<PAGE>
FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K.--ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For fiscal year ended December 31, 1998
[_] Transition Report Pursuant to Section 133 or 15(d) of the Securities
Exchange Act of 1934
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 (I.R.S. Employer
incorporation or organization) Identification No.)
7100 E. Belleview Ave., Ste 201, Greenwood Village, Colorado 80111
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (303) 770-7600
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
(Title of each class) (Name of Exchange)
-------------------------- ------------------
Common Stock, no par value NASDAQ
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. [_]
As of January 22, 1999, the approximate aggregate market value of voting
stock held by non-affiliates of the Registrant was $7,375,411 (based upon the
closing price for shares of the Registrant's Common Stock as reported by The
Nasdaq SmallCap Market of the National Association of Securities Dealers
Automated Quotation System on that date). Shares of Common Stock held by each
officer, director, and holder of 5% or more of the outstanding Common Stock has
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of January 22, 1999, 5,617,637 shares of registrant's common stock were
outstanding.
DOCUMENTS REPORTED BY REFERENCE.
(1) Portions of the Registrant's Proxy Statement related to the 1999 Annual
Meeting of Shareholders, to be held on May, 27 1999, are incorporated by
reference into Part III of this Annual Report on Form 10-K where indicated.
The table of exhibits filed appears on page 39.
1
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
Form 10-K cover page 1
Index page 2
Part I
Item I - Business 3
Item 2 - Properties 8
Item 3 - Legal Proceedings 8
Item 4 - Submission of Matters to a Vote of Securities Holders 9
Part II
Item 5 - Market for Registrant's Common Equity and
Related Stockholder Matters 9
Item 6 - Selected Financial Data 10
Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 7A - Quantitative and Qualitative Disclosure About Market Risk 16
Item 8 - Financial Statements and Supplementary Data 17
Item 9 - Changes in and disagreements with Accountants
on Accounting and Financial Disclosure 38
Part III
Item 10 - Directors an Executive Officers of the Registrant 38
Item 11 - Executive Compensation 38
Item 12 - Security Ownership of Certain Beneficial Owners and
Management 38
Item 13 - Certain Relationships and Related transactions 38
Part IV
Item 14 - Exhibits, Financial Statement Schedules and Reports on 39
Form 8-K
Signature page 41
2
<PAGE>
Item 1. BUSINESS
--------
General
- -------
Internet Communications Corporation ("INCC" or "the Company") is a multi-faceted
telecommunications integration and network services company. INCC specializes in
the design, implementation, maintenance and management of premise and
network-based communications for wide area networks ("WANs"). The Company
targets medium-sized corporations and institutions that use technology to
operate and optimize their business over data, voice and integrated networks.
Background
- ----------
The Company was created in 1996 with the merger of two prominent Colorado
communications companies - INCC, a leading data communications network services
company which began operations in 1986, and Interwest Communications Corporation
("Interwest"), a leading telecommunications interconnect company which began
operations in 1977. This combination has produced a company with unique data and
voice integration capabilities. In addition, recent technological developments
have provided the Company with significant opportunities to leverage the
combined expertise of data and voice technologies and the wherewithal to deal
with the convergence of other electronic communications media.
Cautionary Statement Pursuant to Safe Harbor Provisions of the Private
- ----------------------------------------------------------------------
Securities Litigation Reform Act of 1995
- ----------------------------------------
This 10-K 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-K 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.
- Becoming Y2K compliant.
Products and Services
- ---------------------
INCC offers a full array of communication services such as network management,
maintenance, professional services, Internet access, web hosting, project
management, network integration and transport services.
INCC's ability to understand its customers' business dilemmas begins with its
experienced sales and technical staff. INCC understands the critical nature of
designing and deploying the most efficient and cost effective technology. The
Company's services are designed to capitalize on this experience.
3
<PAGE>
Network Management Services
- ---------------------------
As part of its service offerings, the Company provides network management
through its network control center ("NCC"). The NCC provides state-of-the-art
network management of SNMP-based communications devices as well as the circuits
associated with the network 24 hours a day, seven days a week. NCC engineers can
quickly identify, resolve and often prevent network problems. In addition,
engineers are able to collect performance data to identify and analyze
performance trends. Such analysis permits the Company to take preventive
measures before the network experiences interruption or down time. INCC offers
several levels of service to help its customers maintain optimal network
performance.
INCC provides round-the-clock network monitoring and problem resolution. The
network management services include fault detection, diagnosis and customer
reporting. Should an alarm signal a network problem, NCC engineers quickly
notify vendor contacts, coordinate repair, escalate if necessary and notify a
designated customer contact. The objective is to facilitate the timely and
complete correction of problems as they arise.
In addition, the Company offers a performance management service designed to
optimize network performance and to proactively prevent network failures from
occurring thereby maximizing network up-time. By combining the collection and
reporting of information about network performance trends with expert analysis
of that information by NCC engineers, potential problems are identified before
they generate failures.
Network Maintenance
- -------------------
Like its network management services, the Company also provides maintenance
service plans for its customers' networks. The Company's on-site equipment
maintenance service includes 24-hour technical support, contracted response
times, on-site trouble-shooting, parts replacement, verification testing, and
customer notification.
Professional Services
- ---------------------
INCC's professional services division offers in-depth thorough analysis of
enterprise networks. INCC consultants provide a range of services that help
customers determine if and how their network is performing to meet business
objectives. These services are listed below.
- - Network Assessment and Baseline provides a view of the network through an
audit process. INCC monitors the customer's network to determine
traffic/protocol distribution, utilization, network congestion, application
usage and performance inefficiencies.
- - Enterprise Network Architecture and System Design provides design and
redesign of enterprise networks that conform to current and future
technology needs of the customer. Connectivity options such as remote
access, dial-in, Internet and wide-area connectivity are evaluated. In
addition, INCC determines requirements for e-mail, groupware, thin client
applications and then implements them creating a more robust environment
for sharing information across the enterprise.
- - Network Security provides security assessment, security policy and firewall
evaluation for customers who need a more demanding and comprehensive review
of their security requirements.
4
<PAGE>
- - Technology Assessment provides solutions to help customers differentiate
themselves and strengthen their market position within their given
industry. INCC takes into account the customers' business strategy and
offers core competencies in technologies such as IP telephony and
voice-over frame relay which support that strategy.
Internet Access and Web Hosting Services
- ----------------------------------------
The Company is an Internet Service Provider, offering complete Internet access
services. INCC provides high-speed connections to the Internet, carrier
circuits, domain name set-up, network routing, mail routing, self-healing
networks, network monitoring, termination and routing equipment, mailboxes and
newsgroup access. In addition, INCC provides Web hosting services for customers'
Web pages, including technical support, 24 hour server maintenance and security,
daily Web site statistics reporting, and virtual post office.
Project Management and Network Integration Services
- ---------------------------------------------------
The Company provides project management and network integration services to
facilitate the implementation of customer networks pursuant to design
specifications. INCC's project management expertise encompasses legacy
technologies and state-of-the-art technologies enabling the rollout of turnkey
solutions delivering fully operational enterprise networks. The Company also
programs and furnishes premise-based components of integrated networks utilizing
complex network technologies across multi-vendor environments. Furthermore, INCC
partners with best-of-breed technology providers to ensure cost effective
business solutions for its customers.
Network Transport Services
- --------------------------
INCC provides a broad range of transport services for multi-location enterprise
network connectivity. Services include dedicated private line, frame relay,
Asynchronous Transfer Mode ("ATM") and Internet Protocol ("IP"). These services
are blended with INCC's network management and integration services. To provide
transport services, the Company has agreements with a number of carriers,
including MCI Worldcom, US West, ICG, TCG, Sprint, AT&T and approximately 30
other LEC's (local exchange carriers) across the country. INCC operates as a FCC
approved inter-exchange carrier and a PUC approved local exchange carrier. INCC
operates extensive dedicated and frame relay networks, and with affiliated
network resources, is able to provide, manage and maintain service across the
country. INCC's competitive advantage is its track record in deploying
voice-over-data for enterprise networking in both frame relay and internet
protocol environments.
Strategy
- --------
INCC's strategic focus is on delivering increased value to its customers through
its unique technical capabilities in data, voice and integrated multi-media
enterprise networks. The Company is pursuing three interrelated initiatives:
- - Strengthen its long-standing reputation as an innovator in the application
of networking technologies for business solutions with the launch of
additional employee training and educational programs.
- - Strengthen its position as the foremost network services and integration
company in the region.
5
<PAGE>
- - Secure wholesale national partnerships to leverage its Network Control
Center, knowledge base and technical infrastructure.
INCC is well positioned to take advantage of advancements in and convergence of
communications technology through its extensive data and voice engineering
expertise and its ability to deliver value-added services for enterprise-wide
communications. INCC promotes life cycle management of the networking
infrastructure for its growing installed base. Customers benefit by using
multiple INCC services, maximizing their use of the Company's technical
resources. Currently, many customers contract with INCC for multiple services.
The Company attributes the growth in sales of Network Services to its strategy
of delivering increased value both by being a complete service provider and by
cross-selling its services to a long-standing customer base.
INCC will continue to provide expertise in areas such as packet switching
technologies like Frame Relay, ATM and IP. In addition, the Company plans on
adding more value-added services to integrated system and network designs to
increase its recurring revenue base. The Company will continue to leverage
vendor relationships and strengthen technical skill sets.
