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 June 30, 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 July
31, 2000 was approximately 5,889,231 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...................................................... 6
PART II-OTHER INFORMATION
Item 1. Legal Proceedings........................................... 6
Signatures ............................................................ 6
PART I-FINANCIAL INFORMATION
ITEM 1.**
Index to Financial Statements:
PAGE
----
Consolidated balance sheets as of June 30, 2000 (unaudited)
and December 31, 1999 F-1
Consolidated statements of operations for the three and six months
ended June 30, 2000 and 1999 (unaudited) 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 six months ended June 30, 2000 (unaudited) F-3
Consolidated Statements of Cash Flows for the three and six months
ended June 30, 2000 and 1999 (unaudited) F-4
Notes to Consolidated Financial Statements F-5
<PAGE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, JUNE 30,
ASSETS 1999 2000
------------- -------------
(Unaudited)
Current assets:
Cash $ 2,552,113 $ 243,212
Accounts Receivable - 29,095
Receivable from related party 332,006 126,007
Note Receivable - 474,250
Prepaid and other current assets 293,032 95,281
------------- -------------
Total current assets 3,177,151 967,845
------------- -------------
Property and equipment:
Operating equipment 2,825,700 2,308,350
Equipment, furniture and software
under capital leases 549,685 1,305,526
Leasehold improvements 114,490 117,669
Furniture, fixtures and equipment 60,524 429,765
------------- -------------
3,550,399 4,161,310
Less - Accumulated depreciation and amortization (459,428) (719,830)
------------- -------------
3,090,971 3,441,480
------------- -------------
Goodwill, net 8,907,517 8,596,548
Other noncurrent assets 280,377 302,228
------------- -------------
Total noncurrent assets 12,278,865 12,340,256
------------- -------------
$ 15,456,016 $ 13,308,101
============= =============
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 823,860 $ 2,170,887
Accrued expenses 526,074 972,774
Unearned revenue 334,130 80,069
Long-term debt-current portion 82,696 58,697
Capital lease obligations-current portion 114,078 345,097
------------- -------------
Total current liabilities 1,880,838 3,627,524
------------- -------------
Long-term debt, net of current portion (Note 2) 5,034,813 5,030,089
Capital lease obligations, net of current portion 209,836 617,499
Commitments and contingencies (Note 3) - -
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 June 30, 2000 - -
Series A-1 12% redeemable convertible preferred
stock, $.01 par value per share:
Authorized - 7,500,000 shares at December 31,
1999 and June 30, 2000
Issued and outstanding-3,167,974 at December 31,
1999 and June 30, 2000 4,847,000 4,847,000
Series A-1 preferred stock subscribed (218,500) -
Stockholders' equity:
Common stock, $.01 par value:
Authorized - 250,000,000 shares
Issued and outstanding 5,867,780 and 5,889,231
at December 31, 1999 and
June 30, 2000, respectively 58,677 58,892
Common stock subscribed (105,750) -
Additional paid-in capital 22,858,958 22,925,778
Accumulated deficit (18,996,555) (23,685,380)
Treasury stock (113,301) (113,301)
------------- -------------
Total stockholders' equity 3,702,029 (814,011)
------------- -------------
$ 15,456,016 $ 13,308,101
============= =============
The accompanying notes are an integral part of these
consolidated financial statements
F-1
<PAGE>
<TABLE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<CAPTION>
For the three months ended For the six months ended
June 30, June 30,
--------------------------- ---------------------------
1999 2000 1999 2000
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
(Unaudited) (Unaudited)
Revenues $ 259,572 $ 773,135 $ 301,679 $ 1,396,345
Operating expenses:
Data communications and
telecommunications 364,781 1,158,348 463,685 2,550,589
Selling, general & administrative
expenses 785,129 1,694,951 1,201,230 2,950,804
Depreciation and amortization 202,423 353,344 257,042 726,225
Write-down of impaired assets - - 2,554,819 -
------------- ------------- ------------- -------------
Total operating expenses 1,352,333 3,206,643 4,476,776 6,227,618
------------- ------------- ------------- -------------
Loss from operations (1,092,761) (2,433,507) (4,175,097) (4,831,272)
------------- ------------- ------------- -------------
Other income (expense):
Interest income 434 4 557 9,289
Interest expense (39,598) (272,382) (48,992) (513,439)
Realized gain on sale
of investment - (0) - 992,329
Gain on casualty loss, net 131,006 - 131,006 -
Loss on sale of assets - (0) - (346,116)
Write-off of assets - - (216,600) -
Other income (expense), net - (7,286) 385
------------- ------------- ------------- -------------
91,842 (279,664) (134,029) 142,448
------------- ------------- ------------- -------------
Net loss $ (1,000,919) $ (2,713,172) $ (4,309,126) $ (4,688,825)
