<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 COMMISSION FILE NO. 0-12386
INCOMNET, INC.
A California IRS Employer No.
Corporation 95-2871296
21031 Ventura Blvd., Suite 1100
Woodland Hills, California 91364
Telephone no. (818) 887-3400
SECURITIES REGISTERED PURSUANT TO
SECTION 12(B) OF THE ACT:.....................None
SECURITIES REGISTERED PURSUANT TO
SECTION 12(G) OF THE ACT:.....................Common Stock, No Par Value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
Number of shares of registrant's common stock outstanding as of
September 30, 1997...................................14,006,793
1
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) September 30, December 31,
1997 1996
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash & cash equivalents 1,169 $ 2,214
Accounts receivable, including $287,000 and $267,000 due from related
party at September 30, 1997 and December 31, 1996, respectively
and less allowance for doubtful accounts of $2.1 million at
September 30, 1997 and $1.9 million at December 31, 1996 18,914 13,137
Notes receivable - current portion 445 323
Notes receivable from officers & shareholders, net of reserves
of $209,000 1,009 438
Inventories 499 2,760
Other current assets 1,327 1,332
-------- --------
Total current assets 23,363 20,204
Property, plant and equipment, at cost, net 16,670 14,357
Goodwill, net 6,894 5,783
Investments, notes receivable and other assets 1,725 243
-------- --------
Total assets 48,652 $ 40,587
-------- --------
-------- --------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
2
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INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONT'D)
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) September 30, December 31,
1997 1996
---- ----
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable 14,597 $ 14,746
Accrued expenses 6,502 8,217
Current portion of notes payable 5,994 3,918
Deferred income 3,190 4,040
-------- --------
Total current liabilities 30,283 30,921
Long-term liabilities
Notes payable 1,190 1,040
Notes payable, GenSource 2,165 --
Liabilities in excess of assets of RCI 3,600 --
Shareholders' equity:
Common stock, no par value; 20,000,000 shares
authorized; 14,006,793 shares issued and outstanding
at September 30, 1997 and 13,369,681 shares at
December 31, 1996 69,972 61,320
Preferred stock, no par value; 100,000 shares authorized;
3,909 issued and outstanding September 30, 1997 and
2,355 shares issued and outstanding at
December 31, 1996 3,698 2,355
Treasury stock (5,492) (5,492)
Accumulated deficit (56,765) (49,557)
-------- --------
Total shareholders' equity 11,413 8,626
-------- --------
Total liabilities & shareholders' equity $ 48,652 $ 40,587
-------- --------
-------- --------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
3
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SEPTEMBER 30,
(DOLLARS IN THOUSANDS) 1997 1996
---- ----
SALES $ 33,318 $ 27,591
-------- --------
OPERATING COSTS & EXPENSES:
Cost of sales 23,384 17,777
General & administrative 6,730 8,254
Depreciation & amortization 821 502
Bad debt expense 1,600 1,292
Other (income)/expense 11,238 10,676
-------- --------
Total operating costs and expenses 43,773 38,501
-------- --------
Income/(loss) before income taxes and minority interest (10,455) (10,910)
INCOME TAX BENEFITS/(EXPENSE) 887 (866)
-------- --------
Income/(loss) before minority interest (9,569) (10,044)
MINORITY INTEREST -- 781
Net income/(loss) $ (9,569) $ (9,263)
-------- --------
-------- --------
INCOME/(LOSS) PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS:
Net income/(loss) $ (0.70) $ (0.70)
-------- --------
-------- --------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND
COMMON SHARE EQUIVALENTS OUTSTANDING 13,687,977 13,244,674
---------- ----------
---------- ----------
See accompanying "Notes to Consolidated Financial Statements."
4
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INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
(DOLLARS IN THOUSANDS)
1997 1996
---- ----
SALES $ 99,341 $ 77,296
--------- --------
OPERATING COSTS & EXPENSES:
Cost of sales 69,525 49,144
General & administrative 20,740 22,083
Depreciation & amortization 2,218 1,396
Bad debt expense 3,448 3,829
Other (income)/expense 11,297 12,046
--------- --------
Total operating costs and expenses 107,228 88,498
--------- --------
Income/(loss) before income taxes and minority interest (7,886) (11,202)
INCOME TAX BENEFITS/(EXPENSE) 679 (679)
--------- --------
Income/(loss) before minority interest (7,207) (10,523)
MINORITY INTEREST -- 1,908
--------- --------
Net income/(loss) $ (7,207) $ (8,615)
--------- --------
--------- --------
INCOME/(LOSS) PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS:
Net income/(loss) $ (0.53) $ (0.65)
--------- --------
--------- --------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
AND COMMON SHARE EQUIVALENTS OUTSTANDING 13,687,977 13,268,050
---------- ----------
---------- ----------
See accompanying "Notes to Consolidated Financial Statements."
5
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INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
1997 1996
--------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (7,207) $ (10,523)
Depreciation and amortization 2,524 3,222
--------- --------
(4,683) (7,301)
-------- --------
CASH FLOWS FROM (INCREASE)/DECREASE IN OPERATING ASSETS:
Accounts receivable (5,777) (372)
Notes receivable - current (122) (67)
Notes receivable - due from officers (571) 711
Inventories 2,261 (1,101)
Prepaid expenses and other& (5) (1,374)
Notes receivable - long term - 155
Deposits and other (1,481) (20)
-------- --------
(5,695) (2,068)
-------- --------
CASH FLOWS FROM INCREASE/(DECREASE) IN OPERATING LIABILITIES
Accounts payable (149) 2,225
Accrued expenses (1,715) 869
Deferred income (850) 528
-------- --------
(2,714) 3,622
-------- --------
Net cash flow from operations (13,092) (5,747)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of plant and equipment (3,725) (5,159)
Patents/intangible assets - (162)
Investment in Lab Tech - 66
Goodwill from acquisition of GenSource (2,223)
Liability in excess of assets 3,600
Goodwill from acquisition of NTC - 222
Goodwill from acquisition of RCI - 8,000
-------- --------
Net cash flow from investing activities (2,348) 2,967
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Notes payable - current - 3,146
Sale of common stock, net 8,651 436
Preferred stock 1,343
Notes payable - long term 4,391 (876)
Other - net 10 46
-------- --------
Net cash flow from financing activities 14,395 2,752
-------- --------
Net increase/(decrease) in cash and equivalents $ (1,045) $ (28)
-------- --------
-------- --------
See accompanying "Notes to Consolidated Financial Statements."
