               PAGE
                                                               ----
<S>                                                            <C>
Independent Auditors' Report of KPMG LLP....................   F-2
Independent Auditors' Reports of Burds, Reed and Mercer,
  P.C.......................................................   F-3
Consolidated Balance Sheets as of December 31, 1997 and
  1998......................................................   F-5
Consolidated Statements of Operations for the years ended
  December 31, 1996, 1997 and 1998..........................   F-6
Consolidated Statements of Stockholders' Equity and
  Comprehensive Income for the years ended December 31,
  1996, 1997 and 1998.......................................   F-7
Consolidated Statements of Cash Flows for the years ended
  December 31, 1996, 1997 and 1998..........................   F-8
Notes to Consolidated Financial Statements..................   F-9
</TABLE>
 
                                       F-1
<PAGE>   44
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors and Stockholders
CapRock Communications Corp.
(formerly IWL Holdings Corp.):
 
     We have audited the accompanying consolidated balance sheets of CapRock
Communications Corp. and subsidiaries, as of December 31, 1997 and 1998, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits. We did
not audit the 1996 financial statements of certain consolidated subsidiaries,
which statements reflect total assets constituting 56 percent and total revenues
constituting 45 percent of the related 1996 consolidated totals. Those financial
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts of these consolidated
subsidiaries, is based solely on the report of the other auditors.
 
     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, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of CapRock Communications Corp. and
subsidiaries as of December 31, 1997 and 1998, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
 
                                            KPMG LLP
 
Dallas, Texas
February 19, 1999
 
                                       F-2
<PAGE>   45
 
                          INDEPENDENT AUDITORS' REPORT
 
The Board of Directors
CapRock Telecommunications Corp.:
(formerly CapRock Communications Corp.)
 
     We have audited the balance sheet of CapRock Telecommunications Corp.
(formerly CapRock Communications Corp.) as of December 31, 1996, and the related
statements of operations, stockholders' equity, and cash flows for the year then
ended (not presented separately herein). 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 financial position of CapRock Telecommunications
Corp. (formerly CapRock Communications Corp.) as of December 31, 1996, and the
results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles.
 
                                            BURDS, REED AND MERCER, P.C.
 
Dallas, Texas
May 28, 1997
 
                                       F-3
<PAGE>   46
 
                          INDEPENDENT AUDITORS' REPORT
 
The Partners of
CapRock Fiber Network, Ltd.:
 
     We have audited the balance sheet of CapRock Fiber Network, Ltd., as of
December 31, 1996, and the related statements of operations, partners' capital,
and cash flows for the year then ended (not presented separately herein). These
financial statements are the responsibility of the Partnership'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 financial position of CapRock Fiber Network, Ltd.,
as of December 31, 1996, and the results of its operations and its cash flows
for the year then ended in conformity with generally accepted accounting
principles.
 
                                            BURDS, REED AND MERCER, P.C.
 
Dallas, Texas
March 19, 1997
 
                                       F-4
<PAGE>   47
 
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1997 AND 1998
 
                                     ASSETS
 
<TABLE>
<CAPTION>
                                                                 1997           1998
                                                              -----------   ------------
<S>                                                           <C>           <C>
Current assets:
  Cash and cash equivalents.................................  $ 3,520,017   $    293,860
  Marketable securities.....................................           --     97,019,789
  Accounts receivable and unbilled services, less allowance
     for doubtful accounts of $1,781,355 and $709,941 at
     December 31, 1997 and 1998, respectively...............   15,143,525     19,936,214
  Income tax receivable.....................................           --      1,405,000
  Costs and estimated earnings in excess of billings........           --      7,238,402
  Inventory.................................................    1,022,927      1,301,726
  Prepaid expenses and other................................    1,022,319        706,775
  Deferred income taxes.....................................      731,845      1,989,250
                                                              -----------   ------------
          Total current assets..............................   21,440,633    129,891,016
Property, plant and equipment, net..........................   27,340,599     59,606,752
Other assets................................................      608,219      2,468,000
                                                              -----------   ------------
          Total assets......................................  $49,389,451   $191,965,768
                                                              ===========   ============
 
                          LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current liabilities:
  Current portion of long-term debt.........................  $ 8,116,424   $         --
  Accounts payable and accrued expenses.....................   11,851,945     26,850,525
  Accrued commitment and guarantor fees.....................      406,010             --
  Current installments of obligations under capital
     leases.................................................      239,672             --
  Income taxes payable......................................      589,514             --
  Unearned revenue..........................................      542,441        551,341
                                                              -----------   ------------
          Total current liabilities.........................   21,746,006     27,401,866
Long-term debt, excluding current portion...................   12,338,341             --
Senior notes, net of unamortized debt issuance costs........           --    145,187,039
Deferred income taxes.......................................      851,307      3,314,568
Obligations under capital lease, excluding current
  installments..............................................      367,493             --
                                                              -----------   ------------
          Total liabilities.................................   35,303,147    175,903,473
Stockholders' equity:
  Preferred stock, $.01 par value; 20,000,000 shares
     authorized; none issued................................           --             --
  Common stock, $.01 par value; 200,000,000 shares
     authorized; issued and outstanding, 28,677,743 and
     28,932,395 shares at December 31, 1997 and 1998,
     respectively...........................................      286,777        289,377
  Additional paid-in capital................................    8,810,627     10,521,713
  Retained earnings.........................................    5,385,144      5,608,237
  Accumulated other comprehensive income....................           --          8,878
  Unearned compensation.....................................     (396,244)      (329,070)
  Treasury stock, at cost...................................           --        (36,840)
                                                              -----------   ------------
          Total stockholders' equity........................   14,086,304     16,062,295
                                                              -----------   ------------
          Total liabilities and stockholders' equity........  $49,389,451   $191,965,768
                                                              ===========   ============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       F-5
<PAGE>   48
 
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                  YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
 
<TABLE>
<CAPTION>
                                                          1996          1997           1998
                                                       -----------   -----------   ------------
<S>                                                    <C>           <C>           <C>
Revenues:
  Carriers' carrier..................................  $22,405,158   $41,804,704   $ 72,165,460
  Integrated services................................    1,980,393     8,640,427     17,978,115
  Systems services...................................   16,030,586    21,958,772     31,630,566
  Product resales....................................   10,553,846     2,945,563             --
                                                       -----------   -----------   ------------
          Total revenues.............................   50,969,983    75,349,466    121,774,141
Costs of services and product resales:
  Services...........................................   29,684,388    50,124,257     83,221,102
  Product resales....................................    9,672,078     2,347,060             --
                                                       -----------   -----------   ------------
          Gross profit...............................   11,613,517    22,878,149     38,553,039
Operating expenses:
  Selling, general and administrative................    8,983,394    14,073,691     23,528,038
  Merger related expenses............................           --            --      2,312,973
  Depreciation and amortization......................    1,535,880     3,345,819      4,887,157
                                                       -----------   -----------   ------------
          Total operating expenses...................   10,519,274    17,419,510     30,728,168
                                                       -----------   -----------   ------------
Operating income.....................................    1,094,243     5,458,639      7,824,871
Interest expense.....................................     (630,952)   (1,735,156)    (9,458,895)
Interest income......................................       46,300       132,634      3,017,816
Other income.........................................       41,148       219,211        105,789
                                                       -----------   -----------   ------------
          Income before income taxes.................      550,739     4,075,328      1,489,581
Income tax expense...................................      227,148     1,513,561      1,266,488
                                                       -----------   -----------   ------------
          Net income.................................  $   323,591   $ 2,561,767   $    223,093
                                                       ===========   ===========   ============
Earnings per common share:
  Basic..............................................  $      0.01   $      0.09   $       0.01
  Diluted............................................  $      0.01   $      0.09   $       0.01
Weighted average shares outstanding:
  Basic..............................................   27,145,920    27,983,504     28,899,449
  Diluted............................................   27,156,471    28,480,968     30,027,569
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       F-6
<PAGE>   49
 
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                            AND COMPREHENSIVE INCOME
 
