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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 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 $2 13/16
and $2 15/16 respectively, as reported by the NASDAQ
System on March 21, 1997) $30,958,080
Number of shares of registrant's common stock outstanding
as of March 21, 1997.................................................13,520,669
DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant's proxy statements
relating to registrant's 1997 annual meeting of shareholders have been
incorporated by reference into Part III hereof.
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TABLE OF CONTENTS
PAGE
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INTRODUCTORY NOTE 7
PART I
ITEM 1 - BUSINESS
General 7
Telephone Services 7
Optical Systems 7
Network Products and Services 8
National Telephone & Communications, Inc. (NTC) 8
Products 8
Network Marketing Program 8
Disclosure of Independent Representative Organizations
Related to NTC Executives 9
Wiltel Contract 9
Management Incentive Agreement 9
Reincorporation of NTC in Delaware 11
Rapid Cast, Inc. (RCI) 11
General 11
The Optical Marketplace 11
The Production and Dispensing of Prescription
Eyeglass Lenses 12
The Fast Cast LenSystem 13
Technical Overview of the Rapid Cast LenSystem 13
Marketing and Pricing Strategy 14
Manufacturing Strategy 14
Research and Development Strategy 14
Maintenance, Warranty and Insurance 14
Competition 15
Patents and Proprietary Rights 15
Governmental Regulation 16
Recent Capitalization of Rapid Cast, Inc. (RCI) 16
Issuance of Convertible Preferred Stock 20
Agreement with Price International, Inc. 22
Network Services 22
Employees, Officers and Directors 22
Employees 22
Directors and Officers 23
Appointment of New Director by the Company 24
Appointment of Committee Members 24
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TABLE OF CONTENTS (CONT'D)
PAGE
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ITEM 2 - PROPERTIES 24
ITEM 3 - LEGAL PROCEEDINGS 25
Class Action and Related Lawsuits 25
Settlement with RCI Parties 26
Settlement of Stevens Lawsuit 26
Settlement of the Atlanta Lawsuits 26
Section 16 (b) Lawsuit 26
Settlement of Patent Infringement Lawsuit 27
Legal Action Against Prior Representatives 27
Settlement With Prior Noteholders 27
Settlement with Price International 28
Potential Lawsuits 28
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29
PART II
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SHAREHOLDER MATTERS 29
Market Information 29
Dividends 29
ITEM 6 - SELECTED FINANCIAL DATA 29
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 30
Liquidity and Capital Resources 30
Results of Operations 31
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 33
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE 33
PART III
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS OF THE REGISTRANT 33
ITEM 11 - EXECUTIVE COMPENSATION 33
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 34
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 34
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 10-K 34
Index to Financial Statements 34
Index to Exhibits 34
Signatures 37
Report of Independent Auditors 38
Consolidated Balance Sheet 39
Consolidated Statement of Operations 40
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TABLE OF CONTENTS (CONT'D)
PAGE
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Consolidated Statement of Cash Flows 41
Consolidated Statement of Shareholders' Equity 42
Notes to Consolidated Financial Statements 43
Note 1 - Summary of Significant Accounting Policies 43
Note 2 - Funding of Marketing Commissions and
Deferred Income 45
Note 3 - Related Party Transactions 45
Note 4 - Acquisition of Rapid Cast, Inc. 45
Note 5 - Property, Plant and Equipment 46
Note 6 - Patent Rights from Acquisition of RCI 46
Note 7 - Investments, Notes Receivable and Other Assets 46
Note 8 - Notes Payable 46
Note 9 - Income Taxes 47
Note 10 - Shareholders' Equity 48
Note 11 - Commitments, Contingencies and Other 51
Note 12 - Network Marketing Costs 53
Note 13 - Compensation of Independent Sales
Representatives 53
Note 14 - Segment Information 53
Note 15 - Fourth Quarter Adjustments 55
Note 16 - Changes in Accounting 55
Note 17 - Subsequent Events 55
Schedule II - Valuation and Qualifying Accounts 56
Exhibit 3.1 - Certificate of Determination for Series A 2%
Convertible Preferred Stock. (Incorporated
by reference from Incomnet, Inc.'s Registration
Statement on Form S-3 filed with the Securities
and Exchange Commission on November 22, 1996.)
Exhibit 4.1 - Form of Warrant to Purchase 75,000 Shares
of Incomnet, Inc. (Incorporated by reference
from the Company's Registration Statement on
Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996.)
Exhibit 4.2 - Form of Warrant to Purchase 510,000 Shares
of RCI Common Stock with Registration Rights
Agreement, dated April 19, 1996. (Incorporated
by reference from the Company's Registration
Statement on Form S-3 filed with the Securities
and Exchange Commission on May 10, 1996.)
Exhibit 4.3 - Form of Warrant to Purchase RCI Common Stock,
dated February 8, 1995. (Incorporated by reference
from the Company's Registration Statement on
Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996.)
Exhibit 4.4 - Form of Warrant to Purchase 360,000 Shares
of Incomnet, Inc. (Incorporated by reference
from Incomnet, Inc.'s Pre-Effective Amendment
Number One to the Registration Statement on
Form S-3 filed with the Securities and Exchange
Commission on March 24, 1997.)
Exhibit 4.5 - Form of Warrant to Purchase 12,500 Shares of
Incomnet, Inc. (Incorporated by reference from
Incomnet, Inc.'s Pre-Effective Amendment Number
One to the Registration Statement on Form S-3
filed with the Securities and Exchange Commission
on March 24, 1997.)
Exhibit 10.1 - Employment Agreement with James Quandt, dated
January 6,
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1997. (Incorporated by reference from Incomnet,
Inc.'s Pre-Effective Amendment Number One to the
Registration Statement on Form S-3 filed with the
Securities and Exchange Commission on March 24,
1997.)
Exhibit 10.2 - Amended and Restated Management Incentive
Agreement Between NTC and Incomnet, Inc., dated
January 28, 1997. (Incorporated by reference
from Incomnet, Inc.'s Pre-Effective Amendment
Number One to the Registration Statement on
Form S-3 filed with the Securities and Exchange
Commission on March 24, 1997.)
Exhibit 10.3 - Settlement Agreements With Prior Noteholders.
(Incorporated by reference from the Company's
Registration Statement on Form S-3 filed with the
Securities and Exchange Commission on May 10, 1996.)
Exhibit 10.4 - Form of 8% Convertible Note Issued by RCI in
January 1996. (Incorporated by reference from
the Company's Registration Statement on Form S-3
filed with the Securities and Exchange Commission
on May 10, 1996.)
Exhibit 10.5 - Form of Short-Term 10% Note Issued by RCI in
April 1996. (Incorporated by reference from the
Company's Registration Statement on Form S-3 filed
with the Securities and Exchange Commission on
May 10, 1996.)
Exhibit 10.6 - Amended Carrier Switched Services Agreement with
Wiltel, Inc. dated June 17, 1996. (Incorporated by
reference from Incomnet's Registration Statement on
Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996 and declared effective
on October 31, 1996, or incorporated by reference
from the Company's filings with the Securities and
Exchange Commission pursuant to the Securities
Exchange Act of 1934, as amended. Certain
information has been deleted from this agreement
pursuant to a request for confidential treatment
pursuant to Rule 406.)
Exhibit 10.7 - Settlement Agreement Between Joel W. Greenberg
and Incomnet, Inc. (Incorporated by reference from
the Company's Report on Form 8-K, dated June 7,
1996, relating to the settlement agreement with
Joel W. Greenberg and his resignation as a director
of the Company.)
Exhibit 10.8 - Form of Registration Rights Agreement Between
Incomnet, Inc. and Purchasers of Series A
Convertible Preferred Stock. (Incorporated by
reference from Incomnet's Registration Statement
on Form S-3 filed with the Securities and
Exchange Commission on May 10, 1996 and declared
effective on October 31, 1996, or incorporated by
reference from the Company's filings with the
Securities and Exchange Commission pursuant to the
Securities Exchange Act of 1934, as amended.)
Exhibit 10.9 - Form of Purchase Agreement for the Series A 2%
Convertible Preferred Stock. (Incorporated by
reference from Incomnet's Registration Statement
on Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996 and declared effective
on October 31, 1996, or incorporated by reference
from the Company's filings with the Securities and
Exchange Commission pursuant to the Securities
Exchange Act of 1934, as amended.)
Exhibit 10.10 -Management Incentive Agreement with NTC, dated
October 14, 1996. (Incorporated by reference from
Incomnet, Inc.'s Registration Statement on Form S-3
filed with the Securities and Exchange Commission
on November 22, 1996.)
Exhibit 10.11 -Settlement Agreements With Edward Jacobs and
Jerry Ballah, dated November 14, 1996.
(Incorporated by reference from
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Incomnet, Inc.'s Registration Statement on Form S-3
filed with the Securities and Exchange Commission on
November 22, 1996.)
Exhibit 10.12 - Shareholders Agreement for Rapid Cast, Inc.,
dated January 16, 1997. (Incorporated by reference
from Incomnet, Inc.'s Pre-Effective Amendment Number
One to the Registration Statement on Form S-3 filed
with the Securities and Exchange Commission on
March 24, 1997.)
Exhibit 10.13 - Registration Rights Agreement for Rapid Cast,
Inc., dated January 16, 1997. (Incorporated by
reference from Incomnet, Inc.'s Pre-Effective
Amendment Number One to the Registration Statement
on Form S-3 filed with the Securities and Exchange
Commission on March 24, 1997.)
Exhibit 10.14 - Settlement Agreement and Mutual Release Between
Incomnet, Inc. and the RCI Parties, dated
January 9, 1996. (Incorporated by reference from
Incomnet, Inc.'s Pre-Effective Amendment Number One
to the Registration Statement on Form S-3 filed
with the Securities and Exchange Commission on
March 24, 1997.)
Exhibit 10.15 - Lease Agreement By NTC for space in Honolulu,
Hawaii. *
Exhibit 10.16 - Credit Agreement dated March 27, 1997 between
National Telephone & Communication, Inc. and
First Bank & Trust, Irvine Regional office. *
Exhibit 21 - Subsidiaries of the Registrant *
Exhibit 27 - Financial Data Schedule *
* Previously Filed on Form 10-K filed with the Securities and
Exchange Commission on April 15, 1997
6
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INTRODUCTORY NOTE
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section
21E of the Securities Exchange Act of 1934. The Company intends that such
forward-looking statements be subject to the safe harbors created by such
statutes. The forward-looking statements included herein are based on current
expectations that involve a number of risks and uncertainties. Accordingly,
to the extent that this Annual Report contains forward-looking statements
regarding the financial condition, operating results, business prospects or
any other aspect of the Company and its subsidiaries, please be advised that
the Company and its subsidiaries' actual financial condition, operating
results and business performance may differ materially from that projected or
estimated by the Company in forward-looking statements. The differences may
be caused by a variety of factors, including but not limited to adverse
economic conditions, intense competition, including intensification of price
competition and entry of new competitors and products, adverse federal, state
and local government regulation, inadequate capital, unexpected costs and
operating deficits, increases in general and administrative costs, lower
sales and revenues than forecast, loss of customers, customer returns of
products sold to them by the Company or its subsidiaries, disadvantageous
currency exchange rates, termination of contracts, loss of supplies,
technological obsolescence of the Company's products, technical problems with
the Company's products, price increases for supplies and components,
inability to raise prices, failure to obtain new customers, litigation and
administrative proceedings involving the Company, including the pending class
action and related lawsuits and SEC investigation, the possible acquisition
of new businesses that result in operating losses or that do not perform as
anticipated, resulting in unanticipated losses, the possible fluctuation and
volatility of the Company's operating results, financial condition and stock
price, losses incurred in litigating and settling cases, dilution in the
Company's ownership of its subsidiaries and businesses, adverse publicity and
news coverage, inability to carry out marketing and sales plans, challenges
to the Company's patents, loss or retirement of key executives, changes in
interest rates, inflationary factors, and other specific risks that may be
alluded to in this Annual Report or in other reports issued by the Company.
In addition, the business and operations of the Company are subject to
substantial risks which increase the uncertainty inherent in the
forward-looking statements. In light of the significant uncertainties
inherent in the forward-looking information included herein, the inclusion of
such information should not be regarded as a representation by the Company or
any other person that the objectives or plans of the Company will be achieved.
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. 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 for certain materials, training
and services from NTC which are used by the independent representatives to
sell new retail customers and enroll 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 94.2% of the Company's total 1996 sales.
7
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OPTICAL SYSTEMS- The Company, through its 35%-owned subsidiary Rapid Cast, Inc.
(RCI), acquired in February 1995, 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 4.4% of the Company's total 1996 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
1.4% of the Company's total 1996 sales.
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$aver Gold Card,
Global$aver 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 30% or more 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 increased its use of LECs to bill and collect
telephone service accounts receivable. The increase in the use of LECs has
increased 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 customers as well
as the collection of monies owed by the customers for their use of the NTC
telephone services/products. NTC pays each independent representative a
commission on the telephone usage monies billed to those retail telephone
customers who are directly sourced by that representative. NTC also pays
override commissions to each independent representative on the monies billed
to those telephone customers sourced by the representative's downline as well
as a bonus percentage of all telephone monies billed by NTC from the retail
telephone customers collectively sourced by all independent representatives,
if certain minimums of retail telephone business are personally achieved by
the representative. In addition, NTC pays sales quota bonuses to independent
representatives for assisting other representatives to obtain certain minimum
quotas 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 representatives, (4) NTC's network
8
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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 States Attorney
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 (Chairman of the Board), James R. Quandt
(President), Victor C. Streufert (Vice President of Finance and Administration
and Chief Financial Officer), Debra Chuckas (Vice President-Marketing Support),
Louis W. Cheng (Vice President-Information Services), and Michael A. Keebaugh
(Vice President of Operations).
In addition, NTC's current policy requires full disclosure by all senior NTC
officers and executives of any NTC downline organizations headed by an immediate
family member of such senior officer or 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 or executives have Immediate Family Customers/Downlines.
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 million of long distance telephone time over a
five year period commencing in November 1995. Effective February 1996, NTC
entered into a revised multiple-year $1.0 billion contract with Wiltel, Inc.,
which has a fixed term expiring January 2002. As in the prior carrier contract
with Wiltel, Inc., NTC has committed to purchase the designated volume of
telephone time in accordance with a schedule over the term of the contract. NTC
currently relies in part 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 January 28, 1997 the Company entered into
an amended and restated management incentive agreement with NTC pursuant to
which the Company agreed to spin-off 10% of the shares it owns in NTC, to
establish stock option programs for the senior executives, employees and key
independent sales representatives of NTC, and to vote its shares for NTC
management's slate of director nominees. The new management incentive
agreement entirely supersedes the incentive agreements entered into by the
Company with NTC in February and November 1996. See "Item 5. Other
Information - Agreement with NTC Management" in the Company's Form 10-Q for
the quarter ended September 30, 1996. In November 1996 the Company also
entered into settlement agreements with Edward Jacobs and Jerry Ballah (the
former Executive Vice President and director of NTC, who is now the Executive
Director, Global Marketing of NTC's network marketing program as a consultant
to NTC), pursuant to which mutual general releases were given. The Company
agreed to assume certain debt obligations of Mr. Jacobs and Mr. Ballah to
NTC, as well as to make a cash payment to them to cover their tax liabilities
from the debt forgiveness. See "Item 5. Other Information - Settlement
Agreement with NTC Directors" in the Company's Form 10-Q for the quarter
ended September 30, 1996. With respect to a potential spin-off of NTC shares
by the Company, there is no assurance as to if or when a spin-off will occur,
or whether or not NTC will make a public offering of its stock.
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The amended and restated management incentive agreement essentially contains the
same terms and conditions as the agreement entered into in November 1996, except
as follows: The Company and NTC agree that the Company, as the owner of 100% of
the total issued and outstanding stock of NTC, owns ten million shares of NTC.
