<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q--QUARTERLY REPORT UNDER SECTION 13 OR (15)d
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1999
------------------
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _____________ to _____________
Commission file number 0-19578
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INTERNET COMMUNICATIONS CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Colorado 84-1095516
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(State or other jurisdiction of (IRS Employer
incorporation or organization) identification No.)
7100 E. Belleview Avenue, Suite 201, Greenwood Village, Colorado 80111
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(Address of principal executive offices) (Zip Code)
(303) 770-7600
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
At November 10, 1999, 5,710,894 shares of Common Stock, no par value, were
outstanding.
Page 1 of 17 pages.
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Internet Communications Corporation
INDEX
Page
-----
Form 10-Q Cover Page 1
Index Page 2
Part I FINANCIAL INFORMATION
Item 1-Financial Statements
Condensed Consolidated Balance 3
Sheets at September 30, 1999 and December 31, 1998
Condensed Consolidated Statements of Operations for the 4
three and nine months ended September 30, 1999 and 1998
Condensed Consolidated Statements of Cash Flows 5
for the nine months ended September 30, 1999 and 1998
Notes to Condensed Consolidated Financial Statements 6
Item 2-Management's Discussion and Analysis of Financial Condition 9
and Results of Operations
Item 3-Quantitative and Qualitative Disclosures About Market Risk 14
Part II OTHER INFORMATION
Item 1-Legal Proceedings 15
Item 2-Changes in Securities and use of Proceeds 15
Item 3-Defaults upon Senior Securities 15
Item 4-Submission of Matters to a Vote of 16
Security Holders
Item 5-Other Information 16
Item 6-Exhibits and Reports on Form 8-K 16
Signature Page 17
2
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INTERNET COMMUNICATIONS CORPOARATION
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------------- -----------------
(unaudited)
<S> <C> <C>
Assets
Current assets:
Cash $ 173 14
Restricted cash --- 650
Trade receivables, net of allowance for doubtful accounts and
sales returns of $371 at September 30, 1999 and $472 at
December 31, 1998 4,320 5,637
Subscription receivable from a related party --- 2,500
Inventory 2,971 3,296
Prepaid expenses and other 300 350
Costs and estimated earnings in excess of billings 550 772
---------------- -----------------
Total current assets 8,314 13,219
Equipment, net 1,153 1,458
Goodwill, net 783 838
Spares inventory 189 252
Net assets of discontinued operations 414 460
Other assets, net 451 540
---------------- -----------------
Total assets $ 11,304 16,767
================ =================
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable $ 2,001 1,569
Notes payable to a related party --- 1,300
Accounts payable 2,881 2,933
Accrued expenses 766 808
Billings in excess of costs and estimated earnings 611 1,239
Unearned income and deposits 784 834
---------------- -----------------
Total current liabilities 7,043 8,683
---------------- -----------------
Notes payable 42 3,585
Deferred revenue 181 184
---------------- -----------------
Total liabilities 7,266 12,452
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 5,000
Series B Convertible Preferred Stock, issued and outstanding
19,000 shares, stated value $100.00 1,900 ---
Common stock, no par value, 20,000,000 shares authorized, 5,710,894
and 5,617,637 shares issued and outstanding at September 30, 1999
and December 31, 1998, respectively 15,021 14,826
Stockholders' notes (22) (22)
Accumulated deficit (17,861) (15,489)
---------------- -----------------
Total stockholders' equity 4,038 4,315
Commitments and contingencies
---------------- -----------------
Total liabilities and stockholders' equity $ 11,304 16,767
================ =================
See accompanying notes to these condensed consolidated financial statements.