============= ============= ============= =============
Basic and diluted weighted average
common shares outstanding 2,233,558 5,867,780 3,072,152 5,867,780
============= ============= ============== =============
Basic and diluted net loss per
share $ (0.45) $ (0.46) $ (1.40) $ (0.80)
============= ============= ============== =============
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
</TABLE>
<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 SIX MONTHS ENDED JUNE 30, 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 - - - - 218,500
Stock issued for true-up (Note 5) - - - - -
Net loss - - - - -
------------- ------------- ------------- ------------- -------------
Balance, June 30, 2000, (Unaudited) - $ - 3,167,974 $ 4,847,000 $ -
============= ============= ============= ============= =============
(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 - - 105,750 - - - 105,750
Stock issued for true-up 21,451 215 - 66,820 - - 67,035
Net loss - - - - (4,688,825) - (4,688,825)
------------- ------------- ------------- ------------- ------------- ------------- -------------
Balance, June 30, 2000,
(Unaudited) 5,889,231 $ 58,892 $ - $ 22,925,778 $(23,685,380) $ (113,301) $ (814,011)
============= ============= ============= ============= ============= ============= =============
The accompanying notes are an integral part of these consolidated financial statements
F-3
</TABLE>
<PAGE>
<TABLE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
For the three months ended For the six months ended
June 30, June 30,
---------------------------- ----------------------------
1999 2000 1999 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
(Unaudited) (Unaudited)
Cash Flows From Operating Activities:
Net loss $ (1,000,919) $ (2,713,172) $ (4,309,126) $ (4,688,825)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization 202,423 353,344 257,042 726,224
Write-down of impaired assets - - 2,554,819 -
Write-off assets casualty loss 39,581 - 39,581 -
Gain on sale of marketable security - - - (992,329)
Loss on sale of equipment - - - 346,116
Shares issued for services - 67,034 - 67,034
Decrease (increase) in assets:
Accounts receivable 29,585 95,695 21,456 20,133
Notes receivable - 230,201 - 198,328
Prepaid expenses and other
current assets 124,633 (48,281) (234,298) 105,216
Increase (decrease) in liabilities:
Accounts payable 129,330 915,558 91,355 1,351,865
Accrued expenses (12,057) 217,946 93,879 440,708
Unearned revenue (66) (70,914) (1,170) (254,059)
Customer deposits 1,000 7,500 1,000 7,500
Other advance - - (317,802) -
Payable to related party 138,886 - 127,705 -
------------- ------------- ------------- -------------
Net cash used in operating
activities (347,604) (945,089) (1,675,559) (2,672,089)
------------- ------------- ------------- -------------
Cash Flows From Investing Activities:
Purchases of property and equipment (748,534) (309,670) (1,039,461) (384,644)
Proceeds from sale of equipment - - - 50,000
Purchase of investment in marketable
security - - - (1,000,000)
Proceeds from sale of marketable
security - 1,200,750 - 1,525,750
------------- ------------- ------------- -------------
Net cash used in investing
activities (748,534) 891,080 (1,039,461) 191,106
------------- ------------- ------------- -------------
Cash Flows From Financing Activities:
Principal payments of capital lease
obligation (9,814) (30,927) (18,920) (123,444)
Proceeds from issuance of
long-term debt 901,390 - 901,390 -
Principal payments on long-term debt (55,336) (8,032) (61,025) (28,724)
Proceeds from preferred stock
subscription 291,685 218,500 1,950,000 218,500
Proceeds from issuance of common
stock 750,000 5,750 750,000 105,750
------------- ------------- ------------- -------------
Net cash provided by financing
activities 1,877,925 185,291 3,521,445 172,081
------------- ------------- ------------- -------------
Increase (decrease) in cash 781,787 131,282 806,425 (2,308,901)
------------- ------------- ------------- -------------
Cash at the beginning of the period 24,638 111,929 - 2,552,113
------------- ------------- ------------- -------------
Cash at the end of the period $ 806,425 $ 243,212 $ 806,425 $ 243,212
============= ============= ============= =============
Supplemental disclosure of cash flow
information:
Cash paid during the year for
interest $ 9,565 $ 21,730 $ 18,959 $ 59,943
============= ============= ============= =============
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
</TABLE>
<PAGE>
INTEGRATED COMMUNICATION NETWORKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 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 and six months ended June 30, 2000 are not necessarily indicative
of the results that may be expected for the year ending December 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 subsidiaries Internet Call Centers, Inc. and C3.Com,
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 June 2000 presentation.