The three NTC stock option plans previously agreed to have been revised. The
Company and NTC have now agreed that there will be three stock option plans and
one convertible debt plan. The exercise price of all stock options issued under
the option plans will not be less than the fair market value of NTC common stock
on the date of the grant, and the conversion price of the convertible debt
issued under the convertible debt plan will not be less than the fair market
value of NTC common stock on the date of the issuance of the convertible
debenture. Shares issuable pursuant to the plans are expected to be registered
with the Securities and Exchange Commission no later than at the time of NTC's
planned public offering. Upon the creation of the plans and first grant of
options and convertible debt units pursuant to the plans, Edward Jacobs will
waive his rights to all remaining outstanding unexercised warrants and options
issued to him by the Company pursuant to his employment agreement, dated
December 28, 1994.
The first stock option plan is the one for key independent sales
representatives. A total of 2,884,615 shares are reserved for issuance under
this plan. Options to purchase 961,538 shares of NTC common stock have been
granted to key independent sales representatives who are Corporate Team
members, 480,769 of which will vest on June 30, 1998, subject to acceleration
if NTC's public offering occurs prior to January 1, 1998. Options to
purchase the other 480,769 shares will vest on June 30, 1999. The remaining
1,923,077 shares reserved for issuance pursuant to stock options granted
under this plan may be granted to key independent sales representatives after
each of June 30, 1997, December 31, 1997, June 30, 1998 and December 31, 1998
if NTC's gross revenues for the three month periods ending on each of such
dates exceed NTC's gross revenues for the corresponding three month periods
ending December 31, 1996, June 30, 1997, December 31, 1997 and June 30, 1998,
by the percentage amounts indicated on the following table:
<TABLE>
<CAPTION>
Percentage Increase in NTC Gross Revenues In Number of Options Available For Grant At End
Comparative Three Month Period of Each Period(1)
------------------------------ -----------------
<S> <C>
30% 125,000
40% 250,000
50% 500,000(1)
</TABLE>
- --------------------
(1) Stock options in the amount indicated may be granted at the end of each of
the four comparative three month periods. If the percentage increase for all
four of the comparative periods is 50% or more, then the total stock options
available for grant in the fourth period would be 423,077 instead of 500,000
because there are 1,923,077 (not 2,000,000) options available for grant under
this portion of the key independent sales representatives' stock option plan.
These stock options, once granted, will vest in four equal annual installments
on each anniversary date after the stock option grant date. The NTC Board of
Directors will determine when and to whom these stock options will be granted.
The second stock option plan is the one for NTC executives, employees and key
consultants. A total of 3,705,001 shares are reserved for issuance under
this plan. Options representing 1,446,076 of these reserved shares will be
subject only to a time-in-service vesting requirement, but in no event will
such options vest prior to January 1, 1998. Options representing 1,682,051
of the reserved shares will vest in four equal annual installments on each
anniversary date of the option grant date, subject to the acceleration of
vesting in the event that NTC achieves certain income targets in 1997, to be
determined by the NTC Board of Directors. No more than 480,770 shares
issuable pursuant to options granted under this plan may be issued to persons
eligible to receive convertible debt units under the Senior Executive and
Consultant Convertible Debt Plan described below in this section. The NTC
Board of Directors will determine when and to whom these stock options will
be granted.
Options representing 576,924 shares will be reserved under this plan for
issuance to persons eligible to receive convertible debt units under the
Senior Executive and Consultant Convertible Debt Plan described below in this
section in equal amounts. These options will be granted upon the creation of
the plan but will not vest until January 31, 2002, except that the vesting of
these options will accelerate in the following amounts if NTC achieves
revenues which exceed the following amounts for any calendar quarter ending
prior to January 1, 2000.
QUARTERLY REVENUES NUMBER OF SHARES VESTING
------------------ ------------------------
$100 million 192,308
$125 million 192,308
$180 million 192,308
The third stock option plan is the one for members of NTC's Board of
Directors. A total of 300,000 shares are reserved for issuance under this
plan. Each director of NTC will receive an option to purchase 25,000 shares
of NTC common stock which will vest in four equal annual installments on each
anniversary date of the option grant date.
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The fourth option plan is the Senior Executive and Consultant Convertible
Debt Plan for Edward Jacobs and Jerry Ballah. A total of 2,664,231 shares are
reserved for issuance under this plan to be allocated between Mr. Jacobs and
Mr. Ballah as determined by the NTC Board of Directors. These units will
vest upon grant. A portion of the convertible debt units granted under this
plan may be assignable.
The amended and restated NTC management incentive agreement provides that,
until four additional independent directors are appointed to the NTC Board of
Directors, if a vacancy is created on the NTC Board of Directors by reason of
the death, resignation or removal, with or without cause, of Mr. Jacobs or
Mr. Ballah, then the Company has agreed to vote its shares for the individual
nominated by the remaining NTC management director. In addition to the
regular members of the NTC Board of Directors, a key independent sales
representative may be nominated and elected to the NTC Board of Directors on
a rotating basis, such that the same sales representative cannot serve
consecutive terms. NTC has agreed to make total cash payments to the Company
on or before December 31, 1997 equal to $2,200,000, of which $1,200,000 of
payments have already been made as of March 17, 1997. The cash payments of
up to $2,200,000 by NTC to Incomnet, Inc. will be treated as a return of
capital to the Company. NTC may make advances to Incomnet, Inc. in excess of
its cash payment obligation of $2,200,000, subject to the limitations of its
credit agreement, which Incomnet, Inc. will be obligated to repay with
interest upon demand. Any charge to earnings or taxable income associated
with advances made by NTC to Incomnet, Inc. or costs incurred in the spin-off
of NTC shares will be incurred by Incomnet, Inc. for financial reporting
purposes rather than by NTC.
REINCORPORATION OF NTC IN DELAWARE
Effective March 21, 1997, NTC, previously a Nevada corporation,
reincorporated under the laws of the State of Delaware. Pursuant to its new
Articles of Incorporation, NTC has authorized 100 million shares of common
stock, par value $.01 per share, of which 10 million shares are issued and
outstanding, all of which are held by Incomnet Inc., and 1.5 million shares
of preferred stock, none of which are issued or 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
11
<PAGE>
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. 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 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.
12
<PAGE>
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 and Pearle Express. 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 FAST 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 Fast 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, one of the RCI founding shareholders, and others formed
ORGIC, which contracted with the 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." in the Company's Form 10-K for the
fiscal year ending December 31, 1995.
TECHNICAL OVERVIEW OF THE FAST CAST LENSYSTEM - The Rapid Cast LenSystem
consists of three primary components: The Fast Cast Mold and Gasket Library,
the Fast Cast Liquid Monomer (the "Monomer"), and the Fast Cast Ultraviolet
Curing Unit (the "Curing Unit"). The Fast 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 Fast Cast Liquid Monomer.
The Fast 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 Fast Cast Liquid Monomer is chemically inert and, because it
is cured by ultraviolet light, does not require the addition of a separate
13
<PAGE>
chemical initiator for the hardening process. As a result of its chemical
stability, the Fast 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 Fast 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 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.
Certain RCI customers have experienced technical problems with the LenSystem,
including the calibration of the molds, the generation of heat by the Curing
Unit, and related problems. As a result, machine orders have declined
significantly while RCI works on corrective measures. While RCI management
believes that the design and functional problems can be corrected, there is
no assurance that these problems will be resolved or that new problems will
not arise. There is no assurance that the rate of machine orders received by
RCI will stabilize or increase in the future.
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 Fast 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.
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 has such
components manufactured through subcontractors.
RESEARCH AND DEVELOPMENT STRATEGY - RCI anticipates that 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.
RCI has experienced several customer requests for service and replacement
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<PAGE>
parts due to problems with the design and functioning of certain aspects of the
Fast Cast LenSystem. As a result, RCI is making design modifications and
servicing these customers, which have resulted in increased costs and slower
sales than anticipated. RCI believes that it will be able to satisfy these
customers and make the necessary design modifications to solve the problems.
There is no assurance, however, that RCI's design modifications will solve the
current problems with the Fast Cast LenSystem or that future design and
operating problems may not occur.
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 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
15
<PAGE>
Technology, other than the patent dispute with Ronald D. Blum O.D., which was
settled in January 1997. See "Item 3. Legal Proceedings - Settlement of 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 fo 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 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
currently utilizes the tradenames and marks "Fast Cast," "Rapidcast," and
"LenSystem." None of these marks have been federally registered.
GOVERNMENTAL REGULATION - The lens produced by the LenSystem may be medical
"devices" within the meaning of the Federal Food, Drug and Cosmetic Act (the
"Food and Drug Act"), but management believes 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, apply to RCI's business.
Although the FDA may disagree, RCI also believes that the LenSystem is itself
not a "medical device" under the Food and Drug Act. 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.
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RECENT CAPITALIZATION OF RCI:
On January 16, 1997, Rapid Cast, Inc., a minority owned subsidiary of the
Company, issued 8,000,000 shares of Series A and Series B 7% Convertible
Preferred Stock to institutional investors in a private placement pursuant to
Regulation D of the Securities Act of 1933, as amended. The investors
contributed $12,000,000 in capital in consideration for the issuance of
7,275,000 shares of voting Series A 7% Convertible Preferred Stock and
725,000 shares of nonvoting Series B 7% Convertible Preferred Stock. The
investors also have the option to purchase up to an additional 6,666,666
shares of voting or nonvoting 7% Convertible Preferred Stock from RCI for a
purchase price $1.50 per share, exercisable with respect to 3,333,333 of the
shares upon the sooner to occur of (i) the appointment of a permanent Chief
Executive Officer of RCI, or (ii) July 15, 1997, or the option relating to
those shares will expire unexercised. The option with respect to the
remaining 3,333,333 shares must be exercised on or before July 16, 1998, or
the option with respect to those shares will expire unexercised. Frank Pipp,
the new Chairman of the Board of Directors of RCI, also has an option to
purchase up to 1,333,333 shares of Series A 7% Preferred Stock at any time
until July 15, 1998 for a price of $1.50 per share. The Company's ownership
of RCI will be diluted to the extent that those investors or Mr. Pipp
exercise their options to purchase additional shares of Series A 7% Preferred
Stock.
The proceeds of the issuance of the Series A and Series B 7% Convertible
Preferred Stock were utilized by RCI (i) to repay short-term bridge loans made
to RCI by its shareholders, including Incomnet, Inc., in the approximate total
amount of $3,705,430; (ii) to repurchase 1,200,000 shares of RCI common stock
from Dr. Larry Joel for a redemption price of $1.28 per share; (iii) to make the
final settlement payment and license new technology for $325,000 on the patent
infringement lawsuit known as RONALD BLUM, O.D. VS. RAPID CAST, INC., ET AL.,
which has been dismissed; (iv) to repay the bank line of credit with Bank Leumi
in the approximate outstanding amount of $500,000 plus interest; (v) to pay
placement costs of approximately $700,000; (vi) to pay all overdue trade
payables in the approximate outstanding amount of $1,700,000, and (vii) the
balance for working capital. The outstanding RCI founder loans in the
approximate outstanding principal balance of $1,205,000 on the date of the
closing, the other RCI shareholder bridge loans which were not repaid from the
proceeds of the private placement of the Series A and Series B 7% Convertible
Preferred Stock, and the outstanding 8% convertible notes in the approximate
outstanding balance of $648,000 (which were convertible into RCI common stock at
a price of $.80 per share), were all converted into newly issued RCI common
stock and Series C 7% Convertible Preferred Stock as follows:
<TABLE>
<CAPTION>
No. of Shares of
Series C No. of Shares
Name of RCI Shareholder Preferred Stock(1) of Common Stock (2)
- ----------------------- ------------------ -------------------
<S> <C> <C>
Robert Cohen 121,543 260,708(3)
Alan Cohen 120,194 260,708(5)
Jeff Rubin 122,260 45,752
Dr. Shawn Zimberg 111,781 135,252
Dr. Larry Joel(6) 0 255,099
Huberfeld Bodner Partnership 0 543,390
Martin Price 27,485 52,628
Incomnet, Inc. 0 428,570
</TABLE>
- --------------------
(1) Issued at a price of $1.50 per share.
(2) Issued at a price of $.80 per share with respect to the conversion of the
outstanding principal balance of the 8% convertible promissory notes, and
$1.28 with respect to the conversion of the RCI founder loans, the accrued
but unpaid interest on the 8% convertible promissory notes, the unpaid
bridge notes and accrued interest.
(3) Includes 36,603 shares issued in the name of Robert Cohen's children.
(4) Includes 120,194 shares issued in the name of Alan Cohen's children.
(5) Includes 36,602 shares issued in the name of Alan Cohen's children.
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(6) In September 1996 Dr. Joel surrendered 142,222 shares of RCI common stock
to RCI as the settlement payment for $448,000 of liabilities owed by Dr.
Joel to RCI.
From the proceeds of the capitalization of RCI on January 15, 1997, Incomnet,
Inc. was repaid $2,647,348 of principal and accrued interest on its short term
bridge loans which it made to RCI during the period from April 1996 through
January 1997. RCI also issued 428,570 shares of its common stock to Incomnet,
Inc. in exchange for the conversion by Incomnet, Inc. of $326,400 of 8%
convertible promissory notes purchased by it from RCI in January 1996.
Incomnet, Inc. now owns 10,628,570 shares of RCI common stock. Melvyn Reznick
was repaid $80,000 plus interest at the rate of 10% per annum for the loan he
made to RCI in late December 1996, and Stephen Caswell was repaid $12,500 plus
interest at the rate of 10% per annum for the loan he made to RCI in early
January 1997.
Pursuant to its Amended and Restated Certificate of Incorporation filed on
January 15, 1997, RCI is authorized to issue a total of 60,000,000 shares of
common stock, 22,000,000 shares of which are nonvoting common stock, and
42,500,000 shares of preferred stock, all having a par value of $.001 per
share. As of March 17, 1997, RCI has a total of 22,233,335 shares of common
stock issued and 20,891,113 outstanding, 10,628,570 of which are owned by
Incomnet, Inc., 7,275,000 shares of voting Series A 7% Convertible Preferred
Stock, 725,000 shares of nonvoting Series B 7% Convertible Preferred Stock,
and 503,264 voting Series C 7% Convertible Preferred Stock. Incomnet, Inc.
does not own any outstanding RCI preferred stock. Each share of issued and
outstanding Series A, Series B and Series C Preferred Stock is convertible
into one share of RCI common stock (subject to adjustment) at any time at the
option of the preferred shareholder, and automatically upon the occurrence of
a "qualified public offering" by RCI, as that term is defined in the
Certificate of Determination of Rights, References and Privileges for all
outstanding series of RCI preferred stock. The terms of conversion and other
rights of the outstanding RCI preferred stock are all subject to customary
adjustments and antidilution provisions in the event of stock splits, certain
stock dividends, stock combinations, reorganizations, recapitalizations and
similar events. A "qualified public offering" by RCI occurs when RCI makes a
public offering of its securities having gross proceeds of at least
$20,000,000 and an offering price of at least $1.90 per share if it occurs on
or prior to December 31, 1997, $2.14 per share if it occurs on or prior to
June 30, 1998, $2.40 per share if it occurs on or prior to December 31, 1998,
$2.69 per share if it occurs on or prior to June 30, 1999, $3.02 per share if
it occurs on or prior to December 31, 1999, $3.40 per share it occurs on or
prior to June 30, 2000, $3.81 per share if it occurs on or prior to December
31, 2000, $4.29 per share if it occurs on or prior to June 30, 2001, $4.82
per share if it occurs on or prior to December 31, 2001, $5.41 per share it
if occurs on or prior to June 30, 2002, and $6.08 per share if it occurs
after June 30, 2002, in each case as adjusted for stock splits, certain stock
dividends, stock combinations and similar events.