</TABLE>
3
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INTERNET COMMUNICATIONS CORPORATION
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For Three Months Ended For Nine Months Ended
----------------------------------- -------------------------------------
September 30, September 30, September 30, September 30,
1999 1998 1999 1998
(Unaudited) (Unaudited) (Unaudited) (Undaudited)
----------------- ---------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Sales:
Network Services $ 2,795 3,518 9,313 11,097
Network Integration 3,132 4,856 10,138 14,032
----------------- ---------------- ----------------- -----------------
Total sales 5,927 8,374 19,451 25,129
Cost of Sales (4,584) (6,102) (14,330) (18,409)
----------------- ---------------- ----------------- -----------------
Gross margin 1,343 2,272 5,121 6,720
----------------- ---------------- ----------------- -----------------
Operating expenses:
Selling 897 1,166 2,520 4,065
General and administrative 1,321 1,790 4,498 5,168
Restructuring --- --- --- 1,199
Interest expense, net 76 157 297 448
----------------- ---------------- ----------------- -----------------
Total expenses 2,294 3,113 7,315 10,880
----------------- ---------------- ----------------- -----------------
Income (Loss) from continuing operations (951) (841) (2,194) (4,160)
Discontinued operations--
Income (Loss) from operations --- --- --- (206)
Estimated loss on disposal --- (730) --- (967)
----------------- ---------------- ----------------- -----------------
Net Income (Loss) $ (951) (1,571) (2,194) (5,333)
================= ================ ================= =================
Income (Loss) per share - basic and diluted:
Weighted average common shares
outstanding 5,621 5,460 5,619 5,429
Income (Loss) from continuing operations (0.17) (0.15) (0.39) (0.76)
Income (Loss) from discontinued operations --- (0.14) --- (0.22)
Net Income (Loss) (0.17) (0.29) (0.39) (0.98)
See accompanying notes to these condensed consolidated financial statements
</TABLE>
4
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INTERNET COMMUNICATIONS CORPORATION
Condensed Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
For Nine Months Ended
--------------------------------------------------
September 30, September 30,
1999 1998
---------------------- ---------------------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss from continuing operations $ (2,194) (4,160)
Adjustments to reconcile net loss from continued operations
Depreciation and amortization 692 1,033
Allowance for doubtful accounts and sale returns 540 350
Directors compensation 30 ---
Changes in operating assets and liabilities:
(Increase) decrease in:
Receivables 777 (3,108)
Inventory 338 (136)
Prepaid expenses and other (7) (83)
Costs in excess of billings and estimated
earnings 222 274
Increase (decrease) in:
Accounts payable (52) 600
Accrued expenses (43) 440
Unearned income and deferred revenue (53) (110)
Billings in excess of costs and estimated
earnings (628) 440
------------------- ---------------------
Net cash used in operating activities (378) (4,460)
Net cash provided by discontinued operations 46 1,534
Cash flows from investing activities:
Capital expenditures (141) (174)
Proceeds from sales of assets 5 113
------------------- ---------------------
Net cash used in investing activities (136) (61)
Cash flows from financing activities:
Proceeds from debt 16,944 7,865
Repayment of debt (20,055) (5,734)
Repayment of note from a related party (1,300) ---
Subscription receivable from a related party 2,500 ---
Proceeds from sale of preferred stock, net 1,888 ---
Proceeds from exercise of stock options --- 916
Repayment of stockholders' note --- 9
------------------- ---------------------
Net cash provided by (used in) financing activities (23) 3,056
------------------- ---------------------
Increase (decrease) in cash: (491) 69
Cash, beginning of period 664 ---
------------------- ---------------------
Cash, end of period $ 173 69
=================== =====================
See accompanying notes to these condensed consolidated financial statements.
</TABLE>
5
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
NOTE 1 -- BASIS OF PRESENTATION
---------------------
The financial statements included herein have been prepared by Internet
Communications Corporation ("Internet" or the "Company"), without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission
and include all adjustments which are, in the opinion of management, necessary
for a fair presentation. Certain information and footnote disclosures normally
included in the financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The Company believes that the disclosures are adequate to
make the information presented not misleading. However, it is suggested that
these financial statements be read in conjunction with the financial statements
and the notes thereto which are included in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1998. The financial data for the
interim periods may not necessarily be indicative of results to be expected for
the year.