2. LONG-TERM DEBT
Long-term debt consists of the following:
June 30, 2000
(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. $ 50,761
(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. 38,024
(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
-----------
5,088,785
-----------
Less: Current maturities (58,697)
-----------
$5,030,088
===========
Aggregate maturities of long-term debt over the next five years is as
follows:
Year Ending
June 30: Amount
----------- ----------
2001 $ 58,697
2002 8,766
2003 9,684
2004 5,010,698
2005 940
----------
$5,088,785
==========
3. 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 June 30, 2000, the Company has received
equipment eligible to be financed under the Master Lease Agreement valued at
approximately $5 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 June 30, 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 $110,302 and $77,049, for the three months ended
June 30, 2000 and 1999, respectively and approximately $193,766 and $114,466,
for the six months ended June 30, 2000 and 1999, 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.
Future minimum lease payments associated with the leases described herein,
including renewal options are as follows:
Dedicated Other
Year Ending Capital Private Operating
June 30: Leases Lines Leases
----------------- ----------- ----------- -----------
2001 $ 518,199 $ 954,784 $ 516,673
2002 414,932 241,262 444,195
2003 217,452 16,662 410,695
2004 59,321 -0- 410,695
2005 29,327 -0- 308,020
Thereafter -0- -0- -0-
----------- ----------- -----------
Total minimum lease payments $1,239,231 $1,212,708 $2,090,278
=========== ===========
Less: amount representing interest (276,843)
Net present value of minimum
lease payments 962,388
-----------
Less: current portion (356,554)
-----------
Long-term capitalized lease obligation $ 605,834
===========
(d) Legal Matters
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.
4. EQUITY TRANSACTION
In June, 2000, the Company issued 21,451 shares of restricted common stock
pursuant to a true-up provision related to the previous payoff of a note due by
its subsidiary in the amount of $132,804.
5. SUBSEQUENT EVENTS
On July 28, 2000, the Company sold $210,000 principle amount of its 10%
Senior Secured Notes, due November 1, 2000 to a shareholder. The principle and
accrued interest are due on the earlier of (i) November 1, 2000 or (ii) receipt
by the Company of net proceeds of $400,000 from the next financing completed by
the Company. The note is secured by all assets of the Company.
<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 June 30, 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 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 and six months ended June 30, 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, 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.
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.
(1)
<PAGE>
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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 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 June 30, 2000 increased $513,563 to $773,135 from $259,572 for the
three months ended June 30, 1999. This increase is due to the increase in
volumes of wholesale long distance voice services which the Company began
operations in February 28, 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.
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 for the three months
ended June 30, 2000 increased $793,567 to $1,158,348 from $364,781 for the three
months ended June 30, 1999. This increase is due to the fact that 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 believes it 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.
(2)
<PAGE>
Selling, general and administrative expenses for the three months ended
June 30, 2000 increased $909,822 to $1,694,951 from $785,127 for the three
months ended June 30, 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 June 30, 2000 increased $150,920 to $353,343 from $202,423
for the three months ended June 30 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.
