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 SEPTEMBER 30, 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
November 4, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . .13,294,764
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
September 30, December 31,
1996 1995
(unaudited) (audited)
----------- ---------
CURRENT ASSETS:
Cash & cash equivalents $ 1,616,616 $ 1,644,968
Accounts receivable, less allowance for doubtful
accounts of $5,314,941 at September 30, 1996 and
$3,154,241 at December 31, 1995 12,549,605 12,177,257
Notes receivable - current portion 169,121 102,594
Notes receivable from officers & shareholders -
net of reserves of $1,265,365 at September 30, 1996 and
$208,800 at December 31, 1995 152,540 863,440
Inventories 2,748,002 1,646,829
Prepaid expenses and other 2,571,877 1,197,245
------------- -------------
Total current assets 19,807,761 17,632,333
------------- -------------
PLANT AND EQUIPMENT:
Computer hardware & software 6,503,356 5,113,588
Furniture & office equipment 3,306,391 1,878,439
Leasehold improvements 6,221,127 4,133,885
------------- -------------
Total plant & equipment (gross) 16,030,874 11,125,912
Less accumulated depreciation (3,344,064) (1,979,858)
------------- -------------
Total plant & equipment (net) 12,686,810 9,146,054
------------- -------------
OTHER ASSETS:
Excess of purchase price over net assets of NTC, less
accumulated amortization of $1,163,825 at
September 30, 1996 and $941,644 at December 31, 1995 4,616,429 4,838,610
Patent rights from the acquisition of RCI,
less accumulated amortization of $3,950,404 at
September 30, 1996 and $2,019,233 at December 31, 1995 31,854,215 41,688,844
Investment in Lab Tech 65,000 130,725
Investment in marketable securities 190,714 190,714
Notes receivable - long term -- 155,000
Deposits and other 343,114 323,349
------------- -------------
Total other assets 37,069,472 47,327,242
------------- -------------
Total assets $ 69,564,043 $ 74,105,629
------------- -------------
------------- -------------
See accompanying "Notes to Consolidated Financial Statements."
2
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY
September 30, December 31,
1996 1995
(unaudited) (audited)
----------- ---------
CURRENT LIABILITIES:
Accounts payable $ 11,009,170 $ 8,783,797
Accrued expenses 4,555,887 3,686,661
Current portion of notes payable 4,158,969 2,530,886
Deferred income 1,718,769 1,190,474
------------- -------------
Total current liabilities 21,442,795 16,191,818
------------- -------------
LONG-TERM LIABILITIES:
Notes Payable 651,419 9,622
Deposits & other 1,200 1,100
Deferred tax liability (net) 8,055,562 8,449,050
------------- -------------
Total long-term liabilities 8,708,181 8,459,772
------------- -------------
Total liabilities 30,150,976 24,651,590
------------- -------------
MINORITY INTEREST 4,998,099 6,905,983
------------- -------------
SHAREHOLDERS' EQUITY:
Common stock, no par value; 20,000,000 shares
authorized; issued and outstanding 13,294,764
shares at September 30,1996 and 13,262,648
shares at December 31, 1995 61,019,979 60,883,892
Preferred stock 300,000 --
Treasury stock (5,491,845) (5,491,845)
Accumulated deficit (21,413,166) (12,843,991)
------------- -------------
Total shareholders' equity 34,414,968 42,548,056
------------- -------------
Total liabilities, minority interest & shareholders' equity $ 69,564,043 $ 74,105,629
------------- -------------
------------- -------------
See accompanying "Notes to Consolidated Financial Statements."
3
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30,
1996 1995
---- ----
SALES $ 27,591,284 $ 22,660,377
------------- -------------
OPERATING COSTS & EXPENSES:
Cost of sales 17,777,193 15,733,118
General & administrative 8,253,785 4,953,698
Depreciation & amortization 501,787 475,023
Bad debt expense 1,291,763 636,166
Other (income)/expense 10,031,605 11,793
------------- -------------
Total operating costs and expenses 37,856,133 21,809,798
------------- -------------
ACQUISITION COSTS & EXPENSES:
NTC acquisition - goodwill amortization 74,060 69,530
RCI acquisition - patent rights amortization 571,137 301,677
RCI acquisition - interest and legal 375 19,760
------------- -------------
Total acquisition costs & expenses 645,572 390,967
------------- -------------
Income/(loss) before income taxes,
extraordinary items & minority interest (10,910,421) 459,612
INCOME TAXES (866,387) 77,408
------------- -------------
Income/(loss) before extraordinary items & minority interest (10,044,034) 382,204
EXTRAORDINARY ITEMS -- --
MINORITY INTEREST 781,273 182,641
------------- -------------
Net income/(loss) $ (9,262,761) $ 564,845
------------- -------------
------------- -------------
INCOME PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS:
Income before extraordinary items $ (0.70) $ 0.04
Extraordinary items -- --
------------- -------------
Net income/(loss) $ (0.70) $ 0.04
------------- -------------
------------- -------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES FOR 1996 AND
COMMON SHARES AND COMMON SHARE EQUIVALENTS OUTSTANDING FOR 1995 13,244,674 13,566,743
------------- -------------
------------- -------------
See accompanying "Notes to Consolidated Financial Statements."
