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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 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
--- ---
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Aggregate market value of voting common stock held by non-
affiliates of the registrant (based upon the average of the
closing bid and ask prices of $5 3/8 and $5 5/8 respectively,
as reported by the NASDAQ System on March 27, 1996) $55,939,956
Number of shares of registrant's common stock outstanding as of
March 27, 1996
...........................................................13,224,024
DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant's proxy statements
relating to registrant's 1996 annual meeting of shareholders have been
incorporated by reference into Part III hereof.
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TABLE OF CONTENTS
PART I PAGE
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ITEM 1 - BUSINESS
General 5
Telephone Services 5
Optical Systems 5
Network Products and Services 5
National Telephone & Communications, Inc. (NTC) 6
Products 6
Network Marketing Program 6
Disclosure of Independent Representative Organizations
Related to NTC Executives 7
Pager Agreement 7
Wiltel Contract 8
Management Incentive Agreement 8
Acquisition of Rapid Cast, Inc. (RCI) 9
Acquisition 9
Financing of Acquisition 10
Registration Rights 11
Right to Designate Directors 11
Certain Transactions 11
Agreement with Martin Price 12
Rapid Cast, Inc. (RCI) 12
General 12
The Optical Marketplace 12
The Production and Dispensing of Prescription
Eyeglass Lenses 13
The Rapid Cast LenSystem 15
Technical Overview of the Rapid Cast LenSystem 15
Marketing and Pricing Strategy 16
Manufacturing Strategy 17
Research and Development Strategy 17
Maintenance, Warranty and Insurance 17
Competition 17
Patents and Proprietary Rights 18
Governmental Regulation 19
Acquisition of LabTech, Inc. 19
Nonissuer Sales of Stock Pursuant to Regulation S 20
Agreement with Price International, Inc. 20
Network Services 21
Employees, Officers and Directors 21
Employees 21
Officers 22
Reconstitution of Board of Directors 22
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TABLE OF CONTENTS (CONT'D)
PAGE
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ITEM 2 - PROPERTIES 23
ITEM 3 - LEGAL PROCEEDINGS 24
Securities & Exchange Commission Investigation 24
Class Action and Related Lawsuits 24
Section 16 (b) Lawsuit 25
Patent Infringement Lawsuit 26
Legal Action Against Prior Representatives 26
Claims by Prior Noteholders 27
Potential Lawsuits 27
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 28
PART II
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS 29
Market Information 29
Dividends 30
ITEM 6 - SELECTED FINANCIAL DATA 30
Statements of Operations Data 30
Balance Sheet Data 31
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 31
Liquidity and Capital Resources 31
Results of Operations - 1995 Compared to 1994 33
Results of Operations - 1994 Compared to 1993 35
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 36
PART III
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS OF THE REGISTRANT 37
ITEM 11 - EXECUTIVE COMPENSATION 37
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 37
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 37
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K 38
Index to Financial Statements 38
Index to Exhibits 39
Report of Independent Auditors 41
Consolidated Balance Sheets 42
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TABLE OF CONTENTS (CONT'D)
PAGE
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Consolidated Statements of Operations 44
Consolidated Statements of Shareholders' Equity 45
Consolidated Statements of Cash Flows 46
Notes to Consolidated Financial Statements 48
Note 1 - Summary of Significant Accounting Policies 48
Note 2 - Funding of Marketing Commissions and
Deferred Income 49
Note 3 - Related Party Transactions 50
Note 4 - Notes Payable 50
Note 5 - Deferred Tax Liability 51
Note 6 - Shareholders' Equity 52
Note 7 - Commitments and Contingencies 55
Note 8 - Network Marketing Costs 57
Note 9 - Segment Information 57
Note 10 - Gain on Settlement with Creditors 59
Note 11 - Acquisition of Rapid Cast, Inc. 59
Note 12 - Fourth Quarter Adjustments 59
Schedule II - Valuation and Qualifying Accounts 60
Exhibit 21 - Subsidiaries of the Registrant 62
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PART I
ITEM 1. BUSINESS
GENERAL:
Incomnet, Inc. (the "Company") was incorporated under the laws of the State of
California on January 31, 1974. The Company is engaged in the following
businesses:
TELEPHONE SERVICES- The Company, through its wholly-owned subsidiary,
National Telephone & Communications,-Registered Trademark- Inc. (NTC),
markets long distance telecommunications services to commercial and
residential customers in the United States. Service is provided by
procuring long distance telecommunications transmission services from long
distance communication carriers at high volume wholesale rates and
reselling those services at retail rates. NTC uses a network marketing
program of independent representatives to sell its
telecommunications-related services to retail customers. NTC does not sign
up telephone customers directly. The growth in NTC's
telecommunications-related revenues is directly tied to its network
marketing program. NTC's independent representatives typically pay an
annual fee in order to purchase materials, training and/or annual services
from NTC to assist them in selling new retail customers and enrolling other
representatives in the NTC program. NTC pays the independent
representatives a residual monthly commission on the telecommunications
revenue. In addition, the network marketing program pays various bonuses
and overrides when and if representatives obtain a minimum number of new
telephone customers within a specific 30 to 60 day period. This program has
been designed to bring NTC new retail telephone customers even if little or
no growth occurs in the marketing program revenues. The new
telecommunications revenues generally lag the new marketing program
revenues by one to three months. Sales from this segment accounted for 96%
of the Company's total 1995 sales.
OPTICAL SYSTEMS- The Company, through its 51%-owned subsidiary Rapid Cast,
Inc. (RCI), acquired in February 1995 (see "Acquisition of Rapid Cast,
Inc."), manufactures and markets the FastCast-TM- LenSystem that allows
retail optical stores and wholesale optical lens manufacturing laboratories
to produce single vision, flat-top bifocal and progressive bifocal lenses
on demand, in approximately 30 minutes. The FastCast-TM- LenSystem uses a
series of high-accuracy prescription glass molds that are filled with a
proprietary liquid monomer (plastic). When exposed to ultraviolet light
within the system's curing chamber, the monomer undergoes a chemical
reaction that rapidly "cures" or hardens the lens. Sales from this segment
accounted for 2.3% of the Company's total 1995 sales. Rapid Cast's
operating results are included in the accompanying financial statements.
NETWORK PRODUCTS AND SERVICES- The Company acquires and/or develops
hardware and software, primarily for interactive data communications
networks. In this regard, the Company operates a communications network
known under the tradename "AutoNETWORK" that services the automotive
dismantling industry in California, Nevada, Arizona, Oregon and Washington.
Sales from this segment accounted for 1.7% of the Company's total 1995
sales.
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NATIONAL TELEPHONE & COMMUNICATIONS, INC. (NTC):
PRODUCTS - NTC is an inter-exchange carrier and reseller of long distance
telephone services to residential and small business customers throughout the
United States. NTC's primary product is its Dial-1 Telephone Service. Its other
long distance telephone products are 800-Number Services and Calling Card
Services, which include the Flag Card, Sure$aver Card, Sure$aver Gold Card and
Call$aver Card.
In order to provide these products, NTC generally contracts to purchase long
distance telephone time from national carriers at wholesale rates based upon
high volume usage. NTC then resells this time to its customers at its own
discounted retail rates which are generally 10% to 60% below AT&T's published,
tariffed MTS rates. NTC's Dial-1 Service is transparent to its customers once a
customer's long distance service has been converted to NTC. NTC's calling card
products operate similarly to the calling card products offered by the major
carriers. NTC's customers pay for their long distance calling usage either
through direct billing from NTC , through billing from the customer's local
exchange carrier ("LEC"), through direct billing by NTC of the customer's major
credit card, or by prepaying for long distance time in the case of certain NTC
calling card products. In certain states, NTC has an agency agreement with an
unaffiliated company which bills customers' local intrastate calls through the
local telephone company. Commencing in the second quarter of 1996, NTC intends
to increase its use of LECs to bill and collect telephone service accounts
receivable. The planned increase in the use of LECs is expected to increase the
amount of time that it takes for NTC to receive payment on its accounts
receivable.
NETWORK MARKETING PROGRAM - NTC markets its products on a nationwide basis
through a multi-level, network marketing program of independent sales
representatives. NTC authorizes and trains the independent representatives to
resell its services to residential and small business customers, and allows the
individual representatives to build up their own "downline" sales force of other
independent representatives. NTC currently has in excess of 40,000 independent
representatives in its network marketing program. Once an independent
representative has signed up a long distance telephone customer on one or more
of NTC's services/products, the customer becomes an NTC customer. NTC takes over
the servicing and billing of the customer as well as the collection of monies
owed by the customer for the use of the NTC telephone services/products . NTC
pays each independent representative a commission on the telephone usage monies
collected from those retail telephone customers who are directly signed up by
that representative. NTC also pays override commissions to each independent
representative on the monies collected from those telephone customers signed up
by the representative's downline as well as a bonus percentage of all telephone
monies collected by NTC from the retail telephone customers collectively signed
up by all independent representatives, if certain minimums of retail telephone
business are personally achieved by the representative. In addition, NTC pays
sales bonuses to independent representatives for assisting other representatives
to obtain certain minimums of new retail long distance telephone business. NTC
does not pay any monies to independent representatives simply for recruiting
other representatives into NTC's network marketing program. NTC generally
maintains communications with its independent representatives through (1) NTC's
proprietary communications systems, (2) NTC's internal personnel dedicated to
the support of the independent representatives, (3) various NTC manuals,
newsletters and other publications that are periodically and continually sent to
the independent
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representatives, (4) NTC's network of senior independent representatives, and
(5) various training programs offered by NTC and its senior independent
representatives throughout the United States.
NTC believes it is in compliance with all State and Federal regulations
governing multi-level marketing companies. However, to ensure the Company has
objective and knowledgeable outside legal opinion in this area, NTC has formed a
Regulatory Compliance Committee consisting of four former State Attorneys
General that periodically reviews NTC's marketing programs for such compliance.
DISCLOSURE OF INDEPENDENT REPRESENTATIVE ORGANIZATIONS RELATED TO NTC EXECUTIVES
- - In order to eliminate potential conflicts of interest, at the end of 1992, NTC
implemented its current policy that no senior, decision-making NTC executive or
officer may have a downline organization of independent representatives involved
with the selling of NTC's long distance telephone services and/or marketing
programs ("Executive Downlines"). Violation of this policy subjects such an NTC
officer/executive to immediate termination and forfeiture of all past and future
commissions from such disallowed Executive Downlines. To the best of the
Company's knowledge, none of NTC's senior officers/executives have an Executive
Downline, including Ed Jacobs (President and CEO), Jerry Ballah (Executive Vice
President), Richard Marting (Vice President of Finance and Administration) and
William Savage (Vice President of Operations).
In addition, NTC's current policy requires full disclosure by all senior NTC
officers/executives of any NTC downline organizations headed by an immediate
family member of such senior officer/executive as well as disclosure of the
personal involvement of an immediate family member in the sale of NTC's long
distance telephone services to retail customers ("Immediate Family
Customers/Downlines"). To the best of the Company's knowledge, none of NTC's
senior officers/executives have Immediate Family Customers/Downlines with the
exception of Jerry Ballah. Mr. Ballah has previously disclosed the existence of
Immediate Family Customers/Downlines, at the time each such customer base and/or
downline was being initiated by the specific family member, for his mother and
his two sons. In addition, although not required by NTC's current policy, Mr.
Ballah voluntarily disclosed, at the time each such customer base and/or
downline was being initiated, that certain members of the immediate family of
Mr. Ballah's fiance have Immediate Family Customers/Downlines. It is NTC's
policy to periodically have the activities and income of such Immediate Family
Customers/Downline reviewed by an NTC company committee headed by NTC's
President and CEO (and from which the related senior officer/executive is
excluded) for the purpose of determining that all of NTC's policies and
procedures are being strictly followed.
PAGER AGREEMENT - In June 1995, NTC entered into additional promotional
agreements with a publicly-traded, personal pager company and a privately-held
Internet access service provider. Under the terms of these agreements, (i) NTC
will use certain merchandise and services offered by these two companies to
enhance NTC's marketing of long distance services, and (ii) NTC will be
compensated by the two companies for each subscriber added to their respective
services and for the development of certain promotional programs.
WILTEL CONTRACT - In September 1995, NTC entered into a new carrier contract
with Wiltel, Inc. of Tulsa, Oklahoma, a subsidiary of WorldCom, Inc., covering a
potential volume purchase of $600
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million of long distance telephone time over a five year period commencing in
November 1995. As in the prior carrier contract with Wiltel, Inc., NTC commits
to purchase the designated volume of telephone time in accordance with a
schedule over the term of the contract. NTC currently relies on the purchases
of another unaffiliated long distance telephone service provider to meet its
volume purchase requirements under the new contract.
MANAGEMENT INCENTIVE AGREEMENT - On February 6, 1996, the Company entered into
an agreement with NTC pursuant to which it agreed to permit NTC to do a public
underwriting of its (NTC's) common stock in the future. The underwriting would
be implemented if NTC receives a firm commitment from a reputable regional or
national investment banking firm. The Company also agreed to create three stock
option plans for the management, employees and independent sales representatives
of NTC. The exercise price of all options issued under such plans will be based
on the fair market appraisal value of NTC shares as of the date of the grant of
the options. The options will be granted and become exercisable only if NTC
becomes a public reporting company and its stock is publicly traded. The
options will be granted pursuant to a stock option plan meeting the requirements
of Section 16(b)(3) of the Securities Exchange Act of 1934, as amended, and the
plans will be registered on Form S-8 under the Securities Act of 1933, as
amended.
Pursuant to one plan, up to 15% of NTC's outstanding shares, after taking into
account the issuance of all shares pursuant to all three plans and the
underwriting, will be reserved for issuance pursuant to options granted to
current and/or future key independent sales representatives of NTC and will only
be vested conditioned upon NTC's achieving certain specific minimum revenue
levels prior to January 1, 1999. The NTC Board of Directors will determine the
grantees of the stock options under this plan.
Pursuant to the second plan, up to 10% of NTC's outstanding shares, after taking
into account the issuance of all shares pursuant to all three plans and the
underwriting, will be reserved for issuance to two senior executive officers and
a key consultant of NTC. The options issued to the two senior executive
officers will be fully vested on the date of grant (i.e. the date NTC's stock
first becomes publicly traded), while one-third of the options to be granted to
the key consultant will vest immediately upon grant, and two-thirds of such
options will vest in accordance with a schedule to be determined by NTC's Board
of Directors.
Pursuant to the third plan, up to 10% of NTC's outstanding shares, taking into
account the issuance of all shares pursuant to all three plans, will be reserved
for issuance to current and future executive officers, employees and key
consultants of NTC. The options, once granted, will vest one-third based on the
time of service and two-thirds only if NTC achieves a total of $10 million in
pre-tax profits in any four consecutive calendar quarters prior to January 1,
1998. Only 25% of the options eligible for grant under this third plan may be
issued to the senior executive officers who are the beneficiaries of the second
stock option plan. The Board of Directors of NTC will determine the grantees of
the stock options under this plan.
Upon the creation of the three plans and issuance of options to Ed Jacobs and
Jerry Ballah, Mr. Jacobs will waive his rights to the remaining outstanding
warrants and options to purchase the Company's common stock which are provided
for in Mr. Jacobs' Employment Agreement. See the
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Company's Proxy Statement for its 1996 Annual Meeting of Shareholders, filed
with the Securities and Exchange Commission on or about April 30, 1996.
The agreement with NTC also provides that upon NTC becoming a publicly traded
company, it will add four new independent outside directors to the existing
Board, which currently consists of three individuals. Initially, the Company
will have the right to select two of the new independent directors and NTC will
have the right to select the other two. After NTC's initial public offering,
the NTC Board of Directors will select future nominees for the NTC Board. The
independent directors will constitute the Audit and Compensation Committees of
NTC's Board of Directors. Until NTC becomes publicly traded, the NTC Board will
remain as currently constituted and certain transactions will require the
unanimous consent of the NTC Board members, including the terms of any public
offering of NTC's stock. The NTC Board currently consists of Edward Jacobs,
Jerry Ballah and Joel W. Greenberg, the Company's designee. The Company has
agreed to vote its shareholdings in NTC for the NTC management slate of
nominees. The timing and terms of any public offering of NTC's stock is not
known at this time, and there is no assurance regarding when or if NTC will do
its initial public offering.
