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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q--QUARTERLY REPORT UNDER SECTION 13 OR (15)D
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
------------------
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 0-19578
-------
INTERNET COMMUNICATIONS CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
COLORADO 84-1095516
- ------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) identification No.)
7100 E. BELLEVIEW AVENUE, SUITE 201, GREENWOOD VILLAGE, COLORADO 80111
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(303) 770-7600
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [_] No
AT NOVEMBER 6, 1998, 5,617,637 SHARES OF COMMON STOCK, NO PAR VALUE, WERE
OUTSTANDING.
Page 1 of 16 pages.
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INTERNET COMMUNICATIONS CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Form 10-Q Cover Page 1
Index Page 2
Part I FINANCIAL INFORMATION
Condensed Consolidated Balance Sheets at 3
September 30, 1998 and December 31, 1997
Condensed Consolidated Statements of Operations For the 4
Three and Nine months ended September 30, 1998 and October 31, 1997
Condensed Consolidated Statements of Cash Flows 5
For the Nine months ended September 30, 1998 and October 31, 1997
Notes to Condensed Consolidated Financial Statements 6
Management's Discussion and Analysis of Financial 9
Condition and Results of Operations
Part II OTHER INFORMATION
Item 1 - Legal Proceedings 15
Item 2 - Changes in Securities and use of Proceeds 15
Item 3 - Defaults upon Senior Securities 15
Item 4 - Submission of Matters to a Vote of 15
Security Holders
Item 5 - Other Information 15
Item 6 - Exhibits and Reports on Form 8-K 15
Signature Page 16
</TABLE>
2
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INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash $ 69 --
Trade receivables, net of allowance
for doubtful accounts and sales returns 7,665 4,907
Inventory 3,522 3,255
Prepaid expenses and other 525 328
Costs and estimated earnings in
excess of billings 1,551 1,825
------------- ------------
Total current assets 13,332 10,315
Equipment, net 1,436 2,015
Goodwill, net 2,090 2,198
Spares inventory 240 507
Net assets of discontinued operations -- 2,078
Other, net 737 1,000
------------- ------------
Total assets $ 17,835 18,113
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable $ 6,634 4,435
Accounts payable and accrued expenses 5,585 4,706
Billings in excess of costs and
estimated earnings 1,977 1,537
Unearned income 966 1,125
Net liabilities of discontinued
operations 629 --
------------- ------------
Total current liabilities 15,791 11,803
Notes payable and other long term
obligations 302 209
Deferred revenue 166 117
------------- ------------
Total liabilities 16,259 12,129
Stockholders' equity:
Common stock, no par value 14,881 13,965
Stockholders' notes (22) (31)
Accumulated deficit (13,283) (7,950)
------------- ------------
Total stockholders' equity 1,576 5,984
------------- ------------
Total liabilities and
stockholders' equity $ 17,835 18,113
============= ============
</TABLE>
3
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INTERNET COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For Three Months Ended For Nine Months Ended
---------------------------------- -------------------------------------------
September 30, October 31, September 30, October 31,
1998 1997 1998 1997
---- ---- ---- ----
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Sales:
Network Services 3,518 3,356 11,097 9,836
Network Integration 4,856 5,887 14,032 18,884
------------- ------------- ------------- ------------
Total sales 8,374 9,243 25,129 28,720
Cost of Sales (6,102) (6,599) (18,409) (19,997)
------------- ------------- ------------- ------------
Gross margin 2,272 2,644 6,720 8,723
------------- ------------- ------------- ------------
Operating expenses:
Selling 1,166 1,533 4,065 4,684
General and
administrative 1,790 1,710 5,168 4,806
Restructuring -- -- 1,199 --
Interest expense, net 157 85 448 334
Loss from sale of
Subsidiary -- 152 -- 152
------------- ------------- ------------- ------------
Total expenses 3,113 3,480 10,880 9,976
------------- ------------- ------------- ------------
Income (Loss) from
continuing operations (841) (836) (4,160) (1,253)
Discontinued operations --
Income (Loss) from
operations -- (218) (206) (261)
Estimated loss on
disposal (730) -- (967) --
------------- ------------- ------------- ------------
Net Income (Loss) (1,571) (1,054) (5,333) (1,514)
------------- ------------- ------------- ------------
Income (Loss) per share -
basic and diluted:
Weighted average
common shares
outstanding 5,460 5,378 5,429 5,175
Income (Loss) from
continuing
operations (0.15) (0.16) (0.76) (0.24)
Income (Loss) from
discontinued
operations (0.14) (0.04) (0.22) (0.05)
Net Income
