THIS DOCUMENT IS A COPY OF THE FORM 10-Q FILED ON MAY 16, 1996 PURSUANT TO A
RULE 201 TEMPORARY HARDSHIP EXEMPTION.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1996 COMMISSION FILE NO. 0-12386
INCOMNET, INC.
A California IRS Employer No.
Corporation 95-2871296
21031 Ventura Blvd., Suite 1100
Woodland Hills, California 91364
Telephone no. (818) 887-3400
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: ...............None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g)
OF THE ACT:......................................Common Stock, No Par Value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO__
Number of shares of registrant's common stock outstanding as of
April 30, 1996........................................................13,264,404
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
March 31, December 31,
1996 1995
(unaudited) (audited)
----------- -----------
CURRENT ASSETS:
Cash & cash equivalents $ 1,845,175 $ 1,644,968
Accounts receivable, less allowance for doubtful
accounts of $3,499,732 at March 31, 1996 and
$3,154,241 at December 31, 1995 11,761,544 12,177,257
Notes receivable - current portion 215,422 102,594
Notes receivable from officers & shareholders -
net of reserves of $208,800 at March 31, 1996 and
$208,800 at December 31, 1995 928,440 863,440
Inventories 1,203,452 1,646,829
Prepaid expenses and other 1,385,700 1,197,245
----------- -----------
Total current assets 17,339,733 17,632,333
----------- -----------
PLANT AND EQUIPMENT:
Computer hardware & software 5,539,698 5,113,588
Furniture & office equipment 2,833,852 1,878,439
Leasehold improvements 4,840,049 4,133,885
----------- -----------
Total plant & equipment (gross) 13,213,599 11,125,912
Less accumulated depreciation (2,408,871) (1,979,858)
----------- -----------
Total plant & equipment (net) 10,804,728 9,146,054
----------- -----------
OTHER ASSETS:
Excess of purchase price over net assets of NTC, less
accumulated amortization of $1,015,704 at
March 31, 1996 and $941,644 at December 31, 1995 4,764,550 4,838,610
Patent rights from the acquisition of RCI
less accumulated amortization of $2,653,200 at
March 31, 1996 and $2,019,233 at December 31, 1995 41,091,016 41,688,844
Investment in Lab Tech 130,725 130,725
Investment in marketable securities 190,714 190,714
Notes receivable - long term -- 155,000
Deposits and other 375,660 323,349
----------- -----------
Total other assets 46,552,665 47,327,242
----------- -----------
Total assets $ 74,697,126 $ 74,105,629
----------- -----------
----------- -----------
See accompanying "Notes to Consolidated Financial Statements."
2
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY
March 31, December 31,
1996 1995
(unaudited) (audited)
----------- -----------
CURRENT LIABILITIES:
Accounts payable $ 9,081,916 $ 8,783,797
Accrued expenses 3,303,074 3,686,661
Current portion of notes payable 2,407,618 2,530,886
Deferred income 1,261,703 1,190,474
----------- -----------
Total current liabilities 16,054,311 16,191,818
----------- -----------
LONG-TERM LIABILITIES:
Notes Payable 785,589 9,622
Deposits & other 1,200 1,100
Deferred tax liability (net) 8,317,887 8,449,050
----------- -----------
Total long-term liabilities 9,104,676 8,459,772
----------- -----------
Total liabilities 25,158,987 24,651,590
----------- -----------
MINORITY INTEREST 6,425,037 6,905,983
----------- -----------
SHAREHOLDERS' EQUITY:
Common stock, no par value; 20,000,000 shares
authorized; issued and outstanding 13,294,024
shares at March 31,1996 and 13,262,648
shares at December 31, 1995 61,031,361 60,883,892
Treasury stock (5,491,845) (5,491,845)
Accumulated deficit (12,426,414) (12,843,991)
----------- -----------
Total shareholders' equity 43,113,102 42,548,056
----------- -----------
Total liabilities, minority interest &
shareholders' equity $ 74,697,126 $ 74,105,629
----------- -----------
----------- -----------
See accompanying "Notes to Consolidated Financial Statements."