ACQUISITION OF RAPID CAST, INC. (RCI):
ACQUISITION - On February 8, 1995, the Company acquired 10,200,000 shares
representing approximately 51% of the outstanding common stock of Rapid Cast,
Inc. ("RCI"), a private corporation headquartered in Louisville, Kentucky, for
$15,000,000 cash paid to RCI, 750,000 shares of the Company's common stock
issued to RCI's current stockholders ("Founding Stockholders"). The purchase
agreement also originally provided that an additional 750,000 shares of the
Company's common stock could be earned by RCI's Founding Stockholders based upon
the earnings of RCI during its first four full fiscal quarters. On June 30,
1995 the Company's purchase agreement for RCI was amended to provide for the
immediate issuance of 600,000 shares of the Company's common stock to the
Founding Shareholders in lieu of their right to potentially earn up to 750,000
shares. See "Acquisition of Rapid Cast, Inc.- Certain Transactions." As part
of the acquisition, the Company agreed that after the end of the fiscal quarter
in which RCI achieves cumulative pre-tax earnings of $1,250,000, provided such
earnings are achieved during the first four quarters after the acquisition, it
will spin off ("Spin Off") RCI as a public company by registering RCI's shares
with the Securities and Exchange Commission and by providing to the Company's
shareholders a dividend of a minimum of 25% of the common stock of RCI now owned
by the Company. In such event, RCI agreed to take all reasonable steps in order
to permit public trading of the Spin Off shares. RCI did not achieve the
cumulative pre-tax earnings threshold in its first three fiscal quarters after
the acquisition, and the Company is therefore not obligated to implement the
Spin-Off.
RCI has used about $14,000,000 of the funds it received to acquire all of the
outstanding capital stock of Q2100, Inc. ("Q2100"), a company that owns a
proprietary technology for manufacturing single focal, bifocal, and progressive
eyeglass lenses ("LenSystem"), as well as 15 fully assembled and 66 partially
assembled production line machines which incorporate this technology and which
are suitable for installation in retail optical stores. The system is named the
FastCast-TM- LenSystem. Q2100 was previously owned by Pearle, Inc. ("Pearle"),
which entered into a stock purchase agreement on October 28, 1994 for the sale
of 100% of Q2100 to RCI.
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The purchase price payable by RCI under the stock purchase agreement with Pearle
was $15,000,000 in cash (less certain expenses), of which $1,000,000 was paid by
RCI on October 28, 1994 as a deposit, and the balance of $14,000,000 was paid on
the closing of the acquisition on February 8, 1995 from the proceeds of its
stock issuance to the Company. As part of the agreement, Pearle has assumed or
discharged all liabilities of Q2100 prior to the acquisition closing. As part
of the agreement, RCI has also agreed that after the acquisition it will make
the technology available to Pearle and its affiliates on a most favored nation
basis, which means that RCI will provide systems and supplies to Pearle at the
lowest price at which it will sell its products and services. RCI used the
remaining $1,000,000 from the issuance of its stock to the Company to fund its
operations.
FINANCING OF ACQUISITION - In order to pay the purchase price of the stock of
RCI, the Company provided $5,000,000 in cash and financed the balance by a
private placement of securities consisting of 10 Units. Each Unit consisted of
one convertible Note issued by the Company and one Warrant to purchase 100,000
shares of RCI common stock. Each Note was in the principal amount of $1,000,000
or fraction thereof, matured on January 31, 1996, and accrued interest at the
rate of 8% per annum. Interest was payable quarterly and at maturity or upon
conversion. Purchasers of seven of the Units, who are affiliates of RCI or
shareholders of the Company, waived interest accruals on the Notes included in
their Units.
On June 30, 1995, Units representing $9,350,000 of the Notes were converted at a
rate of $10 per share into 935,000 shares of the Company's common stock. An
additional $150,000 of the Notes were converted at the rate of $10 per share
into 15,000 shares of the Company's common stock in July 1995. In January
1995, the remaining Note for $500,000 was repaid in full. The Company is
obligated to register the shares of its common stock issued upon the conversion
of the Notes which were not otherwise sold in 1995 by those shareholders in
transactions under Regulation S. See Item 1 - Business, "Rapid Cast, Inc.",
"Nonissuer Sales of Stock Pursuant to Regulation S." The Company is in the
process of registering under the Securities Act of 1933, as amended, the
remaining shares held by the original Noteholders. In addition, in order to
settle potential claims by certain of those shareholders and the one Noteholder
who did not convert his Note into shares, which could have been asserted because
of the Company's failure to register the underlying shares in 1995, the Company
agreed to (i) issue and register 31,000 additional shares of common stock and
convey a Warrant to purchase 5,000 shares of RCI common stock to the Noteholder
who did not convert his shares, (ii) issue sufficient additional shares to said
prior Noteholder, if necessary, to ensure that on the effective date of the
registration of these shares, the prior Noteholder has $155,000 worth of the
Company's common stock, including the 31,000 shares, based on the average
closing market price of the Company's stock on the five trading days immediately
following the effective date of the registration statement, and (iii) to issue
to the holders of 32,500 shares who did convert their Notes, sufficient
additional shares of the Company's common stock, if necessary, to ensure that
they have an aggregate of $390,000 worth of the Company's stock on the effective
date of the registration statement, based on the average closing market price of
the Company's stock on the five trading days immediately preceding the effective
date of the registration statement. See "Item 3. Legal Proceedings - Claims By
Prior Noteholders."
The Warrants to purchase shares of RCI common stock are exercisable commencing
with the 35th business day (the "Start Date") on which securities of RCI are
first traded publicly, provided that the Start Date must occur on or before
December 31, 1998. The exercise price of the Warrants will be equal to 50% of
the average of the last reported sales price during the first 30
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business days after the Start Date. Securities of RCI will become publicly
traded only if RCI is spun off as a public corporation as anticipated under the
terms of the acquisition, or if RCI in its discretion determines to consummate a
public offering of its securities. The Warrants will expire 180 days after the
date, if any, on which they first become exercisable.
REGISTRATION RIGHTS - RCI granted to the Company the right to demand
registration at RCI's cost of all of the Company's RCI shares. The Company may
demand this right only after RCI's securities are publicly traded (whether as a
result of the Spin Off or otherwise) and only as to one-third of these shares in
each of 1996, 1997 and 1998 on a cumulative basis. RCI has also granted to the
Company piggyback registration rights with respect to these shares after RCI's
securities are publicly traded.
RIGHT TO DESIGNATE DIRECTORS - The Company has the right to elect two of RCI's
five directors until the Spin Off, and one of RCI's five directors after the
Spin Off. Melvyn Reznick and Joel W. Greenberg are the Company's two designees
on the Board of RCI.
CERTAIN TRANSACTIONS - The current stockholders of RCI (the "Founding
Stockholders") other than the Company, consist, among others, of persons related
to Broad Capital Associates, Inc. (the "Broad Group") who own 3,266,666 shares
of RCI common stock, and Larry Joel, Robert Cohen and persons related to them
(the "CRJ Group") who own 6,533,334 of RCI common stock. The Founding
Stockholders acquired these shares at a purchase price of approximately $.03 per
share. The Founding Stockholders and their affiliates as of December 31, 1995
loaned approximately $1,463,334 to RCI, which amounts, together with any
additional loans which are thereafter made by them, will be payable July 31,
1996, together with interest at 7% per annum. RCI may determine to prepay this
indebtedness, whether from the proceeds of the placement of the Units or
otherwise.
As part of the purchase price for the acquisition of 10,200,000 shares of RCI
common stock by the Company, the Company issued 750,000 shares of its common
stock to the Founding Stockholders on February 8, 1995. The Company also agreed
to issue to the Founding Stockholders a maximum of 750,000 additional shares of
the Company's common stock depending on RCI's pre-tax earnings during the first
four full fiscal quarters after the acquisition closing, which occurred on
February 8, 1995. On June 30, 1995, the Company renegotiated the terms of the
Agreement and issued to RCI's Founding Stockholders 600,000 unregistered shares
of its common stock in lieu of the maximum of 750,000 shares that were to be
issued based upon performance factors. The Company made this issuance because,
in its opinion, it believed that it was likely that RCI would meet its
performance requirements and, hence, attempted to reduce the potential dilution
of the Company's stock by 150,000 shares. Based on RCI's actual performance
during its first three fiscal quarters, no additional shares would have been
issued to the Founding Stockholders.
The exact number of additional shares of the Company's common stock which would
have been issuable to the Founding Stockholders under the original terms of the
acquisition agreement was to be calculated on the last day of each of RCI's
first and fourth fiscal quarters following the acquisition closing as follows:
(i) for the first quarter, by multiplying $7.5 million by a fraction, the
numerator of which was the net pre-tax earnings generated by RCI during such
first full fiscal quarter, and the denominator of which is $4.5 million, and
(ii) for the first four full fiscal
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quarters, by multiplying $7.5 million by a fraction, the numerator of which was
the aggregate net pre-tax earnings generated by RCI during such four full fiscal
quarters less the net pre-tax earnings generated by RCI in the first full
quarter, and the denominator of which was $4.5 million. The products determined
in (i) and (ii) above were then to be divided by $12.50 per share to determine
the number of additional shares issuable to the Founding Stockholders, provided,
that if any time during the first four full fiscal quarters after February 8,
1995, RCI earned more than $5.5 million in net pre-tax earnings, the value of
each additional share for calculation purposes would have been $10.00 rather
than $12.50.
AGREEMENT WITH MARTIN PRICE. On August 31, 1995, RCI entered into an agreement
with Martin Price pursuant to which it issued 250,000 shares of RCI common stock
and paid $150,000 to Mr. Price ($100,000 in cash and $50,000 pursuant to a note)
in consideration for the cancellation of a net profits interest in RCI's
business which Mr. Price previously owned. Accordingly, RCI currently has
20,250,000 shares of common stock issued and outstanding.
RAPID CAST, INC. (RCI):
GENERAL. RCI is a Delaware corporation formed in February 1994 which acquired
100% of the outstanding capital stock of Q2100, Inc. ("Q2100") from Pearle,
Inc., an unaffiliated subsidiary of Grand Metropolitan, Ltd., a United Kingdom
conglomerate. Q2100 owns certain domestic and foreign patents and patent
applications relating to a new technology, commonly known as Thick Film
Radiation Cured Polymer Technology (the "Technology"), which enables retail
optical stores and wholesale optical lens manufacturing laboratories to produce
many prescription ophthalmic lenses on site at a cost generally lower than if
they were purchased from third party manufacturers or distributors. RCI is
marketing the Technology under the name Fast Cast-TM- LenSystem.
THE OPTICAL MARKETPLACE. Nearly 60% of the United States population
(approximately 151 million people) required some form of vision correction in
1992, according to CENSUS INTERNATIONAL '93: THE OPTICAL INDUSTRY FACT BOOK
("Census93"). It is estimated that, by the year 2000, the United States
prescription eyewear population will rise to approximately 164 million people
and that, in the following decade, over 180 million people will use prescription
eyewear products. Census93 reports that, in the approximately $11.9 billion
United States retail optical market in 1992, the average optical retailer's
breakdown of dollar revenue by product category was: (a) approximately 47% (or
nearly $5.6 billion) from the sale of eyeglass lenses and lens treatments (e.g.,
the application of scratch-resistant and ultraviolet coatings), (b)
approximately 38% from the sale of eyeglass frames and sunglasses, and (c)
approximately 15% from the sale of contact lenses.
Census93 reports that, out of the approximately 80 million pairs of prescription
eyeglass lenses sold in the United States in 1992, an estimated 55% to 60% were
single vision lenses, while an estimated 40% to 45% were multifocal lenses
(i.e., bifocal, trifocal and cataract lenses). According to Census93, bifocal
lenses currently constitute the substantial majority of consumer purchases of
multifocal lenses, representing an estimated average of approximately 84% of all
multifocal lenses purchased in the years 1987, 1989 and 1991. Multifocal lenses
are produced as either "flat-top" or "progressive" lenses. Progressive lenses
are distinguished from flat-top lens by the absence of visible horizontal lines
separating the different corrective prescription areas.
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Census93 reports that, by the end of 1992, flat-top bifocal and trifocal lenses
held approximately 79% of the multifocal market, while approximately 21% of this
market consisted of progressive lenses. The LenSystem is capable of producing
single vision, flat-top bifocal and progressive bifocal lenses. Although no
assurance can be given in this regard, RCI believes that the market for
progressive bifocal lenses offers particularly great opportunities, both because
of the potential to convert persons currently wearing flat-top bifocals to the
"no-line" option offered by progressive lenses, and because the bulk of the baby
boomer generation (ages 30 to 49 in 1994) has not yet reached their early 40s,
when people typically first experience the presbyopia that requires correction
by bifocals.
Single vision and multifocal prescription eyeglass lenses are currently
manufactured using one of three basic types of materials. According to Census93,
the two conventional materials, glass and hard-resin plastic, accounted
respectively for approximately 13% and 64% of 1993 United States prescription
lens sales, while the newer premium materials such as polycarbonates, high index
plastic and high index glass, accounted for approximately 23% of such sales.
Within the categories of single vision and multifocal lenses, there are many
types of premium lenses (generally designed to be especially thin, strong, and
light) that the LenSystem currently cannot manufacture: (a) high index plastic
and high index glass lenses, which generally are very thin, lightweight lenses
used to reduce the thickness of very high strength prescription lenses; (b)
polycarbonate lenses, which are made from a material with superior impact
resistance and are typically used for sports and other eye-safety purposes; and
(c) aspheric lenses, which are made to have flatter curves than conventional
spherical lenses, thereby improving visual acuity and the appearance of the eyes
through the lenses. Census93 estimates that aspheric lenses represented about
1% of 1992 United States sales of prescription lenses. RCI anticipates that
sales of high index lenses will continue to grow steadily over the next several
years.
During the years 1990 through 1992, the United States market of contact lens
wearers remained basically flat, according to Census93, at approximately 25
million users. There can be no assurance, however, that technological
developments, medical advances, changes in consumer tastes or other factors will
not cause the use of contact lenses to grow significantly in the future at the
expense of prescription eyeglass lenses. Census93 reports that, despite the
recent flat rate of overall contact lens use, a Bausch & Lomb study has found
that first-time usage of disposable contact lenses grew at a compounded annual
growth rate of 47% from 1989 through 1992.
THE PRODUCTION AND DISPENSING OF PRESCRIPTION EYEGLASS LENSES. As previously
noted, approximately 77% of all conventional single vision and multifocal
prescription eyeglass lenses are currently manufactured from glass or hard-resin
plastic. According to Census93, during the years 1991 through 1993 hard-resin
plastic was used in the manufacturing of approximately 82% of all prescription
lenses made from conventional materials. Although there can be no assurance in
this regard, RCI anticipates that the use of glass in manufacturing conventional
lenses will decrease over time due to a variety of factors, including its
relatively greater weight and inferior impact resistance.
After being prescribed for an individual by his or her medical doctor
(ophthalmologist) or optometrist, prescription eyeglass lenses reach the
consumer through three traditional channels: independent dispensers (consisting
of thousands of private sector optometrists, opticians and
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ophthalmologists), retail optical chain stores (i.e., retailers having at
least four stores, including so-called "superoptical" stores or
"superstores", mass merchandisers and warehouse membership clubs), and
miscellaneous third party and other dispensers. Census93 estimates that
independent dispensers accounted for approximately 62% of 1992 United States
optical sales, retail optical chain stores accounted for approximately 33% of
such sales, and third party and other dispensers accounted for approximately
5% of such sales.
The substantial majority of glass and hard-resin plastic prescription lenses
purchased in the United States are currently obtained from lens dispensers (such
as independent optometrists, opticians, ophthalmologists and retail chain
stores) who do not manufacture the lenses on-site. They instead obtain lenses
from third party manufacturers and distributors, including hundreds of large
factories and large, mid-sized and small wholesale manufacturing laboratories.
These manufacturers and distributors have invested in the space and equipment
required to grind glass or plastic lenses into a specific prescription and then
to finish (i.e., polish) the lenses in order to provide clarity. In the case of
plastic lenses, these manufacturers additionally possess the molds and other
machinery required in order to form and then "cure" (i.e., harden) such lenses.
Conventional curing processes utilize heat-driven reactions to harden the
plastic. Heat-curing processes are relatively time-consuming, generally
requiring between approximately six and 16 hours, depending upon the specific
type of plastic involved.
In most cases, a retail lens dispenser who obtains finished lenses from third
party manufacturers and distributors cannot offer consumers "same day" service
unless that retailer maintains a relatively large, mostly idle and generally
expensive inventory of lens blanks. This inventory generally has consisted
principally of single vision and flat-top bifocal lenses, due to the
historically greater demand for such lenses. Even a retailer who maintains a
very extensive inventory of lens blanks typically must place special orders for
the majority of lenses required to fill more complex prescriptions and for most
premium lenses. Filling any such order generally takes one or more days.