                  YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
                                                                                                              ACCUMULATED
                                          COMMON STOCK         TREASURY STOCK     ADDITIONAL                     OTHER
                                      ---------------------   -----------------     PAID IN      RETAINED    COMPREHENSIVE
                                        SHARES      AMOUNT    SHARES    AMOUNT      CAPITAL      EARNINGS       INCOME
                                      ----------   --------   ------   --------   -----------   ----------   -------------
<S>                                   <C>          <C>        <C>      <C>        <C>           <C>          <C>
Balance at December 31, 1995........  27,145,713   $271,457       --   $     --   $ 1,041,596   $2,239,378      $   --
Issuance of common stock............       2,808         28       --         --         9,968           --          --
Net income..........................          --         --       --         --            --      323,591          --
                                      ----------   --------   ------   --------   -----------   ----------      ------
Balance at December 31, 1996........  27,148,521    271,485       --         --     1,051,564    2,562,969          --
Issuance of common stock............      79,222        792       --         --       777,058           --          --
Proceeds from initial public common
 stock offering, net of expenses
 (note 12)..........................   1,450,000     14,500       --         --     6,982,005           --          --
Deferred compensation from
 compensatory stock option grants
 (note 12)..........................          --         --       --         --            --           --          --
Amortization of deferred
 compensation.......................          --         --       --         --            --           --          --
Net income..........................          --         --       --         --            --    2,561,767          --
Net income excluded from IWL
 Communications for the six months
 ended December 31, 1996 as a result
 of conforming fiscal year end (note
 2).................................          --         --       --         --            --      260,408          --
                                      ----------   --------   ------   --------   -----------   ----------      ------
Balance at December 31, 1997........  28,677,743    286,777       --         --     8,810,627    5,385,144          --
Issuance of common shares under
 stock option plans and restricted
 stock awards.......................      52,641        527       --         --       135,345           --          --
Acquisition of treasury shares under
 stock option plans.................          --         --   (5,255)   (36,840)           --           --          --
Issuance of stock relating to
 acquisition (note 16)..............     207,266      2,073       --         --     1,575,741           --          --
Amortization of deferred
 compensation.......................          --         --       --         --            --           --          --
Comprehensive income:...............
 Net income.........................          --         --       --         --            --      223,093          --
 Currency translation adjustment....          --         --       --         --            --           --       8,878
                                      ----------   --------   ------   --------   -----------   ----------      ------
Total comprehensive income                    --         --       --         --            --      223,093       8,878
                                      ----------   --------   ------   --------   -----------   ----------      ------
Balance at December 31, 1998........  28,937,650   $289,377   (5,255)  $(36,840)  $10,521,713   $5,608,237      $8,878
                                      ==========   ========   ======   ========   ===========   ==========      ======
 
<CAPTION>
 
                                                     CONSOLIDATED
                                        UNEARNED     STOCKHOLDERS'
                                      COMPENSATION      EQUITY
                                      ------------   -------------
<S>                                   <C>            <C>
Balance at December 31, 1995........   $      --      $ 3,552,431
Issuance of common stock............                        9,996
Net income..........................          --          323,591
                                       ---------      -----------
Balance at December 31, 1996........          --        3,886,018
Issuance of common stock............          --          777,850
Proceeds from initial public common
 stock offering, net of expenses
 (note 12)..........................          --        6,996,505
Deferred compensation from
 compensatory stock option grants
 (note 12)..........................    (417,100)        (417,100)
Amortization of deferred
 compensation.......................      20,856           20,856
Net income..........................          --        2,561,767
Net income excluded from IWL
 Communications for the six months
 ended December 31, 1996 as a result
 of conforming fiscal year end (note
 2).................................          --          260,408
                                       ---------      -----------
Balance at December 31, 1997........    (396,244)      14,086,304
Issuance of common shares under
 stock option plans and restricted
 stock awards.......................     (32,500)         103,372
Acquisition of treasury shares under
 stock option plans.................          --          (36,840)
Issuance of stock relating to
 acquisition (note 16)..............          --        1,577,814
Amortization of deferred
 compensation.......................      99,674           99,674
Comprehensive income:...............
 Net income.........................          --          223,093
 Currency translation adjustment....          --            8,878
                                       ---------      -----------
Total comprehensive income                    --          231,971
                                       ---------      -----------
Balance at December 31, 1998........   $(329,070)     $16,062,295
                                       =========      ===========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       F-7
<PAGE>   50
 
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                  YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
 
<TABLE>
<CAPTION>
                                                                  1996           1997           1998
                                                              ------------   ------------   -------------
<S>                                                           <C>            <C>            <C>
Cash flows from operating activities:
  Net income................................................  $    323,591   $  2,561,767   $     223,093
  Adjustments to reconcile net income to net cash provided
    by operating activities:
    Depreciation and amortization...........................     1,535,880      3,345,819       4,887,157
    Amortization of discount on notes payable...............         7,338          7,338              --
    Gain on sale of assets..................................       (67,021)      (105,048)        (51,361)
    Deferred income taxes...................................       (98,088)       384,247       1,205,856
    Equity earnings of unconsolidated joint venture.........        25,873       (115,107)        (46,075)
    Amortization of debt issuance costs, included in
      interest expense......................................            --             --         202,158
    Allowance for doubtful accounts.........................       356,223      1,382,119       1,649,773
    Changes in operating assets and liabilities:
      Accounts receivable and unbilled services.............    (5,384,642)    (7,876,944)     (6,442,462)
      Inventory.............................................      (253,022)     1,631,929        (278,799)
      Costs and earnings in excess of billings..............      (132,794)        83,265      (7,238,402)
      Prepaid expenses and other............................      (275,987)      (911,597)        407,325
      Accounts payable and accrued liabilities..............     4,746,639      3,378,009      14,592,570
      Income taxes payable..................................        37,418        553,739      (1,994,514)
      Other.................................................       (40,507)      (207,851)          8,900
                                                              ------------   ------------   -------------
         Net cash provided by operating activities..........       780,901      4,111,685       7,125,219
Cash flows from investing activities:
  Purchases of property, plant and equipment................   (10,211,878)   (13,630,464)    (36,854,766)
  Purchase of marketable securities.........................            --             --    (145,000,000)
  Proceeds from sale of marketable securities...............            --             --      47,980,211
  Proceeds from note receivable.............................       659,972             --              --
  Proceeds from disposal of property, plant and equipment...       201,550        643,836         303,805
  Investment in unconsolidated subsidiary...................            --             --        (169,166)
  Purchase of ICEL..........................................            --             --        (609,822)
                                                              ------------   ------------   -------------
         Net cash used in investing activities..............    (9,350,356)   (12,986,628)   (134,349,738)
Cash flows from financing activities:
  Proceeds from issuance of senior notes, net of debt
    issuance................................................    15,395,225     20,553,869     144,984,881
  Principal payments on notes payable.......................    (8,307,785)   (14,608,429)    (19,302,437)
  Proceeds from line of credit..............................    18,564,432     40,742,755      44,717,209
  Principal payments on line of credit......................   (17,750,010)   (40,404,848)    (45,869,537)
  Loan fees paid under long-term note agreement.............      (135,749)      (346,935)             --
  Net change in bank overdraft..............................       957,497       (957,497)             --
  Purchase of treasury stock................................            --             --         (36,840)
  Proceeds from issuance of common stock....................         9,996      7,347,258         103,373
  Principal payments under capital lease obligations........      (128,324)      (212,695)       (607,165)
                                                              ------------   ------------   -------------
         Net cash provided by financing activities..........     8,605,282     12,113,478     123,989,484
Effect of exchange rate on cash and cash equivalents........            --             --           8,878
                                                              ------------   ------------   -------------
Net increase (decrease) in cash and cash equivalents........        35,827      3,238,535      (3,226,157)
Cash and cash equivalents at beginning of year..............       325,103        281,482       3,520,017
                                                              ------------   ------------   -------------
Cash and cash equivalents at end of year....................  $    360,930   $  3,520,017   $     293,860
                                                              ============   ============   =============
Supplemental disclosure of cash flow information:
  Cash paid for interest....................................  $    550,332   $  1,760,777   $   1,344,441
                                                              ============   ============   =============
  Cash paid for income taxes................................  $    150,866   $    801,124   $   1,861,656
                                                              ============   ============   =============
Non-cash investing activity:
  Issuance of stock for ICEL acquisition....................  $         --   $         --   $   1,577,814
                                                              ============   ============   =============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       F-8
<PAGE>   51
 