(Loss) (0.29) (0.20) (0.98) (0.29)
</TABLE>
- ---------------------------------------------------------------------------
See accompanying notes to these condensed consolidated financial statements
4
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INTERNET COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
For Nine Months Ended
--------------------- ---------------
September 30, October 31,
1998 1997
---- ----
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss from continuing operations (4,160) (1,253)
Adjustments to reconcile net loss from continued operations
Depreciation and amortization 1,033 1,043
Allowance for doubtful accounts and sale returns 229 (99)
Changes in operating assets and liabilities:
(Increase) decrease in:
Receivables (2,987) 202
Inventory (136) (844)
Prepaid expenses and other (83) 28
Costs in excess of billings and estimated earnings 274 1,940
Increase (decrease) in:
Accounts payable and accrued expenses 879 (443)
Unearned income and deferred revenue (110) (157)
Other Liabilities 161 328
Billings in excess of costs and estimated earnings 440 --
--------- ---------
Net cash provided by (used in) operating activities (4,460) 745
Net cash provided by (used in) discontinued operations 1,534 (1,412)
Cash flows from investing activities:
Capital expenditures (174) (703)
Proceeds from sales of assets 113 --
--------- ---------
Net cash used in investing activities (61) (703)
Cash flows from financing activities:
Proceeds from sale of common stock -- 3,041
Expenses from sale of common stock -- (29)
Repayment of debt (5,734) (11,258)
Proceeds from debt 7,865 9,146
Repayment of stockholders' note 9 --
Proceeds from exercise of stock options 916 --
--------- ---------
Net cash provided by financing activities 3,056 900
--------- ---------
Increase (decrease) in cash: 69 (470)
Cash, beginning of period -- 571
--------- ---------
Cash, end of period $ 69 101
--------- ---------
</TABLE>
See accompanying notes to these condensed consolidated financial statements.
5
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INTERNET COMMUNICATIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
NOTE 1 -- BASIS OF PRESENTATION
---------------------
The financial statements included herein have been prepared by Internet
Communications Corporation ("Internet" or the "Company"), without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission
and include all adjustments which are, in the opinion of management, necessary
for a fair presentation. Certain information and footnote disclosures normally
included in the financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The Company believes that the disclosures are adequate
to make the information presented not misleading. However, it is suggested that
these financial statements be read in conjunction with the financial statements
and the notes thereto which are included in the Company's Annual Report on Form
10-KSB for the fiscal year ended December 31, 1997. The financial data for the
interim periods may not necessarily be indicative of results to be expected for
the year.
CHANGE IN FISCAL YEAR END
The Company elected to change its fiscal year end to December 31 from January
31, effective February 1, 1997. References to the third quarter of 1997 relate
to the three-month period ended October 31, 1997.
DISCONTINUED OPERATIONS
In March 1998, the Company's Board of Directors adopted a formal plan to sell
its non-core business segments ("Segments"), Omega and ICNS. On April 30, 1998,
the Company executed two separate divestiture agreements for the Segments. The
Segments have been accounted for as discontinued operations in accordance with
APB 30. As of the issuance date of the Company's Annual Report on Form 10-KSB
for the year ended December 31, 1997, management was not anticipating net losses
on the disposal of the Segments or the related interim period results of
operations. Based in part on the definitive agreements entered into on April
30, 1998, management determined that a net loss on disposal would be incurred as
well as operating losses. Management revised its estimates in the financial
statements for the quarter ended March 31, 1998. During August 1998, the
Company entered into negotiations to relinquish its role under the last major
contract to be completed under the Company's plan to divest of ICNS. The
Company has entered into an agreement to terminate the contract and expects
final settlement during December 1998. Based on the settlement terms and the
results of the contracts covered under the April 30, 1998 divestiture agreement
for ICNS, management has determined that an additional loss on disposal should
be recognized. Management has revised its estimates in the financial statements
for the quarter ended September 30, 1998. The October 31, 1997 consolidated
financial statements have been restated to conform to the September 30, 1998
presentation.