Largely as a result of these limitations in the ability of retail lens
dispensers to provide consumers with same day service for certain lenses, full
service eyeglass lens manufacturing began to move into retail optical outlets in
the form of the so-called "superoptical store". Many of these superstores are
operated by the large retail optical chain stores, such as LensCrafters,
Opti-World, Pearle Express and D&K Optical (of which Dr. Larry Joel, a
shareholder, officer and director of RCI, is Chairman of the Board and a
significant stockholder). A "superoptical store" is generally understood in the
United States optical industry to be a retail store with the on-site equipment
necessary to produce the great majority of finished prescription lenses in about
one hour. The required equipment generally consists of a surfacing (or
grinding) laboratory and a finishing machine. According to Census93,
superoptical stores rarely fall below 1,900 square feet in total area. In
addition to an investment in equipment and space, a superoptical store typically
requires the maintenance of a largely idle inventory of semi-finished lens
blanks.
THE RAPID CAST LENSYSTEM. The LenSystem incorporates a new technology called
Thick Film Radiation Cured Polymer Technology, which uses ultraviolet light
instead of heat to initiate the chemical reaction that hardens the Rapid Cast
Liquid Monomer into a plastic lens. The Technology resulted from a research
program that was initially begun in 1985 by the University of Louisville. In
1988, Dr. Larry Joel and others formed ORGIC, which contracted with the
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University of Kentucky to sponsor and continue that research program in return
for the ownership of all resulting patents and discoveries. By 1990, ORGIC
(then majority-owned by Dr. Joel and the predecessor of Q2100) had developed and
tested a new liquid monomer, an ultraviolet curing unit and a lens casting
machine. ORGIC believed that equipment utilizing the Technology could permit
on-site production of prescription eyeglass lenses at a low cost and in a very
short amount of time. ORGIC also believed that, in order to commercialize the
use of such equipment and effectively bring it to the marketplace, financial and
other resources would be required that ORGIC did not possess. In 1991, ORGIC,
with the Technology (together with all related issued patents and patent
applications), was sold to Pearle and subsequently renamed Q2100, Inc. On
February 8, 1995, RCI purchased 100% of Q2100 from Pearle, and the Company
purchased 51% of RCI. See "Item 1. Business - Acquisition of Rapid Cast, Inc."
TECHNICAL OVERVIEW OF THE RAPID CAST LENSYSTEM. The Rapid Cast LenSystem
consists of three primary components: The Rapid Cast Mold and Gasket Library,
the Rapid Cast Liquid Monomer (the "Monomer"), and the Rapid Cast Ultraviolet
Curing Unit (the "Curing Unit"). The Rapid Cast Mold and Gasket Library is used
to create the actual mold assembly from which a lens will be made. Once the
type of lens (i.e., single vision, flat-top bifocal or progressive bifocal) and
prescription to be produced are known, a front mold and a back mold are selected
from an easy to read wall chart. A gasket is used to hold the front and back
molds in place, creating a mold assembly consisting of a hollow cavity. This
cavity is then filled with the Rapid Cast Liquid Monomer.
The Rapid Cast Liquid Monomer is a proprietary monomer that is injected in
liquid form into the mold assembly using a standard squeeze bottle. This
Monomer is a "thick film" monomer, meaning that its thickness is best measured
in parts of centimeters (as opposed to thin film monomers, which are measured in
parts of millimeters). The Rapid Cast Liquid Monomer is chemically inert and,
because it is cured by ultraviolet light, does not require the addition of a
separate chemical initiator for the hardening process. As a result of its
chemical stability, the Rapid Cast Liquid Monomer has a shelf-life of many years
and does not require special shipping and storage precautions. These advantages
are not generally realized by conventional lens manufacturing processes which
use hard-resin monomers to produce plastic lenses. These conventional monomers
(such as the CR-39 Monomer, which has long been the substance most commonly used
in manufacturing plastic lenses) require the addition of chemical initiators
prior to being cured, and those initiators are in some cases flammable or
explosive prior to being mixed with the monomer. Temperature-controlled
shipping and storage arrangements must accordingly be made, and cold storage
facilities must be utilized even after the monomer and initiator are mixed,
since the resulting substance hardens and becomes useless when exposed for an
extended period to temperatures above approximately 25 degrees fahrenheit.
The Curing Unit controls the chemical reaction that occurs when the Rapid Cast
Liquid Monomer is exposed to ultraviolet light. It monitors the exact
temperature of the lens during this reaction, utilizing multiple cold air jets
to control the temperature of each sector of a lens. The Curing Unit also
continuously monitors the energy output of the ultraviolet light in order to
maintain a constant output, even with fluctuations in electrical current. RCI
currently intends to utilize two versions of the Curing Unit, which differ only
in the quantity of the lenses that can be produced at one time. The Premier
Curing Unit will cure two pairs of lenses within approximately 30 minutes. The
smaller Deluxe Curing Unit will cure one pair of lenses in the same amount of
time. In
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addition, the front mold assembly may be coated with a scratch resistant coating
and then cured with high intensity UV light onto the mold surface. This coating
then adheres to the lens during the curing process.
A lens produced by the LenSystem can be subjected to the application of various
additional treatments (such as scratch resistant, anti-reflective and
ultraviolet coatings) using the same materials and process now employed to apply
such coatings to conventional plastic lenses. Scratch resistant and ultraviolet
coatings can generally be applied on site in under ten minutes, whereas the
application of an anti-reflective coating requires that the lens be sent out to
a third party service company. If inadequacies appear in the Lensystem during
day to day operation, there is no assurance that any such inadequacies can be
corrected at commercially acceptable cost, or at all.
MARKETING AND PRICING STRATEGY. RCI expects that initially the bulk of RCI's
revenues will be derived from sales of equipment and that as the installed base
of equipment stabilizes, an increasing share of revenues will be derived from
Monomer sales. RCI is initially seeking to market the LenSystem principally to
operators of retail optical stores and small to mid-sized wholesale lens
manufacturing laboratories, both inside and outside the United States.
Currently the sale price for a single LenSystem with one set of molds is
approximately $37,000 for a smaller unit and $43,000 for a larger unit.
Operators may be able to lease RCI equipment from third party lessors for
approximately $750 to $950 per month at current interest rates over a 60 month
period. RCI expects that each purchaser or lessee of a LenSystem will at least
initially use RCI's Rapid Cast Liquid Monomer.
RCI does not believe that, in the short term, marketing of the LenSystem will
require the purchase of significant print, television, radio or other
advertising. RCI instead anticipates that the LenSystem will receive a large
amount of nonpaid publicity within trade magazines that regularly report on
technological changes in the optical industry. RCI may nonetheless utilize
limited print advertising in optical industry trade magazines for the purpose of
highlighting the LenSystem's perceived advantages.
RCI currently intends to focus its marketing resources in the short term on the
introduction and demonstration of the LenSystem at one or more optical industry
conventions and trade shows. RCI believes that such conventions will provide an
attractive forum for exhibiting the LenSystem's limited space requirements, ease
of use and high quality output. By the end of the third quarter of 1995, RCI had
also hired four employees to market the LenSystem, primarily in the United
States. RCI pays these employees salaries and commissions, and reimburses them
for expenses in connection with their marketing services.
MANUFACTURING STRATEGY. RCI currently does not have the facilities or the
experience to manufacture the components of the LenSystem and has no plans to
develop its own manufacturing capabilities. RCI currently intends to have such
components manufactured through subcontractors. In this regard, RCI will not be
able to directly control the cost of components or the reliability of the
quality and timing of deliveries.
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RESEARCH AND DEVELOPMENT STRATEGY. RCI anticipates that, if and to the extent
funds become available from future revenues (if any) or other sources, its
research and development efforts will emphasize the further development and
enhancement of the Technology and the LenSystem, generally in response to
potential future changes in technologies, customer preferences and optical
industry standards. Should RCI be unable to anticipate these changes (whether
because of a lack of adequate research and development funding or otherwise) or
fail to improve the LenSystem or develop new technologies in response to these
changes, RCI's ability to grow and become profitable could be materially
adversely affected.
More specifically, RCI believes that, in addition to single vision, flat-top
bifocal and progressive bifocal lenses, the Technology could be enhanced to
enable it to produce other existing types of prescription lenses as well as new
lens designs that may be developed in the future. If and to the extent funds
become available, RCI accordingly expects that it might seek to improve the
LenSystem so as to broaden the range of low cost, high quality lenses it can
produce. There can be no assurance, however, that RCI will in fact ever
undertake to develop any such improvements or that any effort to do so would be
successful or commercially viable. RCI does not currently anticipate that it
will conduct future research and development relating to technologies or
products that are not related to the on-site production of prescription eyeglass
lenses. There can be no assurance that, if conducted in the future, any of
RCI's research and development efforts will be successful, be completed in a
timely manner, improve RCI's profitability, or enable it to respond effectively
to technological or medical advances or new product developments by competitors.
MAINTENANCE, WARRANTY AND INSURANCE. Initial sales of LenSystems are supported
by sales and technical representatives who provide installation and training
services. RCI provides its customers with a complete operations manual and
training videos. RCI currently offers the LenSystem with a one year warranty
for parts and labor. RCI currently maintains product liability insurance which
provides coverage of $6,000,000 per occurrence and $7,000,000 in the aggregate.
There can be no assurance that the coverage provided by those policies is
sufficient to protect RCI against liability. RCI's inability or failure to
protect itself adequately against such liabilities could have a material adverse
effect upon its prospects, financial condition and results of operations.
COMPETITION. The prescription ophthalmic lens industry is intensely
competitive. Numerous manufacturers and distributors currently supply United
States lens dispensers, including such dispensers as retail optical stores and
small to mid-sized wholesale optical lens manufacturing laboratories. These are
the customers to whom RCI initially intends to market the LenSystem. Many of
these manufacturers and distributors are currently capable of supplying lenses
to a lens dispenser within 24 hours after receipt of the dispenser's order, and,
in many cases they can do so at prices competitive with the cost of producing
such lenses utilizing the LenSystem. Innotech Corporation is one competitor of
RCI which uses plastic to produce lenses. RCI believes that the LenSystem has
superior quality (i.e. better durability) and equivalent pricing to other
manufacturers of single vision lenses, and both superior quality and lower
pricing with respect to flat-top bifocal and progressive bifocal lenses.
If RCI is successful in marketing the LenSystem, it anticipates that other
companies or entities will attempt to develop competitive lens casting systems
capable of being placed in retail optical
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store locations. Potential competitors may include companies that own large
optical lens manufacturing factories, owners of chains of retail optical stores,
large wholesale optical lens manufacturing laboratories, mass merchandisers and
warehouse membership clubs that have entered or may enter the retail optical
industry, companies in the optical instrument business, companies in the contact
lens industry, pharmaceutical and chemical companies that have entered or may
enter the retail optical industry or the optical lens manufacturing industry,
and universities and public research organizations. Many of these competitors
have substantially greater financial, technological, research, product
development, manufacturing, sales, marketing and human resources than RCI.
There can be no assurance that one or more of these competitors will not develop
a system for on-site production of prescription ophthalmic lenses which is
competitive with or superior to the LenSystem, or that RCI will have the
technological, marketing or financial resources or flexibility to respond to any
such development. The development of such a system would, in all likelihood,
exert adverse price pressures on the LenSystem and could render it obsolete and
unmarketable.
PATENTS AND PROPRIETARY RIGHTS. In February 1995 RCI acquired all of the
capital stock of Q2100 and thus all of Q2100's issued patents and patent
applications that relate to the Technology. RCI is not aware that any party, in
the United States or elsewhere, has challenged the validity or enforceability of
the issued patents relating to the Technology, other than the patent dispute
with Ronald D. Blum O.D. See "Item 3. Legal Proceedings - Patent Infringement
Lawsuit."
The status of pending patent applications involves complex legal and factual
questions, and the scope and breadth of claims to be allowed is uncertain.
Accordingly, there can be no assurance that pending patent applications, or
patent applications that may be filed by RCI in the future, will result in
patents being issued, or that any patents that may be issued in the future will
afford protection against competitors with similar technology. Patent
applications in the United States are maintained in secrecy until patents are
issued and, since publication of discoveries in the scientific or patent
literature tends to lag behind actual discoveries by several months or even
years, there can be no assurance with respect to pending patent applications
that the covered inventions were not first created by other parties, or that
such applications were the first to be filed on such inventions. In addition,
patents relating to the Technology that have been or may be issued in some
foreign countries may not afford the same protection to RCI as is provided under
the patent laws of the United States.
No assurance can be given that the issued patents relating to the Technology
will afford protection against competitors with similar technology, or that any
of such patents will not be infringed, designed around by others or invalidated.
Applications of the Technology (or future technologies RCI may develop) may
infringe patents or proprietary rights of others. If any licenses are found to
be required in order for RCI to use the Technology or other processes or
products, such licenses may not be available on acceptable terms, if at all.
Furthermore, there can be no assurance that challenges will not be instituted
against the validity or enforceability of any patent owned by RCI or, if
instituted, that such challenges will not be successful. The cost of litigation
to uphold the validity and prevent infringement of a patent can be substantial
and could have a material adverse effect upon RCI's financial condition and
results of operations.
In addition to potential patent protection, RCI will rely upon the laws of
unfair competition and trade secrets to protect its proprietary rights. RCI
currently intends to seek to protect its trade secrets and
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other proprietary information in part by entering into appropriate
confidentiality and nondisclosure agreements with its future employees,
consultants, suppliers, joint venturers, subcontractors, licensees, scientific
collaborators, sponsored researchers and others. These agreements will
generally provide that all confidential information developed by or made known
to the other party during the course of the relationship with RCI is to be kept
confidential and not disclosed to third parties, except in certain
circumstances. In the case of employees, consultants, scientific collaborators
and sponsored researchers, the agreements will generally provide that all
inventions conceived by them relating to the business of RCI will be the
exclusive property of RCI. There can be no assurance, however, that any such
agreements will provide meaningful protection for RCI's trade secrets in the
event of unauthorized use or disclosure of such information.
Although RCI intends to protect its rights vigorously, there can be no assurance
that trade secrets will be established or maintained, that secrecy,
confidentiality or nondisclosure agreements will be honored, or that others will
not independently develop similar or superior technologies. To the extent that
employees, consultants or other third parties (such as prospective joint
venturers or subcontractors) apply technological information to RCI's projects
which has been independently developed by them or others, disputes may arise as
to the proprietary rights to such information, which disputes may not be
resolved in favor of RCI.
RCI was advised by the previous owner of Q2100 that it believes that Q2100 owns
the trademark "Fast Cast." RCI may use the Fast Cast mark, "OMB-91,"
"Rapidcast," or "LenSystem." None of these marks have been federally
registered. A prior user of one of these marks could successfully challenge
RCI's ownership or use of the mark.
GOVERNMENTAL REGULATION. It is the opinion of special counsel to RCI that the
lenses produced by the LenSystem are medical "devices" within the meaning of the
Federal Food, Drug and Cosmetic Act (the "Food and Drug Act"), but that the
lenses may be marketed without pre-market notification, review, approval or
clearance by the Federal Food and Drug Administration ("FDA"). Other
requirements, principally those concerning impact resistance, good manufacturing
practices, labeling and reporting of certain alleged adverse effects will apply.
Although the FDA may disagree, such counsel is also of the opinion that the
LenSystem is itself not a "medical device" under the Food and Drug Act.
However, certain state and local governmental authorities (such as the State of
California) also regulate medical device manufacturers. Depending upon where
LenSystem equipment is manufactured, RCI may be subject to such additional
regulations. Although there can be no assurance in this regard, RCI does not
anticipate that compliance with such governmental regulation will have an
adverse effect upon its business.
ACQUISITION OF LABTECH, INC. - In September 1995, RCI acquired the assets of
LabTech, Inc. for $75,000 in cash, a three year interest bearing note for
$50,000, and a royalty on future sales using LabTech's technology. The $50,000
Note was paid in full in December, 1995. The LabTech assets include proprietary
technology which accelerates the photochromatic process of tinting lenses in
response to changes in light. RCI intends to incorporate this technology into
its lens and monomer manufacturing system.
NONISSUER SALES OF STOCK PURSUANT TO REGULATION S - Shareholders of the Company
who had received shares of the Company's common stock in private placements made
in connection with the Company's acquisition and financing of a controlling
interest in Rapid Cast, Inc. (i.e.
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purchasers of convertible notes and the founding shareholders of Rapid Cast,
Inc.) sold a substantial portion of such shares in offshore sales pursuant to
Rule 904 of Regulation S of the Securities Act of 1933, as amended. The Company
estimates that approximately 1,650,000 of such shares were sold pursuant to Rule
904 of Regulations S. The Company's obligation to register those shares with
the Securities and Exchange Commission under the terms and conditions of the
convertible notes and purchase agreement for the controlling interest in Rapid
Cast, Inc. terminated when the shares were sold to the offshore buyers. See
Item 1. Business - "Acquisition of Rapid Cast, Inc." The Company did not sell
any shares pursuant to Regulation S.
