-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IDWz+LZpAnJSLdhdFwQiN3O4o6MYju/fd785WTEcEKXHmQ6HVn1R+iOvlyemL8Hy /lFIXmRgMNShoWqUZFqZRg== 0001047469-98-015158.txt : 19980416 0001047469-98-015158.hdr.sgml : 19980416 ACCESSION NUMBER: 0001047469-98-015158 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980415 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INCOMNET INC CENTRAL INDEX KEY: 0000353356 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 952871296 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-12386 FILM NUMBER: 98594458 BUSINESS ADDRESS: STREET 1: 21031 VENTURA BLVD STREET 2: STE 1100 CITY: WOODLAND HILLS STATE: CA ZIP: 91364 BUSINESS PHONE: 8188873400 MAIL ADDRESS: STREET 1: 21031 VENTURA BLVD STREET 2: SUITE 1100 CITY: WOODLAND HILLS STATE: CA ZIP: 91364 FORMER COMPANY: FORMER CONFORMED NAME: INTELLIGENT COMMUNICATIONS NETWORKS INC DATE OF NAME CHANGE: 19860805 10-K 1 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 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NO. 0-12386 INCOMNET, INC. A California IRS Employer No. Corporation 95-2871296 21031 Ventura Blvd., Suite 1100 Woodland Hills, California 91364 Telephone no. (818) 887-3400 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:......None SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:......Common Stock, No Par Value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO__ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Aggregate market value of voting common stock held by non-affiliates of the registrant (based upon the average of the closing bid and ask prices of $0.56 and $0.53, respectively, as reported by the NASDAQ System on April 9, 1998) $ 7,906,871 Number of shares of registrant's common stock outstanding as of April 9, 1998 14,508,021 DOCUMENTS INCORPORATED BY REFERENCE: 1
TABLE OF CONTENTS PAGE - ----------------- ---- INTRODUCTORY NOTE 5 PART I ITEM 1 - BUSINESS General 5 Telephone Services 5 Computer Software 5 Optical Systems 6 National Telephone & Communications, Inc. (NTC) 6 Products 6 Network Marketing Program 6 Disclosure of Independent Representative Organizations Related to NTC Executives 7 WorldCom Contract 7 Reincorporation of NTC in Delaware 7 Management Incentive Agreement 7 Agreement to Sell National Telephone & Communications, Inc. (NTC) 8 NTC Assets To be Sold 8 NTC and Company Liabilities To be Assumed 8 Purchase Price For Assets 8 Purchase Price Adjustment 8 Escrow 8 Pre-Closing Discussions and Breakup Fee 8 Buyer's Capitalization 9 Pre-Closing Consultation 9 NTC's Conditions to Closing 9 Buyer's Conditions to Closing 9 Termination 9 Covenant Not to Compete 9 Indemnification 9 Shareholder Agreement 9 Letter of Credit 9 PUC Consents 9 Stop Loss Condition to Closing 10 Board Representation 10 GenSource Corporation 10 General 10 Change of Name 10 Terms of Acquisition 10 Market for GenSource's Products and Services 11 GenSource's Product Line 11 Rapid Cast, Inc. (RCI) 12 General 12 The Production and Dispensing of Prescription Eyeglass Lenses 12 The Fast Cast LenSystem 12 Marketing and Pricing Strategy 12 Manufacturing Strategy 12 Patents and Proprietary Rights 13 Governmental Regulation 13 Sale of AutoNETWORK Operations 13 Conveyance of Series A 2% Convertible Preferred Stock and Issuance of Series B 6% Convertible Preferred Stock 13 Conveyance of Series A 2% Convertible Preferred Stock 13 Issuance of Series B 6% Convertible Preferred Stock 14 Voting 14 Dividend 14 Liquidation Preference 14 Conversion 14
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TABLE OF CONTENTS PAGE - ----------------- ---- Redemption 15 Registration Rights 15 Antidilution Provision 15 Restrictive Covenants 15 Issuance of $185,000 Convertible Debenture 15 Employees, Officers and Directors 15 Employees 15 Directors and Officers 15 Appointment of New Directors by the Company 16 Appointment of Committee Members 17 ITEM 2 - Properties 17 Item 3 - Legal Proceedings 18 Securities and Exchange Commission Investigation 18 Class Action and Related Lawsuits 18 Lawsuit Against Sam D. Schwartz 19 Complaint For Arbitration Against National Telephone & Communications (NTC) and Incomnet, Inc. 20 Settlement of Civil Consumer Protection Lawsuit With The State of California 20 Settlement of Stevens Lawsuit 20 Settlement of the Atlanta Lawsuit 20 Settlement of the Section 16 (b) Lawsuit 21 Settlement of Legal Action Against Prior Representatives 21 Potential Lawsuits 21 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 22 PART II ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS 22 Market Information 22 Dividends 22 ITEM 6 - SELECTED FINANCIAL DATA 22 ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 23 Overview 23 Liquidity and Capital Resources 23 Results of Operations 24 ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 26 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 26 PART III ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT 26 ITEM 11 - EXECUTIVE COMPENSATION 26 ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 26 ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 26 PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 27 Index to Financial Statements 27 Index to Exhibits 27 Signatures 31 Report of Independent Auditors 32 Consolidated Balance Sheet 33 Consolidated Statement of Operations 34 Consolidated Statement of Cash Flows 35 Consolidated Statement of Shareholders' Equity 37 Notes to Consolidated Financial Statements 38
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TABLE OF CONTENTS PAGE - ----------------- ---- Note 1 - Summary of Significant Accounting Policies 37 Note 2 - Funding of Marketing Commissions and Deferred Income 40 Note 3 - Related Party Transactions 40 Note 4 - Property, Plant and Equipment 40 Note 5 - Patent Rights from Acquisition of RCI 41 Note 6 - Investments, Notes Receivable and Other Assets 41 Note 7 - Notes Payable 41 Note 8 - Income Taxes 43 Note 9 - Shareholders' Equity 44 Note 10 - Commitments, Contingencies and Other 45 Note 11 - Network Marketing Costs 47 Note 12 - Compensation of Independent Sales Representatives 47 Note 13 - Subsequent Events 47 Note 14 - Change in Accounting 48 Note 15 - Segment Information 48 Exhibit 21 - Subsidiaries of the Registrant Exhibit 27 - Financial Data Schedule
4 INTRODUCTORY NOTE This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company intends that such forward-looking statements be subject to the safe harbors created by such statutes. The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties. Accordingly, to the extent that this Annual Report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company and its subsidiaries, please be advised that the Company and its subsidiaries' actual financial condition, operating results and business performance may differ materially from that projected or estimated by the Company in forward-looking statements. The differences may be caused by a variety of factors, including but not limited to adverse economic conditions, intense competition, including intensification of price competition and entry of new competitors and products, adverse federal, state and local government regulation, inadequate capital, unexpected costs and operating deficits, increases in general and administrative costs, lower sales and revenues than forecast, loss of customers, customer returns of products sold to them by the Company or its subsidiaries, disadvantageous currency exchange rates, termination of contracts, loss of supplies, technological obsolescence of the Company's products, technical problems with the Company's products, price increases for supplies and components, inability to raise prices, failure to obtain new customers, litigation and administrative proceedings involving the Company, including the pending class action and related lawsuits and SEC investigation, the possible acquisition of new businesses that result in operating losses or that do not perform as anticipated, resulting in unanticipated losses, the possible fluctuation and volatility of the Company's operating results, financial condition and stock price, losses incurred in litigating and settling cases, dilution in the Company's ownership of its subsidiaries and businesses, adverse publicity and news coverage, inability to carry out marketing and sales plans, challenges to the Company's patents, loss or retirement of key executives, loss of independent sales representatives, changes in interest rates, inflationary factors, default on indebtedness and other specific risks that may be alluded to in this Annual Report or in other reports issued by the Company. In addition, the business and operations of the Company are subject to substantial risks which increase the uncertainty inherent in the forward-looking statements. The inclusion of forward looking statements in this Annual Report should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. PART I ITEM 1. BUSINESS GENERAL: Incomnet, Inc. (the "Company") was incorporated under the laws of the State of California on January 31, 1974. The Company is engaged in the following businesses: TELEPHONE SERVICES- The Company, through its wholly-owned subsidiary, National Telephone & Communications,-Registered Trademark- Inc. (NTC), markets long distance telecommunications services to commercial and residential customers in the United States. Service is provided by procuring long distance telecommunications transmission services from long distance communication carriers at high volume wholesale rates and reselling those services at retail rates. NTC uses a network marketing program of independent representatives to sell its telecommunications-related services to retail customers. The growth in NTC's telecommunications-related revenues is directly tied to its network marketing program. NTC's independent representatives typically pay an annual fee for certain materials, training and services from NTC which are used by the independent representatives to sell new retail customers and enroll other representatives in the NTC program. NTC pays the independent representatives a residual monthly commission on the telecommunications revenue. In addition, the network marketing program pays various bonuses and overrides when and if representatives obtain a minimum number of new telephone customers within a specific 30 to 60 day period. This program has been designed to bring NTC new retail telephone customers even if little or no growth occurs in the marketing program revenues. The new telecommunications revenues generally lag the new marketing program revenues by one to three months. Sales from this segment accounted for 96.8% of the Company's total 1997 sales. In April 1998, the Company announced that it had reached an agreement to sell substantially all of the assets of NTC to NTC Acquisition, Inc., a newly-formed, unaffiliated corporation sponsored by Minneapolis, Minnesota-based John R. Dennis and Sire Capital Partners [see "Item 1. Business. Sale of National Telephone & Communications, Inc."]. COMPUTER SOFTWARE - The Company, through its 100%-owned subsidiary, GenSource Corporation ("GenSource"), designs, develops and markets computer software used for insurance-related claims administration, including workers' compensation, non-occupational disability, property & casualty and general medical. GenSource's software is used by organizations that self-insure their various lines of coverage. Such organizations include large corporations, state and 5 city government agencies, insurance companies and third-party administrators, who provide claims administration services to self-insured organizations. GenSource was acquired by the Company in May 1997 under the name of California Interactive Computing, Inc. (CIC). In September 1997, CIC's name was changed to GenSource Corporation. Sales from this segment accounted for 1.4% of the Company's total 1997 sales. OPTICAL SYSTEMS- The Company, through its 29%-owned subsidiary (22% owned on a fully-diluted basis) Rapid Cast, Inc. (RCI), acquired in February 1995, manufactures and markets the FastCast-TM-LenSystem that allows retail optical stores and wholesale optical lens manufacturing laboratories to produce single vision, flat-top bifocal and progressive bifocal lenses on demand, in approximately 30 minutes. The FastCast-TM- LenSystem uses a series of high-accuracy prescription glass molds that are filled with a proprietary liquid monomer (plastic). When exposed to ultraviolet light within the system's curing chamber, the monomer undergoes a chemical reaction that rapidly "cures" or hardens the lens. Because the Company accounts for its investment in RCI using the equity method, RCI's operating results are not included in the accompanying financial statements. NATIONAL TELEPHONE & COMMUNICATIONS, INC. (NTC): PRODUCTS - NTC is an inter-exchange carrier and reseller of long distance telephone services to residential and small business customers throughout the United States. NTC's primary product is its Dial-1 Telephone Service. Its other long distance telephone products are 800-Number services and prepaid and debit calling card services. In order to provide these products, NTC generally contracts to purchase long distance telephone time from national carriers at wholesale rates based upon high volume usage. NTC then resells this time to its customers at its own discounted retail rates which are generally 10% to 30% or more below AT&T's published, tariffed basic rates. NTC's Dial-1 Service is transparent to its customers once a customer's long distance service has been converted to NTC. NTC's calling card products operate similarly to the calling card products offered by the major carriers. NTC's customers pay for their long distance calling usage either through direct billing from NTC, through billing from the customer's local exchange carrier ("LEC"), through direct billing by NTC of the customer's major credit card, or by prepaying for long distance time in the case of certain NTC calling card products. In certain states, NTC has a billing and collection agreement with an unaffiliated company which bills customers' long distance calls through the local telephone company. Commencing in the second quarter of 1996, NTC increased its use of LECs to bill and collect telephone service accounts receivable. The increase in the use of LECs has increased the amount of time that it takes for NTC to receive payment on its accounts receivable. NTC has recently decided to reemphasize direct billing and to cease referring new customers to LEC billing. NETWORK MARKETING PROGRAM - NTC markets its products on a nationwide basis through a multi-level, network marketing program of independent sales representatives. NTC authorizes and trains the independent representatives to resell its services to residential and small business customers, and allows the individual representatives to build up their own "downline" sales force of other independent representatives. NTC currently has approximately 38,000 independent representatives in its network marketing program. Once an independent representative has signed up a long distance telephone customer on one or more of NTC's services/products, the customer becomes an NTC customer. NTC takes over the servicing and billing of the customers as well as the collection of monies owed by the customers for their use of the NTC telephone services/products. NTC pays each independent representative a commission on the telephone usage monies billed to those retail telephone customers who are directly sourced by that representative. NTC also pays override commissions to each independent representative on the monies billed to those telephone customers sourced by the representative's downline as well as a bonus percentage of all telephone monies billed by NTC from the retail telephone customers collectively sourced by all independent representatives, if certain minimums of retail telephone business are personally achieved by the representative. In addition, NTC pays sales quota bonuses to independent representatives for assisting other representatives to obtain certain minimum quotas of new retail long distance telephone business. NTC does not pay any monies to independent representatives simply for recruiting other representatives into NTC's network marketing program. NTC generally maintains communications with its independent representatives through (1) NTC's proprietary communications systems, (2) NTC's internal personnel dedicated to the support of the independent representatives, (3) various NTC manuals, newsletters and other publications that are periodically and continually sent to the independent representatives, (4) NTC's network of senior independent representatives, and (5) various training programs offered by NTC and its senior independent representatives throughout the United States. NTC believes it is in compliance with all State and Federal regulations governing multi-level marketing companies. However, to ensure the Company has objective and knowledgeable outside legal opinion in this area, NTC has formed a Regulatory Compliance Committee consisting of four former States Attorney General that periodically reviews NTC's marketing programs for such compliance. On October 28, 1997, NTC reached a settlement of a civil consumer 6 protection lawsuit with the State of California in which NTC agreed to pay costs and penalties of $1,250,600 and to institute safeguards associated with preventing switching long distance phone service without the permission of customers. On February 4, 1998, the California Public Utilities Commission (CPUC) approved the settlement of an administrative action in which NTC agreed to pay $350,000 to the CPUC for customer restitution, educational brochures and investigative costs. In recent months, NTC has experienced a substantial decline in the number of its independent sales