<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the transition period from to
------- -------
Commission file number 000-27967
Integrated Communication Networks, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Nevada 33-0670130
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
27061 Aliso Creek Road, Suite 100
Aliso Viejo, California 92656
(Address Principal Executive Offices) (Zip Code)
(949) 349-1770
(Registrant's telephone number, including area code)
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 / /
The number of shares of the Registrant's Common Stock outstanding as of
April 30, 2000 was approximately 5,867,780 shares.
<PAGE>
TABLE OF CONTENTS PAGE
------------------------------------------------------------ ----
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements........................................ **
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 1
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 5
PART II-OTHER INFORMATION
Item 1. Legal Proceedings........................................... 6
Signatures ............................................................ 7
PART I-FINANCIAL INFORMATION
ITEM 1.**
Index to Financial Statements:
PAGE
----
Consolidated balance sheets as of March 31, 2000 (unaudited)
and December 31, 1999 F-1
Consolidated statements of operations for the three months
ended March 31, 2000 (unaudited) and 1999 F-2
Statement of Redeemable Convertible Preferred Stock and Stockholders' Equity
from inception (January 16, 1997) through December 31, 1997, Year-ended December
31, 1998 and Consolidated Statement of Redeemable Convertible Preferred Stock
and Stockholders' Equity (Deficit) for the year ended December 31, 1999 and the
three months ended March 31, 2000 (unaudited) F-3
Consolidated Statements of Cash Flows for the three months ended
March 31, 2000 (unaudited) and 1999 F-4
Notes to Consolidated Financial Statements F-5
<PAGE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, MARCH 31,
ASSETS 1999 2000
------------- -------------
(Unaudited)
Current assets:
Cash $ 2,552,113 $ 111,929
Accounts Receivable - 124,791
Receivable from related party 332,006 356,208
Note Receivable (Note 2) - 1,675,000
Prepaid and other current assets 293,032 118,531
------------- -------------
Total current assets 3,177,151 2,386,459
------------- -------------
Property and equipment:
Operating equipment 2,825,700 2,280,603
Equipment, furniture and software
under capital leases 549,685 1,298,263
Leasehold improvements 114,490 114,490
Furniture, fixtures and equipment 60,524 151,022
------------- -------------
3,550,399 3,844,378
Less - Accumulated depreciation and amortization (459,428) (523,221)
------------- -------------
3,090,971 3,321,157
------------- -------------
Goodwill, net 8,907,517 8,752,032
Other noncurrent assets 280,377 235,972
------------- -------------
Total noncurrent assets 12,278,865 12,309,161
------------- -------------
$ 15,456,016 $ 14,695,620
============= =============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 823,860 $ 1,260,168
Accrued expenses 526,074 748,836
Unearned revenue 334,130 150,984
Long-term debt-current portion 82,696 64,671
Capital lease obligations-current portion 114,078 300,342
------------- -------------
Total current liabilities 1,880,838 2,525,001
------------- -------------
<PAGE>
Long-term debt, net of current portion (Note 4) 5,034,813 5,032,147
Capital lease obligations, net of current portion 209,836 683,596
Commitments and contingencies (Note 7) - -
Redeemable, convertible preferred stock:
Series A 8% redeemable convertible preferred stock, $.01 par value per
share:
Authorized - 50,000 shares
Issued and outstanding - no shares at
December 31, 1999 and March 31, 2000 - -
Series A-1 12% redeemable convertible preferred
stock, $.01 par value per share:
Authorized - 7,500,000 shares at December 31,
1999 and March 31, 2000
Issued and outstanding-3,167,974 at December 31,
1999 and March 31, 2000 4,847,000 4,847,000
Series A-1 preferred stock subscribed (218,500) (218,500)
Stockholders' equity:
Common stock, $.01 par value:
Authorized - 250,000,000 shares
Issued and outstanding 5,867,780 at
December 31, 1999 and March 31, 2000 58,677 58,677
Common stock subscribed (105,750) (5,750)
Additional paid-in capital 22,858,958 22,858,958
Accumulated deficit (18,996,555) (20,972,208)
Treasury stock (113,301) (113,301)
------------- -------------
Total stockholders' equity 3,702,029 1,826,376
------------- -------------
$ 15,456,016 $ 14,695,620
============= =============
The accompanying notes are an integral part of these
consolidated financial statements
F-1
<PAGE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended
March 31,
---------------------------
1999 2000
------------- -------------
(Unaudited)
Revenues $ 42,107 $ 623,210
Operating expenses:
Data communications and
telecommunications 98,904 1,392,241
Selling, general & administrative
expenses 416,101 1,255,853
Depreciation and amortization 54,619 372,881
Write-down of impaired assets 2,554,819 -
------------- -------------
Total operating expenses 3,124,443 3,020,975
------------- -------------
Loss from operations (3,082,336) (2,397,765)
------------- -------------
Other income (expense):
Interest income 123 9,285
Dividend income - 7,671
Interest expense (9,394) (241,057)
Realized gain on sale
of investment (Note 2) - 992,329
Loss on sale of assets (Note 3) - (346,116)
Write-off of assets (216,600) -
------------- -------------
(225,871) 422,122
------------- -------------
Net loss $ (3,308,207) $ (1,975,653)
============= =============
Basic and diluted weighted average
common shares outstanding 3,915,313 5,867,780
============= =============
Basic and diluted net loss per
share $ (0.84) $ (0.34)
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
<PAGE>
<TABLE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
FROM YEAR ENDED DECEMBER 31, 1998 THROUGH YEAR ENDED DECEMBER 31, 1999
AND FOR THE THREE MONTHS ENDED MARCH 31, 2000 (Unaudited)
<CAPTION>
SERIES A 8% REDEEMABLE
CONVERTIBLE SERIES A-1 12% REDEEMABLE
PREFERRED STOCK CONVERTIBLE PREFERRED STOCK
---------------------------- -------------------------------------------
SHARES AMOUNT SHARES AMOUNT SUBSCRIBED
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1998 - - - - -
------------- ------------- ------------- ------------- -------------