6
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INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1997
1. MANAGEMENT'S REPRESENTATION:
The consolidated financial statements included herein have been prepared by
the management of Incomnet, Inc. (the Company) without audit. Certain
information and note disclosures normally included in the consolidated
financial statements prepared in accordance with generally accepted
accounting principles have been omitted. In the opinion of the management of
the Company, all adjustments considered necessary for fair presentation of
the consolidated financial statements have been included and were of a normal
recurring nature, and the accompanying consolidated financial statements
present fairly the financial position as of September 30, 1997, and the
results of operations for the three and nine months ended September 30, 1997
and 1996, and cash flows for the nine months ended September 30, 1997 and
1996.
It is suggested that these consolidated financial statements be read in
conjunction with the consolidated financial statements and notes for the
three years ended December 31, 1996, included in the Company's Annual Report
on Form 10-K filed with the Securities and Exchange Commission on April 14,
1997. The interim results are not necessarily indicative of the results for
a full year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiaries, National
Telephone & Communications-TM-, Inc. (NTC) and GenSource-TM- Corporation
(GenSource - see "Item 5. Change of Name From California Interactive
Computing, Inc. to GenSource Corporation"). The statements do not include
consolidated results of Rapid Cast, Inc., the Company's 22%-owned
subsidiary, which is accounted for using the equity method of accounting. The
Company accounted for RCI using the consolidated method of accounting from
the third quarter of 1995 until December 31, 1996 because the Company owned
51% of RCI. In January 1997, the Company's ownership changed from 51% of RCI
to 35%, as a result, the method of accounting has changed to the equity
method. In June 1997, the Company's ownership position changed to 22%. On
the date of change in the method of accounting, RCI's liabilities
significantly exceeded its assets, and the Company recorded its ratable share
of such excess in the balance sheet caption "Liabilities in excess of assets
of RCI". Accordingly, all assets and liabilities of RCI, including patent
rights of $1,241,000 (after previously recorded reserves of approximately $39
million) were, during the first quarter of 1997, combined under this caption.
REVENUE RECOGNITION - The Company recognizes revenue during the month in
which services or products are delivered, as follows:
(1) NTC's long distance telecommunications service revenues are generated
when customers make long distance telephone calls from their business or
residential telephones or by using any of NTC's telephone calling cards.
Proceeds from prepaid telephone calling cards are recorded as deferred
revenues when the cash is received, and recognized as revenue as the
telephone service is utilized. The reserve for deferred revenues is carried
on the balance sheet as an accrued liability. Long distance telephone
service sales in the three months and nine months ending September 30, 1997
totaled $28.7 million and $83.5 million, respectively versus long distance
telephone service sales of $21.1 million and $61.6 million, respectively in
the three months and nine months ending September 30, 1996.
(2) NTC's marketing-related revenues are derived from programs and material
sold to the Company's base of independent sales representatives, including
forms and supplies, fees for representative and certified trainer renewals,
and the Company's Certified Trainer, Independent Representative and Home
Study programs. The Company requires that all such services and materials be
paid at the time of purchase. Revenues from marketing-related materials, net
of amounts deferred for future services provided to the representatives, are
booked as cash sales when the revenues are received. A portion of the
revenues from marketing-related programs and materials is deferred and
recognized over a twelve month period to accrue the Company's obligation to
provide customer support to its independent representatives. For the three
months and nine months ending September 30, 1997, marketing sales totaled
$3.6 million and $13.6 million, respectively versus marketing sales of $4.8
million and $10.9 million, respectively for the three months and nine months
ended September 30, 1996.
7
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INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1997
(3) The Company's network service revenues from its AutoNETWORK service are
recognized as sales as the service is delivered. Network service sales in
the three months and nine months ending September 30, 1997 totaled $369,885
and $1.1 million, respectively versus $360,587 and $1.1 million, respectively
in the three months and nine months ending September 30, 1997.
(4) Revenues from the Company's GenSource subsidiary (see "Item 5. Change of
Name From California Interactive Computing, Inc. to GenSource Corporation")
are derived from the sale of computer software and from related services,
such as software maintenance fees, custom programming and customer training.
Revenues are recognized when software is shipped to customers and when
services are performed and invoiced. Because the Company acquired GenSource
on May 2, 1997, revenues and earnings only reflect GenSource's operations
from May 2, 1997. Revenues in the three months and five months ending
September 30, 1997 totaled $662,678 and $1.1 million, respectively.
CONCENTRATION OF CREDIT RISK - The Company sells its telephone, network
services and insurance-related software and related services to individuals
and small businesses throughout the United States and does not require
collateral. Reserves for uncollectible amounts are provided, which management
believes are sufficient.
COMPUTER HARDWARE, FURNITURE AND OFFICE EQUIPMENT - Computer hardware,
furniture and office equipment are stated at cost. Depreciation is provided
by the straight-line method over the assets' estimated useful lives of 3 to
10 years.
COMPUTER SOFTWARE - The Company capitalizes the costs associated with
purchasing, developing and enhancing its computer software. All software
costs are amortized using the straight-line method over the assets' estimated
useful lives of 3 to 10 years.