NOTE 2 - AGREEMENT AND PLAN OF MERGER
----------------------------
On June 5, 1998, the Company executed a definitive Agreement and Plan of Merger
(the "Merger Agreement") with Rocky Mountain Internet, Inc. ("RMI"). Upon
consummation, the Company was to become a wholly-owned subsidiary of RMI and the
shareholders of the Company were to receive $6.764 per share of common stock of
the Company, for a total consideration to the Company's shareholders of
approximately $39.4 million. Additionally, in connection with the merger, RMI
was to repay certain of the Company's indebtedness. The acquisition was
approved by the Company's shareholders at a Special
6
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Meeting of Shareholders on September 18, 1998. On October 13, 1998, RMI notified
the Company that it would not close the merger, asserting that INCC was unable
to accurately certify to compliance with conditions precedent to RMI's
obligation to close. The Company believes this claim to be entirely without
merit and an attempt by RMI to avoid its obligations under the merger agreement.
The Company filed suit against RMI on October 14, 1998 for damages of at least
$30 million.
NOTE 3 - NOTES PAYABLE
-------------
In March 1998, the Company received $1.6 million from a related party, in
exchange for a convertible promissory note, due March 1999. The note bears
interest at 10% and interest payments are due quarterly. If the Company
defaults on the promissory note, the remaining principal outstanding may be
converted into common stock of the Company at $4.25 per share.
The Company has a borrowing agreement with a lending institution which provides
for a $5.0 million credit facility. At September 30, 1998, the Company had
borrowed $5.0 million against the facility. The borrowing agreement expired on
October 15, 1998. The amount of funds available under the credit facility is
limited to the lesser of $5.0 million or a borrowing base calculation. As of
October 31, 1998, the amount borrowed of $5.0 million exceeded the borrowing
base calculation by $1,350,000. The Company is currently in discussions with the
lender to extend and/or modify the existing credit facility, however, there is
no assurance that the Company will be successful.
NOTE 4 - STOCKHOLDERS' EQUITY
--------------------
On November 20, 1998, the Company entered into an agreement with Interwest
Group, Inc., a wholly-owned subsidiary of Anschutz Company. Under the terms of
the agreement, the Company will issue 7 1/8% convertible preferred stock,
convertible at $2.25 per share, in exchange for $2.0 million.
During the quarter ended September 30, 1998, 25,500 options to purchase shares
of common stock were exercised for total proceeds to the Company of $123,000.
For the nine months ended September 30, 1998, 219,750 options to purchase shares
of common stock were exercised for total proceeds to the Company of $916,000.
On May 19, 1998, the Company's shareholders approved an amendment to the
Company's 1996 Incentive Stock Plan which increases the number of options which
may be granted from 875,000 shares to 975,000 shares.
NOTE 5 - INCOME (LOSS) PER SHARE
-----------------------
Basic income (loss) per share is computed on the basis of weighted-average
common shares outstanding. Diluted loss per share considers potential common
stock in the calculation, and is the same as basic loss per share for the three
and nine months ended September 30, 1998 and the three and nine months ended
October 31, 1997, as all of the Company's potentially dilutive securities were
anti-dilutive during these periods.
NOTE 6 - IMPACT OF RECENTLY ISSUED ACCOUNTING PROUNOUNCEMENTS
----------------------------------------------------
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 requires that all items which are components of comprehensive
earnings or losses be reported in a financial statement in the period in which
they are recognized. The Company has no items which are components of
comprehensive earnings or losses, other than net income (loss), accordingly the
adoption of this pronouncement had no effect on the accompanying financial
statements.
