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, 1998 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 March 31,
1998..................................................................14,508,021
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
MARCH 31, DECEMBER 31,
--------- ------------
ASSETS 1998 1997
---- ----
Current assets:
Cash and cash equivalents $ 1,824 $ 776
Accounts receivable, including $305 due from related
party at March 31, 1998 and less allowance for
doubtful accounts of $3,520 at March 31, 1998 and
$2,764 at December 31, 1997 10,921 13,850
Notes receivable - current portion 457 237
Notes receivable from officers & shareholders, net of
reserves of $378 and $1,265 887 840
Inventories 220 315
Other current assets 790 876
-------- --------
Total current assets 15,099 16,894
Property, plant and equipment, at cost, net 15,288 16,248
Goodwill, net 6,655 6,484
Investments and other assets 1,054 888
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Total assets 38,096 $ 40,514
-------- --------
-------- --------
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(DOLLARS IN THOUSANDS)
MARCH 31, December 31,
--------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997
---- ----
Current liabilities:
Accounts payable 10,067 $ 9,792
Accrued expenses 6,326 7,366
Current portions of notes payable & capitalized lease
obligations 9,050 9,383
Deferred income 1,380 1,989
-------- --------
Total current liabilities 26,823 28,530
Notes payable and capitalized lease obligations 3,078 2,855
Liability in excess of assets of RCI 3,600 3,600
Shareholders' equity:
Common stock, no par value; 20,000,000 shares
authorized; 14,508,021 shares issued and outstanding
at March 31, 1998 and 13,550,00 shares at December 31, 1997 71,898 70,811
Preferred stock, no par value; 100,000 shares authorized;
2,843.9 shares issued and outstanding at March 31, 1998,
and 3,995 shares at December 31, 1997 2,753 3,758
Treasury stock (5,492) (5,492)
Accumulated deficit (64,562) (63,548)
-------- --------
Total shareholders' equity 4,596 5,529
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Total liabilities and shareholders' equity 38,096 $ 40,514
-------- --------
-------- --------
See accompanying "Notes to Consolidated Financial Statements."
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INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
(DOLLARS IN THOUSANDS)
1998 1997
---- ----
SALES 19,007 $ 31,169
---------- ----------
OPERATING COSTS & EXPENSES:
Cost of sales 11,553 21,531
General & administrative 6,369 6,159
Depreciation & amortization 947 665
Bad debt expense 1,410 1,697
Other (income)/expense 314 (83)
---------- ----------
Total operating costs and expenses 20,593 30,043
---------- ----------
Gain on sale of AutoNETWORK 559 --
INCOME/(LOSS) BEFORE INCOME TAXES AND EXTRAORDINARY ITEMS (1,027) 1,126
Income tax benefits/(expense) 14 107
---------- ----------
INCOME/(LOSS) BEFORE EXTRAORDINARY ITEMS (1,013) 1,019
Extraordinary items -- 9
---------- ----------
NET INCOME/(LOSS) ($1,013) $1,010
---------- ----------
---------- ----------
INCOME/(LOSS) PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS, BASIC AND DILUTED:
Net income/(loss) ($ 0.7) $ 0.7
---------- ----------
---------- ----------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND
COMMON SHARE EQUIVALENTS OUTSTANDING 14,508,000 13,550,000
---------- ----------
---------- ----------
See accompanying "Notes to Consolidated Financial Statements."
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INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
(DOLLARS IN THOUSANDS)
1998 1997
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss)/income $ (1,013) $ 1,010
Depreciation & amortization 905 739
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Net cash inflow/(outflow) from operating activities (108) 1,749
---------- ----------
CASH FLOWS FROM (INCREASE)/DECREASE
IN OPERATING ASSETS:
Accounts receivable 2,929 (2,194)
Notes receivable - current portion (220) (147)
Notes receivable - due from officers and shareholders (47) (357)
Inventories 95 (15)
Prepaid expenses 86 -
Deferred tax (41)
Deposits & others (172) (148)
---------- ----------
Net cash inflow/(outflow) from changes in operating assets 2,671 (2,902)
CASH FLOWS FROM INCREASE/(DECREASE)
IN OPERATING LIABILITIES:
Accounts payable 275 348
Accrued expenses (1,040) 246
Deferred income (609) (727)
---------- ----------
Net cash inflow/(outflow) from changes in operating
liabilities (1,374) (133)
---------- ----------
Net cash inflow/(outflow) from operations 1,189 (1,286)
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of plant and equipment 55 (1,335)
Organization cost (166) (219)
Patents/intangible assets -- -
Investment in lab tech -- 35
Liability in excess of asset -- 2,801
---------- ----------
Net cash inflow/(outflow) from investing activities $ (111) $ 1,282
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1998 1997
---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Notes payable - current $ (333) $ (68)
Sale of common stock, net 80 465
Preferred stock - (365)
Notes payable - long term 223 (114)
Paid in capital -- 36
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Net cash inflow/(outflow) from financing activities (30) (46)
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Net cash inflow/(outflow) from investing and financing (141) 1,236
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Net increase/(decrease) in cash and cash equivalents 1,048 (50)
Cash at beginning of period 776 2,214
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Cash at end of period $ 1,824 $ 2,164
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------- -------
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES
Conversion of preferred stock into common stock 1,005 --
The company recorded the following in connection with the
change in the method of accounting of RCI from the
consolidated to equity method
Accounts receivable -- $(1,139)
Inventory -- (2,449)
Prepaid expenses and other -- (245)
Property and equipment - net -- (888)
Intangible assets -- (1,241)
Other assets -- (35)
Accounts payable -- 2,656
Accrued expenses -- 862
Notes payable -- 3,630
Cash received from RCI private placement -- 2,449
-------
$3,600
-------
-------
See accompanying "Notes to Consolidated Financial Statements."
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INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1998
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, 1998, and the results of operations for the three
months ending March 31, 1998 and 1997, and cash flows for the three months
ending March 31, 1998 and 1997.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes for the three
years ending December 31, 1997, included in the Company's Annual Report on Form
10-K/A filed with the Securities and Exchange Commission on April 30, 1998. 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 and its wholly-owned subsidiaries, National Telephone &
Communications-TM-, Inc. (NTC) and GenSource Corporation-TM- . The statements do
not include consolidated results of Rapid Cast, Inc., the Company's 29%-owned
subsidiary, which is accounted for using the equity method of accounting. On
March 20, 1998, the Company sold its AutoNETWORK division [see "Part II. Item
5. Sale of AutoNETWORK Operations"], and on March 31, 1998, the Company entered
an agreement to sell its NTC subsidiary [see "Part II. Item 5. Agreement to Sell
the Assets of National Telephone & Communications, Inc. (NTC)"].