LEASEHOLD IMPROVEMENTS - All leasehold improvements are stated at cost and
are amortized using the straight-line method over the expected lease term.
NET INCOME PER SHARE - Net income per common share is based on the weighted
average number of common shares and common share equivalents for 1997 and
1996.
ACQUISITION AMORTIZATION - The excess of purchase price over net assets of
NTC and GenSource have been recorded as an intangible asset and is being
amortized by the straight-line method over twenty years.
DEFERRED TAX LIABILITY - Deferred income taxes result from temporary
differences in the basis of assets and liabilities reported for financial
statement and income tax purposes.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
date of the financial statements, as well as the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
3. FUNDING OF MARKETING COMMISSIONS AND DEFERRED INCOME:
The Company's subsidiary, NTC, maintains separate bank accounts for the payment
of marketing commissions. Funding of these accounts is adjusted regularly to
provide for management's estimates of required reserve balances. NTC estimates
the total commissions owed to active independent representatives ("IR Earned
Compensation") each
8
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INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1997
week for all monies collected that week due to the efforts of those active
independent representatives. All IR Earned Compensation is then paid to the
independent representatives, when due, directly out of the separate bank
account.
IMPAIRMENT OF LONG-LIVED ASSETS - In accordance with the provisions of SFAS
No. 121, the Company regularly reviews long-lived assets and intangible
assets for impairment whenever events or changes in circumstances indicate
that the carrying amount to the assets may not be recoverable.
4. NOTES PAYABLE:
Notes payable consist of the following as of September 30, 1997:
Notes payable to founding stockholders of GenSource, interest
at 8%, due beginning in May 1998 $ 2,165,095
Note payable to bank for line of credit to NTC, interest at
prime plus 1.25%, due as current liability $ 5,550,000
Capitalized lease obligations $ 1,633,995
-----------
$ 9,349,090
-----------
-----------
5. NETWORK MARKETING COSTS:
During the three and nine months ending September 30, 1997, NTC's net costs to
operate its network marketing program were $3.0 million and $11.2 million,
respectively, as summarized below (in $ millions):
<TABLE>
<CAPTION>
3 Months Ending 9 Months Ending
September 30,1997 September 30,1997
----------------- -----------------
<S> <C> <C>
Sales $ 3.6 $ 13.6
----- ------
Cost of sales 3.0 11.2
Operating expenses for support services 1.3 4.1
----- ------
Total marketing-related costs 4.3 15.3
----- ------
Net marketing cost $ 0.7 $ 1.7
% of total NTC (long distance & marketing) sales 2.2% 1.8%
</TABLE>
9
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INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1997
Marketing sales of $3.6 million and $13.6 million, during the three and nine
month periods ending September 30, 1997, respectively were generated by the
sale of materials, training and support services to assist NTC independent
sales representatives in selling new retail customers and enrolling other
representatives in the NTC program. Beginning in January 1996, NTC began to
accrue its obligation to provide customer support to its representatives.
These reserved marketing revenues are reflected as deferred income on the
Company's balance sheet and are amortized over the succeeding twelve months.
The marketing-related costs include commissions paid to independent sales
representatives for acquiring new retail telephone customers, as well as the
cost of sales materials, salaries and wages of marketing department
personnel, services required to support the independent sales
representatives, and other directly identifiable support costs, but do not
include residual commissions paid on continuing long distance telephone usage
or the typical indirect cost allocations, such as floor-space and supporting
departments. When marketing-related costs of $4.3 million and $15.3 million
for the three months and nine months ended September 30, 1997, respectively
are compared against marketing-related revenues of $3.6 million and $13.6
million for the same period, the results are a net cost in marketing-related
activities during the three months and nine months ended September 30, 1997
of $0.7 million and $1.7 million, respectively, or 2.2% and 1.8%,
respectively of total NTC sales.
6. COMPENSATION OF INDEPENDENT SALES REPRESENTATIVES:
The Company's subsidiary, NTC, compensates its independent sales
representatives by an earned commission structure based upon signing up new
telephone customers and based upon the telephone usage generated by those
customers. In the three and nine months ending September 30, 1997, expenses
associated with commissions, bonuses and overrides paid out to NTC's
independent representatives were $4.4 million and $15.3 million, respectively
versus commissions, bonuses and overrides paid out to NTC's independent
representatives of $5.0 million and $12.3 million, respectively for the three
months and nine months ended September 30, 1996.
7. COMMITMENTS AND CONTINGENCIES:
Litigation - The Company is a defendant in a class action matter and related
lawsuits alleging securities law violations with respect to alleged false
denial and non-disclosure of a Securities and Exchange Commission
investigation and alleged non-disclosure of purchases and sales of the
Company's stock by an affiliate of the former Chairman of the Board. On
October 7, 1997, the Company announced that it had reached a settlement of
the class action lawsuit for $8,650,000. Accordingly, the Company has taken a
reserve of $8,650,000 in the third quarter ended September 30, 1997 for
expenses associated with the anticipated settlement
[see "Part II. Item 1. Legal Proceedings - Class Action and Related Lawsuits"].
Counsel for the company is unable to estimate the ultimate outcome of the
related lawsuits and is unable to predict a range of potential loss.
Accordingly, no amounts have been provided for the related lawsuits in the
accompanying financial statements. In addition, the Company has recorded an
additional 1.5 million shares of its common stock in connection with the
settlement of this matter.
On October 28, 1997, the Company announced that that its NTC subsidiary
reached a settlement of a civil consumer protection lawsuit with the State of
California. Accordingly, the Company has taken a reserve of $1.6 million in
the third quarter ended September 30, 1997 for expenses associated with the
anticipated settlement [see "Part II. Item 1. Legal Proceedings - Civil
Consumer Protection Lawsuit With The State of California"].