Stock to be issued for
assets acquired January
1999 - - - - -
Stock cancelled - - - - -
Stock issued for acquisition
of PhoneXchange, Inc. - - - - -
Common stock issued for
conversion of debt - - - - -
Stock issued for receivable - - - - -
Effective options issued for services - - - - -
Stock issued for cash and
receivable - - 3,267,974 5,000,000 (218,500)
Stock issued to Directors for services - - - - -
Stock issued for services - - - - -
Stock issued for cash - - - - -
Conversion of preferred
stock - - (100,000) (153,000) -
Purchase of common stock - - - - -
Stock issued for additional
shares in phoneXchange, Inc. - - - - -
Net loss - - - - -
------------- ------------- ------------- ------------- -------------
Balance, December 31, 1999 - $ - 3,167,974 $ 4,847,000 $ (218,500)
============= ============= ============= ============= =============
Proceeds from subscription - - - - -
Net loss - - - - -
------------- ------------- ------------- ------------- -------------
Balance, March 31, 2000, (Unaudited) - $ - 3,167,974 $ 4,847,000 $ (218,500)
============= ============= ============= ============= =============
(CONTINUED BELOW)
<PAGE>
TOTAL
COMMON STOCK ADDITIONAL RETAINED STOCK-
------------------------------------------- PAID-IN EARNINGS TREASURY HOLDERS'
SHARES AMOUNT SUBSCRIBED CAPITAL (DEFICIT) STOCK EQUITY
------------- ------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1998 5,262,206 52,620 - 8,047,480 (8,107,099) - (6,999)
------------- ------------- ------------- ------------- ------------- ------------- -------------
Stock to be issued for
assets acquired 441,600 4,416 - 2,589,984 - - 2,594,400
Stock cancelled (3,475,000) (34,750) - 34,750 - - -
Stock issued for acquisition
of PhoneXchange, Inc. 921,428 9,215 - 6,440,788 - - 6,450,003
Common stock issued for
conversion of debt 25,296 253 - 132,550 - - 132,803
Stock issued for receivable 141,000 1,410 (105,750) 104,340 - - -
Effective options issued
for services - - - 2,250,000 - - 2,250,000
Stock issued for cash and
receivable - - - - - - -
Stock issued to Directors
for services 10,500 105 - 56,164 - - 56,269
Stock issued for services 23,500 235 - 142,528 - - 142,763
Stock issued for cash 1,332,000 13,320 - 985,680 - - 999,000
Conversion of preferred
stock 1,000,000 10,000 - 143,000 - - 153,000
Purchase of common stock - - - - - (113,301) (113,301)
Stock issued for additional
shares in phoneXchange, Inc. 185,250 1,853 - 1,931,694 - - 1,933,547
Net loss - - - - (10,889,456) - (10,889,456)
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance, December 31, 1999 5,867,780 $ 58,677 $ (105,750) $ 22,858,958 $(18,996,555) $ (113,301) $ 3,702,029
------------- ------------- ------------- ------------- ------------- ------------- -------------
Proceeds from subscription - - 100,000 - - - 100,000
Net loss - - - - (1,975,653) - (1,975,653)
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance, March 31, 2000,
(Unaudited) 5,867,780 $ 58,677 $ (5,750) $ 22,858,958 $(20,972,208) $ (113,301) $ 1,826,376
============= ============= ============= ============= ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements
</TABLE>
F-3
<PAGE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended
March 31,
----------------------------
1999 2000
------------- -------------
(Unaudited)
Cash Flows From Operating Activities:
Net loss $ (3,308,207) $ (1,975,653)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization 54,619 372,881
Write-down of impaired assets 2,554,819 -
Gain on sale of marketable security - (992,329)
Loss on sale of equipment - 346,116
Decrease (increase) in assets:
Accounts receivable (8,129) (75,562)
Notes receivable - (31,873)
Prepaid expenses and other
assets (358,931) 153,496
Increase (decrease) in liabilities:
Accounts payable (37,975) 436,308
Accrued expenses 105,936 222,762
Unearned revenue (1,104) (183,146)
Other advance (317,802) -
Payable to related party (11,181) -
------------- -------------
Net cash used in operating
activities (1,327,955) (1,727,000)
------------- -------------
Cash Flows From Investing Activities:
Purchases of property and equipment (290,927) (74,974)
Proceeds from sale of equipment - 50,000
Purchase of investment in marketable
security - (1,000,000)
Proceeds from sale of marketable
security - 325,000
------------- -------------
Net cash used in investing
activities (290,927) (699,974)
------------- -------------
Cash Flows From Financing Activities:
Principal payments of capital lease
obligation (9,106) (92,517)
Principal payments on long-term debt (5,689) (20,692)
Proceeds from preferred stock
subscription 1,658,315 -
Proceeds from issuance of common
stock - 100,000
------------- -------------
Net cash provided by financing
activities 1,643,520 (13,209)
------------- -------------
Increase (decrease) in cash 24,638 (2,440,184)
------------- -------------
Cash at the beginning of the period - 2,552,113
------------- -------------
Cash at the end of the period $ 24,638 $ 111,929
============= =============
Supplemental disclosure of cash flow
information:
Cash paid during the year for
interest $ 9,394 $ 38,213
============= =============
Supplemental disclosure of noncash
investing and financing activities:
Equipment and software acquired
under capital lease obligations - 755,733
============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2000
(Unaudited)
(1) GENERAL
The financial statements included herein are unaudited and have been prepared in
accordance with generally accepted accounting principles for interim financial
reporting and Securities and Exchange Commission ("SEC") regulations. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. In management's
opinion, the financial statements reflect all adjustments (of a normal and
recurring nature) which are necessary to present fairly the financial position,
results of operations, stockholders' equity and cash flows for the interim
periods. These financial statements should be read in conjunction with the
audited financial statements for the year ended December 31, 1999, as set forth
in the Company's Annual Report on Form 10-K. Certain prior year balances have
been reclassified to conform to the current year presentation. The results for
the three months ended March 31, 2000 are not necessarily indicative of the
results that may be expected for the year ending March 31, 2000.