The Series A, Series B and Series C 7% Convertible Preferred Stock have a
liquidation preference of $1.50 per share. All outstanding RCI preferred stock
have a cumulative noncompounded dividend of 7% per annum which must be declared
and paid in full before any dividends may be declared or paid on the RCI common
stock. All dividends on outstanding RCI preferred stock, regardless of whether
Series A, Series B or Series C, must be declared and paid ratably on all such
outstanding preferred stock. Each holder of outstanding RCI preferred stock has
the right to be paid the 7% dividend, when declared, either in cash, in shares
of Series A, Series B or Series C Preferred Stock (at a price of $1.50 per
preferred share, subject to adjustment), or in a combination of cash and
preferred stock. The cumulative unpaid dividend on the outstanding RCI
preferred stock must be paid in full in shares of RCI common stock (at a price
of $1.50 per common share, subject to adjustment) or in cash, at the option of
the preferred shareholder, upon the conversion of the preferred stock into
common stock. The preferred shareholder may require RCI to redeem the
outstanding preferred stock beginning after January 1, 2003 if the preferred
stock has not otherwise been converted. The redemption price would equal the
original issue price plus cumulative unpaid dividends. The Certificate of
Determination for the outstanding RCI preferred stock contains numerous
restrictive covenants applicable to RCI with respect to the incurrence of debt,
sale of assets, issuance of shares, mergers, reorganizations, recapitalizations,
affiliate transactions, and similar transactions by RCI.
In connection with the issuance of the preferred stock by RCI, RCI and its
shareholders entered into a Registration Rights Agreement, a Shareholders
Agreement and related agreements governing the outstanding RCI shares and the
management of RCI.
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Pursuant to the Registration Rights Agreements, the Series A and Series B
Preferred Shareholders have priority demand and piggyback registration rights
with respect to the shares of RCI common stock issuable upon the conversion of
the preferred stock, and issuable upon the exercise of warrants held by them.
The Series A and Series B Preferred Shareholders are the only RCI shareholders
with demand registration rights, of which they have three for less than
$5,000,000 of proposed sales and an unlimited number of proposed sales in excess
of $5,000,000. With respect to piggyback registration rights, the holders of
Series A and Series B Preferred Stock are entitled to 80% of the available
registration of shares for selling security holders on a pro rata basis, and the
other existing RCI shareholders are entitled to 20% of the available share
registration for selling security holders on a pro rata basis, subject to other
conditions and limitations.
Pursuant to the RCI Shareholders Agreement, the RCI shareholders and RCI are
granted certain first rights of refusal to purchase RCI stock proposed for sale
by other RCI shareholders. The RCI Shareholders Agreement imposes certain other
restrictions on the transferability of RCI shares, except for Rule 144 sales, a
sale of shares in a public offering pursuant to the Registration Rights
Agreement, and a transfer to RCI. The RCI shareholders also agree to vote their
shares so that (i) the RCI Board of Directors will consist of nine members, (ii)
subject to certain conditions, the RCI Board of Directors will consist of two
members designated by J.P.Morgan Investment Corporation and its related
investors, two members designated by Clipper Capital Associates, L.P. and its
related investors, one member designated by Incomnet, Inc., provided, that if
Incomnet, Inc. undergoes a "change of control" (defined as the cessation of
Melvyn Reznick's service on the RCI Board of Directors for any reason or certain
other changes in the Incomnet, Inc. Board of Directors or the stock ownership of
Incomnet, Inc.), then the Incomnet designee must be approved by a majority of
the other members of the RCI Board of Directors, one member designated by Jeff
Rubin, one member designated by Robert Cohen, one member (initially Frank Pipp)
designated by a majority of the RCI Board of Directors who qualify as outside
directors and approved by a majority of the RCI shareholders, and one member who
is the interim or permanent Chief Executive Officer of RCI. RCI has established
Executive, Audit and Compensation Committees.
The following persons are the current members of the RCI Board of Directors and
its Committees:
I. BOARD OF DIRECTORS(1)
Molly F., Ashby (J.P. Morgan Designee)
Robert Cohen
Patrick H. Garrett (J.P. Morgan Designee)
Kevin A. Macdonald (Clipper Designee)
Frank Pipp (Chairman and Interim Chief Executive Officer)(2)
Melvyn Reznick (Incomnet Designee)
Jeff Rubin
II. EXECUTIVE COMMITTEE
Molly F., Ashby (Chairman)
Kevin A. Macdonald
Frank Pipp
III. COMPENSATION COMMITTEE
Patrick H. Garrett (Chairman)
Kevin A. Macdonald
Frank Pipp
Melvyn Reznick
IV. AUDIT COMMITTEE
Melvyn Reznick (Chairman)
Patrick H. Garrett
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Kevin A. Macdonald
- --------------------
(1) The Board of Directors currently has one vacancy which is reserved for
the permanent Chief Executive Officer when he is hired.
(2) John L. Vidovich is currently a consultant and acting co-Chief Executive
Officer of RCI with Frank Pipp. Mr. Vidovich may become the permanent
Chief Executive Officer of RCI. The permanent Chief Executive Officer of
RCI is expected to join the RCI Board of Directors and may join one or
more of its Committees.
Upon the completion of a "qualified public offering" by RCI, as that term is
defined in the Certificate of Determination for the outstanding RCI preferred
stock and as described above, the voting and transferability restrictions in the
RCI Shareholders Agreement generally terminate, except that the RCI shareholders
agree to vote for one director designee each for J.P. Morgan and Clipper after
the "qualified public offering" as long as their investors hold a specified
minimum number of shares of RCI. The RCI Shareholders Agreement grants the RCI
shareholders pro rata preemptive rights to purchase new securities proposed to
be issued by RCI, except in circumstances such as when RCI makes a public
offering, issues stock to acquire another company in a purchase, merger or other
reorganization, issues stock pursuant to outstanding conversion rights, options
or warrants, issues up to 120,000 shares to John L. Vidovich or 450,000 shares
to Frank Pipp, implements a stock split or stock dividend, or issues stock after
a "qualified public offering" by RCI.
In connection with the short term bridge loans made to RCI from April 1996 to
January 1997 and the issuance of the preferred stock by RCI on January 16,
1997, RCI issued options and warrants to purchase its common stock, and
amended and restated its 1994 Stock Option Plan. The RCI 1994 Stock Option
Plan was amended to authorize and reserve up to 4,514,732 shares of its
common stock for issuance upon the exercise of stock options granted and
which may be granted by the RCI Board of Directors in the future. Under the
RCI 1994 Stock Option Plan, a total of 3,260,000 stock options have been
granted to various officers, directors, employees and key consultants of RCI.
The exercise price of 1,408,000 of the stock options is $2.25 per share and
the exercise price of 1,342,000 of the stock options is $2.00 per share.
These stock options have vested (subject to continued employment) and are
exercisable at any time from the date of grant until dates ranging from
November 1, 2005 until July 31, 2006. Melvyn Reznick was granted 100,000 of
these options by RCI, having an exercise price of $2.25 per share and
exercisable at any time until July 31, 2006. Frank Pipp was granted 450,000
of these stock options to purchase a total of 450,000 shares of RCI common
stock at any time until January 20, 2007, 225,000 to which may be purchased
at an exercise price of $1.28 per share and 225,000 of which may be purchased
at an exercise price of $4.00 per share. RCI also granted to John L.
Vidovich 60,000 of these stock options to purchase 60,000 common stock at any
time until January 20, 2007 at an exercise price of $1.28 per share.
RCI issued to the purchasers of the Series A and Series B Preferred Stock
warrants to purchase 1,400,000 shares of RCI common stock at an exercise
price of $1.74 per share, exercisable at any time until January 16, 2004.
The holders of these warrants have certain registration rights under the
Registration Rights Agreement described above, and customary adjustment and
antidilution protection.
In connection with short term bridge loans made to RCI by its shareholders and
others during the period from April 1996 until early January 1997, RCI issued a
total of 4,441,933 warrants to purchase 4,441,933 shares of RCI common stock at
any time until dates ranging from September 30, 2003 to December 31, 2003. The
exercise price of 1,853,683 of the warrants is $2.25 per share, the exercise
price of 302,500 of the warrants is $1.28 per share, and the exercise price of
2,285,750 of the warrants is $.75 per share. Incomnet, Inc. holds 841,416 of
these warrants to purchase 841,416 shares of RCI common stock at an exercise
price of $2.25 per share at any time until September 30, 2003, 480,000 of these
warrants to purchase 480,000 shares of RCI common stock at an exercise price of
$.75 per share at any time until December 30, 2003, 150,000 of these warrants to
purchase 150,000 shares of RCI common stock at an exercise price of $1.28 per
share at any time until December 31, 2003, and 1,090,000 of these warrants to
purchase 1,090,000 shares of RCI common stock at an exercise price of $.75 per
share at any time until November 30, 2003. In consideration for personal loans
and loan guarantees, Melvyn Reznick holds 175,000 of these warrants to purchase
175,000 shares of RCI common stock at an exercise price of $2.25 per share at
any time
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until September 30, 2003, and 160,000 of these warrants to purchase 160,000
shares of RCI common stock at an exercise price of $.75 per share at any time
until December 31, 2003. In consideration for personal loans to RCI, Albert
Milstein was issued 25,000 warrants to purchase 25,000 shares of RCI common
stock at an exercise price of $1.28 per share at any time until December 31,
2003. In consideration for personal loans to RCI, Steve Caswell was issued
12,500 of these warrants to purchase 12,500 shares of RCI common stock at an
exercise price of $1.28 per share at any time until December 31, 2003.
RCI also has a total of 1,000,000 additional warrants outstanding which entitle
their holders to purchase a total of 1,000,000 shares of RCI common stock at an
exercise price equal to 50% of the average of the last reported sales price of
RCI shares during the first 30 business days after the shares of RCI first
become publicly traded, provided that they become publicly traded on or before
December 31, 1998. If RCI becomes publicly traded on or before December 31,
1998, these warrants are then exercisable for a period of 180 days after the
public trading commencement date. These 1,000,000 RCI warrants were issued on
February 8, 1995 in connection with the issuance of 8% convertible promissory
notes by Incomnet, Inc. on that date to finance its acquisition of a controlling
interest in RCI. See "Item 1. Business - Acquisition of Rapid Cast, Inc." in
the Company's Form 10-K for the fiscal year ending December 31, 1995.
ISSUANCE OF CONVERTIBLE PREFERRED STOCK:
From September 20, 1996 to October 25, 1996, the Company issued 2,440 shares of
Series A 2% Convertible Preferred Stock to 12 accredited investors in a private
placement pursuant to Regulation D of the Securities Act of 1933, as amended.
The shares of Series A 2% Convertible Preferred Stock were purchased by four
affiliated individuals and eight unaffiliated investors. The Company raised
$2,440,000 in capital from the issuance of the Preferred Stock, a portion of
which it utilized to repay advances made to it by Melvyn Reznick, the Company's
Chairman and Chief Executive Officer, who in turn owed approximately $723,000 to
a bank on a loan with a maturity date of September 16, 1996. Mr. Reznick had
borrowed these funds from the bank in order to make a substantial portion of his
loan to the Company, which enabled the Company to make its pro rata share of
loans to RCI. See "Item 5. Other Information - Loan to Company By Melvyn
Reznick" in the Company's Form 10-Q for the fiscal quarter ending September 30,
1996. The balance of the proceeds is being utilized and is expected to be
utilized for general working capital and to pay the costs of settling pending
litigation. The Company paid a referral fee to Newport Capital Partners, an
unaffiliated financial consultant, equal to 5% of the capital raised through its
referrals, which was $1,700,000. The Company has therefore paid $85,000 of
referral fees to Newport Capital Partners. The basic terms and conditions of
the Series A 2% Convertible Preferred Stock are described in the following
paragraphs:
VOTING - The Series A 2% Convertible Preferred Stock does not have voting
rights.
DIVIDEND - The Series A 2% Convertible Preferred Stock has a cumulative
noncompounded annual dividend of 2% payable in cash or stock at the Company's
option upon conversion of the Preferred Stock into Common Stock, and prior to
the payment of any dividends on the Common Stock.
LIQUIDATION PREFERENCE - The Series A 2% Convertible Preferred Stock has a
liquidation preference of $1,000 per share plus all cumulative unpaid dividends,
whether or not declared by the Company's Board of Directors. Upon any
liquidation or change of control of the Company (i.e. transfer of more than 50%
of its voting stock), the Preferred Shareholders are entitled to the first
priority in payment from the Company's assets, before any payments are made on
the Company's Common Stock, until the liquidation preference is paid in full.
CONVERSION - The Preferred Shareholders may convert each share of Series A 2%
Convertible Preferred Stock into the number of shares of the Company's Common
Stock calculated as follows, at any time upon the earlier of (i) 90 days after
the issuance of the Preferred Stock, or (ii) 60 days after the shares of Common
Stock underlying the Preferred Stock are registered with the Securities and
Exchange Commission: The conversion price (the "Conversion Price") for each
share of Series A 2% Convertible Preferred Stock is equal to the LESSER of (a)
80% of the average bid price for the Company's Common Stock on the public
trading market for the five trading days immediately preceding the conversion
date, as specified by the Preferred Shareholder, or (b) the bid price of the
Company's Common Stock on the funding date (i.e. the issuance date of the
Preferred Stock). To calculate the number of shares of Common Stock issuable
upon the conversion of the Preferred Stock, the Conversion Price is multiplied
by a ratio, the numerator of which is the sum of 1,000 and the accrued but
unpaid dividends, and the denominator of which is the Conversion Price. If for
any reason a registration statement covering the shares of Common Stock issuable
upon the conversion of the Preferred Stock is not in effect with the Securities
and Exchange Commission at the time of a valid conversion by a Preferred
Shareholder,
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then the Conversion Price is reduced by 3% per month for each of the first three
months that the effectiveness of the registration is late. The Company has the
right to cause a conversion of the Preferred Stock into Common Stock on the same
terms at any time after one year after the Preferred Stock is issued.
REDEMPTION - The Company has the right to redeem the Preferred Stock for its
issuance price plus cumulative unpaid dividends if the Company's stock trades at
a price which averages $2.00 per share or less for any period of five
consecutive trading days after the Preferred Stock is issued.
REGISTRATION RIGHTS - Pursuant to a Registration Rights Agreement entered into
by the Company with each purchaser of the Series A 2% Convertible Preferred
Stock, the Company is obligated to file a registration statement with the
Securities and Exchange Commission covering the shares of Common Stock
underlying the Preferred Stock within 30 days after the Preferred Stock is
issued, and to have the registration statement declared effective within 75 days
after it is filed. The Underlying Shares issuable upon the conversion of the
first 365 shares of Series A 2% Convertible Preferred Stock were covered by a
prior registration statement declared effective by the Securities and Exchange
Commission on October 31, 1996. The balance of the shares of Common Stock
issuable upon the conversion of outstanding Series A 2% Convertible Preferred
Stock are covered by this Prospectus.
ANTIDILUTION PROVISION - The Certificate of Determination for the Series A 2%
Convertible Preferred Stock contains comprehensive provisions for adjustments to
the Conversion Price and the conversion ratio of the Preferred Stock in the
event of stock dividends, asset distributions, reorganizations,
recapitalizations, mergers, stock splits or similar transactions by the Company,
in order to protect the Preferred Stock from dilution as a result of such
transactions.
RESTRICTIVE COVENANTS - During the first 90 days after the Series A 2%
Convertible Preferred Stock is issued, the Company is not permitted to issue any
other securities, except in limited circumstances, including pursuant to the
exercise of outstanding options or warrants or pursuant to existing settlement
agreements, without first notifying the Preferred Shareholders and giving them a
right of first refusal to purchase the securities themselves. While the Series
A 2% Convertible Preferred Stock is outstanding or until it is converted into
Common Stock, the Company is not permitted to engage in certain transactions,
such as the redemption or purchase of its own Common Stock (except in connection
with the collection of Section 16(b) short-swing profits), without the prior
consent of the Preferred Shareholders. Furthermore, the Company is not
permitted to pay cash dividends on its Common Stock unless all cumulative unpaid
dividends on the Series A 2% Convertible Preferred Stock is paid. The Company
cannot take any action which would modify the rights of the Preferred
Shareholders under the Certificate of Determination without the prior consent of
the Preferred Shareholder being affected by the modification.
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. In June 1996, the license with the NHLPA
expired and was not renewed. PRI and Incomnet also agreed to end their
relationship in providing telephone calling cards. Incomnet has also decided,
at this point in time, not to issue additional cards to the ones issued under
the agreement. In August 1996, the Company entered into a settlement
agreement with PRI pursuant to which the Company agreed to lower the exercise
price of PRI's 75,000 warrants from $11.25 to $4.50 per share, and to extend
the expiration date of the warrants from November 15, 1997 until December 31,
1998. The Company also registered the 75,000 shares issuable upon the
exercise of the warrants in a registration statement with the Securities &
Exchange Commission declared effective on October 31, 1996 (see Item 3. Legal
Proceedings - "Settlement With Price International, Inc.").