The amounts provided for these matters are included in the caption "Other
(income)/expense" in the accompanying Consolidated Statements of Operations.
The Company is under investigation by the Securities and Exchange Commission
under a non-public "formal order of private investigation." Management has
furnished all information requested by the Commission and does not believe
that the matter will have a material adverse impact on its financial position
or results of operations.
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES:
Overall, the Company had negative cash flows of $1.1 million during the first
nine months of 1997 resulting from negative cash flows from operations of
$13.1 million and negative cash flows from investing activities of $2.4
million, which were offset by positive cash flows from investing activities
of $14.4 million. The Company expects that its operating and investing
activities will continue to experience negative cash flows due to (1)
anticipated cash costs associated with the class action lawsuit, related
lawsuits and other legal and regulatory issues (see "Item 1. Legal
Proceedings") and (2) anticipated funding requirements of approximately $1.2
million through fiscal year 1998 associated with the operation and
acquisition of GenSource (see the Company's Report on Form 10-Q for the
second quarter ended June 30, 1997). To meet these anticipated funding needs,
the Company has issued options to acquire up to 250 shares of Series B 6%
Convertible Preferred Stock at an 88% conversion ratio, the right to acquire
200 shares of Series B 6% Convertible Preferred Stock at an 80% conversion
ratio, and warrants to acquire 105,000 shares of the Company's common stock
(see "Item 5. Conveyance of Series A 2% Convertible Preferred Stock and
Issuance of Series B 6% Convertible Preferred Stock"). There is no assurance
that these options will be exercised and therefore management is not certain
that its liquidity and capital resources will be sufficient to fund these
activities for the foreseeable future.
The Company's cash flows are discussed below, as follows:
CASH FLOW FROM OPERATIONS - The Company experienced $13.1 million in negative
cash flow from operations during the first nine months of 1997 compared to
$5.8 million in negative cash flow from operations during the prior year's
comparable period. This year-to-year decrease in cash flow from operations
resulted primarily from: (1) a net loss from operating activities of $7.2
million, which includes reserves of $8.65 million and $1.6 million for
anticipated legal settlements, (2) an increase in operating assets, primarily
accounts receivable of $5.7 million and (3) a decrease in operating
liabilities of $2.7 million.
CASH FLOW FROM INVESTING - The Company experienced negative cash flows from
investing activities of $ 2.3 million in the first nine months of 1997 as
compared with a positive cash flow of $2.9 million in the first nine months
of 1996. The negative cash flow in the first nine months of 1997 resulted
primarily from $3.7 million used to acquire plant and equipment, primarily by
NTC, and by $2.2 million for the acquisition of GenSource, reduced by a $3.6
million liability in excess of assets arising from changing to the equity
method of accounting for RCI.
CASH FLOW FROM FINANCING - Positive cash flows from financing activities
totaled $14.4 million during the first nine months of 1997 compared with $2.7
million during the first nine months of 1996. The positive cash flow during
the first nine months of 1997 resulted primarily from (1) issuance of $8.65
million of common stock primarily to settle the class action lawsuit against
the Company (see "Item 1. Legal Proceedings"), (2) net sales of $1.3 million
worth of convertible preferred stock (see "Item 5. Conveyance of Series A 2%
Convertible Preferred Stock and Issuance of Series B 6% Convertible Preferred
Stock"), (3) increased borrowings under NTC's line of credit and (4)
assumption of $2.2 million in obligations associated with the acquisition of
GenSource.
RESULTS OF OPERATIONS:
SALES - Sales of $33.3 million in the third quarter ended September 30, 1997
increased 21% over sales of $27.6 million in the third quarter ended
September 30, 1996. The majority of this increase was attributable to NTC's
sales increase to $32.3 million in the three months ended September 30, 1997
from $25.8 million in the three months ended September 30, 1996,
respectively. The following table summarizes the Company's sales performance
by subsidiary and segment during the comparable third quarters in 1997 and
1996:
$ in millions
------------------
Subsidiary Segment 1997 1996
- -------------- --------------------------------------- ------ ------
NTC Telephone (telecommunications services) $ 28.7 $ 21.1
NTC Telephone (marketing programs) 3.6 4.7
RCI Optical -- 1.4
GenSource Software 0.6 --
AutoNETWORK Network 0.4 0.4
------ ------
Total Company Sales $ 33.3 $ 27.6
------ ------
------ ------
COST OF SALES - Total Company cost of sales increased to $23.4 million or 70%
of sales during the quarter ending September 30, 1996 verses $17.7 million or
64% of sales during the comparable prior year quarter. The
quarter-to-quarter increase in cost of sales resulted largely from the
increase in carrier costs associated with increased telephone service sales
by NTC. The increase in the percentage of overall sales to 70% in the third
quarter of 1997 from 64% in the third quarter of 1996 was due primarily to a
percentage increase in NTC's carrier costs in the third quarter of 1997
versus the third quarter of 1996. The following table summarizes the
Company's changes in three major cost components in the third quarter ended
September 30, 1997 and 1996, respectively:
$ in millions
----------------------
September September
30, 1997 30, 1996
--------- ---------
Commissions paid to NTC independent sales reps $ 4.4 $ 5.0
Carrier costs for NTC's long distance telephone service 17.8 11.0
All other costs of sales 1.2 1.8
------ ------
Total Company Cost of Sales $ 23.4 $ 17.8
------ ------
------ ------
11
<PAGE>
NTC's total commission expense decreased to $4.4 million in the third quarter
of 1997 compared to $5.0 million in the same quarter of 1996. NTC's carrier
costs to deliver long distance telephone service to its telephone customers
increased to $17.8 million in the third quarter of 1997 compared to $11.0
million in the third quarter of 1996. This increase in carrier costs reflects
a decline in the gross margin of carrier-related sales. In the third quarter
of 1996, gross margin was 48%, or $11.0 million in carrier costs on $21.1
million in carrier sales, while in the third quarter of 1997, gross margin
declined to 38%, or $17.8 million in carrier costs on $28.7 million in
carrier sales.