3
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1996 1995
----------- -----------
SALES $ 24,399,421 $ 18,884,761
------------ ------------
OPERATING COSTS & EXPENSES:
Cost of sales 15,905,794 12,993,483
General & administrative 6,290,528 3,537,892
Depreciation & amortization 429,222 162,101
Bad debt expense 1,091,347 539,179
Other (income)/expense 68,750 (35,738)
----------- -----------
Total operating costs and expenses 23,785,641 17,196,917
----------- -----------
ACQUISITION COSTS & EXPENSES:
NTC Acquisition - goodwill amortization 74,060 69,530
RCI Acquisition - patent rights amortization 502,805 --
RCI Acquisition - interest and legal 5,606 28,640
RCI Acquisition - equity in (profit)/loss of
unconsolidated subsidiary -- 186,260
----------- -----------
Total acquisition costs & expenses 582,471 284,430
----------- -----------
Income before income taxes,
extraordinary items & minority interest 31,309 1,403,414
INCOME TAXES 94,080 1,600
----------- -----------
Income before extraordinary items & minority interest (62,771) 1,401,814
EXTRAORDINARY ITEMS -- --
MINORITY INTEREST 480,345 --
----------- -----------
Net income $ 417,574 $ 1,401,814
----------- -----------
----------- -----------
INCOME PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS:
Income before extraordinary items $ .03 $ .13
Extraordinary items -- --
----------- -----------
Net income $ .03 $ .13
----------- -----------
----------- -----------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND
COMMON SHARE EQUIVALENTS OUTSTANDING 13,278,242 11,163,640
----------- -----------
----------- -----------
See accompanying "Notes to Consolidated Financial Statements."
4
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
1996 1995
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
After tax profit $ (62,771) $ 1,401,816
Depreciation & amortization - operations 632,938 162,101
Depreciation & amortization - acquisitions 373,149 69,530
----------- -----------
Net cash inflow/(outflow) from operating activities 943,319 1,633,447
----------- -----------
CASH FLOWS FROM (INCREASE)/DECREASE IN OPERATING ASSETS:
Accounts receivable 415,712 (477,476)
Notes receivable - current portion (112,827) --
Notes receivable - due from officers and shareholders (65,000) --
Inventories 443,378 6,111
Prepaid expenses & other (188,454) (279,994)
Notes receivable - long term 155,000 --
Deposits & other (52,311) (131,577)
----------- -----------
Net cash inflow/(outflow) from changes in
operating assets 595,498 (882,936)
----------- -----------
CASH FLOWS FROM INCREASE/(DECREASE) IN OPERATING LIABILITIES:
Accounts payable 298,119 1,107,337
Accrued expenses (383,583) (430,519)
Deferred income 71,229 315,426
----------- -----------
Net cash inflow/(outflow) from changes in operating (14,235) 992,244
----------- -----------
Net cash inflow/(outflow) from operations 1,524,582 1,742,755
----------- -----------
CASH FLOWS FROM (INCREASE)/DECREASE IN INVESTING ACTIVITIES:
Acquisition of plant & equipment (2,161,957) (928,221)
Patents/intangible assets (36,139) --
Investment in Lab Tech -- --
Investment in marketable securities -- 153,300
Investment in RCI (14,813,740)
Goodwill from acquisition of NTC 74,060 --
Patent rights from acquisition of RCI -- --
----------- -----------
Net cash inflow/(outflow) from investing activities (2,124,036) (15,588,661)
----------- -----------
See accompanying "Notes to Consolidated Financial Statements."
5
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, (CONT'D)
1996 1995
----------- -----------
CASH FLOWS FROM INCREASE/(DECREASE) IN FINANCING ACTIVITIES:
Bank overdraft -- (56,770)
Minority interest (600) --
Notes payable - current 157,891 9,986,656
Sale of common stock, net 147,468 1,066,013
Treasury stock -- (4,776,638)
Notes payable - long term 494,908 --
Paid in capital -- --
Prior period adjustment to retainer earnings -- 13,386
Change in valuation allowance -- (153,300)
----------- -----------
Net cash inflow/(outflow) from financing activities 799,667 6,079,347
----------- -----------
Net cash inflow/(outflow) from investing & financing (1,324,369) (9,509,314)
----------- -----------
Net increase/(decrease) in cash & cash equivalents $ 200,213 $ (7,766,559)
----------- -----------
----------- -----------
See accompanying "Notes to Consolidated Financial Statements."