Industry Overview and Market Niche
- ----------------------------------
Enterprises are accelerating the deployment of increasingly complex network
architectures. This is due to technology advancements for business applications
that reduce operating expenses and improve customer care. Advancements in WAN
technologies such as ATM switches, frame relay switches, and IP tools, enable
businesses to reach and serve broader customers bases faster and more
efficiently than ever. In addition, hardware and carrier technologies have
enabled data and voice applications to run on a common infrastructure thereby
reducing operating expenses, especially for businesses operating in a WAN
environment. Furthermore, intranets, extranets and virtual private networks are
becoming viable solutions for enterprises looking to communicate and collaborate
with their customers and partners without geographic limitations.
According to IDC, a leading industry research firm, the enterprise networking
market is expected to grow 13% in 1999, with emerging sectors expected to grow
even faster. In a survey conducted by IDC, a majority of business customers are
expected to increase or maintain current spending levels for local area networks
(LANs) and WANs.
Advancements in carrier technologies like IP, ATM and Sonet facilitate
simultaneous transportation of data, voice and multimedia applications, at
vastly higher speeds and with greater quality of service than previously thought
possible. Carrier providers are expected to continue significant network
infrastructure investment in order to keep up with the demand for evolving
technologies. In addition, cable operators are investing in deployment of
two-way broadband services across hybrid fiber coaxial cable providing yet
another choice for high-speed data transmission and telephony.
With technology so accessible and affordable and geographic boundaries all but
eliminated, enterprises are faced with the same challenges as before, magnified
by the probability that their competitors are using technology to win and retain
customer loyalty. The challenges businesses, financial institutions,
governmental entities and other enterprises are faced with are significant and
are centered around:
- - Competitive advantage through information technologies
- - Financial risk associated with network downtime
- - Financial risk associated with new project implementation
6
<PAGE>
- - Network security
- - Shortage of technical personnel
Communications companies who provide solutions to these challenges and can bring
together all the components that comprise a network - the systems and equipment
that switch, route and terminate information, the circuits that carry
information and the services that make the network work and keep it working are
well positioned.
Competition
- -----------
Industry competition includes a variety of companies from all sectors of the
telecommunications industry. Examples include: hardware manufacturers and
carriers who sell their own products, sales agents who act on behalf of
manufacturers and carriers, and distributors who buy and resell products.
Hardware manufacturers include multinational companies like Cisco and Lucent
Technologies. Carriers include regional bell operating companies, such as US
West, and interexchange carriers such as MCI Worldcom, AT&T and Sprint.
Distributors include national systems integrators such as EDS, IBM Global
Services and large consulting firms. Although many of the Company's competitors
have substantially greater resources, INCC believes its competitive advantage is
its broad-based communications services, technical depth and its ability to
quickly respond to customer needs.
Government Regulation
- ---------------------
Certain aspects of the Company's operations are subject to regulation by the
Federal Communications Commission ("FCC"). The FCC has the authority to regulate
prices charged by inter-city common carriers. In August 1982, the FCC
substantially deregulated non-facilities-based, resale carriers such as the
Company, and no longer requires certification of these type of carriers or the
filing of tariffs. The Company is consequently not obligated to file tariffs
with the FCC for the interstate circuits it provides to customers. The Company
and other such carriers, however, will still be required to provide service upon
reasonable request and will be prohibited from engaging in discriminatory
activities.
The Company's ability to provide intrastate circuits is also subject to
regulation in each state by the appropriate state regulatory agency. Although
the Company has no immediate plans to offer these services, it has been
certified by the Colorado Public Utilities Commission to resell intrastate
circuits in that state.
Sales
- -----
INCC's sales efforts are currently staffed by 27 sales personnel. The Company's
sales representatives initially contact potential customers from referrals from
other customers or by local market knowledge. Thereafter, the Company is engaged
to evaluate and recommend a network integration solution and network services.
One of INCC's strengths is the continuing customer relationships that providing
both cross selling and repeat business opportunities and a solid base for
references. The Company's sales efforts are divided into two areas: one
targeting new business and the other targeting INCC's installed base.
Customers
- ---------
The Company has an installed base of approximately 5,000 business, government
and institutional customers, ranging from single location, single system
customers to national accounts with integrated networks dispersed over a wide
geographic area. No single customer accounted for more than 10% of sales in the
fiscal year ended December 31, 1998.
7
<PAGE>
Seasonality
- -----------
The sales of the Company are not seasonal to any significant extent. Sales may
decrease or increase at various times throughout a year due to customers'
purchasing decisions.
Backlog
- -------
The Company receives orders for the sale and installation of network systems and
network services to be installed and provisioned in the future. As of December
31, 1998 there were orders received from various customers which are expected to
account for approximately $3.1 million in future sales for the Company.
In addition, the Company has on-going contracts with customers that range from 3
months to 5 years for network management, maintenance service and transport
services which provide monthly recurring revenue to the Company. The total
monthly revenue provided by these contracts is approximately $813,000 per month
as of December 31, 1998.
Employees
- ---------
On March 16, 1999, the Company employed 136 full-time employees including 4
executive officers, 27 in sales and marketing, 82 in network operations and
technical services, and 23 in accounting, administration, and other support
areas
Research and Development
- ------------------------
INCC is primarily a network integrator and network services provider and as such
is not involved in any significant research and development efforts.
Locations
- ---------
The Company's headquarters and principal office is located at 7100 East
Belleview Avenue, Suite 201, Greenwood Village, Colorado 80111. Its telephone
number is (303) 770-7600.
Item 2. PROPERTIES
----------
The Company leases under multi-year agreements approximately 47,000 square feet
of office and/or office/warehouse space at lease rates ranging from $6.00 to
$14.50 per square foot at locations in Greenwood Village, Colorado Springs, Fort
Collins, Colorado and Minneapolis, Minnesota.
Item 3. 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, based on a merger agreement 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. RMI has counterclaimed
8
<PAGE>
that the Company breached the merger agreement by failing to file the merger
proxy in a timely manner, misrepresenting the Company's compatibility with RMI
and failing to maintain satisfactory business operations. The counterclaim seeks
substantial damages based on RMI's inability to complete a $175 million high
yield debt offering as a result of the Company's breach of contract. The Company
believes RMI's counterclaims are frivolous and without merit and intends to
vigorously defend its position and pursue its claim against RMI. In addition,
both parties have filed motions for partial summary judgement addressed to the
applicability of a provision of the merger agreement which would limit damages
upon termination to $1,050,000 for the non-breaching party. While the ultimate
outcome of these matters cannot be determined at this time, management does not
believe the resolution will have a material adverse affect on the Company's
financial position.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
There were no matters submitted to a vote of security holders during the quarter
ended December 31, 1998.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
---------------------------------------------------------------------
(a) Principal Market or Markets. The Company's Common Stock is traded on the
---------------------------
NASDAQ Small-Cap Market under the symbol INCC.
The following table represents the range of high and low closing prices for the
Common Stock for the eight fiscal quarters ended December 31, 1998.
<TABLE>
<CAPTION>
Quarter Ended
-------------
Apr-30-97 Jul-31-97 Oct-31-97 Dec-31-97
--------- --------- --------- ---------
High Low High Low High Low High Low
<S> <C> <C> <C> <C> <C> <C> <C>
5.56 4.13 8.88 4.63 9.50 7.31 8.00 4.56
<CAPTION>
Quarter Ended
-------------
March 31-98 June-30-98 Sept 30-98 Dec 31-98
----------- ---------- ---------- ---------
High Low High Low High Low High Low
<S> <C> <C> <C> <C> <C> <C> <C>
6.25 4.44 6.75 4.63 6.72 4.38 5.25 2.13
</TABLE>
(b) Approximate Number of Holders of Common Stock and Warrants. As of January
----------------------------------------------------------
22, 1999, there were 122 record holders and an additional estimated 1,500
beneficial holders of INCC's Common Stock.
(c) Dividends. The Company has paid no cash dividends on its Common Stock and
---------
has no present intention of paying cash dividends in the foreseeable future. It
is the present policy of the Board of Directors to retain all earnings to
provide for the growth of the Company. Payment of cash dividends in the future
will depend upon, among other things, the Company's future earnings,
requirements for capital improvements and financial condition. The current loan
agreement requires lender approval of dividend payments.
9
<PAGE>
Item 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
11 Mos. Year
Ended Ended
Year Ended January 31, December 31,(1) December 31,
------------------------------------------ --------------- ------------
1995 1996 1997 1997 1998
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue ....................................... $ 16,350 18,528 26,505 33,113 32,086
Cost of sales ................................ 11,996 13,502 18,815 23,693 23,688
Gross margin .................................. 4,354 5,026 7,690 9,420 8,398
Selling, general and administrative
expenses .................................... 6,276 5,806 8,246 12,370 14,121(3)
Operating loss ............................... (1,922) (780) (556) (2,950) (5,723)
Interest expense ............................. 45 325 378 400 643
Net loss from continuing operations ........... (1,830) (997) (934) (3,350) (6,366)
Net loss per share from continuing
operations(2) .............................. $ (0.78) (0.41) (0.28) (0.64) (1.15)
Other Data:
Net cash provided - (used in) by:
Operating activities ...................... 295 (66) (3,143) 732 (4,826)
Investing activities ...................... (1,563) (724) (604) (995) (135)
Financing activities ...................... 1,125 691 2,590 1,873 5,180
Balance Sheet Data:
Cash and cash equivalents ..................... $ 572 473 643 -- 664
Working capital (deficit) ..................... 2,052 892 5,990 (1,488) 4,536
Total assets .................................. 7,064 7,450 18,372 18,113 16,767
Notes payable net of current portion .......... -- -- 5,587 209 3,585
Total Stockholders' Equity .................... $ 3,853 2,917 7,405 5,984 4,315
</TABLE>
- ---------------------
(1) INCC elected to change its fiscal year from January 31 to December 31
effective February 1, 1997.