(a) FORMATION AND DESCRIPTION OF BUSINESS
The Company began operation in February 1999 through the Company's
acquisition of phoneXchange, Inc. phoneXchange is a facilities-based wholesale
carrier that provides switched voice and data services, primarily to U.S.-based
carriers. phoneXchange provides domestic and international long distance service
through foreign termination relationships, international gateway switches,
leased and owned transport facilities and resale arrangements with other long
distance providers.
(b) GOING CONCERN
Management has spent a significant amount of time identifying,
evaluating and pursuing strategic acquisitions to accomplish this objective. To
achieve the objectives outlined in its plan, the Company must obtain sufficient
financing to obtain and complete its long-distance network facilities and,
ultimately, achieve a sufficient level of sales and profitability to support its
contemplated operations. Management is currently pursuing various financing
alternatives. However, no assurance can be provided that management will be able
to obtain financing on terms acceptable to the Company, or at all. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. The accompanying financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
(c) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of
Integrated Communication Networks, Inc. and its majority-owned subsidiary,
phoneXchange, Inc. and its wholly owned subsidiary Internet Call Centers, Inc.
All significant inter-company transactions and balances have been eliminated.
Minority interest represents the minority shareholders' proportionate share of
the equity or income of the Company's majority-owned subsidiary phoneXchange,
Inc.
(d) CONCENTRATION OF CUSTOMERS
The loss of any significant customer could have a significant negative
impact on our revenues from operations.
(e) RECLASSIFICATIONS
Certain reclassifications have been made to the 1999 financial
statements to conform to the March 2000 presentation.
2. REALIZED GAIN ON SALE OF INVESTMENT
On January 24, 2000, the Company purchased 1,000,000 shares of Series
A, 5% Convertible Preferred Stock, $.01 par value of OMNI Neutraceuticals, Inc.
for $1,000,000. On March 1, 2000, the Company sold its interest in 1,000,000
shares of Series A, 5% Convertible Preferred Stock, $.01 par value of OMNI
Neutraceuticals, Inc. for $325,000 in cash and a short term, non interest
bearing note receivable of $1,675,000 due at the end of each month commencing on
April 30, 2000 in the amount of $325,000 with the remaining payment of $375,000
due on August 30, 2000. The Company recorded a realized gain of $992,329, net of
accrued dividend income, on the sale of the investment as of March 31, 2000.
3. LOSS ON SALE OF EQUIPMENT
The Company sold certain telecommunications equipment for $50,000 and
recorded a realized loss on the sale of $346,116.
4. LONG-TERM DEBT
Long-term debt consists of the following:
(a) 7.5% note payable to a vendor. Principal and interest
are payable in monthly installments of $6,525, December 2001,
secured by related equipment. $ 56,931
(b) 10% note payable to the Company's landlord. Principal and
interest are payable in monthly installments of $948 through
July 2004, secured by leasehold improvements. 39,887
(c) In November 1999, the Company sold $5.0 million
principal amount of its 4% Convertible Debenture, and received
net proceeds of $4,480,000 on December 2, 1999. The Convertible
Debenture is due on December 2, 2004. 5,000,000
-----------
5,096,818
-----------
Less: Current maturities (64,671)
-----------
$5,032,147
===========
Aggregate maturities of long-term debt over the next five years is as
follows:
Year Ending
March 31: Amount
----------- ------
2001 $ 64,671
2002 6,332
2003 9,214
2004 5,016,601
2005 -
----------
$5,096,818
==========
Convertible Debenture
In November 1999, the Company sold $5.0 million principal amount
of its 4% Convertible Debenture, and received net proceeds of
$4,480,000 on December 2, 1999. The Convertible Debenture is due
on December 2, 2004.
The Debentures automatically convert into common stock on December
2, 2004 at the then effective conversion price. The holders of the
Debentures have the right, at any time after April 1, 2000, to
convert all or any portion of the Debentures into common stock at
the lesser of (i) 80% of the averaged three lowest closing bid
prices, as reported by Bloomberg, LP, for the common stock for the
20 trading days immediately preceding the conversion date, or (ii)
$10.00. The Company has the right to redeem the Debentures at any
time for 120% of the principal amount of the Debentures, plus
accrued interest up to the date of redemption.