representatives, customers and revenues. The decline may be attributable in part to the terms of its settlement with the CPUC, which imposes significant new customer verification procedures and requirements on NTC. The Company is also conducting an audit of the NTC commission accounts for independent sales representatives to ascertain if there have been any improper payments. [see "Item 3. Legal Proceedings - Settlement of Civil Consumer Protection With The State of California".] DISCLOSURE OF INDEPENDENT REPRESENTATIVE ORGANIZATIONS RELATED TO NTC EXECUTIVES - In order to eliminate potential conflicts of interest, at the end of 1992, NTC implemented its current policy that no senior, decision-making NTC executive or officer may have a downline organization of independent representatives involved with the selling of NTC's long distance telephone services and/or marketing programs ("Executive Downlines"). Violation of this policy subjects such an NTC officer/executive to immediate termination and forfeiture of all past and future commissions from such disallowed Executive Downlines. To the best of the Company's knowledge, none of NTC's senior officers/executives have an Executive Downline. In addition, NTC's current policy requires full disclosure by all senior NTC officers and executives of any NTC downline organizations headed by an immediate family member of such senior officer or executive as well as disclosure of the personal involvement of an immediate family member in the sale of NTC's long distance telephone services to retail customers ("Immediate Family Customers/Downlines"). To the best of the Company's knowledge, none of NTC's senior officers or executives have Immediate Family Customers/Downlines. The Company is currently conducting an audit to determine whether there are any Immediate Family Customers/Downlines of which it is not aware or which are, or were, violations of NTC policy. WORLDCOM CONTRACT - In September 1995, NTC entered into a new carrier contract with WorldCom, Inc. of Tulsa, Oklahoma, formerly Wiltel, Inc., covering a potential volume purchase of $600 million of long distance telephone time over a five year period commencing in November 1995. Effective February 1996, NTC entered into a revised multiple-year $1.0 billion contract with WorldCom, Inc., which has a fixed term expiring January 2002. On May 12, 1997, NTC entered into an amendment to the contract under which the minimum purchase requirement was increased to $1.1 billion and the contract was extended through February 2003. As in the prior carrier contract with WorldCom, Inc., NTC has committed to purchase the designated volume of telephone time in accordance with a schedule over the term of the contract. NTC currently relies in part on the purchases of another unaffiliated long distance telephone service provider to meet its volume purchase requirements under the new contract. As of April 10, 1998, NTC was in default on its contract with WorldCom for approximately $2 million for services and also has a $4.3 million shortfall through February 28, 1998 on the take or pay provisions of the contract. NTC is in discussion with WorldCom, which has expressed a willingness to extend NTC relief from deficiency charges to the extent of NTC's overperformance. Pursuant to terms of the agreement to sell NTC, NTC and WorldCom have entered into an agreement under which WorldCom has deferred action on the default of the contract and has agreed to extend credit to NTC of up to $3 million that can be temporarily deducted from payments owing to WorldCom under terms of the carrier contract [see "Item 1. Business. Sale of National Telephone & Communications, Inc."]. As of April 10, 1998, NTC has deferred $2 million of payments to WorldCom under the contract and anticipates that it will use the remaining $1 million deferral. REINCORPORATION OF NTC IN DELAWARE - Effective March 21, 1997, NTC, previously a Nevada corporation, reincorporated under the laws of the State of Delaware. Pursuant to its new Articles of Incorporation, NTC has authorized 100 million shares of common stock, par value $.01 per share, of which 10 million shares are issued and outstanding, all of which are held by Incomnet, Inc. and 1.5 million shares of preferred stock, none of which are issued or are outstanding. MANAGEMENT INCENTIVE AGREEMENT - On January 28, 1997 the Company entered into an amended and restated management incentive agreement with NTC pursuant to which the Company agreed to spin-off 10% of the shares it owns in NTC, to establish stock option programs for the senior executives, employees and key independent sales representatives of NTC, and to vote its shares for NTC management's slate of director nominees. The new management incentive agreement entirely supersedes the incentive agreements entered into by the Company with NTC in February and November 1996. See "Item 5. Other Information - Agreement with NTC Management" in the Company's Form 10-Q for the quarter ended September 30, 1996. In November 1996 the Company also entered into settlement agreements with Edward Jacobs and Jerry Ballah (the former Executive Vice President and director of NTC, who, until Feburary 28, 1998, was also the Executive Director, Global Marketing of NTC's network marketing program as a consultant to NTC), pursuant to which mutual general releases were given. The Company agreed to assume certain debt obligations of Mr. Jacobs and Mr. Ballah to NTC, as well as to make a cash payment to them to cover their tax liabilities from the debt forgiveness. See "Item 5. Other Information - Settlement Agreement with NTC Directors" in the Company's Form 10-Q for the quarter ended September 30, 1996. While Mr. Jacobs and Mr. Ballah were released from certain of their debt obligations to NTC pursuant to the settlement, the Company has not made any payments to them with respect to the tax liabilities to date. The amended and restated management incentive agreement essentially contains the same terms and conditions as the agreement entered into in November 1996, except as follows: The Company and NTC agree that the Company, as the owner of 100% of the total issued and outstanding stock of NTC, owns ten million shares of NTC. The three NTC stock option plans previously agreed to have been revised. The Company and NTC have now agreed that there will be three stock option plans and one convertible debt plan. In all of these plans, there were a total of 9,553,847 options and convertible debentures issued to acquire stock in NTC [see the Company's "Annual Report on Form 10-K for the fiscal year ended December 31, 1996"]. The exercise price of all stock options issued under the option plans will not be less than the fair market value of NTC common stock on the date of the grant, and the conversion price of the convertible debt issued under the convertible debt plan will not be less than the fair market 7 value of NTC common stock on the date of the grant, and the conversion price of the convertible debt issued under the convertible debt plan will not be less than the fair market value of NTC common stock on the date of the issuance of the convertible debenture. As of April 10, 1998, no options have been exercised, and no convertible debt units have been converted into shares of NTC common stock. On March 31, 1998, the Company entered into a definitive Asset Purchase Agreement to sell substantially all of the assets of NTC [see "Item 1. Business - Sale of National Telephone & Communications, Inc. (NTC)]". The effect of the sale, if the transaction is completed, will be to negate the entire Management Incentive Agreement with NTC, including the stock option plans. In addition, the potential buyer has agreed to assume all of the Company's and NTC's liabilities to Mr. Jacobs and Mr. Ballah, and a release of the Company and NTC by them is a condition of the closing. If the sale is not completed, the Management Incentive Agreement and the stock option plans will remain in effect. AGREEMENT TO SELL NATIONAL TELEPHONE & COMMUNICATIONS, INC. (NTC): On March 31, 1998, National Telephone & Communications, Inc. ("NTC"), a wholly owned subsidiary of Incomnet, Inc. (the "Company"), entered into a definitive Asset Purchase Agreement (the "Agreement") with NTC Acquisition, Inc., a newly formed unaffiliated buyer (the "Buyer"), pursuant to which NTC has agreed to sell substantially all of its assets to the Buyer, and the Buyer has agreed to assume certain liabilities of the Company, subject to the terms and conditions of the Agreement. The Buyer is controlled by John R. Dennis, an unaffiliated individual. In order for the sale of the assets to close, certain conditions must be satisfied. The following are the basic terms and conditions of the Agreement and its related exhibits: NTC ASSETS TO BE SOLD - NTC has agreed to sell substantially all of its assets to the Buyer, except (i) shares of Page Prompt stock owned by NTC, (ii) any claims that NTC may have against the Company or any of NTC's or the Company's officers or directors, in their capacity as officers and directors, and (iii) all tax loss carry forwards. The assets to be acquired include but are not limited to all tangible and intellectual property, leaseholds, leases, contract rights, cash, securities, accounts receivable, licenses and permits, and certain leasehold improvements. NTC AND COMPANY LIABILITIES TO BE ASSUMED - The Buyer will assume only specified liabilities, including but not limited to (i) most of NTC's balance sheet liabilities, (ii) post-closing liabilities under all contracts that are part of the assigned assets, (iii) up to an aggregate of $10,000,000 of combined NTC debt to First Bank on its line of credit, and deferred payables to WorldCom Communications, Inc., (iv) NTC's obligations to Edward Jacobs and certain consultants to NTC, (v) excise tax liabilities, (vi) any obligation to Paine Webber in connection with the transaction, (vii) NTC employee and consultant severance obligations in excess of $50,000, (viii) obligations to NTC's independent sales representatives, (ix) any obligations in connection with the pending arbitration case against NTC brought by Paul Yao et al and (x) the Company's obligations to Edward Jacobs and Jerry Ballah under existing settlement agreements between the Company and those individuals. PURCHASE PRICE FOR ASSETS - The purchase price for the assets to be acquired is (i) $13,750,000 in cash, subject to adjustment, (ii) shares of the Buyer's common stock representing 16% of the outstanding shares of the Buyer's common stock on a fully diluted basis, and (iii) assumption of the liabilities described above by the Buyer. Pursuant to a separate Antidilution Agreement to be entered into by the Buyer and the Company, the Company's 16% ownership interest in the Buyer will not be reduced for the first 10% of new stock issued before or after the closing by the Buyer to the Buyer's officers, directors, employees or consultants, other than to John R. Dennis and his affiliates. In addition, NTC will have the right to purchase its pro rata portion of any new stock of the Buyer proposed to be issued to other controlling shareholders of the Buyer or their affiliates (i.e. pre-emptive rights), to enable NTC to have the opportunity to maintain its ownership percentage in the Buyer under such circumstances. PURCHASE PRICE ADJUSTMENT - The cash portion of the purchase price will be adjusted, up or down, based upon whether the difference between NTC's current assets and current liabilities on the closing date is greater (a price increase) or less (a price decrease) than such difference was on November 30, 1997. NTC may elect not to close if the estimated adjustment amount (exclusive of amounts relating to undisclosed litigation) exceeds $3,000,000 (unless the Buyer agrees to limit the Adjustment Amount to $3,000,000). ESCROW - NTC's shares of the Buyer's common stock representing 4% of the Buyer's outstanding common stock on the closing date, on a fully-diluted basis, will be placed in a six-month escrow as security for NTC's and the Company's indemnification obligations and for any negative purchase price adjustments. NTC and the Company may elect to settle any such claims in cash, rather than surrender shares of Buyer's common stock. PRE-CLOSING DISCUSSIONS AND BREAKUP FEE - NTC and the Company may not solicit or provide information to other prospective buyers. NTC and the Company may, however, provide information to and negotiate with a third party which presents an unsolicited proposal if the failure to do so would be a breach of the fiduciary duty of the Board of Directors of the Company or NTC. NTC may also terminate the 8 Agreement to enter into a financially superior offer. If NTC terminates the Agreement because it receives a financially superior offer, the Buyer will be entitled to a $500,000 break-up fee if within six months NTC enters into another agreement to sell substantially all of its assets to another party. BUYER'S CAPITALIZATION - The Buyer is a newly-formed shell corporation which has agreed to maintain a minimum capitalization of $500,000 of equity while certain of its covenants, representations and warranties under the Agreement are in effect. PRE-CLOSING CONSULTATION - Through the closing, the Buyer may consult with, and provide recommendations to, NTC with respect to the conduct of NTC's business, but all authority for the conduct of NTC's business will remain fully vested in NTC's officers and directors, subject to additional controls and oversight rights of the Company set forth in a separate letter agreement between the Company and NTC, dated April 2, 1998. The Buyer will not be entitled to any compensation for its consulting services. NTC'S CONDITIONS TO CLOSING - NTC's obligations are expressly conditioned on, among other things, (i) approval of the Agreement by the Company's shareholders, (ii) receipt of a fairness opinion, (iii) receipt of releases from James Quandt and Victor Streufert with respect to their employment agreements, (iv) receipt of releases with respect to the YAO litigation/arbitration, (v) receipt of releases from the lessors of the Hawaii and Irvine properties, equipment vendors, First Bank and WorldCom Communications, Inc., and (vi) receipt of releases from Edward Jacobs, Jerry Ballah and Christopher Mancuso. BUYER'S CONDITIONS TO CLOSING - Buyer's obligations are expressly conditioned on, among other things, (i) execution of satisfactory employment agreements with James Quandt and Victor Streufert, (ii) receipt of releases with respect to the YAO litigation/arbitration, (iii) receipt of releases from Messrs. Jacobs, Ballah and Mancuso, (iv) receipt of consents from certain public utility commissions, and (v) the Buyer will have entered into definitive financing agreements with lenders to provide financing of not less than $40 million to permit Buyer to complete the purchase and to provide working capital for the business. TERMINATION - The Agreement may be terminated (i) by mutual agreement, (ii) by Buyer or NTC as a result of material breach by the other (subject to a 30-day cure period), (iii) by NTC if it receives a financially superior offer prior to the closing, or (iv) by either party if the transaction does not close by June 30, 1998. COVENANT NOT TO COMPETE - NTC and the Company will agree not to compete in any of NTC's businesses for five years after the closing. INDEMNIFICATION - NTC and the Company will indemnify Buyer for breaches of representations, warranties and covenants (including with respect to nonassumed liabilities). Buyer will indemnify NTC and the Company for breaches of representations, warranties and covenants (including with respect to assumed liabilities). Indemnification obligations are subject to a $100,000 aggregate minimum. Indemnification obligations for breaches of representations are subject to a $2,500,000 limit. Indemnification obligations for covenant breaches (primarily assumed and nonassumed liabilities, as applicable) are not subject to a maximum limit. The Company's indemnification obligations for NTC's breaches of representations, warranties and covenants become effective only if (i) NTC liquidates and dissolves, (ii) NTC dividends or distributes a material portion of its assets to its shareholders(s), or (iii) NTC otherwise transfers without value a material portion of its assets. SHAREHOLDERS AGREEMENT - At the closing, the Company and other shareholders of the Buyer will enter into a Shareholders Agreement. The Shareholders Agreement will provide for, among other things, (i) a limited pre-emptive right for NTC, as described above, (ii) a right of first refusal in favor of Buyer, (iii) drag-along rights in connection with the sale of Buyer by a majority interest of the shareholders, (iv) tag-along rights for NTC in connection with sales by certain other controlling shareholders of the Buyer and their affiliates, (v) registration rights for NTC (piggyback and PARI PASSU demand registration rights with certain other controlling shareholders), and (vi) limits on affiliate transactions by Buyer. PUC CONSENTS - The Public Utility Commission consents that are conditions to closing are California, New York and Hawaii. Buyer will indemnify NTC from any losses it may incur from closing the transaction without consents from all 9 jurisdictions that require such consent as long as consents are received from jurisdictions that represented 80% of NTC's 1997 revenues. BOARD REPRESENTATION - NTC will have one representative on the Buyer's Board of Directors as long as its owns at least 10% of Buyer's equity. NTC's representative will be subject to reasonable approval by John R. Dennis. There is no assurance regarding whether or when the transactions contemplated by the Agreement and its related documents will close. NTC is presently in technical default on certain