The Financial Accounting Standards Board recently issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," ("SFAS 133"), which is effective for all fiscal years beginning
after June 15, 1999. SFAS 133 establishes accounting and
7
<PAGE>
reporting standards for derivative instruments and hedging activities by
requiring that all derivative instruments be reported as assets or liabilities
and measured at their fair values. Although management of the Company has not
completed its assessment of the impact of SFAS 133 on its consolidated results
of operations and financial position, management estimates that the impact of
SFAS 133 will not be material.
NOTE 7 - YEAR 2000 RISKS
---------------
Currently, many computer systems, hardware and software products are coded to
accept only two digit entries in the date code field and, consequently, cannot
distinguish 21/st/ century dates from 20/th/ century dates. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. The Company and third
parties with which the Company does business rely on numerous computer programs
in their day to day operations.
The Company has begun the process of identifying computer systems that could be
affected by the Year 2000 issue as it relates to the Company's internal hardware
and software, as well as third parties which provide the Company goods or
services. The Company groups its analysis of these software, hardware and
systems into the following four categories:
(a) Customer Network Installations, where the Company has installed third
party vendor equipment and software, and the software is covered by
certain maintenance programs provided by the Company.
(b) Network Control Center, where the Company monitors and manages the
integrity and quality of customer networks.
(c) Third party vendors and providers (other than the equipment vendors
referred to above), including those which provide the Company with
services such as its data transmission capacity.
(d) Corporate Administrative Functions, including financial systems and
other corporate functions.
For categories (a) and (b), the Company has substantially completed its
inventory of the software and devices involved. During this inventory phase,
the project team has been working with third party equipment and software
vendors to assess whether these devices and software programs are date dependent
and whether it is anticipated that they will be Year 2000 compliant.
The Company has not commenced a detailed inventory and assessment process for
categories (c) and (d) as these were deemed to be less critical to the Company's
operations and less likely to require remediation or replacement.
The inventory and assessment for each of the four categories should be completed
by the end of 1998. Testing, remediation and replacement will commence in the
fourth quarter of 1998 for selected areas and will commence by the first quarter
of 1999 for all categories. The Company has not developed a contingency plan
which would be utilized if current efforts by the Company and its vendors are
unsuccessful.
In the event that the Company acquires other assets of businesses, the software
and hardware acquired by the Company in connection with those business
combinations may also be Year 2000 non-compliant.
There can be no assurance that the Year 2000 issues will be resolved in 1998 or
1999. The Company does not currently have an estimate of the total costs
required for this effort and may incur significant costs in resolving its Year
2000 issues. If not resolved, this issue would have a material adverse impact
on the Company's business, operating results, financial condition and cash flow.
8
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INTERNET COMMUNICATIONS CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE
- ----------------------------------------------------------------------
SECURITIES LITIGATION REFORM ACT OF 1995
- ----------------------------------------
This 10-Q contains "forward-looking statements" within the meaning of the
federal securities laws. These forward-looking statements include statements of
expectations, beliefs, future plans and strategies, anticipated events or trends
and similar expressions concerning matters that are not historical facts. The
forward-looking statements in this 10-Q are subject to risks and uncertainties
that could cause actual results to differ materially from those expressed in or
implied by the statements.
With regard to the Company, the most important factors include, but are not
limited to, the following:
- Changing technology.
- Competition.
- Possible future government regulation.
- Competition for talented employees.
- Company's ability to fund future operations.
- Company's need to refinance debt.
The following is management's discussion and analysis of certain significant
factors which have affected the Company's financial condition and results of
operations during the periods included in the accompanying condensed financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
CAPITAL RESOURCES
On November 20, 1998, the Company entered into an agreement with Interwest
Group, Inc., a wholly-owned subsidiary of Anschutz Company. Under the terms of
the agreement, the Company will issue 7 1/8% convertible preferred stock,
convertible at $2.25 per share, in exchange for $2.0 million.