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 months ending
March 31, 1998 totaled $17.1 million versus long distance telephone service
sales of $25.1 million in the three months ending March 31, 1997, a decrease of
32%. On March 31, 1998, the Company approved an agreement to sell its NTC
subsidiary [see "Item 5. Agreement to Sell the Assets of National Telephone &
Communications, Inc. (NTC)"].
(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 Independent 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 amounts deferred for future
services provided to the representatives, are booked as cash sales when the
revenues are received. A portion of the revenues from marketing related
programs and materials is deferred and recognized over a twelve month period to
accrue the Company's obligation to provide customer support to its independent
representatives. For the three months ending March 31, 1998, marketing sales
totaled $0.7 million versus marketing sales of $5.7 million for the three months
ending March 31, 1997, a decrease of 88%. On March 31, 1998, the Company
approved an agreement to sell its NTC subsidiary [see "Item 5. Agreement to Sell
the Assets of National Telephone & Communications, Inc. (NTC)"].
(4) Revenues from the Company's GenSource subsidiary are derived from the sale
of computer software and from related services, such as software maintenance
fees, custom programming and customer training. Revenues are recognized when
software is shipped to customers and when services are performed and accepted by
customers. Revenues in the three months ending March 31, 1998 totaled $0.8
million. Since the Company acquired GenSource in May 1997, there were no
revenues for a comparable period in 1997. When maintenance fees are billed
annually, the revenues are deferred and recognized ratably over a twelve month
period.
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(4) The Company's network service revenues are recognized as sales as the
service is delivered. Network service sales in the three months ending March
31, 1998 totaled $0.4 million versus $0.4 million in the three months ending
March 31, 1997. On March 20, 1998, the Company sold its AutoNETWORK division
[see "Item 5. Sale of AutoNETWORK Operations"].
CONCENTRATION OF CREDIT RISK - The Company sells its telephone, network services
and insurance-related software and related services to individuals and small
businesses throughout the United States and does not require collateral.
Reserves for uncollectible amounts are provided, which management believes are
sufficient.
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 3 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 3 to 10 years.
LEASEHOLD IMPROVEMENTS - All leasehold improvements are stated at cost and are
amortized using the straight-line method over the expected lease term.
NET INCOME PER SHARE - Net income per common share is based on the weighted
average number of common shares and common share equivalents for 1997 and 1996.
ACQUISITION AMORTIZATION - The excess of purchase price over net assets of NTC
and GenSource have been recorded as an intangible asset and is being amortized
by the straight-line method over twenty 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.
IMPAIRMENT OF LONG-LIVED ASSETS - In accordance with the provisions of SFAS No.
121, the Company regularly reviews long-lived assets and intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount to the assets may not be recoverable.
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.
4. NETWORK MARKETING COSTS:
During the three months ending March 31, 1998, NTC's net costs to operate its
network marketing program was $0.7 million versus $0.5 million for the three
months ending March 31, 1997, as summarized below (in $ millions):
3 Months Ending 3 Months Ending
March 31, 1998 March 31, 1997
--------------- ---------------
Sales $ 0.7 $ 5.7
------ ------
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Cost of sales 0.3 4.9
Operating expenses for support services 1.1 1.3
----- -----
Total marketing-related costs 1.4 6.2
----- -----
Net marketing cost $ 0.7 $ 0.5
----- -----
----- -----
% of total NTC (long distance &
marketing) sales 3.9% 1.8%
Marketing sales of $0.7 million for the three months ending March 31, 1998 and
$5.7 million for the three months ending March 31, 1997 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. Effective January 1, 1996, the Company
changed its accounting procedures to defer a portion of marketing revenues,
which had previously been recognized upon receipt. The Company believes that
the change is preferable because it provides a better matching of revenues with
services provided to the marketing representatives.
5. 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 ending March 31, 1998, expenses associated with commissions, bonuses and
overrides paid out to NTC's independent representatives were $1.3 million versus
$5.4 million for the three months ending March 31, 1997, a decline of 76%.
6. COMMITMENTS AND CONTINGENCIES:
LITIGATION - The Company is a defendant in a class action matter and related
lawsuits alleging securities 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. In October 1997, the Company reached a
settlement of the class action lawsuit and established a reserve of $8.65
million associated with the settlement. Because of the operational problems
associated with NTC, there are no assurances that the settlement will be
completed as proposed. Counsel for the Company, furthermore, is unable to
estimate the outcome of the other lawsuits and is unable to predict a range of
potential loss. Accordingly, no amounts have been provided for these additional
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 has been informed by
its counsel that they do not believe the investigation will have a material
adverse impact on its financial position or results of operations.
-9-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW:
The following is management's discussion and analysis of certain significant
factors which have affected the results of operations and financial condition of
the Company during the period included in the accompanying financial statements.
This discussion should be read in conjunction with the financial statements and
associated notes. The discussion herein is qualified by reference to the
Cautionary Statements. See "Part II. Cautionary Statements".
LIQUIDITY AND CAPITAL RESOURCES:
GENERAL - Overall, the Company experienced positive cash flows of $1 million
during the first quarter ending March 31, 1998, resulting from a cash inflow
from operating activities of $1.2 million and cash used in investing and
financing activities of $141,000. The Company will need to raise additional
capital in 1998 to fund settlement costs relating to pending litigation or to
fund business operations if the pending sale of National Telephone &
Communications (NTC) is not completed [see "Part II. Item 5. Agreement to Sell
the Assets of National Telephone & Communications, Inc. (NTC)"]. There is no
assurance that the sale of NTC will be completed or that the Company and NTC
will have sufficient capital or financing to meet their needs should the sale
not be completed. In the latter part of 1997, NTC began experiencing a
substantial decline in revenues, the number of its independent sales
representatives and telephone customers. NTC has no borrowing capacity remaining
on its credit line with First Bank and is experiencing net operating deficits.