covenants under its credit facility with First Bank, where the outstanding balance of the credit line was $8,241,000, as of April 10, 1998. The Company intends to call for a special meeting of the Company's shareholders to vote on whether to approve or disapprove the proposed Agreement. In order for the Agreement to be approved, the holders of more than 50% of the total issued and outstanding voting stock of the Company must vote in favor of approving the Agreement. The Company expects to circulate proxy statements to its shareholders in the near future describing the Agreement and related documents in greater detail, and soliciting the votes of its shareholders. GENSOURCE CORPORATION: GENERAL - On May 2, 1997, Incomnet, Inc. ("Company") acquired 88,370.5 shares representing 100% of the outstanding common stock of California Interactive Computing, Inc. ("CIC"), a private corporation headquartered in Valencia, California. CIC is engaged in the development and marketing of software that is used to process insurance-related claims, including workers compensation, non-occupational disability, general medical and property & casualty. Its software is leased to companies who provide their own insurance and claims administration, to insurance companies, and to third-party administrators who process claims for either self-insured companies or insurance companies. CIC was incorporated in 1977 in California and has provided software for claims processing for 20 years. CHANGE OF NAME - On October 10, 1997, CIC changed its name to GenSource Corporation ("GenSource"). The name change reflects an enhanced identity for CIC, which was often perceived in the market as a regional company focused primarily on California. GenSource provides its computer software and related services to organizations on a nationwide basis and has customers in more than 15 states and in the Virgin Islands. The name change also reflects the trade name of GenSource's products, almost all of which begin with the moniker "Gen". These products include GenCOMP-TM-, GenMED-TM-, GenDIS-TM-, GenPAC-TM-, GenRISK-TM- and GenIRIS-TM-. GenCOMP, GenMED, GenDIS and GenPAC automate claims processing for workers' compensation, general medical, disability and property & casualty, respectively. In addition, GenSource also offers several computer and service-related products, including GenARS-TM-, which is an optical disk-based information storage and retrieval system, and GenSERVE-TM-, which is a maintenance and service program for on-going customers. While GenSource offers a variety of software modules across multiple lines of insurance, it is best known in the market for providing a comprehensive product for workers' compensation claims administration. More than 90% of its customer base has GenCOMP, its workers' compensation product, while about 50% have modules for multiple lines of coverage. TERMS OF ACQUISITION - To acquire GenSource, the Company agreed to pay a total of $1,758,302 in cash, payable over a five year period of time. In addition, the Company agreed to assume the outstanding balance of $418,526 for outstanding loans to GenSource made by two of GenSource's former shareholders. The Company also signed an employment agreement for a period of two years with GenSource's former president and CEO, pursuant to which it will pay $10,000 per month in consideration for services as the Director of Strategic Planning for GenSource. The Company has also agreed to provide 10,000 and 20,000 stock options, respectively, in GenSource to two former shareholders when a stock incentive plan is established for GenSource's officers, directors, employees and key consultants. At the close of the transaction on May 2, 1997, the Company paid a total of $249,818 to the former shareholders of GenSource, $84,818 of which was paid to acquire GenSource's stock and $165,000 of which was utilized to pay down loans to two former GenSource shareholders. The Company has signed promissory notes in the aggregate principal amount of $1,927,016 to four former shareholders of GenSource to repay the balance of the loans owed by GenSource ($253,527 as of April 10, 1998) and to pay the balance of the price to purchase their GenSource stock by the Company ($1,674,489 as of April 10, 1998). These notes bear interest at the rate of 8% per annum, beginning on May 2, 1998. The stock of GenSource purchased by the Company is held in an escrow account until the promissory notes issued by the Company to GenSource's former shareholders are repaid in full. The outstanding balances owed on these notes can be repaid at any time, which would lower the total amount of scheduled payments, including interest. 10 During the first year after the acquisition, the Company has agreed to pay $27,859 to one shareholder in 12 equal monthly payments of principal and interest. During the 13th - 24th month after the acquisition, the Company has contracted to pay a total of $591,175 of principal and interest, of which $369,136 is scheduled to be paid for the purchase of GenSource stock from four former shareholders and of which $222,039 is scheduled to pay down the outstanding loans owed by GenSource to two former shareholders. During the 25th - 36th month after the acquisition, the Company has contracted to pay a total of $559,662 of principal and interest, of which $514,662 is scheduled to be paid for the purchase of GenSource stock from four former GenSource shareholders and of which $45,000 is scheduled to pay off the remaining balance of the loans owed by GenSource to two former GenSource shareholders. During the 37th - 48th month after the acquisition, the Company is contracted to pay a total of $574,572 of principal and interest for the purchase of GenSource stock from four former shareholders. During the 49th - 60th month after the acquisition, the Company is contracted to pay a total of $514,662 of principal and interest for the purchase of GenSource stock from four former shareholders. During the first year of the acquisition, GenSource's founders agreed not to have interest accrue on their notes because GenSource is developing a new line of software [see section entitled GENSOURCE'S PRODUCT LINE] that will require an investment by the Company. As of April 10, 1998, the Company has invested approximately $850,000 in GenSource to upgrade to new computing equipment and to develop new products. MARKET FOR GENSOURCE'S PRODUCTS AND SERVICES: The overall insurance market encompasses a wide variety of products and services, including life, auto, property & casualty, medical, disability, workers' compensation and numerous specialty lines of coverage. Companies providing software into this market also have numerous market segments in which they may compete. GenSource is primarily focused on a vertical niche within the industry in which it provides software that is used to manage the claims administration process by organizations that are self-insured organizations which provide their own claims administration, and to organizations that provide third-party claims administration (TPAs) to self-insured organizations. GenSource also sells its products to insurance companies which provide comprehensive claims administration as part of an overall insurance package. According to a survey performed by GenSource, there are more than 50,000 self-insured organizations that have more than 100 employees registered to provide insurance-related services in the United States, such as general medical and workers' compensation. An estimated 14,500 of these organizations are self-insured to provide workers' compensation insurance, according to the survey. These self-insured organizations include large public and private corporations, as well as numerous government organizations at city, county, state and national levels. In addition to self-insured organizations, there are more than 25,000 TPAs, which provide services either to self-insured companies or to insurance companies. Of these TPAs, according to GenSource's survey, in excess of 10,000 provide workers' compensation-related services to either self-insured companies or to insurance carriers. Finally, GenSource estimates that there are 5,000 insurance carriers which provide workers' compensation, group medical, non-occupational disability and property & casualty insurance. GENSOURCE'S PRODUCT LINE: GenSource's products are distinguished in the market by their comprehensiveness and their ability to be integrated together. Because GenSource has provided workers' compensation software for more than 20 years, it is considered to have one of the most comprehensive workers' compensation claims administration products on the market. GenSource's products are also noted for their ability to integrate multiple lines of insurance coverage, which is not generally provided by other companies in the market. In March 1998, GenSource began shipping its GenDIS, non-occupational disability claims administration software product, which is integrated with GenCOMP and GenSource's other lines of coverage. GenSource expects that GenDIS will be well-received by the marketplace because of a similarity of needs in administering workers' compensation and non-occupational disability insurance lines of coverage. While early testing from initial users has produced positive results, there can be no assurance that GenDIS will perform as well technically as GenSource anticipates nor can there be assurance that GenDIS will perform in the marketplace as anticipated. While GenSource's products are considered to be comprehensive in their scope, they were developed over the past 20 years using traditional, character-oriented, timesharing-based computer technology. During the past year, GenSource has been actively upgrading its line of software to operate in a modern client-server environment running under Microsoft Windows-TM-, which is a trademark of Microsoft Corporation. The first product from this development effort, GenCOMP for Windows-TM-, is expected to be ready for "beta" testing by customers beginning in May 1998 and to be shipped as a completed product beginning in October 1998. There can be no assurance that GenSource will meet its targeted shipment dates for either beta testing or for completion. There also can be no assurance that the product will be well-received in the market even if it does meet its anticipated dates for beta testing and completion. 11 RAPID CAST, INC. (RCI): GENERAL - RCI is a Delaware corporation formed in February 1994 which acquired 100% of the outstanding capital stock of Q2100, Inc. ("Q2100") from Pearle, Inc., an unaffiliated subsidiary of Grand Metropolitan, Ltd., a United Kingdom conglomerate. Q2100 owns certain domestic and foreign patents and patent applications relating to a new technology, commonly known as Thick Film Radiation Cured Polymer Technology (the "Technology"), which enables retail optical stores and wholesale optical lens manufacturing laboratories to produce many prescription ophthalmic lenses on site at a cost generally lower than if they were purchased from third party manufacturers or distributors. RCI is marketing the Technology under the name Fast Cast-TM- LenSystem. ACQUISITION OF RCI - In February 1995, the Company acquired 51% of the outstanding stock of RCI. In January 1997, affiliates of J. P. Morgan and First Boston invested $12 million in RCI by purchasing convertible preferred stock, reducing the Company's percentage ownership in RCI to approximately 40% (33% on a fully diluted basis). In September 1997, RCI made a rights offering to its existing shareholders, pursuant to which an additional $8 million was invested in RCI. The Company did not participate in the rights offering. As a result, the Company's percentage ownership of RCI has been reduced to approximately 29%, or 22% on a fully-diluted basis. THE PRODUCTION AND DISPENSING OF PRESCRIPTION EYEGLASS LENSES - According to market research on the production of eyeglass lenses, approximately 77% of all conventional single vision and multifocal prescription eyeglass lenses are currently manufactured from glass or hard-resin plastic. According to Census93, during the years 1991 through 1993 hard-resin plastic was used in the manufacturing of approximately 82% of all prescription lenses made from conventional materials. Although there can be no assurance in this regard, RCI anticipates that the use of glass in manufacturing conventional lenses will decrease over time due to a variety of factors, including its relatively greater weight and inferior impact resistance. After being prescribed for an individual by his or her medical doctor (ophthalmologist) or optometrist, prescription eyeglass lenses reach the consumer through three traditional channels: independent dispensers (consisting of thousands of private sector optometrists, opticians and ophthalmologists), retail optical chain stores (i.e., retailers having at least four stores, including so-called "superoptical" stores or "superstores", mass merchandisers and warehouse membership clubs), and miscellaneous third party and other dispensers. Census93 estimates that independent dispensers accounted for approximately 62% of 1992 United States optical sales, retail optical chain stores accounted for approximately 33% of such sales, and third party and other dispensers accounted for approximately 5% of such sales. THE FAST CAST LENSYSTEM - The LenSystem incorporates a new technology called Thick Film Radiation Cured Polymer Technology, which uses ultraviolet light instead of heat to initiate the chemical reaction that hardens the Fast Cast Liquid Monomer into a plastic lens. The FastCast LenSystem consists of three primary components: The Fast Cast Mold and Gasket Library, the Fast Cast Liquid Monomer (the "Monomer"), and the Fast Cast Ultraviolet Curing Unit (the "Curing Unit"). The Fast Cast Mold and Gasket Library is used to create the actual mold assembly from which a lens will be made. This mold is then filled with the Fast Cast Liquid Monomer, which is a chemically-inert, "thick film" liquid that hardens when subjected to ultraviolet light. The Curing Unit controls the chemical reaction that occurs when the Fast Cast Liquid Monomer is exposed to ultraviolet light, resulting in finished plastic eyeglass lenses. A lens produced by the LenSystem can be subjected to the application of various additional treatments (such as scratch resistant, anti-reflective and ultraviolet coatings) using the same materials and process now employed to apply such coatings to conventional plastic lenses. In 1996, after a sufficient number of LenSystems had been in operation for several months, certain RCI customers, especially in the international market, experienced technical problems with the LenSystem, including the calibration of the molds, the generation of heat by the Curing Unit, and related problems. As a result, machine orders declined significantly while RCI worked on corrective measures. Today, RCI management believes that the design and functional problems have been corrected. There is no assurance, however, that the rate of machine orders received by RCI will stabilize or increase in the future. MARKETING AND PRICING STRATEGY - RCI expects that initially the bulk of RCI's revenues will be derived from sales of equipment and that as the installed base of equipment stabilizes, an increasing share of revenues will be derived from Monomer sales. RCI is initially seeking to market the LenSystem principally to operators of retail optical stores and small to mid-sized wholesale lens manufacturing laboratories, both inside and outside the United States. Currently the sale price for a single LenSystem with one set of molds is approximately $37,000 for a smaller unit and $43,000 for a larger unit. Operators may be able to lease RCI equipment over a 60 month period. RCI expects that each purchaser or lessee of a LenSystem will at least initially use RCI's Fast Cast Liquid Monomer. MANUFACTURING STRATEGY - RCI currently does not have the facilities or the experience to manufacture the components of the LenSystem and has no plans to develop its own manufacturing capabilities. RCI currently has such components manufactured through subcontractors. 