The Company has a borrowing agreement with a lending institution which provides
for a $5.0 million credit facility. At September 30, 1998, the Company had
borrowed $5.0 million against the facility. The borrowing agreement expired on
October 15, 1998. The amount of funds available under the credit facility is
limited to the lesser of $5.0 million or a borrowing base calculation. As of
October 31, 1998, the amount borrowed of $5.0 million exceeded the borrowing
base calculation by $1,350,000. The Company is current on interest payments and
the lender has not demanded repayment of the principal. The Company is currently
in discussions with the lender to extend and/or modify the existing credit
facility, however, there is no assurance that the Company will be successful.
In March 1998, the Company received $1.6 million from a related party, in
exchange for a convertible promissory note, due March 1999. The note bears
interest at 10% and interest payments are due quarterly. If the Company
defaults on the promissory note, the remaining principal outstanding may be
converted into common stock of the Company at $4.25 per share.
9
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LIQUIDITY
At September 30, 1998, The Company had a working capital deficit of $2,459,000,
which included $6,634,000 relating to the current portion of long term debt and
amount outstanding under the Company's credit facility. The Company had a
working capital deficit of $1,448,000 at December 31, 1997. The amounts relating
to the current portion of long term debt and the amounts outstanding under the
Company's credit facility were $4,435,000 at December 31, 1997.
The Company's accounts receivable, net of allowance for doubtful accounts and
sales returns was $7,665,000 at September 30, 1998, as compared to $4,907,000 at
December 31, 1997. As discussed in the March 31, 1998 Form 10-Q, the Company
converted its primary management information systems in January. Certain of the
Company's customers considered the descriptive detail provided on the invoices
generated by this system to be inadequate, and have delayed payment pending
additional support being provided by the Company. The Company has committed
additional resources in the collection area to address customer concerns. In
addition, the Company increased the allowance for doubtful accounts by $229,000
during the three months ended September 30, 1998. Continued delays in
collection or uncollectibility of accounts receivable could have an adverse
effect on the Company's liquidity and working capital position.
Accounts payable and accrued expenses at September 30, 1998 were $5,585,000 as
compared to $6,441,000 at June 30, 1998 and $4,706,000 at December 31, 1997.
The increase in the accounts receivable has resulted in the Company extending
the time in which it paid its vendors. The Company has made advances in the
timing of payments to vendors, assisted by proceeds from the exercise of stock
options.
The Company incurred capital expenditures of $100,000 during the quarter ended
September 30, 1998, and $174,000 for the nine months ended September 30, 1998.
Some of the capital expenditures incurred during the quarter ended September 30,
1998 were to buy out leases on executive vehicles. The Company subsequently sold
these vehicles. There are no material commitments for capital expenditures and
the Company is maintaining tight controls over its capital purchases.
RESULTS OF OPERATIONS:
- ----------------------
RESTRUCTURING
In March 1998, the Company announced a restructuring plan aimed at tightening
the strategic focus on the data communications network service market.
Management determined the Company had over-extended resources in the Rocky
Mountain region and had evolved into an overly complex organization.
Accordingly, the number of departments was reduced, employees were separated
from the Company, the number of manufacturers' product lines were reduced and
the wholesale engineering services business launched during the fourth quarter
of the fiscal year ended December 31, 1997 was closed.
These restructuring actions resulted in the Company recognizing expenses for the
three months ended March 31, 1998 totaling $1,608,000. The expenses have been
classified for financial statement purposes as follows:
10
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<TABLE>
<CAPTION>
Operating expenses:
<S> <C>
Restructuring:
Employee Severance $ 653,000
Closure of Wholesale
Engineering Company 274,000
Facilities Consolidation 229,000
Other 43,000
----------
1,199,000
----------
Cost of Sales:
Product Line Reduction 409,000
----------
Total $1,608,000
----------
</TABLE>
Employee Severance: The Company severed 50 positions and accepted the
resignations of Thomas C. Galley, the Company's former President, CEO and a
Director, and Arnell Galley, the Company's former Secretary, Vice President -
Administration and a Director. The severed employees each signed a Severance
Agreement and Legal Release, which provided them 30 days severance pay and
continued health insurance coverage for the month of April 1998. As disclosed
in the Company's Definitive Proxy Statement filed April 23, 1998, Mr. Galley
entered into a Severance Agreement and Mutual Legal Release whereby the Company
agreed to pay a total of two years severance at a rate of $160,000 per year.