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 revised these estimates in the financial statements
for the year ended December 31, 1998. The net assets of discontinued operations
includes a receivable that is currently in litigation.
NOTE 2 - 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. On August 10, 1999,
the Fifth Amendment to Credit Agreement and Note Modification Agreement was
executed. The facility consists of a line-of-credit for $3,500,000 with
interest at prime plus 1% (9.25% at September 30, 1999). As of September 30,
1999, there was $1,941,000 outstanding under the line of credit. 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 subject to a borrowing base
calculation and collateralized by accounts receivable and inventory. The line
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 Earnings Before Interest
Taxes Depreciation and Amortization ("EBITDA"), accounts receivable and accounts
payable. In addition, the Company has monthly and quarterly reporting
requirements. As of September 30, 1999, the Company is not in compliance with
the EBITDA covenant. The Company is currently negotiating with the bank to
resolve the covenant violation. In addition, the Company will be entering into
discussions with the bank to extend and/or modify the credit facility, which
matures on March 1, 2000. However, there is no assurance that the Company will
be successful modifying the current credit facility, obtaining alternative
financing or securing other forms of funding.
6
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In March 1998, the Company received $1,600,000 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. As of December 31, 1998, the
balance on the note was $1,300,000. This note was paid off on February 24,
1999.
NOTE 3 - 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 $5,000,000. Of
the proceeds, $2,500,000 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 owned 50% of the outstanding common stock of the
Company and 64% on an if converted basis.
On August 11, 1999, the Company executed a stock purchase agreement with
Interwest Group, Inc., a related party. Under the terms of the agreement the
Company issued 19,000 shares of Series B 7-3/8% convertible preferred stock,
convertible at $2.9063 per share, and 100,000 warrants to purchase common stock
(exercisable for four years at $2.9063) in exchange for $1,900,000. In
addition, the agreement provides a one year commitment for an additional sale of
5,000 shares of Series B 7-3/8% convertible preferred stock ($500,000) subject
to the Company meeting certain requirements. After the purchase, Interwest Group
owns 52% of the outstanding common stock of the Company and 68% on an if
converted basis.
On May 27, 1999, at the annual meeting of shareholders, the shareholders
approved the 1999 Employee Stock Purchase Plan. The employees began
contributing to the plan effective October 1, 1999.
NOTE 4 - INCOME (LOSS) PER SHARE
-----------------------
Basic income (loss) per share is computed on the basis of weighted-average
common shares outstanding. Diluted loss per share considers potential common
stock in the calculation, and is the same as basic loss per share for the three
and nine months ended September 30, 1999 and 1998 as all of the Company's
potentially dilutive securities were anti-dilutive during these periods.
NOTE 5 - IMPACT OF RECENTLY ISSUED ACCOUNTING PROUNOUNCEMENTS
----------------------------------------------------
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 that all
derivative instruments be reported as assets or liabilities and measured at
their fair values. Although management of the Company has not completed its
assessment of the impact of SFAS 133 on its consolidated results of operations
and financial position, management estimates that the impact of SFAS 133 will
not be material.
NOTE 6 - 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.
7
<PAGE>
The Company has identified 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
September 30, 1999, testing, remediation and replacement has been substantially
completed. The Company intends to continue developing a contingency plan that
will 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 has an estimate of approximately $50,000 for the costs required for
this effort, but may incur additional 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.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
- ---------------------
CAUTIONARY STATEMENT PURSUANT TO SAFE HARBOR PROVISIONS OF THE PRIVATE
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SECURITIES LITIGATION REFORM ACT OF 1995
- ----------------------------------------
This 10-Q contains "forward-looking statements" within the meaning of the
federal securities laws. These forward-looking statements include statements of
expectations, beliefs, future plans and strategies, anticipated events or trends
and similar expressions concerning matters that are not historical facts. The
forward-looking statements in this 10-Q are subject to risks and uncertainties
that could cause actual results to differ materially from those expressed in or
implied by the statements.