5. INCOME TAXES
The Company's effective tax benefit on pretax loss differs from the U.S. Federal
Statutory tax rate for the three months ended March 31, 1999 and 2000 as
follows:
For the three months ended
March 31,
----------------------------------
1999 2000
--------------- ---------------
Federal statutory tax (benefit) (34.0%) (34.0%)
State taxes, net of federal tax benefit (5.83%) (5.83%)
--------------- ---------------
(39.83%) (39.83%)
=============== ===============
Deferred income tax assets and liabilities are computed based on temporary
differences between the financial statement and income tax bases of assets and
liabilities using the enacted marginal income tax rate in effect for the year in
which the differences are expected to reverse. Deferred income tax expenses or
credits are based on the changes in the deferred income tax assets or
liabilities from period to period. The components of deferred tax liabilities
and assets at December 31, 1997, 1998 and 1999 are as follows:
For the three months ended
March 31,
----------------------------------
1999 2000
--------------- ---------------
DEFERRED TAX LIABILITIES
DEPRECIATION $ 136,000 $ 642,000
--------------- ---------------
TOTAL DEFERRED LIABILITI 136,000 642,000
--------------- ---------------
DEFERRED TAX ASSETS
STATE TAXES 255,000 515,000
NET OPERATING LOSS CARRY FORWARD 3,773,000 7,971,000
--------------- ---------------
TOTAL DEFERRED ASSETS 4,028,000 8,486,000
--------------- ---------------
VALUATION ALLOWANC (3,892,000) (7,844,000)
--------------- ---------------
NET DEFERRED TAX ASS $ - $ -
=============== ===============
The Company and its majority-owned subsidiaries report separately for
income tax reporting purposes. The Company had available approximately
$18,540,000 and $18,863,000 of unused federal and state operating loss carry
forwards, respectively, at March 31, 2000, that may be applied against future
taxable income. These net operating loss carry forwards expire for federal
purposes from 2018 to 2020 and will expire for state purposes in 2006. There can
be no assurance that the Company will realize the benefit of the net operating
loss carry forwards.
SFAS No. 109 requires a valuation allowance to be recorded when it is
more likely than not that some or all of the deferred tax assets will not be
realized. At March 31, 1999 and 2000, valuations for 100% of the net deferred
tax assets were recorded due to uncertainties as to the amount of taxable income
that will be generated in future years. No income tax benefit has been recorded
for all periods presented because of the valuation allowance.
Due to the "change in ownership" provisions in Internal Revenue Code
Section 382, the availability of the Company's net operating loss carry forwards
may be subject to an annual limitation against taxable income in future periods,
which could substantially limit the eventual utilization of these net operating
loss carry forwards.
6. LEGAL PROCEEDINGS
On August 30, 1999, J&W Ventures, Inc. filed a claim against the
Company in the Superior Court of Los Angeles County, alleging that the Company
is in breach of a contract to purchase telecommunications equipment. The
plaintiff is seeking performance of the contract plus damages. The Company has
filed a cross-complaint seeking rescission and damages, asserting that J&W
Ventures, Inc. breached certain representations and warranties. The Company
intends to vigorously contest the litigation and to pursue its own remedies
fully. While no assurance can be given regarding the outcome of this matter, the
Company believes that the Company has strong and meritorious defenses to the
claims asserted. However, a determination that the Company breached its contract
with J&W Ventures, Inc. could have a material adverse effect on its business,
operating results and financial condition.
Pursuant to the J&W Ventures Asset Purchase Agreement, the Company paid
$300,000 in cash, issued 441,600 shares of common stock and was obligated to
designate and issue 850,000 shares of a new series of preferred stock, $2.50 par
value. Pending the outcome of the litigation between the parties, the Company
has placed a stop transfer order on the common stock issued, and has not
designated or issued any preferred stock to the J&W Ventures sellers. The
Company has not made any reserve on its balance sheet in connection with this
litigation.
7. COMMITMENTS AND CONTINGENCIES
(a) Master Lease
On July 30, 1999, the Company and Lucent Technologies, Inc.
InterNetworking Systems signed a Master Lease Agreement pursuant to which Lucent
agreed to provide the Company $3 million in credit for leasing Lucent equipment.
On February 7, 2000, Lucent amended this agreement to increase the Company's
line of credit to $10 million. As of March 31, 2000, the Company has received
equipment eligible to be financed under the Master Lease Agreement valued at
approximately $4 million but has not completed type testing and acceptance of
the equipment. Upon type testing and acceptance, the equipment will be placed
under operating leases. As of March 31, 2000, the Company had no outstanding
borrowings under the Master Lease Agreement.
(b) Operating Leases
The Company leases office space for its co-location space, dedicated
private telephone lines, equipment and other items under various agreements
expiring through 2005.
Rent expense included in the unaudited consolidated statements of
operations was approximately $37,417 and $83,465, for the three months ended
March 31, 1999 and 2000, respectively.
(c) Capital Leases
The Company is obligated under various capital lease agreements for
certain computer software, office furniture, telecommunications switching
equipment and desktop workstations.
In February 2000, the Company entered into a lease agreement for
certain computer equipment and office furniture. The lease agreement bears
interest at an annual rate of 20.7% and calls for 36 equal minimum monthly
payments of $2,186 and a deposit of $4,939.
In February and March of 2000, the Company entered into various lease
agreements for certain desktop computers, network servers and communication
switching equipment. The lease agreements bear interest at an annual rate
ranging from 17% to 21% and call for 60 equal minimum monthly payments of $3,962
and deposits totaling $3,962. As of March 31, 2000 the Company had tested,
accepted and recorded the assets on the balance sheet. The capital lease was
secured by the related assets.