6
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1996
1. MANAGEMENT'S REPRESENTATION:
The consolidated financial statements included herein have been prepared by the
management of Incomnet, Inc. (the Company) without audit. Certain information
and note disclosures normally included in the consolidated financial statements
prepared in accordance with generally accepted accounting principles have been
omitted. In the opinion of the management of the Company, all adjustments
considered necessary for fair presentation of the consolidated financial
statements have been included and were of a normal recurring nature, and the
accompanying consolidated financial statements present fairly the financial
position as of March 31, 1996, and the results of operations for the three
months ended March 31, 1996 and 1995, and cash flows for the three months ended
March 31, 1996 and 1995.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes for the three
years ended December 31, 1995, included in the Company's Annual Report on Form
10-K filed with the Securities and Exchange Commission on April 8, 1996. The
interim results are not necessarily indicative of the results for a full year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of the Company, its wholly-owned subsidiary National Telephone &
Communications-Registered Trademark-, Inc. (NTC), and its 51%-owned subsidiary
Rapid Cast, Inc. (RCI). As a company with a controlling interest in RCI, the
Company is accounting for RCI using the consolidation method of accounting. The
Company shifted from the equity method of accounting for RCI under FASB
Statement No. 94 in the first and second quarters of 1995 to the consolidation
method because it controls RCI and it is not certain when the Company will cease
to hold a controlling interest in RCI by virtue of a spin-off or otherwise. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
REVENUE RECOGNITION - The Company recognizes revenue during the month in which
services or products are delivered, as follows:
(1) NTC's long distance telecommunications service revenues are generated when
customers make long distance telephone calls from their business or residential
telephones or by using any of NTC's telephone calling cards. Proceeds from
prepaid telephone calling cards are recorded as deferred revenues when the cash
is received, and recognized as revenue as the telephone service is utilized.
The reserve for deferred revenues is carried on the balance sheet as an accrued
7
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1996
liability. Long distance telephone service sales in the fiscal quarter ending
March 31, 1996 totaled $20,273,132.
(2) NTC's marketing-related revenues are derived from programs and material
sold to the Company's base of independent sales representatives, including forms
and supplies, fees for representative and certified trainer renewals, and the
Company's Certified Trainer and Customer Representative programs. The Company
requires that all such services and materials be paid at the time of purchase.
Revenues from marketing-related materials, net of estimated reserves for
refunds, are booked as cash sales when the revenues are received. For the fiscal
quarter ended March 31, 1996, marketing sales totaled $2,653,056.
(3) RCI's optical-related revenues are derived from the sale of the Company's
optical lens manufacturing system and related supplies. Revenues from optical-
related systems and supplies are recognized as sales at the time the products
are shipped to the customer. For the three-month period ending March 31, 1996,
optical product sales totaled $1,136,042
(4) The Company's network service revenues are recognized as sales as the
service is delivered. Network service sales in the fiscal quarter ending March
31, 1996 totaled $337,190.
CONCENTRATION OF CREDIT RISK - The Company sells its telephone and network
services to individuals and small businesses throughout the United States and
does not require collateral. It sells its optical products both domestically
and internationally. Reserves for uncollectible amounts are provided, which
management believes are sufficient.
INVENTORY - Inventory consists of completed optical machines at the RCI
subsidiary and is valued at the lower of cost (weighted average method) or
market.
COMPUTER HARDWARE, FURNITURE AND OFFICE EQUIPMENT - Computer hardware, furniture
and office equipment are stated at cost. Depreciation is provided by the
straight-line method over the assets' estimated useful lives of 5 to 10 years.
COMPUTER SOFTWARE - The Company capitalizes the costs associated with
purchasing, developing and enhancing its computer software. All software costs
are amortized using the straight-line method over the assets' estimated useful
lives of 5 to 10 years
8
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1996
LEASEHOLD IMPROVEMENTS - All leasehold improvements are stated at cost and are
amortized using the straight-line method over the building lease term of 10
years.
NET INCOME PER SHARE - Net income per common share is based on the weighted
average number of common shares and common share equivalents.
ACQUISITION AMORTIZATION - The excess of purchase price over net assets of NTC
has been recorded as an intangible asset and is being amortized by the straight-
line method over twenty years. The excess of purchase price over the value of
patent rights acquired with the purchase of the 51% ownership of RCI has been
recorded as an intangible asset and is being amortized using the straight-line
method over seventeen years.
DEFERRED TAX LIABILITY - Deferred income taxes result from temporary differences
in the basis of assets and liabilities reported for financial statement and
income tax purposes.
USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
3. FUNDING OF MARKETING COMMISSIONS AND DEFERRED INCOME:
The Company's subsidiary, NTC, maintains separate bank accounts for the deposit
of funds related to the reserve of deferred income from the sale of prepaid
calling cards and for the payment of marketing commissions. Funding of these
accounts is adjusted regularly to provide for management's estimates of required
reserve balances. For the marketing commission account, NTC estimates the total
commissions owed to active independent representatives ("IR Earned
Compensation") each week for all monies collected that week due to the efforts
of those active independent representatives. All IR Earned Compensation is then
paid to the independent representatives, when due, directly out of the separate
marketing bank account.
4. NOTES PAYABLE:
Notes payable consist of the following as of March 31, 1996:
9
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1996
Notes payable to founding stockholders of RCI,
interest at 7%, due in July 1996 $1,496,333
Revolving line of credit of RCI, interest at bank reference
rate (approximately 10% at March 31, 1996) 500,000
Convertible notes payable to certain stockholders and officers
of RCI, interest at 8%, due December 31, 1999 253,600
Notes payable to GTE for lease of telephone equipment
with monthly payments through December, 2002 826,985
Other 116,289
----------
$3,193,207
-----------
-----------
5. NETWORK MARKETING COSTS:
During the quarter ending March 31, 1996, NTC's net cost to operate its network
marketing program was $0.7 million as summarized below (in $ millions):
Quarter Ending
March 31, 1996
--------------
Sales $ 2.7
Cost of sales 2.5
Operating expenses for support services .9
----------
Total marketing-related costs 3.4
----------
Net marketing cost $ .7
----------
----------
% of total NTC (long distance & marketing) sales 3.2%
Marketing sales of $2.7 million were generated by the sale of materials,
training and support services to assist NTC independent sales representatives in
selling new retail customers and enrolling other representatives in the NTC
program. Beginning in January, 1996, NTC commenced reserving a portion of all
marketing revenues in order to match the recognition of revenues with the
incurrence of associated marketing support costs. These reserved marketing
revenues are reflected as deferred income on the Company's balance sheet and are
amortized over the succeeding twelve months. The marketing-related costs
include commissions paid to
10
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1996
independent sales representatives for acquiring new retail telephone customers,
as well as the cost of sales materials, salaries and wages of marketing
department personnel, services required to support the independent sales
representatives, and other directly identifiable support costs, but do not
include residual commissions paid on continuing long distance telephone usage or
the typical indirect cost allocations, such as floor-space and supporting
departments. When the marketing-related costs of $3.4 million are compared
against marketing-related revenues of $2.7 million, the result is a net loss in
marketing-related activities of $0.7 million or 3.2% of total NTC sales.
6. COMPENSATION OF INDEPENDENT SALES REPRESENTATIVES:
The Company's subsidiary, NTC, compensates its independent sales representatives
by an earned commission structure based upon signing up new telephone customers
and based upon the telephone usage generated by those customers. In the three
months ended March 31, 1996, expenses associated with commissions, bonuses and
overrides paid out to NTC's independent representatives were $3,449,187.
7. COMMITMENTS AND CONTINGENCIES:
LITIGATION - The Company is a defendant in a class action matter alleging
securities violation with respect to alleged false denial and non-disclosure of
a Securities and Exchange Commission investigation and alleged non-disclosure of
purchases and sales of the Company's stock by an affiliate of the former
Chairman of the Board. Counsel for the company is unable to estimate the
ultimate outcome of this matter and is unable to predict a range of potential
loss. Accordingly, no amounts have been provided for the class action lawsuit
in the accompanying financial statements.
The Company is under investigation by the Securities and Exchange Commission
under a non-public "formal order of private investigation." Management has
furnished all information requested by the Commission and does not believe that
the matter will have a material adverse impact on its financial position or
results of operations.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES:
Overall, the Company achieved slightly positive cash flows of $200,213 during
the first quarter of 1996 resulting from positive cash flows from operations
($1,524,582) and from financing activities ($799,667) which were partially
offset by negative cash flows from investing activities ($2,124,036) as
discussed below:
CASH FLOW FROM OPERATIONS - The Company generated $1,524,582 in positive cash
flow from operations during the first quarter of 1996, compared to $1,742,755 in
positive cash flow from operations during the prior year's comparable period.