4
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
1996 1995
---- ----
SALES $ 77,295,795 $ 62,123,548
------------- -------------
OPERATING COSTS & EXPENSES:
Cost of sales 49,144,359 42,697,385
General & administrative 22,082,445 12,341,173
Depreciation & amortization 1,395,905 850,616
Bad debt expense 3,828,784 1,773,324
Other (income)/expense 10,202,087 (46,534)
------------- -------------
Total operating costs and expenses 86,653,580 57,615,964
------------- -------------
ACQUISITION COSTS & EXPENSES:
NTC acquisition - goodwill amortization 222,181 208,590
RCI acquisition - patent rights amortization 1,603,409 520,059
RCI acquisition - interest and legal 18,946 98,482
RCI acquisition - equity in (profit)/loss of
unconsolidated subsidiary -- 107,841
------------- -------------
Total acquisition costs & expenses 1,844,536 934,972
------------- -------------
Income/(loss) before income taxes,
extraordinary items & minority interest (11,202,321) 3,572,612
INCOME TAXES (679,580) 286,120
------------- -------------
Income/(loss) before extraordinary items & minority interest (10,522,741) 3,286,492
EXTRAORDINARY ITEMS -- --
MINORITY INTEREST 1,907,933 182,641
------------- -------------
Net Income/(loss) $ (8,614,808) $ 3,469,133
------------- -------------
------------- -------------
INCOME PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS:
Income before extraordinary items $ (0.65) $ 0.28
Extraordinary items -- --
------------- -------------
Net income/(loss) $ (0.65) $ 0.28
------------- -------------
------------- -------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES FOR 1996
AND COMMON SHARES AND COMMON SHARE EQUIVALENTS OUTSTANDING
FOR 1995 13,268,050 12,435,930
------------- -------------
------------- -------------
See accompanying "Notes to Consolidated Financial Statements."
5
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
1996 1995
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
After tax profit $ (10,522,637) $ 3,286,495
Depreciation & amortization - operations 1,395,905 850,616
Depreciation & amortization - acquisitions 1,825,590 728,649
------------- -------------
Net cash inflow/(outflow) from operating activities (7,301,142) 4,865,760
------------- -------------
CASH FLOWS FROM (INCREASE)/DECREASE IN OPERATING ASSETS:
Accounts receivable (372,344) (3,495,522)
Notes receivable - current portion (66,527) --
Notes receivable - due from officers and shareholders 710,900 --
Inventories (1,101,172) (740,872)
Prepaid expenses & other (1,374,632) (510,417)
Notes receivable - long term 155,000 --
Deposits & other (19,765) (200,818)
------------- -------------
Net cash inflow/(outflow) from changes in
operating assets (2,068,540) (4,947,629)
------------- -------------
CASH FLOWS FROM INCREASE/(DECREASE) IN OPERATING LIABILITIES:
Accounts payable 2,225,371 2,085,019
Accrued expenses 869,227 1,326,349
Deferred income 528,295 402,770
------------- -------------
Net cash inflow/(outflow) from changes in operating 3,622,893 3,814,138
liabilities ------------- -------------
Net cash inflow/(outflow) from operations (5,746,789) 3,732,269
------------- -------------
CASH FLOWS FROM (INCREASE)/DECREASE IN INVESTING ACTIVITIES:
Acquisition of plant & equipment (5,158,842) (6,507,819)
Patents/intangible assets (162,267) (65,393)
Investment in Lab Tech 65,725 (130,725)
Investment in marketable securities -- (35,914)
Investment in RCI -- (20,283,459)
Goodwill from acquisition of NTC 222,181 69,530
Goodwill from acquisition of RCI 8,000,000 --
------------- -------------
Net cash inflow/(outflow) from investing activities 2,966,797 (26,953,780)
------------- -------------
See accompanying "Notes to Consolidated Financial Statements."
6
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, (CONT'D)
1996 1995
---- ----
CASH FLOWS FROM INCREASE/(DECREASE) IN FINANCING ACTIVITIES:
Bank overdraft -- (56,770)
Minority interest -- (7,252,641)
Notes payable - current 3,145,842 674,052
Sale of common stock, net 435,945 29,101,901
Treasury stock (447,858) (4,776,638)
Notes payable - long term (875,862) --
Paid-in capital -- (40,000)
Prior period adjustment to retained earnings 45,578 96,004
Adjustment to retained earnings - not related to operations 448,000 --
Change in valuation allowance -- (189,086)
------------- -------------
Net cash inflow/(outflow) from financing activities 2,751,645 17,556,822
------------- -------------
Net cash inflow/(outflow) from investing & financing 5,718,442 (9,396,958)
------------- -------------
Net increase/(decrease) in cash & cash equivalents $ (28,347) $ (5,664,689)
------------- -------------
------------- -------------
See accompanying "Notes to Consolidated Financial Statements."
7
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30,1996
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 September 30, 1996, and the results of operations for the three
and nine months ended September 30, 1996 and 1995, and cash flows for the nine
months ended September 30, 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
liability. Long distance telephone service sales in the three and nine months
ending September 30, 1996 totaled $21,107,008 and $61,586,218, respectively.
8
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30,1996
(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 three
and nine months ending September 30, 1996, marketing sales totaled $4,783,550
and $10,901,767, respectively.
(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 and nine month periods ending
September 30, 1996, optical product sales totaled $1,440,138 and $3,846,190,
respectively.
(4) The Company's network service revenues are recognized as sales as the
service is delivered. Network service sales in the three and nine months ending
September 30, 1996 totaled $360,587 and $1,061,621, respectively.
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 primarily 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.
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.
9
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30,1996
NET INCOME PER SHARE - Net income per common share is based on the weighted
average number of common shares for 1996, and common shares and common share
equivalents for 1995.
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 payment
of marketing commissions. Funding of these accounts is adjusted regularly to
provide for management's estimates of required reserve balances. 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
bank account.