AGREEMENT WITH PRICE INTERNATIONAL, INC.:
On October 27, 1994, the Company entered into an exclusive agreement with Price
International, Inc. ("PRI") of Boca Raton, FL, to provide production, management
and marketing services for sports-oriented private label and collectible
telephone calling cards. PRI's parent corporation, Price International Ltd. of
Toronto, Ontario, Canada has a license with the National Hockey League Players'
Association (NHLPA) to provide telephone calling cards of NHLPA players. The
Company has already produced and is marketing the first edition of cards under
the agreement and is actively working on additional editions. Under the terms of
the agreement, PRI has received a warrant that expires on December 31, 1997 to
purchase 100,000 shares of the Company's common stock at $11.25 per share under
the following terms: (i) 25,000 shares were vested on the day the agreement was
effective, and (ii) 75,000 shares can be vested based upon a performance
requirement in which one share will be vested for every $10 in pre-tax profits
earned by the Company from products issued under the agreement during any
continuous four audited quarterly periods, up to a maximum of 75,000 shares.
In May 1995, PRI and the Company entered into another agreement pursuant to
which PRI exercised 25,000 warrants at $11.25 per share before their expiration
date at the request of the Company and, for the early exercise and other
considerations, was vested to exercise the remaining 75,000 warrants at $11.25
per share. The Company agreed to register the 75,000 shares underlying the
warrants in a registration statement with the Securities and Exchange Commission
that was anticipated to be filed by the Company in 1995. As part of its
agreement with the Company, PRI agreed to exercise an additional 25,000 warrants
within 30 days of the stock being registered, provided that the price of the
stock was at $13 or higher. PRI also agreed to extend the license period with
the NHLPA at PRI's expense until the end of June 1996 and also agreed to allow
the joint venture to use the trade name Parkhurst in association with the NHLPA
phone cards. PRI has the right to use the name Parkhurst, which is a leading
manufacturer of trading cards in the hockey market.
In December 1995, the Company entered into discussions with PRI to voluntarily
terminate the entire agreement due to lower sales than anticipated. The Company
does not believe that the agreement with PRI has been profitable. The Company
is also in discussions with PRI associated with the remaining 75,000 warrants
that were not registered in 1995 as agreed upon by the Company.
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NETWORK SERVICES:
The Company's major network service is the Auto Dismantler Network (known under
the tradename "AutoNETWORK") that currently links several hundred licensed
automobile dismantlers in California, Nevada, Arizona, Utah, Oregon and
Washington. AutoNETWORK is a monthly subscription service that auto dismantlers
utilize to buy, sell and trade used parts that have been salvaged from
automobiles damaged in traffic collisions.
The Company evaluates on a continual basis other applications that could use the
Company's broadcast and point-to-point business communications technologies.
AutoNETWORK allows automobile dismantlers to buy, sell and trade used automobile
parts. By entering a parts request into a personal computer, the request is
transmitted to the communications message switching system, which in turn
broadcasts the request within seconds to every dismantler on the network or to a
selected local or regional subgroup of dismantlers. Those dismantlers who have
the requested part in stock and wish to sell it then transmit private messages
and enter into private negotiations to sell the part. Generally, a dismantler
using AutoNETWORK can locate a part, if available, within minutes of entering
his request. The majority of dismantlers on the network generate substantially
increased parts sales per month using the network.
During September 1989, the Company agreed to a joint venture with Dismantlers
Exchange, a privately-owned, Fairfield, California-based operator of voice
telephone hotlines used by more than 200 auto dismantlers to locate auto parts
throughout Central and Northern California, Oregon and Washington. Under the
joint venture agreement, Dismantlers Exchange markets its own version of the
Company's computerized parts locator network in its marketing area under the
tradename "DX PC Network". Although both companies operate their networks
separately, customers of each network are able to receive appropriate parts
requests and send private messages to each other. Dismantlers Exchange also
operates a central clearinghouse so that customers of either network can search
for parts on each network as required.
In 1996, the Company intends to invest approximately $30,000 into the
AutoNETWORK business to enhance the services provided to the automobile
dismantlers in the network.
EMPLOYEES, OFFICERS AND DIRECTORS:
EMPLOYEES - As of March 22, 1996, the Company, including its subsidiaries, NTC
and RCI, employed 267 full-time people, consisting of 32 general and
administrative, 48 marketing and sales, and 187 operations and customer service
personnel.
None of the Company's employees are subject to a collective bargaining
agreement, and the Company has not experienced any slow-downs, strikes or work
stoppages due to labor difficulties. The Company considers its employee
relations to be satisfactory.
OFFICERS - The success of the Company is heavily dependent on the Company's
President and Chief Executive Officer, Melvyn Reznick, and the President of the
Company's NTC subsidiary, Edward R. Jacobs.
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The Company has a three-year employment contract with Mr. Jacobs that expires on
July 25, 1997. Should Mr. Jacobs become unavailable or incapable of performing
his duties and functions, the Company could suffer material adverse
consequences. There can be no assurance that the Company would be able to
attract a competent replacement on a timely basis should the Company find it
necessary to replace Mr. Jacobs.
On November 30, 1995, the Company entered into a Severance Agreement with Sam D.
Schwartz, the prior Chief Executive Officer of the Company, pursuant to which
Mr. Schwartz resigned as an officer and director of the Company. Pursuant to
the Severance Agreement, the Company agreed to pay Mr. Schwartz severance
compensation of $20,000 per month for a twelve month period, and to indemnify
him to the extent generally available to officers and directors of companies
under California law. Pursuant to the Severance Agreement, the Company
currently is reviewing the tender of short-swing profits made by Mr. Schwartz to
the Company on August 18, 1995 and September 1, 1995 pursuant to Section 16(b)
of the Securities Exchange Act of 1934, as amended. The amount of short-swing
profits and the value of the stock options tendered by Mr. Schwartz may be
recalculated based on the Company's review procedures. See "Item 3. Legal
Proceedings - Section 16(b) Lawsuit" and Note 5 - "Short Swing Profits" in the
"Notes to Consolidated Financial Statements."
On November 30, 1995, the Company entered into a two year Employment Agreement
with Melvyn Reznick pursuant to which Mr. Reznick became the President and a
director of the Company. Mr. Reznick is also a director of RCI. Pursuant to
the Employment Agreement, Mr. Reznick is paid an annual salary of $175,000 and
has been granted stock options to purchase 300,000 shares of the Company's
common stock at an exercise price of $4.87 per share for a period of five years
from the date of vesting. The stock options vest according to the following
schedule: 25,000 options on February 28, 1996, 25,000 on May 31, 1996, 25,000
on August 31, 1996, 25,000 on November 30, 1996, 100,000 upon RCI earning
cumulative net profits in four or less consecutive fiscal quarters of $1.5
million before taxes and before the Company's acquisition amortization relating
to RCI, and 100,000 upon RCI earning cumulative net profits in four or less
consecutive fiscal quarters of $2 million before taxes and before the Company's
acquisition amortization relating to RCI. The vesting of the 200,000 options
which are based on the financial performance of RCI may accelerate upon a sale,
spin-off or similar transaction relating to RCI. The Company has agreed to
indemnify Mr. Reznick to the extent that indemnification of officers and
directors is permitted under California law.
RECONSTITUTION OF BOARD OF DIRECTORS - On October 26, 1995, the NASDAQ Listing
Qualification Committee determined that it was inadvisable to continue the
Company's listing on the Small Capital Market, but also advised that the
termination was delayed for a period of 45 days pending a review by the NASDAQ
Hearing Review Committee. The Board of Directors of Incomnet requested a
reconsideration by the Qualifications Committee of its determination and
immediately took action to address the concerns raised by the Qualifications
Committee as follows:
(a) On November 15, 1995, the Board reconstituted itself with several
changes. Rita L. Schwartz and Stephen A. Caswell resigned from the Board and Sam
D. Schwartz resigned as Chairman of the Board. Melvyn Reznick, Nancy Zivitz and
Albert Milstein were appointed to the Board and Joel W. Greenberg was named
Chairman of the Board.
22
<PAGE>
(b) On November 15, 1995, the Board of Directors established a policy that
all Board members and senior officers must receive permission before purchasing
stock in the Company. The Board established a compliance committee to 1) review
requests of senior officers to buy stock in the Company, 2) review contracts
with outside consultants and 3) set up procedures for communications with the
general public.
(c) On November 30, 1995, Sam D. Schwartz resigned as President and Chief
Executive Officer of Incomnet and Melvyn Reznick was appointed as President and
Chief Executive Officer.
In December 1995, the Company was notified by the NASDAQ Listing Qualification
Committee that after further consideration, the steps taken by the Company were
satisfactory and that the Company's stock would remain listed on the NASDAQ
Small Capital Market.
ITEM 2. PROPERTIES
The Company does not own any real estate. The Company leases approximately
6,224 square feet of office facilities at 21031 Ventura Boulevard, Suite 1100,
Woodland Hills, California 91364. The Company was obligated to make lease
payments at the rate of $8,215 per month through April 1995, and at the rate of
$8,713 per month from May 1995 through July 1998.
The Company's subsidiary, NTC, currently occupies 70,281 square feet of office
space at three sites in Irvine, California which are covered by several lease
agreements. Two of these leases are short-term agreements for satellite
facilities which will terminate during 1996. NTC is presently nearing
completion of negotiations to extend the lease on its headquarters buildings at
2801 Main Street , Irvine, California through June, 2004. Currently, lease
payments for the three sites total $59,577 per month. According to the terms of
existing leases and the proposed lease extension, NTC would be obligated to pay
monthly lease payments averaging $48,912 during 1996, and $49,269 during 1997,
with subsequent monthly lease payments increasing by $1,000 to $2,000 each year,
reaching average lease payments of $63,957 during 2004.
The Company's subsidiary, Rapid Cast, has entered into a lease on approximately
12,250 square feet of office, research and development space for its facilities
in Louisville, Kentucky, expiring on May 30, 2000. RCI is obligated to make
lease payments at the rate of $8,167 per month through December 31, 1997, $8,322
per month in 1998, and $8,433 per month from January 1999 through May 2000. RCI
also leases approximately 1,700 square feet of office space in East Rockaway,
New York, from an affiliated party on a month-to-month basis for $2,000 per
month.
ITEM 3. LEGAL PROCEEDINGS
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION:
On August 9, 1994, the Company was notified by the Pacific Regional Office of
the Securities and Exchange Commission that the Commission had initiated an
informal investigation of the Company and its subsidiary, NTC. The inquiry is
fact-finding in nature. In September 1994, the order was changed to a "formal
order of private, nonpublic investigation." The Commission stated in its
correspondence to the Company that the investigation "should not be construed as
an
23
<PAGE>
adverse reflection on any person, entity or security, or as an indication by the
Commission or its staff that any violation of law has occurred." The Company
believes that the investigation was prompted by erroneous reports in the press
in June 1994 that the Company's NTC subsidiary was engaged in unethical business
practices associated with its marketing program. In August 1994, the Company
voluntarily and promptly supplied copious and substantial copies of its books
and records to the Commission, and the Company's present and prior independent
certified public accounting firms submitted their working papers. The
Commission has taken investigative testimony from several current and former
officers and directors of the Company and NTC. The Company has responded
promptly to all requests for information from the Commission.
The Company believes that it has provided substantial documentation to the
Commission that verifies the propriety of its business operations and believes
that the ultimate result of the fact-finding investigation will not have a
material adverse effect on the Company's financial condition or results of
operations.
CLASS ACTION AND RELATED LAWSUITS:
On October 17, 1995, the Company was served with an amended complaint in the
class action lawsuit entitled SANDRA GAYLES; THOMAS COMISKEY, AS TRUSTEE FBO
THOMAS COMISKEY, IRA; CHARLES KOWAL; ARTHUR KALTER; MATTHEW G. HYDE; ARTHUR
WIRTH; AND ISABEL SPERBER, VS. SAM D. SCHWARTZ AND INCOMNET, INC., Case No.
CV95-0399 AWT (BQRx), filed in the United States District Court for the Central
District of California, Western Division, which was originally filed in January
1995. The amended complaint retains the claim alleging that the Company
violated Sections (10)b and 20(a) of the Securities Exchange Act of 1934, as
amended, and Rule 10b-5 promulgated under Section 10(b) of the Exchange Act,
because it did not disclose and falsely denied the existence of the non-public
investigation of the Company commenced by the Securities and Exchange Commission
in August 1994. The complaint adds claims that the Company and its former
Chairman, Sam D. Schwartz, violated Sections 10, 16(a), 20(a) and 23(a) of the
Exchange Act, and Section 25400 of the California Corporations Code, because
they did not disclose until August 1995 purchases and sales of the Company's
stock made in the open market by an affiliate of Mr. Schwartz between September
1994 and August 1995. The amended complaint seeks (i) certification of the
class, (ii) compensatory damages, (iii) damages pursuant to Section 25500 of the
California Corporations Code, (iv) interest and attorneys' fees and costs, and
(v) other extraordinary, equitable and injunctive relief as may be appropriate.
The Company believes that the prior President's purchases and sales were made in
substantial compliance with Rule 10b-18 promulgated under Section 10(b) of the
Exchange Act. On January 11, 1996, the case was certified as a class action
pursuant to the parties' stipulation. The Company has answered the complaint
and the lawsuit is currently in the discovery phase.
In October 1995, the Company was served with a civil lawsuit entitled HERBERT M.
SCHWARTZ ET AL. V. INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT
CORPORATION, CV 96-0776 LGB (SHX), now pending in the United States District
Court, Central District of California. The case was originally filed in the
Northern District of Georgia, but the Company successfully moved to transfer it
to the Central District of California, the situs of the class action. In
February 1996, the Company was served with an additional lawsuit entitled BRENT
ABRAHM, ET AL, V. INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT
CORPORATION, Civil Action No. 1-96-CV-0051-CC pending in the United States
District Court, Northern District of Georgia.
24
<PAGE>
These two lawsuits were filed against the Company, its former Chairman and his
affiliate by current and prior shareholders of the Company and both allege
claims under federal and state law pertaining to misrepresentations, omissions
to disclose material facts and undisclosed insider trading which adversely
affected the market price for the Company's securities. The complaints allege
that the plaintiffs suffered losses in the market value of their stock as a
result of the alleged violations. The Company's motion to strike two of the
plaintiffs' claims is pending in the HERBERT SCHWARTZ case. The Company is also
seeking to have the ABRAHM case transferred to the same California court and
consolidated with the HERBERT SCHWARTZ case which is in the initial stages of
discovery. The Company intends to vigorously defend against these lawsuits.
SECTION 16(b) LAWSUIT:
In January 1996, the Company was served with a derivative shareholders lawsuit
entitled RICHARD MORALES VS. INCOMNET, INC. AND SAM D. SCHWARTZ, 96 Civil 0225
in the United States District Court for the Southern District of New York,
alleging violations of Section 16(b) of the Securities Exchange Act of 1934, as
amended, and demanding that the Company assert claims against Mr. Schwartz for
the payment of short-swing profits plus interest. Mr. Schwartz has retained
separate counsel for this action. Plaintiff's Fourth Amended Complaint alleges,
short-swing profits to be approximately $2,128,000. The Company's latest
calculations indicate short-swing profits of approximately $2,074,000. The
Company is currently reviewing the plaintiff's calculation to determine the
reason for the difference, and has forwarded the information to Mr. Schwartz's
counsel. The plaintiff also asserts that the 250,000 stock options tendered by
Mr. Schwartz on August 20, 1995 and September 1, 1995 as payment of the
short-swing profits should be accorded no value because of alleged manipulative
and undisclosed trading in the Company's stock by Mr. Schwartz and his
affiliate. The parties have not yet agreed on the value of the tendered stock
options. The Company's time to respond to the complaint has been extended until
early April 1996 while settlement discussions proceed. Mr. Schwartz has not yet
answered the complaint. The Company intends to attempt to settle this action
and to collect the unpaid amount of the short-swing profits plus interest from
Mr. Schwartz. There is no assurance regarding whether a settlement will be
reached, whether the short-swing profits plus interest will be collected, the
timing of a settlement or collection, or the amount of legal costs which may be
incurred in connection with the lawsuit. See "Item 1. Employees - Severance
Agreement with Sam D. Schwartz."
PATENT INFRINGEMENT LAWSUIT:
In July 1995 Rapid Cast, Inc. was served with a lawsuit entitled RONALD D. BLUM,
O.D. VS. RAPID CAST, INC., Case No. 95-CV5113, filed in the United States
District Court in the Southern District of New York. The complaint alleges that
Rapid Cast, Inc. has infringed on the plaintiff's patent for curing plastic
lenses by virtue of employing its technology in the FastCast-TM- LenSystem. On
July 28, 1995, Rapid Cast, Inc. filed an Answer and Counterclaim for Declaratory
Judgment denying the plaintiff's allegations, asserting that the FastCast-TM-
LenSystem does not infringe on the plaintiff's patent, alleging that claims in
the plaintiff's patent are invalid and unenforceable, and requesting that
plaintiff be enjoined from threatening or commencing any litigation against
Rapid Cast, Inc. or any of it suppliers, customers or prospective customers.