NTC is in technical default on certain covenants in its line of credit with
First Bank. There is no assurance that NTC will have sufficient working capital
to remain in business during 1998. In the short run, certain of its working
capital needs are being met by an agreement with WorldCom, Inc. to permit NTC to
defer a portion of the payments owed by NTC to WorldCom. Nevertheless, a
shortage of working capital and a continued decline in NTC's operating results
and financial condition are on-going risks associated with the Company.
Furthermore, after the sale of its AutoNETWORK division in March 1998 [see "Part
II. Item 5. Sale of AutoNETWORK Operations"], the Company no longer has the
positive cash flow associated with that business, resulting in a larger
operating deficit at the parent company, which is expected to continue in 1998.
There is no assurance that the Company will be able to obtain additional capital
or financing from any source. The sale of GenSource Corporation or sale of
shares of Rapid Cast, Inc. is being contemplated by the Company as a means of
raising additional capital, but there is no assurance that such sales can be
made on a timely basis or at all.
CASH FLOW FROM OPERATIONS - The Company generated $1.2 million in positive
cash flow from operations during the three months ending March 31, 1998,
compared to a cash outflow of $1.3 million from operations during the prior
year's comparable period. This year-to-year increase in cash flow from
operations resulted primarily from an increase in accounts receivable of $2.9
million, which was offset by a net loss of $1 million and a net cash decrease
from accrued expenses of $1 million. On March 20, 1998, the Company sold its
AutoNETWORK operation, which will decrease cash flow in future quarters
[see "Part II, Item 5. OTHER INFORMATION - SALE OF AUTONETWORK OPERATIONS"].
CASH FLOW FROM INVESTING - The Company generated negative cash flows from
investing activities of $111,000 in the three months ending March 31, 1998
versus positive cash flow of $1.3 million in the three months ending March 31,
1997.
CASH FLOW FROM FINANCING - The Company generated negative cash flows of $30,000
from financing activities in the three months ending March 31, 1998 compared to
negative cash flows of $46,000 from financing activities in the three months
ending March 31, 1997.
LITIGATION - The Company is subject to pending litigation and an investigation
by the Securities and Exchange Commission. Management is not yet able to
predict the impact of the pending litigation on its financial condition and
results of operations. The Company has been advised by its attorneys that the
investigation by the Securities and Exchange Commission should not result in a
material impact on the Company's financial condition or results of operations.
Other pending litigation may have a material adverse effect on the Company's
financial condition and operating results [see "Part II. Item 1. Legal
Proceedings.]"
GOING CONCERN - As a result of the substantial net losses incurred by the
Company and its subsidiaries in 1997, and because its current liabilities
exceeded its current assets by $11,636,000 on December 31, 1997, the Company's
independent certified public accountants stated in their Auditor's Letter in the
Company's Annual Report on Form 10-K/A
-10-
as filed with the Securities and Exchange Commission on April 30, 1998, that
there is substantial doubt regarding the Company's ability to continue as a
going concern. As of March 31, 1998, current liabilities exceeded current assets
by $11,814,000, which the Company believes would result in a similar concern
from the Company's independent certified public accountant were an opinion
letter to be issued based upon results for the three months ending March 31,
1998.
RESULTS OF OPERATIONS:
SALES - Sales in the first quarter ending March 31, 1998 decreased to $19.0
million from sales of $31.2 million in the first quarter ending March 31, 1997,
a decrease of 39%. The majority of this decrease was attributable to NTC's
decrease in sales to $17.8 million in the first quarter ending March 31, 1998
from $30.8 million in the three months ending March 31, 1997, a decrease of 42%.
The following table summarizes the Company's sales performance by subsidiary and
segment during the comparable first quarters in 1998 and 1997:
$ IN MILLIONS
- -------------
SUBSIDIARY SEGMENT 1998 1997
- ---------- -------------------------------------- ---- ----
NTC Telephone (telecommunications services) $17.1 $25.1
NTC Telephone (marketing programs) 0.7 5.7
GenSource Software 0.8 --
AutoNETWORK Network 0.4 0.4
----- -----
Total Company Sales $19.0 $31.2
----- -----
----- -----
COST OF SALES - Total Company cost of sales decreased to $11.5 million or 61% of
sales during the quarter ending March 31, 1998 versus $21.5 million or 69% of
sales during the comparable prior year quarter. The quarter-to-quarter decrease
in cost of sales resulted largely from decreasing carrier costs associated with
decreased telephone service sales by NTC. The gross margin of NTC's long
distance telephone service for the first quarter ending March 31, 1998 was 44%,
which increased from a gross margin of 37% in the first quarter ending March 31,
1997.
The following table summarizes the Company's changes in three major cost
components for the first quarter:
$ IN MILLIONS 1998 1997
- ---------------- ------- -------
Commissions, bonuses
and overrides paid to NTC independent sales reps $ 1.3 $ 5.4
Carrier costs for NTC's long distance telephone 9.8 15.9
GenSource's cost of sales 0.2 --
AutoNETWORK 0.2 0.2
------ ------
Total Cost of Sales $ 11.5 $ 21.5
------ ------
------ ------
NTC's total commission, bonus and override expense decreased to $1.3 million in
the first quarter of 1998 as compared to $5.4 million in the first quarter of
1997. NTC's carrier costs to deliver long distance telephone service to its
telephone customers decreased to $9.8 million in the first quarter of 1998
compared to $15.9 million in the first quarter of 1997. This decrease in carrier
costs reflects the year-to-year decline in telephone sales.
GENERAL & ADMINISTRATIVE - Total general and administrative costs increased to
$6.4 million or 34% of sales in the first quarter ending March 31, 1998 versus
$6.2 million or 20% of sales in the quarter ending March 31, 1997. 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. The increase in general and
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administrative costs in the current quarter primarily reflects (1) the
addition of $0.6 million in general and administrative expenses for
GenSource, which was not a part of the Company in the corresponding period in
1997 and (2) a relative increase in the percentage of general and
administrative expenses at NTC in relationship to sales at NTC.
DEPRECIATION & AMORTIZATION - Total Company depreciation and amortization
expense was $947,000 in the first quarter ending March 31, 1998 versus
$665,000 in the first quarter of 1997. This increase was caused by increased
investment by NTC in computer hardware and software, furniture and equipment,
and leasehold improvements in 1997 prior to a decline in its sales and by an
increase in investment in computer software and hardware by GenSource in 1997.