Also, as described in the Definitive Proxy Statement, Mrs. Galley entered into a
Severance Agreement and Mutual Legal Release whereby the Company agreed to pay a
total of twelve months severance pay at a rate of $100,000 per year.
Closure of Wholesale Engineering Company: The Company launched an entirely
separate wholesale engineering services business during the fourth quarter of
the fiscal year ended December 31, 1997, which was closed as part of the
restructuring. The restructuring expenses include an accrual of a liability
triggered by the closure of the business related to a contractual agreement
entered into by the Company.
Facilities Consolidation: The facilities consolidation expense includes the
cost of leased space which would no longer be required by the Company, for the
period from the date of the restructuring to the estimated date of securing a
sublease and the related real estate brokers commissions for subletting the
space. In addition, the expense includes the net furniture costs in excess of
expected trade in or sales value.
Other: Other represents legal fees related to the severance plan and agreements
and disposition of vehicles related to the restructuring.
Product Line Reduction: The Company's restructuring plan included a clearly
defined approach to hardware and material offerings. The Company undertook a
review of the then offered products which included the product and technical
support requirements and the manufacturer's warranty, quality standards and
support standards. As a result of this review, the Company reduced the number
of approved vendors from 51 to 22. This reduction in product offerings allows
the Company to reduce future training costs and allow its technicians to be more
proficient on the products offered. The product line reduction expense
represents inventory that would no longer be offered as part of the Company's
standard product offerings.
The balance of these restructuring expenses remaining to be funded as of
September 30, 1998 was approximately $702,000.
11
<PAGE>
DISCONTINUED OPERATIONS
Pursuant to a plan adopted in March 1998, the Company executed two separate
divestiture agreements on April 30, 1998 for its non-strategic subsidiaries,
Omega and ICNS. The Segments have been accounted for as discontinued operations
in accordance with APB 30. The remaining assets and liabilities of the Segments
at September 30, 1998 primarily consisted of accounts receivable and accounts
payable.
The Company executed a Stock Purchase Agreement on April 30, 1998 for the sale
of its 80% ownership of the common stock of Omega to Omega's vice president and
sole minority shareholder. The consideration for the sale of Company's common
stock ownership of Omega was $209,000.
The Company executed an Agreement on April 30, 1998 for the transition of the
business activities of its wholly owned subsidiary, ICNS, to a newly formed
corporation ("MetroWest") owned and operated by the principal managers of ICNS.
The Agreement specifies that MetroWest shall satisfactorily complete the ICNS
contracts existing at April 30, 1998. ICNS shall pay MetroWest incentive
compensation for the completion and final customer acceptance of ICNS contracts.
As of September 30, 1998, all but one of the contracts were substantially
completed. The status of the remaining contract is discussed below.
As of the issuance date of the Company's Annual Report on Form 10-KSB for the
year ended December 31, 1997, management was not anticipating net losses on the
disposal of the Segments or the related interim period results of operations.
Subsequent to this date, based in part on the definitive agreements entered into
on April 30, 1998, management determined that a net loss on disposal would be
incurred as well as operating losses. Management revised its estimates in the
financial statements for the quarter ended March 31, 1998. During August 1998,
the Company entered into negotiations to relinquish its role under the last
major contract to be completed under the Company's plan to divest of ICNS. The
Company has entered into an agreement to terminate the contract and expects
final settlement during December 1998. Based on the settlement terms and the
results of the contracts covered under the April 30, 1998 divestiture agreement
for ICNS, management has determined that an additional loss on disposal should
be recognized. Management has revised its estimates in the financial statements
for the quarter ended September 30, 1998.