10
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30,1996
4. NOTES PAYABLE:
Notes payable consist of the following as of September 30, 1996:
Notes payable to founding stockholders of RCI,
interest at 7%, due in July 1996 $1,267,842
Notes payable to certain stockholders of RCI,
interest at 10%, due December 31, 1996 1,214,622
Revolving line of credit of RCI, interest at bank reference
rate (approximately 10% at September 30, 1996) 500,000
Convertible notes payable to certain stockholders and officers
of RCI, interest at 8%, due in December 31, 1999 321,600
Notes payable to bank by parent company, invested in RCI,
interest at bank reference rate (approximately 9.75%
at September 30, 1996) 696,996
Note payable by NTC to GTE for lease of telephone equipment
with monthly payments through December, 2002 740,864
Other 68,464
----------
Total Notes Payable $4,810,388
----------
----------
5. NETWORK MARKETING COSTS:
During the three and nine months ending September 30, 1996, NTC's net costs to
operate its network marketing program were a breakeven and $1.3 million,
respectively, as summarized below (in $ millions):
11
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30,1996
3 Months Ending 9 Months Ending
September 30,1996 September 30,1996
----------------- -----------------
Sales $ 4.7 $ 10.8
-------- --------
Cost of sales 3.6 9.1
Operating expenses for support services 1.1 3.0
-------- --------
Total marketing-related costs 4.7 12.1
-------- --------
Net marketing cost $ 0.0 $ 1.3
-------- --------
-------- --------
% of total NTC (long distance
& marketing) sales 0.0% 1.8%
Marketing sales of $4.7 million and $10.8 million, during the three and nine
month periods ending September 30, 1996, respectively, 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 provide a fund from
which to draw estimated future refunds of marketing proceeds. 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 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 three and
nine month marketing-related costs of $4.7 million and $12.1 million,
respectively, are compared against marketing-related revenues of $4.7 million
and $10.8 million for the same periods, the result is a breakeven in marketing-
related activities during the three months and a net loss in marketing related
activities during the nine months of $1.3 million or 0.0% and 1.8% of total NTC
sales, respectively.
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
and nine months ending September 30, 1996, expenses associated with commissions,
bonuses and overrides paid out to NTC's independent representatives were
$4,994,396 and $12,286,754, respectively.
7. COMMITMENTS AND CONTINGENCIES:
12
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30,1996
Litigation - The Company is a defendant in a class action matter and related
lawsuits alleging securities law violations 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 these matters
and is unable to predict a range of potential loss. Accordingly, no amounts
have been provided for the class action or related lawsuits 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.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES:
Overall, the Company achieved slightly negative cash flows of $28,347 during the
first nine months of 1996 resulting from negative cash flows from operations
($5,746,789) which were almost entirely offset by positive cash flows from
investing ($2,966,797) and from financing activities ($2,751,645) as discussed
below:
CASH FLOW FROM OPERATIONS - The Company generated $5,746,789 in negative cash
flow from operations during the first nine months of 1996, compared to
$3,732,269 in positive cash flow from operations during the prior year's
comparable period. This year-to-year decrease in cash flow from operations
resulted primarily from: (1) a $12,166,902 decrease in profits adjusted for non-
cash expenses, (2) a $3,123,178 increase in cash generated from the collection
of accounts receivable, (3) a $140,352 increase in cash from increased use of
accounts payable, (4) a $457,122 decrease in cash from a reduction in accrued
expenses, (5) a $360,300 decrease in cash generated by increased investment in
inventory, primarily at the company's Rapid Cast subsidiary, and (6) a $710,900
increase in cash generated from decreased investment in notes receivable due
from officers and shareholders.
CASH FLOW FROM INVESTING - The Company generated positive cash flows from
investing activities of $2,966,797 in the first nine months of 1996 and
$26,953,780 in the first nine months of 1995. The 1996 positive cash flow
resulted primarily from an $8,000,000 devaluation of the Company's investment in
RCI which was partially offset by 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 $2,751,645 during the first nine months of 1996 and $17,556,822
during the first nine months of 1995. The 1996 positive cash flow resulted
primarily from RCI entering into various loan agreements to finance the
building of infrastructure to support its anticipated future sales growth.
In September 1996, the Company also raised $365,000 from the sale of 365 shares
of 2% convertible preferred stock, and raised an additional $2,075,000 in
October 1996 through the placement of additional shares of 2% convertible
preferred stock. The Company paid aggregate referral fees equal to
approximately 5% of the capital raised from the placement of the 2%
convertible preferred stock. The 1995 positive cash flow was generated by a
$29,101,901 sale of common stock, which was partially offset by an outflow of
$4,776,638 from the Company's purchase of treasury stock.
14
RESULTS OF OPERATIONS:
SALES - Third quarter, 1996 sales of $27,591,284 increased 22% over the third
quarter, 1995 sales of $22,660,377. The majority of this increase was
attributable to NTC's sales increase to $25,790,559 from $21,381,603 in the
three months ending September 30, 1996 verses 1995, respectively. The following
table summarizes the Company's sales performance by subsidiary and segment
during the comparable third quarters in 1996 and 1995:
$ in millions
------------------
Subsidiary Segment 1996 1995
- ------------ --------------------------------------- -------- --------
NTC Telephone (telecommunications services) $ 21.1 $ 17.5
NTC Telephone (marketing programs) 4.7 3.9
RCI Optical 1.4 0.9
AutoNETWORK Network 0.4 0.4
-------- --------
Total Company Sales $ 27.6 $ 22.7
-------- --------
-------- --------
COST OF SALES - Total Company cost of sales increased to $17,777,193 or 64% of
sales during the quarter ending September 30, 1996 verses $15,733,118 or 69% of
sales during the comparable prior year quarter. The quarter-to-quarter increase
in cost of sales resulted largely from two factors. The first factor in the
increasing cost of sales was the increase in carrier costs associated with
increased telephone service sales by NTC. A second factor was a rapid rise in
RCI costs of sales. 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) continuing improvements in the mix of sales in the higher profit
product lines.