BAD DEBT EXPENSE - Total Company bad debt expense decreased to $1.4 million in
the first quarter ending March 31, 1998 compared to $1.7 million in the first
quarter of 1997. The quarter-to-quarter decrease in bad debt was caused
primarily by decreases in sales volumes.
NET INCOME - The Company had a net loss in the first quarter ending March 31,
1998 of $1 million or 5.3% of sales compared to net income of $1 million or 3.2%
of sales in the first quarter of 1997. The net loss was due to the substantial
decrease in telephone sales and marketing sales at NTC.
PART II - OTHER INFORMATION
CAUTIONARY STATEMENTS:
This Quarterly Report on Form 10-Q contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The Company intends that such
forward-looking statements be subject to the safe harbors created by such
statutes. The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties. Accordingly, to
the extent that this Annual 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
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,
increases in general and administrative costs, lower sales and revenues than
forecast, loss of customers, customer returns of products sold to them by the
Company or its subsidiaries, disadvantageous currency exchange rates,
termination of contracts, loss of supplies, technological obsolescence of the
Company's products, technical problems with 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, the possible acquisition of new businesses that result in
operating losses or that do not perform as anticipated, resulting in
unanticipated losses, the possible adverse effects of the sale of assets of
National Telephone & Communications, Inc. (NTC), the possible adverse effects of
the failure by NTC to close the proposed sale of its assets, the possible
fluctuation and volatility of the Company's operating results, financial
condition and stock price, losses incurred in litigating and settling cases,
dilution in the Company's ownership of its subsidiaries and businesses, 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, loss
of independent sales representatives, changes in interest rates, inflationary
factors, default on indebtedness and other specific risks that may be alluded to
in this Annual Report or in other reports issued by the Company. In addition,
the business and operations of the Company are subject to substantial risks
which increase the uncertainty inherent in the forward-looking statements. The
inclusion of forward looking statements in this Quarterly Report should not be
regarded as a representation by the Company or any other person that the
objectives or plans of the Company will be achieved.
ITEM 1. LEGAL PROCEEDINGS
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION:
The investigation of the Company by the SEC has apparently been settled with
respect to the Company and two former directors of the Company, Stephen A.
Caswell and Joel W. Greenberg. Mr. Caswell is presently employed by the Company
as Vice President and Corporate Secretary. On May 14, 1998, the Company, Mr.
Caswell and Mr. Greenberg entered into an Offer of Settlement and Order with the
Securities and Exchange Commission pursuant to which they agreed, without
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admitting or denying any wrongdoing, not to violate Sections 10(b) and 13(a) of
the Exchange Act and Rules 10b-5, 12b-2, 13a-11 and 13a-13 thereunder of the
Securities Exchange Act of 1934, as amended. No civil penalties or other
financial sanctions were imposed on any of the parties. The final administrative
order has not yet been entered by the SEC.
CLASS ACTION AND RELATED LAWSUITS:
The status of the pending class action lawsuit, 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 (BQRx), filed in the United States District Court for the
Central District of California, Western Division, which was originally filed in
January 1995, has not experienced any material changes from its status as
described in "Item 3. Legal Proceedings" in the Company's Form 10-K/A for its
fiscal year ending December 31, 1997, as filed with the Securities & Exchange
Commission on April 30, 1998.
The status of the pending lawsuit, JAMES A. BELZ, ET AL VS. SAMUEL D. SCHWARTZ
AND RITA SCHWARTZ, HUSBAND AND WIFE; STEPHEN A. CASWELL; JOEL W. GREENBERG;
INCOMNET, INC., A CALIFORNIA CORPORATION; DAVID BODNER AND MURRAY HUBERFELD,
filed in the United States District Court, District of Minnesota in July 1997,
has not experienced any material changes from its status as described in "Item
3. Legal Proceedings" in the Company's Form 10-K/A for its fiscal year ending
December 31, 1997, as filed with the Securities & Exchange Commission on April
30, 1998.
The status of the pending lawsuit, 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 ANTILLANO, 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 in November
1996, has not experienced any material changes from its status as described in
"Item 3. Legal Proceedings" in the Company's Form 10-K/A for its fiscal year
ending December 31, 1997, as filed with the Securities & Exchange Commission on
April 30, 1998.
INCOMNET, INC. VS. SAM D. SCHWARTZ:
The status of the pending lawsuit, INCOMNET, INC. VS. SAM D. SCHWARTZ, filed in
the Superior Court of California in the County of Los, which was originally
filed in April 1997, has not experienced any material changes from its status as
described in "Item 3. Legal Proceedings" in the Company's Form 10-K/A for its
fiscal year ending December 31, 1997, as filed with the Securities & Exchange
Commission on April 30, 1998. In the course of indemnifying Mark Richardson for
his defense costs in the lawsuit brought against Mr. Richardson by Mr. Schwartz,
the Company participated in the settlement of that case and thereby ended its
ongoing defense cost obligation by issuing 65,000 shares of its Common Stock to
Sam Schwartz. Mr. Richardson paid the balance of the settlement amount to Mr.
Schwartz from his own funds. The Company is responsible for the remaining
outstanding balance of approximately $50,000 owed to the law firm that
represented Mr. Richardson in the litigation.
COMPLAINT FOR ARBITRATION AGAINST NATIONAL TELEPHONE & COMMUNICATIONS, INC.