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 1997 AND 1998
 
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  (a) Basis of Presentation and Nature of Business
 
     The consolidated financial statements include CapRock Communications Corp.
("CapRock" or the "Company") and its majority owned subsidiaries. The Company
was formed on February 3, 1998, to serve as a holding company for the operations
of CapRock Telecommunications ("Telecommunications"), CapRock Fiber Network Ltd.
("Partnership") and IWL Communications, Inc. ("IWL") and its wholly owned
subsidiaries. All significant inter-company transactions are eliminated in
consolidation. The consolidated financial statements include the accounts of
Telecommunications, Partnership, IWL, Spacelink Systems, Inc., Spacelink
Systems, FSC, Inc., and IWL Communications Ltd. ("Russia") and Integrated
Communications and Engineering Ltd. ("ICEL") (note 16). The equity method is
used to account for unconsolidated investments in companies in which CapRock
exercises significant influences over operating and financial policies, but does
not have a controlling interest. On August 26, 1998, pursuant to the Plan of
Agreement of Merger and Plan of Exchange dated February 16, 1998, as amended,
the Company completed the mergers and interest exchange with Telecommunications,
Partnership and IWL (note 2).
 
     The Company is a regional facilities-based integrated communications
provider offering local, long distance, Internet, data and private line services
to small and medium-sized businesses. The Company also provides switched and
dedicated access, regional and international long distance, private lines and
dark fiber to carrier customers. The Company is in the process of building an
advanced fiber network throughout Texas, Louisiana, Arkansas, New Mexico and
Oklahoma. Additionally, the Company, through its wholly owned subsidiary -- IWL,
provides communications solutions to customers with operations in remote,
difficult-access regions. The Company markets its services through its internal
sales representatives and a network of independent agents.
 
  (b) Cash Equivalents and Short-Term Investments Available for Sale
 
     The Company considers all cash in bank accounts as cash equivalents.
Marketable securities consist of U.S. government, money market and commercial
paper securities, with maturities of less than one year. Marketable securities
are stated at cost and are adjusted for discount accretion and premium
amortization, which approximate fair value. The Company's short-term investment
objectives are safety, liquidity and yield.
 
  (c) Inventory
 
     Inventory substantially consists of parts and equipment held for resale.
Inventory that can be specifically identified using a unique identification
number is stated at the lower of specified cost or market. Inventory that cannot
be specifically identified is stated at the lower of cost or market, where cost
is determined using the first in first out method. Market value, in all cases,
represents the lower of replacement cost or net realizable value.
 
  (d) Property, Plant and Equipment
 
     Property, plant and equipment are stated at cost and include certain costs,
which are capitalized during the installation and expansion of the
telecommunications network including interest costs, and payroll related to the
construction. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets. Leasehold improvements are amortized using
the straight-line method over the shorter of the estimated useful lives of the
assets or the remaining terms of the leases. Assets under construction are not
depreciated until placed in service.
 
     In the process of building out its fiber network, the Company may enter
into Indefeasible Right to Use contracts ("IRUs") for the sale of fiber usage
rights and to provide the construction services for such fiber. The Company may
install additional conduits for these segments included in the IRUs for its own
use while
 
                                       F-9
<PAGE>   52
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
performing the construction services. This additional conduit is capitalized
proportionately with the number of conduits placed, and depreciation begins for
these costs as the specific fiber segment is placed in service.
 
 (e) Revenues and Cost of Revenues
 
     The Company recognizes revenue from the following sources: Carriers'
Carrier, Integrated Services, System Services and Product Resale.
 
     CARRIERS' CARRIER:
 
     Carriers' carrier revenue includes all carrier revenues generated from the
sale of domestic and international switched services, from the sale of T-1 and
DS-3 broadband capacity and from the sale and lease of dark fiber. The revenue
generated from international switched services represent minutes of long
distance traffic terminating in foreign countries, but generated by domestic
U.S. based long distance carriers. Such revenues are recognized when the
services are provided. The cost of revenues associated with these services is
based primarily on the direct costs associated with owned and leased
transmission capacity and the cost of transmitting and terminating traffic on
other carriers' facilities. Commissions paid to sales representatives or agents
to acquire customer call traffic are expensed in the period when associated call
revenues are recognized.
 
     The Company accounts for long-term construction contracts relating to the
development of telecommunications networks for customers using the
percentage-of-completion method, which would include the sale of fiber usage
rights through IRUs and the related construction services associated with
building the fiber network specified in the IRUs. Progress under the
percentage-of-completion is measured based upon costs incurred to date compared
with total estimated construction costs. Customers are billed based upon
contractual milestones.
 
     INTEGRATED SERVICES:
 
     Integrated services revenue includes all revenues generated from the sale
of telecommunications products to business and residential customers. These
products include local, long distance, Internet, data and private line services.
The Company records revenues for these telecommunications services at the time
of customer usage. The cost of revenues associated with services is based
primarily on the direct costs associated with owned and leased transmission
capacity and the cost of transmitting and terminating traffic on other carriers'
facilities. The cost of revenues for local services also includes payments to
local exchange carriers and interexchange carriers for access and transport
charges. Commissions paid to sales representatives or agents to acquire customer
call traffic are expensed in the period when associated call revenues are
recognized.
 
     SYSTEMS SERVICES:
 
     Systems services revenue includes revenues generated from the design,
installation, leasing and sale of voice and data systems and products, primarily
to companies in the oil and gas industry. The revenues associated with the
leasing and sale of voice and data systems products are recorded as the services
are provided. The revenue associated with the design and installation of voice
and data systems products primarily relates to communication system contracts
involving the engineering and integration of telecommunications systems and
sales, service and maintenance of telecommunications equipment. These contracts
are typically fixed price and such revenue is recognized based upon the
percentage-of-completion method, primarily based upon contract costs incurred to
date compared with total estimated contract costs.
 
     PRODUCT RESALES:
 
     In 1997, the Company provided services to a subsidiary of Shell, which
included the resale of a significant amount of Alcatel products. The Company
sold $2.9 million to the Shell subsidiary in 1997, relating to Alcatel
 
                                      F-10
<PAGE>   53
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
products and other equipment and hardware. The Shell project was substantially
completed in May 1997 and, therefore, is not expected to contribute in a
material manner to the Company's total sales in future periods.
 
  (f) Business and Credit Concentration
 
     Financial instruments which potentially expose the Company to a
concentration of credit risk, as defined by SFAS No. 105, Disclosure of
Information about Financial Instruments with Off-Balance Sheet Risk and
Financial Instruments with Concentrations of Credit Risk, consist primarily of
accounts receivable from carriers, retail and commercial customers. The Company
extends credit to customers on an unsecured basis with the risk of loss limited
to outstanding amounts.
 
  (g) Income Taxes
 
     Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
 
  (h) Stock-Based Compensation
 
     The Company accounts for its stock-based employee compensation plan using
the intrinsic value based method prescribed by Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"). As
such, compensation expense is recorded on the date of grant to the extent the
current market price of the underlying stock exceeds the exercise price. The
Company has provided pro forma disclosures as if the fair value-based method of
accounting for these plans, as prescribed by Statement of Financial Accounting
Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation ("SFAS No.
123"), had been applied.
 
  (i) Foreign Currency Translation
 
     Results of operations for foreign investments are translated from the
designated functional currency to the U.S. dollar using average exchange rates
during the period, while assets and liabilities are translated at the exchange
rate in effect at the reporting date. Resulting gains and losses from
translating foreign currency financial statements are included in accumulated
other comprehensive income, a component of stockholders' equity.
 