The following table summarizes the Company's changes in three major cost
components for the third quarter:
$ in millions
--------------------
1996 1995
---------- ---------
Commissions paid to NTC independent sales reps $ 5.0 $ 4.4
Carrier costs for NTC's long distance telephone service 11.0 10.3
All other costs of sales 1.8 1.0
--------- ---------
Total Company Cost of Sales $ 17.8 $ 15.7
--------- ---------
--------- ---------
NTC's total commission expense increased to $4,994,396 in the third quarter of
1996 compared to $4,381,233 in the same quarter of 1995. NTC's carrier costs to
deliver long distance telephone service to its telephone customers increased to
$10,993,771 in the third quarter of 1996 compared to $10,331,142 in the third
quarter of 1995. This increase in carrier costs reflects the
15
year-to-year growth in telephone sales, although these costs have grown at a
slower pace than sales, thus reflecting improvements in overall telephone gross
profits.
The third cost component shown in the table above is "all other costs of sales"
which represents: (1) NTC's costs of producing sales materials for its
independent sales representatives, (2) RCI's costs of producing optical systems
and ancillary goods, and (3) AutoNETWORK costs of providing communications
network products and services.
GENERAL & ADMINISTRATIVE - Total general and administrative costs increased to
$8,253,785 or 30% of sales in the quarter ending September 30, 1996 compared to
$4,953,698 or 22% 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 25% of sales in the third
quarter of 1996 from 19% of sales in the third quarter of 1995. This increase
was caused largely by: (1) increases in fees paid to local exchange carriers
(LEC's) to process NTC's billing and collection of its LEC-billed long distance
telephone service, and (2) increases in compensation and fringe benefits
expended as NTC continues to build infrastructure to support anticipated future
sales growth. RCI's general & administrative costs increased to 92% of sales in
the third quarter of 1996 from 76% of sales in the third quarter of 1995, thus
continuing to reflect the startup nature of its operations.
DEPRECIATION & AMORTIZATION - Total Company depreciation and amortization
expense was $501,787 in the third quarter of 1996 verses $475,023 in the third
quarter of 1995. This increase was caused by continuing investment by NTC in
computer hardware and software, furniture and equipment, and leasehold
improvements required to support its anticipated expansion in sales.
BAD DEBT EXPENSE - Total Company bad debt expense increased to $1,291,763 in the
third quarter of 1996 compared to $636,166 in the same prior year quarter. The
quarter-to-quarter increase in bad debt was caused primarily by increased
provisioning of NTC's LEC billed receivables.
OTHER INCOME & EXPENSE - The Company's other income and expense deteriorated to
net other expense of $10,051,243 in the third quarter of 1996 verses net other
expense of $11,793 during the comparable prior year quarter. This $10,039,450
net deterioration was primarily caused by: (1) an $8,000,000 reserve to devalue
the Company's investment in RCI, and (2) a $2,000,000 reserve at the company's
headquarters for settlement costs associated with claims by officers.
ACQUISITION COSTS & EXPENSES - Acquisition costs increased to $645,572 during
the third quarter of 1996 compared to $390,967 during the third quarter of 1995.
This increase was primarily caused by a reclassification of RCI's patent
amortization which is categorized in 1996 as an
16
acquisition cost and was categorized in 1995 as amortization from
operations. If the 1995 third quarter acquisition costs and expenses were
restated to include RCI's patent amortization, the restated total Company
acquisition costs and expenses would equal $593,721, thus reflecting a $51,851
increase in 1996 third quarter acquisition costs and expenses verses prior year.
This increase was caused by higher costs of monthly patent amortization by RCI
in 1996 than in 1995.
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, 49% (the "minority interest")of RCI's losses during the three
months ending September 30, 1995 and during the three months and nine months
ending September 30, 1996 has been eliminated from the Company's "Consolidated
Statements of Operations" for 1996 and 1995. The increase in the minority
interest elimination from $182,641 to $781,273 during the third quarters of 1995
verses 1996, respectively, reflects the same year-to-year percentage (49%) of
RCI's increase in losses.
NET INCOME - Total Company net income declined to a loss of $9,262,761 or 33.6%
of sales in the third quarter of 1996 as compared to net income of $564,845 or
2.5% of sales in the same quarter of 1995. The quarter-to-quarter decline in
net income resulted from: (1) higher losses from RCI in 1996 caused by
significantly increased operating costs incurred to build infrastructure for
future potential sales growth, and (2) higher losses at the Company's
headquarters which were caused by the establishment of reserves for devaluation
of the Company's investment in RCI and the establishment of reserves for
settlement costs.