(2) Loss per share is computed based on 2,352,000; 2,397,000; 3,371,000;
5,216,000; and 5,523,000 shares outstanding for 1995, 1996, 1997, the
eleven months ended December 31, 1997, and the year ended December 31,
1998, respectively. This represents the weighted average common shares
outstanding for both basic and diluted earnings per share for each period.
(3) Selling, general and administrative expenses includes $936,000 of
restructuring cost and $1,215,000 of goodwill impairment. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-----------------------------------------------------------------------
OF OPERATIONS
-------------
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 financial statements.
The Company acquired Interwest and its subsidiaries on September 1, 1996. The
results of operations for the period of September 1, 1996 to January 31, 1997 of
Interwest are included in the results of operations of INCC for fiscal 1996 and
periods thereafter.
The Company elected to change its fiscal year end to December 31 from January
31, effective February 1, 1997. References to fiscal 1996 relate to the year
ended January 31, 1997. References to fiscal 1997 relate to the eleven months
ended December 31, 1997. References to fiscal 1998 relate to the year ended
December 31, 1998.
10
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Capital Resources
On December 30, 1998, the Company executed a stock purchase agreement with
Interwest Group, Inc., a wholly owned subsidiary of Anschutz Company. Under the
terms of the agreement, the Company issued Series A 7-1/8% convertible preferred
stock, convertible at $2.25 per share, in exchange for $5.0 million. On December
30, 1998, $2.5 million was funded to the Company, of which $650,000 was
restricted for payment on the Company's credit facility. Of the balance of the
proceeds, $300,000 was used to pay down the note from the related party, and
$1,550,000 was used for working capital. The remaining $2.5 million was funded
to escrow subject to shareholder approval as required by NASDAQ corporate
governance rules. On February 23, 1999, the Company received shareholder
approval and the escrow was released. The Company used $850,000 to pay down the
Company's credit facility, $1,300,000 to pay the balance of the note from the
related party, and $350,000 for working capital purposes. As a result of this
equity investment, the Company reduced its debt by $3.1 million.
On December 30, 1998, the Company entered into an agreement with the bank to
amend its credit facility. On February 1, 1999, the Fourth Amendment to Credit
Agreement and Note Modification Agreement was executed. The new facility
consists of a line-of-credit of $4,350,000 through March 31, 1999 and $4,000,000
thereafter with interest at prime plus 1% (8.75% at December 31, 1998). As of
December 31, 1998, there was $5,000,000 outstanding under the line-of-credit. In
accordance with the agreement with the Bank, the Company paid down the amount
outstanding by $650,000 on January 4, 1999. The cash used to make this payment
was reflected as restricted cash at December 31, 1998. The line-of-credit is
collateralized by accounts receivable and inventory and matures on March 1,
2000.
In March 1998, the Company received $1.6 million from a related party in
exchange for a convertible promissory note ("Note"), due March 1999. The Note
bears interest at 10% and interest payments are due quarterly. The Note includes
a conversion clause which allows conversion if the Note is not paid when due and
carries a conversion price of $4.25 per common share. At December 31, 1998,
$1,300,000 was outstanding on this note. This note was paid in full upon release
of the escrowed funds as mentioned above.
Liquidity
The Company's cash position increased by $664,000 in 1998. Of this increase,
$650,000 was classified as restricted cash at December 31, 1998, and used to pay
down the line of credit on January 4, 1999. The Company's current ratio improved
to 1.52 at December 31, 1998, as compared to .87 at December 31, 1997, and 2.19
at January 31, 1997. Significant factors in the improvement of the current ratio
were the reclassification of a portion of the Company's bank note payable from
short-term to long-term, due to a renegotiation of the credit facility, and the
subscription receivable for the balance of the preferred stock investment. The
Company's cash position decreased by $571,000 in 1997.
The Company had an outstanding receivable at December 31, 1997, related to a
project for which the Company was a subcontractor. This receivable related to
the cost of delays and inefficiencies, as a result of environmental hazards at
the worksite. The Company sold this receivable to a related party during the
fourth quarter of 1998 for $500,000 recognizing a loss on the receivable of
$109,000.
The Company's accounts receivable, net of allowance for doubtful accounts and
sales returns was $5,637,000 at December 31, 1998, as compared to $4,907,000 at
December 31, 1997, and $4,765,000 at January 31, 1997. The Company continues to
have some problems with descriptive information provided
11
<PAGE>
on invoices for recurring services produced out of the new management
information system, resulting in customers requesting additional details. The
Company has committed extra resources to address these issues. In addition, the
Company provided for increases in the allowance for doubtful accounts of
$220,000 in the third quarter of 1998. The balance of the allowance for doubtful
accounts was $472,000 at December 31, 1998, as compared to $301,000 at December
31, 1997, and $304,000 at January 31, 1997.
Accounts payable and accrued expenses at December 31, 1998 were $3,741,000, as
compared to $4,706,000 at December 31, 1997. The additional working capital
provided by the equity investment at December 30, 1998, contributed to the
decrease at December 31, 1998. Declines in the Company's cash position in 1997
caused the company to extend the time in which it paid its vendors at December
31, 1997.
The Company's investment in equipment in support of its technical operations was
$188,000 in 1998, $995,000 in 1997 and $682,000 in 1996.
The balance of goodwill as of December 31, 1998 is $838,000. Goodwill represents
the balance paid for an acquired entity in excess of the net assets of the
acquired company prior to the acquisition. The goodwill included in the balance
sheet relates to the acquisition of Interwest. The goodwill is being
amortized over a remaining period of 11 years.
RESULTS OF OPERATIONS:
- ---------------------
**As previously noted, references to fiscal 1997 relate to the eleven month
period ended December 31, 1997.
The Company recorded a loss from continuing operations of $6,366,000 for fiscal
1998. This loss includes restructuring costs of $936,000, product line
discontinuation related to the restructuring of $409,000, direct out-of-pocket
expenses associated with the failed merger of $165,000 and goodwill impairment
of $1,215,000. This compares to a loss of $3,350,000 and $934,000 in fiscal 1997
and 1996, respectively. The 1997 loss included goodwill impairment of $259,000
and a loss from the sale of a subsidiary of $152,000. In addition, the Company
experienced a loss from discontinued operations of $1,173,000, $1,225,000 and
$191,000 in fiscal 1998,1997 and 1996, respectively.
Continuing Operations
- ---------------------
Revenue
Revenue in fiscal 1998 decreased by $1,027,000, or 3%, as compared to fiscal
1997. This decrease is due, in part, to the phase out in 1997 of the Telesales
division, which accounted for $1,490,000 of 1997 revenue. In addition, the 1997
revenue included $545,000 of revenue related to a subsidiary, Work Telcom
Services, Inc. ("WTS"), which was sold in 1997. Revenue on continuing business
increased in fiscal 1998 by $1,008,000, or 3% when compared to fiscal 1997. This
increase is primarily services revenue and is the result of the Company's
strategy to cross-sell services to its customers.
Revenue in fiscal 1997 increased by $6,608,000 or 25%, as compared to fiscal
1996. The acquisition of Interwest accounted for $8,503,000 of the increase
while the Company's net sales (on a stand-alone basis) decreased by $1,895,000,
or 11%. The primary cause for the decrease in the Company's (on a stand-alone
basis) sales was the reduction in equipment sales from fiscal 1996 to fiscal
1997 (a $1,863,000 decrease). A number of factors contributed to this decrease.
The prior year results included $989,000 of equipment sales from the Company's
"Indirect Sales Department," which was eliminated in early 1996. Also, the
Company (on a stand-alone basis) had been reducing its emphasis on equipment
sales that did not include any recurring services. There was an intentional
effort to sell "total network systems" as opposed to equipment only, which must
usually be sold at lower margins because of
12
<PAGE>
increasing price competition. Although the conversion to this type of sale by
the Company (on a stand-alone basis) began in fiscal 1996, this approach was
expanded during fiscal 1997 and resulted in the decrease in equipment sales
Gross Margin
- ------------
The gross margin percentage for 1998 was 26.2% compared to 28.5% in 1997. The
decrease in gross margin was due, in part, to the Company's restructuring, which
included discontinuing certain product lines resulting in expenses of $409,000.
This expense accounts for 1.3% of the decline in the gross margin. The remaining
decline was due to tightening margins on network integration sales and lower
returns in carrier services, a component of network services.
The gross margin percentages for fiscal 1997 and 1996 were not significantly
different. The consistent gross margin from year to year is primarily
attributable to the consistency of equipment and services revenue mix from
fiscal 1996 (50% equipment sales as percentage of total sales) as compared to
fiscal 1997 (51%).