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.
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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 February 1997, the Company agreed
with Dismantlers Exchange to end the joint venture. Incomnet has taken over the
customer base serviced by Dismantler's Exchange.
In 1997, the Company intends to invest approximately $5,000 into the
AutoNETWORK business to enhance the services provided to the automobile
dismantlers in the network.
EMPLOYEES, OFFICERS AND DIRECTORS:
EMPLOYEES - As of December 31, 1996, the Company, including its subsidiaries,
NTC and RCI, employed 288 full-time people, consisting of 73 general and
administrative, 46 marketing and sales, and 169 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.
DIRECTORS AND OFFICERS - The success of the Company is heavily dependent on
the Company's President and Chief Executive Officer, Melvyn Reznick, and the
Chief Executive Officer and President of the Company's NTC subsidiary, Edward
R. Jacobs and James R. Quandt, respectively.
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 January 6, 1997, NTC entered into an employment agreement with James R.
Quandt pursuant to which Mr. Quandt is serving as NTC's President and is a
member of NTC's Board of Directors. The employment agreement contemplates that
Mr. Quandt will eventually become the Chief Executive Officer of NTC upon the
retirement of Edward Jacobs, the current Chief Executive Officer, which is
presently scheduled for January 1, 1999. Mr. Quandt's employment agreement
commenced on January 6, 1997 and has a term of three years. The employment
agreement recites that Mr. Jacobs also contemplates retiring as the Chairman of
the Board of Directors of NTC on July 25, 1999, although such retirement is not
contractually mandated. The employment agreement contemplates that Mr. Quandt
may be nominated to become the Chairman of the Board of Directors of NTC upon
Mr. Jacobs' retirement from that position.
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Pursuant to the employment agreement, Mr. Quandt is entitled to the following
compensation: (1) A base salary of $40,000 per month, (2) an incentive bonus
equal to one and one-half (1.5%) of the quarterly net profit earned by NTC,
provided that the quarterly net profit is at least $1,250,000, and the
payment of the bonus does not cause the quarterly net profit of NTC to be
less than $1,250,000, and NTC's pretax profit for the succeeding calendar
quarter is reasonably expected to exceed the minimum quarterly net profit of
$1,250,000, and (3) nonqualified stock options to purchase 600,000 shares of
the common stock of NTC. The stock options will have an exercise price
determined by the Board of Directors of NTC in accordance with the NTC Stock
Options Plan, but in no event greater than the higher of $5.00 per share or
the fair market value of NTC's stock at the time of the grant. See "THE
COMPANY - Amendment to NTC management Incentive Agreement." The stock
options will have an exercise period of five years from the date of grant.
The stock options will vest as follows: (1) 300,000 stock options will vest
upon Mr. Quandt completing 15 months of employment for NTC under the
employment agreement, and (2) 350,000 stock options will vest only in the
event NTC achieves certain pretax profits goals prior to January 1, 1998 or
prior to January 1, 1999 whichever first occurs.
In addition to the base salary, regular bonus and stock options, Mr. Quandt will
earn a hiring bonus equal to $225,000, payable if NTC's quarterly net profits
exceed $1,250,000, but in any event no later than December 31, 1997 with respect
to $150,000 of the guaranteed hiring bonus, and the balance by no later than
June 30, 1998. The hiring bonus will be paid at the rate of 1.5% of quarterly
pre-tax profits of NTC in excess of $1,250,000, and if not earned in that
manner, will be paid in full in two installments as follows: $150,000 by
December 31, 1997 and the balance by June 30, 1998. To the extent that the
regular bonus and guaranteed hiring bonuses are paid to Mr. Quandt pursuant to
his employment agreement, Mr. Jacobs has agreed to waive any remaining portion
of the quarterly incentive bonus payable by NTC to Mr. Jacobs (i.e. 1.5% of the
pre-tax net profits in excess of $1,250,000 of net profits of NTC per calendar
quarter) pursuant to Mr. Jacobs' current employment agreement with NTC.
Under the employment agreement, Mr. Quandt is entitled to a significant
severance payment if his employment terminates prior to the agreement's
termination date because of his death, disability, or for a reason other than
cause, or because of a voluntary resignation by Mr. Quandt for "good cause", as
defined in the employment agreement. Mr. Quandt has agreed not to compete with
NTC during the term of his employment agreement and for a period of one year
after the agreement terminates for any reason.
Prior to assuming his executive position with NTC, Mr. Quandt was the Chairman
of the Board of Directors of Global Financial Information Corporation, a
privately held group of companies in the financial information and technology
industry. Global Financial Information corporation operates from a base of 27
offices internationally, with a staff of approximately 840 professionals. From
1991 to 1995, Mr. Quandt was the President and Chief Executive Officer of
Standard & Poors Financial Information Services, a subsidiary of McGraw Hill
Corporation in New York, New York. At Standard & Poors, Mr. Quandt was
responsible for all executive, administrative and operational functions of nine
domestic and international companies that comprised the Standard & Poors Group.
From 1980 to 1991, Mr. Quandt was an executive officer in various capacities
with Security Pacific Bank in Los Angeles, California. Mr. Quandt was the
Senior Vice President and Group Division Head of Security Pacific Bank's
Financial Management & Trust Services Group from 1988 to 1991. From 1983 to
1990, Mr. Quandt was the President and Chief Executive Officer of Security
Pacific Brokerage, Inc., a subsidiary of Security Pacific Bank.
Effective April 8, 1997, James R. Quandt was elected to be a member of the
Board of Directors of NTC to replace Jerry Ballah, who resigned as a director
and as an officer of NTC. Mr. Ballah is now a marketing consultant to NTC.
Effective January 17, 1997, the Company entered into an Amendment to the
Employment Agreement with Melvyn Reznick pursuant to which the term of Mr.
Reznick's Employment Agreement has been extended for two additional years,
until November 30, 1999. Mr. Reznick is also a director and a member of
several committees of the Board of Directors of RCI, as well as being a
director of NTC.
APPOINTMENT OF NEW DIRECTOR BY THE COMPANY - On January 20, 1997, the Company's
Board of Directors appointed Dr. Howard Silverman to fill a vacancy and become a
member of the Board of Directors. Since March 1996, Dr. Silverman has been
consulting for various companies in the optical and financial areas, including
Andrew, Alexander, Wise & Company in New York, and Rapid Cast, Inc. From August
1995 to March 1996, Dr. Silverman served as a Vice President of Corporate
Finance for Rickel & Associates, an investment banking firm. From 1991 until he
joined Rickel & Associates in 1995, Dr. Silverman was an independent business
consultant specializing in early stage and mid-size operating companies. From
1985 to 1991, Dr. Silverman was the founder and Chairman of the Board of
Directors of Vision Sciences, Inc., a company that developed, manufactured and
sold in-office lens casting systems, which enabled the optical retailer to cast
his own finished plastic optical lenses. Dr. Silverman was a member of the
Board of Directors and the director of business development for Staar Surgical
Co., Inc., a publicly owned company, from 1984 to 1990. He was the co-founder
and Chief Operating Officer of Hydro-Optics, Inc., a manufacturer of hydrophilic
contact lens, from 1974 until 1984. Dr. Silverman has also been the Vice
President and Chief Operating Officer of Diversified Health Industries, Inc. and
the President and Chief Executive Officer of Precision Contact Lens, Inc. Dr.
Silverman had a private optometric practice in New York City from 1968 to 1972,
specializing in contact lenses. Dr. Silverman earned a Bachelor of Science in
Chemical Engineering from the College of the City of New York in 1965 and a
Doctor of Optometry form Illinois College of Optometry in 1968. See the
Company's Report on Form 8-K, dated January 20, 1997.
24
<PAGE>
APPOINTMENT OF COMMITTEE MEMBERS - The current members of the Audit Committee of
the Company's Board of Directors are Albert Milstein, Nancy Zivitz and Dr.
Howard Silverman. The current members of the Compliance Committee of the
Company's Board of Directors are Melvyn Reznick, Mark Richardson, Albert
Milstein and Nancy Zivitz. The current members of the Compensation Committee of
the Company's Board of Directors are Albert Milstein, Nancy Zivitz, Stephen
Caswell and Dr. Howard Silverman.
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 has been obligated to make lease
payments at the rate of $8,713 per month from May 1995 through July 1998.
The Company's subsidiary, NTC, currently leases approximately 64,000 square
feet of office space in Irvine, California at a rate of approximately $52,000
per month. NTC has entered into an agreement to extend the lease on its
headquarters building at 2801 Main Street, Irvine, California. According to
the terms of this agreement, NTC would be obligated to pay formula based
monthly lease payments estimated to be approximately $57,000 per month during
1997 and increasing to approximately $72,000 per month for the remainder of
the initial five year lease term. In addition, in February 1997, NTC entered
into a ten year lease for office space in Honolulu, Hawaii, with the lease
expiring in 2007. The monthly payments on the lease in Honolulu, Hawaii
commence at $36,698 per month in 1997 and 1998, and increase on a bi-annual
basis through the term of the lease to $43,536 per month in 2006 and 2007.
The Company's other subsidiary, Rapid Cast, Inc., 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 2,850 square
feet of office space in East Meadow, New York, for $2,417 per month with
annual escalations.
ITEM 3. LEGAL PROCEEDINGS
SECURITIES AND EXCHANGE COMMISSION INVESTIGATION:
In August 1994, the Company was notified by the Pacific Regional Office of
the Securities and Exchange Commission that the Commission had initiated an
informal inquiry of the Company. In September 1994 the Commission issued a
formal order of private investigation. The Commission stated in its
correspondence to the Company that the investigation "should not be construed
as an 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." In August and September 1994, the Company supplied 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
pursuant to the Commission's subpoena. In February 1995, the Company
provided to the Commission pursuant to its subpoena additional documents
associated with NTC's regulatory authorizations and with the Company's recent
acquisition of a controlling interest in RCI. The Company continues to fully
cooperate with the Commission. While the Company believes that the outcome of
the fact finding investigation will not have a material adverse effect on the
financial condition or operating results of the Company, no assurance can be
given on this matter until the investigation is concluded. See "Item 3.
Legal Proceedings - Securities and Exchange Commission Investigation" in the
Company's 1995 Form 10-K, as updated in the Company's Form 10-Q for the
quarter ended September 30, 1996 under "Item 1. Legal Proceedings -
Securities and Exchange Commission Investigation."
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),
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<PAGE>
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. 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.
The plaintiffs in the class action lawsuit SAUNDRA GAYLES VS. INCOMNET, INC.
AND SAM D. SCHWARTZ have conducted written discovery and taken the deposition
of the Company's custodian of records. The discovery phase of the case is
currently scheduled to close on May 31, 1997. A hearing is expected to be
held on May 5, 1997 to determine whether a specific group of investors who
filed a motion to elect not to be part of the class will be entitled to
opt-out of the class action lawsuit and commence their own lawsuit. The
plaintiffs and the Company have filed motions opposing the request for
opt-out status by those investors, who filed their election forms after the
deadline established for such elections. Several other parties have timely
filed elections to be separate from the class, but none have filed separate
lawsuits to date. The Company is not certain whether any of those potential
plaintiffs will file separate lawsuits against the Company or any of the
other defendants. The Company and the class plaintiffs have and continue to
engage in settlement discussions. No assurance can be given that a settlement
will be reached, or the terms of such settlement, if any.
The Company has been served with a complaint in the lawsuit entitled SILVA
RUN WORLDWIDE LIMITED VS. INCOMNET, INC., SAM D. SCHWARTZ, BEAR STEARNS &
CO., INC., LESLIE SOLMONSON, RONALD F. SEALE, MARINER RESERVE FUND, COMPANIA
DI INVESTIMENTO ANTILLIANO, COUTTS & CO. AG, SALVATORE M. FRANZELLA, PETER G.
EMBIRICOS, AND JOS SCHUETZ, filed in the United States District Court for the
Southern District of New York. The complaint states that the plaintiff was a
purchaser of the Company's stock in July 1995. The complaint alleges that
the Company and it's former Chairman, Sam D. Schwartz, violated Sections
10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934, as
amended, and committed common law fraud, as a result of false and misleading
statements made by the defendants and undisclosed trading in the Company's
stock engaged in by Mr. Schwartz and his affiliate. The plaintiff also
alleges that Mr. Schwartz and his affiliate owed a fiduciary duty to the
plaintiff that was breached by their conduct. The complaint also alleges
other causes of action against other unrelated defendants. The Company
answered the complaint in November 1996 and moved to have it transferred to
California. In March 1997, the claims relating to the Company and Sam
Schwartz was ordered severed and transferred from the court in New York to
the same court in California which is hearing the pending class action
lawsuit. See "Part II, Item 1. Legal Proceedings - Class Action and Related
Lawsuits" in the company's Form 10-Q for the fiscal quarter ending September
30, 1996.
SETTLEMENT WITH RCI PARTIES
As of December 9, 1996, the Company entered into a Settlement and Mutual Release
Agreement with Robert Cohen, Alan Cohen, Jeff Rubin, Jeff Cohen, Broadway
Partners, a partnership comprised of the children of Alan and Robert Cohen, and
Lenore Katz (the "RCI Parties"). Robert Cohen is a director and shareholder of
Rapid Cast, Inc. and Jeff Rubin is a director, shareholder and executive officer
of Rapid Cast, Inc. Jeff Cohen is the son-in-law of Robert Cohen. Pursuant to
the settlement agreement, the RCI Parties purchased 360,000 Warrants entitling
them to purchase 360,000 shares of the Common Stock of the Company for an
exercise price of $3.75 per share at any time until December 9, 1999. The RCI
Parties paid a total of $36,000 in cash to the Company for the warrants.
Certain of the RCI Parties also purchased a total of 33,000 shares of the Common
Stock of the Company for an aggregate purchase price of $100,000. The Company
is registering those shares and the shares issuable upon the exercise of the
warrants pursuant to a registration statement pending with the Securities and
Exchange Commission in accordance with its agreement to do so in the Settlement
and Mutual Release Agreement. The Company and the RCI Parties also mutually
released each other from all claims, if any, which they may have had against
each other, and the RCI Parties assigned all of the claims which they may have
against Sam and Rita Schwartz, prior directors of the Company, to the Company.
SETTLEMENT OF THE STEVENS LAWSUIT
In January 1997, the Company entered into a Settlement Agreement and Mutual
Release of all claims in the pending lawsuit entitled CHARLES STEVENS VS. SAM D.
SCHWARTZ AND INCOMNET, INC. Pursuant to the settlement, the Company paid $7,500
in cash to the plaintiff and issued 12,500 warrants to purchase 12,500 shares of
the Company's Common Stock at an exercise price of $2.94 per share, exercisable
at any time until December 16, 2001. The Company agreed to register the shares
underlying the 12,500 warrants issued to Mr. Stevens and his legal counsel. In
consideration for the
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<PAGE>
issuance of warrants and payment of cash, the plaintiff released the Company
from all claims and dismissed the lawsuit against the Company with prejudice.
The settlement did not include Sam D. Schwartz.
SETTLEMENT OF THE ATLANTA LAWSUITS
In February 1997, the Company entered into a settlement and release agreement
with the plaintiffs in the lawsuits entitled HERBERT M. SCHWARTZ ET AL. VS.
INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT CORP. and BRENT ABRAHM
ET AL. VS. INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT CORP.
pursuant to which the lawsuit against the Company were dismissed and an order
was entered barring indemnification or contribution between the Company and
Sam D. Schwartz. In consideration for the payment of $400,000 in cash and
the issuance of a note in the principal amount of $400,000 to the plaintiffs,
the plaintiffs released the Company from all claims and dismissed their
lawsuits against the Company with prejudice. The $400,000 note was issued as
of January 1, 1997 and bears interest at the rate of 12% per annum from
January 1, 1997 to January 22, 1997, and 8% per annum thereafter until
December 31, 1997, when the note is due and payable in full. The note is
secured by a certificate of deposit in the amount of $415,000 purchased by
the Company, which the Company has the right to replace with a number of
registered shares of its Common Stock equivalent in value to the certificate
of deposit as collateral for the note.