(NTC) AND INCOMNET, INC.:
In December 1997, NTC was served with a complaint for arbitration by Paul Yao,
Dennis Wong and their affiliates, who are prior independent sales
representatives of NTC. In the complaint, the plaintiffs are alleging breach of
contract, discrimination and other causes of action against NTC. As part of the
proposed sale of the assets of NTC [see "Part II. Item 5. Agreement to Sell The
Assets of National Telephone & Communications, Inc. (NTC)"], the Buyer of the
assets has agreed to assume the liabilities of NTC to Paul Yao, Dennis Wong and
the other plaintiffs. In April 1998, NTC entered into a Settlement Agreement and
Mutual Release with the plaintiffs pursuant to which the parties have released
each other from all claims and the arbitration proceeding will be dismissed with
prejudice. Pursuant to the settlement agreement, NTC agreed to pay to the
plaintiffs an undisclosed amount of cash. In addition to the payment, NTC has
agreed to pay the plaintiffs a small fixed payment for each verified new
subscriber for NTC's long distance telephone service referred by plaintiffs,
plus a residual commission on net revenues that NTC derives from those telephone
customers. If the closing of the asset sale does occur, then NTC Acquisition,
Inc. will pay the plaintiffs additional funds. If the closing of the asset sale
occurs, NTC Acquisition, Inc. has also agreed to make certain lease payments for
the plaintiffs on their business automobiles and on their business center in
Monterey Park, CA. Prior to the closing of the sale of the assets of NTC to NTC
Acquisition, Inc., NTC and the plaintiffs will enter into an agency agreement
and thereafter, a marketing agreement, pursuant to which the plaintiffs will
market NTC's (and NTC Acquisition, Inc.'s, if the closing occurs) long distance
telephone service for (i) a residual commission on the net telephone revenues
collected by NTC from customers who
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subscribe as a result of the marketing efforts of the plaintiffs, (ii) a small
payment for each verified new subscriber who subscribes to NTC's long distance
telephone service as a result of the plaintiffs' marketing efforts, and (iii)
options to purchase an undisclosed number of shares of the common stock of NTC
Acquisition, Inc. exercisable at a price of $1.00 per share and vesting one-half
on the closing of the asset sale and the balance in equal annual installments
over a three-year period after the closing.
SETTLEMENT OF CIVIL CONSUMER PROTECTION LAWSUIT WITH THE STATE OF CALIFORNIA:
On October 28, 1997, the Company announced that its NTC subsidiary reached a
settlement of a civil consumer protection lawsuit with the State of California.
In the settlement, which NTC reached without admitting any wrongdoing, NTC
agreed to a court order requiring it to implement policies to prevent the
practice of switching customers' long distance telephone service without their
permission or knowledge by its independent sales representatives or employees,
and agreed to pay $1,250,600 in costs and penalties. NTC also agreed to
institute safeguards to prevent violations from occurring in the future. Among
those safeguards, NTC agreed to wait 24 hours after the consumer agrees to
switch his or her telephone company to NTC before calling the customer to
confirm that the consumer really wants to switch to NTC. The lawsuit was brought
through the California Attorney General's Office and the Orange County District
Attorney Office. The California Public Utility Commission was the investigative
agency. As part of a related administrative action, restitution to consumers
was being sought by the Consumer Services Division of the California Public
Utility Commission. On November 12, 1997, NTC reached a settlement with the
staff of the California Public Utility Commission pursuant to which it agreed to
pay to total of approximately $350,000 to the Commission for customer
restitution, educational brochures and investigative costs. The terms of the
settlement with the Commission require the resignation by June 30, 1998 of the
officers and directors of NTC who were engaged prior to January 1, 1997, as well
as the termination by February 28, 1998 of any consultants of NTC who were
officers or directors of NTC prior to January 1, 1997. On February 4, 1998,
the settlement was approved by the California Public Utility Commission.
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 asserted claims against the Company and its directors.
Approximately 50 members of the class in the pending class action lawsuit
against the Company have opted out of the class and may file separate lawsuits
against the Company [see "Part II. Item 1. Legal Proceedings - Class Action and
Related Lawsuits"]. 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.
On April 7, 1998, an existing shareholder of the Company who owns approximately
5.7% of the outstanding stock of the Company filed a Schedule 13D with the
Securities and Exchange Commission and, on April 9, 1998, also submitted a
letter to the Board of Directors of the Company. The letter asked for an
explanation of certain actions taken by the Company, including the Board's
approval of the agreement to sell NTC [see "Part II. Item 5. Agreement to Sell
The Assets of National Telephone & Communications, Inc. (NTC)"]. On April 14,
1998, the shareholder filed an amended Schedule 13D disclosing that he owns more
shares of the Company's common stock, equaling 6.5% of the outstanding stock as
of the date of the amended filing. The shareholder also disclosed his intention
to review the Company's management as well as NTC and its management, and the
proposed sale of assets by NTC. On May 13, 1998, the shareholder filed an
amended Schedule 13D disclosing that he has acquired more shares of the
Company's common stock so that he owns approximately 8.1% of the total issued
and outstanding stock as of the date of the filing. The shareholder further
indicated that he intends to oppose the proposed sale of NTC's assets [see "Part
II. Item 5. Agreement to Sell The Assets of National telephone & Communications,
Inc. (NTC)"] and stated that if the shareholders do not give the requisite
approval for the sale he may then seek to replace at least a majority of the
present members of the Company's board of directors and thereafter to replace
the present chief executive officer of the Company and other members of senior
management of Incomnet and NTC. He further stated that although he has no
present plans to do so, he may do one or more of the following if he decides the
circumstances warrant: he may enter into agreements with other shareholders to
vote against the proposed sale of NTC; he may solicit proxies in opposition to
the proposed sale of NTC; he may take legal action to oppose corporate actions
by Incomnet or NTC that he believes would impair the value of Incomnet; he may
call a special meeting of shareholders of Incomnet or otherwise seek to remove
the existing board and elect new directors; he may seek to invalidate certain
severance arrangements for senior management of NTC and Incomnet; and he may
propose financing, possibly including financing by Mr. Casey and possibly
involving the issuance of securities of Incomnet, in order to attempt to improve
the cash flow, financial condition and results of operations of NTC and
Incomnet.
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There are also potential claims which may be asserted against the Company, but
which have not been filed as complaints, by Edward Jacobs and Jerry Ballah for
amounts owed to them pursuant to an agreement with the Company reached in
November 1996 [see "Certain Relationships and Related Transactions - Settlement
Agreement With NTC Directors in the Company's Proxy Statement, filed with the
Securities and Exchange Commission on November 19, 1997"]. To date, no payment
has been made on the settlement with Mr. Jacobs and Mr. Ballah other than the
discharge of their payment obligations to NTC on loans made by NTC to them.
Payment of the settlement with Mr. Jacobs and Mr. Ballah is expected to be made
as part of the agreement to sell NTC [see "Part II. Item 5. Agreement to Sell
the Assets of National Telephone & Communications, Inc. (NTC)"]. Should the sale
of NTC not be completed and should the Company not pay the settlement, the
amount of the damages to be asserted by Mr. Jacobs and Mr. Ballah would be
approximately $988,000 plus interest, and possibly consequential damages
relating to the nonpayment of their tax liability, if applicable. NTC and the
Company do not believe that there is any basis for any claims by the prior
consultant.