Selling
- -------
Selling expenses for 1998 decreased by $630,000, or 11% as compared to fiscal
1997. Selling expenses as a percentage of revenue were 15.8% in 1998 compared to
17.3% in 1997. The decrease in selling expenses and percentage of revenue is
attributable to the controls and cost containment measures implemented in the
restructuring in March of 1998.
Selling expenses were considerably higher in fiscal 1997 as compared to fiscal
1996. As a percentage of revenue, selling expenses increased from 15.1% to
17.3%. Both Interwest and the Company (on a stand-alone basis) contributed to
higher selling expenses due to the increase in sales staff and higher fixed
costs for increased salaries.
General and Administrative
- --------------------------
General and administrative expenses increased by $489,000 in fiscal 1998
compared to fiscal 1997. As a percentage of revenue general and administrative
expenses increased from 19% in 1997 to 21% in 1998. The increase is primarily
due to increases in the allowance for doubtful accounts of $171,000, costs
associated with the failed merger with RMI of $165,000, loss on sale of an
account receivable of $109,000, settlement costs of $63,000 and various
personnel costs of $463,000 which were incurred prior to the restructuring.
General and administrative expenses increased by $2,138,000 in fiscal 1997
compared to fiscal 1996. As a percentage of revenue general and administrative
expenses increased from 16% in fiscal 1996 to 19% in fiscal 1997. A contributing
factor to the increase was goodwill and intangible amortization expense which
increased from $98,000 in fiscal 1996 to $406,000 in fiscal 1997, primarily due
to the acquisition of Interwest. General and administrative expenses for fiscal
1997 also include a loss on the sale of the Company's interest in WTS, in the
amount of $152,000 in fiscal 1997. The Company's basis in the shares of WTS was
$309,000 and the shares were sold for $157,000. The Company received half of the
sales price in cash and the other half in a note, secured by the shares sold,
payable over five years. WTS contributed $28,000 towards the Company's loss in
fiscal 1997 and was considered to be non-core in its future operations.
13
<PAGE>
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.
The restructuring resulted in the Company recognizing expenses totaling
$1,345,000 for the year ended December 31, 1998. The restructuring charge, as
initially recorded in the three month period ended March 31, 1998, was based on
management's best estimates at the time. As a result of the actual costs of the
restructuring, the Company revised its estimates.
A description of the major components of the restructuring expense and the
product line reduction are as follows:
Employee Severance of $664,000: The Company severed 50 positions, closed the
wholesale engineering business and accepted the resignations of the Company's
former president, CEO and a Director, and 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, the
former president 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, the
former secretary and vice president 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.
Facilities Consolidation of $229,000: 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 of $43,000: Other represents legal fees related to the severance plan and
agreements and disposition of vehicles related to the restructuring.
Product Line Reduction of $409,000: 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 and has been included in cost of
sales.
The balance of these restructuring expenses remaining to be funded as of
December 31, 1998 was approximately $135,000.
14
<PAGE>
Goodwill Impairment
The Company recognized an impairment of goodwill in the amount of $1,215,000 in
fiscal 1998. The goodwill arose from the 1996 purchase of Interwest. This
non-cash charge represents the difference between the historical book value of
the goodwill and the discounted cash flow expected from the related operations.
The Company recognized an impairment of goodwill in the amount of $259,000 in
fiscal 1997. The impairment was determined based on a comparison of the
realizable value of the goodwill to its book basis. The goodwill relates to a
1996 purchase business combination and was determined to have been impaired
because the purchased business was generating recurring operating losses and key
employees were transferred to other operating units of the Company.
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 subsidiaries have been accounted for as discontinued
operations in accordance with APB 30. The remaining assets and liabilities of
the subsidiaries at December 31, 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 December 31, 1998, all of the contracts were completed.
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 Subsidiaries or the related interim period results of
operations. Based, in part, on the definitive agreements entered into on April
30, 1998, and an agreement entered into by the Company to terminate the last
major contract to be completed under the Company's plan to divest of ICNS,
management determined that a net loss on disposal would be incurred as well as
operating losses. Management has revised its estimates in the financial
statements for the year ended December 31, 1998. The Company recognized a loss
of $1,173,000 from discontinued operations for fiscal 1998, as compared to
$1,225,000 for fiscal 1997, and $191,000 for fiscal 1996.
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 21st century dates from 20th 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.
15
<PAGE>
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 and assessment 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. In addition, the Company has commenced a detailed inventory and
assessment process for categories (c) and (d).
As of the first quarter of 1999, testing, remediation and replacement had
commenced for all categories. The Company has not developed a contingency plan
that would be utilized if current efforts by the Company and its vendors are
unsuccessful.
In the event that the Company acquires other assets or 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 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 could have a material adverse impact on the
Company's business, operating results, financial condition and cash flow.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
---------------------------------------------------------
The Company's exposure to interest rate changes is primarily related to its
variable rate debt which may be outstanding from time to time under the
Company's credit facility. The Company's credit facility is a line of credit
with an interest rate based on the prime rate plus 1%. The credit facility
matures on March 1, 2000. Because the interest rate on the credit facility is
variable, the Company's cash flow may be affected by increases in the prime
rate. Management does not, however, believe that any risk inherent in the
variable-rate nature of the loan is likely to have a material effect on the
Company. As of December 31, 1998, the Company's outstanding balance on the
credit facility was $5,000,000.
Sensitivity Analysis. To assess exposure to interest rate changes, the Company
has performed a sensitivity analysis assuming the Company has a $5 million
balance outstanding under the line of credit. The monthly interest payment, if
the rate stayed constant, would be approximately $36,500. If the prime rate rose
100 basis points, the monthly interest payment would be approximately $40,600.
The Company does not believe the risk resulting from such fluctuations is
material nor that the payment required would have material effect on cash flow.
16
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
The following Financial Statements are filed as part of this Report:
Page
----
Independent Auditors' Reports 18-19
Consolidated Balance Sheets, December 31, 1998 and December 31,
1997 20
Consolidated Statements of Operations, For the Periods Ended
December 31, 1998, December 31, 1997 and January 31, 1997 21
Consolidated Statement of Stockholders' Equity, For the Period
from January 31, 1996 through December 31, 1998 22
Consolidated Statements of Cash Flows, For the Periods Ended
December 31, 1998, December 31, 1997 and January 31, 1997 23
Notes to Consolidated Financial Statements 24-37
17
<PAGE>
Independent Auditors' Report
----------------------------
To the Board of Directors and Stockholders
Internet Communications Corporation
Greenwood Village, Colorado
We have audited the consolidated balance sheet (not included herein) of Internet
Communications Corporation and Subsidiaries as of January 31, 1997, and the
related accompanying consolidated statements of operations, stockholders' equity
and cash flows for the year then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial statements.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall consolidated
financial statement presentation. We believe that our audit provides 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
Internet Communications Corporation and Subsidiaries as of January 31, 1997, and
the results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.
HEIN + ASSOCIATES LLP
May 2, 1997
18
<PAGE>
Independent Auditors' Report
----------------------------
The Board of Directors and Stockholders
Internet Communications Corporation:
We have audited the accompanying consolidated balance sheets of Internet
Communications Corporation and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for the year ended December 31, 1998 and the eleven-month period
ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. 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 financial position of Internet
Communications Corporation and subsidiaries as of December 31, 1998 and 1997,
and the results of their operations and their cash flows for the year ended
December 31, 1998 and the eleven-month period ended December 31, 1997 in
conformity with generally accepted accounting principles.
KPMG LLP
March 30, 1999
19
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Amounts)
December 31, 1998 and
December 31, 1997
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
December 31,
------------
1998 1997
-------- --------
<S> <C> <C>
Assets
- ------
Current assets:
Cash $ 14 --
Restricted cash 650 --
Trade receivables, net of allowance for doubtful accounts and sales returns of
$472 and $301 at December 31, 1998 and 1997, respectively 5,637 4,907
Subscription receivable from a related party 2,500 --
Inventory 3,296 3,255
Prepaid expenses and other 350 328
Costs and estimated earnings in excess of billings 772 1,825
-------- --------
Total current assets 13,219 10,315
Equipment, net 1,458 2,015
Goodwill, net 838 2,198
Spares inventory 252 507
Net assets of discontinued operations 460 2,078
Other assets, net 540 1,000
-------- --------
Total assets $ 16,767 18,113
======== ========
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Notes payable $ 1,569 4,435
Notes payable to a related party 1,300 --
Accounts payable 2,933 3,516
Accrued expenses 808 1,190
Billings in excess of costs and estimated earnings 1,239 1,537
Unearned income and deposits 834 1,125
-------- --------
Total current liabilities 8,683 11,803
-------- --------
Notes payable 3,585 209
Deferred revenue 184 117
-------- --------
Total liabilities 12,452 12,129
Stockholders' equity:
Preferred stock, 100,000,000 shares authorized Series A Convertible
Preferred Stock, issued and outstanding
50,000 shares, stated value of $100.00 5,000 --
Common stock, no par value, 20,000,000 shares authorized, 5,617,637
and 5,397,887 shares issued and outstanding at December 31, 1998
and 1997, respectively 14,826 13,965
Stockholders' notes (22) (31)
Accumulated deficit (15,489) (7,950)
-------- --------
Total stockholders' equity 4,315 5,984
Commitments and contingencies (note 6)
-------- --------
Total liabilities and stockholders' equity $ 16,767 18,113
======== ========
See accompanying notes to consolidated financial statements
</TABLE>
20
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Operations
(In Thousands, Except Per Share Amounts)
Year Ended December 31, 1998,
Eleven Months Ended December 31, 1997 and
Year Ended January 31, 1997
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
December 31, December 31, January 31,
1998 1997 1997
-------- -------- --------
<S> <C> <C> <C>
Revenue:
Network integration $ 17,415 20,744 14,764
Network services 14,671 12,369 11,741
-------- -------- --------
Total revenue 32,086 33,113 26,505
Cost of sales 23,688 23,693 18,815
-------- -------- --------
Gross margin 8,398 9,420 7,690
-------- -------- --------
Operating expenses:
Selling 5,092 5,722 3,995
General and administrative 6,878 6,389 4,251
Restructuring 936 -- --
Goodwill impairment 1,215 259 --
-------- -------- --------
Operating expenses 14,121 12,370 8,246
-------- -------- --------
Operating loss (5,723) (2,950) (556)
Interest expense, net (643) (400) (378)
-------- -------- --------
Loss from continuing operations (6,366) (3,350) (934)
Discontinued operations -
Loss from operations (206) (1,225) (191)
Estimated loss on disposal (967) -- --
-------- -------- --------
Net loss $ (7,539) (4,575) (1,125)
======== ========= ========
Loss per share - basic and diluted:
Weighted average common shares
outstanding 5,523 5,216 3,371
Loss from continuing operations $ (1.15) (0.64) (0.28)
Loss from discontinued operations $ (0.21) (0.24) (0.05)
Net loss $ (1.36) (0.88) (0.33)
</TABLE>
See accompanying notes to consolidated financial statements.