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. In early July 1996, Mr.
Schwartz deposited 800,000 shares of his Incomnet, Inc. Common Stock into a
court-approved escrow account with the Company's New York counsel as security
for his obligation to pay short swing profits. In early February 1997,
plaintiff's counsel prepared a motion for summary judgment in the case
seeking $5,050,000 in short swing profits from Mr. Schwartz plus pre-judgment
interest. On February 21, 1997, the plaintiffs and Sam Schwartz entered into
a stipulated settlement pursuant to which Mr. Schwartz agreed to pay
$4,250,000 to the Company as full payment of his short swing profit
obligation to the Company. The plaintiff's lawyer indicated that he would
request a fee of $850,000 plus reimbursement of $65,000 of expenses, to be
paid by the Company from the proceeds of the recovery. Under the stipulated
settlement, the disgorgement of short-swing profits would be payable $600,000
in cash and the balance by tender to the Company of shares of the Company's
Common Stock owned by Mr. Schwartz, based on 90% of the average between the
bid and the asked price of the Company's Common Stock on the NASDAQ market
during the 30 calendar days immediately preceding the date that the court
enters an order approving the settlement. Pursuant to the agreement, Mr.
Schwartz has deposited $600,000 in cash and has agreed to deposit additional
shares of the Company's common stock into a separate escrow account from the
one which already contains 800,000 shares of the Company's stock owned by him
or his affiliates. The Company intends to oppose the amount of plaintiff's
attorney's fees sought. The Company does not otherwise intend to oppose the
proposed settlement. On April 11, 1997, a revised stipulation was filed
containing the same economic terms. Notice of the settlement is to be given
to the shareholders by April 21, 1997. Any opposition to the settlement is
due by May 16, 1997, and a hearing to approve the settlement is to be held on
May 30, 1997. There is no assurance that the Company will recover the
short-swing profits from Mr. Schwartz.
SETTLEMENT OF 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 FastCastTM LenSystem. On
January 16, 1997, RCI settled the lawsuit and the lawsuit has been dismissed.
In consideration for a total cash payment of $525,000 in cash to Dr. Blum and
the release by RCI of all claims which it may have had against Dr. Blum, RCI
received a release of all claims by Dr. Blum. See "Item 1. Legal Proceedings -
Patent Infringement Lawsuit" in the Company's Form 10-Q for the fiscal quarter
ending September 30, 1996.
LEGAL ACTION AGAINST PRIOR REPRESENTATIVES:
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<PAGE>
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.
SETTLEMENT WITH 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 (i.e. $500,000 plus
interest), 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. The settlement agreement has been filed with the
court and the case has been dismissed with prejudice. Commencing in March
1996 the Company entered into a series of settlement agreements with six
other prior holders of a total of $325,000 in principal amount of 8%
convertible promissory notes issued by the Company on February 8, 1995 to
finance the acquisition of 51% of RCI. See "Item 1. Business - Acquisition
of RCI" in the Company's 1995 Form 10-K. Pursuant to the settlement
agreements with Mr. Nordlicht and the six other noteholders, the Company
issued a total of 74,917 new shares and registered a total of 138,417
outstanding and newly issued shares, including the 74,917 newly issued
settlement shares. The registration statement covering the prior
noteholders' outstanding shares and newly issued settlement shares issued
pursuant to the settlement agreements was declared effective by the
Securities and Exchange Commission on October 31, 1996. See also "Item 3.
Legal Proceedings - Claims by Prior Noteholders" in the Company's 1995 Form
10-K and "Part II, Item 1. Legal Proceedings - Claims By Prior Noteholders"
in the Company's Form 10-Q for the fiscal quarter ended September 30, 1996.
SETTLEMENT WITH PRICE INTERNATIONAL:
Price International, Inc. (PRI) asserted 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. In
August 1996, the Company entered into a settlement agreement with Price
International pursuant to which the Company agreed to lower the exercise price
of Price International's 75,000 warrants from $11.25 per share to $4.50 per
share, and to extend the expiration date of the warrants from November 15, 1997
until December 31, 1998. The Company also agreed to register the 75,000 shares
issuable upon the exercise of the warrants. Those shares were registered by the
Company in the registration statement which was declared effective by the
Securities and Exchange Commission on October 31, 1996. In consideration for
the modification to the terms and conditions of the warrants, Price
International agreed that (a) it would be required to exercise at least 25,000
of the warrants once the trading price
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<PAGE>
of the Company's stock averages $5.30 per share during any 30 day period, and
(b) it releases and forever discharges the Company from all claims it may have
had against the Company for events occurring prior to the date of the settlement
agreement. Price International has not yet exercised any of the warrants issued
to it in its settlement agreement with the Company.
POTENTIAL LAWSUITS:
There is no assurance that claims similar to those asserted in the pending class
action and related lawsuits, or other claims, will not be asserted against the
Company by new parties in the future. In this regard, potential plaintiffs have
from time to time orally asserted claims against the Company and its prior
directors. Several members of the class in the pending class action lawsuit
against the Company have opted out, and certain other class members are
attempting to opt out even though they did not file their elections in a timely
manner. See "Legal Proceedings - Class Action and Related Lawsuits." Sam
Schwartz may file claims against the Company for indemnification and payments
under his Severance Agreement with the Company. See "Item 1. Business -
Employees, Officers and Directors - Officers" in the Company's 1995 Form 10-K.
If such claims are filed as legal complaints, the Company will seek to have them
consolidated with other pending lawsuits, if appropriate, or will defend them
separately. From time to time, the Company is also 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. See "Part II, Item 1. Legal
Proceedings - Potential Lawsuits" in the Company's Form 10-Q for the fiscal
quarter ended September 30, 1996.
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, 1996.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
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, 1996:
Quarter High Low Last Sale
------- ---- --- ---------
4 5 2 7/8 2 31/32
3 5 5/16 4 3/16 4 5/16
2 6 1/4 4 3/8 4 3/4
1 6 3/16 4 3/8 5 3/8
YEAR ENDED DECEMBER 31, 1995:
Quarter High Low Last Sale
------- ---- --- ---------
4 11 1/4 2 1/2 4 9/16
29
<PAGE>
3 24 1/2 9 11
2 16 3/8 10 7/8 15
1 14 5/8 8 1/4 14 3/8
On March 21, 1997, the last sales price per share of the Company's common stock,
as reported by the NASDAQ Stock Market, was $2 15/16.
On March 21, 1997, the Company's 13,520,669 shares of common stock outstanding
were held by approximately 797 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.
Furthermore, the payment of dividends on the Company's common stock is subject
to the payment in full of all accrued but unpaid dividends on its outstanding
Series A 2% Convertible Preferred Stock. See "Item 1. Business - Issuance of
Convertible Preferred Stock." 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.")
ITEM 6. SELECTED FINANCIAL DATA
A summary of selected financial data for the five years ended December 31, 1996,
1995, 1994, 1993, and 1992, is presented below, and should be read in
conjunction with the audited consolidated financial statements for the years
ended December 31, 1996, 1995 and 1994 at "Item 8. Financial Statements and
Supplementary Data." Segment information is presented at "Item 1. Business
segment information" (In thousands, except per share amounts).
<TABLE>
<CAPTION>
FOR THE YEAR: 1996(2) 1995(2) 1994(2) 1993(1,2) 1992(2)
------ ------ ------ -------- -------
<S> <C> <C> <C> <C> <C>
Sales $106,905 $86,565 $46,815 $11,299 $5,535
Income (loss) before
income taxes,
minority interest and
extraordinary items (51,517) 957 4,000 (1,607) (2,265)
Income (loss) before
minority interest and
extraordinary items (43,705) 857 3,999 (1,607) (2,462)
Net Income (37,676) 1,366 4,071 (949) (2,021)
PER SHARE:
Net income (loss) before
extraordinary items (2.75) 0.11 0.42 (0.20) (0.34)
Net income (loss) (2.82) 0.11 0.42 (0.12) (0.28)
AT YEAR END:
Total assets $40,587 $74,106 $26,158 $8,666 $6,745
Long-term obligations 1,040 8,460 1 20 176
</TABLE>
- -------------------------
(1) 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)" in the
Company's 1995 Form 10-K.
(2) 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
OVERVIEW:
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<PAGE>
The following is management's discussion and analysis of certain significant
factors which have affected the results of operations and financial condition
of the Company during the period included in the accompanying financial
statements. This discussion should be read in conjunction with the financial
statements and associated notes. The discussion herein is qualified by
reference to the Introductory Note.
LIQUIDITY AND CAPITAL RESOURCES:
GENERAL - Overall, the Company achieved slightly positive cash flows of $0.6
million during 1996 resulting from positive cash flows from operating
activities ($3.0 million) and from financing activities ($5.2 million), which
were almost entirely offset by negative cash flows from investing activities
($7.6 million). The Company may need to raise additional capital in 1997 to
fund settlement costs relating to pending litigation or to make a business
acquisition, although specific needs have not yet been identified. Pursuant
to its management incentive agreement with NTC, the Company receives cash
distributions from NTC on a periodic basis, which are scheduled to be made
until December 31, 1997. See "Item 1. Business - National Telephone &
Communications, Inc. - Management Incentive Agreement." The Company does not
expect to have to make loans to RCI in 1997, and RCI's capital needs in the
short-term have been met through its private placement of preferred stock and
warrants in January 1997. See "Item 1. Business - The Recent Capitalization
of RCI." NTC is expected to have sufficient capital and financing to fund
its requirements in 1997, including funds required for the establishment of
its branch marketing offices, one of which is currently being built on leased
premises in Honolulu, Hawaii. There is no assurance that the cash
distributions by NTC to the Company or the cash flow from AutoNETWORK will be
sufficient to meet the Company's future funding requirements, or that RCI or
NTC will have sufficient capital or financing to meet their needs.
CASH FLOW FROM OPERATIONS - Net cash provided by operating activities of $3.0
million in 1996 was primarily attributable to the operating loss for 1996 ($37.7
million) and non-cash items principally from a devaluation of the Company's
investment in RCI ($39.1 million), depreciation and amortization ($4.3 million),
and changes in operating assets and liabilities ($11.7 million).
With regard to the collection of accounts receivable, the Company increased
its allowance for doubtful accounts to 13.2% of gross receivables as of
December 31, 1996 compared to 8.0% of gross receivables as of December 31,
1995. This increased provisioning reflects NTC's reserves for all
direct-billed Dial-one receivables which have been submitted to collection
agencies for collection and a modest improvement in collection rates for
LEC-billed and calling card products.
CASH FLOW FROM INVESTING - Net cash used in investing activities of $7.6 million
in 1996 was attributable principally to the Company's additions to property,
plant and equipment ($7.2 million) and additions to patents ($0.7 million).
CASH FLOW FROM FINANCING - Net cash provided by financing activities of $5.2
million in 1996 was attributable principally to changes in short-term debt ($2.9
million), proceeds from the issuance of preferred stock ($2.3 million) and
additions to long-term debt ($1.3 million), partially offset by reduction of
long-term debt ($1.8 million). In addition, positive cash flow resulted
primarily from RCI entering into various loan agreements to finance the building
of infrastructure to support its anticipated future sales growth. In September
1996, the Company also raised $0.4 million from the sale of 365 shares of Series
A 2% Convertible Preferred Stock, and raised an additional $2.1 million in
October 1996 through the placement of additional shares of Series A 2%
Convertible Preferred Stock. The Company paid aggregate referral fees equal to
approximately 5% of the capital raised from the placement of the Series A 2%
Convertible Preferred Stock. Cash paid to reduce debt totaled $1.2 million,
$0.0 million and $0.3 million during 1996, 1995 and 1994, respectively.
The Company had material commitments for capital expenditures of $1.5 million
in tenant improvements for its Honolulu, Hawaii office space at December 31,
1996, and expects to continue making improvements to the NTC headquarters
building and purchasing additional equipment commensurate with the expansion
of its business. During 1996, the Company had capital expenditures of $7.2
million for plant and equipment.
31
<PAGE>
At December 31, 1996, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $22.6 million, which are expected
to be available to offset taxable income for the next several years.
LITIGATION - The Company is subject to pending litigation and an investigation
by the Securities and Exchange Commission. Management is not yet able to
predict the impact of the pending litigation on its financial condition and
results of operations. Management does not believe that the investigation by
the Securities and 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:
FINANCIAL ANALYSIS-
SALES - For 1996, 1995 and 1994, the Company's net sales totaled
approximately $106.9 million, $86.6 million and $46.8 million, respectively.
The increases in sales in 1996 compared with 1995 and 1995 compared with
1994, were attributable principally to increases sales at NTC. The following
table summarizes the Company's year-to-year sales performance by subsidiary
and segment:
<TABLE>
<CAPTION>
$ in millions
-----------------------------------
Subsidiary Segment 1996 1995 1994
- ---------- ------- -----------------------------------
<S> <C> <C> <C>
NTC Telephone (telecommunications services) $83.7 $ 70.0 $ 34.2
NTC Telephone (marketing programs) 17.1 13.1 11.4
RCI Optical 4.7 2.0 --
AutoNETWORK Network 1.4 1.5 1.2
-----------------------------------
Total Company Net Sales $106.9 $ 86.6 $ 46.8
-----------------------------------
-----------------------------------
</TABLE>
NTC's net 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
83.0%, 84.2% and 75.0% of NTC's total revenues for 1996, 1995 and 1994,
respectively, with the remaining 17.0%, 15.8% and 25.0% generated by sales of
NTC's marketing programs for 1996, 1995 and 1994, respectively. Revenues from
the optical segment may decline in 1997 because the Company's percentage
ownership in RCI is lower than in 1995 and 1996, and machine orders at RCI
have declined while RCI implements design modifications and improvements. See
"Item 1. Business--Rapid Cast, Inc.--Technical Overview of the Rapid Cast
LenSystem."
COST OF SALES - Total Company cost of sales for 1996, 1995 and 1994, were
approximately $68.6 million, $57.9 million and $31.2 million, respectively.
The increases in cost of sales were attributed principally to the increase in
carrier costs associated with increased telephone service sales by NTC and a
volume related rise in RCI cost of sales. Gross margin when stated as a
percentage of net sales was 35.9%, 33.1% and 33.3% for 1996, 1995 and 1994,
respectively. The increase in gross margin in 1996 was attributable
principally to reductions in NTC's telecommunication service cost of sales
resulting from: 1) lower long-distance transport costs from NTC's carriers
and, 2) continuing improvements in the mix of sales in the higher profit
product lines. The following table summarizes the Company's year-to-year
changes in three major cost components:
<TABLE>
<CAPTION>
$ in millions
-----------------------------------
1996 1995 1994
-----------------------------------
<S> <C> <C> <C>
Carrier costs for NTC's long distance telephone service $44.7 $ 40.4 $ 21.3
Commissions paid to NTC independent sales reps 18.0 14.2 7.7
All other costs of sales 5.9 3.3 2.2
-----------------------------------
Total Company Cost of Sales $68.6 $ 57.9 $ 31.2
-----------------------------------
-----------------------------------
</TABLE>
32
<PAGE>
NTC's total commission expenses for 1996, 1995 and 1994, were $18.0 million,
$14.2 million and $7.7 million, respectively. The increases were attributed
principally to the residual monthly sales commissions and various bonuses and
overrides paid to sales representatives on increased marketing and telephone
service revenues.
The third cost component shown in the table above is "all other costs of sales"
which represents: (1) NTC's costs of producing sales materials for its
independent sales representatives, (2) RCI's costs of producing optical systems
and ancillary goods, and (3) AutoNETWORK costs of providing communications
network products and services.
GENERAL AND ADMINISTRATIVE - Total general and administrative costs for 1996,
1995 and 1994, were approximately $36.9 million, $19.8 million and $9.4
million, respectively. General and administrative expenses represented
34.57%, 22.9% and 20.2% of net sales in 1996, 1995 and 1994, respectively.