Future minimum lease payments associated with the leases described
herein, including renewal options are as follows:
Dedicated Other
Year Ending Capital Private Operating
March 31: Leases Lines Leases
- ----------------- ----------- ----------- -----------
2001 $ 459,520 $ 832,789 $ 379,777
2002 431,657 338,549 356,478
2003 291,784 191,556 329,528
2004 65,221 90,193 323,154
2005 41,214 -0- 302,855
Thereafter -0- -0- 8,794
----------- ----------- -----------
Total minimum lease payments $1,289,396 $1,453,087 $1,700,586
=========== ===========
Less: amount representing interest (305,457)
Net present value of minimum
lease payments 983,938
-----------
Less: current portion (300,342)
-----------
Long-term capitalized lease obligation $ 683,596
===========
8. SUBSEQUENT EVENTS
On January 5, 2000, the Company filed a Registration Statement on Form
S-1 (Registration No. 333-94105) registering up to 13,775,061 shares of Common
Stock issuable upon conversion of certain securities of the Company. The Company
intends to use the proceeds, if any, for capital expenditures, working capital
and general corporate purposes. The Company subsequently filed an amendment to
the registration statement on May 11, 2000.
In April 2000, the Company incorporated a wholly owned subsidiary in
the Philippines known as C3.com, which has no asset value at this time. This
entity will act as a point of presence for the Company's long distance
operations and is expected to decrease international termination costs and to
eventually initiate outbound calls from the local market.
In May 2000, the Company reserved 3,000,000 common shares in an
OMNIBUS Stock Incentive Plan for its employees.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is an emerging multinational carrier focused primarily on
the international long distance market. The Company seeks to offer highly
reliable, low-cost switched voice services on a wholesale basis, primarily to
U.S.-based long distance carriers. The Company provides international long
distance service to various foreign countries through its flexible network
comprised of various foreign termination relationships, international gateway
switches, leased transport lines and resale arrangements with other long
distance providers.
The following discussion should be read in conjunction with the
Company's consolidated audited financial statements and the unaudited March 31,
2000 Financial statements. Integrated Communication Networks, Inc., which was
incorporated on January 16, 1997 began operations through its acquisition of its
majority owned subsidiary phoneXchange, Inc. in February 1999. The Company began
offering long distance services on February 28, 1999 by reselling the services
of other long distance carriers. The Company offers domestic and international
wholesale long distance services, including switched, private line, special
access and prepaid long distance services, to other telecommunications carriers
and agents and brokers of prepaid phone cards. The Company operates long
distance switching centers in Los Angeles, Dallas, Mexico City and New York. For
the year ended December 31, 1998 and for the period from inception on January
16, 1997 to December 31, 1997, the Company had no revenue and no material
operations. The following is management's discussion and analysis of financial
condition and results of operations for the three months ended March 1999 and
2000, respectively.
REVENUES. Most of the Company's revenues are generated by the sale of
international long distance services on a wholesale basis to other, primarily
domestic, long distance providers. The Company records revenues from the sale of
long distance services at the time of customer usage. The Company's agreements
with its wholesale customers are short-term in duration and the rates charged to
customers are subject to change from time to time, generally with five days
notice to the customer.
OPERATING EXPENSES. The Company's primary operating expenses include
data communications and telecommunications expenses and selling, general and
administrative expenses. The Company has pursued a strategy of attracting
customers and building calling volume and revenue by offering favorable rates
compared to other long distance providers. The Company continues to lower its
data communications and telecommunications expenses by (i) expanding the
Company's owned network facilities, (ii)continuing to utilize the Company's
sophisticated information systems to route calls over the most cost-effective
routes and (iii) leveraging the Company's traffic volumes and information
systems to negotiate lower variable usage-based costs with domestic and foreign
providers of transmission capacity.
Data communications and telecommunications expenses include those costs
associated with the transmission and termination of international long distance
services. Currently, a majority of transmission capacity used by the Company is
obtained on a variable, per minute basis. As a result, some of the Company's
current cost of services is variable. The Company's contracts with its vendors
provide that rates may fluctuate, with rate change notice periods varying from
five days to one year, with certain of the Company's longer term arrangements
requiring the Company to meet minimum usage commitments in order to avoid
penalties. Such variability and the short-term nature of many of the contracts
subject the Company to the possibility of unanticipated cost increases and the
loss of cost-effective routing alternatives. Included in the Company's data
communications and telecommunications expenses are accruals for rate and minute
disputes and unreconciled billing differences between the Company and its
vendors. Each quarter management reviews the data communications and
telecommunications expenses accrual and adjusts the balance for resolved items.
Data communications and telecommunications expenses also includes fixed costs
associated with the leasing of network facilities.
Selling, general and administrative expenses consist primarily of
personnel costs, depreciation and amortization, tradeshow and travel expenses
and commissions and consulting fees. These expenses have been increasing over
the past year, which is consistent with the Company's recent growth, accelerated
expansion into Latin America, and investment in systems and facilities. The
Company expects this trend to continue, and to include, among other things, a
significant increase in depreciation and amortization. Management believes that
additional selling, general and administrative expenses will be necessary to
support the expansion of the Company's network facilities, its sales and
marketing efforts and the Company's expansion into other international markets.
1
<PAGE>
Prices in the international long distance market have declined in
recent years and, as competition continues to increase, the Company believes
that prices are likely to continue to decline. Additionally, the Company
believes that the increasing trend of deregulation of international long
distance telecommunications will result in greater competition, which could
adversely affect the Company's revenue per minute and gross margin. The Company
believes, however, that the effect of such decreases in prices will be offset by
increased calling volumes and decreased costs.