21
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(In Thousands Except Share Amounts)
Year Ended December 31, 1998
Eleven Months Ended December 31, 1997
Year Ended January 31, 1997
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholder's
Preferred Stock Common stock Stockholders' Accumulated Equity
Shares Amount Shares Amount Notes Deficit Total
------ ------ ------ ------ ----- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, January 31, 1996 -- $ -- 2,400,686 $ 5,198 (31) (2,250) 2,917
Stock options exercised -- -- 6,500 20 -- -- 20
Stock issued in connection with purchase of
Interwest -- -- 2,306,541 5,480 -- -- 5,480
Stock issued in connection with purchase of --
Paragon -- -- 25,000 113 -- -- 113
Net loss -- -- -- -- -- (1,125) (1,125)
--------- ------ ---------- ------- ----- ------- ------
Balances, January 31, 1997 4,738,727 10,811 (31) (3,375) 7,405
Stock options exercised -- -- 8,333 41 -- -- 41
Stock issued in connection with purchase of
Pueblo -- -- 12,570 100 -- -- 100
Stock issued in connection with private
placement, net -- -- 631,579 2,973 -- -- 2,973
Stock issued to directors and advisors -- -- 6,678 40 -- -- 40
Net loss -- -- -- -- -- (4,575) (4,575)
--------- ------ ---------- ------- ----- ------- ------
Balances, December 31, 1997 -- -- 5,397,887 $13,965 (31) (7,950) 5,984
Stock options exercised -- -- 219,750 916 -- -- 916
Series A Convertible Preferred stock issued,
net of costs 50,000 5,000 -- (55) -- -- 4,945
Payment on stockholders' note -- -- -- -- 9 -- 9
Net loss -- -- -- -- -- (7,539) (7,539)
--------- ------ ---------- ------- ----- ------- ------
Balances, December 31, 1998 50,000 $5,000 5,617,637 $14,826 (22) (15,489) 4,315
========= ====== ========== ======= ===== ======= ======
</TABLE>
See accompanying notes to consolidated financial statements.
22
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Year Ended December 31, 1998,
Eleven Months Ended December 31, 1997, and
Year Ended January 31, 1997
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
December 31 December 31 January 31
1998 1997 1997
------- ------- -------
<S> <C> <C> <C>
Cash Flows from operating activities:
Net loss from continuing operations $(6,366) (3,350) (934)
Adjustments to reconcile income from continued operations
to net cash provided by (used in) operating activities
Depreciation and amortization 1,262 1,469 932
Allowance for doubtful accounts and sales returns 171 301 61
Goodwill impairment 1,215 259 --
Changes in operating assets and liabilities, net of effect from
disposition of businesses:
Trade receivables (901) 1,567 (2,149)
Inventory 38 (1,130) 860
Prepaid expenses and other 184 270 127
Costs and estimated earnings in excess of billings 1,053 (1,114) --
Accounts payable and accrued expenses (960) 762 (2,187)
Billing in excess of costs and estimated earnings (298) 1,537 --
Deferred revenue and extended warranty (224) 144 147
------- ------- -------
Net cash provided by (used in) operating activities of
continued operations (4,826) 732 (3,143)
Net cash provided by (used in) operating activities of
discontinued operations 445 (2,164) 1,255
Cash flows from investing activities:
Capital expenditures (135) (995) (682)
Cash acquired through business acquisitions -- -- 78
------- ------- -------
Net cash used in investing activities of continued
operations (135) (995) (604)
Cash flows from financing activities
Proceeds from debt 6,265 11,766 6,567
Repayment of debt (5,755) (12,906) (2,561)
Proceeds form related party note 1,600 -- --
Repayment of note/advances from related party (300) -- (1,436)
Proceeds from sale of common including exercise of stock options 916 3,013 20
Proceeds from sale of preferred stock, net 4,945 -- --
Escrow of proceeds from sale of preferred stock (2,500) -- --
Repayment of stockholders' note 9 -- --
------- ------- -------
Net cash provided by financing activities of
continued operations 5,180 1,873 2,590
------- ------- -------
Increase (decrease) in cash and cash equivalents 664 (571) 98
Cash and cash equivalents, at beginning of period -- 571 473
------- ------- -------
Cash and cash equivalents, at end of period $ 664 -- 571
======= ======= =======
Supplemental disclosure of cash flow information
Cash paid during the year for interest $ 582 391 316
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies
General
Internet Communications Corporation ("INCC" or "the Company") is a
multi-faceted telecommunications integration and network services company.
INCC specializes in the design, implementation, maintenance and management
of premise and network-based communications for wide area networks
("WANs"). The Company targets medium-sized corporations and institutions
that use technology to operate and optimize their business over data, voice
and integrated networks.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company;
its wholly-owned subsidiaries Interwest and Interwest Cable Network
Systems, Inc. (ICNS); and its 80% subsidiary, Omega Business Communications
Services, Inc. (Omega). ICNS and Omega have been accounted for as
discontinued operations, as more fully described in Note 10. All material
intercompany transactions and amounts have been eliminated in
consolidation.
Change in Fiscal Year End
The Company changed its fiscal year end to December 31 from January 31,
effective February 1, 1997. References to fiscal year 1996 relate to the
year ended January 31, 1997.
Cash and Cash Equivalents
The Company considers all highly liquid financial instruments purchased
with an original maturity of three months or less to be cash equivalents.
The Company may deposit funds in a financial institution in excess of
amounts insured by the Federal Deposit Insurance Corporation.
Concentrations of Credit Risk
Credit risk represents the accounting loss that would be recognized at the
reporting date if counterparties failed completely to perform as
contracted. Concentrations of credit risk (whether on or off balance sheet)
that arise from financial instruments exist for groups of customers or
counterparties when they have similar economic characteristics that would
cause their ability to meet contractual obligations to be similarly
affected by changes in economic or other conditions.
Substantially all of the Company's accounts receivable result from data and
telecommunications services and hardware sales. Historically, credit losses
incurred by the Company have not been significant. The Company's activities
are primarily located in the State of Colorado, however, activities are
conducted throughout the United States.
24
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies (continued)
Inventory
Inventory, which consists of finished goods (communications equipment), is
stated at average cost. Spares inventory consists of finished parts used in
servicing customer maintenance contracts and is depreciated over a
five-year period. These amounts are stated at the lower of cost or market
and a provision is provided for expected obsolescence.
Equipment
Equipment is stated at cost, and depreciation is calculated on a
straight-line basis over the estimated useful lives of these assets
generally five to seven years. Leasehold improvements are amortized over
the lesser of the useful lives of the assets or the lease term.
Expenditures for maintenance and repairs are expensed as incurred. When
assets are retired or otherwise disposed of, the cost and related
accumulated depreciation are removed from the respective accounts and any
gain or loss on the disposition is reflected in operations.
Equipment consists of the following at December 31, 1998 and 1997 (in
thousands):
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Telecommunications equipment $ 2,392 2,338
Office furniture and equipment 2,178 2,159
Transportation equipment 5 60
Leasehold improvements 482 482
------- -------
5,057 5,039
Less accumulated depreciation and amortization (3,599) (3,024)
------- -------
Total $ 1,458 2,015
======= =======
</TABLE>
Goodwill
The excess of the purchase price over the net fair value of assets and
liabilities acquired in the acquisition of Interwest is recorded as
goodwill. Goodwill is being amortized on a straight-line basis over a
remaining period of 11 years. Accumulated amortization at December 31, 1997
is approximately $360,000. At December 31, 1998, there is no accumulated
amortization after giving effect to the goodwill impairment recorded in
1998. The amortization expense for the year ended December 31, 1998, the
eleven months ended December 31, 1997 and the year ended January 31, 1997
for the above goodwill was approximately $199,000, $168,000 and $66,000,
respectively.