12 PATENTS AND PROPRIETARY RIGHTS - In February 1995 RCI acquired all of the capital stock of Q2100 and thus all of Q2100's issued patents and patent applications that relate to the Technology. RCI is not aware that any party, in the United States or elsewhere, has challenged the validity or enforceability of the issued patents relating to the Technology, other than the patent dispute with Ronald D. Blum O.D., which was settled in January 1997. See "Item 3. Legal Proceedings - Settlement of Patent Infringement Lawsuit." No assurance can be given that the issued patents relating to the Technology will afford protection against competitors with similar technology, or that any of such patents will not be infringed, designed around by others or invalidated. GOVERNMENTAL REGULATION - The lens produced by the LenSystem may be medical "devices" within the meaning of the Federal Food, Drug and Cosmetic Act (the "Food and Drug Act"), but management believes that the lenses may be marketed without pre-market notification, review, approval or clearance by the Federal Food and Drug Administration ("FDA"). Other requirements, principally those concerning impact resistance, good manufacturing practices, labeling and reporting of certain alleged adverse effects apply to RTC's business. Although the FDA may disagree, RCI also believes that the LenSystem is itself not a "medical device" under the Food and Drug Act. Certain state and local governmental authorities (such as the State of California) also regulate medical device manufacturers. Depending upon where LenSystem equipment is manufactured, RCI may be subject to such additional regulations. Although there can be no assurance in this regard, RCI does not anticipate that compliance with such governmental regulation will have an adverse effect upon its business. SALE OF AUTONETWORK OPERATIONS: On March 20, 1998, the Company sold its Auto Dismantler Network (known under the tradename "AutoNETWORK") to AutoSkill, Inc., a newly-formed corporation owned by Jeffrey Rubin of Rosslyn, NY and Robert Cohen of New York City, NY. The operations were sold for $1.3 million in cash, payable as follows: $800,000 in cash was paid on the close of the transaction and a note for $500,000, bearing simple interest at the rate of 9% per annum was issued to the Company, payable in full on May 20, 1998. As part of the transaction, the Company repaid $42,500 of a note for $185,000 that is payable to Mr. Rubin and Mr. Cohen [see "Item 1. Business - Issuance of $185,000 Convertible Debenture."] The Company has agreed to repay the remaining balance of $142,500 on or before May 20, 1998, although the Company also has an option to delay payment of $100,000 of the note until July 31, 1998, provided that the Company secures the balance of the note with 300,000 shares of stock that the Company owns in its Rapid Cast, Inc. subsidiary. AutoNETWORK links several hundred licensed automobile dismantlers in California, Nevada, Arizona, Utah, Oregon and Washington. AutoNETWORK is a monthly subscription service that auto dismantlers utilize to buy, sell and trade used parts that have been salvaged from automobiles damaged in traffic collisions. CONVEYANCE OF SERIES A 2% CONVERTIBLE PREFERRED STOCK AND ISSUANCE OF SERIES B 6% CONVERTIBLE PREFERRED STOCK: CONVEYANCE OF SERIES A 2% CONVERTIBLE PREFERRED STOCK - From September 20, 1996 to October 25, 1996, the Company sold 2,440 shares of Series A 2% Convertible Preferred Stock (the "Series A Stock") to 12 accredited private investors [see the Company's Annual Report on Form 10-K for fiscal year ended December 31, 1996]. The sale included an agreement that the Company would register the common stock issuable upon the conversion of the Series A Stock on a Form S-3 Registration Statement and included liquidated damages of 3% per month should the Registration Statement not be declared effective beginning 75 days after the funding was completed. The registration of such stock was delayed by the Securities and Exchange Commission, resulting in liquidated damage payment obligations being incurred by the Company to the holders of the Series A Stock. On November 7, 1997, $1.7 million of the Series A Stock was purchased from four institutional investors, who were original purchasers of the Series A Stock, for $1.7 million by 12 individual accredited investors. These individuals all agreed to waive all registration rights and liquidated damage rights associated with the Series A Stock and agreed that they will convert their Series A Stock into shares of the Company's common stock subject to Rule 144 of the Securities Act of 1933, as amended. The Company paid total liquidated damages of $540,000 in cash to the four original purchasers of the Series A Stock conveyed to the new buyers. On November 3, 1997, three other individuals converted $225,000 of the Series A Stock (i.e. the original investment amount) into the Company's common stock, subject to Rule 144. These three individuals received liquidated damages of $67,500 paid in additional shares of common stock at a price of $3.00 per share. As of April 10, 1998, a total of 1,428 shares of the Series A Stock had been converted to a total of 1,241,232 shares of common stock of the Company, including conversion of principal and the payment of dividends in shares. As of April 10, 1998, 937 shares of Series A Stock have yet to be converted. As of April 10, 1998, the Company owes approximately $45,000 in penalties to two Series A Stock holders who have not yet converted their stock and $35,000 13 in dividends penalties on the remaining balance of Series A Stock that has not yet been converted. ISSUANCE OF SERIES B 6% CONVERTIBLE PREFERRED STOCK - In July 1997, the Company's Board of Directors approved the issuance of 2,990 shares of Series B 6% Convertible Preferred Stock (the "Series B Stock"), $1,000 per share. At that time, the Company raised $1.8 million by selling 1,834 shares of the authorized Series B Stock [see the Company's Report on Form 10-Q for the second quarter ending June 30, 1997 for a detailed description]. On November 4, 1997, the Company issued 600 additional shares of Series B Stock, raising an additional $600,000, less a cash fee of $60,000 to the individual who arranged the sale ( the same individual arranged the sale of the 1,834 shares of Series B Stock sold in July 1997). In connection with this new issuance of the Series B Stock, the Company also issued warrants to the individual to purchase 55,000 shares of the Company's common stock at an exercise price of $3.00 per share for a period of two years, an option to the individual to acquire an additional 125 shares of Series B Stock at 88% of the average bid price of the Company's common stock quoted on the five trading days immediately preceding the date of issuance of the additional Series B Stock, and the right for one year for the individual to provide the Company with an additional $200,000 in Series B Stock. The cash fee, warrants and options paid and issued, respectively to the individual were contingent upon the placement of $1.7 million of Series A Stock being sold by four original institutional purchasers who owned the Series Stock, to 12 new individuals who would waive all associated registration rights. On November 7, 1997, this contingency was met [see "Conveyance of Series A 2% Convertible Preferred Stock"]. On February 10, 1998, the shares of common stock underlying the Series B Stock was registered with the Securities and Exchange Commission on a Form S-3 Registration Statement. As of April 10, 1998, 370.7 shares of Series B Stock has been converted into a total of 643,987 shares of the Company's common stock and 2,063.3 shares of Series B Stock remain to be converted. As of April 10, 1998, the Company owes approximately $80,000 in dividends on the remaining balance of Series B Stock that has not yet been converted. The basic terms and conditions of the Series B Stock are as follows: VOTING - The Series B Stock does not have voting rights. DIVIDEND - The Series B Stock has a cumulative non-compounded annual dividend of 6% payable in cash or stock at the Company's option upon conversion of the Series B Stock into the Company's common stock, and prior to the payment of any dividends on the Company's common stock. No dividends may be declared or paid on the Series B Stock until all cumulative unpaid dividends have been declared and paid on the outstanding Series A Stock. LIQUIDATION PREFERENCE - The Series B Stock has a liquidation preference of $1,000 per share plus all cumulative unpaid dividends, whether or not declared by the Company's Board of Directors. Upon any liquidation or change of control of the Company (i.e. transfer of more than 50% of its voting stock), the Preferred Stockholders are entitled to the second priority in payment from the Company's assets, before any payments are made on the Company's common stock, until the liquidation preference is paid in full. The Series B Stock is junior in preference to Series A Stock issued in October 1996 (see the Company's Annual Report of Form 10-K filed on April 15, 1997). No liquidation preference may be paid to the holders of the Series B Stock until the full liquidation preference has been paid to the holders of the outstanding Series A Stock. CONVERSION - The Preferred Stockholders may convert each share of Series B Stock into the number of shares of the Company's common stock calculated as follows, at any time upon the earlier of (i) 120 days after the issuance of the Preferred Stock, or (ii) when the shares of common stock underlying the Preferred Stock are registered with the Securities and Exchange Commission. The conversion price (the "Conversion Price") for each share of Series B Stock is equal to the lesser of (a) 80% of the average bid price for the Company's common stock on the public trading market for the five trading days immediately preceding the conversion date, as specified by the Preferred Stockholder, or (b) the bid price of the Company's common stock on the funding date (i.e. the issuance date of the Preferred Stock). To calculate the number of shares of common stock issuable upon the conversion of the Preferred Stock, the Conversion Price is multiplied by a ratio, the numerator of which is the sum of 1,000 and the accrued but unpaid dividends, and the denominator of which is the Conversion Price. If for any reason a registration statement covering the shares of common stock issuable upon the conversion of the Preferred Stock is not in effect with the Securities and Exchange Commission at the time of a valid conversion by a Preferred Stockholder, then the Conversion Price is reduced by 3% per month for each of the first three months that the effectiveness of the registration is late, and thereafter the Company is obligated to pay a cash penalty equal to 3% of the investment per month. The Company has the right to cause a conversion of the Preferred Stock into common stock on the same terms at any time after one year after the Preferred 14 Stock is issued. REDEMPTION - The Company has the right to redeem the Preferred Stock for its issuance price plus cumulative unpaid dividends if the Company's stock trades at a price which averages $2.00 per share or less for any period of five consecutive trading days after the Preferred Stock is issued. REGISTRATION RIGHTS - Pursuant to a Registration Rights Agreement entered into by the Company with each purchaser of the Series B Stock, the Company is obligated to file a registration statement with the Securities and Exchange Commission covering the shares of common stock underlying the Preferred Stock within 30 days after the Preferred Stock is issued, and to have the registration statement declared effective within 120 days after it is filed. Failure to have the registration statement declared effective results in a penalty of 3% interest per month. The registration statement was declared effective on February 10, 1998, approximately 70 days late, which has resulted in a penalty of approximately $170,000 payable to the Series B Stockholders. ANTIDILUTION PROVISION - The Certificate of Determination for the Series B Stock contains comprehensive provisions for adjustments to the Conversion Price and the conversion ratio of the Preferred Stock in the event of stock dividends, asset distributions, reorganizations, recapitalizations, mergers, stock splits or similar transactions by the Company, in order to protect the Preferred Stock from dilution as a result of such transactions. RESTRICTIVE COVENANTS - During the first 90 days after the Series B Stock is issued, the Company is not permitted to issue any other securities, except in limited circumstances, including pursuant to the exercise of outstanding options or warrants or pursuant to existing settlement agreements, without first notifying the Preferred Stockholders and giving them a right of first refusal to purchase the securities themselves. While the Series B Stock is outstanding or until it is converted into common stock, the Company is not permitted to engage in certain transactions, such as the redemption or purchase of its own common stock (except in connection with the collection of Section 16(b) short-swing profits), without the prior consent of the Preferred Stockholders. Furthermore, the Company cannot take any action which would modify the rights of the Preferred Stockholders under the Certificate of Determination without the prior consent of the Preferred Stockholder being affected by the modification. ISSUANCE OF $185,000 OF CONVERTIBLE DEBENTURES - On January 20, 1998, the Company issued Convertible Secured Debentures (collectively, the "Debentures") to three individuals in the aggregate principal amount of $185,000, bearing simple interest at the rate of 10% per annum and secured by a perfected security interest in the Company's AUTONETWORK assets. See "SELLING SECURITY HOLDERS." The Debentures are due and payable in full on or before April 30, 1998. At any time prior to the repayment of the Debentures, the Debenture holders have the right to convert the outstanding principal and interest balance of the Debentures into shares of the Company's common stock at a conversion ratio equal to the lesser of (i) $1.09 per share, or (ii) 80% of the average bid price for the Company's Common Stock on the public trading market for the five trading days immediately preceding the conversion date, as specified by the Debenture holder. The Company registered the shares issuable upon the conversion of the Debentures pursuant to a registration statement on Form S-3 declared effective by the Securities and Exchange Commission on February 10, 1998. In connection with the issuance of the Debentures, the Company also granted an aggregate of 18,000 warrants to purchase 18,000 shares of the Common Stock of the Company at an exercise price of $1.09 per share at any time until January 20, 2000. These warrants were granted to the Debenture holders on a pro rata basis. The Company also amended 105,000 of its outstanding warrants previously granted to affiliates of the Debenture holders in July and November 1997 by lowering the exercise price of 50,000 of the warrants from $5.26 per share to $3.50 per share, and by lowering the exercise price of 55,000 of the warrants from $3.00 per share to $2.00 per share [see "Item 1. Business - Conveyance of 2% Series A Convertible Preferred Stock and Issuance of 6% Convertible Preferred Stock"]. The Debenture holders have the right of first refusal to provide any additional financing to the Company until July 12, 1998. On March 20, 1998, the Company sold its AutoNETWORK division to two of the Debenture holders. The Debenture is being paid off with the proceeds of the sale [see "Item 1. Business - Sale of AutoNETWORK Operations"]. EMPLOYEES, OFFICERS AND DIRECTORS: EMPLOYEES - As of December 31, 1997, the Company, including its NTC and GenSource subsidiaries, employed 252 full-time people, consisting of 38 general and administrative, 42 marketing and sales, and 172 programming, operations and customer service personnel. None of the Company's employees are subject to a collective bargaining agreement, and the Company has not experienced any slow-downs, strikes or work stoppages due to labor difficulties. The Company considers its employee relations to be satisfactory. DIRECTORS AND OFFICERS - The Company has employment agreements with the following officers: Melvyn Reznick, Chairmen, President and Chief Executive Officer of Incomnet; Stephen A. Caswell, Vice President and Corporate Secretary of Incomnet; Edward Jacobs, Chairman of NTC; James R. Quandt, President and Chief Executive Officer of NTC; and Victor Streufert, Senior Vice President and Chief Financial Officer of NTC. Effective January 17, 1997, the Company entered into an Amendment to the Employment Agreement with Melvyn Reznick pursuant to which the term of Mr. Reznick's Employment Agreement was extended for two additional years, until November 30, 1999. On June 8, 1997, the Company's Board of Directors approved an extension of the employment agreement with Mr Reznick until the earlier of (i) June 30, 2002, or (ii) six months after the date that 100% of the Company's holdings of NTC stock are sold, conveyed or otherwise distributed but no sooner than December 31, 1999 ("Early Termination Date"). His base compensation is set at $20,833 per month. In the event of an improper termination of the agreement by the Company for any reason, Mr. Reznick is entitled (i) to be paid a lump sum amount equal to his annual salary during the remaining term of his agreement plus his annual salary for three additional years, plus accrued bonus, if any, (ii) to receive all of his benefits during such period, and (iii) to exercise all of his vested stock options at any time during the remaining term of the options. In the event of an early termination because of the disposition of 100% of the Company's NTC stock, then the Company has agreed to pay Mr. Reznick a lump sum amount equal to the sum of the annual compensation and accrued but unpaid bonus (if any, with respect to the bonus) which would be payable to him for one additional year after the Early Termination Date, but not beyond June 30, 2002, as well as receive his benefits during that period and exercise his vested stock options during the remaining term of the options. 