With regard to the Company, the most important factors include, but are not
limited to, the following:
- Changing technology.
- Competition.
- Possible future government regulation.
- Competition for talented employees.
- Company's ability to fund future operations.
- Becoming Y2K compliant.
The following is management's discussion and analysis of certain significant
factors which have affected the Company's financial condition and results of
operations during the periods included in the accompanying condensed financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Capital Resources
On 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 Series A 7-1/8% convertible preferred stock, convertible at $2.25
per share, in exchange for $5,000,000. On December 30, 1998, $2,500,000 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 $2,500,000 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 August 11, 1999, the Company executed a stock purchase agreement with
Interwest Group, Inc., a related party. Under the terms of the agreement the
Company issued 19,000 shares of Series B 7-3/8% convertible preferred stock,
convertible at $2.9063 per share, and 100,000 warrants to purchase common stock
(exercisable for four years at $2.9063) in exchange for $1,900,000. In
addition, the agreement provides a one year commitment for an additional sale of
5,000 shares of Series B 7-3/8% convertible preferred stock ($500,000) subject
to the Company meeting certain requirements. The proceeds were used for working
capital.
On December 30, 1998, the Company entered into an agreement with the bank to
amend its credit facility.
9
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On February 1, 1999, the Fourth Amendment to Credit Agreement and Note
Modification Agreement was executed. On August 10, 1999, the Fifth Amendment to
Credit Agreement and Note Modification Agreement was executed. The facility
consists of a line-of-credit for $3,500,000 with interest at prime plus 1%
(9.25% at September 30, 1999). As of September 30, 1999, there was $1,941,000
outstanding under the line of credit. 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 subject to a borrowing base calculation and
collateralized by accounts receivable and inventory. The Company was not subject
to any limitations under the borrowing base calculation as of September 30,
1999.The line 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. As of September 30, 1999, the Company is not
in compliance with the EBITDA covenant. The Company is currently negotiating
with the bank to resolve the covenant violation. In addition, the company will
be entering into discussions with the bank to extend and/or modify the credit
facility, which matures on March 1, 2000. However, there is no assurance that
the Company will be successful modifying the current credit facility, obtaining
alternative financing or securing other forms of funding.
In March 1998, the Company received $1,600,000 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. 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 decreased by $491,000 during the nine months ended
September 30, 1999. Of this decrease, $650,000 of cash classified as restricted
on December 31, 1998, was used to pay down the Company's credit facility on
January 4, 1999. The Company's current ratio declined to 1.18 at September 30,
1999, as compared to 1.52 at December 31, 1998. The decline in the current
ratio is due primarily to the decline in the accounts receivable balance, and
the reclassification of the Company's credit facility to short-term at March 1,
1999 from long-term at December 31, 1998.
The Company's accounts receivable, net of allowance for doubtful accounts and
sales returns, was $4,320,000 at September 30, 1999, as compared to $5,637,000
at December 31, 1998. The decrease in accounts receivable is due to decreased
revenue, and aggressive credit review and collection efforts. A credit manager
was hired during the second quarter, and additional resources were committed to
collection efforts. Based on accounts receivable collection efforts made by the
Company this year, $641,000 has been written off during the nine months ended
September 30, 1999, as compared to $122,000 for the nine months ended September
30, 1998. These write-offs were primarily due to customer billing problems when
the Company implemented new software in the first quarter of 1998, and data base
and process problems on changes in recurring service contract terms. Both
problems have been addressed in 1999. The company has provided for increases
for the allowance for doubtful accounts of $540,000 for the first nine months of
1999, as compared to $350,000 for the first nine months of 1998.
Accounts payable and accrued expenses at September 30, 1999 were $3,647,000 as
compared to $3,741,000 at December 31, 1998.
During the third quarter of 1999 the Company made investments of $132,000 in
equipment. Most of this investment was related to upgrades in, and additions
to, transport facilities for providing high speed data services. There are no
material commitments for capital expenditures and the company is maintaining
10
<PAGE>
tight controls over capital purchases.