FOREIGN EXCHANGE. The Company's cost of long distance services are
sensitive to foreign currency fluctuations. The Company expects that an
increasing portion of the Company's revenues and expenses will be denominated in
currencies other than U.S. dollars, and changes in exchange rates may have a
significant effect on the Company's results of operations.
FACTORS AFFECTING FUTURE OPERATING RESULTS. The Company's quarterly
operating results are difficult to forecast with any degree of accuracy because
a number of factors subject these results to significant fluctuations. As a
result, the Company believes that period-to-period comparisons of its operating
results are not necessarily meaningful and should not be relied upon as
indications of future performance.
The Company's revenues, costs and expenses have fluctuated
significantly in the past and are likely to continue to fluctuate significantly
in the future as a result of numerous factors. The Company's revenues in any
given period can vary due to factors such as call volume fluctuations,
particularly in regions with relatively high per-minute rates, the addition or
loss of major customers, whether through competition, merger, consolidation or
otherwise, the loss of economically beneficial routing options for the
termination of the Company's traffic, financial difficulties of major customers,
pricing pressure resulting from increased competition, and technical
difficulties with or failures of portions of the Company's network that impact
the Company's ability to provide service to or bill its customers. The Company's
cost of services and operating expenses in any given period can vary due to
factors such as fluctuations in rates charged by carriers to terminate the
Company's traffic, the timing of capital expenditures, and other costs
associated with acquiring or obtaining other rights to switching and other
transmission facilities, changes in the Company's sales incentive plans and
costs associated with changes in staffing levels of sales, marketing, technical
support and administrative personnel. In addition, the Company's operating
results can vary due to factors such as changes in routing due to variations in
the quality of vendor transmission capability, loss of favorable routing
options, the amount of, and the accounting policy for, return traffic under
operating agreements, actions by domestic or foreign regulatory entities, the
level, timing and pace of the Company's expansion in international markets and
general domestic and international economic and political conditions. Further, a
substantial portion of transmission capacity used by the Company is obtained on
a variable, per minute and short term basis, subjecting the Company to the
possibility of unanticipated price increases and service cancellations. Since
the Company does not generally have long-term arrangements for the purchase or
resale of long distance services, and since rates fluctuate significantly over
short periods of time, the Company's gross margins are subject to significant
short term fluctuations. The Company's gross margins also may be negatively
impacted in the longer term by competitive pricing pressures.
On January 5, 2000, the Company filed a Registration Statement on Form
S-1 (Registration No. 333-94105) registering up to 13,775,061 shares of Common
Stock issuable upon conversion of certain securities of the Company. The Company
filed an amendment to the Registration Statement on May 11, 2000.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 AND 2000
REVENUE: The Company generates the majority of its revenue from the
sale of wholesale long distance voice services, largely to other
telecommunications carriers seeking overflow capacity, and the sale of prepaid
long distance voice services to agents and brokers of prepaid phone cards.
Revenue for the three months ended March 31, 2000 increased $581,103 to $623,210
from $42,107 for the three months ended March 31, 1999. This increase is due to
the fact that the Company began operations in February 28, 1999. Revenues from
prepaid long distance voice services represented approximately 99% and 99% of
its total revenue for the three months ended March 31, 2000 and 1999. During the
past several years, market prices for telecommunications services have been
declining, which is a trend that the Company believes will likely continue. This
decline will have a negative effect on its revenue and gross margin, which may
not be offset completely by savings from decreases in its cost of services.
2
<PAGE>
OPERATING EXPENSES: The Company's primary operating expense categories
include data communications and telecommunications expenses and selling, general
and administrative expenses. Data and telecommunications include the fixed costs
of leased facilities, leased transport lines and the variable costs of
origination, termination and access services provided through local exchange
carriers and other long distance telecommunications companies. Selling, general
and administrative expenses include all infrastructure costs, such as selling
expenses, customer support, corporate administration, personnel network
maintenance, depreciation and amortization and a write-off of certain assets.
Selling expenses include commissions for its direct sales program. Selling
expenses also include commissions paid to its dealers and agents, which are
based on a fixed percentage of the customers' monthly billings.
Data communication and telecommunication expenses ended March 31, 2000
increased $1.3 million to $1.4 from $98,904 for the three months ended March 31,
1999. This increase is due to the fact that the Company began operations on
February 28, 1999. In addition to incurring the costs associated with the
origination, transmission and termination from other carriers, the Company has
also incurred the costs associated with establishing its own transmission
network and termination relationships primarily in the Latin America market. By
establishing its own transmission network and termination relationships, which
became operational in the fourth quarter of 1999, the Company will be able to
carry a significant portion of its international long distance traffic over its
own facilities, thereby reducing its costs of services by decreasing payments to
other carriers for the use of their facilities. The Company is continuing to
install switching and transmission equipment, which will allow the Company to
increase the percentage of the long distance services the Company provides on
its own network, thereby improving its margins.
Selling, general and administrative expenses for the three months ended
March 31, 2000 increased $839,752 to $1.3 million from $416,101 for the three
months ended March 31, 1999. The increase in selling, general and administrative
expenses is largely attributable to the significant investments in human
resources and increased marketing and sales efforts associated with the
continued expansion of its services. Since these investments often occur before
the Company realizes significant revenue from operations, they have the effect
of increasing selling, general and administrative expenses as a percentage of
revenue. These investments in infrastructure and support are intended to provide
the Company with the ability to continue to expand into new markets, maximize
customer retention and provide for growth. In addition, the Company has hired
additional personnel to facilitate the deployment of its network.