The litigation is
25
<PAGE>
presently in the discovery phase. The parties are also actively engaged in
settlement discussions. There is no assurance that a final settlement agreement
will be made.
LEGAL ACTION AGAINST PRIOR REPRESENTATIVES:
On July 28, 1994, NTC filed a lawsuit against six prior independent marketing
representatives who terminated their relationship with NTC on March 31, 1994.
The lawsuit alleges that the defendants breached their agreements with NTC after
terminating their representative status by (i) soliciting NTC's customers to
leave NTC and sign up with a competitor, (ii) soliciting NTC's other independent
marketing representatives to leave NTC and work for a competitor, (iii)
misappropriating and failing to return the NTC customer and independent sales
representative lists, (iv) disclosing NTC's customers, representatives and other
trade secrets to a competitor and (v) willfully and maliciously conspiring to
injure NTC's business in order to improve their own business. The causes of
action against the defendants are breach of contract, misappropriation of trade
secrets and intentional interference with NTC's economic relationships. NTC
sought injunctive relief and is seeking monetary damages of at least $500,000,
as well as punitive damages in an unspecified amount. On August 31, 1994, the
court awarded NTC a temporary injunction against the defendants, enjoining them
from disclosing or utilizing any of NTC's trade secrets, including its list of
customers and independent sales representatives. A permanent injunction was
subsequently denied by the court on the basis that NTC had failed to demonstrate
irreparable harm. All of the defendants were located in Northern California. The
Company believes that as a result of the defendants' wrongful actions, NTC lost
independent marketing representatives in Northern California and retail
customers. While these actions slowed the growth rate of NTC's customers and
marketing representatives in the spring of 1994, growth is continuing. The rate
at which NTC is signing new representatives, especially from other parts of the
United States, is also increasing, which may result in an increased rate of
growth in the customer base in the future. On August 30, 1994, the defendants
filed a cross-complaint against NTC and the Company, claiming that NTC failed to
meet its contractual obligations to the defendants and that actions taken by the
defendants as a result were proper and legal. The cross complainants are
seeking compensatory and special damages, along with general and punitive
damages. Management cannot predict the ultimate resolution of the lawsuit or
its impact on the Company at this time.
26
<PAGE>
CLAIMS BY PRIOR NOTEHOLDERS:
In January 1996 a civil action was filed against the Company and Sam D. Schwartz
in the United States District Court for the Eastern District of New York,
entitled JULES NORDLICHT VS. INCOMNET, INC. AND SAM D. SCHWARTZ, Case No. CV
95-5134, alleging breach of contract and material misrepresentations and
nondisclosures in connection with the issuance and conversion of promissory
notes by the Company in a private placement. The complaint sought damages of
$750,000. In early February 1996 the Company entered into a settlement
agreement with Mr. Nordlicht pursuant to which the Company agreed to issue to
Mr. Nordlicht and register 31,000 shares of the Company's common stock, repay
the outstanding balance of his note, and issue him 5,000 additional warrants to
purchase shares of Rapid Cast, Inc. (if and when it goes public) which the
Company had received pursuant to the redemption of another convertible
promissory note previously issued by the Company. Pursuant to the settlement,
the Company is obligated to file the registration statement by May 12, 1996 or
it is required to pay a $100,000 penalty to Mr. Nordlicht. In addition, the
Company may be obligated to issue additional shares to Mr. Nordlicht if, during
the five trading days immediately following the effective date of the
registration statement, the average last sale price of the Company's common
stock on the NASDAQ Small Capital Market is less than $5.00 per share.
Accordingly, on the effective date of the registration statement, Mr. Nordlicht
is entitled to $155,000 worth of Incomnet, Inc. stock, with a minimum of 31,000
shares which have already been issued to him. The settlement agreement has been
filed with the court and the case has been dismissed with prejudice, subject to
compliance with the settlement agreement.
Claims similar to Mr. Nordlicht's could be asserted against the Company by other
holders of shares acquired upon the conversion of privately placed 8%
convertible notes which were issued in February 1995 and converted into shares
by the holders in July 1995. The Company has had settlement discussions with
six such shareholders holding 32,500 shares, and there are additional conversion
shares held by prior or current officers or directors of the Company or RCI.
Settlement agreements have been sent to all six holders and four covering 20,000
shares have been executed and returned. There is no assurance that the other
two settlement agreements will be executed. If the settlement agreements are
not signed and a suit is filed, the Company will vigorously defend the action.
The settlement agreements call for the Company to register the outstanding
shares held by the six holders, and to issue them sufficient additional shares
upon the effective date of the registration statement to result in the six
holders having free trading shares with a value equal to 120% of the amount of
their original investment, based on the average trading price of the Company's
common stock for the five trading days immediately preceding the effective date.
POTENTIAL LAWSUITS:
Price International, Inc. (PRI) may assert a claim for breach of contract and
federal securities laws violations in connection with the exercise of 25,000
warrants at $11.25 per share by it allegedly based on statements made to it by
the Company (See Agreement with Price International, Inc.). PRI asserted this
claim in a letter written to the Company by its counsel in October 1995. The
Company has communicated directly with Price International and agreed to
register the shares
27
<PAGE>
underlying the remaining 75,000 warrants held by Price International. No
settlement agreement was, however, entered into and no further threats by Price
International have been made.
Two clients of a broker-dealer firm have asserted claims against the Company and
its prior President alleging misrepresentations in the course of providing
information to the shareholders of the Company and alleging omissions to state
material facts. These two potential plaintiffs have asserted their claims
informally, and that they purchased the Company's securities through a
registered broker-dealer firm in the open market. They claim to have purchased
several million dollars worth of the Company's common stock and to have suffered
losses because of the acts and/or omissions of the Company and its prior
President. If these claims are filed as a legal complaint, the Company will
seek to consolidate them with the HERBERT SCHWARTZ and/or the class action
lawsuits.
From time to time, the Company is involved in litigation arising from the
ordinary course of business, the ultimate resolution of which management
believes will not have a material adverse effect on the financial condition or
results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth
quarter of the year ended December 31, 1995.
28
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION:
The Company's common stock trades on the Nasdaq Small-Cap Market under the
symbol "ICNT". The following table sets forth the range of bid prices for the
common stock during the periods indicated. Prices represent the actual high and
low sale prices of the Company's stock as provided by Nasdaq real-time pricing
information.
YEAR ENDED DECEMBER 31, 1995:
QUARTER HIGH LOW LAST SALE
------- ---- --- ---------
4 11 1/4 2 1/2 4 9/16
3 24 1/2 9 11
2 16 3/8 10 7/8 15
1 14 5/8 8 1/4 14 3/8
YEAR ENDED DECEMBER 31, 1994:
QUARTER HIGH LOW LAST SALE
------- ---- --- ---------
4 14 5/8 9 15/16 14 5/8
3 12 1/2 8 11 3/8
2 11 1/8 6 3/8 9 3/4
1 7 1/4 6 6 3/4
On March 27, 1996, the last sales price per share of the Company's common stock,
as reported by the NASDAQ Stock Market, was $5 1/2.
On March 27, 1996, the Company's 13,224,024 shares of common stock outstanding
were held by approximately 700 shareholders of record.
DIVIDENDS:
The Company has not paid cash dividends on its common stock since inception.
Payment of dividends is within the discretion of the Company's Board of
Directors and will depend, among other factors, on earnings, capital
requirements and the operating and financial condition of the Company. At the
present time, the Company's anticipated working capital requirements are such
that it intends to follow a policy of retaining earnings in order to finance the
development of its business. (See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations").
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<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
A summary of selected financial data for the five years ended December 31, 1995,
1994, 1993, 1992 and 1991, is presented below, and should be read in conjunction
with the audited consolidated financial statements for the years ended December
31, 1995, 1994 and 1993 at "Item 8. Financial Statements and Supplementary
Data."
STATEMENTS OF OPERATIONS DATA(1):
<TABLE>
<CAPTION>
FISCAL YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1995(4) 1994(4) 1993(4) 1992(3,4) 1991(2)
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Sales $86,564,917 $46,815,057 $11,298,972 $5,534,874 $1,898,071
Income/(loss) before
income taxes,
extraordinary items
& minority interest 957,044 4,000,242 (1,606,844) (2,264,597) 397,631
Income/(loss) before
extraordinary items
& minority interest 856,543 3,999,187 (1,606,844) (2,461,697) 1,322
Net income/(loss) 1,366,025 4,071,194 (948,769) (2,021,333) 1,322
Per common share
and common
share equivalents:
Net income/(loss) before
extraordinary items 0.11 0.42 (0.20) (0.34) .00
Net income/(loss) 0.11 0.42 (0.12) (0.28) .00
30
<PAGE>
<CAPTION>
BALANCE SHEET DATA(1):
DECEMBER 31,
------------------------------------------------------------------------------------------
1995(4) 1994(4) 1993(4) 1992(3,4) 1991(2)
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Total assets $74,105,629 $26,158,346 $8,665,839 $6,744,994 $2,174,428
Long-term obligations 8,459,772 900 20,000 176,000 83,334
</TABLE>
__________________________________________
(1) Segment information is presented at "Item 1. Business - Segment
Information."
(2) In 1991, the Company wrote off its entire investment in Incomnet India
Limited.
(3) In 1992, the Company acquired a controlling interest in National Telephone
& Communications, Inc. This information is described in "Item 1. Business -
Acquisition of National Telephone & Communications, Inc. (NTC)."
(4) The Company is engaged in legal proceedings where the ultimate outcome
cannot presently be determined. This information is described at "Item 3. Legal
Proceedings."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES:
For the year ended December 31, 1995, the Company had a net profit of $1,366,025
and, at that date, current assets exceeded current liabilities by $1,440,515.
Since the Company acquired a controlling interest in NTC in early 1992, the
Company's capital needs have been satisfied from outside sources such as the
private placement of securities, the exercise of warrants and options, and loans
and bank credit lines guaranteed by its principal shareholders. Cash flow from
operations did not provide net working capital to the Company during the period
from February 1992 to May 1994, but has been positive since that date.
The Company had net working capital of $1,440,515 at December 31, 1995, as
compared to net working capital of $8,798,793 at December 31, 1994. During 1995,
net cash flow from operations was $1,378,839 compared to net cash flow from
operations of $3,083,887 in 1994.
During 1995, the Company's allowance for doubtful accounts increased to 20.6% of
gross accounts receivable from 15.1% in the prior year. This increased
provisioning related primarily to slower collections of NTC's direct-billed and
LEC-billed Dial-one products which was partially offset by improved collections
of NTC's calling card business.
During 1995, the Company's cash requirements were met through a combination of
cash flow from operations, exercise of warrants to purchase the Company's common
stock and private placements of its common stock. In 1995, the Company raised
$29,058,773 in either private placements or from the exercise of warrants. The
Company anticipates that it will continue to attain cash flow sufficient to meet
the Company's cash requirements in 1996 through a
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<PAGE>
combination of operations, bank borrowings, private placements of its common
stock and the exercise of warrants to purchase the Company's common stock. On
February 5, 1996, Melvyn Reznick, the President and a director of the Company,
personally guaranteed and arranged for a $500,000 bank line of credit for the
Company, which may be expanded to a range of $750,000 to $1,000,000 in the near
future. As of March 22, 1996, the line had not been drawn upon, although the
Company expects to draw on it in the future to fund operating expenses at the
parent company level, or to fund capital contributions to Rapid Cast, Inc.
("RCI") when the shareholders of RCI are called upon to provide additional funds
to RCI for its operations. In this regard, the Company made an additional
capital contribution of $324,000 to RCI in January 1996 pursuant to a private
rights offering made by RCI. The Company anticipates that during 1996 it and RCI
will need financing in addition to their respective cash flows to fund
operations and, in the case of RCI, to finance the growth of its business.
The Company had no material commitments for capital expenditures at December 31,
1995, but does expect to continue expanding the NTC headquarters building and
purchasing additional equipment commensurate with the requirements of its
customer base. During 1995, the Company had capital expenditures of $7,389,419
for plant and equipment.
Effective February 12, 1992, the Company entered into a Letter of Agreement (the
"Agreement") with National Telephone Communications, Inc. ("NTC"), to ultimately
acquire a controlling interest in NTC. NTC is a public company that resells long
distance telecommunications services. The Company loaned NTC $2,850,000 during
1992, collateralized by substantially all the assets of NTC, from its available
working capital resources. In 1993, the Company loaned an additional $1,935,961
to NTC, bringing the total to $4,785,961. In 1994, the Company loaned NTC an
additional $308,879, bringing the total to $5,094,810. All loans to NTC were
converted into an additional equity investment in NTC at the end of 1994. No
further loans were made to NTC during 1995.
In May 1992, as settlement with a creditor on a past due accounts payable of
approximately $725,000, the Company entered into a non-interest bearing credit
facility of approximately $432,000, resulting in a gain of approximately
$293,000 ($.04 per common share). The contract was payable in monthly
installments of $12,000 for the first twelve months and monthly installments of
$16,000 thereafter through November 1994. Maturities of the contract were
$84,000 in 1992, $172,000 in 1993 and $176,000 in 1994. This obligation was paid
in full in 1994.
At December 31, 1995, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $16,800,000, which are expected to
be available to offset taxable income for the next several years. The Company's
subsidiary is engaged in legal proceedings where the ultimate outcome cannot
presently be determined. This information is described at "Item 3. Legal
Proceedings."
The Company is subject to pending litigation and an investigation by the
Securities & Exchange Commission. Management is not yet able to predict the
impact of the pending litigation on its financial condition and results of
operations. Management does not believe that the investigation by the
Securities & Exchange Commission will result in a material impact on the
Company's financial condition or results of operations. SEE ITEM 3. LEGAL
PROCEEDINGS.
RESULTS OF OPERATIONS - 1995 COMPARED TO 1994:
SALES - Total 1995 sales increased by 85% from $46.8 million in 1994 to $86.6
million in 1995. The majority of this increase was attributable to NTC's sales
increase from $45.6 million in 1994
32
<PAGE>
to $83.1 million in 1995. The following table summarizes the Company's year-to-
year sales performance by subsidiary and segment:
$ in millions
---------------------
Subsidiary Segment 1995 1994
- ---------- ------- --------- ---------
NTC Telephone (telecommunications services) $ 70.0 $ 34.2
NTC Telephone (marketing programs) 13.1 11.4
RCI Optical 2.0 --
AutoNETWORK Network 1.5 1.2
--------- ---------
Total Company Sales $ 86.6 $ 46.8
--------- ---------
--------- ---------
NTC's sales increase was driven largely by continued expansion of the customer
base for its telecommunication services. As a result of this continuing
expansion, NTC's telecommunication service revenues represented 84% of NTC's
total 1995 revenues with the remaining 16% generated by sales of NTC's marketing
programs. This 1995 revenue mix compares to NTC's 1994 mix of 75% from
telecommunication services and 25% from marketing programs.
The consolidation of RCI in the third and fourth quarters of 1995 added $2.0
million of optical product sales to the total year results.
COST OF SALES - Total Company cost of sales, which tends to vary directly with
sales, increased from $31.2 million or 67% of sales in 1994 to $57.9 million or
67% of sales in 1995. The following table summarizes the Company's year-to-year
changes in two major cost components:
$ in millions
---------------------
1995 1994
--------- ---------
Commissions paid to NTC independent sales reps $ 14.2 $ 7.7
All other costs of sales 43.7 23.5
--------- ---------
Total Company Cost of Sales $ 57.9 $ 31.2
--------- ---------
--------- ---------
33
<PAGE>
NTC's total commission expense increased from $7.7 million in 1994 to $14.2
million in 1995. The most significant single factor in this year-to-year change
was an annual increase of $3.0 million in residual monthly sales commissions
paid to independent sales representatives on NTC's expanding telecommunication
service revenues. The remainder of the year-to-year change was caused by
increases in various bonuses and overrides paid to sales representatives who
signed up new telephone service customers for NTC.
The second cost component shown in the table above is "all other costs of sales"
which represents: (1) NTC's long distance carrier costs, (2) NTC's costs of
producing sales materials for its independent sales representatives, (3) RCI's
costs of producing optical systems and ancillary goods, and (4) AutoNETWORK
costs of providing communications network products and services.
GENERAL AND ADMINISTRATIVE - Total G&A costs increased from $9.4 million or 20%
of sales in 1994 to $19.8 million or 23% of sales in 1995. G&A costs generally
include the costs of employee salaries, fringe benefits, supplies, and related
support costs which are required in order to provide such operating functions as
customer service, billing, marketing, product development, information systems,
collections of accounts receivable, and accounting.
NTC's G&A costs increased during 1995 in order to: (1) support its continuing
sales growth in 1995 and, (2) build stronger infrastructure to accommodate still
greater sales growth and improved cost efficiencies in the future. RCI incurred
substantial G&A costs in 1995 relating to its startup of operations.