  (j) Intangible Assets
 
     The Company recorded approximately $1.6 million of goodwill and $300,000
relating to other intangibles in connection with the acquisition of Integrated
Communications and Engineering Ltd. ("ICEL") (note 16). Goodwill represents the
excess of the purchase price over fair value of identifiable net assets acquired
and is amortized on a straight-line basis over the expected periods to be
benefited. Goodwill in connection with the acquisition of ICEL will be amortized
over 20 years. The Company assesses the recoverability of this intangible asset
by determining whether the amortization of the goodwill balance over its
remaining life can be recovered through undiscounted future operating cash
flows. The amount of goodwill impairment, if any, is measured based upon
projected discounted future operating cash flows using a discounted rate
reflecting the Company's average cost of funds. The assessment of the
recoverability of goodwill will be impacted if estimated future operating cash
flows are not achieved.
 
                                      F-11
<PAGE>   54
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
  (k) Impairment of Long-Lived Assets
 
     The Company accounts for long-lived assets in accordance with the
provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of. The Statement requires that
long-lived assets and certain identifiable intangibles be assessed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceeds the fair value of
the assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
 
  (l) Fair Value of Financial Instruments
 
     The Company believes that the carrying amounts of its financial instruments
included in current assets and current liabilities approximate the fair value of
such items due to their short-term nature. As of December 31, 1998, the
estimated fair value and the carrying amount of the Company's 12% Senior Notes
due 2008 was $144 million and $145.2 million, respectively.
 
  (m) Use of Estimates
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures. Accordingly,
actual results could differ from those estimates.
 
  (n) Earnings per Share
 
     In 1997, the Company adopted the Financial Accounting Standards Board
Statement No. 128 ("SFAS No. 128"), Earnings Per Share. All earnings per share
amounts for all periods have been presented, and where necessary, restated to
conform to SFAS No. 128 requirements. All data in the table below is in
thousands, except for per share data.
 
<TABLE>
<CAPTION>
                                                           1996      1997      1998
                                                          -------   -------   -------
<S>                                                       <C>       <C>       <C>
Numerator:
  Net income...........................................   $   324   $ 2,562   $   223
Denominator:
  Denominator for basic earnings per share-weighted
     average shares outstanding........................    27,146    27,984    28,899
Effect of dilutive securities:
  Employee stock options...............................        10       497     1,129
                                                          -------   -------   -------
Denominator for diluted earnings per share-weighted
  average shares outstanding...........................    27,156    28,481    30,028
                                                          =======   =======   =======
Basic and diluted earnings per share...................   $  0.01   $  0.09   $  0.01
                                                          =======   =======   =======
</TABLE>
 
  (o) Comprehensive Income
 
     On January 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income ("SFAS No. 130"). SFAS No. 130 establishes standards for
reporting and presentation of comprehensive income and its components in a full
set of financial statements. Comprehensive income consists of net income and
currency translation adjustments and is presented in the consolidated statements
of stockholder's equity and comprehensive income. The Statement requires only
additional disclosures in the consolidated financial
 
                                      F-12
<PAGE>   55
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
statements; it does not affect the Company's financial position or results of
operations. Prior to 1998, the Company's comprehensive income only consisted of
net income.
 
(2) BUSINESS COMBINATION
 
     On August 26, 1998, pursuant to the Plan of Agreement of Merger and Plan of
Exchange dated February 16, 1998, as amended, the Company completed the mergers
with Telecommunications, Partnership and IWL. Accordingly, the Consolidated
Balance Sheets as of December 31, 1997 and 1998 and the Consolidated Statements
of Operations, Stockholders' Equity and Comprehensive Income and Cash Flows for
each of the years in the three year period ended December 31, 1998 include
Telecommunications, Partnership and IWL as though these entities had always been
a part of CapRock.
 
     All previously outstanding shares of IWL common stock ceased to exist and
each such share was converted into and became exchangeable for one share of
CapRock common stock, and all previously outstanding shares of
Telecommunications common stock ceased to exist, and each such share was
converted into and became exchangeable for 1.789030878 shares of CapRock common
stock and each one percent (1%) of the Partnership interests issued and
outstanding was exchanged for 63,194.54 shares of CapRock common stock. The
Company issued 28,910,221 common shares in exchange for the outstanding common
share of Telecommunications, Partnership and IWL. Additionally, outstanding
employee stock options of IWL and Telecommunications were converted at the above
exchange factors into options to purchase shares of CapRock common stock. The
mergers and interest exchange constituted a tax-free reorganization and was
accounted for as a pooling of interests.
 
     In May 1998, IWL changed its fiscal year end to coincide with the fiscal
years of CapRock, Telecommunications and the Partnership. The Consolidated
Statement of Operations for the year ended December 31, 1997 and 1998 combine
the operating activity for all three entities for these years. The Consolidated
Statement of Operations for 1996 combine IWL's operating activity for the year
ended June 30, 1996 with Telecommunications and the Partnership operating
activity for the year ended December 31, 1996. The net income of IWL for the six
month period ended December 31, 1996 was excluded from the Consolidated
Statement of Operations for the year ended December 31, 1996 in the amount of
approximately $260,000 as a result of the non-conforming year ends for such
period. This amount was included as an adjustment to retained earnings in the
Consolidated Statement of Stockholders' Equity. IWL's cash flow for this six
month period was added to the 1997 beginning balance in the Consolidated
Statement of Cash Flows.
 
     The transactions between CapRock, IWL and the Partnership have been
eliminated for all respective periods presented. Certain reclassifications were
made to IWL's financial statements to conform to CapRock's presentations.
 
(3) MARKETABLE SECURITIES
 
     Investments in marketable securities at December 31, 1998 consist of money
market investments of $46,666,281 and commercial paper securities of
$50,353,508.
 
     At December 31, 1998, the estimated fair value of the Company's money
market instruments and commercial paper securities approximated cost, and the
gross unrealized gains were not significant.
 
                                      F-13
<PAGE>   56
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(4) PROPERTY, PLANT AND EQUIPMENT
 
     Property, plant and equipment, including assets acquired under capital
leases of $1,732,000 as of December 31, 1997 (no capital leases as of December
31, 1998), is comprised of the following:
 
<TABLE>
<CAPTION>
                                                USEFUL LIVES      1997          1998
                                                ------------   -----------   -----------
<S>                                             <C>            <C>           <C>
Land..........................................      --         $    51,289   $   299,752
Buildings.....................................     20-31           982,484     1,188,812
Leasehold improvements........................  Lease Term         330,468     1,191,277
Office equipment, furniture and other.........      5-7          4,264,606     9,706,840
Telecommunications network....................     5-20         13,501,993    21,148,362
Equipment for rent/lease......................     7-10         12,003,374    16,658,582
Construction in progress......................      --           4,373,499    21,774,422
                                                               -----------   -----------
          Total property, plant and
            equipment.........................                  35,507,713    71,968,047
Less accumulated depreciation, including
  amounts applicable to assets acquired under
  capital leases of $721,667 and $0 as of
  December 31, 1997 and 1998, respectively....                   8,167,114    12,361,295
                                                               -----------   -----------
Net property, plant and equipment.............                 $27,340,599   $59,606,752
                                                               ===========   ===========
</TABLE>
 
(5) COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS
 
<TABLE>
<CAPTION>
                                                                1997        1998
                                                              --------   ----------
<S>                                                           <C>        <C>
Costs incurred on uncompleted contracts.....................  $381,074   $3,479,846
Estimated earnings..........................................   281,869    6,119,136
                                                              --------   ----------
                                                               662,943    9,598,982
Less: billings to date......................................   662,943    2,360,580
                                                              --------   ----------
                                                              $     --   $7,238,402
                                                              ========   ==========
</TABLE>
 
(6) INVESTMENT IN KENWOOD SYSTEMS GROUP
 
     In September 1997, the Company sold its 50% ownership in Kenwood Systems
Group, Inc. ("KSG"), a California corporation. The remaining 50% of the voting
common stock is owned by Kenwood Americas Corporation ("KAC"). The results of
operations from January 1, 1997 through the date of sale (September 30, 1997) of
KSG have been reflected in the Company's operating results. The Company recorded
a gain on the sale of KSG of $66,226 in 1997.
 