25
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies (continued)
Other Assets
Other assets is comprised primarily of noncompete agreements and purchased
customer lists which are being amortized on a straight-line basis over five
years. At December 31, 1998 and 1997, the related accumulated amortization
is approximately $739,000, and $456,000.
The amortization expense for the year ended December 31, 1998, the eleven
months ended December 31, 1997 and the year ended January 31, 1997 for the
above intangibles was approximately $283,000, $406,000 and $98,000,
respectively.
Revenue Recognition
Most of the Company's contracts are short-term. For contract revenue, the
Company utilizes the percentage-of-completion method under which revenues
are recognized by measuring the percentage of costs incurred to date to
estimated total costs for each contract. Contract costs include direct
material and labor costs and those indirect costs related to contract
performance, such as indirect labor, supplies, and tools.
Operating costs are charged to expense as incurred. Provisions for
estimated losses on incomplete contracts are made in the period in which
such losses are determined. Changes in job performance, job conditions, and
estimated profitability may result in revisions to costs and income and are
recognized in the period in which the revisions are determined.
Revenue on maintenance contracts is recognized over the term of the
agreement. Unearned income represents the current month's advance billings
and revenue received in advance for services under contract. These amounts
will be recognized as revenue when earned. Commissions paid in advance are
expensed over the term of the related noncancelable service agreements.
Income Taxes
The Company uses the asset and liability method of accounting for income
taxes, whereby deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
26
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies (continued)
Loss Per Share
During 1997, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 128, Earnings Per Share (SFAS 128), which is
effective for financial statements issued for periods ending after December
15, 1997. Under SFAS 128, basic 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 year ended December 31, 1998, the 11 months
ended at December 31, 1997 and the year ended January 31, 1997, as all of
the Company's potentially dilutive securities were anti-dilutive during
these periods. If the effect had been dilutive, potential common shares
would have included the effects of the assumed conversion of the preferred
shares and the assumed exercise of the outstanding options and warrants
using the treasury stock method of assumed conversion. The convertible
preferred shares are convertible or convert into 2,222,222 shares of
Company common stock. The outstanding options and warrants would have been
anti-dilutive, even if the Company had net income in the three years
presented, because of the relationship between the exercise price and the
quoted market price of the Company stock.
Use of Estimates
The preparation of the Company's consolidated financial statements in
conformity with generally accepted accounting principles requires the
Company's management to make estimates and assumptions that affect the
amounts reported in these financial statements and accompanying notes.
Actual results could differ from those estimates.
The Company's consolidated financial statements are based on a number of
significant estimates, including the percentage of completion on projects
in progress at year-end which is the basis for the calculation of revenue
earned for these projects. The Company's estimates to complete are
determined by management for all projects in process at year-end and could
change as future information becomes available. Management believes it is
reasonably possible that there will be changes to total revenues and
expenses on projects in process at year-end through change orders that will
affect these projects' ultimate profitability.
Fair Value of Financial Instruments
The estimated fair values for financial instruments under SFAS No. 107,
Disclosures About Fair Value of Financial Instruments, are determined at
discrete points in time based on relevant market information. These
estimates involve uncertainties and cannot be determined with precision. At
December 31, 1998 and 1997, the Company believes the carrying values of its
receivables, notes payables and accounts payable approximate their
estimated fair values.
27
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies (continued)
Impairment of Long-Lived Assets
The Company reviews its long-lived assets for impairment when events or
changes in circumstances indicate that the carrying value of such assets
may not be recoverable, in accordance with Statement of Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of (SFAS 121). This review consists of
a comparison of the carrying value of the asset with the asset's expected
future undiscounted cash flows without interest costs. Estimates of
expected future cash flows are to represent management's best estimate
based on reasonable and supportable assumptions and projections. If the
expected future cash flow exceeds the carrying value of the asset, no
impairment is recognized. If the carrying value of the asset exceeds the
expected future cash flows, an impairment exists and is measured by the
excess of the carrying value over the fair value of the asset. Fair value
of the asset may be determined by sales of similar assets, or other
estimates of fair value such as discounting estimated future cash flows.
Any impairment provisions recognized are permanent and may not be restored
in the future.
Stock-Based Compensation
In fiscal 1996, the Company adopted SFAS No. 123, Accounting for
Stock-Based Compensation, (SFAS 123). SFAS 123 encourages, but does not
require, companies to recognize compensation expense for grants of stock,
stock options and other equity instruments to employees based on fair
value. Companies that do not adopt the fair value accounting rules must
disclose the impact of adopting a new method in the notes to the financial
statements. Transactions in equity instruments with non-employees for goods
or services must be accounted for on the fair value method. The Company has
elected not to adopt the fair value accounting method prescribed by SFAS
123 for employee stock compensation, and is subject only to the disclosure
requirements prescribed by SFAS 123. Adoption of SFAS 123 has no effect on
the Company's consolidated financial statements.
Impact of recently issued accounting pronouncements
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 reporting standards for derivative instruments and hedging
activities by requiring
28
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
(1) Summary of Significant Accounting Policies (continued)
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.
Reclassifications
Certain reclassifications have been made to the 1997 and 1996 financial
statements to conform to the 1998 presentations. Such reclassifications has
no effect on net income.
(2) Acquisitions
In September 1996, the Company acquired the outstanding common stock of
Interwest through the issuance of 2,306,541 shares of its common stock,
which was valued at approximately $5,480,000. This acquisition was
accounted for under the purchase method of accounting. The excess of the
purchase price over the net liabilities acquired is being amortized over a
period not to exceed 15 years.
Additionally, in October 1996, the Company purchased the assets of another
entity for 25,000 shares of the Company's common stock and accounted for
the acquisition under the purchase method of accounting.
During 1997, the Company acquired its remaining interest in Interwest
Communications Pueblo Corporation for 12,570 shares of common stock, valued
at $100,000. Any pro-forma results of operations are immaterial to the
consolidated financial statements.
(3) Contracts in Progress
Costs and billings on uncompleted contracts included in the accompanying
consolidated financial statements are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Costs incurred on uncompleted contracts $ 4,385 5,879
Estimated earnings 1,447 1,790
------- -------
5,832 7,669
Less: Billings to date 6,299 7,381
------- -------
$ (467) 288
======= =======
Included in the accompanying balance sheet accounts under
the following captions:
Costs and estimated earnings in excess of billings $ 772 1,825
Billings in excess of costs and estimated earnings 1,239 1,537
------- -------
$ (467) 288
======= =======
</TABLE>
29
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
The Company has entered into various contracts for the installation of
wide-area and local-area data and voice networks. Progress billings are
made to customers upon contract acceptance and completion of certain
milestones. The Company expects to bill and collect all costs and estimated
earnings in excess of billings as of December 31, 1998 in 1999.
(4) Goodwill
In 1998, the Company recognized a goodwill impairment of $1,215,000. The
goodwill arose from the 1996 purchase of Interwest. This non-cash charge
represents the difference between the historical book value of the goodwill
and the discounted estimated future cash flows expected from the related
operations. Considerable management judgement is necessary to estimate
discounted future cash flows. Accordingly, actual results could vary from
such estimates.
In 1997, the Company recognized a goodwill impairment of $746,000 which is
directly associated with discontinued operations (note 10). The goodwill is
related to two of the Company's non-core business segments which the
Company's Board of Directors adopted a plan to sell during 1998.
In addition, in 1997, the Company recognized a goodwill impairment of
$259,000. The goodwill relates to a 1996 purchase business combination and
was determined to have been impaired because the purchased business was
generating recurring operating losses and key employees were transferred to
other operating units of the Company.
(5) Notes Payable
On December 30, 1998, the Company entered into an agreement with the bank
to amend its credit facility. On February 1, 1999, the Fourth Amendment to
Credit Agreement and Note Modification Agreement was executed. The new
facility consists of a line-of-credit for $4,350,000 through March 31, 1999
and $4,000,000 thereafter with interest at prime plus 1% (8.75% at December
31, 1998). As of December 31, 1998, there was $5,000,000 outstanding under
the line-of-credit. In accordance with the agreement with the Bank, the
Company paid down the amount outstanding by $650,000 on January 4, 1999 and
by $850,000 on February 24, 1999. The cash used to make the $650,000
payment was reflected as restricted cash at December 31, 1998. The
line-of-credit is collateralized by accounts receivable and inventory and
matures on March 1, 2000. The credit agreement requires that the Company
remain in compliance with certain affirmative and negative covenants. The
financial covenants include specific requirements for EBITDA, accounts
receivable and accounts payable. In addition, the Company has monthly and
quarterly reporting requirements.
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. As of
December 31, 1998, the balance on the note was $1,300,000. This amount was
paid off on February 24, 1999.
30
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
The Company also has various notes payable agreements with various
individuals totaling approximately $154,000 at December 31, 1998. In
general, these notes are unsecured, however, a few are collateralized by
certain equipment of the Company. Interest accrues on these notes at
between approximately 7% and 14% per annum.