The third cost component shown in the table above is "all other costs of
sales" which represents: (1) NTC's costs of producing sales materials for its
independent sales representatives, (2) GenSource's cost of producing software
products and related services, and (3) AutoNETWORK's costs of providing
communications network products and services.
GENERAL & ADMINISTRATIVE - Total general and administrative costs decreased
to $6.7 million or 20% of sales in the quarter ending September 30, 1996
compared to $8.3 million or 30% of sales in the same prior year quarter.
General and administrative costs generally include the costs of employee
salaries, fringe benefits, supplies, and related support costs which are
required in order to provide such operating functions as customer service,
billing, marketing, product development, information systems, collections of
accounts receivable, and accounting. The decrease in general and
administrative expense is associated with improved efficiencies at NTC and by
no longer consolidating the financial statements of RCI.
DEPRECIATION & AMORTIZATION - Total Company depreciation and amortization
expense was $821,409 in the third quarter of 1997 verses $501,787 in the
third quarter of 1996. This increase was caused primarily by continuing
investment by NTC in computer hardware and software, furniture and equipment,
and leasehold improvements required to support its anticipated expansion in
sales.
BAD DEBT EXPENSE - Total Company bad debt expense increased to $1.6 million
in the third quarter of 1997 from $1.3 million in the third quarter of 1996.
The increase in bad debt was associated with an increase in total sales at
NTC in the third quarter of 1997 versus the third quarter of 1996.
OTHER INCOME & EXPENSE - The Company's other income and expense was an
expense of $11.2 million in the third quarter of 1997 compared to other
expense of $10.7 million in the third quarter of 1996. The $11.2 million in
other expenses consists primarily of: (1) an $8.7 million reserve for the
settlement of the class action lawsuit against the company, (2) a $1.6
million reserve for the settlement of a civil consumer protection lawsuit by
the State of California against the Company's NTC subsidiary and
approximately $600,000 in additional legal expenses associated with related
lawsuits and administrative matters.
NET INCOME - The Company incurred a net income loss of $9.6 million in the
third quarter of 1997 compared to a loss of $9.3 million in the third quarter
of 1997. The net loss was due primarily to the reserves taken for legal
settlements, including $8.65 million to settle the class action lawsuit
against the Company and $1.6 million for NTC to settle a civil consumer
protection lawsuit with the State of California (See "Item 1. Legal
Proceedings"). Without the reserves for legal settlements and associated
expenses, the Company had net operating income of approximately $806,397 in
the third quarter ended September 30, 1997.
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PART II - OTHER INFORMATION
CAUTIONARY STATEMENTS:
This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933
and Section 21E of the Securities Exchange Act of 1934. The Company intends
that such forward-looking statements be subject to the safe harbors created
by such statutes. The forward-looking statements included herein are based on
current expectations that involve a number of risks and uncertainties.
Accordingly, to the extent that this Quarterly Report contains
forward-looking statements regarding the financial condition, operating
results, business prospects or any other aspect of the Company and its
subsidiaries, please be advised that the Company and its subsidiaries' actual
financial condition, operating results and business performance may differ
materially from that projected or estimated by the Company in forward-looking
statements. The differences may be caused by a variety of factors, including
but not limited to adverse economic conditions, intense competition,
including intensification of price competition and entry of new competitors
and products, adverse federal, state and local government regulation,
inadequate capital, unexpected costs and operating deficits, increases in
general and administrative costs, lower sales and revenues than forecast,
loss of customers, customer returns of products sold to them by the Company
or its subsidiaries, disadvantageous currency exchange rates, termination of
contracts, loss of supplies, technological obsolescence of the Company's or
its subsidiaries' products, technical problems with the Company's or its
subsidiaries' products, price increases for supplies and components,
inability to raise prices, failure to obtain new customers, litigation and
administrative proceedings involving the Company, including the pending class
action and related lawsuits and SEC investigation, the possible acquisition
of new businesses that result in operating losses or that do not perform as
anticipated, resulting in unanticipated losses, the possible fluctuation and
volatility of the Company's operating results, financial condition and stock
price, losses incurred in litigating and settling cases, dilution in the
Company's ownership of its subsidiaries and businesses, adverse publicity and
news coverage, inability to carry out marketing and sales plans, challenges
to the Company's patents, loss or retirement of key executives, changes in
interest rates, inflationary factors, and other specific risks that may be
alluded to in this Quarterly Report or in other reports issued by the
Company. In addition, the business and operations of the Company are subject
to substantial risks which increase the uncertainty inherent in the
forward-looking statements. In light of the significant uncertainties
inherent in the forward-looking information included herein, the inclusion of
such information should not be regarded as a representation by the Company
or any other person that the objectives or plans of the Company will be
achieved.
ITEM 1. LEGAL PROCEEDINGS
CIVIL CONSUMER PROTECTION LAWSUIT WITH THE STATE OF CALIFORNIA:
On October 28, 1997, the Company announced that its NTC subsidiary reached a
settlement of a civil consumer protection lawsuit with the State of
California. In the settlement, which NTC reached without admitting any
wrongdoing, NTC agreed to a court order requiring them to implement policies
to prevent the practice of slamming (switching customers' long distance
telephone service without their permission or knowledge) by its independent
sales representatives and employees, and agreed to pay $1,250,600 in costs
and penalties. NTC also agreed to institute safeguards to prevent slamming
violations from occurring in the future. Among those safeguards, NTC agreed
to wait 24 hours after the consumer agrees to switch their telephone company
to NTC before calling the customer to confirm that the consumer really wants
to switch to NTC.