The Company has not yet made scheduled payments on promissory notes to four
former shareholders of GenSource Corporation. Payments of approximately $50,375
were due on April 25, 1998. If the payments are not made in a timely manner by
the Company, the Company may be sued for payment by those former shareholders.
The Company is presently exploring funding alternatives, including the sale of
its GenSource subsidiary, which will allow such payments to be made [see "Part
I. Item 2. Management's Discussion and Analysis of Financial Condition and
Result of Operations - Liquidity and Capital Resources"]. There can be no
assurances that payments will be made in a timely manner or that a lawsuit may
not be filed.
There also may be potential claims by prior or present independent sales
representatives of NTC against NTC for alleged nonpayment of commissions or
for the alleged improper allocation of commissions by NTC and NTC management
responsible for such payments or allocations. There are also possible claims
against NTC by Christopher Mancuso, a former consultant to NTC, who may
assert claims against NTC for options or convertible debt units that were not
provided under an alleged agreement with NTC for non-payment of consulting
fees allegedly owed to him by NTC. The Company and NTC do not believe that
there is any merit to the claims by Mr. Mancuso.
From time to time, the Company is also involved in litigation arising from the
ordinary course of business, the ultimate resolution of which may or may not
have a material adverse effect on the financial condition or results of
operations of the Company.
ITEM 2. CHANGES IN SECURITIES
On February 10, 1998, the Securities and Exchange Commission declared
effective a Registration Statement on Form S-3 in which the Company
registered an aggregate number of 5,512,501 shares of the Company's common
stock to be issued for purposes including: (i) the conversion of Series A and
Series B Convertible Preferred Shares to shares of the Company's common stock
[see "Part I. Business - Conveyance of Series A 2% Convertible Preferred Stock
and Issuance of Series B 6% Convertible Preferred Stock" in the Company's
Annual Report on Form 10-K/A, submitted to the Securities and Exchange
Commission on April 30, 1998], (ii) as shelf shares by the Company as
required and (iii) underlying warrants issued by the Company. In the period
ending March 31, 1998, 756,867 shares of the Company's common stock
registered as part of the Registration Statement declared effective on
February 10, 1998 were issued. Of these common stock shares, 118,163 common
stock shares were converted from 75 Series A Preferred Stock shares and
638,704 common stock shares were converted from 377 Series B preferred stock.
No registered common stock shares underlying warrants were issued during the
three months ending March 31, 1998 and no registered shelf shares were issued
during the period ending March 31, 1998.
On April 1, 1998, the Company issued 350,000 registered shelf shares to
Pacific Continental Securities Corporation, which may be sold on the open
market on Company's behalf or issued directly to individuals as required. Of
those shares, 50,000 shares of registered shelf shares were issued in partial
payment of legal expenses [see "Part II. Item 1. Legal Proceedings - Incomnet,
Inc. Vs. Sam D. Schwartz"] and 68,000 registered shelf shares have been sold
on the open market, raising the Company $29,791. The Company, for the time
being, has stopped the sale of shelf shares on the open market, although such
sales may be made in the future.
As of May 20, 1998, a total of 2,165.9 shares of Series A and Series B
Preferred Stock has been converted into 2,711,995 shares of the Company's
common stock. As of May 20, 1998, there are 2,708.1 remaining shares of
Series A and Series B Convertible Preferred Stock that may be converted into
the Company's common stock.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Item 3 is not applicable for the three months ending March 31, 1998.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Item 4 is not applicable for the three months ending March 31, 1998.
ITEM 5. OTHER INFORMATION
AGREEMENT TO SELL ASSETS OF NATIONAL TELEPHONE & COMMUNICATIONS, INC. (NTC):
On March 31, 1998, National Telephone & Communications, Inc. ("NTC"), a wholly
owned subsidiary of Incomnet, Inc. (the "Company"), entered into a definitive
Asset Purchase Agreement (the "Agreement") with NTC Acquisition, Inc., a newly
formed unaffiliated buyer (the "Buyer"), pursuant to which NTC has agreed to
sell substantially all of its assets to the Buyer, and the Buyer has agreed to
assume certain liabilities of the Company, subject to the terms and conditions
of the Agreement. The Buyer is controlled by John R. Dennis, an unaffiliated
individual. In order for the sale of the assets to close, certain conditions
must be satisfied. The following are the basic terms and conditions of the
Agreement and its related exhibits:
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NTC ASSETS TO BE SOLD - NTC has agreed to sell substantially all of its assets
to the Buyer, except (i) shares of Page Prompt stock owned by NTC, (ii) any
claims that NTC may have against the Company or any of NTC's or the Company's
officers or directors, in their capacity as officers and directors, and (iii)
all tax loss carry forwards. The assets to be acquired include but are not
limited to all tangible and intellectual property, leaseholds, leases, contract
rights, cash, securities, accounts receivable, licenses and permits, and certain
leasehold improvements.
NTC AND COMPANY LIABILITIES TO BE ASSUMED - The Buyer will assume only
specified liabilities, including but not limited to (i) most of NTC's balance
sheet liabilities, (ii) post-closing liabilities under all contracts that are
part of the assigned assets, (iii) up to an aggregate of $10,000,000 of
combined NTC debt to First Bank on its line of credit (NTC is currently in
technical default under certain covenants in its loan agreement with First
Bank), and deferred payables to WorldCom Inc., (iv) NTC's obligations to
Edward Jacobs and certain consultants to NTC, (v) excise tax liabilities,
(vi) any obligation to Paine Webber in connection with the transaction, (vii)
NTC employee and consultant severance obligations in excess of an aggregate
of $50,000, (viii) any obligations in connection with an arbitration case
against NTC brought by Paul Yao et. al., which was recently settled
[see "Part I. Item 1. Legal Proceedings - Complaint for Arbitration Against
National Telephone & Communications, Inc. and Incomnet, Inc."] and (ix) the
Company's obligations to Edward Jacobs and Jerry Ballah under existing
settlement agreements between the Company and those individuals.