CONTINUING OPERATIONS
Revenues were $8,374,000, and $25,129,000 for the three and nine month periods
ended September 30, 1998, as compared to $9,243,000 and $28,720,000 for the
three and nine month periods ended October 31, 1997. This represents decreases
of $869,000, or 9.4% and $3,591,000, or 12.5% when compared to the three and
nine month periods ended October 31, 1997. Work Telcom, a division of Internet
was sold in October 1997 and accounted for $150,000 and $545,000 of the revenues
for the three and nine month periods ended October 31, 1997. The Telesales
division, which was phased out in 1997, accounted for $204,000 and $1,379,000 of
the revenues for the three and nine month periods ended October 31, 1997.
During the nine month period ended October 31, 1997 the company recognized
Network Integration revenues of $2,085,000 on two large contracts. During that
same period, the Company also recognized Network Integration revenues of
$512,000 on a significant fiber infrastructure construction contract which was
outside of the Company's normal scope of business. The Company did not have any
comparable contracts during the first nine months of 1998. These decreases were
offset by service sales which increased by $162,000, or 4.83% and $1,261,000, or
12.8% for the three and nine month periods ended September 30, 1998, reflecting
the Company's continued emphasis to increasing sales of recurring service
contracts.
12
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GROSS MARGIN
Gross margin for the three and nine month periods ended September 30, 1998 was
27.1% and 26.7% of sales as compared to 28.6% and 30.4% for the three and nine
month periods ended October 31, 1997. As discussed above, included in Cost of
Sales for the first quarter of 1998 is $409,000 of product line reduction
expense related to the Company's restructuring. Excluding the effects of the
product line reduction expense, the gross margin for the nine months ended
September 30, 1998 would have been 28.4%. Margins declined in 1998 due to
tightening margins on Network Integration sales, and lower returns in Carrier
Services, a component of Network Services.
SELLING EXPENSES
Selling expenses decreased by $367,000, or 23.9%, and $619,000, or 13.2% for the
three and nine month periods ended September 30, 1998 as compared to the three
and nine month periods ended October 31, 1997. Selling expenses as a percentage
of revenue were 13.9% and 16.2% of revenues for the three and nine month periods
ended September 30, 1998 versus 16.6% and 16.3% for comparable periods in 1997.
Selling expenses for the nine months ended September 30, 1998 included
$1,710,000, or 20.8% of revenues for the quarter ended March 31, 1998. Controls
and cost savings continue to be recognized as a result of the restructuring in
March.
GENERAL & ADMINISTRATIVE
General and administrative expenses increased $80,000, or 4.7% for the three
months ended September 30, 1998 as compared to the three months ended October
31, 1997. Included in the third quarter of 1998 balance is $117,000 of costs
associated with the failed merger. The Company also increased its allowance for
doubtful accounts by $229,000 due to the growth in accounts receivable balances.
General and administrative costs for the nine months ended September 30, 1998
increased $362,000, or 7.5% due to the previously mentioned items, as well as
the increases in the first quarter of 1998 in personnel costs, settlement costs,
and increases in allowances for bad debt and obsolete inventory.
YEAR 2000 RISKS
Currently, many computer systems, hardware and software products are coded to
accept only two digit entries in the date code field and, consequently, cannot
distinguish 21/st/ century dates from 20/th/ century dates. As a result, many
companies' software and computer systems may need to be upgraded or replaced in
order to comply with such "Year 2000" requirements. The Company and third
parties with which the Company does business rely on numerous computer programs
in their day to day operations.
The Company has begun the process of identifying computer systems that could be
affected by the Year 2000 issue as it relates to the Company's internal hardware
and software, as well as third parties which provide the Company goods or
services. The Company groups its analysis of these software, hardware and
systems into the following four categories:
(a) Customer Network Installations, where the Company has installed third party
vendor equipment and software, and the software is covered by certain
maintenance programs provided by the Company.