RESULTS OF OPERATIONS:
- ----------------------
The Company recorded a loss from continuing operations of $951,000 and
$2,194,000 for the three and nine months ended September 30, 1999, as compared
to $841,000 and $4,160,000 for the three and nine months ended September 30,
1998. Included in the loss for the nine months ended September 30, 1998, were
restructuring costs of $1,199,000, and product line reduction costs associated
with the restructuring of $409,000. In addition, in March of 1998, the Company
adopted a plan to divest itself of its non-strategic subsidiaries, Omega and
ICNS. These segments were accounted for as discontinued operations in
accordance with APB 30. For the three months ended March 31, 1998, the Company
recorded a loss from discontinued operations of $206,000. In addition, for the
three and nine months ended September 30, 1998, the Company recorded an
estimated loss on disposal of discontinued operations of $730,000 and $967,000,
respectively.
Continuing Operations
Revenue
Revenue for the three months ended September 30, 1999 decreased by $2,447,000,
or 29.2% as compared to the three months ended September 30, 1998, and by
$5,678,000, or 22.6% as compared to the nine months ended September 30, 1998.
The Company experienced significant turnover and attrition in its sales force
during and as a result of, the failed merger with Rocky Mountain Internet in the
third and fourth quarters of 1998. As a result, management had to restaff the
sales department in the first half of 1999. The lower revenue in the third
quarter is primarily due to the ramping up of the new sales force. In addition
to restaffing, the Company has added a sales manager to enhance existing
customer relations, added a telemarketing group led by an experienced manager to
increase leads, and has initiated a professional marketing communications
program. Additionally, project installations were delayed due to construction
delays at customer sites.
The Company is continuing to focus sales efforts on "total network solutions"
which includes recurring service sales, rather than on equipment and
installation projects that do not include recurring services. During the three
months ended September 30, 1999, 47% of revenue was derived from Network
Services as compared to 42% for the three months ended September 30, 1998.
Gross Margin
The gross margin percentage for the three and nine months ended September 30,
1999 was 22.7% and 26.3% of revenue as compared to 27.1% and 26.7% of revenue
for the similar periods in 1998. The decline in the margin for the three months
ended September 30, 1999 is due to reduced labor utilization resulting from the
delays at the customers sites. During the quarter ended March 31, 1998, the
Company recorded a charge of $409,000 for product line reduction as part of the
restructuring.
Selling
Selling expenses for the three and nine months ended September 30, 1999
decreased by $269,000 and $1,545,000 as compared to the three and nine months
ended September 30, 1998. Selling expenses as a percentage of revenue were
15.1% and 13.0% of revenue for the three and nine months ended September 30,
1999, as compared to 13.9% and 16.2% of revenue for the three and nine months
ended September 30, 1998. The decrease in selling expenses is primarily due to
a decrease of $372,000 and $1,419,000 in personnel related expenditures for the
three and nine months ended September 30, 1999, as compared to similar periods
in 1998, offset by increases in recruiting, advertising and promotion in 1999.
11
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General and Administrative
General and administrative expenses decreased by $469,000 and $670,000 for the
three and nine months ended September 30, 1999 as compared to similar periods in
1998. The decrease in general and administrative costs for the three months
ended September 30, 1999 is due to decreases in personnel related expenses of
$140,000, and decreased bad debt, amortization and depreciation expenses. The
decrease in general and administrative costs for the nine months ended September
30, 1999 is due primarily to decreases in personnel related expenses of
$499,000, and decreased amortization and depreciation expenses.
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 during the fourth quarter of
1998.
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, 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 30, 1999, 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. As described in the Definitive Proxy Statement filed April
23, 1998, 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,
12
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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.
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 September 30, 1999, primarily consists of accounts
receivable.
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 the 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.