17
PART II - OTHER INFORMATION
The following are cautionary statements pursuant to the Private Securities
Litigation Reform Act of 1995 in order for the Company to avail itself of the
"safe harbor" provisions of the Reform Act. The discussions and information in
this report may contain both historical and forward-looking statements. To the
extent that the report contains forward-looking statements regarding the
financial condition, operating results, business prospects or any other aspect
of the Company and its subsidiaries, please be advised that the Company's and
its subsidiaries' actual financial condition, operating results and business
performance may differ materially from that projected or estimated by the
Company in forward-looking statements. The differences may be caused by a
variety of factors, including but not limited to adverse economic conditions,
intense competition, including intensification of price competition and entry of
new competitors and products, adverse federal, state and local government
regulation, inadequate capital, unexpected costs and operating deficits,
increased general and administrative costs, lower sales and revenues than
forecast, loss of customers, disadvantageous currency exchange rates,
termination of contracts, loss of supplies, technological obsolescence of the
Company's products, price increases for supplies and components, inability to
raise prices, failure to obtain new customers, litigation and administrative
proceedings involving the Company, including the pending class action and
related lawsuits and SEC investigation, adverse publicity and news coverage,
inability to carry out marketing and sales plans, challenges to the Company's
patents, loss or retirement of key executives, changes in interest rates,
inflationary factors, and other specific risks that may be alluded to in this
report or in other reports issued by the Company.
ITEM 1. LEGAL PROCEEDINGS
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION:
The investigation of the Company by the SEC, 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 continues to believe that it has provided substantial documentation
to the Commission that demonstrates the propriety of its business operations and
that the ultimate result of the investigation will not have a material adverse
effect on the Company's financial condition or results of operations.
CLASS ACTION AND RELATED LAWSUITS:
18
The status of the pending class action lawsuit described in "Item 3. Legal
Proceedings" in the Company's Form 10-K for its fiscal year ending December 31,
1995, SANDRA GAYLES, ET AL. VS. SAM D. SCHWARTZ AND INCOMNET, INC., Case No.
CV95-0399 KMW (BQRx), has not materially changed since the filing of the Form
10-K, other than a trial date in July 1997 was established. The case currently
remains in the discovery phase and the parties have engaged in preliminary
settlement discussions.
The status of the pending lawsuit entitled BRENT ABRAHM, ET AL. VS. INCOMNET,
INC., SAM SCHWARTZ AND KALIBER MANAGEMENT CORPORATION, Civil Action No. 96-5325
RSL (AJW), has not materially changed since the filing of the Company's Form 10-
K for its fiscal year ending December 31, 1995, except that it has been
transferred from the Northern District of Georgia to the Central District of
California, the same district court in California which is presiding over the
pending class action lawsuit and the case HERBERT M. SCHWARTZ ET AL. VS.
INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT CORPORATION, CV 96-0776
KMW (BQRx), and Company has answered the complaint. A trial date in January
1997 has been set in the HERTBERT SCHWARTZ case. The parties in the HERBERT
SCHWARTZ AND ABRAHM lawsuits are currently in the process of finalizing a
settlement of the lawsuits, although there can be no assurance that the
settlement will completed.
On July 22, 1996, the Company was served with a complaint in the lawsuit CHARLES
STEVENS VS. SAM D. SCHWARTZ AND INCOMNET, INC., Civil Action No. 96-4906 RMT
(VAPx), filed in the United States District Court for the Central District of
California, Western Division. The complaint alleges that the Company and its
former Chairman, Sam D. Schwartz, violated Section 10(b) and Rule 10b-5 of the
Securities Exchange Act of 1934, as amended, and Section 25400 of the California
Corporations Code, as a result of false and misleading statements made by
defendants and undisclosed trading in the Company's stock engaged in by Mr.
Schwartz and his affiliates. The claims are similar to those made in the
pending class action lawsuit and are expected to be defended by the Company in
the same manner. The parties are currently engaging in settlement discussions,
although there can be no assurance that a settlement will be reached.
The Company has been served with a complaint in the lawsuit entitled SILVA
RUN WORLDWIDE LIMITED VS. INCOMNET, INC., SAM D. SCHWARTZ, BEAR STEARNS &
CO., INC., LESLIE SOLMONSON, RONALD F. SEALE, MARINER RESERVE FUND, COMPANIA
DI INVESTIMENTO ANTILLIANO, COUTTS & CO. AG, SALVATORE M. FRANZELLA, PETER G.
EMBIRICOS, AND JOS SCHUETZ, filed in the United States District Court for the
Southern District of New York. The complaint states that the plaintiff was a
purchaser of the Company's stock in July 1995. The complaint alleges that
the Company and its former Chairman, Sam D. Schwartz, violated Sections 10(b)
and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended,
and committed common law fraud, as a result of false and misleading
statements made by the defendants and undisclosed trading in the Company's
stock engaged in by Mr. Schwartz and his affiliate. The plaintiff also
19
alleges that Mr. Schwartz and his affiliate owed a fiduciary duty to the
plaintiff that was breached by their conduct. The complaint also alleges other
causes of action against other unrelated defendants. The Company's response to
the complaint is due on November 20, 1996.
SECTION 16(b) LAWSUIT:
In the pending case RICHARD MORALES VS. INCOMNET, INC. AND SAM D. SCHWARTZ, 96
Civil 0225, the Company and Sam D. Schwartz entered into a settlement agreement
on June 7, 1996 for the payment of short-swing profits totalling approximately
$2,128,424 plus accrued interest of approximately $180,000, based ONLY on
transactions which had been reported to the Securities and Exchange Commission.
The Company reserved the right to assert additional claims against Mr. Schwartz
for short-swing profits resulting from undisclosed transactions in the Company's
stock which may subsequently be discovered. In the settlement agreement, Mr.
Schwartz represented and warranted that the transactions reported by him to the
date of the settlement agreement were all of the transactions in the Company's
stock engaged in by Mr. Schwartz and his affiliates. Soon after the execution
of the settlement agreement and before it was submitted to the court for
approval, additional unreported transactions in the Company's stock by Mr.