The lawsuit was brought through the California Attorney General's Office and
the Orange County District Attorney Office. The California Public Utility
Commission was the investigative agency. As part of a related administrative
action, restitution to consumers is being sought by the Consumer Services
Division of the California Public Utility Commission. NTC is in settlement
discussions with the California Public Utility Commission, but there is no
assurance that a settlement will be reached.
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION:
The investigation of the Company by the SEC, which was commenced in August 1994,
has not experienced any material changes from its status as described in "Item
3. Legal Proceedings" in the Company's Form 10-K for its fiscal year ending
December 31, 1996. The Company continues to believe that it has provided
substantial documentation to
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the Commission that demonstrates the propriety of its business operations
and that the ultimate result of the investigation will not have a material
adverse effect on the Company's financial condition or results of operations.
CLASS ACTION AND RELATED LAWSUITS:
The status of the pending class action lawsuit described in "Item 3. Legal
Proceedings" in the Company's Form 10-K for its fiscal year ending December
31, 1996, known as and updated in "Item 1. Legal Proceedings" in the
Company's Form 10-Q for its fiscal quarters ending March 31, 1997 and June
30, 1997, SANDRA GAYLES, ET AL. VS. SAM D. SCHWARTZ AND INCOMNET, INC., Case
No. CV95-0399 KMW (BQRx), has materially changed since the filing of the
Form 10-K for the fiscal year ending December 31, 1996 and Form 10-Q for the
fiscal quarter ending June 30, 1997, in the following manner:
On October 7, 1997, the Company reached a settlement of the lawsuit. The
settlement, which is subject to court approval, consists of a payment of
$500,000 in cash plus securities with a value of $8.15 million for a total
settlement value of $8.65 million. The securities consist of 1,500,000 shares
of the Company's common stock, plus a number of warrants to be determined if
the value of the common stock does not equal at least $8.15 million after the
settlement is approved by the court.
On July 22, 1997, the Company was named in a lawsuit, JAMES A BELTZ, ET AL.
VS. SAMUEL D. SCHWARTZ and RITA SCHWARTZ, husband and wife; STEPHEN A.
CASWELL; JOEL W. GREENBERG; INCOMNET, INC., a California corporation; DAVID
BODNER and MURRAY HUBERFELD, in the United States District Court, District of
Minnesota. The lawsuit was filed by 17 individuals who were allowed to opt
out of the class action lawsuit to pursue a lawsuit on their own. The lawsuit
alleges that Mr. Schwartz and the other defendants created a fraudulent
scheme to drive up the price of the Company's stock in violation of federal
securities law. The lawsuit alleges losses by the plaintiffs of approximately
$1.5 million and seeks unspecified damages.
The status of the pending lawsuit described in the Company's Form 10-Q for
its second quarter ending June 30, 1997, known as SILVA RUN WORLDWIDE LIMITED
VS. INCOMNET, INC., SAM D. SCHWARTZ, BEAR STEARNS & CO., INC., LESLIE
SOLMONSON, RONALD F. SEALE, MARINER RESERVE FUND, COMPANIA DI INVESTIMENTO
ANTILLANO, COUTTS & CO. AG, SALVATORE M. FRANZELLA, PETER G. EMBIRICOS, AND
JOS SCHUETZ, filed in the United States District Court for the Southern
District of New York and transferred in March 1997 to the same court in
California which is hearing the pending class action lawsuit has not
materially changed since the filing of the Form 10-Q for the second quarter
ending June30, 1997.
INCOMNET, INC. VS. SAM D. SCHWARTZ:
The status of the lawsuit by the Company against Sam D. Schwartz, its prior
President and Chairman of the Board, alleging fraud, breach of fiduciary
duty, negligence, declaratory relief, breach of contract and imposition of
constructive trust, which was commenced in April 25, 1997, has not
experienced any material changes from its status as described in "Item 1.
Legal Proceedings - INCOMNET VS. SAM D. SCHWARTZ" in the Company's Form 10-Q
for its fiscal quarter ending June 30, 1997.
LEGAL ACTION AGAINST PRIOR REPRESENTATIVES:
The status of the pending lawsuit by NTC against certain of its prior
representatives described in "Item 3. Legal Proceedings" in the Company's
Form 10-K for its fiscal year ending December 31, 1996 and updated in the
filing of the Form 10-Qs for the fiscal quarters ending March 31, 1997 and
June 30, 1997, respectively, has not materially changed since the filing of
the Form 10-K.
POTENTIAL LAWSUITS:
There is no assurance that claims similar to those asserted in the pending
class action and related lawsuits, or other claims, will not be asserted
against the Company by new parties in the future. In this regard, potential
plaintiffs have from time to time orally asserted claims against the Company
and its prior directors. Several members of the class in the class action
lawsuit against the Company have opted out and filed their own lawsuits
against the Company as described above. From time to time, the Company is
also involved in litigation arising from the ordinary course of
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business, the ultimate resolution of which management believes will not have
a material adverse effect on the financial condition or results of operations
of the Company.
ITEM 2. CHANGES IN SECURITIES
Item 2 is not applicable for the three months ended September 30, 1997.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Item 3 is not applicable for the three months ended September 30, 1997.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Item 4 is not applicable for the three months ended September 30, 1997.
ITEM 5. OTHER INFORMATION
EMPLOYMENT AGREEMENT BETWEEN INCOMNET AND EDWARD R. JACOBS:
On October 30, 1997, the Company's NTC subsidiary entered into a new
employment agreement with Edward R. Jacobs, who had been the Chairman and
Chief Executive Officer of NTC under a previous employment agreement from
December 28, 1994 to July 25, 1997. Under terms of the new agreement, which
was approved by NTC's Board of Directors, Mr. Jacobs will serve as the
Chairman of the Board of NTC until July 25, 1999. Detailed information on the
employment agreement is in the Company's Proxy Statement dated November 17,
1997.