     The investment was recorded using the equity method in which the original
investment, adjusted for the Company's proportionate share of KSG's income,
losses and dividend distributions, was recorded as a long-term investment. The
Company's original investment in KSG was $200,000. An additional investment of
$50,000 was made during the year ended December 31, 1997. The Company's
proportionate share of KSG's (losses)/earnings for the years ended December 31,
1996 and 1997 were $(25,873) and $115,107, respectively.
 
     The Company received a management fee of $58,253 and $76,995 from KSG for
the years ended December 31, 1996 and 1997, respectively. Billings by the
Company to KSG for the years ended December 31, 1996 and 1997 for insurance,
supplies, equipment and management fees totaled approximately $128,178 and
$174,500, respectively.
 
                                      F-14
<PAGE>   57
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(7) LEASES
 
     The Company leases equipment, office space, communication services and land
and buildings (used for transmission sites) under operating leases. Future
minimum lease payments under these lease agreements for each of the next five
years are summarized as follows:
 
<TABLE>
<S>                                                           <C>
Year ending December 31,
  1999......................................................  $ 3,810,959
  2000......................................................    4,181,258
  2001......................................................    4,063,546
  2002......................................................    3,147,298
  2003......................................................    2,514,350
  Thereafter................................................    1,813,588
                                                              -----------
          Total minimum lease payments......................  $19,530,999
                                                              ===========
</TABLE>
 
     As operating leases expire, it is expected that they will be replaced with
similar leases. Rent expense under operating leases totaled $768,108, $1,419,812
and $1,027,651 for each of the years ended December 31, 1996, 1997 and 1998,
respectively.
 
(8) DEBT
 
     A summary of the lines of credit and the notes payable is as follows:
 
<TABLE>
<CAPTION>
                                                       1997           1998
                                                    -----------   ------------
<S>                                                 <C>           <C>
Senior notes, 12%, due 2008.......................  $        --   $145,187,039
Lines of credit, variable rates, 8.12% to 10.5%...    5,275,608             --
Notes to banks, variable rates, 8.12%.............    2,274,590             --
Notes to banks, fixed rates, 8.5% to 9.0%.........    1,968,674             --
Term construction loan, variable rate, 8.5%.......    9,550,892             --
Notes to financing companies, variable rates......      180,328             --
Notes to financing companies, fixed rates.........    1,026,733             --
Shareholder notes, 5.8% imputed rate..............      128,167             --
Other.............................................       49,773             --
                                                    -----------   ------------
          Total...................................   20,454,765    145,187,039
Less: current portion of long-term debt...........    8,116,424             --
                                                    -----------   ------------
          Long-term debt..........................  $12,338,341   $145,187,039
                                                    ===========   ============
</TABLE>
 
     In July 1998, the Company issued, through a private placement under Rule
144A under the Securities Act of 1998, as amended, $150 million aggregate
principal amount of its 12% Senior Notes due 2008 (the "Senior Notes"), which
closed on July 16, 1998. Interest on the Senior Notes is payable semi-annually
in arrears on January 15 and July 15 of each year, commencing on January 15,
1999, at the rate of 12% per annum. The Senior Notes are presented net of
unamortized debt issuance costs of $4,821,961. The amortization of debt issuance
cost is recorded to interest expense and such amount was $202,000 in 1998. The
net proceeds from the offering were used to repay existing debt obligations.
Such proceeds for debt payoffs totaled $26.8 million. The proceeds will be used
to fund capital expenditures for the construction of its fiber optic network, to
expand its sales offices, for potential acquisitions and for general working
capital purposes. The funds have been invested in high-grade liquid securities.
 
     The Senior Notes contain certain covenants which provide for limitations on
indebtedness, dividends, asset sales and certain other transactions and
effectively prohibits the payment of cash dividends.
 
                                      F-15
<PAGE>   58
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     In March 1996, the Company entered into a revolving credit facility with a
bank for borrowings up to $15 million. In December 1997, the Company entered
into an amended agreement that provided for borrowings up to $25 million. The
line of credit was amended in June 1998 and was increased to $7.0 million. The
balance outstanding as of December 31, 1997 under the line of credit was
$1,152,329. The line of credit was paid off in August 1998 with the proceeds
from the Senior Notes.
 
     The Company also entered into a secured revolving line of credit, which
allowed the Company to borrow up to a maximum of $5.0 million subject to
borrowing base limitations on accounts receivable and inventory. The Company
also secured a guidance line of credit, which allowed the Company to borrow up
to $5.0 million to finance certain purchases and subsequent leases of
communications equipment. These lines of credit were paid off in August 1998
with the proceeds from the Senior Notes.
 
     The Company had a loan agreement with a bank ("Term Construction Loan")
whereby it borrowed $10.0 million used for the construction, start-up and
related expenses of the fiber optic network. The loan was initially secured by
the network, investment securities of a shareholder, accounts receivable and
guarantees of certain shareholders. The balance outstanding for this loan as of
December 31, 1997 was $9,550,892 and the loan was paid off in August 1998 with
the proceeds from the Senior Notes.
 
     Certain shareholders guaranteed the Term Construction Loan. In
consideration, the Company agreed to pay a one-time commitment fee equal to 1%
of each shareholder's guarantee. The guarantors were also paid a loan guaranty
fee by the Company equal to 7% of the amount of the lesser of $8.0 million or
the average outstanding daily principal of the loan. The bank released the
guaranty requirement in April 1997 for certain limited partners. The total
accrued commitment fees and loan guarantor fees as of December 31, 1997 were
approximately $406,000. All commitment and guarantee fees were paid in full in
August 1998 with the proceeds from the Senior Notes. Such payments totaled
approximately $430,000.
 
     In 1994, the Company entered into note payable agreements with three
officers of the Company ("Shareholder Notes") relating to stock repurchased by
the Company. The unamortized discount was $21,834 as of December 31, 1997. The
Shareholder Notes were repaid in August 1998 with the proceeds from the Senior
Notes.
 
(9) RELATED PARTIES
 
     In 1996 the Company entered into an agreement with a related party to
manage the construction of the fiber optic network build out for the initial 260
route miles, which was completed in 1997. Under this agreement, the Company paid
4% of the costs of constructing this portion of the network, payable monthly at
a minimum of $15,000 per month. The Company paid management fees of $296,576 in
1997 and $461,576, cumulative under the arrangement since construction of this
segment commenced. This arrangement ceased to exist in 1997.
 
     The Company currently leases private line services from affiliated
companies. Total payments to these affiliated companies for services totaled
$765,000 in 1997 and $1,176,000 in 1998. The Company believes that the prices
charged for such services do not exceed prices charged by unrelated parties.
 
     The Company's billing and back office systems are being developed by
RiverRock Systems, Ltd. ("RiverRock"), a limited partnership formed in July
1998. The Company owns a 49% interest in the limited partnership and David E.
Thompson owns a 50% limited partnership interest. Thompson Technology, Inc.
(which is owned by David Thompson, a brother of Jere W. Thompson, Jr. -- CEO of
CapRock Communications Corp.) is the general partner and owns a 1% general
partnership interest. The Company contributed a total of $170,000 in 1998 for
the development of the systems and had committed to fund up to a total of
$700,000, as capital contributions to RiverRock. The investment balance of
$86,000 as of December 31, 1998 was included in other assets.
 
                                      F-16
<PAGE>   59
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(10) ALLOWANCE FOR DOUBTFUL ACCOUNTS
 
     The activity in the allowance for doubtful accounts for the years ended
December 31, 1997 and 1998 is as follows:
 
<TABLE>
<CAPTION>
                                                                 1997         1998
                                                              ----------   -----------
<S>                                                           <C>          <C>
Allowance for doubtful accounts at beginning of year........  $  399,216   $ 1,781,335
Additions charged to bad debt expense.......................   1,382,119     1,649,773
Write-downs charged against the allowance, net of
  recoveries................................................          --    (2,721,167)
                                                              ----------   -----------
Allowance for doubtful accounts at end of year..............  $1,781,335   $   709,941
                                                              ==========   ===========
</TABLE>
 
(11) LEASE CONTRACTS
 
     The Company provides telecommunications services to various customers under
operating leases. The services include agreements to lease capacity to customers
over the fiber optic line, communications equipment, line/satellite charges
and/or maintenance charges. These leases impose certain obligations on both the
lessor and lessee, which must be met during the term of the lease.
 