Schwartz and his affiliates were discovered. As a result of this discovery, the
Company is conducting an expanded investigation of Mr. Schwartz's trading
activities. As soon as the investigation is complete, the amount of short-swing
profits will be re-computed and a demand for payment of the profits plus
interest will be made on Mr. Schwartz. In early July 1996, Mr. Schwartz
deposited 800,000 shares of his Incomnet stock into a court-approved escrow
account with the Company's New York counsel as security for his obligation to
pay short-swing profits. On July 29, 1996, the Company demanded in writing the
deposit of an additional 400,000 shares by Mr. Schwartz into the escrow account
to secure his obligation. The Company's demand was rejected. While the Company
anticipates that this lawsuit will be settled providing 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. The case has not settled, although
settlement discussions are underway. There are no assurances the case will be
settled.
LEGAL ACTION AGAINST PRIOR REPRESENTATIVES:
20
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 and in "Item 1. Legal Proceedings" in
the Company's Form 10-Q for the quarter ended June 30, 1996, has not materially
changed, except that the Company's registration statement on Form S-3 covering
the settlement shares was declared effective on October 31, 1996. The aggregate
number of additional settlement shares issuable to the prior noteholders is
74,917.
POTENTIAL LAWSUITS:
There is no assurance that claims similar to those asserted in the pending class
action and related lawsuits, or other claims, will not be asserted against the
Company by new parties in the future. In this regard, potential plaintiffs have
from time to time orally asserted claims against the Company and its prior
directors. If such claims are filed as legal complaints, the Company will seek
to have them consolidated with other pending lawsuits, if appropriate, or will
defend them separately. From time to time, the Company is also 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 September 30, 1996.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Item 3 is not applicable for the three months ended September 30, 1996.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of shareholders on July 29, 1996. At the
annual meeting, the shareholders elected the following persons as directors of
the Company, to serve until the next annual meeting of shareholders: Melvyn
Reznick, as Chairman of the Board of Directors, Nancy Zivitz and Albert
Milstein. Gerald Katell was also elected, but declined to serve. See "Item 5.
Other Information - Nominated Director Declines To Serve" in this report. The
shareholders also ratified the appointment of Stonefield Josephson as the
Company's auditors
21
and independent certified public accounting firm, and the adoption of the
Company's Stock Option Plan for its employees, officers, directors and key
consultants, as described in the Company's Proxy Statement for the 1996 Annual
Meeting of the Shareholders of Incomnet, Inc., dated July 29, 1996.
ITEM 5. OTHER INFORMATION
AGREEMENT WITH NTC MANAGEMENT
In November 1996, the Company entered into an amended and restated management
incentive agreement with the management of National Telephone & Communications,
Inc., ("NTC"). Pursuant to the amended management incentive agreement, the
Company and NTC established that the total issued and outstanding capital stock
of NTC is 10 million shares, all of which is owned by the Company. The Company
also agreed to spin off one million shares of NTC's issued and outstanding
common stock to the Company's shareholders. The Company has filed a no action
request with the Securities and Exchange Commission (SEC) to implement the spin-
off. While the Company plans for the spin-off to take place in the first
quarter of 1997, there is no assurance regarding the timing of the spin-off, or
that the SEC will issue a no action letter in response to the Company's request.
As in the original NTC management incentive agreement, dated February 7, 1996,
NTC has agreed to seek a firm commitment underwriting by a reputable regional or
national investment banking firm during 1997, pursuant to which it plans to sell
new shares in number up to 20% of its total issued and outstanding stock at the
time of the public offering, including shares sold in the public offering. The
public offering of new NTC shares, if it occurs, is expected to occur subsequent
to the spin-off. The Company agreed to sell a portion of its shares in the NTC
public offering, if the underwriter so requires, representing up to an
additional 10% (i.e. 1.25 million shares) of NTC's outstanding shares, after
taking into account the public offering. There is no assurance as to when or if
NTC will make a public offering of its stock, or when the spin-off will occur.
Pursuant to the amended NTC management incentive agreement, the Company agreed
to the following restrictions and conditions with respect to its ownership of
NTC shares: (1) The Company will not spin-off, sell, pledge, hypothecate or
otherwise dispose of more than 20% of NTC's then issued and outstanding shares
prior to the earlier of January 1, 1998 or the date of NTC's initial public
offering; (2) the Company will not spin-off, sell, pledge, hypothecate or
otherwise dispose of more than 10% of NTC's then issued and outstanding shares
to any single person or entity, or affiliated persons or entities; (3) the
Company will not sell more than 5% of NTC's then issued and outstanding shares
without giving NTC a 30-day right of first refusal to purchase the shares on the
same terms and conditions; (4) subsequent to NTC's initial public offering, the
Company will not sell, pledge, hypothecate or otherwise dispose of more than one
million shares of NTC in 1997 and one million shares of NTC in 1998 without the
prior written
22
consent of NTC, and (5) through December 31, 1998, the Company will coordinate
with NTC and NTC will coordinate with the Company (but prior approvals are not
required) regarding sales of more than five percent of NTC's then issued and
outstanding shares in order to assure the maintenance of an orderly market in
the public trading of NTC's stock.