CONVEYANCE OF SERIES A 2% CONVERTIBLE PREFERRED STOCK AND ISSUANCE OF SERIES B
6% CONVERTIBLE PREFERRED STOCK:
CONVEYANCE OF SERIES A 2% CONVERTIBLE PREFERRED STOCK. From September 20, 1996
to October 25, 1996, the Company sold 2,440 shares of Series A 2% Convertible
Preferred Stock (the "Series A Stock") to 12 accredited private investors [See
the Company's Annual Report on Form 10-K for fiscal year ended December 31,
1996]. The sale included an agreement that the Company would register the stock
with an S-3 Registration Statement and included liquidated damages of 3% per
month should the Registration Statement not be declared effective beginning 75
days after the funding was completed. The Company submitted the Registration
Statement in November 1996, but has not yet had it declared effective, which has
resulted in liquidated damages commencing in January 1997. These damages have
been paid by the Company to holders of the Series A Stock as either cash or
additional shares.
On November 7, 1997, 1,700 shares of the Series A Stock was purchased from four
institutional investors, who were original purchasers of the Series A Stock, for
$1.7 million by 12 individual accredited investors. These individuals have all
agreed to waive all registration rights and liquidated damage rights associated
with the Series A Stock and have agreed that they will convert their Series A
Stock into shares subject to Rule 144 of the Securities and Exchange Act of
1933, as amended, instead of shares that will be registered by the Company. The
Company has paid total liquidated damages of $540,000 in cash to the four
original purchasers of the Series A Stock conveyed to the new buyers.
On November 3, 1997, three other individuals converted $225,000 of the Series
A Stock (i.e. the original investment amount) to the Company's common stock,
subject to Rule 144. These three individuals received liquidated damages of
$67,500 paid in additional shares of common stock at a price of $3.00 per
share. As of November 7, 1997, only 150 shares of original Series A Stock
remains on the Company's books held by two individuals. These individuals are
owed liquidated damages of approximately $45,000.
SERIES B 6% CONVERTIBLE PREFERRED STOCK. In July 1997, the Company's Board of
Directors approved the issuance of 2,990 shares of Series B 6% Convertible
Preferred Stock (the "Series B Stock"), with each share worth $1,000 that
could be converted into the Company's common stock. At that time, the Company
raised $1.8 million by selling 1,834 shares of the authorized Series B Stock
(see the Company's Report on Form 10-Q for the second quarter ending June 30,
1997 for a detailed description). On November 4, 1997, the Company issued 600
additional shares of Series B Stock, raising an additional $600,000, less a
cash fee of $60,000 to the
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investment banker, who arranged the sale ( the same investment banker
arranged the sale of the 1,834 shares of Stock sold in July 1997). In
connection with this new issuance of the Series B Stock, the Company also
issued warrants to the investment banker to purchase 55,000 shares of the
Company's common stock at an exercise price of $3.00 per share for a period
of two years, an option to the investment banker to acquire an additional 125
Series B Stock at 88% of the average bid price of the Company's common stock
quoted on the five trading days immediately preceding the date of issuance of
the additional Series B Stock, and the right for one year of the investment
banker to provide the Company with an additional $200,000 in Series B Stock.
The cash fee, warrants and options paid and issued, respectively to the
investment banker were contingent upon the investment banker placing $1.7
million of Series A Stock being sold by four original institutional
purchasers who owned the Series Stock, to 12 new individuals who would waive
all associated registration rights. On November 7, 1997, this contingency was
met (see "Conveyance of Series A 2% Convertible Preferred Stock").
The basic terms and conditions of the Series B Stock are as follows:
VOTING. The Series B Stock does not have voting rights.
DIVIDEND. The Series B Stock has a cumulative non-compounded annual dividend of
6% payable in cash or stock at the Company's option upon conversion of the
Series B Stock into the Company's common stock, and prior to the payment of any
dividends on the Company's common stock. No dividends may be declared or paid on
the Series B Stock until all cumulative unpaid dividends have been declared and
paid on the outstanding Series A Stock.
LIQUIDATION PREFERENCE. The Series B Stock has a liquidation preference of
$1,000 per share plus all cumulative unpaid dividends, whether or not declared
by the Company's Board of Directors. Upon any liquidation or change of control
of the Company (i.e. transfer of more than 50% of its voting stock), the
Preferred Stockholders are entitled to the second priority in payment from the
Company's assets, before any payments are made on the Company's common stock,
until the liquidation preference is paid in full. The Series B Stock is junior
in preference to Series A Stock issued in October 1996 (see the Company's Annual
Report of Form 10-K filed on April 15, 1997). No liquidation preference may be
paid to the holders of the Series B Stock until the full liquidation preference
has been paid to the holders of the outstanding Series A Stock.
CONVERSION. The Preferred Stockholders may convert each share of Series B Stock
into the number of shares of the Company's common stock calculated as follows,
at any time upon the earlier of (i) 120 days after the issuance of the Preferred
Stock, or (ii) when the shares of common stock underlying the Preferred Stock
are registered with the Securities and Exchange Commission. The conversion
price (the "Conversion Price") for each share of Series B Stock is equal to the
lesser of (a) 80% of the average bid price for the Company's common stock on the
public trading market for the five trading days immediately preceding the
conversion date, as specified by the Preferred Stockholder, or (b) the bid price
of the Company's common stock on the funding date (i.e. the issuance date of the
Preferred Stock). To calculate the number of shares of common stock issuable
upon the conversion of the Preferred Stock, the Conversion Price is multiplied
by a ratio, the numerator of which is the sum of 1,000 and the accrued but
unpaid dividends, and the denominator of which is the Conversion Price. If for
any reason a registration statement covering the shares of common stock issuable
upon the conversion of the Preferred Stock is not in effect with the Securities
and Exchange Commission at the time of a valid conversion by a Preferred
Stockholder, then the Conversion Price is reduced by 3% per month for each of
the first three months that the effectiveness of the registration is late, and
thereafter the Company is obligated to pay a cash penalty equal to 3% of the
investment per month. The Company has the right to cause a conversion of the
Preferred Stock into common stock on the same terms at any time after one year
after the Preferred Stock is issued.