Future debt maturities as of December 31, 1998 are as follows (in
thousands):
<TABLE>
<S> <C>
1999 $ 2,869
2000 3,557
2001 28
-------
$ 6,454
=======
</TABLE>
(6) Commitments and Contingencies
The Company leases office space, equipment and vehicles under noncancelable
operating leases. Total rental expense for the year ended December 31,
1998, the eleven months ended December 31, 1997 and the year ended January
31, 1997 was $981,000, $929,945 and $688,000, respectively. The total
minimum rental commitments as of December 31, 1998 are as follows (in
thousands):
<TABLE>
<S> <C>
1999 $ 656
2000 576
2001 510
2002 352
-------
$ 2,094
=======
</TABLE>
The Company also leases telecommunications circuits under noncancelable
leases. The Company subleases these circuits to its customers as part of
its normal operations. Minimum commitments under these agreements total
approximately $920,000 for fiscal 1999, $980,000 for fiscal 2000,
$1,200,000 for fiscal 2001, $1,200,000 for fiscal 2002, and only minimal
commitments thereafter.
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, based on a merger agreement 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. RMI has
counterclaimed that the Company breached the merger agreement by failing to
file the merger proxy in a timely manner, misrepresenting the Company's
compatibility with RMI and failing to maintain satisfactory business
operations. The counterclaim seeks substantial damages based on RMI's
inability to complete a $175 million high yield debt offering as a result
of the Company's breach of contract. The Company believes RMI's
counterclaims are frivolous and without merit and intends to vigorously
defend its position and pursue its claim against RMI. In addition, both
parties have filed motions for partial summary judgement addressed to the
applicability of a provision of the merger agreement which would limit
damages upon termination to $1,050,000 for the non-breaching party. While
the ultimate outcome of these matters cannot be determined at this time,
management does not believe the resolution will have a material adverse
affect on the Company's financial position.
31
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
(7) Stockholders' Equity
The Company has authorized 100,000,000 shares of preferred stock, which may
be issued in series and with such preferences as determined by the
Company's Board of Directors. On December 30, 1998, the Company executed a
stock purchase agreement with Interwest Group, Inc., a related party. Under
the terms of the agreement, the Company issued 50,000 shares of Series A, 7
1/8% convertible preferred stock, convertible at $2.25 per share, in
exchange for $5.0 million. Of the proceeds, $2.5 million was placed in
escrow subject to shareholder approval as required by NASDAQ corporate
governance rules. On February 23, 1999, the Company received shareholder
approval and the escrow was released. After the purchase, Interwest Group
owns 50% of the outstanding common stock of the Company and 64% on an if
converted basis.
During 1998, 219,750 options to purchase common stock were exercised for
total proceeds to the Company of $916,000.
In April 1997, the Company issued 631,579 shares of common stock for
$3,000,000 and 63,158 warrants to purchase common stock at $5.70 per share
exercisable for a period of 5 years to Interwest Group.
During the fiscal year 1996, the Company adopted, and the stockholders
approved, an Incentive Stock Plan (Plan), that authorizes the issuance of
up to 875,000 shares of common stock. At the Company's Annual Shareholders'
meeting held on May 19, 1998, the shareholders approved an amendment to the
Company's 1996 Incentive Stock Plan to increase the number of options which
may be granted from 857,000 shares to 975,000 shares. Pursuant to the Plan,
the Company may grant "incentive stock options" (intended to qualify under
Section 422 of the Internal Revenue Code of 1986, as amended),
non-qualified stock options and stock purchase rights or a combination
thereof.
Incentive stock options may not be granted at an exercise price of less
than the fair market value of the common stock on the date of grant (except
for holders of more that 10% common stock, whereby the exercise price must
be at least 110% of the fair market value at the date of grant for
incentive stock options). The term of the options may not exceed ten years.
During the fiscal year 1996, the Company also adopted the Non Employee
Directors' Stock Option Plan (Outside Directors' Plan), which provides for
the grant of stock options to non-employee directors of the Company and any
subsidiary. An aggregate of 40,000 shares of common stock are reserved for
issuance under the Outside Directors' Plan. The exercise price of the
options will be the fair market value of the stock on the date of grant.
All options granted vest over a 3-year period from the date of the grant.
32
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
The following is a summary of activity under these stock option plans for
the year ended December 31, 1998, the eleven months ended December 31, 1997
and the year ended January 31, 1997:
<TABLE>
<CAPTION>
Weighted
Number of average
shares exercise price
--------- --------------
<S> <C> <C>
Balances, January 31, 1996 296,800 $3.44
Granted 686,344 4.10
Exchanged (217,900) 3.20
Exercised (6,500) 3.00
Forfeitures (98,900) 4.20
-------- -----
Balances, January 31, 1997 659,844 4.18
Granted 221,800 5.52
Exercised (8,333) 4.95
Forfeitures (40,867) 4.53
-------- -----
Balances December 31, 1997 832,444 4.62
Granted 535,994 3.22
Exercised (219,750) 4.17
Forfeitures (532,044) 5.01
-------- -----
Balance, December 31, 1998 616,644 $3.22
======== =====
</TABLE>
The following tables summarize certain information about the Company's
stock options at December 31, 1998.
<TABLE>
<CAPTION>
Options outstanding
-----------------------------------------------------------------------
Weighted Weighted
Range of Number of average average
exercise outstanding remaining exercise
prices options contractual life price
-------- ----------- ---------------- --------
<S> <C> <C> <C>
$2.25-2.66 350,394 9.6 years $ 2.39
$2.67-4.44 164,800 1.6 3.72
$4.45-8.88 101,450 4.1 5.26
-------
$2.25-8.88 616,644 6.5 $ 3.22
=======
</TABLE>
Of the options outstanding, 225,879 are exercisable as of December 31, 1998
at a weighted average exercise price of $4.32.
Pro Forma Stock Based Compensation Disclosures
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock options and warrants which are granted to
employees. Accordingly, no compensation cost was recognized for grants of
options during the year ended December 31, 1998, the eleven months
33
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
ended December 31, 1997 and year ended January 31, 1997 to employees since
the exercise prices were not less than the fair value of the Company's
common stock on the grant dates. Had compensation cost been determined
based on the fair value method described in SFAS 123, the Company's net
loss and net loss per share would have been increased to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
Eleven months
Year ended ended Year ended
December 31, December 31, January 31,
1998 1997 1997
---- ---- ----
<S> <C> <C> <C>
Net loss applicable to common shareholders:
As reported $ (7,539) (4,575) (1,125)
Pro forma $ (8,386) (5,612) (1,803)
Net loss per common share - basic and diluted:
As reported $ (1.36) (0.88) (0.33)
Pro forma $ (1.52) (1.08) (0.53)
</TABLE>
The per share weighted average fair value of options granted in the year
ended December 31, 1998, the eleven months ended December 31, 1997 and the
year ended January 31, 1997 on the date of grant was estimated to be $2.58,
$4.05 and $2.98, respectively, using the Black-Scholes option-pricing model
with the following weighted average assumptions:
<TABLE>
<CAPTION>
Year Ended Eleven Months Year Ended
December 31, December31, January 31,`
1998 1997 1997
---- ---- ----
<S> <C> <C> <C>
Expected volatility 96% 57% 83%
Risk-free interest rate 6% 6% 7%
Expected dividends -- -- --
Expected term (in years) 6 10 5
</TABLE>
(8) Income Taxes
Deferred income taxes are provided for differences between the tax and book
basis of assets and liabilities as a result of temporary differences in the
recognition of revenues or expenses for tax and financial reporting
purposes.
34
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
At December 31, 1998 and 1997, these differences consist of the following
(in thousands):
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Income tax loss carryforward $ 4,302 2,401
Allowance on assets 500 263
Deferred revenue -- 53
Equipment and goodwill expense 262 258
Other 65 40
------- -------
5,129 3,015
Less valuation allowance (5,129) (3,015)
------- -------
Net $ -- --
======= =======
</TABLE>
The Company did not recognize tax benefits in the year ended December 31,
1998, the eleven months ended December 31, 1997 and the year ended January
31, 1997 due to increases in the valuation allowance for deferred tax
assets in those periods. The valuation allowance for deferred tax assets
increased from $952,000 at January 31, 1997 to $3,015,000 at December 31,
1997 and to $5,129,000 at December 31, 1998, due primarily to an increase
in the Company's net operating loss carryforwards.
As of December 31, 1998, the Company has income tax loss carryforwards of
approximately $11,500,000 which expire in the years 2006 through 2018. The
utilization of certain of these net operating loss carryforwards have been
restricted because of ownership changes. These restrictions limit the
amount of utilizable net operating loss carryforwards each year.
(9) Employee Saving Plans
The Company had provided two separate savings plans to its' employees: (1)
the Internet Communications Employee Retirement Savings Plan and Trust, and
(2) the Interwest Communications Employee Thrift Retirement Plan. Effective
January 1, 1998, the Company adopted a new 401(k) plan. The new plan merged
the two existing plans together.
The Internet Communications Employee Retirement Savings Plan and Trust
permits employees to make contributions by salary reductions pursuant to
section 401(k) of the Internal Revenue Code. This plan covers substantially
all of the Internet Communications Corporation employees who have been
employed with the Company for six months and are at least 21 years of age.
Each employee's contribution, up to a maximum of 6%, is matched 50% by the
Company. The Company may also make additional cash contributions at the
discretion of the Board of Directors. Employees are fully vested in
employer contributions after they complete six years of service. Company
contributions charged against income for the year ended December 31, 1998,
the eleven month period ended December 31, 1997 and for the year ended
January 31, 1997 were $122,000, $98,000 and $45,000, respectively.