Depreciation and amortization is primarily related to switching
equipment, facilities, computer equipment and software and is expected to
increase as the Company incurs substantial capital expenditures to continue the
expansion of its network facilities. Depreciation and amortization also includes
the amortization of goodwill related to its acquisition of phoneXchange, Inc.
and certain telecommunications equipment. Depreciation and amortization expenses
for the three months ended March 31, 2000 increased $318,262 to $372,881 from
$54,619 for the three months ended March 31 1999. The increase in depreciation
and amortization is largely attributable due to capital expenditures related to
the establishment and expansion of its network operations center and support
infrastructure to accommodate increased traffic volume and expanded service
offerings.
IMPAIRMENT OF ASSETS: The Company wrote-down certain switching
equipment previously acquired in the amount of $ 2.5 million for the three
months ended March 31, 1999 as the result of an impairment of value.
INTEREST INCOME AND INTEREST EXPENSE: Interest expense is primarily
comprised of interest paid on the Company's long-term debt and various capital
leases. Interest expense increased by $231,663 to $241,057 for the three months
ended March 31, 2000 from $9,394 for the three months ended March 31, 1999. This
increase was attributable to the new borrowings under certain long-term notes,
the proceeds of which were primarily used for working capital. Interest income
is primarily composed of income earned on cash and cash equivalents. Interest
income increased by $9,162 to $9,285 for the three months ended March 31, 2000
from $123 for the three months ended March 31, 1999. This increase was primarily
attributable to increased interest earnings on the Company's cash.
INCOME TAXES: The Company generated a net loss for the three months
ended March 31, 2000 and 1999. Based on the Company's plans to expand through
the construction and expansion of its network, customer base and product
offerings, the Company expects this trend to continue. Given these circumstances
and the level of taxable income expected to be generated from reversing
temporary differences, the Company has established a valuation allowance for the
deferred tax assets associated with these net operating losses.
3
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES: The Company's principal capital and
liquidity needs historically have related to the development of its network
infrastructure, its sales and marketing activities and general capital needs.
The Company's capital needs have been met, in large part, from the net proceeds
from borrowings under long-term notes and the sale of its common stock and
preferred stock. As the Company placed greater emphasis on expanding its network
infrastructure, the Company has also sought to meet its capital needs through
vendor leases and other equipment financings.
Net cash used by financing activities was $13,209 for the three months
ended March 31, 2000 and net cash provided by financing activities was
$1,643,520 for the three months ended March 31, 1999. The March 1999 amount is
primarily attributable to the net proceeds from the issuance of long term notes
and the sale its common and preferred stock. The March 2000 amount is
attributable to debt repayments.
Net cash used in operating activities was $1.7 million for the three
months ended March 31, 2000 and $1.3 for the three months ended March 31, 1999.
Cash used in operating activities for all periods resulted from net losses and
increases in accounts receivable, deposits and prepaids, which were partially
offset by the write-off of certain assets, increases in accounts payable and
accrued liabilities.
Net cash used in investing activities was $699,974 for the three months
ended March 31, 2000 and $290,927 for the three months ended March 31, 1999.
Cash used in investing activities was primarily related to purchases and sales
of equipment and the purchase and sale of marketable securities.
The continued development and expansion of its sales and marketing
efforts and network infrastructure are expected to require substantial cash
expenditures. In addition, the Company's existing operations are not currently
profitable on a stand-alone basis. As a result, the Company expects to continue
to incur operating losses and negative cash flows from operations for the
foreseeable future. The Company has budgeted its future capital requirements
based on current estimates of its future revenue and with a view on current
competitive factors and the domestic and international regulatory environment
pertaining to its business. The Company cannot be certain that actual revenue
will be in line with management's expectations or that expenditures will not be
significantly higher than anticipated. In addition, there can be no assurance
that the Company will be able to meet its strategic objectives or that the
Company will have access to adequate capital resources on a timely basis, or at
all, or that such capital will be available on terms that are acceptable to the
Company. The failure to obtain such capital would have a material adverse effect
on the Company's business and its ability to implement its business plan. The
Company may consider potential acquisitions or other strategic arrangements that
may fit the Company's strategic plan. Any such acquisitions or strategic
arrangements likely would require additional equity or debt financing, which may
result in dilution.
MASTER LEASE AGREEMENT WITH LUCENT TECHNOLOGIES: On July 30, 1999,
phoneXchange and Lucent Technologies, Inc. InterNetworking Systems signed a
Master Lease Agreement pursuant to which Lucent agreed to provide the Company $3
million in credit for leasing Lucent equipment. On February 7, 2000, Lucent
amended this agreement to increase the Company's line of credit to $10 million.
The Company has received equipment eligible to be financed under the Master
Lease Agreement valued at approximately $4 million but has not completed type
testing and acceptance of the equipment. Upon type testing and acceptance, the
equipment will be placed under an operating lease with 36 monthly payments. As
of March 31, 2000, the Company had no outstanding borrowings under the Master
Lease Agreement. The Company is currently attempting to negotiate an increase in
the total financing to $25 million. However, there is no assurance that any
increase will be approved. If an increase is not approved, the Company may not
be able to maintain its current and projected growth.