15 Mr. Caswell's employment agreement has a term which expires on the earlier of (i) December 31, 1999, or (ii) six months after the date that 100% of the Company's holdings of NTC stock are sold, conveyed or otherwise distributed. His base compensation is set at $9,583 per month. In the event of an improper termination of Mr. Caswell's employment agreement by the Company for any reason, Mr. Caswell is entitled (i) to be paid a lump sum amount equal to his annual salary during the remaining term of his agreement plus his annual salary for 15 additional months, (ii) to receive all of his benefits during that period, and (iii) to exercise all of his vested stock options at any time during the remaining term of the options. In the event of an early termination because of the disposition of 100% of the Company's NTC stock, then the Company has agreed to pay Mr. Caswell a lump sum amount equal to the sum of the annual compensation and accrued bonus (if any, with respect to the bonus) which would be payable to him for one additional year after the Early Termination Date, but not beyond December 31, 1999, as well as receive his benefits during the remaining term of the options. In addition, Mr. Caswell also will receive a severance of eight months salary if he is terminated after the employment agreement expires. On January 6, 1997, NTC entered into an employment agreement with James R. Quandt for a period of three years pursuant to which Mr. Quandt is serving as NTC's President, and is a member of NTC's Board of Directors. On June 25, 1997, the agreement was amended and restated. In August 1997, Mr. Quandt was also named as Chief Executive Officer of NTC. The employment agreement contemplates that Mr. Quandt may be nominated to become the Chairman of the Board of Directors of NTC upon Mr. Jacobs' retirement from that position. Pursuant to the employment agreement, Mr. Quandt is entitled to the following compensation: (1) A base salary of $40,000 per month, (2) an incentive bonus equal to one and one-half (1.5%) of the quarterly net profit earned by NTC, provided that the quarterly net profit is at least $1,250,000, and the payment of the bonus does not cause the quarterly net profit of NTC to be less than $1,250,000, and NTC's pretax profit for the succeeding calendar quarter is reasonably expected to exceed the minimum quarterly net profit of $1,250,000, and (3) non-qualified stock options to purchase 600,000 shares of the common stock of NTC. In addition to the base salary, regular bonus and stock options, Mr. Quandt will earn a hiring bonus equal to $225,000, payable if NTC's quarterly net profits exceed $1,250,000, but in any event no later than December 31, 1997 with respect to $150,000 of the guaranteed hiring bonus, and the balance by no later than June 30, 1998. Under the employment agreement, Mr. Quandt is entitled to a severance payment of 24 months of his base compensation if his employment terminates prior to the agreement's termination date for a reason other than cause or because of a voluntary resignation by Mr. Quandt for "good cause", as defined in the employment agreement. Included in "good cause" is a material change in the ownership of Incomnet's common stock or Incomnet's or NTC's Board of Directors. Mr. Quandt has agreed not to compete with NTC during the term of his employment agreement and for a period of one year after the agreement terminates for any reason. On November 1, 1996, NTC entered into an employment agreement with Victor C. Streufert for a period of three years pursuant to which Mr. Streufert is serving as Senior Vice President of Finance and Administration and Chief Financial Officer of NTC. On June 25, 1997, the agreement was amended and restated. Pursuant to the employment agreement, Mr. Streufert is entitled to the following compensation: (1) A base salary of $20,000 per month, (2) a minimum bonus in 1997 of $100,000 payable in quarterly installments, (3) an incentive bonus program no less than 50% of his annual salary based upon NTC achieving its annual profit plan and (4) non-qualified stock options to purchase 125,000 shares of the common stock of NTC. Under the employment agreement, Mr. Streufert is entitled to a severance payment of 24 months of his base compensation if his employment terminates prior to the agreement's termination date for a reason other than cause or because of a voluntary resignation by Mr. Streufert for "good cause", as defined in the employment agreement. Included in "good cause" is a material change in the ownership of Incomnet's common stock or Incomnet's or NTC's Board of Directors. Mr. Streufert has agreed not to compete with NTC during the term of his employment agreement and for a period of one year after the agreement terminates for any reason. On October 30, 1997, NTC entered into an employment agreement with Edward R. Jacobs, whose previous employment agreement expired on June 30, 1997. Under the new agreement, Mr. Jacobs will receive a salary of $40,000 per month for a period of two years. Pursuant to terms of the settlement with the California Public Utilities Commission [see "Item 3. Legal Proceedings - Settlement of Civil Consumer Protection Lawsuit With The State of California], Mr. Jacobs is required to resign from NTC by June 30, 1998. As part of the sale of NTC, it is anticipated that Mr. Jacobs will sever his relationship with NTC. As such, one of the terms of the sale of NTC is a general release from Mr. Jacobs stating that he has no outstanding claims against NTC or the Company [see "Item 1. Business - Agreement to Sell National Telephone & Communications, Inc. (NTC)"]. APPOINTMENT OF NEW DIRECTORS BY THE COMPANY - On January 20, 1997, the Company's Board of Directors appointed Dr. Howard Silverman to fill a vacancy and become a member of the Board of Directors. Since March 1996, Dr. Silverman has been consulting for various companies in the optical and financial areas, including Andrew, Alexander, Wise & Company in New York, and Rapid Cast, Inc. From August 1995 to March 1996, Dr. Silverman served as a 16 Vice President of Corporate Finance for Rickel & Associates, an investment banking firm. From 1991 until he joined Rickel & Associates in 1995, Dr. Silverman was an independent business consultant specializing in early stage and mid-size operating companies. From 1985 to 1991, Dr. Silverman was the founder and Chairman of the Board of Directors of Vision Sciences, Inc., a company that developed, manufactured and sold in-office lens casting systems, which enabled the optical retailer to cast his own finished plastic optical lenses. Dr. Silverman was a member of the Board of Directors and the director of business development for Staar Surgical Co., Inc., a publicly owned company, from 1984 to 1990. He was the co-founder and Chief Operating Officer of Hydro-Optics, Inc., a manufacturer of hydrophilic contact lens, from 1974 until 1984. Dr. Silverman has also been the Vice President and Chief Operating Officer of Diversified Health Industries, Inc. and the President and Chief Executive Officer of Precision Contact Lens, Inc. Dr. Silverman had a private optometric practice in New York City from 1968 to 1972, specializing in contact lenses. Dr. Silverman earned a Bachelor of Science in Chemical Engineering from the College of the City of New York in 1965 and a Doctor of Optometry form Illinois College of Optometry in 1968. On August 13, 1997, the Company's Board of Directors amended the Company's By-laws to set the number of directors of the Company to be seven members. The Company's Board elected Richard M. Horowitz, Stanley C. Weinstein and David Wilstein to fill the vacancies on the Board. Richard M. Horowitz has served as President of Management Brokers Insurance Agency (Beverly Hills, CA) since 1974. He also serves as Chairman of Leviathan Corporation, a computer sales, consulting and software company, and Chairman of Dial 800, Inc., a telecommunication company. Since 1990, he has been a member of the Board of Directors of Trio-Tech International, a company that produces environmental testing equipment. He has an MBA from Pepperdine University. Stanley C. Weinstein is a co-founder and the Managing Shareholder of Weinstein Spira & Company, P.C. Certified Public Accountants, which was established in 1962 in Houston, TX. His expertise includes diverse business consulting, executive recruitment and compensation, and the development and utilization of marketing strategies. Mr. Weinstein attended Rutgers University and obtained a B.B.A. from Upsala College. He is a member of the American Institute of Certified Public Accountants (AICPA) and the Texas Society of Certified Public Accountants (TSCPA). On December 26, 1997, the Company's Board of Directors received and accepted the resignation of Stanley Weinstein who resigned for personal, business and family reasons. Mr. Weinstein has not yet been replaced. David Wilstein is the President and Chairman of the Realtech Group, a real estate development and management firm in Los Angeles, CA, which he founded in 1968. He is also the Chairman of the Board of Aero Products Research, a company that develops plastic products and is a member of the Board of C. I. Systems, a company that develops electro-optical test equipment. Mr. Wilstein has a B.S. in civil-structural engineering from the University of Pittsburgh. On December 15, 1997, the Company held its Annual Meeting of Shareholders. At the meeting, Rolf Lesem was elected as a new member to the Company's Board of Directors. Mr. Lesem was nominated to run for election by a stockholder of the Company prior to the Annual Meeting in accordance with the Bylaws of the Company. Albert Milstein, who was nominated by management for election to the Board and who had served as a Board member since November 15, 1995, resigned from the Board on December 15, 1997. At the Annual Meeting, the following members were elected to the Company's Board of Directors: Melvyn Reznick, Richard Horowitz, Rolf Lesem, Howard Silverman, Stanley Weinstein, David Wilstein and Nancy Zivitz. APPOINTMENT OF COMMITTEE MEMBERS - The Board of Directors has created an Executive Committee, consisting of David Wilstein, Rolf Lesem and Melvyn Reznick. ITEM 2. PROPERTIES The Company does not own any real estate. The Company leases approximately 6,224 square feet of office facilities at 21031 Ventura Boulevard, Suite 1100, Woodland Hills, California 91364. The Company has been obligated to make lease payments at the rate of $8,713 per month from May 1995 through July 1998. The Company's subsidiary, NTC, currently leases approximately 64,000 square feet of office space in Irvine, California at a rate of approximately $66,000 per month. In April 1997, the Company entered into a new lease agreement on its primary facility in Irvine. The lease provides for an original, non-cancellable term of five years ending in April 2002 and seven 5-year extension periods at lease rates based on the Consumer Price Index. 17 In addition, in February 1997, NTC entered into a ten year lease for approximately 9,900 square feet of office space in Honolulu, Hawaii, with the lease expiring in 2007. The lease also provides for a termination option in 2002. The monthly payments on the lease in Honolulu, Hawaii commence at $36,698 per month in 1997 and 1998, and increase on a bi-annual basis through the term of the lease to $43,536 per month in 2006 and 2007. The Company's GenSource subsidiary currently leases approximately 8,000 square feet of office space for its facilities in Valencia, CA, expiring on August 31, 1999. GenSource is obligated to make lease payments at the rate of $6,208 per month through March 31, 1999. Commencing on April 1, 1999 through the balance of the lease, the rate will be adjusted based upon the increase in the Consumer Price Index from September 1, 1997. ITEM 3. LEGAL PROCEEDINGS SECURITIES AND EXCHANGE COMMISSION INVESTIGATION: In August 1994, the Company was notified by the Pacific Regional Office of the Securities and Exchange Commission that the Commission had initiated an informal inquiry of the Company. In September 1994 the Commission issued a formal order of private investigation. The Commission stated in its correspondence to the Company that the investigation "should not be construed as an adverse reflection on any person, entity or security, or as an indication by the Commission or its staff that any violation of law has occurred." In August and September 1994, the Company supplied copies of its books and records to the Commission, and the Company's present and prior independent certified public accounting firms submitted their working papers pursuant to the Commission's subpoena. In February 1995, the Company provided to the Commission pursuant to its subpoena additional documents associated with NTC's regulatory authorizations and with the Company's acquisition of a controlling interest in RCI. On December 15, 1997, the Company submitted an Offer of Settlement to the Pacific Regional Office of the Securities and Exchange Commission (SEC) to resolve a proposed public administrative proceeding against the Company. Under terms of the Offer of Settlement, the Company, without admitting or denying any specific findings by the SEC or paying any civil penalties, will agree to an order to cease and desist from committing or causing any violations of Section 10 (b) and 13 (a) of the Exchange Act and Rules 10b-5, 12b-20, 13a-11 and 13a-13 thereunder. As of April 10, 1998, a final resolution with the SEC in Washington, D.C. has not been concluded. CLASS ACTION AND RELATED LAWSUITS: On October 17, 1995, the Company was served with an amended complaint in the class action lawsuit entitled SANDRA GAYLES; THOMAS COMISKEY, AS TRUSTEE FBO THOMAS COMISKEY, IRA; CHARLES KOWAL; ARTHUR KALTER; MATTHEW G. HYDE; ARTHUR WIRTH; AND ISABEL SPERBER, VS. SAM D. SCHWARTZ AND INCOMNET, INC., Case No. CV95-0399 AWT (BQRx), filed in the United States District Court for the Central District of California, Western Division, which was originally filed in January 1995. The amended complaint retains the claim alleging that the Company violated Sections (10)b and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated under Section 10(b) of the Exchange Act, because it did not disclose and falsely denied the existence of the non-public investigation of the Company commenced by the Securities and Exchange Commission in August 1994. The complaint adds claims that the Company and its former Chairman, Sam D. Schwartz, violated Sections 10, 16(a), 20(a) and 23(a) of the Exchange Act, and Section 25400 of the California Corporations Code, because they did not disclose until August 1995 purchases and sales of the Company's stock made in the open market by an affiliate of Mr. Schwartz between September 1994 and August 1995. The amended complaint seeks (i) certification of the class, (ii) compensatory damages, (iii) damages pursuant to Section 25500 of the California Corporations Code, (iv) interest and attorneys' fees and costs, and (v) other extraordinary, equitable and injunctive relief as may be appropriate. On January 11, 1996, the case was certified as a class action pursuant to the parties' stipulation. On October 7, 1997, the Company reached a settlement of the lawsuit. The settlement, which is subject to court approval, consists of an agreement by the Company to pay $500,000 in cash plus securities with a value of $8.15 million for a total settlement value of $8.65 million. The securities consist of 1,500,000 shares of the Company's common stock, plus a number of warrants to be determined if the value of the common stock does not equal at least $8.15 million after the settlement is approved by the court. Because of the decline in the value of the Company's stock since July 1997 and because of the impending sale of NTC [see "Item 1. Business - Agreement to Sell National Telephone & Communications, Inc. (NTC)"], there is serious doubt that the preliminary settlement would be approved by the court. As a result, the Company and the class 18 plaintiffs have begun to renegotiate the proposed settlement. There is no assurance that a new settlement agreement will be made. Should the settlement not be approved and should the Company be unable to negotiate a new settlement with the class plaintiffs, the Company plans to vigorously defend the lawsuit. Should the lawsuit not be settled, the case is still in the discovery phase. There is no assurance that the case will not have a material adverse impact on the financial condition, operating results and business performance of the Company and its subsidiaries. On July 22, 1997, the Company was named in a lawsuit, JAMES A. BELZ, ET AL VS. SAMUEL D. SCHWARTZ AND RITA SCHWARTZ, HUSBAND AND WIFE; STEPHEN A. CASWELL; JOEL W. GREENBERG; INCOMNET, INC., A CALIFORNIA CORPORATION; DAVID BODNER AND MURRAY HUBERFELD, in the United States District Court, District of Minnesota. The lawsuit was filed by 17 individuals who were allowed to opt out of the class action lawsuit to pursue a lawsuit on their own. The lawsuit alleges that Mr. Schwartz and the other defendants created a fraudulent scheme to drive up the price of the Company's stock in violation of federal securities law. The lawsuit alleges losses by the plaintiffs of approximately $1.5 million and seeks unspecified damages. This lawsuit is presently in the discovery phase. There is no assurance that the case will not have a material adverse impact on the financial condition, operating results and business performance of the Company and its subsidiaries. The Company has been served with a complaint in the lawsuit entitled SILVA RUN WORLDWIDE LIMITED VS. INCOMNET, INC., SAM D. SCHWARTZ, BEAR STEARNS & CO., INC., LESLIE SOLMONSON, RONALD F. SEALE, MARINER RESERVE FUND, COMPANIA DI INVESTIMENTO ANTILLANO, COUTTS & CO. AG, SALVATORE M. FRANZELLA, PETER G. EMBIRICOS, AND JOS SCHUETZ, filed in the United States District Court for the Southern District of New York. The complaint states that the plaintiff was a purchaser of the Company's stock in July 1995. The complaint alleges that the Company and it's former Chairman, Sam D. Schwartz, violated Sections 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended, and committed common law fraud, as a result of false and misleading statements made by the defendants and undisclosed trading in the Company's stock engaged in by Mr. Schwartz and his affiliate. The plaintiff also alleges that Mr. Schwartz and his affiliate owed a fiduciary duty to the plaintiff that was breached by their conduct. The complaint also alleges other causes of action against other unrelated defendants. The Company answered the complaint in November 1996 and moved to have it transferred to California. In March 1997, the claims relating to the Company and Sam Schwartz were ordered severed and transferred from the court in New York to the same court in California which is hearing the pending class action lawsuit. The Company is not yet aware of