General and administrative costs generally include the costs of employee
salaries, fringe benefits, supplies, and related support costs which are
required in order to provide such operating functions as customer service,
billing, marketing, product development, information systems, collections of
accounts receivable, and accounting.
NTC's general and administrative costs increased to 24.5% of sales in 1996 from
20.3% of sales in 1995. This increase was due principally to: (1) increases in
fees paid to local exchange carriers (LEC's) to process NTC's billing and
collection of its LEC-billed long distance telephone service, and (2) increases
in compensation and fringe benefits expended as NTC continues to build
infrastructure to support anticipated future sales growth. RCI's general and
administrative costs continue to reflect the startup nature of its operations.
DEPRECIATION AND AMORTIZATION - The Company's depreciation and amortization
expense totaled $2.0 million, $1.0 million and $0.4 million for 1996, 1995 and
1994, respectively. These increases were caused by the continuing 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 - The Company's bad debt expense totaled $6.1 million, $4.1
million and $1.8 million for 1996, 1995 and 1994, respectively. Bad debt
expense represented 5.7%, 4.8% and 3.8% of net sales in 1996, 1995 and 1994,
respectively. The increase in bad debt was caused primarily by increased
provisioning of NTC's LEC billed receivables which currently carry a higher
than estimated bad debt provision and direct billed collection agency
write-offs.
OTHER (INCOME) AND EXPENSE - The Company's other (income) and expense totaled
$3.4 million, $1.0 million and $(0.3) million for 1996, 1995 and 1994,
respectively. The increase in 1996 was attributable in large part to
settlement costs of $2.0 million associated with claims by officers against
the Company. The increase in 1995 was attributed principally to: (1) a $0.4
million settlement with convertible noteholders relating to the acquisition
of RCI, (2) a $0.2 million settlement with a former Company officer, and (3)
a $0.3 million write-off of marketable securities by NTC.
CHARGE FOR ASSET IMPAIRMENT - The charge for asset impairment totaled $39.1
million for 1996 for the devaluation of the Company's investment in RCI. There
was no impairment in 1995 and 1994.
MINORITY INTEREST - Effective July 1, 1995, when it became apparent that
control of Incomnet was "other than temporary," RCI's operating results were
presented on a consolidated basis, with 49% of its losses charged to minority
interest.
NET INCOME (LOSS) - The Company's net income (loss) totaled $(37.7) million,
$1.4 million and $4.1 million for 1996, 1995 and 1994, respectively. Net income
(loss) represented (35.2)%, 1.6% and 8.7% of net sales for 1996, 1995 and 1994,
respectively. The decreases were attributed principally to: (1) higher losses
at RCI in 1996 due to the devaluation of patent rights and significantly
increased operating costs incurred to build infrastructure for future potential
sales growth, and (2) higher losses at the Company's headquarters which were
caused by the establishment of reserves for devaluation of the Company's
investment in RCI and for settlement costs.
EMPLOYMENT - Employment of the Company totaled 288 at December 31, 1996, not
including independent sales representatives, who are classified as independent
sales representatives and not employees of the Company.
33
<PAGE>
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 10-K" in this
document, and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
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 1997 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by May 31,
1997, 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 1997 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by May 31,
1997, 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 1997 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by May 31,
1997, 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 1997 Annual Meeting of Shareholders to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A by May 31,
1997, and is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K
INDEX TO FINANCIAL STATEMENTS:
Page
----
Report of Independent Auditors..............................................37
Consolidated balance sheet at December 31, 1996 and 1995....................38
Consolidated statement of operations for the years ended December 31,
1996, 1995 and 1994.........................................................39
Consolidated statement of cash flows for the years ended December 31,
1996, 1995 and 1994.........................................................40
Consolidated statement of shareholders' equity for the years ended
December 31, 1996, 1995 and 1994............................................41
34
<PAGE>
Notes to consolidated financial statements..................................42
Schedule II - Valuation and qualifying accounts at December 31, 1996
and 1995....................................................................55
All other schedules are omitted as the required information is not present or is
not present in amounts sufficient to require submission of the schedule, or
because the information required is included in the consolidated financial
statements or notes thereto.
INDEX TO EXHIBITS:
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
- ----------- -----------
3.1 Certificate of Determination for Series A 2% Convertible Preferred
Stock. (Incorporated by reference from Incomnet, Inc.'s
Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on November 22, 1996).
4.1 Form of Warrant to Purchase 75,000 Shares of Incomnet, Inc.
(Incorporated by reference from the Company's Registration
Statement on Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996).
4.2 Form of Warrant to Purchase 510,000 Shares of RCI Common Stock with
Registration Rights Agreement, dated April 19, 1996. (Incorporated
by reference from the Company's Registration Statement on Form S-3
filed with the Securities and Exchange Commission on May 10, 1996).
4.3 Form of Warrant to Purchase RCI Common Stock, dated February 8,
1995. (Incorporated by reference from the Company's Registration
Statement on Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996).
4.4 Form of Warrant to Purchase 360,000 Shares of Incomnet, Inc.
(Incorporated by reference from Incomnet, Inc.'s Pre-Effective
Amendment Number One to the Registration Statement on Form S-3
filed with the Securities and Exchange Commission on March 24,
1997).
4.5 Form of Warrant to Purchase 12,500 Shares of Incomnet, Inc.
(Incorporated by reference from Incomnet, Inc.'s Pre-Effective
Amendment Number One to the Registration Statement on Form S-3
filed with the Securities and Exchange Commission on
March 24, 1997).
10.1 Employment Agreement with James Quandt, dated January 6, 1997.
(Incorporated by reference from Incomnet, Inc.'s Pre-Effective
Amendment Number One to the Registration Statement on Form S-3
filed with the Securities and Exchange Commission on March 24,
1997).
10.2 Amended and Restated Management Incentive Agreement Between NTC and
Incomnet, Inc., dated January 28, 1997. (Incorporated by reference
from Incomnet, Inc.'s Pre-Effective Amendment Number One to the
Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on March 24, 1997).
10.3 Settlement Agreements With Prior Noteholders. (Incorporated by
reference from the Company's Registration Statement on Form S-3
filed with the Securities and Exchange Commission on May 10, 1996).
35
<PAGE>
10.4 Form of 8% Convertible Note Issued by RCI in January 1996.
(Incorporated by reference from the Company's Registration
Statement on Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996).
10.5 Form of Short-Term 10% Note Issued by RCI in April 1996.
(Incorporated by reference from the Company's Registration
Statement on Form S-3 filed with the Securities and Exchange
Commission on May 10, 1996).
10.6 Amended Carrier Switched Services Agreement with Wiltel, Inc. dated
June 17, 1996. (Incorporated by reference from Incomnet's
Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on May 10, 1996 and declared effective on
October 31, 1996, or incorporated by reference from the Company's
filings with the Securities and Exchange Commission pursuant to the
Securities Exchange Act of 1934, as amended. Certain information
has been deleted from this agreement pursuant to a request for
confidential treatment pursuant to Rule 406).
10.7 Settlement Agreement Between Joel W. Greenberg and Incomnet, Inc.
(Incorporated by reference from the Company's Report on Form 8-K,
dated June 7, 1996, relating to the settlement agreement with Joel
W. Greenberg and his resignation as a director of the Company).
10.8 Form of Registration Rights Agreement Between Incomnet, Inc. and
Purchasers of Series A Convertible Preferred Stock. (Incorporated
by reference from Incomnet's Registration Statement on Form S-3
filed with the Securities and Exchange Commission on May 10, 1996
and declared effective on October 31, 1996, or incorporated by
reference from the Company's filings with the Securities and
Exchange Commission pursuant to the Securities Exchange Act of
1934, as amended).
10.9 Form of Purchase Agreement for the Series A 2% Convertible
Preferred Stock. (Incorporated by reference from Incomnet's
Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on May 10, 1996 and declared effective on
October 31, 1996, or incorporated by reference from the Company's
filings with the Securities and Exchange Commission pursuant to
the Securities Exchange Act of 1934, as amended).
10.10 Management Incentive Agreement with NTC, dated October 14, 1996.
(Incorporated by reference from Incomnet, Inc.'s Registration
Statement on Form S-3 filed with the Securities and Exchange
Commission on November 22, 1996).
10.11 Settlement Agreements With Edward Jacobs and Jerry Ballah, dated
November 14, 1996. (Incorporated by reference from Incomnet, Inc.'s
Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on November 22, 1996).
10.12 Shareholders Agreement for Rapid Cast, Inc., dated January 16,
1997. (Incorporated by reference from Incomnet, Inc.'s
Pre-Effective Amendment Number One to the Registration Statement on
Form S-3 filed with the Securities and Exchange Commission on March
24, 1997).
10.13 Registration Rights Agreement for Rapid Cast, Inc., dated January
16, 1997. (Incorporated by reference from Incomnet, Inc.'s
Pre-Effective Amendment Number One to the Registration Statement on
Form S-3 filed with the Securities and Exchange Commission on March
24, 1997).
10.14 Settlement Agreement and Mutual Release Between Incomnet, Inc. and
the RCI Parties, dated January 9, 1996. (Incorporated by reference
from Incomnet, Inc.'s Pre-Effective Amendment Number One to the
Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on March 24, 1997).
10.15 Lease Agreement By NTC for space in Honolulu, Hawaii. *
10.16 Credit Agreement dated March 27, 1997 between National Telephone
& Communication, Inc. and First Bank & Trust, Irvine Regional
office. *
21 Subsidiaries of the Registrant *
36
<PAGE>
23 Consent of independent auditors *
27 Financial data schedule (Article 5 of regulations S-X) *
*Previously filed on Form 10-K filed with the Securities and
Exchange Commission on April 15, 1997.
REPORTS ON FORM 8-K, FILED IN 1996
20.1 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.
20.2 Report on Form 8-K - Settlement Agreement with Joel W. Greenberg.
20.3 Report on Form 8-K - Gerald Katell's Resignation from the Board of
Directors dated August 8, 1996 and filed on August 15, 1996.
20.4 Report on Form 8-K - Appointment of Dr. Howard Silverman as
director dated January 20, 1997 and filed on January 28, 1997.
37
<PAGE>
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: July 8, 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 Chairman of the Board of Directors July 8, 1997
MELVYN REZNICK
/s/ ALBERT MILSTEIN Director July 8, 1997
- -------------------
ALBERT MILSTEIN
/s/ Dr. HOWARD SILVERMAN Director July 8, 1997
- ------------------------
Dr. HOWARD SILVERMAN
/s/ NANCY ZIVITZ Director July 8, 1997
- ----------------
NANCY ZIVITZ
</TABLE>
38
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Incomnet, Inc.
We have audited the consolidated balance sheet of Incomnet, Inc. and
subsidiaries as of December 31, 1996 and 1995 and the related consolidated
statements of operations, shareholders' equity and cash flow for each of the
three years in the period ended December 31, 1996, 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 and schedule based on our audits.
We conducted our audits 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 includes 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Incomnet, Inc. at December 31, 1996 and 1995 and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
As discussed in Note 11 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 the accompanying financial statements.
/s/ Stonefield Josephson
ACCOUNTANCY CORPORATION
Santa Monica, California
March 27, 1997
39
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
December 31,
------------
ASSETS 1996 1995
---- ----
<S> <C> <C>
Current assets:
Cash & cash equivalents $ 2,214 $ 1,645
Accounts receivable, including $267 and $542 due from related
party at December 31, 1996 and 1995 and less allowance for
doubtful accounts of $1,993 at December 31, 1996 and $1,063
at December 31, 1995 13,137 12,177
Notes receivable - current portion 323 103
Notes receivable from officers & shareholders, net of reserves
of $209 438 863
Inventories 2,760 1,647
Other current assets 1,332 1,197
---------- ----------
Total current assets 20,204 17,632
Property, plant and equipment, at cost, net 14,357 9,146
Patent rights, net 1,241 41,689
Goodwill, net 4,542 4,839
Investments, notes receivable and other assets 243 800
---------- ----------
Total assets $40,587 $74,106
---------- ----------
---------- ----------
LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 14,746 $ 8,784
Accrued expenses 8,217 3,687
Current portion of notes payable 3,918 2,531
Deferred income 4,040 1,190
---------- ----------
Total current liabilities 30,921 16,192
Deferred tax liability, net -- 8,449
Other long-term liabilities 1,040 11
Commitments (Note 12) -- --
Minority Interest -- 6,906
Shareholders' equity:
Common stock, no par value; 20,000,000 shares
authorized; 13,369,681 shares issued and outstanding
at December 31, 1996 and 13,262,648 shares at
December 31, 1995 61,320 60,884
Preferred stock, no par value; 100,000 shares authorized;
2,440 shares issued and outstanding at December 31, 1996 2,355 --
Treasury stock (5,492) (5,492)
Accumulated deficit (49,557) (12,844)
---------- ----------
Total shareholders' equity 8,626 42,548
---------- ----------
Total liabilities, minority interest & shareholders' equity $ 40,587 $ 74,106
40
<PAGE>
---------- ----------
---------- ----------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
41
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
NET SALES $106,905 $86,565 $46,815
---------- ---------- ----------
OPERATING COSTS & EXPENSES:
Cost of sales 68,562 57,948 31,221
General & administrative 36,886 19,793 9,438
Depreciation & amortization 2,013 1,007 444
Bad debt expense 6,051 4,125 1,789
Total acquisition costs & expenses 2,334 1,625 265
Charge for asset impairment 39,147 -- --
Other (income) expense 3,429 1,002 (342)
---------- ---------- ----------
Total operating costs and expenses 158,422 85,500 42,815
---------- ---------- ----------
Operating income (loss) (51,517) 1,065 4,000
INCOME TAXES (BENEFIT) (7,812) 111 1
---------- ---------- ----------
Income (loss) before minority interest
and extraordinary items (43,705) 954 3,999
RCI acquisition - equity in profit (loss) of
unconsolidated subsidiary, net of tax -- (97) --
Cumulative effect of accounting change on years
prior to 1996, net of tax of $10 (Note 16) (877) -- --
MINORITY INTEREST 6,906 509 --
EXTRAORDINARY ITEM:
Gain (loss) on settlement with creditors -- -- 72
---------- ---------- ----------
Net income (loss) $ (37,676) $ 1,366 $ 4,071
---------- ---------- ----------
---------- ---------- ----------
INCOME (LOSS) PER COMMON SHARE
AND COMMON SHARE EQUIVALENTS:
Net income (loss) before extraordinary items $ (2.75) $ 0.11 $ 0.42
Cumulative effect of accounting change (0.07) -- --
---------- ---------- ----------
Net income (loss) per share $ (2.82) $ 0.11 $ 0.42
---------- ---------- ----------
---------- ---------- ----------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES FOR
1996 AND COMMON SHARE AND COMMON SHARE
EQUIVALENTS OUTSTANDING FOR 1995 13,370 12,706 9,593
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
42
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
After tax profit (loss) $(37,676) $ 1,366 $ 4,071
Depreciation & amortization - operations 2,013 1,413 444
Depreciation & amortization - acquisitions 2,334 651 121
Write-off of patent rights 39,147 -- --
Deferred income taxes (8,449) -- --
Minority interest (6,906) (8,227) --
Other non-cash (income) loss 877 358 (54)
Changes in operating assets and liabilities:
Accounts receivable (960) (2,784) (6,718)
Notes receivable - current portion (220) (103) --
Notes receivable - due from officers and shareholders 425 (863) --
Inventories (1,113) (401) 42
Other current assets 171 (1,000) (82)
Accounts payable 5,962 2,571 3,316
Accrued expenses 4,540 1,834 150
Deferred income 2,848 (896) 1,649
---------- ---------- ----------
Net cash provided (used) by operating activities 2,993 (6,081) 2,939
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (7,224) (7,389) (1,694)
Additions to patents (717) (21,002) --
(Increase) decrease in investments 281 16 (263)
---------- ---------- ----------
Net cash used in investing activities (7,660) (28,375) (1,957)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (decrease) in short-term debt 2,904 1,306 (265)
Additions to long-term debt 1,274 -- --
Reduction of long-term debt (1,763) -- --
Sale of preferred stock, net 2,355 -- --
Issuance of common stock, net 436 29,508 8,069
Treasury stock -- (4,827) 465
Other, net 30 419 39
---------- ---------- ----------
Net cash provided by financing activities 5,236 26,406 8,308
---------- ---------- ----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 569 (8,050) 9,290
Cash and cash equivalents at beginning of year 1,645 9,695 405
---------- ---------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,214 $ 1,645 $ 9,695
---------- ---------- ----------
---------- ---------- ----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest $ 181 $ 153 $ 1
Income taxes 635 574 1
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
43
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT
SHARES DATA)
<TABLE>
<CAPTION>
Common Stock Common Stock Preferred Treasury Accumulated
Shares Amount Stock Stock Deficit Total
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1993 9,061,382 $22,176 -- -- $(18,247) $3,929
Common stock issued upon
exercise of warrants 1,308,833 8,545 -- -- -- 8,545
Common stock issued under
private placement 100,000 500 -- -- -- 500
Common stock issued in exchange
for NTC shares 82,639 155 -- -- -- 155
Repurchase of treasury shares (70,000) -- -- (665) -- (665)
Net income -- -- -- -- 4,071 4,071
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1994 10,482,854 $31,376 -- $ (665) $(14,176) $16,535
Common stock issued upon
exercise of warrants 489,582 4,343 -- -- -- 4,343
Common stock issued under
private placement 157,500 1,890 -- -- -- 1,890
Common stock issued upon
conversion of note 2,300,000 22,664 -- -- -- 22,664
Common stock issued in exchange
for NTC shares 253,712 507 -- -- -- 507
Repurchase of treasury shares (451,000) -- (5,085) -- (5,085)
Treasury shares sold 30,000 -- 362 -- 362
Change in valuation of
marketable securities -- -- -- -- (34) (34)
Other -- 104 -- (104) -- --
Net income -- -- -- -- 1,366 1,366
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1995 13,262,648 $60,884 -- $(5,492) $(12,844) $42,548
Common stock issued upon
settlement of litigation 107,033 436 -- -- -- 436
Issuance of preferred stock, net
(2,440 shares issued) -- -- 2,355 -- -- 2,355
Cumulative effect -- -- -- -- 877 877
Change in valuation of marketable
securities 86 86
Net loss -- -- -- -- (37,676) (37,676)
- ------------------------------------------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1996 13,369,681 $61,320 $2,355 $(5,492) $(49,557) $8,626
</TABLE>
See accompanying "Notes to Consolidated Financial Statements."