This quarter-to-quarter decrease in positive cash flow from operations resulted
primarily from: (1) a $690,128 decrease in profits adjusted for non-cash
expenses, (2) an $893,188 increase in cash generated from the collection of
accounts receivable, and (3) a $809,218 decrease in cash from accelerated
payment of accounts payable.
CASH FLOW FROM INVESTING - The Company generated negative cash flows from
investing activities of $2,124,036 in the first quarter of 1996 and $15,588,661
in the first quarter of 1995. The 1996 negative cash flow resulted primarily
from continuing investment by NTC in plant and equipment to support its
continuing growth in sales. The 1995 negative cash flow resulted primarily
from the Company's purchase of a 51% ownership in RCI on February 8, 1995.
CASH FLOW FROM FINANCING - Positive cash flows from financing activities totaled
$799,667 during the first quarter of 1996 and $6,079,347 during the first
quarter of 1995. The 1996 positive cash flow resulted primarily from NTC
entering into a 7-year lease agreement for the use of telephone switching
equipment for NTC's internal use. The 1995 positive cash flow was generated by
a $9,986,656 increase in notes payable used to acquire a controlling interest in
RCI, $1,066,013 generated by the sale of common stock, and a partially
offsetting outflow of $4,776,638 from the Company's purchase of treasury stock.
RESULTS OF OPERATIONS:
SALES - First quarter, 1996 sales of $24,399,421 increased 29% over the first
quarter, 1995 sales of $18,884,761. The majority of this increase was
attributable to NTC's sales increase to $22,926,189 from $18,537,896 in the
three months ending March 31, 1996 verses 1995,
12
respectively. The following table summarizes the Company's sales performance by
subsidiary and segment during the comparable quarters in 1996 and 1995:
$ in millions
--------------------
Subsidiary Segment 1996 1995
- ----------- --------------------------------------- --------- ---------
NTC Telephone (telecommunications services) $ 20.3 $ 15.5
NTC Telephone (marketing programs) 2.6 3.1
RCI Optical 1.1 --
AutoNETWORK Network 0.3 0.3
--------- ---------
Total Company Sales $ 24.3 $ 18.9
--------- ---------
--------- ---------
COST OF SALES - Total Company cost of sales increased to $15,905,794 or 65% of
sales during the quarter ending March 31, 1996 verses $12,993,483 or 69% of
sales during the comparable prior year quarter. The quarter-to-quarter increase
in costs resulted primarily from increases in carrier costs and sales
commissions associated with increased sales by NTC. The improvement in costs as
a percent of sales was largely generated by improvements in NTC's
telecommunication service gross profits resulting from: 1) lower long-distance
transport costs from NTC's carriers and, 2) improved mix of sales in the higher
profit product lines.
The following table summarizes the Company's quarter-to-quarter changes in two
major cost components:
$ in millions
--------------------
1996 1995
--------- ---------
Commissions paid to NTC independent sales reps $ 3.4 $ 2.4
All other costs of sales 12.5 10.6
--------- ---------
Total Company Cost of Sales $ 15.9 $ 13.0
--------- ---------
--------- ---------
13
NTC's total commission expense increased to $3,449,187 in the first quarter of
1996 compared to $2,430,284 in the same quarter of 1995. The factors causing
this quarter-to-quarter change were increases of $450,678 in residual monthly
sales commissions paid to independent sales representatives on NTC's expanding
telecommunication service revenues and increases of $568,225 in various bonuses
and overrides paid to sales representatives who signed up new telephone service
customers for NTC.
The second cost component shown in the table above is "all other costs of sales"
which represents: (1) NTC's long distance carrier costs, (2) NTC's costs of
producing sales materials for its independent sales representatives, (3) RCI's
costs of producing optical systems and ancillary goods, and (4) AutoNETWORK
costs of providing communications network products and services.
GENERAL & ADMINISTRATIVE - Total general and administrative costs increased to
$6,290,528 or 26% of sales in the quarter ending March 31, 1996 compared to
$3,537,892 or 19% of sales in the same prior year quarter. General and
administrative costs generally include the costs of employee salaries, fringe
benefits, supplies, and related support costs which are required in order to
provide such operating functions as customer service, billing, marketing,
product development, information systems, collections of accounts receivable,
and accounting.