DEPRECIATION AND AMORTIZATION - Total Company depreciation and amortization
expense increased from $0.4 million in 1994 to $1.0 million in 1995. This
increase was caused by greater investment by NTC in computer hardware and
software, furniture and equipment, and leasehold improvements required to
support its rapid expansion in sales.
BAD DEBT EXPENSE - Total Company bad debt expense increased from $1.8 million or
3.8% of sales in 1994 to $4.1 million or 4.8% of sales in 1995. The
year-to-year increase in bad debt was caused primarily by increased provisioning
of NTC's Dial-1 receivables and secondarily by the Company's establishment of a
bad debt reserve for a potentially uncollectible note receivable from a Company
shareholder.
OTHER INCOME AND EXPENSE - The Company's net income and expense declined from
net other income of $0.3 million in 1994 to net other expense of $1.0 million in
1995. This $1.3 million net decline was primarily caused by: (1) a $382,500
settlement with convertible noteholders relating to the acquisition of RCI, (2)
a $244,010 settlement with a former Company officer, and (3) a $337,500
write-off of marketable securities by NTC.
ACQUISITION COSTS AND EXPENSES - Acquisition costs increased from $ .3 million
in 1994 to $1.7 million in 1995. This increase in costs was caused almost
entirely by the acquisition of RCI and includes: (1) $1,228,206 of amortization
expense relating to the acquisition of RCI patent rights, (2) $118,743 of
interest expense on notes used to finance the RCI acquisition and related legal
costs, and (3) $107,841 of equity in RCI's losses from February, 1995 (date of
acquisition)
34
<PAGE>
through June, 1995 (the period during which the Company's 51% ownership of RCI
was recorded under the equity method of accounting).
MINORITY INTEREST - Beginning on July 1, 1995, the Company converted from the
equity method to the consolidated method of accounting for its 51% ownership in
RCI. As a result, 49% of RCI's losses from July 1 through December 31, 1995
(the "minority interest") were eliminated from the Company's "Consolidated
Statements of Operations" for 1995.
NET INCOME - Total Company net income declined from $4.1 million or 8.7% of
sales in 1994 to $1.4 million or 1.6% of sales in 1995. Although NTC's
year-to-year net income increased substantially, those increases were more than
offset by losses sustained from the Company's internal operations and from RCI's
operations.
RESULTS OF OPERATIONS - 1994 COMPARED TO 1993:
SALES - In 1994, total revenues were $46.8 million as compared to $11.3 million
in 1993, an increase of $35.5 million or 314%. Telecommunications-related
revenues increased to $35.4 million in 1994 from $7.0 million in 1993, an
increase of $28.4 million or 404%, while marketing-related revenues increased to
$11.4 million from $4.3 million in 1993, an increase of $7.1 million or 167%.
The growth of the Company's telecommunications-related revenues was associated
with the increase in the base of marketing representatives, which results in the
signing of new telephone customers. The growth of the Company's
marketing-related revenues was due to a marketing program involving the sale of
marketing programs and materials to independent sales representatives.
COST OF SALES - Total Company cost of sales, including commissions to
independent sales representatives, increased to $31.2 million in 1994 from $9.5
million in 1993, an increase of $21.7 million or 227%. Expenses associated with
commissions, bonuses and overrides paid to NTC's independent representatives for
1994 were $7.7 million versus $2.3 million in 1993, an increase of $5.4 million
or 227%. Other increases in expenses were primarily attributable to the
increased costs of communication services from NTC's primary carriers.
GENERAL AND ADMINISTRATIVE - General and administrative costs were $9.4 million
in 1994 versus $2.6 million in 1993, an increase of $6.8 million or 257%. This
increase was attributable to substantial growth in NTC's telecommunications and
marketing revenues, which necessitated substantial increases in the Company's
selling, general and administrative operations. The increase in these
operations, however, was lower as a percentage increase than the increase in
revenues, reflecting an improved economy of scale in the Company's operations.
DEPRECIATION AND AMORTIZATION - Depreciation and amortization increased to $0.7
million in 1994 from $0.5 million in 1993, an increase of $0.2 million or 38%.
This increase was due to the increased investment in capital goods required to
conduct and expand operations.
BAD DEBT EXPENSE - Total Company bad debt expense increase to $1.8 million in
1994 from $0.2 million in 1993, an increase of $1.6 million or 925%. The
increase in bad debt was due to the rapid growth in telecommunications revenues
in 1994 versus 1993, although the rate of growth of bad debt from 1993 to 1994
reflects an over-reserve for bad debt in 1992 of $1.1 million, which
35
<PAGE>
was applied against bad debt in 1993. The actual rate of growth of bad debt in
1994 was commensurate with the rate of growth in telecommunications revenues
from 1993 to 1994.
OTHER INCOME AND EXPENSE - Total Company other income and expense changed from a
net expense of $0.1 million in 1993 to net income of $0.3 million in 1994, a
gain of $0.4 million, or 765%. The increase was due to the decreased need for
the Company to borrow funds in 1994 versus 1993, along with the increase in the
Company's cash position, which resulted in interest gains on funds held in cash
accounts.
NET INCOME - The Company generated net income of $4.1 million in 1994 versus a
loss of $0.9 million in 1993, an increase of $5.0 million or 529%. The
Company's net income reflects the improved and profitable operations at NTC in
1994.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary financial information
which are required to be filed under this item are presented under "Item 14.
Exhibits, Financial Statement Schedules and Reports on Form 8-K" in this
document, and are incorporated herein by reference.
36
<PAGE>
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE
REGISTRANT
The information required under this Item is contained in the definitive Proxy
Statement for the Company's 1996 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by April 30,
1996, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this Item is contained in the definitive Proxy
Statement for the Company's 1996 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by April 30,
1996, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this Item is contained in the definitive Proxy
Statement for the Company's 1996 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by April 30,
1996, and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this Item is contained in the definitive Proxy
Statement for the Company's 1996 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by April 30,
1996, and is incorporated herein by reference.
37
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
INDEX TO FINANCIAL STATEMENTS:
PAGE NO.
--------
Report of Independent Auditors 41
Consolidated Balance Sheets - December 31, 1995 and 1994 42
Consolidated Statements of Operations - Years Ended
December 31, 1995, 1994 and 1993 44
Consolidated Statements of Shareholders' Equity -Years Ended
December 31, 1995, 1994 and 1993 45
Consolidated Statements of Cash Flows - Years Ended
December 31, 1995, 1994 and 1993 46
Notes to Consolidated Financial Statements 48
Schedule II - Valuation and Qualifying Accounts -
December 31, 1995 and 1994 60
38
<PAGE>
INDEX TO EXHIBITS:
Exhibits designated by the symbol * are filed with this Annual Report on Form
10-K. All exhibits not so designated are incorporated by reference to a prior
filing as indicated.
Exhibits designated by the symbol ** are management contracts or compensatory
plans or arrangements that are required to be filed with this report pursuant to
this Item 14.
The Company undertakes to furnish to any shareholder so requesting a copy of any
of the following exhibits upon payment to the Company of the reasonable costs
incurred by the Company in furnishing any such exhibit.
EXHIBIT NO. DESCRIPTION
3.2 Proposed Amendment to Bylaws Regarding Directors.
10.1 Contract between Wiltel, Inc. and National Telephone
Communications, Inc. dated November 15, 1994, previously filed as
an Exhibit to Registration Statement on Form S-3 #33-87302
declared effective on December 22, 1994.
10.2 Standard Office Lease Between William B. Bellis, Sr. and Rapid
Cast, Inc. from May 31, 1995 to May 30, 2000 for property on
4510-12 Robards Lane, Louisville, KY.
21 Subsidiaries of the Registrant
REPORTS ON FORM 8-K, FILED IN 1995
20.1 Report on Form 8-K - Acquisition of Rapid Cast, Inc. dated and
filed on February 8, 1995.
20.2 Report on Form 8-K - Stock Purchase Agreement for Rapid Cast,
Inc., previously filed as Exhibit A dated and filed on
February 8, 1995.
20.3 Report on Form 8-K - Stock Purchase Agreement for Q2100, Inc.,
previously filed as Exhibit B dated and filed on February 8,
1995.
20.4 Report on Form 8-K - Stock Pledge Agreement, previously filed as
Exhibit C dated and filed on February 8, 1995.
20.5 Report on Form 8-K - Form of Convertible Note, previously filed
as Exhibit D dated and filed on February 8, 1995.
20.6 Report on Form 8-K - Amendment to the Quarterly Report of Form
10-Q for three months ended March 31, 1995, dated July 25, 1995
and filed on July 25, 1995.
39
<PAGE>
20.7 Report on Form 8-K - Irrevocable Tender of Payment to Company to
Return Short Swing Profits by Sam D. Schwartz dated August 18,
1995 and filed on August 18, 1995.
20.8 Report on Form 8-K - Changes to the Board of Directors of
Incomnet dated and filed on November 15, 1995.
20.9 Report on Form 8-K - Change in the President and Chief Executive
Officer of Incomnet dated November 30, 1995 and filed on November
15, 1995.
20.10 Report on Form 8-K - Employment Agreement between Incomnet and
Melvyn Reznick, President of Incomnet, Inc. dated November 27,
1995 and filed on November 30, 1995.
20.11 Report on Form 8-K - Severance Agreement between Incomnet, Inc.
and Sam D. Schwartz, former Chairman and President of Incomnet,
Inc., dated November 30, 1995 and filed on November 30, 1995.
20.12 Report on Form 8-K - Agreement with National Telephone &
Communications, Inc. (NTC) for incentive stock option program and
for a public offering of NTC's stock dated February 6, 1996 and
filed on February 9, 1996.
40
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Incomnet, Inc.
We have audited the consolidated balance sheets of Incomnet, Inc. and
subsidiaries as of December 31, 1995 and 1994 and the related consolidated
statements of operations, stockholder's equity and cash flow for each of the
three years in the period ended December 31, 1995, and the schedule listed in
Item 14. These financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and schedule are
free of material misstatement. An audit included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedule. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Incomnet, Inc. at
December 31, 1995 and 1994, the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1995, in conformity
with generally accepted accounting principles.
As discussed in Note 7 to the financial statements, the Company is a party to a
class action matter, claiming losses arising from alleged securities violations
based upon the denial and non-disclosure of a pending investigation by the
Securities and Exchange Commission and on alleged undisclosed securities
transactions by its former President. Legal counsel to the Company has advised
that the ultimate outcome of this matter and a range of potential loss cannot
presently be determined. Accordingly, no provision for any liability that may
result upon adjudication has been made in accompanying financial statements.
/s/ Stonefield Josephson
ACCOUNTANCY CORPORATION
Santa Monica, California
March 8, 1996
41
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
ASSETS
1995 1994
---- ----
<S> <C> <C>
CURRENT ASSETS:
Cash & cash equivalents $ 1,644,968 $ 9,694,900
Accounts receivable, including $542,000 due from
related party at December 31, 1995 and less
allowance for doubtful accounts of
$3,154,241 at December 31, 1995 and
$1,530,217 at December 31, 1994 12,177,257 8,603,577
Notes receivable - current portion 102,594 --
Notes receivable from officers & shareholders -
net of reserves of $208,800 863,440 --
Inventories 1,646,829 28,362
Prepaid expenses and other 1,197,245 94,247
-------------- --------------
Total current assets 17,632,333 18,421,086
-------------- --------------
PLANT AND EQUIPMENT:
Computer hardware & software 5,113,588 3,513,433
Furniture & office equipment 1,878,439 682,650
Leasehold improvements 4,133,885 400,935
-------------- --------------
Total plant & equipment (gross) 11,125,912 4,597,018
Less accumulated depreciation (1,979,858) (1,994,553)
-------------- --------------
Total plant & equipment (net) 9,146,054 2,602,465
-------------- --------------
OTHER ASSETS:
Excess of purchase price over net assets of NTC, less
accumulated amortization of $941,644 at December 31, 1995
and $663,524 at December 31, 1994 4,838,610 4,667,704
Patent rights from the acquisition of RCI
less accumulated amortization of $2,019,233
at December 31, 1995 41,688,844 --
Investment in Lab Tech 130,725 --
Investment in marketable securities 190,714 337,500
Notes receivable - long term 155,000 --
Deposits and other 323,349 129,591
-------------- --------------
Total other assets 47,327,242 5,134,795
-------------- --------------
Total assets $ 74,105,629 $ 26,158,346
-------------- --------------
-------------- --------------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
42
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY
1995 1994
---- ----
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 8,783,797 $ 5,813,813
Accrued expenses 3,686,661 1,700,213
Current portion of notes payable 2,530,886 21,494
Deferred income 1,190,474 2,086,773
-------------- --------------
Total current liabilities 16,191,818 9,622,293
-------------- --------------
LONG-TERM LIABILITIES:
Notes Payable 9,622 --
Deposits & other 1,100 900
Deferred tax liability (net) 8,449,050 --
-------------- --------------
Total long-term liabilities 8,459,772 900
-------------- --------------
Total liabilities 24,651,590 9,623,193
-------------- --------------
MINORITY INTEREST 6,905,983 --
-------------- --------------
SHAREHOLDERS' EQUITY:
Common stock, no par value; 20,000,000 shares
authorized; issued and outstanding 13,262,648
shares at December 31, 1995 and 10,482,854
shares at December 31, 1994 60,883,892 31,376,094
Treasury stock (5,491,845) (665,208)
Accumulated deficit (12,843,991) (14,175,733)
-------------- --------------
Total shareholders' equity 42,548,056 16,535,153
-------------- --------------
Total liabilities, minority interest & shareholders' equity $ 74,105,629 $ 26,158,346
-------------- --------------
-------------- --------------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
43
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
SALES $ 86,564,917 $ 46,815,057 $ 11,298,972
-------------- -------------- --------------
OPERATING COSTS & EXPENSES:
Cost of sales 57,948,207 31,220,780 9,521,803
General & administrative 19,792,906 9,437,851 2,643,583
Depreciation & amortization 1,006,978 444,486 474,022
Bad debt expense 4,124,589 1,788,772 174,377
Acquisition costs & expenses 1,625,069 265,371 40,576
Other (income)/expense 1,002,283 (342,445) 51,455
-------------- -------------- --------------
Total operating costs and expenses 85,500,032 42,814,815 12,905,816
-------------- -------------- --------------
Operating income/(loss) 1,064,885 4,000,242 (1,606,844)
INCOME TAXES 100,501 1,055 --
-------------- -------------- --------------
Income/(loss) before minority interest &
extraordinary items 964,384 3,999,187 (1,606,844)
RCI Acquisition - equity in (profit)/loss of
unconsolidated subsidiary 107,841 -- --
MINORITY INTEREST 509,482 -- --
EXTRAORDINARY ITEMS:
Gain/(loss) on settlement with creditors -- 72,007 658,075
-------------- -------------- --------------
Net income/(loss) $ 1,366,025 $ 4,071,194 $ (948,769)
-------------- -------------- --------------
-------------- -------------- --------------
INCOME/(LOSS) PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS:
Income/(loss) before extraordinary items $ 0.11 $ 0.42 $ (0.20)
Extraordinary items -- -- 0.08
-------------- -------------- --------------
Net income/(loss) $ 0.11 $ 0.42 $ (0.12)
-------------- -------------- --------------
-------------- -------------- --------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES AND FOR 1995,
COMMON SHARE EQUIVALENTS OUTSTANDING 12,706,401 9,593,207 8,183,877
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
44
<PAGE>
See accompanying "Notes to Consolidated Financial Statements."