PURCHASE PRICE FOR ASSETS - The purchase price for the assets to be acquired is
(i) $13,750,000 in cash, subject to adjustment, (ii) shares of the Buyer's
common stock representing 16% of the outstanding shares of the Buyer's common
stock on a fully diluted basis, and (iii) assumption of the liabilities
described above by the Buyer. Pursuant to a separate Antidilution Agreement to
be entered into by the Buyer and the Company, the Company's 16% ownership
interest in the Buyer will not be reduced for the first 10% of new stock issued
before or after the closing by the Buyer to the Buyer's officers, directors,
employees or consultants, other than to John R. Dennis and his affiliates. In
addition, NTC will have the right to purchase its pro rata portion of any new
stock of the Buyer proposed to be issued to other controlling shareholders of
the Buyer or their affiliates (i.e. preemptive rights), to enable NTC to have
the opportunity to maintain its ownership percentage in the Buyer under such
circumstances.
PURCHASE PRICE ADJUSTMENT - The cash portion of the purchase price will be
adjusted, up or down, based upon whether the difference between NTC's current
assets and current liabilities on the closing date is greater (a price increase)
or less (a price decrease) than such difference was on November 30, 1997. NTC
may elect not to close if the estimated adjustment amount (exclusive of amounts
relating to undisclosed litigation) exceeds $3,000,000 (unless the Buyer agrees
to limit the adjustment amount to $3,000,000).
ESCROW - NTC's shares of the Buyer's common stock representing 4% of the Buyer's
outstanding common stock on the closing date, on a fully-diluted basis, will be
placed in a six-month escrow as security for NTC's and the Company's
indemnification obligations and for any negative purchase price adjustments. NTC
and the Company may elect to settle any such claims in cash, rather than
surrender shares of Buyer's common stock.
PRE-CLOSING DISCUSSIONS AND BREAKUP FEE - NTC and the Company may not solicit or
provide information to other prospective buyers. NTC and the Company may,
however, provide information to and negotiate with a third party which presents
an unsolicited proposal if the failure to do so would be a breach of the
fiduciary duty of the Board of Directors of the Company or NTC. NTC may also
terminate the Agreement to enter into a financially superior offer. If NTC
terminates the Agreement because it receives a financially superior offer, the
Buyer will be entitled to a $500,000 break-up fee if within six months NTC sells
substantially all of its assets to another party.
BUYER'S CAPITALIZATION - The Buyer is a newly-formed shell corporation which has
agreed to maintain a minimum capitalization of $500,000 of equity while certain
of its covenants, representations and warranties under the Agreement are in
effect.
PRE-CLOSING CONSULTATION - Through the closing, the Buyer may consult with, and
provide recommendations to, NTC with respect to the conduct of NTC's business,
but all authority for the conduct of NTC's business will remain fully vested in
NTC's officers and directors, subject to additional controls and oversight
rights of the Company set forth in a separate letter agreement between the
Company and NTC, dated April 2, 1998. The Buyer will not be entitled to any
compensation for its consulting services.
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NTC'S CONDITIONS TO CLOSING - NTC's obligations are expressly conditioned on,
among other things, (i) approval of the Agreement by the Company's shareholders,
(ii) receipt of a fairness opinion, (iii) receipt of releases from James Quandt
and Victor Streufert with respect to their employment agreements, (iv) receipt
of releases with respect to the Yao litigation/arbitration, which have been
obtained, (v) receipt of releases from the lessors of the Hawaii and Irvine
properties, equipment vendors, First Bank and WorldCom Communications, Inc., and
(vi) receipt of releases from Edward Jacobs, Jerry Ballah and Christopher
Mancuso.
BUYER'S CONDITIONS TO CLOSING - Buyer's obligations are expressly conditioned
on, among other things, (i) execution of satisfactory employment agreements with
James Quandt and Victor Streufert, which may have been accomplished, (ii)
receipt of releases with respect to the YAO litigation/arbitration, which have
been obtained, (iii) receipt of releases from Messrs. Jacobs, Ballah and
Mancuso, (iv) receipt of consents from certain public utility commissions, and
(v) the Buyer will have entered into definitive financing agreements with
lenders to provide financing of not less than $40 million to permit Buyer to
complete the purchase and to provide working capital for the business.
TERMINATION - The Agreement may be terminated (i) by mutual agreement, (ii) by
Buyer or NTC as a result of material breach by the other (subject to a 30-day
cure period), (iii) by NTC if it receives a financially superior offer prior to
the closing, or (iv) by either party if the transaction does not close by June
30, 1998.
COVENANT NOT TO COMPETE - NTC and the Company will agree not to compete in any
of NTC's businesses for five years after the closing.
INDEMNIFICATION - NTC and the Company will indemnify Buyer for breaches of
representations, warranties and covenants (including with respect to non-assumed
liabilities). Buyer will indemnify NTC and the Company for breaches of
representations, warranties and covenants (including with respect to assumed
liabilities). Indemnification obligations are subject to a $100,000 aggregate
minimum. Indemnification obligations for breaches of representations are
subject to a $2,500,000 limit. Indemnification obligations for covenant
breaches (primarily assumed and nonassumed liabilities, as applicable) are not
subject to a maximum limit. The Company's indemnification obligations for NTC's
breaches of representations, warranties and covenants become effective only if
(i) NTC liquidates and dissolves, (ii) NTC dividends or distributes a material
portion of its assets to its shareholders(s), or (iii) NTC otherwise transfers
without value a material portion of its assets.
SHAREHOLDER AGREEMENT - At the closing, the Company and other shareholders of
the Buyer will enter into a Shareholders Agreement. The Shareholders Agreement
will provide for, among other things, (i) a limited preemptive right for NTC, as
described above, (ii) a right of first refusal in favor of Buyer, (iii)
drag-along rights in connection with the sale of Buyer by a majority interest of
the shareholders, (iv) tag-along rights for NTC in connection with sales by
certain other controlling shareholders of the Buyer and their affiliates, (v)
registration rights for NTC (piggyback and PARI PASSU demand registration rights
with certain other controlling shareholders), and (vi) limits on affiliate
transactions by Buyer.
PUC CONSENTS - The Public Utility Commission consents that are conditions to
closing are California, New York and Hawaii. Buyer will indemnify NTC from any
losses it may incur from closing the transaction without consents from all
jurisdictions that require such consent as long as consents are received from
jurisdictions that represented 80% of NTC's 1997 revenues.