NTC's general and administrative costs increased to 21% of sales in the first
quarter of 1996 from 18% of sales in the first quarter of 1995 in order to: (1)
support its continuing sales growth in 1996 and, (2) build stronger
infrastructure to accommodate still greater sales growth and improved cost
efficiencies in the future. RCI's general and administrative costs in the first
quarter of 1996 represented 98% of sales, thus reflecting the startup nature of
its operations.
DEPRECIATION & AMORTIZATION - Total Company depreciation and amortization
expense increased to $429,222 in the first quarter of 1996 verses $162,101 in
the first quarter of 1995. This increase was caused by greater investment by
NTC in computer hardware and software, furniture and equipment, and leasehold
improvements required to support its rapid expansion in sales.
BAD DEBT EXPENSE - Total Company bad debt expense increased to $1,091,347 in the
first quarter of 1996 compared to $539,179 in the same prior year quarter. The
quarter-to-quarter increase in bad debt was caused primarily by increased
provisioning of NTC's Dial-1 direct billed and LEC billed receivables.
OTHER INCOME & EXPENSE - The Company's other income and expense declined to net
other expense of $68,750 in the first quarter of 1996 verses net other income of
$35,738 during the comparable prior year quarter. This $104,488 net decline was
primarily caused by: (1) $51,201 of interest expense on notes payable by RCI in
1996, and (2) $33,086 of interest income on cash investments by the Company in
1995 which did not recur in 1996.
14
ACQUISITION COSTS & EXPENSES - Acquisition costs increased to $582,471 during
the first three months of 1996 compared to $284,430 during the first three
months of 1995. Virtually the entire increase is due to: (1) a $502,805
increase in patent right amortization expense in 1996 relating to the RCI
acquisition, which was partially offset by (2) a $186,260 decline in the
Company's equity in losses from RCI. These quarter-to-quarter comparisons are
influenced by two factors: (1) the February 8, 1995 acquisition of the 51%
ownership in RCI caused only a prorated amount of costs for the first quarter of
1995 to be reported verses a full quarter of costs in 1996, and (2) the
conversion on July 1, 1995 from the equity method to the consolidated method of
accounting for the RCI acquisition causes 100% of RCI's sales and expenses to be
reported on various lines of the 1996 "Consolidated Statements of Operations"
with a single line elimination of the 49% "Minority Interest," verses the 1995
equity method treatment which reflected the 51% net value of the Company's
"equity in (profit)/loss of unconsolidated subsidiary" as a single line item on
the 1995 "Consolidated Statements of Operations."
MINORITY INTEREST - Beginning on July 1, 1995, the Company converted from the
equity method to the consolidated method of accounting for its 51% ownership in
RCI. As a result, $480,345 or 49% of RCI's losses from January 1 through March
31, 1996 (the "minority interest") was eliminated from the Company's
"Consolidated Statements of Operations" for 1996.
NET INCOME - Total Company net income declined to $417,574 or 1.7% of sales in
the first quarter of 1996 as compared to net income of $1,401,814 or 7.4% of
sales in the same quarter of 1995. The quarter-to-quarter decline in net income
resulted from: (1) significantly higher losses from RCI in 1996 caused by
operating costs incurred to build infrastructure for future sales growth, (2)
significantly higher losses at the Company's headquarters which were caused by
higher legal fees and increased amortization of costs related to the RCI
acquisition, and (3) a moderate decline in NTC profits caused by increased
general and administrative expenses, depreciation and amortization expenses, and
bad debt expenses as discussed above.
15
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION:
The private investigation of the Company which was commenced in August 1994 has
not experienced any material changes from its status as described in "Item 3.
Legal Proceedings" in the Company's Form 10-K for its fiscal year ending
December 31, 1995.
The Company believes that it has provided substantial documentation to the
Commission that verifies the propriety of its business operations and believes
that the ultimate result of the fact-finding investigation will not have a
material adverse effect on the Company's financial condition or results of
operations.
CLASS ACTION AND RELATED LAWSUITS:
The status of the pending class action lawsuits described in "Item 3. Legal
Proceedings" in the Company's Form 10-K for its fiscal year ending December 31,
1995 has not materially changed since the filing of the Form 10-K. A mandatory
status conference with the plaintiffs and other defendant in the case SANDRA
GAYLES; THOMAS COMISKEY, AS TRUSTEE FBO THOMAS COMISKEY, IRA; CHARLES KOWAL;
ARTHUR KALTER; MATTHEW G. HYDE; ARTHUR WIRTH; AND ISABEL SPERBER, VS. SAM D.