44
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
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 when control became other than temporary. In the first quarter of 1997,
outside equity investments in RCI (see Note 17) reduced Incomnet's ownership
interest to less than 50%, thereby requiring the equity method of accounting for
RCI in 1997. All significant intercompany accounts and transactions have been
eliminated in consolidation. Certain reclassifications have been made to prior
year amounts to conform to current year presentation.
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 amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. Significant estimates made in preparing the consolidated financial
statements include the allowance for doubtful accounts, deferred marketing
reserve, income tax valuation allowance, investment reserves, litigation
settlement costs and future undiscounted cash flows used in the analysis of
the impairment of long-lived assets.
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 income when the cash is
received, and recognized as income as the telephone service is utilized.
Deferred income is carried on the balance sheet as an accrued liability. Total
1996 long distance telephone service sales totaled $83.7 million.
(2) NTC's marketing-related revenues are derived from programs and material
sold to the Company's base of independent sales representatives, including forms
and supplies, fees for representative and certified trainer renewals, and the
Company's Certified Trainer, Independent Representative and Long Distance
University programs. The Company requires that all such services and materials
be paid at the time of purchase. Revenues from marketing-related materials, net
of amounts deferred for future services to be provided to the representatives,
are booked as cash sales when the revenues are received. A portion of the
revenues from marketing-related programs and materials are deferred and
recognized over a twelve month period, to accrue its obligation to provide
customer support to its independent sales representatives. For the fiscal year
ended December 31, 1996, marketing sales totaled $17.1 million.
(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 fiscal year ended December 31,
1996, optical product sales totaled $4.7 million.
(4) The Company's network service revenues are recognized as sales as the
service is delivered. Total 1996 network service sales totaled $1.4 million.
CONCENTRATION OF CREDIT RISK - 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.
INCOME TAXES - The Company recognizes the amount of current and deferred taxes
payable or refundable at the date of the financial statements as a result of all
events that have been recognized in the financial statements and as measured by
the provisions of enacted laws. Deferred income taxes result from temporary
differences in the basis of assets and liabilities reported for financial
statement and income tax purposes.
45
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
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 estimated useful lives ranging from five to
ten 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 estimated useful
lives ranging from three to ten years.
LEASEHOLD IMPROVEMENTS - All leasehold improvements are stated at cost and are
amortized using the straight-line method over the expected lease term.
NET INCOME (LOSS) PER SHARE - Net income (loss) per common share is based on
the weighted average number of common shares for 1996 and common shares and
common share equivalents for 1995. Common share equivalents have been
excluded in 1994 because their effect was immaterial. The Financial
Accounting Standards Board has issued a new statement recently which requires
companies to report "basic" earnings per share, which will exclude options,
warrants and other convertible securities. The accounting and disclosure
requirements of this statement are effective for financial statements for
fiscal years beginning after December 15, 1997, with earlier adoption
encouraged. Management does not believe that the adoption of this
pronouncement will have a material impact on the financial statements.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of cash-on-hand
and short-term certificates of deposit.
FAIR VALUES OF FINANCIAL INSTRUMENTS - Unless otherwise indicated, the fair
values of all reported assets and liabilities which represent financial
instruments (none of which are held for trading purposes) approximate the
carrying values of such amounts.
INVENTORIES - Inventory primarily consists of completed optical machines at
the RCI subsidiary and is valued at the lower of cost (weighted average
method) or market.
INVESTMENTS - Marketable securities are considered available-for-sale and are
stated at fair market value. The excess of fair market value over cost would be
included as a separate component of Shareholders' Equity. During the fourth
quarter of 1996, the Company deemed these investments permanently impaired and
recorded a loss of $0.3 million to their estimated realizable value.
INTANGIBLE ASSETS - Goodwill, representing the excess of purchase price over the
fair value of the net assets of NTC, is amortized on a straight-line method
basis over its estimated useful life of twenty years. Accumulated amortization
at December 31, 1996 and 1995 was $1.2 million and $0.9 million, respectively.
Patent rights are stated at cost since the date of acquisition of RCI, and are
amortized on a straight-line basis over seventeen years (see below).
Accumulated amortization at December 31, 1996 and 1995 was $9.9 million and
$0.04 million, respectively.
LONG-LIVED ASSETS - The Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS No.
121), in March 1995. In accordance with SFAS No. 121, the Company reviewed
its long-lived assets and certain identifiable intangibles for impairment.
Patent rights obtained in the February 1995 acquisition of a controlling
interest in RCI were evaluated by management and deemed to have been
impaired. There was a significant decrease in market value of RCI as
evidenced by an outside equity investment in January of 1997, the change in
the market acceptance of products which were based on those patent rights,
and actual and forecasted operating losses and cash flow losses which were
significantly greater than originally anticipated. Accordingly, management
estimated the fair value of the patent rights acquired in the RCI
acquisition, based upon, among other valuation techniques, the present value
of estimated expected cash flows.
The carrying value of the patent rights exceeded management's estimates of the
discounted present value of net cash flows to be derived therefrom, and a
writedown of approximately $39.1 million and elimination of a related deferred
tax liability of $8.5 million.
46
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
STOCK OPTION PLANS - The Company has elected to follow Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and
related Interpretations in accounting for the employee stock options, rather
than adopt the alternative fair value accounting provided under The Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation."
2. FUNDING OF MARKETING COMMISSIONS AND DEFERRED INCOME:
The Company's subsidiary, NTC, maintains a separate bank account for the payment
of marketing commissions. Funding of this account is adjusted regularly to
provide for management's estimates of required reserve balances. NTC estimates
the total commissions owed to active independent representatives ("IR Earned
Compensation") each week for all monies collected that week due to the efforts
of those active independent representatives. All IR Earned Compensation is then
paid to the independent representatives, when due, directly out of the separate
bank account.
3. RELATED PARTY TRANSACTIONS:
Notes receivable from officers and shareholders arise from aggregate loans of
$0.6 million made to three individuals in connection with the exercise of their
options to purchase the Company's common stock. The notes are non-interest
bearing and 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 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 $0.3 million and $0.5 million
at December 31, 1996 and 1995, respectively, due from companies controlled by an
individual who is an Incomnet shareholder and a founding shareholder of RCI.
On August 15, 1996, RCI and one of its shareholders/officers entered into an
agreement whereby (1) certain contributed property received from the
shareholder/officer valued at $250,000 reduced the amount of indebtedness to
RCI relating to the purchase of equipment and supplies by the
shareholder/officer and certain other entities controlled by the
shareholder/officer from RCI approximating $445,000, with a remaining balance
due RCI of approximately $195,000, (2) the remaining balance due to RCI
described in (1) will be used to reduce the amount of indebtedness to the
shareholder/officer by the Company of approximately $513,000 (including
accrued interest through the date of the agreement), with a remaining balance
due to the shareholder/officer of approximately $318,000 as of the date of
the agreement, and (3) in connection with RCI terminating a "Purchase
Commitment Agreement" with the shareholder/officer and certain other entities
controlled by the shareholder/officer, the shareholder/officer surrendered
142,222 shares of common stock (representing approximately 4% of the
shareholder/officer's holdings in RCI) with an estimated fair value of
$448,000.
4. 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 approximately $42.0 million, $8.0 million of which was written off
in the third quarter ending September 30, 1996, and the remaining balance of
$31.1 million of which was written off in the fourth quarter ending December
31, 1996. The remaining balance is 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
47
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
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.
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, at cost, including capitalized lease assets,
consist of the following:
(IN THOUSANDS) December 31,
------------------------
1996 1995
---- ----
Computer hardware and software $ 7,100 $ 5,113
Furniture and office equipment 3,456 1,878
Leasehold improvements 7,595 4,134
------ -----
18,151 11,125
Less accumulated depreciation 3,794 1,979
------ -----
$14,357 $9,146
------ -----
------ -----
6. PATENT RIGHTS FROM ACQUISITION OF RCI
During the third and fourth quarters of 1996, the Company evaluated the carrying
value of its patent rights in comparison with management's estimates of
discounted net present values of cash flows from those patents, and provided
impairment losses of approximately $8.0 million and $31.1 million, respectively.
7. INVESTMENTS, NOTES RECEIVABLE AND OTHER ASSETS
Investments, notes receivable and other assets consist of the following:
(IN THOUSANDS) December 31,
-------------------------
1996 1995
---- ----
Marketable securities available-for-sale $ 35 $321
Notes receivable -- 155
Other assets 208 324
--- ---
$243 $800
--- ---
--- ---
Marketable securities available-for-sale consist of shares of common stocks
of publicly traded companies. During the fourth quarter of 1996, the Company
deemed these investments permanently impaired and recorded a loss of $0.3
million to their estimated realizable value.
Notes receivable are carried at lower of amortized cost or net realizable
value. Other assets consist primarily of deposits.
8. NOTES PAYABLE:
Notes payable consists of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS) December 31,
--------------
1996 1995
---- ----
<S> <C> <C>
Current Portion of Notes Payable:
Notes payable to founding shareholders of RCI,
interest at 7%, due in July 1996, $1,091 of which was
exchanged for RCI shares in January 1997, balance repaid $1,205 $1,518
Notes payable to certain shareholders, officers and director
</TABLE>
48
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
<TABLE>
<S> <C> <C>
of RCI, interest at 10%, $543 repaid in January 1997 from the
proceeds of private placement (see Note 17) balances exchanged
for equity shares of RCI 1,587 --
Revolving line of credit of RCI, interest at bank reference
rate (approximately 10% at December 31, 1996 and 1995)
repaid in January 1997 from the proceeds of private placement 500 490
Convertible notes payable to certain shareholders and officers
of RCI, interest at 8%, exchanged for equity shares of RCI
in January of 1997 322 --
Capitalized lease obligations, payable in varying installments
to 2000 288 --
Note payable in connection with financing of RCI
acquisition, interest at 8%, repaid in January 1996 -- 500
Miscellaneous 16 23
-------- -------
Total current portion of notes payable $3,918 $2,531
-------- -------
Long Term Portion of Notes Payable:
Capitalized lease obligations, payable in varying installments
to 2000 $1,002 $ --
Miscellaneous 38 11
-------- -------
Total long term portion of notes payable $1,040 $ 11
-------- -------
Total notes payable $4,958 $2,542
-------- -------
-------- -------
</TABLE>
Interest paid for 1996 and 1995 was approximately $0.2 million in each year and
none in 1994. Interest resulted primarily from interest paid on Notes used to
acquire RCI and from interest paid by RCI on its bank revolving line of credit.
9. INCOME TAXES:
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:
(IN THOUSANDS)
December 31,
------------------------
1996 1995
-------- ---------
Deferred tax assets
Allowance for doubtful accounts $ 3,205 $ 1,360
Nondeductible reserves 67 --
Net operating loss carryforwards 11,526 7,503
Other -- 113
49
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
-------- --------
Subtotal 14,798 8,976
-------- --------
Deferred tax liabilities
Property and equipment, principally
due to differences in depreciation 1,847 676
Patent rights -- 8,449
-------- --------
Subtotal 1,847 9,125
-------- --------
Total 12,951 (149)
Less valuation allowance (12,951) (8,300)
-------- --------
Net deferred tax liability $ -- $ 8,449
-------- --------
-------- --------
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 $0.4 million and deferred tax liability-noncurrent of $8.4 million.
The following is a reconciliation of the federal statutory tax rate and the
effective tax rate:
1996 1995
---- ----
Federal statutory tax rate (34.0)% 34.0%
Goodwill 0.6 9.9
Loss producing no current tax benefit 17.0 --
State taxes, net of federal benefits -- 38.2
Benefit from net operating loss carryforward -- (71.5)
Other, net 1.2 --
-------- --------
Effective tax rate (15.2)% 10.6%
-------- --------
-------- --------
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, 1996, Incomnet had available net operating loss carryforwards
for federal income tax purposes of approximately $22,600,000, expiring in
various years between 2000 and 2011, and Rapid Cast had a carryforward of
approximately $6,028,000 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.
10. SHAREHOLDERS' EQUITY:
STOCK OPTIONS - In July 1996, the Company's shareholders adopted a stock option
plan that replaced a previous plan adopted by shareholders in 1994. The plan is
for executives at the Company's parent company level. The plan allows for the
issuance of up to 1,500,000 shares at an exercise price equal to the price of
the last sale of the Company's common stock on the date of issuance. The
Company's subsidiaries have adopted their own separate stock option plans to be
implemented when those companies become publicly traded. To date, the Company
has issued 685,000 stock options that are now vested and can be exercised at
prices from $4.25 to $4.87 up to May 31, 2002. The Company has also issued
300,000 stock options at prices from $4.37 to $4.85 that will vest when the
Company's RCI subsidiary reaches certain financial goals. These options have not
yet vested.
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
50
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
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 $15.0 million in pre-tax profits during any continuous four audited
quarterly periods until December 31, 1997.
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations in accounting for
its plans. Accordingly, no compensation expense has been recognized for its
stock-based compensation plans. Had compensation cost for the Company's
stock option plans been determined based upon the fair value at the grant
date for awards under these plans consistent with the methodology prescribed
under SFAS 123, the Company's net loss and loss per share would have been
increased to the pro forma amounts indicated below:
(IN THOUSANDS)
1996
----
Net loss - reported $(37,676)
------
Net loss - pro forma $(37,940)
------
Loss per share - reported $ (2.82)
----
Loss per share - pro forma $ (2.83)
----
The fair value of each option grant in 1996 and 1995 was estimated on the date
of the grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions: divided yield of 0.0%; expected annual volatility
of 66.1%; risk-free interest rate of 6.0% and expected lives of 3 years for
options. The weighted average per share fair value of options granted in 1996
was approximately $2.50. The pro forma amounts shown for the impact of SFAS 123
are not necessarily indicative of future results because of the phase in rules
and differences in number of grants, stock price and assumptions for future
years.