35
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
(10) 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, and an agreement entered into by
the Company to terminate the last major contract to be completed under the
Company's plan to divest of ICNS, management determined that a net loss on
disposal would be incurred as well as operating losses. Management has
revised its estimates in the financial statements for the year ended
December 31, 1998. Summarized results of Omega and ICNS for 1997 and 1996
are as follows (dollars in thousands):
<TABLE>
<CAPTION>
Omega ICNS
------------ -----------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Loss from operations $ 476 69 749 122
</TABLE>
(11) 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
totaling $1,345,000. In the accompanying financial statements, cost of
sales includes $409,000 related to the product line reductions. The
remaining $936,000 is classified in operating expenses as restructuring.
The balance of these restructuring expenses remaining to be funded as of
December 31, 1998 was approximately $135,000.
(12) Related Party Transactions
The Company has entered into certain transactions in the normal course of
business with related parties. As of December 31, 1998 and 1997, the
Company had outstanding related party receivables of $182,000 and $448,000,
which are included in trade receivables, and related party payables of
$103,000 and $129,000 which are included in accounts payable and accrued
expenses.
The Company had an outstanding receivable at December 31, 1997, related to
a project for which the Company was a subcontractor. This receivable
related to the cost of delays and inefficiencies,
36
<PAGE>
INTERNET COMMUNICATIONS CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------
as a result of environmental hazards at the worksite. The Company sold this
receivable to a related party during the fourth quarter of 1998 for
$500,000 recognizing a loss on the receivable of $109,000. The Company is
required to pursue collection of the receivable and is subject to
reimbursing the purchaser up to $100,000 if the actual collection does not
exceed $500,000.
(13) 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 21st century dates from 20th 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. As of the first quarter of 1999, testing,
remediation and replacement had commenced. The Company has not developed a
contingency plan that would be utilized if current efforts by the Company
and its vendors are unsuccessful.
There can be no assurance that the Year 2000 issues will be resolved in
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 could have a material adverse
impact on the Company's business, operating results, financial condition
and cash flow.
37
<PAGE>
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
NONE
PART III
The information required by Part III: Item 10 - Directors and Executive Officers
of the Registrant; Item 11 - Executive Compensation; Item 12 - Security
Ownership of Certain Beneficial Owners and Management, and Item 13 - Certain
Relationships and Related Transactions of Form 10-K are incorporated herein by
reference to Registrant's definitive Proxy Statement to be filed in connection
with the Annual Meeting of Shareholders to be held on May 27, 1999.
38
<PAGE>
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits:
<TABLE>
<CAPTION>
No. Exhibit Location
<S> <C> <C>
3.1 Corporate Bylaws Incorporated by reference to Exhibit No. 3.1 to
the Registrant's Form S-18 Registration Statement
No. 33-24299-D
3.2 Restated Articles of Incorporation filed with the Incorporated by reference to Registrant's Form
Colorado Secretary of State on 10-KSB for the fiscal year ended December 31, 1997
January 23, 1998
3.3 Articled of Amendment to the Articles of Incorporated by reference to Registrant's
Incorporation filed with the Colorado Secretary of definitive proxy, dated January 13, 1999
State on December 30, 1998
10.1 Non-Compete Agreement between Thomas C. Galley and Incorporated by reference to Registrant's Form
Internet Communications Corporation dated December 10-K for the fiscal year ended January 31, 1992
23, 1991
10.2 Buy-Sell Agreement between Thomas C. Galley and Incorporated by reference to Registrant's Form
Internet Communications Corporation dated May 1, 10-KSB for the fiscal year ended January 31, 1995
1994
10.3 Share Exchange Agreement, Stock Registration Incorporated by reference to Registrant's Form
Agreement, and Loan Agreement dated May 29, 1996, 8-K, dated May 29, 1996
between Internet Communications Corporation and
Interwest Group
10.4 1995 Non-employee Director Stock Option Plan, dated Incorporated by reference to Registrant's
September 12, 1996 definitive proxy, dated August 12, 1996
10.5 1995 Non-employee Director Stock Option Plan, dated Incorporated by reference to Registrant's Form
September 12, 1996 (as amended) S-8, dated September 8, 1997
10.6 1996 Incentive Stock Plan, dated September 12, 1996 Incorporated by reference to Registrant's
definitive proxy, dated August 12, 1996
10.7 1996 Incentive Stock Plan, dated September 12, 1996 Incorporated by reference to Registrant's
(as amended September 1996) definitive proxy, dated May 30, 1997
10.8 1996 Incentive stock Plan, dated September 12, 1996 Incorporated by reference to Registrant's
(as amended December 10, 1997) definitive proxy, dated April 23, 1998
</TABLE>
39
<PAGE>
<TABLE>
<S> <C> <C>
10.9 Convertible Promissory Note dated March 20, 1998 in Incorporated by reference to Registrant's Form
the amount of $1,600,000 10-KSB for the fiscal year ended December 31, 1997
10.10 Employment Agreement between John M. Couzens and Incorporated by reference to Registrant's Form
Internet Communications Corporation dated April 10-Q for the quarter ended March 31, 1998
28,1 997
10.11 Employment Agreement Mary Beth Loesch and Incorporated by reference to Registrant's Form
Internet Communications Corporation dated 10-Q for the quarter ended March31, 1998
January 2, 1998
22.1 Subsidiaries of the Registrant Incorporated by reference to Exhibit 22.1 to
Registrant's Report on Form 10-K for the fiscal
year ended January 31, 1997
23.1 Consent of KPMG LLP Filed herewith
23.2 Consent of Hein + Associates LLP Filed herewith
</TABLE>
(b) Reports on Form 8-K:
There was one report on Form 8-K filed during the quarterly period ended
December 31, 1998. The Form 8-K, filed on October 19, 1998, reports the refusal
by Rocky Mountain Internet, Inc. to close the previously announced merger with
the Company.
40
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTERNET COMMUNICATIONS CORPORATION
(Registrant)
Date: March 30, 1999 By: /s/ John M. Couzens
-------------------
John M. Couzens, President and Chief
Executive Officer
In accordance the Exchange Act, this report has been signed by the following
persons on behalf of the registrant and in the capacities and on the dates
indicated.
Date: March 30, 1999 By: /s/ John M. Couzens
------------------------
John M. Couzens, President, Chief
Executive Officer and Director
Date: March 30, 1999 By: /s/ T. Timothy Kershisnik
-------------------------
T. Timothy Kershisnik, Chief
Financial Officer, Vice President
and Secretary
Date: March 30, 1999 By: /s/ Thomas C. Galley
------------------------
Thomas C. Galley, Director
Date: March 30, 1999 By: /s/ Peter A. Guglielmi
------------------------
Peter A. Guglielmi, Director
Date: March 30, 1999 By: /s/ Richard Liebhaber
------------------------
Richard Liebhaber, Director
Date: March 30, 1999 By: /s/ William J. Maxwell
------------------------
William J. Maxwell, Director
Date: March 30, 1999 By: /s/ Craig D. Slater
-------------------------
Craig D. Slater, Director
Date: March 30, 1999 By: /s/ Robert L. Smith
------------------------
Robert L. Smith, Director
41
<PAGE>
EXHIBIT 23.1
The Board of Directors and Stockholders
Internet Communications Corporation:
We consent to incorporation by reference in the registration statement (No. 333-
35113) on Form S-8 of Internet Communications Corporation of our report dated
March 30, 1999, relating to the consolidated balance sheets of Internet
Communications Corporation and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for the year ended December 31, 1998, and the eleven-month period
ended December 31, 1997, which report appears in the December 31, 1998, annual
report on Form 10-K of Internet Communications Corporation.
KPMG LLP
Denver, Colorado
March 30, 1999
<PAGE>
EXHIBIT 23.2
To the Board of Directors
Internet Communications Corporation:
We consent to incorporation by reference in the registration statement on Form
S-8, filed with the Securities and Exchange Commission on September 8, 1997, of
our report dated May 2, 1997, relating to the consolidated balance sheet of
Internet Communications Corporation and subsidiaries as of January 31, 1997, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for year then ended, which report appears in the December 31, 1998
annual report on Form 10-K of Internet Communications Corporation.
HEIN + Associates LLP
Denver, Colorado
March 26, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 14,000
<SECURITIES> 0
<RECEIVABLES> 6,190,000
<ALLOWANCES> 472,000
<INVENTORY> 3,296,000
<CURRENT-ASSETS> 13,219,000
<PP&E> 5,660,000
<DEPRECIATION> 4,202,000
<TOTAL-ASSETS> 16,767,000
<CURRENT-LIABILITIES> 8,683,000
<BONDS> 0
0
5,000,000
<COMMON> 14,826,000
<OTHER-SE> (15,511,000)
<TOTAL-LIABILITY-AND-EQUITY> 16,767,000
<SALES> 32,086,000
<TOTAL-REVENUES> 32,086,000
<CGS> 23,688,000
<TOTAL-COSTS> 23,688,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 374,000
<INTEREST-EXPENSE> 643,000
<INCOME-PRETAX> (6,366,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,366,000)
<DISCONTINUED> (1,173,000)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,539,000)
<EPS-PRIMARY> (1.36)
<EPS-DILUTED> (1.36)
</TABLE>