any discovery that has begun on this case. There is no assurance that the case will not have a material adverse impact on the financial condition, operating results and business performance of the Company and its subsidiaries. In addition to the BELZ and SILVA RUN lawsuits, the Company has learned that in excess of 50 other investors have timely opted-out of the class action and some may commence their own lawsuits against the Company. No additional lawsuits from opt-out investors have been filed to date. LAWSUIT AGAINST SAM D. SCHWARTZ: On April 25, 1997, the Company filed a lawsuit against Sam D. Schwartz, its prior President and Chairman of the Board, alleging fraud, breach of fiduciary duty, negligence, and breach of contract, and seeking declaratory relief and the imposition of a constructive trust. The lawsuit was filed in the Superior Court of California in the County of Los Angeles. In the lawsuit, the Company alleges that Mr. Schwartz failed to disclose to the Company or its Board of Directors that he would obtain a direct financial benefit in connection with certain transactions considered and/or entered into by the Company during the period from 1993 to 1995. The Company further alleges that Mr. Schwartz fraudulently induced the Company to enter into a Severance Agreement between him and the Company on November 27, 1995, and that he breached his fiduciary duty to the Company by self dealing, acting in bad faith and concealing material facts. The Company seeks payment from Mr. Schwartz of the actual damages incurred by it as a result of Mr. Schwartz's conduct, as well as interest, punitive damages, attorney's fees and costs, and reimbursement of all payments previously made to Mr. Schwartz pursuant to the Severance Agreement. Furthermore, the Company seeks a declaratory order that Mr. Schwartz committed acts or omissions involving known misconduct, the absence of good faith, an improper personal benefit, a reckless disregard of his duties to the Company and its shareholders, an unexcused pattern of inattention, and a violation of Sections 310 and 316 of the California Corporations Code. On June 24, 1997, Mr. Schwartz answered the Company's lawsuit against him denying the allegations and counterclaiming for (i) enforcement of any payments due under his Severance Agreement with the Company, (ii) indemnification against third party claims, and (iii) payment of the same settlement to him as was paid to the prior noteholders who purchased convertible notes from the Company on February 8, 1995 (Mr. Schwartz also purchased convertible notes from the Company on February 8, 1995), even though the Company's settlement with those prior noteholders was based on the misconduct of Mr. Schwartz. The Company intends to vigorously assert its claims against Mr. Schwartz, including possible 19 contribution claims with respect to the Company's proposed settlement payments to the plaintiffs in the class action lawsuit, and to vigorously defend against Mr. Schwartz's counterclaims. The lawsuit against Mr. Schwartz has entered the discovery phase and there is no assurance regarding its outcome. There is no assurance that the case will not have a material adverse impact on the financial condition, operating results and business performance of the Company and its subsidiaries. See "Item 1. Legal Proceedings - INCOMNET, INC. VS. SAM D. SCHWARTZ" in the Company's Form 10-Q for the quarter ended March 31, 1997, and "Item 3. Legal Proceedings - Settlement with Prior Noteholders" in the Company's 1996 Form 10-K. COMPLAINT FOR ARBITRATION AGAINST NATIONAL TELEPHONE & COMMUNICATIONS, INC. (NTC) AND INCOMNET, INC.: In December 1997, NTC was served with a complaint for arbitration by Paul Yao, Dennis Wong and their affiliates, who are prior independent sales representatives of NTC. In the complaint, the plaintiffs are alleging breach of contract, discrimination and other causes of action against NTC. NTC has filed an answer to the complaint and has attempted to engage in settlement discussions with the plaintiffs' counsel. The case is currently in the discovery phase and no settlement agreement has been made to date. As part of the sale of NTC [see "Item 1. Business - Agreement to Sell National Telephone & Communications, Inc. (NTC)"], it is anticipated that this action will be resolved. However, there is no assurance regarding its outcome. One of the terms of the sale is that the participants in the complaint will sign releases expressing that the matter has been resolved to their satisfaction. SETTLEMENT OF CIVIL CONSUMER PROTECTION LAWSUIT WITH THE STATE OF CALIFORNIA: On October 28, 1997, the Company announced that its NTC subsidiary reached a settlement of a civil consumer protection lawsuit with the State of California. In the settlement, which NTC reached without admitting any wrongdoing, NTC agreed to a court order requiring it to implement policies to prevent the practice of switching customers' long distance telephone service without their permission or knowledge by its independent sales representives or employees, and agreed to pay $1,250,600 in costs and penalties. NTC also agreed to institute safeguards to prevent violations from occurring in the future. Among those safeguards, NTC agreed to wait 24 hours after the consumer agrees to switch his or her telephone company to NTC before calling the customer to confirm that the consumer really wants to switch to NTC. The lawsuit was brought through the California Attorney General's Office and the Orange County District Attorney Office. The California Public Utility Commission was the investigative agency. As part of a related administrative action, restitution to consumers was being sought by the Consumer Services Division of the California Public Utility Commission. On November 12, 1997, NTC reached a settlement with the staff of the California Public Utility Commission pursuant to which it agreed to pay to total of approximately $350,000 to the Commission for customer restitution, educational brochures and investigative costs. The terms of the settlement with the Commission require the resignation in 1998 of the officers and directors of NTC who were engaged prior to January 1, 1997. On February 4, 1998, the settlement was approved by the full California Public Utility Commission. SETTLEMENT OF THE STEVENS LAWSUIT: In January 1997, the Company entered into a Settlement Agreement and Mutual Release of all claims in the pending lawsuit entitled CHARLES STEVENS VS. SAM D. SCHWARTZ AND INCOMNET, INC. Pursuant to the settlement, the Company paid $7,500 in cash to the plaintiff and issued 12,500 warrants to purchase 12,500 shares of the Company's Common Stock at an exercise price of $2.94 per share, exercisable at any time until December 16, 2001. The Company agreed to register the shares underlying the 12,500 warrants issued to Mr. Stevens and his legal counsel. In consideration for the issuance of warrants and payment of cash, the plaintiff released the Company from all claims and dismissed the lawsuit against the Company with prejudice. The settlement did not include Sam D. Schwartz. SETTLEMENT OF THE ATLANTA SUITS: In February 1997, the Company entered into a settlement and release agreement with the plaintiffs in the lawsuits entitled HERBERT M. SCHWARTZ ET AL. VS. INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT CORP. and BRENT ABRAHM ET AL. VS. INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT CORP. pursuant to which the lawsuit against the Company were dismissed and an order was entered barring indemnification or contribution between the Company and Sam D. Schwartz. In consideration for the payment of $400,000 in cash and the issuance of a note in the principal amount of $400,000 to the plaintiffs, the plaintiffs released the Company from all claims and dismissed their lawsuits against the Company with prejudice. The $400,000 note was issued as of January 1, 1997 and bears interest at the rate of 12% per annum from January 1, 1997 to January 22, 1997, and 8% per annum thereafter until December 31, 1997, when the note was due and payable in full. The note was secured by a certificate of deposit in the amount of $415,000 purchased by the Company. The note was paid in full in January 1998 and the case was dismissed with prejudice. 20 SETTLEMENT OF THE SECTION 16(B) LAWSUIT: In January 1996, the Company was served with a derivative shareholders lawsuit entitled RICHARD MORALES VS. INCOMNET, INC. AND SAM D. SCHWARTZ, 96 Civil 0225 in the United States District Court for the Southern District of New York, alleging violations of Section 16(b) of the Securities Exchange Act of 1934, as amended, and demanding that the Company assert claims against Mr. Schwartz for the payment of short-swing profits plus interest. Mr. Schwartz has retained separate counsel for this action. In early July 1996, Mr. Schwartz deposited 800,000 shares of his Incomnet, Inc. Common Stock into a court-approved escrow account with the Company's New York counsel as security for his obligation to pay short swing profits. On February 21, 1997, the plaintiffs and Sam Schwartz entered into a stipulated settlement pursuant to which Mr. Schwartz agreed to pay $4,250,000 to the Company as full payment of his short swing profit obligation to the Company. On July 10, 1997, the United States District Court for the Southern District of New York gave final approval to the settlement of the lawsuit. In the final settlement, Mr. Schwartz delivered to the Company 1,047,966 shares of the Company's common stock and $600,000 in cash. Under the agreement, the Company paid $626,450 in attorney's fees and expenses to the shareholder's counsel. SETTLEMENT OF LEGAL ACTION AGAINST PRIOR REPRESENTATIVES: On July 28, 1994, NTC filed a lawsuit against six prior independent marketing representatives who terminated their relationship with NTC on March 31, 1994. The lawsuit alleges that the defendants breached their agreements with NTC after terminating their representative status by (i) soliciting NTC's customers to leave NTC and sign up with a competitor, (ii) soliciting NTC's other independent marketing representatives to leave NTC and work for a competitor, (iii) misappropriating and failing to return the NTC customer and independent sales representative lists, (iv) disclosing NTC's customers, representatives and other trade secrets to a competitor and (v) willfully and maliciously conspiring to injure NTC's business in order to improve their own business. The causes of action against the defendants are breach of contract, misappropriation of trade secrets and intentional interference with NTC's economic relationships. NTC sought injunctive relief and is seeking monetary damages of at least $500,000, as well as punitive damages in an unspecified amount. On August 31, 1994, the court awarded NTC a temporary injunction against the defendants, enjoining them from disclosing or utilizing any of NTC's trade secrets, including its list of customers and independent sales representatives. A permanent injunction was subsequently denied by the court on the basis that NTC had failed to demonstrate irreparable harm. All of the defendants were located in Northern California. On August 30, 1994, the defendants filed a cross-complaint against NTC and the Company, claiming that NTC failed to meet its contractual obligations to the defendants and that actions taken by the defendants as a result were proper and legal. In the fourth quarter of 1997, NTC settled the lawsuit for an undisclosed amount, which did not materially impact the Company's financial statements, in consideration for a general release. The case has been dismissed with prejudice. POTENTIAL LAWSUITS: There is no assurance that claims similar to those asserted in the pending class action and related lawsuits, or other claims, will not be asserted against the Company by new parties in the future. In this regard, potential plaintiffs have from time to time asserted claims against the Company and its directors. Approximately 50 members of the class in the pending class action lawsuit against the Company have opted out of the class and may file separate lawsuits against the Company [see "Item 3. Legal Proceedings - Class Action and Related Lawsuits"]. If such claims are filed as legal complaints, the Company will seek to have them consolidated with other pending lawsuits, if appropriate, or will defend them separately. On April 7, 1998, an existing shareholder of the Company, who owns approximately 5.7% of the outstanding stock of the Company filed a Schedule 13D with the Securities and Exchange Commission and, on April 9, 1998, also submitted a letter to the Board of Directors of the Company. The letter asked for an explanation of certain actions taken by the Company, including the Board's approval of the agreement to sell NTC [see Item 1. Business - Agreement to Sell National Telephone & Communications, Inc. (NTC)"]. There are also potential claims which may be asserted against the Company, but which have not been filed as complaints, by Edward Jacobs and Jerry Ballah for amounts owed to them pursuant to an agreement with the Company reached in November 1996 [see "Certain Relationships and Related Transactions - Settlement Agreement With NTC Directors in the Company's Proxy Statement, filed with the Securities and Exchange Commission on November 19, 1997"]. To date, no payment has been made on the settlement with Mr. Jacobs and Mr. Ballah. Payment of the settlement with Mr. Jacobs and Mr. Ballah is expected to be made as part of the agreement to sell NTC [see "Item 1. Business - Agreement to Sell National Telephone & Communications, Inc. (NTC)"]. Should the sale of NTC not be completed and should the Company not pay the settlement, the amount of the damages to be asserted by Mr. Jacobs and Mr. Ballah would be approximately $988,000 plus interest, and possibly consequential damages relating to the nonpayment of their tax liability, if applicable. There also may be potential claims by prior or present independent sales representatives of NTC against NTC for alleged nonpayment of commissions or for the alleged improper allocation of commissions by NTC and NTC management responsible for such payments or allocations. There are also possible claims against NTC by a former consultant to NTC, who may assert claims against NTC for options or convertible debt units that were not provided under an alleged agreement with NTC. From time to time, the Company is also involved in litigation arising from the ordinary course of business, the ultimate resolution of which may or may not have a material adverse effect on the financial condition or results of operations of the Company. 21 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1997. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS MARKET INFORMATION: The Company's common stock trades on the NASDAQ Small-Cap Market under the symbol "ICNT". The following table sets forth the range of bid prices for the common stock during the periods indicated. Prices represent the actual high and low sale prices of the Company's stock as provided by NASDAQ real-time pricing information. YEAR ENDED DECEMBER 31, 1997:
QUARTER HIGH LOW LAST SALE ------- ---- --- --------- 4 3 13/16 1 1/16 1 3/16 3 5 3/16 2 15/16 3 5/8 2 5 1/2 2 11/16 4 7/8 1 5 1/16 2 13/16 3 1/8
YEAR ENDED DECEMBER 31, 1996:
QUARTER HIGH LOW LAST SALE ------- ---- --- --------- 4 5 2 7/8 2 31/32 3 5 5/16 4 3/16 4 5/16 2 6 1/4 4 3/8 4 3/4 1 6 3/16 4 3/8 5 3/8
On April 9, 1998, the last sales price per share of the Company's common stock, as reported by the NASDAQ Small-Cap Market, was $0.56. On April 9, 1998, the Company's 14,508,021 shares of common stock outstanding were held by approximately 6,000 shareholders, including shareholders of record and shareholders whose stock is held in street name. On April 3, 1998, the Company received a letter from NASDAQ notifying the Company that its stock had failed to maintain a closing bid price greater than or equal to $1.00 for a period of 30 consecutive trading days. NASDAQ has notified the Company that its stock must have a closing bid price of $1.00 or greater for 10 consecutive trading days before July 2, 1998 or the Company will be subject to delisting. To stay a delisting, the Company may request a hearing by the close of business on July 2, 1998. Should the Company's stock be delisted from the NASDAQ SmallCap Market, the Company expects that its stock would be traded on the NASDAQ OTC Bulletin Board. DIVIDENDS: The Company has not paid cash dividends on its common stock since inception. Payment of dividends is within the discretion of the Company's Board of Directors and will depend, among other factors, on earnings, capital requirements and the operating and financial condition of the Company. Furthermore, the payment of dividends on the Company's common stock is subject to the payment in full of all accrued but unpaid dividends on its outstanding Series A 2% Convertible Preferred Stock and Series B 6% Convertible Preferred Stock [see "Item 1. Business - Conveyance of Series A 2% Convertible Preferred Stock and Issuance of Series B 6% Convertible Preferred Stock."] At the present time, the Company has no plans nor the financial resources to declare or pay any dividends on its common stock, nor to pay any dividend in cash on its outstanding Preferred Stock [see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations".] ITEM 6. SELECTED FINANCIAL DATA 22 A summary of selected financial data for the five years ended December 31, 1997, 1996, 1995, 1994 and 1993, is presented below, and should be read in conjunction with the audited consolidated financial statements for the years ended December 31, 1997, 1996 and 1995 at "Item 8. Financial Statements and Supplementary Data." All numbers are in thousands of dollars, except per share amounts.