(b) Network Control Center, where the Company monitors and manages the
integrity and quality of customer networks.
13
<PAGE>
(c) Third party vendors and providers (other than the equipment vendors
referred to above), including those which provide the Company with services
such as its data transmission capacity.
(d) Corporate Administrative Functions, including financial systems and other
corporate functions.
For categories (a) and (b), the Company has substantially completed its
inventory of the software and devices involved. During this inventory phase,
the project team has been working with third party equipment and software
vendors to assess whether these devices and software programs are date dependent
and whether it is anticipated that they will be Year 2000 compliant.
The Company has not commenced a detailed inventory and assessment process for
categories (c) and (d) as these were deemed to be less critical to the Company's
operations and less likely to require remediation or replacement.
The inventory and assessment for each of the four categories should be completed
by the end of 1998. Testing, remediation and replacement will commence in the
fourth quarter of 1998 for selected areas and will commence by the first quarter
of 1999 for all categories. The Company has not developed a contingency plan
which would be utilized if current efforts by the Company and its vendors are
unsuccessful.
In the event that the Company acquires other assets of businesses, the software
and hardware acquired by the Company in connection with those business
combinations may also be Year 2000 non-compliant.
There can be no assurance that the Year 2000 issues will be resolved in 1998 or
1999. The Company does not currently have an estimate of the total costs
required for this effort and may incur significant costs in resolving its Year
2000 issues. If not resolved, this issue would have a material adverse impact
on the Company's business, operating results, financial condition and cash flow.
14
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
-----------------
On October 14, 1998, the Company filed a complaint against Rocky Mountain
Internet Inc. ("RMI") in the District Court, City and County of Denver, State
of Colorado. The complaint relates to RMI's failure to close the merger
between the Company and RMI which agreement was entered into on June 5, 1998.
The complaint alleges that RMI breached the merger agreement and made certain
misrepresentations to the Company with respect to the merger transaction. The
Company has claimed damages of at least $30 million and intends to vigorously
pursue the complaint.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-----------------------------------------
In March 1998, the Company received $1.6 million from a related party, in
exchange for a convertible promissory note, due March 1999. The note bears
interest at 10% and interest payments are due quarterly. If the Company
defaults on the promissory note, the remaining principal outstanding may be
converted into common stock of the Company at $4.25 per share.
During the quarter ended September 30, 1998, 25,500 options to purchase
shares of common stock were exercised for total proceeds to the Company of
$123,000. For the nine months ended September 30, 1998, 219,750 options to
purchase shares of common stock were exercised for total proceeds to the
Company of $ 916,000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
The Company has a borrowing agreement with a lending institution which
provides for a $5.0 million credit facility. At September 30, 1998, the
Company had borrowed $5.0 million against the facility. The borrowing
agreement expired on October 15, 1998. The Company is current on interest
payments and the lender has not demanded repayment of the principal. The
Company is currently in discussions with the lender to extend and/or modify
the existing credit facility, however, there is no assurance that the Company
will be successful.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
On September 18, 1998, a Special Meeting of the Company's shareholders was
held to vote on a proposal contained in the proxy statement mailed to
shareholders on September 8, 1998. The Company's shareholders approved the
Merger of Internet Acquisition Corp. and a wholly-owned subsidiary of Rocky
Mountain Internet. The number of shares voted and withheld were as follows:
FOR WITHHELD ABSTAIN
--------- -------- -------
AMENDMENT 3,501,416 100 1,000
ITEM 5. OTHER INFORMATION
-----------------
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
NONE
15
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERNET COMMUNICATIONS CORPORATION
-----------------------------------
(Registrant)
Date: November 23, 1998 By: /s/ John M. Couzens
---------------------------------------
John M. Couzens, President
Date: November 23, 1998 By: /s/ T. Timothy Kershisnik
---------------------------------------
T. Timothy Kershisnik,
Chief Financial Officer
16
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<PERIOD-START> JAN-01-1998
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