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
Common Stock
Shares Amount Gain/(Deficit) Total
------ ------ ------------- -----
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1992 7,874,217 $ 18,345,283 $(17,298,158) $ 1,047,125
--------- ------------ ------------- ------------
Common stock issued upon exercise
of warrants 248,333 720,312 720,312
Common stock issued under private
placement 770,138 2,747,366 2,747,366
Repayment of short-swing profits -- 25,726 25,726
Common stock issued in exchange
for NTC shares 168,694 337,388 337,388
Net loss (948,769) (948,769)
--------- ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1993 9,061,382 $ 22,176,075 $(18,246,927) $ 3,929,148
Common stock issued upon exercise
of warrants 1,308,833 8,544,862 8,544,862
Common stock issued under private
placement 100,000 500,000 500,000
Common stock issued in exchange
for NTC shares 82,639 155,157 155,157
Repurchase of treasury shares (70,000) (665,208) (665,208)
Net income 4,071,194 4,071,194
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1994 10,482,854 $ 30,710,886 $(14,175,733) $ 16,535,153
Common stock issued upon exercise
of warrants 489,582 4,343,262 4,343,262
Common stock issued under private
placement 157,500 1,890,000 1,890,000
Common stock issued under upon
conversion of note 2,300,000 22,664,000 22,664,000
Common stock issued in exchange
for NTC shares 253,712 507,424 507,424
Repurchase of treasury shares (451,000) (5,085,025) (5,085,025)
Treasury shares sold 30,000 361,500 361,500
Change in valuation of marketable
securities (34,283) (34,283)
Net income 1,366,025 1,366,025
------------ ------------ ------------ ------------
BALANCE AT DECEMBER 31, 1995 13,262,648 $55,392,047 $(12,843,991) $ 42,548,056
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
45
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
After tax profit/(loss) $ 1,366,025 $ 4,071,194 $ (948,769)
Depreciation & amortization - operations 1,413,447 444,486 474,022
Depreciation & amortization - acquisitions 1,099,859 265,371 40,576
Loss from disposition of furniture & equipment -- -- 5,363
Gain on settlement with creditors -- -- (658,075)
Minority interest (509,482) -- --
----------- ----------- -----------
Net cash inflow/(outflow) from operating activities 3,369,849 4,781,051 (1,086,883)
----------- ----------- -----------
CASH FLOWS FROM (INCREASE)/DECREASE IN OPERATING ASSETS:
Accounts receivable (2,784,363) (6,717,705) (1,024,444)
Notes receivable - current portion (102,594) -- --
Notes receivable - due from shareholder (863,440) -- --
Inventories (400,875) 41,615 (62,451)
Prepaid expenses & other (999,831) (82,247) (10,136)
Notes receivable - long term (155,000) -- --
Deposits & other (193,758) (53,591) 6,354
----------- ----------- -----------
Net cash inflow/(outflow) from changes in
operating assets (5,499,861) (6,811,928) (1,090,677)
----------- ----------- -----------
CASH FLOWS FROM INCREASE/(DECREASE)
IN OPERATING LIABILITIES:
Accounts payable 2,571,096 3,315,686 1,105,917
Accrued expenses 1,834,054 149,874 165,242
Deferred income (896,299) 1,649,204 (330,824)
----------- ----------- -----------
Net cash inflow/(outflow) from changes in
operating liabilities 3,508,851 5,114,764 940,335
----------- ----------- -----------
Net cash inflow/(outflow) from operations 1,378,839 3,083,887 (1,237,225)
----------- ----------- -----------
CASH FLOWS FROM (INCREASE)/DECREASE
IN INVESTING ACTIVITIES:
Acquisition of plant & equipment (7,389,419) (1,693,534) (636,266)
Patents/intangible assets (663,721) -- --
Investment in Lab Tech (130,725) -- --
Investment in marketable securities 146,786 (262,500) (118,507)
Goodwill from acquisition of NTC (449,026) (144,430) --
Patent rights from acquisition of RCI (20,338,022) -- --
----------- ----------- -----------
Net cash inflow/(outflow) from investing activities (28,824,127) (2,100,464) (754,773)
----------- ----------- -----------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
46
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, (CONT'D)
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM INCREASE/(DECREASE)
IN FINANCING ACTIVITIES:
Bank overdraft (56,770) 56,770 (45,005)
Minority interest (7,718,137) -- --
Increases in notes payable - current 10,847,486 11,600 351,910
Repayments of notes payable - current (9,541,288) (276,206) (902,243)
Sale of common stock, net 29,507,799 8,069,392 3,267,680
Treasury stock (4,826,638) 465,419 --
Loans from a major shareholder -- (21,125) (600,100)
Notes payable - long term 9,822 -- --
Paid in capital 500,000 -- --
Repayment of short-swing profits by a director -- -- 25,726
Prior period adjustment to retainer earnings (1) 698 --
Change in valuation allowance (34,286) -- --
----------- ----------- -----------
Net cash inflow/(outflow) from financing activities 18,687,987 8,306,548 2,097,968
----------- ----------- -----------
Net cash inflow/(outflow) from investing & financing (10,136,140) 6,206,084 1,343,195
----------- ----------- -----------
Net increase/(decrease) in cash & cash equivalents (8,757,301) 9,289,971 105,970
Cash & cash equivalents at beginning of year 10,402,268 404,929 298,959
----------- ----------- -----------
Cash & cash equivalents at end of year $ 1,644,968 $ 9,694,900 $ 404,929
----------- ----------- -----------
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 132,644 $ 1,295 $ 211,835
Income taxes 574,162 1,055 800
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Common stock subscriptions receivable, recorded
as addition to common stock -- -- $ 199,998
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
47
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of the Company, its wholly-owned subsidiary National Telephone &
Communications-Registered Trademark-, Inc. (NTC), and its 51%-owned subsidiary
Rapid Cast, Inc. (RCI). As a company with a controlling interest in RCI, the
Company is accounting for RCI using the consolidation method of accounting. The
Company shifted from the equity method of accounting for RCI under FASB
Statement No. 94 in the first and second quarters of 1995 to the consolidation
method because it controls RCI and it is not certain when the Company will cease
to hold a controlling interest in RCI by virtue of a spin-off or otherwise. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
REVENUE RECOGNITION - The Company recognizes revenue during the month in which
services or products are delivered, as follows:
(1) NTC's long distance telecommunications service revenues are generated when
customers make long distance telephone calls from their business or residential
telephones or by using any of NTC's telephone calling cards. Proceeds from
prepaid telephone calling cards are recorded as deferred revenues when the cash
is received, and recognized as revenue as the telephone service is utilized.
The reserve for deferred revenues is carried on the balance sheet as an accrued
liability. Total 1995 long distance telephone service sales totaled
$69,994,580.
(2) NTC's marketing-related revenues are derived from programs and material
sold to the Company's base of independent sales representatives, including forms
and supplies, fees for representative and certified trainer renewals, and the
Company's Certified Trainer and Customer Representative programs. The Company
requires that all such services and materials be paid at the time of purchase.
Revenues from marketing-related materials are booked as cash sales when the
revenues are received. For the fiscal year ended December 31, 1995, marketing
sales totaled $13,132,563.
(3) RCI's optical-related revenues are derived from the sale of the Company's
optical lens manufacturing system and related supplies. Revenues from optical-
related systems and supplies are recognized as sales at the time the products
are shipped to the customer. Based on historical experience of immaterial
returns, RCI does not establish a reserve for returns at the time of sale.
All items returned to RCI are placed back into inventory at the lower of cost
or fair market value. For the six-month period ending December 31, 1995,
during which time the Company recorded RCI sales using the consolidation
method of accounting, optical product sales totaled $1,992,578.
(4) The Company's network service revenues are recognized as sales as the
service is delivered. Total 1995 network service sales totaled $1,445,199.
48
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
CONCENTRATION OF CREDIT RISK - The Company maintains cash balances or invests in
U.S. treasury bills at various financial institutions, which are insured up to
$100,000 by the Federal Deposit Insurance Corporation. Balances at one of these
institutions aggregated approximately $570,910 at December 31, 1995, and
$4,087,627 at December 31, 1994. The Company sells its telephone and network
services to individuals and small businesses throughout the United States and
does not require collateral. It sells its optical products both domestically
and internationally. Reserves for uncollectible amounts are provided, which
management believes are sufficient.
COMPUTER HARDWARE, FURNITURE AND OFFICE EQUIPMENT - Computer hardware, furniture
and office equipment are stated at cost. Depreciation is provided by the
straight-line method over the assets' estimated useful lives of 5 to 10 years.
COMPUTER SOFTWARE - The Company capitalizes the costs associated with
purchasing, developing and enhancing its computer software. All software costs
are amortized using the straight-line method over the assets' estimated useful
lives of 5 to 10 years
LEASEHOLD IMPROVEMENTS - All leasehold improvements are stated at cost and are
amortized using the straight-line method over the building lease term of 10
years.
NET INCOME/(LOSS) PER SHARE - Net income/(loss) per common share is based on the
weighted average number of common shares and common share equivalents in 1995.
Common share equivalents have been excluded in 1994 and 1993 either because
their effect was immaterial (1994) or antidilutive (1993).
ACQUISITION AMORTIZATION - The excess of purchase price over net assets of NTC
has been recorded as an intangible asset and is being amortized by the straight-
line method over twenty years. The excess of purchase price over the value of
patent rights acquired with the purchase of the 51% ownership of RCI has been
recorded as an intangible asset and is being amortized using the straight-line
method over seventeen years.
49
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
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
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
IMPAIRMENT OF LONG LIVED ASSETS: In accordance with the provisions of SFAS No.
121, the Company regularly reviews long-lived assets and intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount to the assets may not be recoverable. No impairment losses were
required for the year ended December 31, 1995.
CURRENT ACCOUNTING PRONOUNCEMENTS: The Financial Accounting Standards Board has
issued SFAS No. 123, "Accounting for Stock-Based Compensation," which encourages
companies to account for stock compensation awards based on their fair value at
the date the awards are granted. This statement does not require the application
of fair value method and allows the continuance of current accounting method,
which requires accounting for stock compensation awards based on their intrinsic
value as of the grant date. However, SFAS No. 123 requires proforma disclosure
of net income and, if presented, earnings per share, as if the fair value based
method of accounting defined in this statement has been applied. The accounting
and disclosure requirements of this statement are effective for financial
statements for fiscal years beginning after December 15, 1995, although earlier
adoption is encouraged. The Company has elected not to adopt the fair value
provisions of this statement.
2. FUNDING OF MARKETING COMMISSIONS AND DEFERRED INCOME:
The Company's subsidiary, NTC, maintains separate bank accounts for the deposit
of funds related to the reserve of deferred income from the sale of prepaid
calling cards and for the payment of marketing commissions. Funding of these
accounts is adjusted regularly to provide for management's estimates of required
reserve balances. For the marketing commission account, NTC estimates the total
commissions owed to active independent representatives ("IR Earned
Compensation") each week for all monies collected that week due to the efforts
of those active independent representatives. All IR Earned Compensation is then
paid to the independent representatives, when due, directly out of the separate
marketing bank account.
3. RELATED PARTY TRANSACTIONS:
Notes receivable from officers and shareholders arise from aggregate loans of
$1,072,240 made to three officers in connection with the exercise of their
options to purchase the Company's common stock. Two of the notes bear interest
at the rate of 5.65% and the third note is non-interest bearing. All three
notes are due on demand and are partially secured by the stock acquired upon the
exercise of the options. For one of the officer loans, the Company agreed to
look only to the
50
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
shares held by the officer as a source of loan repayment. Accordingly, a
reserve of $208,800 was provided in the fourth quarter of 1995, representing the
difference between the market value of the shares held by the officer, and the
amount of the loan.
Included in accounts receivable is approximately $542,000 due from companies
controlled by an individual who is an Incomnet shareholder and a founding
stockholder of RCI.
4. NOTES PAYABLE:
In May 1992, as settlement with a creditor on a past due accounts payable of
approximately $725,000, the Company entered into a non-interest bearing credit
facility of approximately $432,000 payable to the creditor, resulting in an
extraordinary gain of approximately $293,000 ($.04 per common share). The
contract was payable in monthly installments of $12,000 for the first twelve
months and monthly installments of $16,000 thereafter through December 1994.
Maturities of the contract were $124,000 in 1993 and $224,000 in 1994, totaling
$348,000. The contract was completed in December 1994.
Notes payable consists of the following as of December 31, 1995 and 1994:
<TABLE>
<CAPTION>
CURRENT PORTION OF NOTES PAYABLE: 1995 1994
---- ----
<S> <C> <C>
Note payable in connection with financing of RCI
acquisition, interest at 8%, repaid in January 1996
(see Part I, item 1, "Acquisition of Rapid Cast, Inc. --
Financing of Acquisition") $ 500,000 $ --
Notes payable to founding shareholders of RCI,
interest at 7%, due in July 1996 1,517,759 --
Revolving line of credit of RCI, interest at bank
reference rate (approximately 10% at December 31, 1995) 490,000 --
Miscellaneous 23,127 21,494
---------- ----------
Total current portion of notes payable 2,530,886 21,494
---------- ----------
LONG TERM PORTION OF NOTES PAYABLE:
Miscellaneous 9,622 --
---------- ----------
Total long term portion of notes payable 9,622 --
---------- ----------
Total notes payable 2,540,508 21,494
---------- ----------
---------- ----------
</TABLE>
Total 1995 interest expense of $153,840 resulted primarily from interest paid on
Notes used to acquire RCI and from interest paid by RCI on its bank revolving
line of credit.
51
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
5. DEFERRED TAX LIABILITY:
On February 15, 1992, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 109 "Accounting for Income
Taxes". Effective January 1, 1993, the Company adopted SFAS No, 109, the effect
of which was immaterial to the Company's financial statements in 1994 and
resulted in a deferred tax liability in 1995.
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that give rise to significant portions of the
deferred income tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
December 31,
------------
1995 1994
---- ----
<S> <C> <C>
Deferred tax assets
Allowance for doubtful accounts $ 1,360,000 $ 612,000
Financing costs -- 190,000
Nondeductible reserves -- 65,000
Net operating loss carryforwards 7,503,000 7,120,000
Other 113,000 --
----------- -----------
Subtotal 8,976,000 7,987,000
----------- -----------
Deferred tax liabilities
Property and equipment, principally
due to differences in depreciation 676,000 267,000
Patent rights 8,449,050 --
----------- -----------
Subtotal 9,125,050 267,000
----------- -----------
Total (176,050) 7,720,000
Less valuation allowance (8,273,000) (7,720,000)
----------- -----------
Net deferred tax liability $ 8,449,050 $ - 0 -
----------- -----------
----------- -----------
</TABLE>
The deferred taxes at December 31, 1995 are presented in the accompanying
balance sheet as deferred tax assets-current (included in prepaid expenses and
other) of $384,000 and deferred tax liability-noncurrent of $8,449,050
52
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
The following is a reconciliation of the federal statutory tax rate and the
effective tax rate:
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
Federal statutory tax rate 34.0% 34.0% (34.0%)
Goodwill 9.9 2.0 9.0
Loss producing no current tax benefit -- -- 25.0
State taxes, net of federal benefits 38.2 -- --
Benefit from net operating loss carryforward (71.5) (36.0) --
Other, net -- -- --
----- ----- -----
Effective tax rate 10.6% 0% 0%
----- ----- -----
----- ----- -----
</TABLE>
Income tax benefits are recognized only when their realization is assured.
Accordingly, potential future income tax benefits resulting from net operating
losses incurred to date are not reflected in the consolidated financial
statements.
At December 31, 1995, Incomnet had available net operating loss carryforwards
for federal income tax purposes of approximately $16,800,000, expiring in
various years between 2000 and 2008, and Rapid Cast had a carryforward of
approximately $1,900,000 expiring through 2012. The company files combined
income tax returns for Incomnet and NTC and separate returns for RCI.
Accordingly, the respective federal net operating loss carryforwards of each
corporation are available to offset taxable income only of each separate
corporation.
6. SHAREHOLDERS' EQUITY:
STOCK OPTIONS - The Company has an incentive stock option plan which was adopted
in 1994 (the "1994 Plan") for key employees and directors. The plan provides
for the issuance of options covering an aggregate of 1,500,000 shares of common
stock. In 1996, the Company intends to replace the 1994 stock option plan with
a new stock option plan for the executive officers, directors and key
consultants of the Company, primarily at the parent company level. The Company's
subsidiaries have or are expected to adopt their own separate stock option plans
to be implemented when those companies become publicly traded. No additional
stock options are expected to be granted under the 1994 stock option plan.
In November 1994, the Company approved the 1994 Plan for directors, employees,
and key outside consultants of the Company that provided for the issuance of up
to 1,500,000 shares of common stock. The plan requires that the option price
must be at least 100% of the fair market value of the shares on the date the
option is granted. In November 1994, options to purchase 1,200,000 shares of the
Company's common stock were granted at exercise prices of $10 per share. These
options will be vested based upon a performance requirement in which National
Telephone & Communications, Inc. must earn at least $15 million in pre-tax
profits during any continuous four audited quarterly periods until December 31,
1997.