     A significant portion of these services requires that the Company have
access to international communication satellites. The Company has contracted
with a Russian entity for rights to access its portion of an international
communications satellite. The Company has agreed to pay a recurring monthly fee
to the entity based on the amount of satellite space segment utilized by each
lessee. Additionally, the Company has sold communication equipment to the
entity. The Company utilizes those facilities to provide communication services
to various United States energy and oil and gas companies and other customers
doing business in Russia.
 
     The following is a summary of expected revenue to be earned during the next
five years by the Company on lease agreements executed on or before December 31,
1998.
 
<TABLE>
<S>                                                       <C>
Year ending December 31:
  1999..................................................  $ 8,051,952
  2000..................................................    7,243,418
  2001..................................................    4,569,128
  2002..................................................    3,622,862
  2003..................................................    3,182,282
  Thereafter............................................    5,244,940
                                                          -----------
          Total.........................................  $31,914,582
                                                          ===========
</TABLE>
 
(12) STOCKHOLDERS' EQUITY
 
  Initial Public Offering
 
     The Company, through its wholly owned subsidiary -- IWL, completed an
initial public offering ("IPO") of common stock on June 12, 1997, issuing
1,450,000 shares at $6.00 per share. The proceeds, net of commissions and
expenses, from this IPO totaled $6,996,505. In July 1997, the underwriters
exercised an over allotment option and purchased an additional 62,496 shares
resulting in net proceeds of $337,473.
 
  Common Stock
 
     CapRock was incorporated as a Texas corporation on February 3, 1998, to
serve as a holding company for the operations of Telecommunications, Partnership
and IWL after completion of their business combination (note 2) in conformance
with the provisions of their Agreement and Plan of Merger dated February 16,
1998.
 
                                      F-17
<PAGE>   60
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
The Company issued 28,910,221 common shares in exchange for the outstanding
common shares of Telecommunications, Partnership and IWL.
 
  Telecommunications Employee Stock Option Plan
 
     In September 1997, Telecommunications adopted a stock option plan (the
"Telecommunication Plan") pursuant to which the Company's Board of Directors may
grant nonqualified options to employees. The Telecommunications Plan authorized
grants of options to purchase up to 10% of the common shares outstanding. All
Telecommunications stock options have a ten-year term and cannot be exercised
prior to September 1, 1998. The options vest in 20% increments over a five-year
period. All options expire August 31, 2007. Upon consummation of the merger, the
outstanding stock options under this plan were converted at the exchange factor
(note 2) into options to purchase shares of CapRock common stock.
 
     In 1997, Telecommunications granted 380,899 nonqualified stock options
under the Telecommunications Plan with an exercise price of $1.00 per share. The
Company recorded deferred compensation of $417,100 related to these stock option
grants, which will be recognized over the vesting period. As of December 31,
1998, 34,501 of the options previously granted were forfeited and canceled,
17,504 options were exercised and 328,894 options were outstanding.
 
  IWL Incentive Stock Option Plan
 
     In 1996, IWL adopted an Employee Incentive Stock Option Plan ("IWL
Incentive Plan"). The option price per share could not be less than the fair
market value of a share on the date the option is granted. Options under such
plan generally vest at the rate of 20% per year over a five year period;
however; the Board at its discretion may accelerate the vesting schedule. All
options granted under the IWL Incentive Plan on or prior to the IPO date, June
12, 1997, vested in full on the offering date. IWL granted 342,214 options under
the plan. The stock options expire ten years from the date of grant. Upon
consummation of the merger, the outstanding stock options under this plan were
converted at a one to one ratio to purchase shares of CapRock common stock.
 
     As of December 31, 1998, 24,000 of the options previously granted were
forfeited, 50,141 options were exercised and 268,073 options were outstanding.
No additional options are available for grant under the IWL Incentive Plan.
 
  Warrants
 
     The Company issued to its investment bankers warrants to purchase up to
145,000 shares of common stock, at an exercise price equal to 120% of the IPO
price. Upon consummation of the merger, the outstanding warrants were converted
at a one to one ratio to purchase shares of CapRock common stock. All of the
warrants were outstanding as of December 31, 1998.
 
     The warrants have certain demand and "piggy-back" registration rights that
may require the Company to register for resale the shares of Common Stock
issuable under the warrants. The warrants are exercisable for a period of four
years, beginning June 12, 1998.
 
  CapRock Equity Incentive Plan
 
     On August 26, 1998, in connection with the approval of the merger, the
shareholders of the Company approved an equity incentive plan (the "CapRock
Plan"). The CapRock Plan authorized the granting of awards, which would allow up
to an aggregate of 5,000,000 share of common stock to be acquired by
participants and provides that a maximum of 2,500,000 shares of common stock may
be issued to any one participant. All prospective equity grants will be issued
from the CapRock Plan. The awards under the Plan may take the form of stock
options, stock appreciation rights, restricted stock awards, deferred stock,
stock
                                      F-18
<PAGE>   61
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
reload options, stock appreciation rights, restricted stock awards, deferred
stock, stock related options and other stock based awards.
 
     Stock options granted under the CapRock Plan may be either options that are
intended to qualify for treatment as incentive stock options under Section 422
of the IRS tax code or options that do not so qualify (non-qualified stock
options). Options under the Plan may be granted to any person who is an officer
or other employee or consultants of the Company or any of its subsidiaries. The
exercise price of incentive stock options must be at least the fair value of a
share of the common stock on the date of grant (and not less than 110% of the
fair market value of a share of the common stock on the date of grant). The
exercise price of non-qualified stock options may be less than 100% of the fair
market value of a share of the common stock on the date of grant. The term of
the option may not exceed 10 years (5 years in the case of incentive stock
options granted to an optionee owning 10% or more of the common stock).
 
     During 1998, the Company granted 1,681,600 options under this plan and
these options vest over five years. As of December 31, 1998, 48,700 of the
options granted were forfeited and canceled, none of the options granted had
been exercised and 1,632,900 of the options were outstanding.
 
  Director Stock Option Plan
 
     On August 26, 1998, in connection with the approval of the merger, the
shareholders of the Company approved the Director Stock Option Plan (the
"CapRock Director Plan"). All options to be granted under the CapRock Director
Plan will be non-qualified stock options. A total of 400,000 shares of common
stock have been reserved for issuance under the CapRock Director Plan. Each
option will expire ten years from the date of grant and the options vest over
three years. Outstanding options will expire earlier if an optionee terminates
service as a director before the end of the first ten-year term. As of December
31, 1998, the Company granted 30,000 options under this plan and all were
outstanding as of December 31, 1998.
 
     The remaining options available for future grant as of December 31, 1998
are 3,363,586 options under the CapRock Plan and 370,000 under the CapRock
Director Plan.
 
     A summary of options activity under the plans described above is as
follows:
 
<TABLE>
<CAPTION>
                                                                      WEIGHTED-
                                                         NUMBER        AVERAGE
                                                       OF OPTIONS   EXERCISE PRICE
                                                       ----------   --------------
<S>                                                    <C>          <C>
Balance at December 31, 1996.........................    160,614        $3.62
  Options granted....................................    552,499         2.25
  Options exercised..................................    (13,919)        3.56
  Options forfeited..................................     (8,275)         .56
                                                       ---------        -----
Balance at December 31, 1997.........................    690,919         2.56
  Options granted....................................  1,721,600         6.58
  Options exercised..................................    (53,726)        3.04
  Options forfeited..................................    (98,926)        4.80
                                                       ---------        -----
Balance at December 31, 1998.........................  2,259,867        $5.51
                                                       =========        =====
</TABLE>
 
                                      F-19
<PAGE>   62
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     A summary of options outstanding as of December 31, 1998 is as follows:
 