The management incentive options established under the original NTC management
incentive agreement were revised as follows: (1) the exercise price of the
options will be the fair market value of NTC's stock on the date of grant, as
appraised by an independent appraisal firm prior to NTC becoming a publicly
traded corporation, and as reflected in NTC's market price after it becomes a
publicly traded corporation; (2) the number of stock options available for grant
to the key independent representatives is a maximum of 2,884,615, one third of
which may be granted only if NTC achieves gross revenues in excess of $28
million in any calendar quarter ending prior to January 1, 1997, and the
remaining two-thirds of which may only be granted if NTC achieves revenues in
excess of $150 million in any calendar quarter ending prior to January 1, 1999,
or if such threshold is not achieved by that date, then the following
percentages of the remaining options would be available for grant upon NTC
achieving the following quarterly gross revenues in any calendar quarter prior
to January 1, 1999: 60% of the remaining options if $125 million in quarterly
revenues are achieved, 30% of the remaining options if $100 million in quarterly
revenues are achieved, and 10% of the remaining options if $75 million in
quarterly revenues are achieved; (3) the number of stock options available for
grant to the senior executives of NTC is a maximum of 3,846,155, 2,629,231 of
which are immediately available for grant to Edward Jacobs and Jerry Ballah, and
576,924 of which are available for grant to Mr. Jacobs and Mr. Ballah if the
following gross revenues are earned by NTC in any calendar quarter prior to
January 1, 2000: if $100 million in quarterly revenues are earned, 192,308 stock
options will be available for grant, if $125 million in quarterly revenues are
earned, an additional 192,308 stock options will be available for grant, and if
$180 million in quarterly revenues are earned, an additional 192,308 stock
options will be available for grant; and (4) the number of options available for
grant to the employees of NTC is maximum of 1,923,077, one third of which are
subject to a time-in-service vesting requirement, and two-thirds of which are
available for grant only if NTC achieves a total of $10 million in cumulative
pre-tax profits in any four consecutive calendar quarters ending prior to
January 1, 1998. No more than 25% of the shares issuable pursuant to the
employee stock option plan may be granted to persons who are eligible to receive
options under the key independent representatives or senior executive plans.
Under the amended NTC management incentive agreement, the Company has agreed
that NTC will have a Board of Directors comprised of at least four independent
outside directors (to be selected prior to NTC's initial public offering, with
two nominated by the Company and two nominated by NTC), and three management
directors. The independent directors may not be affiliated with the Company or
NTC. To the extent feasible, the independent directors will consist of a former
state attorney general, a former commissioner or high ranking staff member
23
of the Federal Communications Commission or Federal Trade Commission, a former
high ranking executive of a major telephone, cable or related company, and a
person with investment banking or comparable service.
After the four independent outside directors are selected, the Company has
agreed that none of its officers or directors will be directors of NTC. Until
the four independent directors are appointed to the NTC Board of Directors, the
Company has agreed to vote its shares for the current NTC Board, plus one key
independent sales representative of NTC, and an experienced current or former
chief executive officer of a recognized financial rating company. After the
independent directors have been selected, the Company has agreed to vote its NTC
shares for management's slate of nominees.
As part of the new NTC management incentive agreement, NTC has agreed to make
$2.2 million in cash distributions to the Company in monthly installments
through November 30, 1997, one million dollars of which have been distributed as
of November 12, 1996. NTC's covenant to make the cash distributions is subject
to its financial capability.
SETTLEMENT AGREEMENT WITH NTC DIRECTORS:
In November 1996, the Company reached settlement agreements with Edward
Jacobs and Jerry Ballah, each an officer and director of NTC. Mr. Jacobs and
Mr. Ballah agreed to release the Company and its officers and directors from
all claims they may have as a result of the exercise of their warrants in the
Company in July 1995 at the request of Sam D. Schwartz, the Company's former
President, and other claims they may have against the Company and its
affiliates, including any claims Mr. Jacobs may have with respect to his
employment agreement with the Company. Mr. Jacobs and Mr. Ballah assigned
their alleged claims against Mr. Schwartz to the Company. In consideration
for the release and assignment of claims, the Company agreed to assume an
aggregate of approximately $1,012,000 plus interest of the loans owed by Mr.
Jacobs and Mr. Ballah to NTC, which they incurred in connection with the
exercise of their warrants in the Company in July 1995, and to pay an
aggregate of approximately $988,000 in cash to Mr. Jacobs and Mr. Ballah
(i.e. a total settlement not to exceed $2,000,000 in loan assumptions and
cash), payable on or before January 1998, to cover Mr. Jacobs' and Mr.
Ballah's federal and state tax liabilities resulting from the loan
assumptions by the Company. The Company and NTC have agreed that the assumed
loans would be written off as intercompany items. The settlement agreements
between the Company, Ed Jacobs and Jerry Ballah include mutual general
releases.
LOAN TO COMPANY BY MELVYN REZNICK:
24
Melvyn Reznick's loans to the Company, as described in the Company's Proxy
Statement for the 1996 Annual Meeting of the Shareholders of Incomnet, Inc.,
dated July 29, 1996, have been repaid in full by the Company.
NOMINATED DIRECTOR DECLINES TO SERVE:
On July 29, 1996, the Company received a letter from Gerald Katell, a nominee to
the Company's Board of Directors, pursuant to which Mr. Katell informed the
Company that he declined to accept a position on the Company's Board of
Directors. Mr. Katell stated that the Company's newly purchased directors' and
officers' liability insurance policy did not have sufficient coverage to satisfy
him. As a result of Mr. Katell's decision, the Company has one vacancy on its
Board of Directors, which it intends to fill when a suitable candidate who is
willing to serve is found. There is no assurance regarding when the vacancy on
the Company's Board of Directors will be filled. See the Form 8-K filed by the
Company, dated July 29, 1996.