REDEMPTION. The Company has the right to redeem the Preferred Stock for its
issuance price plus cumulative unpaid dividends if the Company's stock trades at
a price which averages $2.00 per share or less for any period of five
consecutive trading days after the Preferred Stock is issued.
REGISTRATION RIGHTS. Pursuant to a Registration Rights Agreement entered into
by the Company with each purchaser of the Series B Stock, the Company is
obligated to file a registration statement
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with the Securities and Exchange Commission covering the shares of common
stock underlying the Preferred Stock within 30 days after the Preferred Stock
is issued, and to have the registration statement declared effective within
120 days after it is filed.
ANTIDILUTION PROVISION. The Certificate of Determination for the Series B Stock
contains comprehensive provisions for adjustments to the Conversion Price and
the conversion ratio of the Preferred Stock in the event of stock dividends,
asset distributions, reorganizations, recapitalizations, mergers, stock splits
or similar transactions by the Company, in order to protect the Preferred Stock
from dilution as a result of such transactions.
RESTRICTIVE COVENANTS. During the first 90 days after the Series B Stock is
issued, the Company is not permitted to issue any other securities, except in
limited circumstances, including pursuant to the exercise of outstanding options
or warrants or pursuant to existing settlement agreements, without first
notifying the Preferred Stockholders and giving them a right of first refusal to
purchase the securities themselves. While the Series B Stock is outstanding or
until it is converted into common stock, the Company is not permitted to engage
in certain transactions, such as the redemption or purchase of its own common
stock (except in connection with the collection of Section 16(b) short-swing
profits), without the prior consent of the Preferred Stockholders. Furthermore,
the Company cannot take any action which would modify the rights of the
Preferred Stockholders under the Certificate of Determination without the prior
consent of the Preferred Stockholder being affected by the modification.
AMENDMENT OF EMPLOYMENT AGREEMENT OF MELVYN REZNICK AND EMPLOYMENT AGREEMENT
WITH STEPHEN A. CASWELL:
On June 8, 1997, the Company's Board of Directors approved an extension of
the employment agreement with Melvyn Reznick, the President and Chairman of
the Board of the Company, and a new employment agreement with Stephen A.
Caswell, the Company's Vice President and Corporate Secretary. The existing
employment agreement with Mr. Reznick was extended until the earlier of (i)
June 30, 2002, or (ii) six months after the date that 100% of the Company's
holdings of NTC stock are sold, conveyed or otherwise distributed but no
sooner than December 31, 1999 ("Early Termination Date"). In the event of an
improper termination of the agreement by the Company for any reason, Mr.
Reznick is entitled (i) to be paid a lump sum amount equal to his annual
salary during the remaining term of his agreement plus his annual salary for
three additional years, plus accrued bonus, if any, (ii) to receive all of
his benefits during such period, and (iii) to exercise all of his vested
stock options at any time during the remaining term of the options. In the
event of an early termination because of the disposition of 100% of the
Company's NTC stock, then the Company has agreed to pay Mr. Reznick a lump
sum amount equal to the sum of the annual compensation and accrued but unpaid
bonus (if any, with respect to the bonus) which would be payable to him for
one additional year after the Early Termination Date, but not beyond June 30,
2002, as well as receive his benefits during that period and exercise his
vested stock options during the remaining term of the options.
Mr. Caswell's employment agreement has a term which expires on the earlier of
(i) December 31, 1999, or (ii) six months after the date that 100% of the
Company's holdings of NTC stock are sold, conveyed or otherwise distributed.
In the event of an improper termination of Mr. Caswell's employment agreement
by the Company for any reason, Mr. Caswell is entitled (i) to be paid a lump
sum amount equal to his annual salary during the remaining term of his
agreement plus his annual salary for 15 additional months, (ii) to receive
all of his benefits during that period, and (iii) to exercise all of his
vested stock options at any time during the remaining term of the options.
In the event of an early termination because of the disposition of 100% of
the Company's NTC stock, then the Company has agreed to pay Mr. Caswell a
lump sum amount equal to the sum of the annual compensation and accrued bonus
(if any, with respect to the bonus) which would be payable to him for one
additional year after the Early Termination Date, but not beyond December 31,
1999, as well as receive his benefits during the remaining term of the
options.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
INDEX TO EXHIBITS:
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EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.1 Amendment to Employment Agreement Between Incomnet and
Melvyn Reznick, dated June 8, 1997.*
10.2 Employment Agreement Between Incomnet and Stephen A.
Caswell, dated June 8, 1997.*
10.3 Employment Agreement Between NTC and Edward R. Jacobs,
dated July 25, 1997.*
* Incorporated by reference from prior filing of this Form 10-Q,
filed on November 14, 1997.
REPORTS ON FORM 8-K, FILED IN 1997
- ----------------------------------
20.1 Report on Form 8-K - Election of Dr. Howard Silverman As Director &
Amendment to Employment Contract of Melvyn Reznick, filed on
February 7, 1997.
20.2 Report on Form 8-K - Reincorporation of National Telephone &
Communications, Inc. filed on April 10, 1997.
20.3 Report on Form 8-K - Acquisition of California Interactive Computing,
Inc., filed on May 13, 1997.
20.4 Report on Form 8-K - Election of Richard M. Horowitz, Stanley C.
Weinstein and David Wilstein as Directors, filed on August 20, 1997.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INCOMNET, INC.
Date: November 13, 1997 /s/ MELVYN REZNICK
--------------------------
Melvyn Reznick
President, CEO & CFO
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