<TABLE>
<CAPTION>
            NUMBER OF      WEIGHTED-AVERAGE       NUMBER OF
EXERCISE     OPTIONS     REMAINING CONTRACTUAL     OPTIONS
 PRICE     OUTSTANDING           LIFE            EXERCISABLE
--------   -----------   ---------------------   -----------
<S>        <C>           <C>                     <C>
 $  .56       328,894            8.77               52,241
   3.56       109,918            6.92              109,918
   4.49        10,555            7.36               10,555
   6.00       132,600            8.40               28,167
   6.25         5,000            8.63                1,000
   6.50     1,662,900            9.79                   --
  20.25        10,000            9.22                   --
            ---------            ----              -------
            2,259,867            9.40              201,881
            =========            ====              =======
</TABLE>
 
     The Company applied the intrinsic value method prescribed by APB Opinion
No. 25 in accounting for its plans. SFAS No. 123 requires disclosure of the
compensation cost for stock-based incentives granted based upon the fair value
at grant date for awards. Applying SFAS No. 123 would result in pro forma net
income and earnings per share ("EPS") amounts as follows:
 
<TABLE>
<CAPTION>
                                                         1996        1997        1998
                                                       --------   ----------   --------
<S>                                      <C>           <C>        <C>          <C>
Net income (loss)......................  As reported   $323,591   $2,561,767   $223,093
                                         Pro forma      319,000    2,385,000   (762,238)
Basic EPS..............................  As reported   $   0.01   $     0.09   $   0.01
                                         Pro forma         0.01         0.09      (0.03)
Diluted EPS............................  As reported   $   0.01   $     0.09   $   0.01
                                         Pro forma         0.01         0.08      (0.03)
</TABLE>
 
     The fair value of each option grant was estimated using the Black-Scholes
option pricing model with the following assumptions: risk free interest rates of
5.8%, 5.8% and 5.75%; expected option lives of 2.5, 2.5 and 3 years; expected
volatility of 55%, 55% and 52%, and no expected dividend yield, in 1996, 1997
and 1998, respectively.
 
(13) INCOME TAXES
 
<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31, 1996
                                          -----------------------------------------------
                                          U.S. FEDERAL   FOREIGN     STATE       TOTAL
                                          ------------   --------   --------   ----------
<S>                                       <C>            <C>        <C>        <C>
Current.................................   $  175,404    $149,832   $     --   $  325,236
Deferred................................      (87,737)         --    (10,351)     (98,088)
                                           ----------    --------   --------   ----------
          Total.........................   $   87,667    $149,832   $(10,351)  $  227,148
                                           ==========    ========   ========   ==========
</TABLE>
 
<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31, 1997
                                          -----------------------------------------------
                                          U.S. FEDERAL   FOREIGN     STATE       TOTAL
                                          ------------   --------   --------   ----------
<S>                                       <C>            <C>        <C>        <C>
Current.................................   $  946,703    $112,659   $ 69,952   $1,129,314
Deferred................................      364,993          --     19,254      384,247
                                           ----------    --------   --------   ----------
          Total.........................   $1,311,696    $112,659   $ 89,206   $1,513,561
                                           ==========    ========   ========   ==========
</TABLE>
 
                                      F-20
<PAGE>   63
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31, 1998
                                          -----------------------------------------------
                                          U.S. FEDERAL   FOREIGN     STATE       TOTAL
                                          ------------   --------   --------   ----------
<S>                                       <C>            <C>        <C>        <C>
Current.................................   $       --    $     --   $ 60,632   $   60,632
Deferred................................      896,739     134,442    174,675    1,205,856
                                           ----------    --------   --------   ----------
          Total.........................   $  896,739    $134,442   $235,307   $1,266,488
                                           ==========    ========   ========   ==========
</TABLE>
 
     Foreign income taxes results from taxes withheld on sales related to
Russian operations. Operating income (loss) from such operations for the years
ended December 31, 1996, 1997 and 1998 were $436,000 and $555,000 and
$(441,000), respectively.
 
     Income tax expense differs from the amount computed by applying the federal
income tax rate of 34% to earnings before taxes, as follows:
 
<TABLE>
<CAPTION>
                                                      1996        1997         1998
                                                    --------   ----------   ----------
<S>                                                 <C>        <C>          <C>
Income tax provision at 34%.......................  $187,251   $1,385,612   $  506,458
Merger expenses not deductible for tax purposes...        --           --      612,000
Expenses not deductible for tax purposes..........    11,990       33,094       28,488
State income tax expense, net of federal effect...   (10,351)      89,206      155,303
Effect of foreign operations, including foreign
  tax credits.....................................   (53,071)     (49,326)          --
Exclusion of Partnership income tax benefit.......    84,000       39,000           --
Other.............................................     7,329       15,975      (35,761)
                                                    --------   ----------   ----------
          Total...................................  $227,148   $1,513,561   $1,266,488
                                                    ========   ==========   ==========
</TABLE>
 
     Effective January 1, 1998, the Partnership elected to be taxed as a
corporation. As such, deferred taxes and tax provisions have been established in
1998. The pro forma tax benefit in 1996 and 1997 was approximately $84,000 and
$39,000, respectively, if the partnership would have been taxed as a C
corporation in those years.
 
     The tax effects of temporary differences and carryforwards, which result in
a significant portion of the deferred tax assets and liabilities are as follows:
 
<TABLE>
<CAPTION>
                                                   1997                      1998
                                          ----------------------   ------------------------
                                           ASSETS    LIABILITIES     ASSETS     LIABILITIES
                                          --------   -----------   ----------   -----------
<S>                                       <C>        <C>           <C>          <C>
Effect on deferred taxes of
  carryforwards.........................  $116,958    $     --     $2,035,899   $       --
Foreign tax credit......................    25,600          --        207,235           --
Allowance for doubtful accounts.........   654,875          --        245,263           --
Unearned compensation...................     7,717          --             --       16,864
Deferred revenue........................     7,142          --             --    1,906,520
Accrued vacation pay....................    27,200          --         39,560           --
Property, plant and equipment...........        --     968,265             --    1,960,602
Other...................................     9,311          --         30,711           --
                                          --------    --------     ----------   ----------
          Total deferred taxes..........  $848,803    $968,265     $2,558,668   $3,883,986
                                          ========    ========     ==========   ==========
</TABLE>
 
     A net operating loss of $5,278,132 was generated in 1998 and the operating
loss will be used to offset future taxable income. The net operating loss
carryforward will expire in year 2013; however, management believes that this
carryforward will be utilized prior to expiration. No valuation allowance for
deferred taxes at December 31, 1997 and 1998 is considered necessary as
management has determined that it is more likely than not that these assets will
be realized. The ultimate realization of deferred tax assets is dependent upon
the
 
                                      F-21
<PAGE>   64
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
generation of future taxable income during the periods in which those temporary
differences become deductible. The Company considered the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment.
 
(14) COMMITMENTS
 
     The Company has an agreement with various vendors, which require minimum
usage. In the event such monthly commitments are not met, the Company is
required to remit to the vendor the difference between the commitments and the
actual usage. Such amount, if necessary, would be recorded as cost of revenue in
the period incurred.
 
     The Company entered into a volume purchase commitment of $13 million
relating to the purchase of telecommunications equipment. In the event the $13
million commitment is not fulfilled by CapRock, the Company shall pay the vendor
a penalty ranging from 3%-13% of the purchase commitment. The Company believes
that no penalties will be incurred under this contract.
 
(15) 401(k) PLANS
 
     The Company and a subsidiary offer its qualified employees the opportunity
to participate in one of its defined contribution retirement plans qualifying
under the provisions of Section 401(k) of the Internal Revenue Code. Each
employee may contribute on a tax deferred basis a portion of annual earnings not
to exceed $9,500. The Company matches individual employee contributions in
certain plans, up to a maximum level, which in no case exceeds 6%. The Company's
matching contributions to the Plan (after forfeitures) for the years ended
December 31, 1996, 1997 and 1998 were $23,367, $30,287 and $81,086,
respectively.
 
(16) ACQUISITION
 
     In January 1998, the Company completed the acquisition of Integrated
Communications and Engineering, Ltd. ("ICEL"), a communications systems
integrator and maintenance provider in Aberdeen, Scotland. The Company paid a
total purchase price of approximately $2.2 million comprised of approximately
$610,000 in cash and 207,266 shares of the Company's common stock. The
acquisition was accounted for as a purchase business combination, and
accordingly the purchase price was allocated to assets acquired and liabilities
assumed. Approximately $ 1.6 million was recorded as goodwill and $300,000 was
allocated to contracts as a result of the transaction.
 