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 identified computer systems that could be affected by the Year
2000 issue as it relates to the Company's internal hardware and software, as
well as third parties which provide the Company goods or services. The Company
groups its analysis of these software, hardware and systems into the following
four categories:
(a) Customer Network Installations, where the Company has installed third
party vendor equipment and software, and the software is covered by
certain maintenance programs provided by the Company.
(b) Network Control Center, where the Company monitors and manages the
integrity and quality of customer networks.
13
<PAGE>
(c) Third party vendors and providers (other than the equipment vendors
referred to above), including those which provide the Company with
services such as its data transmission capacity.
(d) Corporate Administrative Functions, including financial systems and
other corporate functions.
For all categories, the Company has completed its inventory and assessment of
the software and devices involved. During this inventory phase, the project
team worked 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.
As of September 30, 1999, testing, remediation and replacement has been
substantially completed for all categories. The Company intends to continue
developing its contingency plan that will 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 has an estimate of approximately $50,000 for the costs required for
this effort, but may incur additional 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 3. 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 September 30, 1999, the Company's outstanding balance on the
credit facility was $1,941,000.
Sensitivity Analysis. To assess exposure to interest rate changes, the Company
has performed a sensitivity analysis assuming the Company has a $3.5 million
balance outstanding under the line of credit (the limit on the line of credit at
September 30, 1999). The monthly interest payment, if the rate stayed constant,
would be approximately $27,200. If the prime rate rose 100 basis points, the
monthly interest payment would be approximately $29,900. 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. In the event the
facility is renewed or replaced, the Company can make no assurances that the
interest rate on the replacement facility will be at comparable rates nor can
the Company represent what the exposure to market risk under the replacement
facility might be.
14
<PAGE>
Part II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
In April 1998, the Company entered into a contract with El Paso County School
District No.11 ("D-11") for an Integrated Technology Communication System,
Wiring and Cable Infrastructure for sixty locations throughout district No. 11
schools and other locations. In August 1998, through mutual agreement, the
contract was terminated and superceded by a Settlement Agreement between the
Company and D-11 pursuant to which the Company was to complete certain locations
and upon completion receive payment. The Company completed its work under the
Settlement Agreement but has not been paid. On July 16, 1999 the Company filed
suit against D-11 in the District Court of El Paso County, Colorado for breach
of the Settlement Agreement. D-11 responded in the suit by filing a Motion to
Dismiss based upon the Company's alleged failure to mediate, and on other
grounds. The parties are now awaiting the Court's ruling on the Motion.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
-----------------------------------------
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 $5,000,000. On December 30,
1998, $2,500,000 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 $2,500,000 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 $3,100,000.
On August 11, 1999, the Company executed a stock purchase agreement with
Interwest Group, Inc., a related party. Under the terms of the agreement the
Company issued 19,000 shares of Series B 7-3/8% convertible preferred stock,
convertible at $2.9063 per share, and 100,000 warrants to purchase common stock
(exercisable for four years at $2.9063) in exchange for $1,900,000. In
addition, the agreement provides a one year commitment for an additional sale of
5,000 shares of Series B 7-3/8% convertible preferred stock ($500,000) subject
to the Company meeting certain requirements. The proceeds were used for working
capital.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
-------------------------------
The Company has a borrowing agreement with a bank which provides a $3,500,000
credit facility. As of September 30, 1999, the Company is not in compliance
with the EBITDA covenant of the credit facility. The Company is currently
negotiating with the bank to resolve this violation, however, there is no
assurance that the company will be successful.
15
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
NONE
ITEM 5. OTHER INFORMATION
-----------------
NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) EXHIBIT 27 - FINANCIAL DATA SCHEDULE
16
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTERNET COMMUNICATIONS CORPORATION
-----------------------------------
(Registrant)
Date: November 15, 1999 By: /s/ John M. Couzens
-----------------------------------------------
John M. Couzens, President
Date: November 15, 1999 By: /s/ T. Timothy Kershisnik
-----------------------------------------------
T. Timothy Kershisnik,
Chief Financial Officer
17
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<PERIOD-START> JAN-01-1999
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