FOR THE YEAR: 1997(2) 1996(2) 1995(2) 1994(2) 1993(1,2) ------- ------- ------- ------- --------- Sales 125,144 $106,905 $86,565 $46,815 $11,299 Income (loss) before income taxes, minority interest and extraordinary items (13,400) (51,517) 1,065 4,000 (1,607) Income (loss) before minority interest and extraordinary items (13,400) (43,705) 954 3,999 (1,607) Net Income (13,601) (37,676) 1,366 4,071 (949) PER SHARE: Net income (loss) before extraordinary items (1.03) (2.75) 0.11 0.42 (0.20) Net income (loss) (1.03) (2.82) 0.11 0.42 (0.12) AT YEAR END: Total assets $40,514 $40,587 $74,106 $26,158 $8,666 Long-term obligations 2,856 1,040 8,460 1 20
- ------------------- (1) In 1992, the Company acquired a controlling interest in National Telephone & Communications, Inc. This information is described in "Item 1. Business - Acquisition of National Telephone & Communications, Inc. (NTC)" in the Company's 1995 Form 10-K. (2) The Company is engaged in legal proceedings where the ultimate outcome cannot presently be determined. This information is described at "Item 3. Legal Proceedings." ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW: The following is management's discussion and analysis of certain significant factors which have affected the results of operations and financial condition of the Company during the period included in the accompanying financial statements. This discussion should be read in conjunction with the financial statements and associated notes. The discussion herein is qualified by reference to the Introductory Note. LIQUIDITY AND CAPITAL RESOURCES: GENERAL - Overall, the Company experienced negative cash flows of $1.4 million during 1997, resulting from cash used in operating activities of $9.2 million and cash used in investing activities of $3.9 million, which is a total of $13.1 million, offset by cash provided by financing activities of $11.7 million. The Company may need to raise additional capital in 1998 to fund settlement costs relating to pending litigation or to fund business operations if the pending sale of National Telephone & Communications (NTC) is not completed [see "Item 1. Business - Sale of National Telephone & Communications, Inc. (NTC)"]. There is no assurance that the sale of NTC will be completed or that the Company and NTC will have sufficient capital or financing to meet their needs should the sale not be completed. In the latter part of 1997, NTC began experiencing a substantial decline in revenues, the number of its independent sales representatives and telephone customers. NTC has little borrowing capacity remaining on its credit line with First Bank and is experiencing net operating deficits. There is no assurance that NTC will have sufficient working capital to remain in business during 1998. In the short run, certain of its working capital needs are being met by an agreement with WorldCom, Inc. to permit NTC to defer a portion of the payments owed by NTC to WorldCom [see "Item 1. Business - National Telephone & Communications, Inc."]. Nevertheless, a shortgage of working capital and a continued decline in NTC's operating results and financial condition are on-going risks associated with the Company. Furthermore, after the sale of its AutoNETWORK division in March 1998, the Company no longer has the positive cash flow associated with that business, resulting in a larger operating deficit at the parent company, which is expected to continue in 1998. There is no assurance that the Company will be able to obtain additional capital or financing from any source. The sale of GenSource Corporation or sale of shares of Rapid Cast, Inc. is being contemplated by the Company as a means of raising additonal capital, but there is no assurance that such sales can be made on a timely basis or at all. CASH FLOW FROM OPERATIONS - Net cash used by operating activities of $9.2 million in 1997 was primarily attributable to an operating loss of $13.6 million, some of which was funded by $8.25 million of non-cash issuances of common stock. CASH FLOW FROM INVESTING - Net cash used in investing activities of $4.0 million in 1997 was attributable principally to the Company's additions to property, plant and equipment ($5.9 million), reduced by a $2.4 million repayment of a loan from Rapid Cast, Inc. (RCI). 23 CASH FLOW FROM FINANCING - Net cash provided by financing activities of $11.7 million in 1997 was attributable principally to short-term borrowings of approximately $8.1 million by NTC on its bank line of credit and the private placement of Series B 6% Convertible Preferred Stock by the Company, raising net proceeds of $2.2 million. At December 31, 1997, the Company had a material commitment for capital expenditures of approximately $400,000 in its GenSource subsidiary for the development of computer software. LITIGATION - The Company is subject to pending litigation and an investigation by the Securities and Exchange Commission. Management is not yet able to predict the impact of the pending litigation on its financial condition and results of operations. The Company has been advised by its attorneys that the investigation by the Securities and Exchange Commission will not result in a material impact on the Company's financial condition or results of operations. See "Item 3. Legal Proceedings." RESULTS OF OPERATIONS: FINANCIAL ANALYSIS- SALES - For 1997, 1996 and 1995, the Company's net sales totaled approximately $125.1 million, $106.9 million, and $86.6 million, respectively. The increases in sales in 1997 compared with 1996 and 1996 compared with 1995, were attributable principally to increased sales at NTC, although sales at NTC began to decline in the latter part of 1997. The following table summarizes the Company's year-to-year sales performance by subsidiary and segment:
$ in millions ---------------------------------------- Subsidiary Segment 1997 1996 1995 - ----------- ------- ---------------------------------------- NTC Telephone (telecommunications services) $106.9 $83.7 $70.0 NTC Telephone (marketing programs) 14.9 17.1 13.1 GenSource Software 1.86 -- -- RCI Optical -- 4.7 2.0 AutoNETWORK Network 1.45 1.4 1.5 ---------------------------------------- Total Company Net Sales $125.1 $106.9 $86.6 ---------------------------------------- ----------------------------------------
NTC's net sales increase was driven largely by continued expansion of the customer base for its telecommunication services until the middle of 1997. As a result of this prior period of expansion, NTC's telecommunication service revenues represented 87.7%, 83.0% and 84.2% of NTC's total revenues for 1997, 1996 and 1995, respectively, with the remaining 12.3%, 17.0% and 15.8% generated by sales of NTC's marketing programs for 1997, 1996 and 1995, respectively. Revenues from NTC's marketing programs declined in 1997 compared to 1996, foreshadowing its decline in overall revenue commencing in the latter part of 1997. Revenues from the Company's new software operations, which began in May 1997, were 1.4% of overall sales in 1997. Revenues from the Company's AutoNETWORK division were 1.2%, 1.3% and 1.7%, respectively for 1997, 1996 and 1995. In March 1998, the Company sold its AutoNETWORK division, which will result in those operations being discontinued. COST OF SALES - Total Company cost of sales for 1997, 1996 and 1995, were approximately $88.1 million, $68.6 million and $57.9 million, respectively. The increases in cost of sales were attributable principally to the increase in carrier costs associated with increased telephone service sales by NTC. Gross margin when stated as a percentage of net sales was 29.5%, 35.9% and 33.1% for 1997, 1996 and 1995, respectively. The decrease in gross margin in 1997 was attributable principally to NTC's low profitability associated with a special limited-time offer with attractive international rates. These rates are no longer in effect. The following table summarizes the Company's year-to-year changes in three major cost components: 24
$ in millions ---------------------------------------- 1997 1996 1995 ---------------------------------------- Carrier costs for NTC's long distance telephone service $65.4 $44.7 $40.4 Commissions paid to NTC independent sales representatives 18.3 18.0 14.2 All other costs of sales 4.5 5.9 3.3 ---------------------------------------- Total Company Cost of Sales $88.2 $68.6 $57.9 ---------------------------------------- ----------------------------------------
NTC's total commission expenses for 1997, 1996 and 1995, were $18.3 million, $18.0 million and $14.2 million, respectively. The relatively small increase in commissions from 1997 to 1996 was attributable principally to a decrease in bonuses and overrides paid to sales representatives for the acquisition of long distance customers. Commissions associated with residual telephone usage increased commensurately with the growth in telephone revenues. The third cost component shown in the table above is "all other costs of sales" which represents: (1) NTC's costs of producing sales materials and related costs of marketing support for its independent sales representatives, which was $2.2 million, (2) GenSource's costs of designing and developing its computer software, which was $1.5 million, and (3) AutoNETWORK costs of providing communications network products and services, which was $0.8 million. GENERAL AND ADMINISTRATIVE - Total general and administrative costs for 1997, 1996 and 1995, were approximately $29.0 million, $36.9 million and $19.8 million, respectively. General and administrative expenses represented 23.1%, 34.5% and 22.9% of net sales in 1997, 1996 and 1995, respectively. General and administrative costs generally include the costs of employee salaries, fringe benefits, supplies, and related support costs which are required in order to provide such operating functions as customer service, billing, marketing, product development, information systems, collections of accounts receivable, and accounting. NTC's general and administrative costs totaled $27.2 million and $24.8 million, or 22.3% and 24.5% of net sales in 1997 and 1996, respectively. Although general and administrative costs increased in 1997, they decreased as a percentage of sales. This decrease as a percentage of sales was attributable primarily to decreases in fees, as a percentage of sales, paid to LECs to process NTC's billing and collection of its LEC-billed long distance service, partially offset by increases in (i) compensation and fringe benefits due to increased head count, (ii) legal costs relating to NTC's lawsuits and (iii) the cost of information systems necessary to support NTC's sales expansion. DEPRECIATION AND AMORTIZATION - The Company's depreciation and amortization expense totaled $3.1 million, $2.0 million and $1.0 million for 1997, 1996 and 1995, respectively. These increases were attributable primarily to leasehold improvements made by NTC to its Irvine headquarters and Hawaii sales office and by the continuing investment by NTC in computer hardware and software, furniture and equipment, and leasehold improvements required to support its sales expansion. BAD DEBT EXPENSE - The Company's bad debt expense totaled $5.5 million, $6.1 million and $4.1 million for 1997, 1996 and 1995, respectively. Bad debt expense represented 4.3%, 5.7% and 4.8% of net sales in 1997, 1996 and 1995, respectively. The decrease in bad debt was caused primarily by improved performance of the Company's billing and collection operations. OTHER (INCOME) AND EXPENSE - The Company's other (income) and expense totaled $12.8 million, $3.4 million and $1.0 million for 1997, 1996 and 1995, respectively. The increase in 1997 was attributable in large part to the settlement of the class action lawsuit for $8.65 million (which may not be implemented and which may have to be renegotiated [see "Item 3. Legal Proceedings - Class Action and Related Lawsuits"], settlement of the State of California and California Public Utilities Commission actions against NTC for $1.6 million) and design costs and leasehold improvements of $1.1 million associated with abandoned capital improvements. CHARGE FOR ASSET IMPAIRMENT - The charge for asset impairment totaled $39.1 million for 1996 for the devaluation of the Company's investment in RCI. There was no impairment in 1997 or 1995. NET INCOME (LOSS) - The Company's net loss totaled $13.6 million and $37.7 million for 1997 and 1996, respectively. The Company had net income of $1.4 million for 1995. Net loss represented 10.8% and 35.2% of net sales for 1997 and 1996, respectively. Net income represented 1.6% of net sales for 1995. The net loss in 1997 was attributed principally to settlement of lawsuits and regulatory matters. The Company's operations had a net gain of approximately $1.1 million in 1997. NTC's operations earned $643,463. GenSource's operations earned $48,078 in 1997 since being acquired by the Company in May 1997. The Company's AutoNETWORK division had an operating profit of $406,257. 25 EMPLOYMENT - Employment of the Company totaled 252 at December 31, 1997, not including independent sales representatives, who are classified as independent sales representatives and not employees of the Company, or outside contractors. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements and supplementary financial information which are required to be filed under this item are presented under "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 10-K" in this document, and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT The information required under this Item will be contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders or in Form 10-KA to be filed with the Securities and Exchange Commission pursuant to Regulation 14A or Section 13 by April 30, 1998, and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required under this Item will be contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders or in Form 10-KA to be filed with the Securities and Exchange Commission pursuant to Regulation 14A or Section 13 by April 30, 1998, and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required under this Item will be contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders or in Form 10-KA to be filed with the Securities and Exchange Commission pursuant to Regulation 14A or Section 13 by April 30, 1998, and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required under this Item will be contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders or in Form 10-KA to be filed with the Securities and Exchange Commission pursuant to Regulation 14A or Section 13 by April 30, 1998, and is incorporated herein by reference. 26 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
INDEX TO FINANCIAL STATEMENTS: PAGE - ----------------------------- ---- Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 Consolidated balance sheet at December 31, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . .32 Consolidated statement of operations for the years ended December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 Consolidated statement of cash flows for the years ended December 31, 1996, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34 Consolidated statement of shareholders' equity for the years ended December 31, 1997, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36 Notes to consolidated financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . .37 Schedule II - Valuation and qualifying accounts at December 31, 1997 and 1996. . . . . . . . . . .49
All other schedules are omitted as the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto. INDEX TO EXHIBITS: Exhibits designated by the symbol ** are management contracts or compensatory plans or arrangements that are required to be filed with this report pursuant to this Item 14. The Company undertakes to furnish to any shareholder so requesting a copy of any of the following exhibits upon payment to the Company of the reasonable costs incurred by the Company in furnishing any such exhibit.