     The following summarizes the unaudited consolidated data as though the
acquisition of ICEL occurred as of the January 1, 1997:
 
<TABLE>
<CAPTION>
                                             HISTORICAL     PRO FORMA
                                             -----------   -----------
<S>                                          <C>           <C>
Revenue....................................  $75,349,466   $78,676,598
Net income.................................    2,561,767     2,681,147
Earnings per share.........................         0.09          0.10
</TABLE>
 
(17) SUBSEQUENT EVENTS
 
     In February 1999, the Company entered into a joint build arrangement with
Enron Communications, Inc., a wholly owned subsidiary of Enron Corp., to jointly
build approximately 1,050 miles of fiber optic network within the state of
Texas. The build plan includes four conduit ducts to be placed throughout the
1,050 miles, with one and one-quarter conduits to be owned and funded by CapRock
and one and one-quarter conduits to be owned and funded by Enron Communications,
Inc., and one and one-half conduits to be owned and funded by a limited
partnership formed by CapRock and Enron Communications, Inc. The limited
partnership will sell a specified amount of fiber usage rights and CapRock will
own 48 fibers.
 
                                      F-22
<PAGE>   65
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The total required capital contributions will depend on the costs to
construct the segment. CapRock and Enron are committed to each contribute
equally to fund the construction. The total construction costs for the 1,050
miles are estimated at approximately $100 million.
 
(18) SEGMENT REPORTING AND CONCENTRATION OF CUSTOMERS
 
     In June 1997, the Financial Accounting Standards Board issued Statement No.
131, Disclosures about Segments of an Enterprise and Related Information, which
the Company has adopted in 1998. The Company identifies such segments based on
management responsibility. The Company measures segment profit as operating
income, which is defined as income before interest expense and income taxes. The
service revenue from the Telecommunications Division include all revenues
generated from the sale of telecommunications products to business and
residential customers. These products include local, long distance, Internet,
data and private line services. The Fiber Division includes the operating
activity and the assets relating to the fiber build out. The revenues for the
Fiber Division primarily relate to the sale of dark fiber through IRUs. The
product and service revenue from the Services Division include revenues
generated from the design, installation, leasing and sale of voice and data
systems and products, primarily to companies in the oil and gas industry. The
Corporate Division includes certain general and administrative functions and
operating expenses and the merger related expenses of $2.3 million, which
comprise the segment operating loss of $3.5 million in 1998. The general and
administrative expenses were allocated to each of the respective divisions prior
to 1998. Information regarding operating segments is as follows (amounts are in
thousands):
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31, 1996
                                      -----------------------------------------------------------------
                                      TELECOMMUNICATIONS   FIBER    SERVICES   CORPORATE   CONSOLIDATED
                                      ------------------   ------   --------   ---------   ------------
<S>                                   <C>                  <C>      <C>        <C>         <C>
Revenue from external customers.....       $23,174            $--   $27,796       $--        $50,970
Depreciation and amortization.......           479             54     1,003       --           1,536
Operating income....................            44           (228)    1,278       --           1,094
Total assets........................         7,356          8,757    12,409       --          28,522
</TABLE>
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31, 1997
                                      -----------------------------------------------------------------
                                      TELECOMMUNICATIONS   FIBER    SERVICES   CORPORATE   CONSOLIDATED
                                      ------------------   ------   --------   ---------   ------------
<S>                                   <C>                  <C>      <C>        <C>         <C>
Revenue from external customers.....       $46,745         $1,945   $26,659       $--        $75,349
Depreciation and amortization.......           694            902     1,750       --           3,346
Operating income....................         3,226            671     1,562       --           5,459
Total assets........................        13,327          9,779    26,283       --          49,389
</TABLE>
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31, 1998
                                     ------------------------------------------------------------------
                                     TELECOMMUNICATIONS    FIBER    SERVICES   CORPORATE   CONSOLIDATED
                                     ------------------   -------   --------   ---------   ------------
<S>                                  <C>                  <C>       <C>        <C>         <C>
Revenue from external customers....       $75,768         $11,930   $34,798       $(722)     $121,774
Depreciation and amortization......         1,113             744     2,993          37         4,887
Operating income...................         3,280           8,128       (55)     (3,528)        7,825
Total assets.......................        26,929          39,175    34,064      91,798       191,966
</TABLE>
 
     All significant transactions and agreements of the Company, with the
exception of the operations of ICEL (Scotland) are generated in U.S. dollars.
The pertinent data relating to foreign operations is as follows (amounts are in
thousands):
 
<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31, 1996
                                            --------------------------------------------------------
                                             U.S.     MEXICO   RUSSIA   INTERNATIONAL   CONSOLIDATED
                                            -------   ------   ------   -------------   ------------
<S>                                         <C>       <C>      <C>      <C>             <C>
Revenue to external customers.............  $44,285   $1,761   $2,281      $2,643         $50,970
Operating income (loss)...................      451      273      436         (66)          1,094
Long-lived assets.........................   15,901       --       --          --          15,901
</TABLE>
 
                                      F-23
<PAGE>   66
                 CAPROCK COMMUNICATIONS CORP. AND SUBSIDIARIES
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31, 1997
                                            --------------------------------------------------------
                                             U.S.     MEXICO   RUSSIA   INTERNATIONAL   CONSOLIDATED
                                            -------   ------   ------   -------------   ------------
<S>                                         <C>       <C>      <C>      <C>             <C>
Revenue to external customers.............  $57,706   $6,495   $1,905      $9,243         $75,349
Operating income..........................    3,464    1,216      555         224           5,459
Long-lived assets.........................   27,341       --       --          --          27,341
</TABLE>
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31, 1998
                                -----------------------------------------------------------------------------
                                 U.S.     MEXICO    INDIA    RUSSIA   SCOTLAND   INTERNATIONAL   CONSOLIDATED
                                -------   -------   ------   ------   --------   -------------   ------------
<S>                             <C>       <C>       <C>      <C>      <C>        <C>             <C>
Revenue to external
  customers...................  $79,185   $16,611   $4,766   $2,312    $5,207       $13,693        $121,774
Operating income (loss).......    3,766     1,920      415     (441)        8         2,157           7,825
Long-lived assets.............   58,893        --       --       --     2,508            --          61,401
</TABLE>
 
     All revenue was derived from unaffiliated customers. For the years ended
December 31, 1996 and 1997 one customer provided $11,681,000 (or 23%) and
$9,349,000 (or 12%) of the Company's revenue, respectively. For the year ended
December 31, 1998, one customer provided $13,985,000 (or 11%) and another
customer provided $12,344,000 (or 10%) of the Company's revenue.
 
(19) QUARTERLY RESULTS
 
     The Company's unaudited quarterly results are as follows (amounts are in
thousands, except share data):
 
<TABLE>
<CAPTION>
                                                              FOR THE 1997 QUARTER ENDED
                                                        ---------------------------------------
                                                        MARCH 31   JUNE 30   SEPT. 30   DEC. 31
                                                        --------   -------   --------   -------
<S>                                                     <C>        <C>       <C>        <C>
Revenue...............................................  $17,022    $18,649   $19,039    $20,640
Gross profit..........................................    4,197      5,631     6,109      6,941
Net income............................................      115        721       970        756
Basic and diluted earnings per share..................       --       0.03      0.03       0.03
</TABLE>
 
<TABLE>
<CAPTION>
                                                              FOR THE 1998 QUARTER ENDED
                                                        ---------------------------------------
                                                        MARCH 31   JUNE 30   SEPT. 30   DEC. 31
                                                        --------   -------   --------   -------
<S>                                                     <C>        <C>       <C>        <C>
Revenue...............................................  $24,412    $27,008   $35,284    $35,070
Gross profit..........................................    8,183      9,202     9,309     11,860
Net income (loss).....................................    1,358      1,515    (1,650)    (1,000)
Basic and diluted earnings (loss) per share...........     0.05       0.10     (0.06)     (0.03)
</TABLE>
 
                                      F-24