SCHWARTZ AND INCOMNET, INC., Case No. CV95-0399 AWT is scheduled for June 8,
1996.
SECTION 16(b) LAWSUIT:
The status of the pending Section 16(b) lawsuit involving Sam D. Schwartz
described in "Item 3. Legal Proceedings" in the Company's Form 10-K for its
fiscal year ending December 31, 1995 has not materially changed since the filing
of the Form 10-K. The Company and Mr. Schwartz are currently reviewing a
proposed settlement agreement which, once agreed upon, will be submitted to
plaintiff's counsel for review in the pending case RICHARD MORALES VS. INCOMNET,
INC. AND SAM D. SCHWARTZ, 96 Civil 0225. While the Company anticipates that
this lawsuit will be settled and provide for the satisfaction of Mr. Schwartz's
Section 16(b) liability to the Company, there is no assurance regarding if and
when such a settlement will be reached.
PATENT INFRINGEMENT LAWSUIT:
The status of the pending patent infringement lawsuit involving Rapid Cast, Inc.
as described in "Item 3. Legal Proceedings" in the Company's Form 10-K for its
fiscal year ending December 31, 1995 has not materially changed since the filing
of the Form 10-K.
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LEGAL ACTION AGAINST PRIOR REPRESENTATIVES:
The status of the pending lawsuit by NTC against certain of its prior
representatives described in "Item 3. Legal Proceedings" in the Company's Form
10-K for its fiscal year ending December 31, 1995 has not materially changed
since the filing of the Form 10-K.
CLAIMS BY PRIOR NOTEHOLDERS:
The status of the settlements of the claims by certain prior noteholders of the
Company described in "Item 3. Legal Proceedings" in the Company's Form 10-K for
its fiscal year ending December 31, 1995 has not materially changed since the
filing of the Form 10-K, except that settlement agreements have now been signed
by all seven prior noteholders, and the Company filed a registration statement
on Form S-3 on May 10, 1996 which includes settlement shares.
POTENTIAL LAWSUITS:
From time to time, the Company is involved in litigation arising from the
ordinary course of business, the ultimate resolution of which management
believes will not have a material adverse effect on the financial condition or
results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES
Item 2 is not applicable for the three months ended March 31, 1996.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Item 3 is not applicable for the three months ended March 31, 1996.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Item 4 is not applicable for the three months ended March 31, 1996.
ITEM 5. OTHER INFORMATION
RETURN OF SHORT SWING PROFITS BY JOEL W. GREENBERG:
On February 29, 1996, the Company delivered a written demand to Joel Greenberg,
the Chairman of the Board of Directors, to pay short swing profits of $46,500 to
the Company pursuant to Section 16(b) of the Exchange Act. The Company expected
the short swing profits to be paid on or before April 29, 1996. As of May 6,
1996, Mr. Greenberg had not paid the short swing profits to the Company. On May
6, 1996, the Company filed a lawsuit in the United States District Court for the
Central District of California against Mr. Greenberg to collect the unpaid short
swing profits pursuant to Section 16(b) of the Securities Exchange Act, as
amended. Pursuant to a proposed settlement agreement to be entered into by the
Company and Mr. Greenberg to be effective as of
17
May 9, 1996, Mr. Greenberg is expected to pay the short swing profits in full
within five (5) business days after the agreement is signed.
PROPOSED SETTLEMENT AGREEMENT WITH JOEL W. GREENBERG:
Effective May 9, 1996, the Company proposes to enter into a settlement agreement
with Joel W. Greenberg pursuant to which Mr. Greenberg is expected to resign as
a director of the Company and its subsidiaries, National Telephone &
Communications, Inc. and Rapid Cast, Inc. Mr. Greenberg was not nominated by the
Board of Directors to stand for reelection as a director of the Company because
of disagreements it had with him regarding compensation for the Chairman
position and certain other unresolved issues. Under the proposed settlement
agreement, which is expected to be executed in the near future, Mr. Greenberg
has agreed not to solicit proxies from shareholders of the Company's common
stock for any purpose, engage in a proxy election contest, assert control or
become an affiliate of the Company for a period of eight years. Furthermore, Mr.