INTEREST INCOME AND INTEREST EXPENSE: Interest expense is primarily
comprised of interest incurred on the Company's long-term debt and various
capital leases. Interest expense increased by $232,784 to $272,382 for the three
months ended June 30, 2000 from $39,598 for the three months ended June 30,
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 decreased by $430 to $4 for the three months ended
June 30, 2000 from $434 for the three months ended June 30, 1999. This decrease
was primarily attributable to reduced interest earnings on the Company's cash.
INCOME TAXES: The Company generated a net loss for the three months ended
June 30, 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.
SIX MONTHS ENDED JUNE 30, 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 six
months ended June 30, 2000 increased $1,094,666 to $1,396,345 from $301,679 for
the six months ended June 30, 1999. This increase is due to an increase in
volumes of wholesale long distance voice services and due to the fact that the
Company began operations in February 28, 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.
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 for the six months ended
June 30, 2000 increased $2,086,904 to $2,550,589 from $463,685 for the six
months ended June 30, 1999. This increase is due to the fact that the Company
began operations on February 28, 1999, increased costs associated with the
origination, transmission and termination from other carriers due to volume
increases, and 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 expects to 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. In addition, the
Company is establishing its own transmission network and termination
relationships in the Philippines. 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.
(3)
<PAGE>
Selling, general and administrative expenses for the six months ended June
30, 2000 increased $1,749,574 to $2,950,804 from $1,201,230 for the six months
ended June 30, 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 six
months ended June 30, 2000 increased $469,182 to $726,224 from $257,042 for the
six months ended June 30 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.
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 $464,447 to $513,439 for the six months
ended June 30, 2000 from $48,992 for the six months ended June 30, 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 $8,732 to $9,289 for the six months ended June 30, 2000 from
$557 for the six months ended June 30, 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 six months ended
June 30, 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.
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.
As of June 30, 2000, the Company had cash of $243,212, note receiveable of
$474,250 and a working captial deficit of $2,659,679.
Net cash provided by financing activities was $172,081 for the six months
ended June 30, 2000 and net cash provided by financing activities was $3,521,445
for the six months ended June 30, 1999. The June 1999 amount is primarily
attributable to the net proceeds from the issuance of long term notes and the
sale of its common and preferred stock. The June 2000 amount is attributable to
proceeds from preferred and common stock subscriptions.
Net cash used in operating activities was $2,672,089 for the six months
ended June 30, 2000 and $1,675,559 for the six months ended June 30, 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 provided by investing activities was $191,106 for the six months
ended June 30, 2000 and net cash used in investing activities was $1,039,461 for
the six months ended June 30, 1999. Cash provided by investing activities for
the six months ended June 30, 2000 was primarily attributable to proceeds from
the sale of marketable securities net of the purchase price. Cash used in
investing activities was primarily related to purchases of equipment.
(4)
<PAGE>
On July 28, 2000, the Company sold $210,000 principle amount of its 10%
Senior Secured Notes, due November 1, 2000 to a shareholder. The principle and
accrued interest are due on the earlier of (i) November 1, 2000 or (ii) receipt
by the Company of net proceeds of $400,000 from the next financing completed by
the Company. The note is secured by all assets of the Company.
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.
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.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 33,
Accounting for Derivative Instruments and Hedging Activities, which stablishes
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.
(5)
<PAGE>
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.
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.
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 August 21, 2000.
INTEGRATED COMMUNICATION NETWORKS, INC.
Date: August 21, 2000 /S/ DAVID J. CHADWICK
---------------------------------------
David J. Chadwick
President, Chief Executive Officer and
Chairman of the Board of Directors
Date: August 21, 2000 /S/ GARY L. KILLORAN
---------------------------------------
Gary L. Killoran
Secretary, Treasurer, Chief Financial
Officer (principal accounting officer)
and Director
Date: August 21, 2000 /S/ PAUL E. HYDE
---------------------------------------
Paul E. Hyde
Director
(6)
<PAGE>
EXHIBIT INDEX
27.1 Financial Data Schedule
-----------------------------