53
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
WARRANTS - Since 1993, the Company has issued warrants to purchase the Company's
common stock to key employees, directors or other individuals or organizations
as follows:
<TABLE>
<CAPTION>
Dollar Cancelled or
Issued Number Price Exercised Amount Expired Expiration
------ ------ ----- --------- ------ ------- ----------
<S> <C> <C> <C> <C> <C> <C>
9/18/93 375,000 5.00 150,000 $ 750,000 225,000
9/18/93 15,000 5.00 15,000
9/18/93 5,000 5.00 5,000 25,000
9/18/93 5,000 5.00 5,000
11/18/93 75,000 5.00 75,000 375,000
1-17-94 500,000 7.00 500,000 3,500,000
5/27/94 500,000 10.00 500,000 5,000,000
5/27/94 100,000 8.50 100,000 850,000
5/27/94 100,000 8.50 100,000 850,000
5/27/94 50,000 8.50 5/27/97
5/27/94 50,000 8.50 5/27/97
8/14/94 10,000 8.50 10,000 85,000
11/15/94 100,000 11.25 25,000 281,250
11/15/94 10,000 11.25 10,000 112,500
6/30/95 900,000 14.00 900,000
8/29/95 250,000 11.00 250,000
8/29/95 35,000 4.875 (2) 8/29/97
8/29/95 35,000 4.875 (2) 8/29/97
8/29/95 25,000 4.875 (2) 8/29/97
11/27/95 300,000 4.875 5 years from date of vesting (1)
12/20/95 2,000 5.125 (2) 12/31/96
12/20/95 3,000 5.125 (2) 12/31/96
12/20/95 1,000 5.125 (2) 12/31/96
12/20/95 1,000 5.125 (2) 12/31/96
--------- --------- ----------- ---------
3,447,000 1,475,000 $11,828,750 1,395,000
- ----------------------------------------------------------------------------------------------------
</TABLE>
(1) These options vest as follows: 25,000 on February 28, 1996, 25,000 on May
31, 1996, 25,000 on August 31, 1996, and 25,000 on November 30, 1996, with an
additional 200,000 upon Rapid Cast, Inc. achieving certain financial goals.
(2) The exercise price on these options was adjusted pursuant to a redemption of
old stock options and a reissuance of an equivalent number of new stock options
with the same expiration date.
Since 1993, the Company has issued warrants to purchase a total of 3,447,000
shares of the Company's common stock. At March 22, 1996, warrants to purchase
1,475,000 of those shares have been exercised bringing the Company $11,828,750;
warrants to purchase 1,395,000 shares have been canceled and warrants remain
outstanding to purchase 577,000 shares of the Company's common stock at prices
ranging from $4.875 to $11.25 per share.
54
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
COMMON STOCK - On August 5, 1994, the Company announced that its Board of
Directors authorized the repurchase of up to 1,000,000 shares of its common
stock from time to time on the open market or in private transactions. The
Company's Chief Executive Officer was given the discretion to decide when and if
the Company would repurchase shares and to effect such transactions. As of March
27, 1996, the Company has repurchased a net of 486,000 shares of common stock
with a value of $5,491,845 under the terms of the repurchase authorization as
follows:
Years ended Shares
December 31, Repurchased Cost
------------ ---------------- -----------
1994 70,000 $ 665,208
1995 416,000 4,826,637
---------------- -----------
486,000 $ 5,491,845
---------------- -----------
---------------- -----------
PRIVATE PLACEMENT - On June 30, 1995, the Company initiated a private
placement of 900,000 shares of the Company's restricted common stock at $12
per share for a total of $10,800,000 and warrants to purchase 900,000
additional shares of the Company's common stock at $14 per share. The
warrants were exercisable for a period of six months until December 31, 1995.
The Company received $1,890,000 in cash from subscribers to the private
placement, which was the effective purchase of 157,500 shares and warrants to
purchase an additional 157,500 shares for $14 per share. The Company also
received subscription notes for $8,910,000 payable upon the registration of
the shares and shares underlying the warrants with the Securities and
Exchange Commission. These notes were for the purchase of 742,500 shares of
the Company's common stock and warrants to purchase an additional 742,500
shares for a purchase price of $14 per share. As the Company did not register
the shares, the notes for $8,910,000 were cancelled on December 31, 1995 by
mutual consent with the investors. As a result, the investors were no longer
obligated to pay the notes to the Company and the Company was no longer
obligated to issue additional shares or warrants to the investors. Since the
warrants to purchase 157,500 additional shares were not exercised, these
warrants expired on December 31, 1995. As a result, the Company issued a
total of 157,500 shares in consideration for the $1,890,000 in cash paid by
the investors. The Company's balance sheet reflects the issuance of 157,500
shares of the Company's common stock in exchange for $1,890,000 in capital.
The Company is using the proceeds of the private placement to finance the
growth requirements of its operating subsidiaries.
SHORT SWING PROFITS - On August 18, 1995, the Company filed a Form 8-K
disclosing the tender of short swing profits to the Company by its former
President and Chief Executive Officer pursuant to Section 16(b) of the
Securities Exchange Act of 1934, as amended. After adjustments and a preliminary
review of all purchases and sales of the Company's common stock through
September 1, 1995, the amount of short swing profits was calculated to be
$972,870. On August 18, 1995 and, including adjustments, on September 1, 1995,
the Company's former President tendered the short swing profits by cancellation
of all his options to purchase 250,000 shares of the Company's common stock.
Pursuant to the Severance Agreement entered into by the Company with Mr.
Schwartz on November 30, 1995, the parties contemplated a review of the short
swing profit calculations and an independent appraisal of the stock
55
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
options tendered by Mr. Schwartz pursuant to Section 16(b) of the Exchange Act.
In addition, the Company was served with a derivative shareholder lawsuit
asserting claims against Mr. Schwartz for the payment of the short swing
profits, and seeking an order that the Company collect those profits from Mr.
Schwartz. Based on the Company's latest calculations which include additional
transactions disclosed by Mr. Schwartz in Filings with the Commission in March,
1996, the short swing profits appear to be approximately $2,074,000. The
plaintiffs in the shareholder derivative lawsuit calculate short swing profits
to be approximately $2,128,000. The value of the tendered stock options has not
yet been agreed upon or appraised. There are no assurances, however regarding a
final determination of the amount of the short swing profits or the value of the
tendered stock options.
On February 29, 1996, the Company delivered a demand to Joel Greenberg, the
Chairman of the Board of Directors, to pay short swing profits of $46,500 to the
Company pursuant to Section 16(b) of the Exchange Act. The Company expects the
short swing profits to be paid on or before April 30, 1996.
7. COMMITMENTS, CONTINGENCIES AND OTHER:
LITIGATION - The Company is a defendant in a class action and related lawsuits
alleging securities violation with respect to alleged false denial and non-
disclosure of a Securities and Exchange Commission investigation and alleged
non-disclosure of purchases and sales of the Company's stock by an affiliate of
the former Chairman of the Board. Counsel for the company is unable to estimate
the ultimate outcome of this matter and is unable to predict a range of
potential loss. Accordingly, no amounts have been provided for the class action
and related lawsuits in the accompanying financial statements.
The Company is under investigation by the Securities and Exchange Commission
under a non-public "formal order of private investigation." Management has
furnished all information requested by the Commission and does not believe that
the matter will have a material adverse impact on its financial position or
results of operations.
BUILDING LEASES - Rent expense for the years ended December 31, 1995, 1994 and
1993 was $800,694, $277,712 and $204,760, respectively.
The Company leases its office and operating facility in Woodland Hills,
California under a noncancellable operating lease expiring July 1998. The
aggregate future minimum annual rental payments required under the operating
lease are as follows:
56
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
Years ending
December 31,
------------
1996 $104,556
1997 104,556
1998 60,991
--------
$270,103
--------
--------
The Company's subsidiary, NTC, leases its office and operating facilities in
Irvine, California under several noncancellable operating leases as described in
Part I, Item 2, "Properties." The aggregate future minimum annual rental
payments required under these operating leases and under the proposed extension
are as follows:
Years ending
December 31,
------------
1996 $586,943
1997 591,231
1998 603,632
1999 616,406
2000 629,562
2001 643,114
2002 657,072
2003 671,449
2004 383,742
----------
$5,383,151
----------
----------
The Company's 51%-owned subsidiary, RCI, leases its facility in Louisville,
Kentucky under a noncancellable operating lease as described in Part I, Item 2,
"Properties." The aggregate future minimum annual rental payments required
under the operating lease are:
Years ending
December 31,
------------
1996 $98,004
1997 98,004
1998 99,864
1999 101,196
2000 42,165
--------
$439,233
--------
--------
57
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
ALLOWANCE FOR DOUBTFUL ACCOUNTS - The total Company allowance for doubtful
accounts totaled $3,154,241 or 20.6% of gross accounts receivable at December
31, 1995 and $1,530,217 or 15.1% of gross accounts receivable at December 31,
1994. The following table summarizes the Company's year-to-year reserve
balances by subsidiary and segment:
<TABLE>
<CAPTION>
ALLOWANCE FOR
DOUBTFUL ACCOUNTS
-------------------------
DEC. 31, DEC. 31,
SUBSIDIARY SEGMENT 1995 1994
- ---------- ------- ---------- ----------
<S> <C> <C> <C>
NTC Telephone (telecommunications services) $2,169,415 $ 990,244
NTC Telephone (marketing programs) 984,826 539,973
RCI Optical -- --
AutoNETWORK Network -- --
---------- ----------
Total Company $3,154,241 $1,530,217
---------- ----------
---------- ----------
% of Gross Accounts Receivables 20.6% 15.1%
</TABLE>
Reserves for NTC's telecommunications service accounts receivable relate
primarily to its direct billed and LEC billed long distance telephone
services. Delinquent direct billed receivables are collected by a
combination of NTC's internal collection department and by external
collection agencies. Delinquent LEC billed receivables are collected by the
LEC's. The estimated percentage of accounts which will become uncollectable
is reviewed periodically by management and is adjusted in accordance with
historical experience.
Reserves for NTC's marketing program accounts receivable are provided at 100%
of gross marketing receivables. These receivables result from payments for
marketing programs which have been denied due to returned checks and rejected
credit card payments.
8. NETWORK MARKETING COSTS:
During 1995, NTC's net cost to operate its network marketing program was $1.9
million as summarized below (in $ millions):
1995
----------
Sales $ 13.1
Cost of sales 11.2
Operating expenses for support services
3.8
----------
Total marketing-related costs 15.0
----------
Net marketing cost $ 1.9
----------
----------
% of total NTC (long distance
& marketing) sales 2.3%
Marketing sales of $13.1 million 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. The marketing-related costs include commissions paid to independent
sales representatives for acquiring new retail telephone customers, as well as
the cost of sales materials, salaries and wages of marketing department
personnel, services required to support the independent sales representatives,
and other directly identifiable support costs, but do not include residual
commissions paid on continuing long distance telephone usage or the typical
indirect cost allocations, such as floor-space and supporting departments. When
the marketing-related costs of $15.0 million are compared against marketing-
related revenues of $13.1 million, the result is a net loss in marketing-related
activities of $1.9 million or 2.3% of total NTC sales.
9. SEGMENT INFORMATION:
In 1993 and 1994, the Company conducted its business operations in two industry
segments, including Network Services and Telephone Services. In 1995, because of
the acquisition of RCI, the Company conducted business in three segments,
including Network Services, Telephone Services and Optical Systems. No one
customer accounted for as much as 10% of the revenues of any segment in 1995,
1994 or 1993.
58
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
SEGMENT INFORMATION
<TABLE>
<CAPTION>
Telephone Optical Network General
YEAR ENDED DECEMBER 31, 1995 Services Systems Services Corporate Consolidated
- ---------------------------- -------- ------- -------- --------- ------------
<S> <C> <C> <C> <C> <C>
Sales $ 83,127,140 $ 1,992,578 $ 1,445,199 $ -- $ 86,564,917
------------ ------------ ------------ ------------ ------------
Income/(loss) before income taxes,
extraordinary items & minority interest 5,059,758 (1,039,760) (1,184,327) (1,878,627) 957,044
Income taxes 365,101 -- (102,311) $ (162,289) 100,501
------------ ------------ ------------ ------------ ------------
Income/(loss) before extraordinary items
& minority interest $ 4,694,657 $ (1,039,760) $ (1,082,016) $ (1,716,338) $ 856,543
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Identifiable assets $ 21,757,624 $ 25,345,466 $ 1,568,668 $ 25,433,871 $ 74,105,629
Depreciation and amortization 704,642 429,719 279,086 $ 1,099,856 2,513,303
Capital expenditures 6,681,148 198,665 509,606 -- 7,389,419
Telephone Optical Network General
YEAR ENDED DECEMBER 31, 1994 Services Systems Services Corporate Consolidated
- ---------------------------- -------- ------- -------- --------- ------------
Sales $ 45,608,753 $ -- $ 1,206,304 $ -- $ 46,815,057
------------ ------------ ------------ ------------ ------------
Income/(loss) before income taxes
& extraordinary items 3,741,972 -- 154,325 103,945 4,000,242
Income taxes -- -- 1,055 -- 1,055
------------ ------------ ------------ ------------ ------------
Income/(loss) before extraordinary
items $ 3,741,972 $ -- $ 153,270 $ 103,945 $ 3,999,187
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Identifiable assets $ 12,830,140 $ -- $ 4,271,190 $ 9,057,016 $ 26,158,346
Depreciation and amortization 220,457 -- 489,400 -- 709,857
Capital expenditures 1,546,708 -- 146,826 -- 1,693,534
Telephone Optical Network General
YEAR ENDED DECEMBER 31, 1993 Services Systems Services Corporate Consolidated
- ---------------------------- -------- ------- -------- --------- ------------
Sales $ 10,031,232 $ -- $ 1,267,740 $ -- $ 11,298,972
------------ ------------ ------------ ------------ ------------
Income/(loss) before income taxes
& extraordinary items (1,604,794) -- 238,685 (240,735) (1,606,844)
Income taxes -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Income/(loss) before extraordinary
items $ (1,604,794) $ -- $ 238,685 $ (240,735) $ (1,606,844)
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
Identifiable assets $ 2,431,339 $ -- $ 905,000 $ 5,329,500 $ 8,665,839
Depreciation and amortization 308,776 -- 205,822 -- 514,598
Capital expenditures 461,563 -- 129,330 -- 590,893
</TABLE>
59
<PAGE>
10. GAIN ON SETTLEMENT WITH CREDITORS:
During 1993, the Company settled certain past due trade accounts payable of the
NTC subsidiary with a face amount of $877,000 in exchange for an agreement to
pay $218,925. The transaction resulted in an extraordinary gain on settlement
with creditors of $658,075.
11. ACQUISITION OF RAPID CAST, INC.:
On February 8, 1995, the Company acquired a 51% ownership in Rapid Cast, Inc.
for $28,164,000, in a transaction accounted for using the purchase method of
accounting. The acquisition resulted in the recognition of intangible patent
assets of $20.3 million, which are being amortized over 17 years.
The following summary, prepared on a pro forma basis, combines the consolidated
results of operations as if RCI had been acquired as of the beginning of the
periods presented, after including the impact of certain adjustments, such as
minority interest, equity in loss of unconsolidated subsidiary and patent
amortization. (Dollars in thousands, except per share amounts).
1995 1994
---- ----
Sales $87,860 $46,815
Net income $ 1,080 $ 4,071
Net income per share $ .08 $ 0.42
The pro forma results are not necessarily indicative of what would have occurred
if the acquisition had been in effect for the entire periods presented. In
addition, they are not intended to be a projection of future results and do not
reflect any synergy that might be achieved from combined operations.
12. FOURTH QUARTER ADJUSTMENTS:
During the fourth quarter of 1995, the Company recorded adjustments having the
effect of reducing net income by approximately $3.1 million or $ .24 per share.
These adjustments resulted primarily from reserve provisioning related to
settlements with shareholders and with the Company's former Chairman, revisions
of management's estimates regarding the collectibility of accounts receivable,
write-off of marketable securities and inventory, and reserve provisioning for
estimated legal fees.
60
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
<TABLE>
<CAPTION>
SCHEDULE II
-----------
INCOMNET, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 1995 AND 1994
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- -------- -------- -------- -------- --------
Additions
------------------------------- (2)
Balance at Charged to Charged to (1) Balance
beginning costs and other accounts Deductions at end
Classification of period expenses - describe - describe of period
- -------------- ---------- ---------- -------------- ---------- ---------
Allowance for
doubtful accounts:
<S> <C> <C> <C> <C> <C>
December 31, 1994 $3,263,659 $4,576,237 -- $4,309,679 $3,530,217
December 31, 1995 $3,530,217 $7,899,168 -- $7,842,435 $3,586,950
</TABLE>
(1) Represents write-offs of specific balances determined to be uncollectible.
(2) Balance at December 31, 1995 includes $487,678 of other allowances, such as
reserves for marketable securities, inventory and notes receivable.
61
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: January 24, 1997
INCOMNET, INC.
---------------
(Registrant)
By: /s/ MELVYN REZNICK
------------------
MELVYN REZNICK
President and Chief Executive Officer
Pursuant to requirements of the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Capacity Date
--------- -------- ----
<S> <C> <C>
/s/ MELVYN REZNICK President, Chief Executive Officer,
- ------------------ and Director January 24, 1997
MELVYN REZNICK
/s/ RICHARD A. MARTING Vice President of Finance and January 24, 1997
- ---------------------- Administration (NTC)
RICHARD A. MARTING
/s/ NANCY ZIVITZ Director January 24, 1997
- ----------------
NANCY ZIVITZ
/s/ ALBERT MILSTEIN Director January 24, 1997
- -------------------
ALBERT MILSTEIN
/s/ HOWARD SILVERMAN Director January 24, 1997
- --------------------
HOWARD SILVERMAN
</TABLE>
62