EFFECTS OF NEW ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" and SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information", which are both effective for fiscal
years beginning after December 15, 1997. SFAS No. 130 addresses reporting
amounts of other comprehensive income and SFAS No. 131 addresses reporting
segment information. In 1999, the Company implemented SFAS No. 130. There are no
material differences between net income and comprehensive income as defined by
SFAS 130 for the periods presented. SFAS 131 uses a management approach to
report financial and descriptive information about a company's operating
segments. Operating segments are revenue-producing components of the enterprise
for which separate financial information is produced internally for the
company's management. Under this definition, the Company operated as a single
segment for periods presented.
4
<PAGE>
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, which
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. In June 1999, SFAS No. 133 was amended by SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of SFAS 133. As a result of this amendment, SFAS No. 133 shall be
effective for all fiscal quarters of all fiscal years beginning after June 15,
2000. In accordance with SFAS No. 133, an entity is required to recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. SFAS No. 133 requires that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement and requires that a company
formally document, designate and assess the effectiveness of transactions that
receive hedge accounting. The Company does not expect the adoption of this
standard to have a material effect on its consolidated financial position or
results of operations.
On December 3, 1999, the Securities and Exchange Commission staff
issued SAB No. 101, Revenue Recognition in Financial Statements. The SAB spells
out four basic criteria that must be met before companies can record revenue.
These are: (a) persuasive evidence that an arrangement exists; (b) delivery has
occurred or services have been rendered; (c) the seller's price to the buyer is
fixed or determinable; and (d) collectibility is reasonably assured.
Many of the examples in the SAB address situations that give rise to
the potential for recording revenue prematurely. They include transactions
subject to uncertainties regarding customer acceptance, including rights to
refunds and extended payment terms, and require continuing involvement by the
seller.
In March 2000, the SEC issued SAB 101A - Amendment: Revenue Recognition
in Financial Statements, that delays the implementation date of certain
provisions of SAB 101. Under the amendment, the Company is not required to
restate its prior financial statements provided that the Company reports a
change in accounting principle no later than the second fiscal quarter (ending
June 30, 2000) in accordance with FASB Statement No. 3, Reporting Accounting
Changes in Interim Financial Statements. In accordance with FAS 3, for companies
that adopt SAB 101 in the second quarter, financial information for the first
quarter would be restated by including a cumulative effect adjustment in that
quarter (i.e., the first quarter). The Company does not believe the adoption of
SAB 101 would have a material impact on its continuing operations.
INFLATION: The Company does not believe inflation has had a significant
impact on its operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
To date, the Company has not entered into any market risk sensitive
instruments or purchased any hedging instruments for trading purposes or
otherwise that would be likely to expose the Company to market risk, whether
interest rate, foreign currency exchange, commodity price or equity price risk.
The Company has not purchased options or entered into swaps of forward or future
contracts. While its global operations currently generate revenues in United
States dollars, the Company is evaluating the impact of foreign currency
exchange risk on its results of operations as the Company continues to expand
globally.
5
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 30, 1999, J&W Ventures, Inc. filed a claim against the
Company in the Superior Court of Los Angeles County, alleging that the Company
is in breach of a contract to purchase telecommunications equipment. The
plaintiff is seeking performance of the contract plus damages. The Company has
filed a cross-complaint seeking rescission and damages, asserting that J&W
Ventures, Inc. breached certain representations and warranties. The Company
intends to vigorously contest the litigation and to pursue its own remedies
fully. While no assurance can be given regarding the outcome of this matter, the
Company believes that the Company has strong and meritorious defenses to the
claims asserted. However, a determination that the Company breached its contract
with J&W Ventures, Inc. could have a material adverse effect on its business,
operating results and financial condition.
Pursuant to the J&W Ventures Asset Purchase Agreement, the Company paid
$300,000 in cash, issued 441,600 shares of common stock and was obligated to
designate and issue 850,000 shares of a new series of preferred stock, $2.50 par
value. Pending the outcome of the litigation between the parties, the Company
has placed a stop transfer order on the common stock issued, and has not
designated or issued any preferred stock to the J&W Ventures sellers. The
Company has not made any reserve on its balance sheet in connection with this
litigation.
6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the city of Aliso
Viejo, state of California, on May 15, 2000.
INTEGRATED COMMUNICATION NETWORKS, INC.
Date: May 15, 2000 /S/ DAVID J. CHADWICK
---------------------------------------
David J. Chadwick
President, Chief Executive Officer and
Chairman of the Board of Directors
Date: May 15, 2000 /S/ GARY L. KILLORAN
---------------------------------------
Gary L. Killoran
Secretary, Treasurer, Chief Financial
Officer (principal accounting officer)
and Director
Date: May 15, 2000 /S/ PAUL E. HYDE
---------------------------------------
Paul E. Hyde
Vice President and Director
Date: May 15, 2000 /S/ RUSSELL J. HENSLEY
---------------------------------------
Russell J. Hensley
Director
7
<PAGE>
EXHIBIT INDEX
27.1 Financial Data Schedule
- -----------------------------
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 111,929
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,386,459
<PP&E> 3,844,378
<DEPRECIATION> 523,221
<TOTAL-ASSETS> 14,695,620
<CURRENT-LIABILITIES> 2,525,001
<BONDS> 0
0
4,628,500
<COMMON> 58,677
<OTHER-SE> 3,643,352
<TOTAL-LIABILITY-AND-EQUITY> 14,695,620
<SALES> 623,210
<TOTAL-REVENUES> 623,210
<CGS> 0
<TOTAL-COSTS> 3,020,975
<OTHER-EXPENSES> (422,122)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 241,057
<INCOME-PRETAX> (1,975,653)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,975,653)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,975,653)
<EPS-BASIC> (0.34)
<EPS-DILUTED> (0.34)
</TABLE>