LOAN TO ROBERT AND NANCY ZIVITZ:
On November 5, 1996, the Company loaned $265,000 to Robert and Nancy Zivitz for
a period of 90 days, at an interest rate of 10% per annum. Nancy Zivitz is a
member of the Company's Board of Directors. The loan was approved by a vote of
the Company's Board of Directors on October 11, 1996 and is secured by 200,000
shares of the Company's stock held in the name of Robert Zivitz.
ISSUANCE OF 2% CONVERTIBLE PREFERRED STOCK
In September 1996, the Company issued 365 shares of Series A 2% Convertible
Preferred Stock to raise $365,000, and in October 1996, the Company issued 2,075
additional shares of Series A 2% Convertible Preferred Stock to raise $2,075,000
in additional capital, less referral fees equal to approximately 5% of the
capital raised. The basic terms and conditions of the Series A 2% Convertible
Preferred Stock are as follows:
VOTING. The Series A 2% Convertible Preferred Stock does not have voting
rights.
DIVIDEND. The Series A 2% Convertible Preferred Stock has a cumulative
noncompounded annual dividend of 2% payable in cash or stock at the Company's
option upon conversion of the Preferred Stock into Common Stock, and prior to
the payment of any dividends on the Common Stock.
25
LIQUIDATION PREFERENCE. The Series A 2% Convertible Preferred Stock has a
liquidation preference of $1,000 per share plus all cumulative unpaid dividends,
whether or not declared by the Company's Board of Directors. Upon any
liquidation or change of control of the Company (i.e. transfer of more than 50%
of its voting stock), the Preferred Stockholders are entitled to the first
priority in payment from the Company's assets, before any payments are made on
the Company's Common Stock, until the liquidation preference is paid in full.
CONVERSION. The Preferred Stockholders may convert each share of Series A 2%
Convertible Preferred Stock into the number of shares of the Company's Common
Stock calculated as follows, at any time upon the earlier of (i) 90 days after
the issuance of the Preferred Stock, or (ii) 60 days after the shares of Common
Stock underlying the Preferred Stock are registered with the Securities and
Exchange Commission. The conversion price (the "Conversion Price") for each
share of Series A 2% Convertible Preferred Stock is equal to the lesser of (a)
80% of the average bid price for the Company's Common Stock on the public
trading market for the five trading days immediately preceding the conversion
date, as specified by the Preferred Stockholder, or (b) the bid price of the
Company's Common Stock on the funding date (i.e. the issuance date of the
Preferred Stock). To calculate the number of shares of Common Stock issuable
upon the conversion of the Preferred Stock, the Conversion Price is multiplied
by a ratio, the numerator of which is the sum of 1,000 and the accrued but
unpaid dividends, and the denominator of which is the Conversion Price. If for
any reason a registration statement covering the shares of Common Stock issuable
upon the conversion of the Preferred Stock is not in effect with the Securities
and Exchange Commission at the time of a valid conversion by a Preferred
Stockholder, then the Conversion Price is reduced by 3% per month for each of
the first three months that the effectiveness of the registration is late. The
Company has the right to cause a conversion of the Preferred Stock into Common
Stock on the same terms at any time after one year after the Preferred Stock is
issued.
REDEMPTION. The Company has the right to redeem the Preferred Stock for its
issuance price plus cumulative unpaid dividends if the Company's stock trades at
a price which averages $2.00 per share or less for any period of five
consecutive trading days after the Preferred Stock is issued.
REGISTRATION RIGHTS. Pursuant to a Registration Rights Agreement entered into
by the Company with each purchaser of the Series A 2% Convertible Preferred
Stock, the Company is obligated to file a registration statement with the
Securities and Exchange Commission covering the shares of Common Stock
underlying the Preferred Stock within 30 days after the Preferred Stock is
issued, and to have the registration statement declared effective within 75 days
after it is filed.
ANTIDILUTION PROVISION. The Certificate of Determination for the Series A 2%
Convertible Preferred Stock contains comprehensive provisions for adjustments to
the Conversion Price and the conversion ratio of the Preferred Stock in the
event of stock dividends, asset distributions,
26
reorganizations, recapitalizations, mergers, stock splits or similar
transactions by the Company, in order to protect the Preferred Stock from
dilution as a result of such transactions.
RESTRICTIVE COVENANTS. During the first 90 days after the Series A 2%
Convertible Preferred Stock is issued, the Company is not permitted to issue any
other securities, except in limited circumstances, including pursuant to the
exercise of outstanding options or warrants or pursuant to existing settlement
agreements, without first notifying the Preferred Stockholders and giving them a
right of first refusal to purchase the securities themselves. While the Series
A 2% Convertible Preferred Stock is outstanding or until it is converted into
Common Stock, the Company is not permitted to engage in certain transactions,
such as the redemption or purchase of its own Common Stock (except in connection
with the collection of Section 16(b) short-swing profits), without the prior
consent of the Preferred Stockholders. Furthermore, the Company cannot take any
action which would modify the rights of the Preferred Stockholders under the
Certificate of Determination without the prior consent of the Preferred
Stockholder being affected by the modification.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
INDEX TO EXHIBITS:
Exhibits designated by the symbol * are filed with this Quarterly Report on Form
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 September 30, 1996.
REPORTS ON FORM 8-K, FILED IN 1996
20.1 Report on Form 8-K - Resignation of Director, dated July 29, 1996 and
filed on August 8, 1996.
27
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: November 14, 1996 /s/ Melvyn Reznick
------------------
Melvyn Reznick
President & CEO
Date: November 14, 1996 /s/ Richard A. Marting
----------------------
Richard A. Marting
Vice President (NTC)
28