BOARD REPRESENTATION - NTC will have one representative on the Buyer's Board of
Directors as long as its owns at least 10% of Buyer's equity. NTC's
representative will be subject to reasonable approval by John R. Dennis.
There is no assurance regarding whether or when the transactions contemplated by
the Agreement and its related documents will close. NTC is presently in
technical default on certain covenants under its credit facility with First
Bank. The Company intends to call for a special meeting of the
Company's shareholders to vote on whether to approve or disapprove the proposed
Agreement. In order for the Agreement to be approved, the holders of more than
50% of the total issued and outstanding voting stock of the Company must vote in
favor of approving the Agreement. The Company expects to circulate proxy
statements to its shareholders in the near future describing the Agreement and
related documents in greater detail, and soliciting the votes of its
shareholders.
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ISSUANCE OF $185,000 OF CONVERTIBLE DEBENTURES:
On January 20, 1998, the Company issued Convertible Secured Debentures
(collectively, the "Debentures") to three individuals in the aggregate principal
amount of $185,000, bearing simple interest at the rate of 10% per annum and
secured by a perfected security interest in the Company's AutoNETWORK assets.
The Debentures are due and payable in full on or before April 30,1998. At any
time prior to the repayment of the Debentures, the Debenture holders have the
right to convert the outstanding principal and interest balance of the
Debentures into shares of the Company's common stock at a conversion ratio equal
to the lesser of (i) $1.09 per share, or (ii) 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 Debenture
holder. The Company registered the shares issuable upon the conversion of the
Debentures pursuant to a registration statement on Form S-3 declared effective
by the Securities and Exchange Commission on February 10, 1998. In connection
with the issuance of the Debentures, the Company also granted an aggregate of
18,000 warrants to purchase 18,000 shares of the Common Stock of the Company at
an exercise price of $1.09 per share at any time until January 20, 2000. These
warrants were granted to the Debenture holders on a pro rata basis. The Company
also amended 105,000 of its outstanding warrants previously granted to
affiliates of the Debenture holders in July and November 1997 by lowering the
exercise price of 50,000 of the warrants from $5.26 per share to $3.50 per
share, and by lowering the exercise price of 55,000 of the warrants from $3.00
per share to $2.00 per share. The Debenture holders have the right of first
refusal to provide any additional financing to the Company until July 12, 1998.
On March 20, 1998, the Company sold its AutoNETWORK division to two of the
Debenture holders. The Debenture is being paid off with the proceeds of the sale
[see "Part II. Item 5. Sale of AutoNETWORK Operations"].
SALE OF AUTONETWORK OPERATIONS:
On March 20, 1998, the Company sold its Auto Dismantler Network (known under
the tradename "AutoNETWORK") to AutoSkill, Inc., a newly-formed corporation
owned by Jeffrey Rubin of Rosslyn, NY and Robert Cohen of New York City, NY.
The operations were sold for $1.3 million in cash, payable as follows:
$800,000 in cash was paid on the close of the transaction and a note for
$500,000, bearing simple interest at the rate of 9% per annum was issued to
the Company, payable in full on May 20, 1998. As part of the transaction, the
Company repaid $42,500 of a note for $185,000 that is payable to Mr. Rubin
and Mr. Cohen [see "Part II. Item 5. Issuance of $185,000 Convertible
Debenture."] The Company has agreed to repay the remaining balance of $142,500
on or before May 20, 1998. On April 29, 1998, the Company prepaid the remaining
balance of its note due to Mr. Rubin and Mr. Cohen, and after a payment of
$100,000 by AutoSkill, Inc. to the Company and certain adjustments, the
outstanding balance of the note payable by AutoSkill, Inc. to the Company is
$257,340.
LOAN BY THE COMPANY TO A DIRECTOR:
On November 5, 1996, the Company extended to a director of the Company a loan of
$265,000 at an interest rate of 10% until January 15, 1997. The loan was secured
by 201,800 shares of the Company's common stock that was signed over to the
Company by the director. On January 15, 1997, the note was extended until May
1, 1997. A new note was signed on May 1, 1997 for $277,955 bearing interest at
the rate of 10% per annum, due and payable in full on January 15, 1998. As of
April 29, 1998, the note has not been repaid. The Company believes that the
director has defaulted on the note. In February 1998, the Company sent a demand
letter for full payment. The note is secured by a perfected security interest in
201,800 shares of the Company's common stock owned by the director. The Company
is preparing to foreclose and cancel the 201,800 shares securing the note, as
well as seeking to collect the balance owed, which is approximately $305,000,
including principal and interest.
DISGORGEMENT OF SHORT SWING PROFITS TO THE COMPANY BY A DIRECTOR:
On January 8, 1998, a director of the Company, disclosed in a Form 4 that he had
purchased 65,000 shares of the Company's common stock on January 5, 6, and 7,
1998 and sold 65,000 shares of the Company's common stock on December 1, 1998 at
a higher price. On January 12, 1998, the Company informed the director that a
short swing profit had been generated pursuant to Section 16(b) of the
Securities Exchange Act of 1934, as amended. On January 26, 1998, the director
paid to the Company short swing profits plus accrued interest of $95,456 that
were generated by the transactions.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
REPORTS ON FORM 8-K, FILED FOR THE THREE MONTHS ENDED MARCH 31, 1998:
20.1 Report on Form 8-K/A - Stock Purchase Agreements and Promissory Notes
Between Incomnet, Inc. and Jerry C. Buckley, Ralph Flygare, Robert
Reisbaum, E.V. Schmidt, Diane Orendorff and Nora Kenner Hoffberg, dated
April 25, 1997, filed with the Securities and Exchange Commission on
January 16, 1998.
20.2 Report on Form 8-K/A - Escrow Agreements Between Incomnet, Inc. and Jerry
C. Buckley, Ralph Flygare, Robert Reisbaum, and E.V. Schmidt,, dated April
25, 1997, filed with the Securities and Exchange Commission on January 21,
1998.
20.3 Report on Form 8-K - Agreement To Sell The Assets of National Telephone &
Communications, Inc. (NTC) Between NTC and NTC Acquisition, Inc., dated
March 31, 1998, filed with the Securities and Exchange Commission on April
9, 1998.
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 20, 1998 /s/ Melvyn Reznick
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Melvyn Reznick
President, CEO & CFO
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