Greenberg is expected to agree to release the Company from all claims and to pay
short swing profits of $46,500 plus interest to the Company pursuant to Section
16(b) of the Securities Exchange Act of 1934, as amended. In consideration for
these covenants and payments, the Company intends to agree to (a) grant to Mr.
Greenberg options to purchase 75,000 shares at an exercise price of $5.37 per
share vesting on May 9, 1996 and expiring on May 9, 2001, (b) grant to Mr.
Greenberg warrants to purchase 100,000 shares at $6.00 per share and 50,000
shares at $7.00 per share, vesting when the Company's stock trades for a price
of $6.00 per share and $7.00 per share, respectively, for a period of 20 trading
days during any 40 consecutive trading day period and expiring on May 9, 2001,
(c) file a registration statement covering the shares issued upon the exercise
of the warrants within 90 days after the warrants are exercised, (d) include
the 75,000 newly issued stock options in the Company's 1996 Stock Option Plan
being presented to the shareholders for ratification at its annual meeting of
the shareholders scheduled for June 14, 1996, (e) indemnify Mr. Greenberg to
the extent permitted by the California Corporations Code, subject to certain
conditions, for claims which may be made for events occurring while
Mr. Greenberg served as a director of the Company, and (f) release
Mr. Greenberg from indemnified claims. The newly issued stock options and
warrants are nontransferable, except to Mr. Greenberg's heirs in the event
of his death, and subject to cancellation if the settlement agreement is
breached by Mr. Greenberg. The stock options and warrants are expected to
have provisions for proportionate adjustment in the event of stock splits,
reverse stock splits, stock dividends or similar recapitalizations or
reorganizations by the Company. The exercisability of the warrants will
accelerate in the event of a merger, sale of all or substantially all of the
assets of the Company, or other similar extraordinary transaction by the
Company.
The basic terms of the settlement agreement have been discussed by the parties,
but the final version is subject to negotiation and execution. The Company
expects the settlement agreement to be signed in the near future. There is no
assurance, however, that a final settlement agreement will be made with Mr.
Greenberg.
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LOAN TO COMPANY BY MELVYN REZNICK:
On February 2, 1996, Melvyn Reznick, the Company's President, Chief Executive
Officer and a director, arranged for a line of credit under his personal
guarantee to be made available to the Company in the amount up to $750,000 from
a bank in Los Angeles, CA. The line of credit may be expanded to $1,000,000 in
the future. When the line is drawn, the loans are made to Mr. Reznick and Mr.
Reznick subsequently advances the funds to the Company on the same terms and
conditions. As of April 26, 1996, the line of credit has been drawn down by
$515,000. The proceeds of the line of credit are being used to make the
Company's pro rata share of a short term $1,000,000 advance made to Rapid Cast,
Inc., by its shareholders to finance the manufacture and shipment of FastCast-
TM- LenSystem machines to customers to fill orders. The advance is expected to
be repaid upon completion of a private or public equity financing of Rapid Cast,
Inc. in 1996, or within one year of the advance, whichever occurs first. In
addition to repayment of the advance with monthly interest at the rate of 10%
per annum, the Company is being issued warrants to purchase 510,000 shares of
Rapid Cast, Inc. at a price of $2.25 per share, exercisable at any time during
the next seven years.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
INDEX TO EXHIBITS:
Exhibits designated by the symbol * are filed with this Quarterly Report on From
10-Q. All exhibits not so designated are incorporated by reference to a prior
filing as indicated.
EXHIBIT NO. DESCRIPTION
There are no exhibits for the three months ended March 31, 1996.
REPORTS OF FORM 8-K, FILED IN 1996
20.1 Report on Form 8-K - Agreement with National Telephone & Communications,
Inc. (NTC) for incentive stock option program and for a public offering of
NTC's stock dated February 6, 1996 and filed on February 9, 1996.
20.2 Report on Form 8-K - Decision Not to Renominate Joel W. Greenberg To Stand
For Election To The Company's Board of Directors, dated April 26, 1996 and
filed on April 29, 1996.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INCOMNET, INC.
Date: May 15, 1996 /S/ MELVYN REZNICK
----------------------
Melvyn Reznick
President & CEO
Date: May 15, 1996 /S/ RICHARD A. MARTING
----------------------
Richard A. Marting
Vice President of Finance and
Administration (NTC)
20