WARRANTS - Since 1994, the Company has issued warrants to purchase the Company's
common stock to key employees, directors or other individuals or organizations
as follows:
51
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
<TABLE>
<CAPTION>
Dollar Canceled or
Issued Number Price Exercised Amount Expired Expiration
------ ------ ----- --------- ------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
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
1/10/95 500,000 10.25 500,000
1/10/95 500,000 11.25 500,000
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 (1) 8/29/97
8/29/95 35,000 4.875 (1) 8/29/97
8/29/95 25,000 4.875 (1) 25,000
12/20/95 2,000 5.125 (1) 2,000
12/20/95 3,000 5.125 (1) 3,000
12/20/95 1,000 5.125 (1) 1,000
12/20/95 1,000 5.125 (1) 1,000
5/9/96 100,000 6.00 (2) 5/9/01
5/9/96 50,000 7.00 (2) 5/9/01
5/9/96 75,000 5.37 (2) 12/31/98
12/9/96 360,000 3.75 (2) 12/9/99
12/17/96 12,500 2.94 (2) 12/17/01
--------- --------- ----------- ---------
4,269,500 1,245,000 $10,678,750 2,182,000
</TABLE>
(1) The exercise price on these warrants 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.
(2) These warrants were issued pursuant to legal settlements in 1996.
Since 1994, the Company has issued warrants to purchase a total of 4,269,500
shares of the Company's common stock. At March 21, 1997, warrants to purchase
1,245,000 of those shares have been exercised bringing the Company $10,678,750;
warrants to purchase 2,182,000 shares have been canceled or have expired; and
warrants remain outstanding to purchase 767,500 shares of the Company's common
stock at prices ranging from $2.94 to $8.50.
WARRANT - OPTION TABLE - The number and weighted average exercise prices of
options and warrants from each of the three years ended December 31, 1996,
1995 and 1994, respectively, are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
---- ---- ----
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
NUMBER PRICE NUMBER PRICE NUMBER PRICE
------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of the year.......489,582 $5.00 2,609,582 $ 8.94 3,872,000 $10.72
Outstanding at
end of the year...........2,609,582 8.94 3,872,000 10.72 5,029,500 9.30
Exercisable at
end of the year...........2,609,582 8.94 3,872,000 10.72 4,729,500 10.26
Granted during the year....2,620,000 9.30 2,252,000 11.81 1,402,500 4.64
Exercised during the year....500,000 7.00 989,582 8.49 0 -
Forfeited/expired
during the year...................0 - 0 - 245,000 5.00
The range of exercise price of outstanding options and warrants at December 31, 1996 is $4.13
to $14.00, and the average contractual life is approximately three years.
</TABLE>
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, 1997, 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 (IN THOUSANDS)
-------------- --------------- ---------------------
1994 70,000 $ 665
1995 416,000 4,827
--------------- ---------------------
486,000 $5,492
--------------- ---------------------
--------------- ---------------------
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
52
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
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
canceled 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.
SHORT SWING PROFITS - 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. In early July 1996, Mr. Schwartz deposited 800,000 shares of his
Incomnet, Inc. Common Stock into a court-approved escrow account with the
Company's New York counsel as security for his obligation to pay short swing
profits. In early February 1997, plaintiff's counsel prepared a motion for
summary judgment in the case seeking $5,050,000 in short swing profits from
Mr. Schwartz plus pre-judgment interest. On February 21, 1997, the plaintiffs
and Sam Schwartz, entered into a stipulated settlement pursuant to which Mr.
Schwartz agreed to pay $4,250,000 to the Company as full payment of his short
swing profit obligation to the Company. The plaintiff's lawyer indicated that
he would request a fee of $850,000 plus reimbursement of $65,000 of expenses,
to be paid by the Company from the proceeds of the recovery. Under the
stipulated settlement, the disgorgement of short-swing profits would be
payable $600,000 in cash and the balance by tender to the Company of shares
of the Company's Common Stock owned by Mr. Schwartz, based on 90% of the
average between the bid and the asked price of the Company's Common Stock on
the NASDAQ market during the 30 calendar days immediately preceding the date
that the court enters an order approving the settlement. Pursuant to the
agreement, Mr. Schwartz has deposited $600,000 in cash and has agreed to
deposit additional shares of the Company's common stock into a separate
escrow account from the one which already contains 800,000 shares of the
Company's stock owned by him or his affiliates. The Company intends to oppose
the amount of plaintiff's attorney's fees sought. The Company does not
otherwise intend to oppose the proposed settlement. On April 11, 1997, a
revised stipulation was filed containing the same economic terms. Notice of
the settlement is to be given to the shareholders by April 21, 1997. Any
opposition to the settlement is due by May 16, 1997, and a hearing to approve
the settlement is to be held on May 30, 1997. There is no assurance that the
Company will recover the short-swing profits from Mr. Schwartz.
11. COMMITMENTS, CONTINGENCIES AND OTHER:
LITIGATION - The Company is a defendant in a class action matter 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 lawsuit 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.
ALLOWANCE FOR DOUBTFUL ACCOUNTS - The total Company allowance for doubtful
accounts totaled $2.0 million or 13.2% of gross accounts receivable at
December 31, 1996 and $1.1 million or 8.0% of gross accounts receivable at
December 31, 1995. The following table summarizes the Company's year-to-year
reserve balances by subsidiary and segment:
$ IN THOUSANDS December 31,
---------------------
Subsidiary Segment 1996 1995
- ------------ ---------- ---------------------
53
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
NTC Telephone $1,908 $1,063
RCI Optical 85 --
AutoNETWORK Network -- --
---------------------
Total Company $1,993 $1,063
---------------------
---------------------
% of Gross Accounts Receivables 13.2% 8.0%
---------------------
---------------------
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 uncollectible 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
the expected bad debt. These receivables result from payments for marketing
programs which have been denied due to returned checks and rejected credit card
payments.
BUILDING LEASES - Rent expense for the years ended December 31, 1996, 1995 and
1994 was $0.8 million, $0.8 million, and $0.3 million, respectively.
The Company leases its office and operating facilities, equipment and
automobiles under noncancellable operating leases. The aggregate future minimum
annual rental payments required under these leases are as follows (IN
THOUSANDS):
For years ending
December 31,
-------------
1997 $2,146
1998 2,176
1999 1,643
2000 1,455
2001 1,361
Thereafter 2,602
In addition, effective February 1996, NTC entered into a revised multiple-year
$1.0 billion contract with Wiltel, Inc., which has a fixed term expiring January
2002. 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 in part, on the purchases
of another unaffiliated long distance telephone service provider to meet its
volume purchase requirements under the new contract.
12. NETWORK MARKETING COSTS:
NTC's net cost to operate its network marketing program consist of the
following:
(IN $ MILLIONS)
1996 1995
--------------------
Sales $17.4 $13.1
Cost of sales 13.7 11.2
Operating expenses for support services 4.3 3.8
--------------------
Total marketing-related costs 18.0 15.0
--------------------
Net marketing cost $ 0.6 $ 1.9
--------------------
--------------------
54
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
% of total NTC (long distance & marketing) sales 0.6% 2.3%
Marketing sales are generated by the sale of materials, training and support
services to assist NTC independent sales representatives in selling new retail
customers and enrolling other representatives in the NTC program. Beginning in
January 1996, NTC began to accrue its obligation to provide customer support to
its representatives (see Note 16). These reserved marketing revenues are
reflected as deferred income on the Company's balance sheet and are amortized
over the succeeding twelve months. The marketing-related costs include
commissions paid to independent sales representatives for acquiring new retail
telephone customers, as well as the cost of sales materials, salaries and wages
of marketing department personnel, services required to support the independent
sales representatives, and other directly identifiable support costs, but do not
include residual commissions paid on continuing long distance telephone usage or
the typical indirect cost allocations, such as floor-space and supporting
departments. Marketing-related costs for 1996 and 1995, of $18.0 million and
$15.0 million, respectively, are compared against marketing-related revenues for
1996 and 1995 of $17.4 million and $13.1 million, respectively. The results are
a net loss in marketing-related activities for 1996 and 1995 of $0.6 million and
$1.9 million, or 0.6% and 2.3%, respectively, of total NTC sales.
13. COMPENSATION OF INDEPENDENT SALES REPRESENTATIVES:
The Company's subsidiary, NTC, compensates its independent sales representatives
by an earned commission structure based upon signing up new telephone customers
and based upon the telephone usage generated by those customers. Expenses
associated with commissions, bonuses and overrides paid out to NTC's independent
sales representatives for 1996 and 1995 were $18.0 million and $14.2 million,
respectively.
14. SEGMENT INFORMATION:
In 1994, the Company conducted its business operations in two industry segments,
including Network Services and Telephone Services. In 1995 and 1996, 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 1996,
1995 or 1994.
55
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
<TABLE>
<CAPTION>
(IN THOUSANDS)
Telephone Optical Network General
YEAR ENDED DECEMBER 31, 1996 Services Systems Services Corporate Consolidated
- ---------------------------- --------- -------- -------- --------- ------------
<S> <C> <C> <C> <C> <C>
Sales $100,811 $ 4,660 $1,426 $ 8 $106,905
-------- -------- ------ -------- --------
Operating income (loss) 3,735 (26,495) 475 (29,232) (51,517)
Income taxes 374 (8,449) 263 -- (7,812)
-------- -------- ------ -------- --------
Income (loss) before minority interest and extraordinary items $ 3,361 $(18,046) $ 212 $(29,232) $(43,705)
-------- -------- ------ -------- --------
-------- -------- ------ -------- --------
Identifiable assets $ 32,987 $ 5,951 $1,562 $ 87 $ 40,587
Depreciation and amortization 1,630 118 265 $ 2,334 4,347
Capital expenditures 6,412 669 143 -- 7,224
Telephone Optical Network General
YEAR ENDED DECEMBER 31, 1995 Services Systems Services Corporate Consolidated
- ---------------------------- --------- -------- -------- --------- ------------
Sales $ 83,127 $ 1,993 $1,370 $ 75 $ 86,565
-------- -------- ------ -------- --------
Operating income (loss) 5,060 (1,040) 369 (3,324) 1.065
Income taxes 365 -- (102) $ (152) 111
-------- -------- ------ -------- --------
Income (loss) before minority interest and extraordinary items $ 4,695 $ (1,040) $ 471 $ (3,172) $ 954
-------- -------- ------ -------- --------
-------- -------- ------ -------- --------
Identifiable assets $ 21,758 $ 25,345 $1,569 $ 25,434 $ 74,106
Depreciation and amortization 705 429 279 $ 1,100 2,513
Capital expenditures 6,681 199 509 -- 7,389
Telephone Optical Network General
YEAR ENDED DECEMBER 31, 1994 Services Systems Services Corporate Consolidated
- ---------------------------- --------- -------- -------- --------- ------------
Sales $ 45,609 $ -- $1,206 $ -- $ 46,815
-------- -------- ------ -------- --------
Operating income (loss) 3,742 -- 154 104 4,000
Income taxes -- -- 1 -- 1
-------- -------- ------ -------- --------
Income (loss) before extraordinary items $ 3,742 $ -- $ 153 $ 104 $ 3,999
-------- -------- ------ -------- --------
-------- -------- ------ -------- --------
Identifiable assets $ 12,830 $ -- $4,271 $ 9,057 $ 26,158
Depreciation and amortization 221 -- 489 -- 710
Capital expenditures 1,547 -- 147 -- 1,694
</TABLE>
56
<PAGE>
INCOMNET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
15. 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 $ 0.24 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.
16. CHANGE IN ACCOUNTING:
Effective January 1, 1996, the Company changed its accounting procedures to
defer a portion of marketing revenues, which had previously been recognized upon
receipt. The Company believes that the change is preferable because it provides
a better matching of revenues with services provided to the marketing
representatives. The cumulative effect of this change and certain other changes
for the periods prior to January 1, 1996 of approximately $0.9 million is shown
as a cumulative effect adjustment. The effect of the changes on 1996 is to
increase income before cumulative effect adjustment by $0.03 per share.
17. SUBSEQUENT EVENTS:
On January 15, 1997, RCI completed a Convertible Preferred Stock and Warrants
Purchase Agreement with two institutional investors whereby they issued (i)
7,275,000 shares of newly created Series A Convertible Preferred Stock, par
value $.001 per share, (ii) 725,000 shares of newly created Series B
Non-Voting Convertible Preferred Stock, par value $.001 per share, and (iii)
1,400,000 warrants (expiring five years from the date of issuance) with each
warrant entitling the holder thereof to purchase one share of common stock at
an exercise price of $1.74 per share, for aggregate gross proceeds of
$12,000,000. The proceeds were used to (i) repay $500,000 of principal, plus
accrued and unpaid interest, under RCI's existing note payable to bank, (ii)
repay $2,765,339 of existing bridge financing owing to Incomnet, including
accrued and unpaid interest thereon, (iii) repay $940,091 of additional
existing bridge financing owing to certain shareholders including accrued and
unpaid interest thereon, (iv) to repurchase 1,200,000 shares of common stock
from one of RCI's shareholders/officers for a purchase price of $1,536,000,
(v) to make a $325,000 partial settlement payment to complete the settlement
of the RCI patent infringement case, which has been dismissed, (vi) to pay
fees and expenses incurred by the institutional investors estimated to be
approximately $500,000, and (vii) the balance is for general working capital
purposes including the immediate repayment of overdue accounts payable of
approximately $1,800,000. The two institutional investors retain an option
to invest an additional $5,000,000 by July 15, 1997 and an additional
$5,000,000 by July 15, 1998 with substantially the same terms as previously
described.
This transaction reduced the Company's outstanding interest to less than 50% of
the voting control of RCI. Accordingly, commencing in the first quarter of
1997, RCI will be accounted for using the equity method of accounting.
In addition, on March 26, 1997, NTC entered into a credit agreement with a bank
for a $5.0 million accounts receivable line of credit to support NTC's
operations and establishment of additional branch marketing offices. This new
agreement provides for interest at prime plus 1.0% and is secured generally by
NTC's accounts receivable. As of March 31, 1997, there are no borrowings
against this line of credit. Under the terms of the agreement, NTC is required
to comply with various covenants, including covenants requiring NTC to maintain
specified ratios and levels of tangible net worth and net income, and limiting
the ability of NTC to pledge assets or incur liens on assets.
57
<PAGE>
Schedule II
INCOMNET, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
(IN THOUSANDS)
Balance at Amounts Balance
beginning charged to costs at end
Classification of period and expenses Write-offs (1) of period
- -------------------- ---------- ---------------- -------------- ---------
<S> <C> <C> <C> <C>
Year ended December 31, 1996
Deducted from asset accounts:
Accounts receivable reserve $1,063 $9,517 $ (8,587) $1,993
Patent reserves 2,019 7,916 (9,891) 44
Goodwill reserves 942 296 -- 1,238
Notes receivable reserve 209 1,472 (1,472) 209
Inventory reserves 100 70 170
Reserve for marketable securities 34 225 (34) 225
------ ------- -------- ------
Total $4,367 $19,496 $(19,984) $3,879
------ ------- -------- ------
------ ------- -------- ------
Year ended December 31, 1995
Deducted from asset accounts:
Accounts receivable reserve $ 991 $ 7,590 $ (7,518) $1,063
Patent reserves 0 2,019 -- 2,019
Goodwill reserves 664 278 -- 942
Notes receivable reserve 0 209 -- 209
Inventory reserves 0 100 -- 100
Reserve for marketable securities 2,000 -- (1,966) 34
------ ------- -------- ------
Total $3,655 $10,196 $ (9,484) $4,367
------ ------- -------- ------
------ ------- -------- ------
Year ended December 31, 1994
Deducted from asset accounts:
Accounts receivable reserve $ 356 $ 4,576 $ (3,941) $ 991
Goodwill reserves 0 664 -- 664
Reserve for marketable securities 2,845 -- (845) 2,000
------ ------- -------- ------
Total $3,201 $ 5,240 $ (4,786) $3,655
------ ------- -------- ------
------ ------- -------- ------
</TABLE>
(1) Amounts are net of recoveries.
58