EXHIBIT NO. DESCRIPTION - ----------- ----------- 2.1 Asset Purchase Agreement between NTC Acquisition, Inc. and National Telephone & Communications, Inc., dated March 31, 1998. (Incorporated by reference from Incomnet, Inc.'s Report on Form 8-K - Sale of Assets of National Telephone & Communications, Inc., filed with the Securities and Exchange Commission on April 8, 1998.) 3.1 Certificate of Determination for Series A 2% Convertible Preferred Stock. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996.) 3.2 Certificate of Determination for Series B 6% Convertible Preferred Stock. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on January 20, 1998.) 4.1 Form of Warrant to Purchase 75,000 Shares of Incomnet, Inc. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) 4.2 Form of Warrant to Purchase 510,000 Shares of RCI Common Stock with Registration Rights Agreement, dated April 19, 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) 4.3 Form of Warrant to Purchase RCI Common Stock, dated February 8, 1995. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) 27 4.4 Form of Warrant to Purchase 360,000 Shares of Incomnet, Inc. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) 4.5 Form of Warrant to Purchase 12,500 Shares of Incomnet, Inc. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) 10.1 Employment Agreement with James Quandt, dated January 6, 1997.(Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) 10.2 Amended and Restated Management Incentive Agreement Between NTC and Incomnet, Inc., dated January 28, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) 10.3 Settlement Agreements With Prior Noteholders. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) 10.4 Form of 8% Convertible Note Issued by RCI in January 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) 10.5 Form of Short-Term 10% Note Issued by RCI in April 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) 10.6 Amended Carrier Switched Services Agreement with WorldCom, Inc. dated June 17, 1996. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Certain information has been deleted from this agreement pursuant to a request for confidential treatment pursuant to Rule 406.) 10.7 Settlement Agreement Between Joel W. Greenberg and Incomnet, Inc. (Incorporated by reference from the Company's Report on Form 8-K, dated June 7, 1996, relating to the settlement agreement with Joel W. Greenberg and his resignation as a director of the Company.) 10.8 Form of Registration Rights Agreement Between Incomnet, Inc. and Purchasers of Series A Convertible Preferred Stock. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended.) 10.9 Form of Purchase Agreement for the Series A 2% Convertible Preferred Stock. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended.) 10.10 Management Incentive Agreement with NTC, dated October 14, 1996. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996.) 10.11 Settlement Agreements With Edward Jacobs and Jerry Ballah, dated November 14, 1996. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996.) 28 10.12 Shareholders Agreement for Rapid Cast, Inc., dated January 16, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) 10.13 Registration Rights Agreement for Rapid Cast, Inc., dated January 16, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) 10.14 Settlement Agreement and Mutual Release Between Incomnet, Inc. and the RCI Parties, dated January 9, 1996. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) 10.15 Lease Agreement By NTC for space in Honolulu, Hawaii. (Incorporated by reference from Incomnet, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1996 filed with the Securities and Exchange Commission on April 15, 1997.) 10.16 Credit Agreement dated Marcy 27, 1997 between National Telephone and Communications, Inc. and First Bank and Trust, Irvine Regional Office. (Incorporated by reference from Incomnet, Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1996 filed with the Securities and Exchange Commission on April 15, 1997.) 10.17 Amended and Restated Management Incentive Agreement Between NTC and Incomnet, Inc., dated January 28, 1997. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on January 20, 1998.) 10.18 Amendment to Employment Agreement between Incomnet, Inc. and Melvyn H. Reznick, dated June 8, 1997. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on January 20, 1998.) 10.19 Employment Agreement between Incomnet, Inc. and Stephen A. Caswell, dated June 8, 1997. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on January 20, 1998.) 10.20 Employment Agreement between National Telephone & Communications, Inc. and Edward R. Jacobs, dated October 30, 1997. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on January 20, 1998.) 10.21 Convertible Debenture and Between Incomnet and Jeffrey Rubin, Robert Cohen and Alan Cohen and related documents, dated January 20, 1998. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on January 20, 1998.) 10.23 Agreement Between NTC Acquisition, Inc., Incomnet, Inc. and National Telephone & Communications, Inc. , dated March 31, 1998. (Incorporated by reference from Incomnet, Inc.'s Report on Form 8-K - Sale of Assets of National Telephone & Communications, Inc., filed with the Securities and Exchange Commission on April 8, 1998.) 10.24 Agreement To Purchase AutoNETWORK Assets From Incomnet, Inc. Between Incomnet, Inc. and AutoSkill, Inc., dated March 20, 1998. 21 Subsidiaries of the Registrant. 29 27 Financial data schedule (Article 5 of regulations S-X). REPORTS ON FORM 8-K, FILED IN 1997 AND 1998 20.1 Report on Form 8-K - Election of Dr. Howard Silverman As Director & Amendment to Employment Contract of Melvyn Reznick, filed on February 7, 1997. 20.2 Report on Form 8-K - Reincorporation of National Telephone &Communications, Inc. filed on April 10, 1997. 20.3 Report on Form 8-K - Acquisition of California Interactive Computing, Inc., filed on May 13, 1997. 20.4 Report on Form 8-K - Election of Richard M. Horowitz, Stanley C. Weinstein and David Wilstein as Directors, filed on August 20, 1997. 20.5 Report on Form 8-K - Resignation of Albert Milstein as Director and Election of Rolf Lesem as Director, filed on December 26, 1997. 20.6 Report on Form 8-K/A - Stock Purchase Agreements and Promissory Notes Between Incomnet, Inc. and Former Owners of California Interactive Computing, Inc., including Jerry C. Buckley, Ralph Flygare, Robert Reisbaum, E. V. Schmidt, Diane Orendorff and Nora Kenner Hoffberg, filed on January 15, 1998. 20.7 Report on Form 8-K/A - Escrow Agreements Between Incomnet, Inc. and Former Owners of California Interactive Computing, Inc., including Jerry C. Buckley, Ralph Flygare, Robert Reisbaum and E. V. Schmidt, filed on January 21, 1998. 20.8 Report of Form 8-K - Sale of Assets of National Telephone & Communications, Inc., filed on April 8, 1998.
30 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: April 14, 1998 INCOMNET, INC. -------------------------- (Registrant) By: /S/ MELVYN REZNICK ----------------------- MELVYN REZNICK President and Chief Executive Officer Pursuant to requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
SIGNATURE CAPACITY DATE --------- -------- ---- /S/ MELVYN REZNICK President, Chief Executive Officer, - ------------------ and Chairman of the Board of Directors April 14, 1998 MELVYN REZNICK /S/ RICHARD HOROWITZ Director April 14, 1998 - -------------------- RICHARD HOROWITZ /S/ ROLF LESEM Director April 14, 1998 - ------------------ ROLF LESEM /S/ DR. HOWARD SILVERMAN Director April 14, 1998 - ------------------------ Dr. HOWARD SILVERMAN /S/ DAVID WILSTEIN Director April 14, 1998 - -------------------- DAVID WILSTEIN /S/ NANCY ZIVITZ Director April 14, 1998 - ------------------ NANCY ZIVITZ
31 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Incomnet, Inc. We have audited the consolidated balance sheet of Incomnet, Inc. and subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of operations, shareholders' equity and cash flow for each of the three years in the period ended December 31, 1997, and the schedule listed in Item 14. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Incomnet, Inc. at December 31, 1997 and 1996 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. As discussed in Note 11 to the financial statements, the Company is a party to a class action matter, claiming losses arising from alleged securities violations based upon the denial and non-disclosure of a pending investigation by the Securities and Exchange Commission and on alleged undisclosed securities transactions by its former President. Legal counsel to the Company has advised that the ultimate outcome of this matter and a range of potential loss cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been made in the accompanying financial statements. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As set forth in the financial statements, the Company incurred a net loss of $13,601,000 for the year ended December 31, 1997 and at that date current liabilities exceeded current assets by $11,636,000. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans with respect to these matters are described in the accompanying footnotes to the financial statements. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. /s/ Stonefield Josephson ACCOUNTANCY CORPORATION Santa Monica, California March 12, 1998 32 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS)
DECEMBER 31, ------------ 1997 1996 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 776 $ 2,214 Accounts receivable, including $267 due from related party at December 31, 1996 and less allowance for doubtful accounts of $2,764 at December 31, 1997 and $1,908 at December 31, 1996 13,850 13,137 Notes receivable - current portion 237 323 Notes receivable from officers and shareholders, net of allowances of $378 and $1,265 840 438 Inventories 315 2,760 Other current assets 876 1,332 ------------ ------------ Total current assets 16,894 20,204 Property, plant and equipment, at cost, net 16,248 14,357 Patent rights, net -- 1,241 Goodwill, net 6,484 4,542 Investments and other assets 888 243 ------------ ------------ Total assets $ 40,514 $40,587 ------------ ------------ ------------ ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 9,792 $ 14,746 Accrued expenses 7,366 8,217 Current portions of notes payable and capitalized lease obligations 9,383 3,918 Deferred income 1,989 4,040 ------------ ------------ Total current liabilities 28,530 30,921 Notes payable and capitalized lease obligations 2,855 -- Other long-term liabilities -- 1,040 Liability in excess of assets of RCI 3,600 -- Shareholders' equity: Common stock, no par value; 20,000,000 shares authorized; 14,259,070 shares issued and outstanding at December 31, 1997 and 13,369,681 shares at December 31, 1996 70,811 61,320 Preferred stock, no par value; 100,000 shares authorized; 3,995 shares issued and outstanding at December 31, 1997, and 2,440 shares at December 31, 1996 3,758 2,355 Treasury stock (5,492) (5,492) Accumulated deficit (63,548) (49,557) ------------ ------------ Total shareholders' equity 5,529 8,626 ------------ ------------ Total liabilities and shareholders' equity $ 40,514 $ 40,587 ------------ ------------ ------------ ------------
See accompanying "Notes to Consolidated Financial Statements." 33 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
YEARS ENDED DECEMBER 31, ------------------------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1997 1996 1995 ---- ---- ---- NET SALES $125,144 $106,905 $86,565 ---------- ---------- --------- OPERATING COSTS & EXPENSES: Cost of sales 88,163 68,562 57,948 General and administrative 28,965 36,886 19,793 Depreciation and amortization 3,111 2,013 1,007 Bad debt expense 5,495 6,051 4,125 Total acquisition costs and expenses -- 2,334 1,625 Charge for asset impairment -- 39,147 -- Other (income) expense 12,810 3,429 1,002 ---------- ---------- --------- Total operating costs and expenses 138,544 158,422 85,500 ---------- ---------- --------- Operating income (loss) (13,400) (51,517) 1,065 INCOME TAXES (BENEFIT) (201) (7,812) 111 ---------- ---------- --------- Income (loss) before minority interest and extraordinary items (13,601) (43,705) 954 RCI acquisition - equity in (loss) of unconsolidated subsidiary, net of tax -- -- (97) Cumulative effect of accounting change on years prior to 1996, net of tax of $10 -- (877) -- MINORITY INTEREST -- 6,906 509 ---------- ---------- --------- Net income (loss) $ (13,601) $ (37,676) $ 1,366 ---------- ---------- --------- ---------- ---------- --------- NET LOSS APPLICABLE TO COMMON STOCK $(14,049) $ (37,676) $ 1,366 ---------- ---------- --------- ---------- ---------- --------- INCOME (loss) PER COMMON SHARE AND COMMON SHARE EQUIVALENTS: Net income (loss) $ (1.03) $ (2.75) $ 0.11 Cumulative effect of accounting change -- (0.07) -- ---------- ---------- --------- Net income (loss) per share basic and diluted $ (1.03) $ (2.82) $ 0.11 ---------- ---------- --------- ---------- ---------- --------- WEIGHTED AVERAGE NUMBER OF COMMON SHARES FOR 1997 AND 1996 AND COMMON SHARE AND COMMON share equivalents outstanding for 1995 13,578 13,370 12,706 ---------- ---------- --------- ---------- ---------- ---------
See accompanying "Notes to Consolidated Financial Statements." 34 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS) YEARS ENDED DECEMBER 31, ------------------------ 1997 1996 1995 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Income (loss) before minority interest and extraordinary items $(13,601) $(37,676) $ 1,366 Depreciation & amortization - operations 3,111 2,013 1,413 Depreciation & amortization - acquisitions -- 2,334 651 Issuance of common stock in litigation settlement 8,250 -- -- Write-off of patent rights -- 39,147 -- Deferred income taxes -- (8,449) -- Minority interest -- (6,906) (8,227) Other non-cash (income) loss -- 877 358 Changes in operating assets and liabilities: Accounts receivable (1,852) (960) (2,784) Notes receivable - current portion 86 (220) (103) Notes receivable - due from officers and shareholders (402) 425 (863) Inventories 4 (1,113) (401) Other current assets 211 171 (1,000) Accounts payable (680) 5,962 2,571 Accrued expenses (2,299) 4,540 1,834 Deferred income (2,051) 2,848 (896) ---------- ---------- --------- Net cash provided (used) by operating activities (9,223) 2,993 (6,081) ---------- ---------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant and equipment (5,886) (7,224) (7,389) Additions to patents -- (717) (21,002) (Increase) decrease in investments -- 281 16 Goodwill - Gensource (552) -- -- Repayment of loan from RCI 2,449 -- -- ---------- ---------- --------- Net cash used in investing activities (3,989) (7,660) (28,375) ---------- ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase (decrease) in short-term debt 8,085 2,904 1,306 Additions to long-term debt 1,435 1,274 -- Reduction of long-term debt -- (1,763) -- Sale of preferred stock, net 2,248 2,355 -- Issuance of common stock net -- 436 29,508 Treasury stock -- -- (4,827) Sale of warrants 36 -- -- Dividends (88) -- -- Other, net 58 30 419 ---------- ---------- --------- Net cash provided by financing activities 11,774 5,236 26,406 ---------- ---------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,438) 569 (8,050) Cash and cash equivalents at beginning of year 2,214 1,645 9,695 ---------- ---------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR 776 $ 2,214 $ 1,645 ---------- ---------- --------- ---------- ---------- --------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 373 $ 181 $ 153 Income taxes 20 635 574
35 Supplemental Schedule of Non-Cash Investing and Financing Activitities The Company purchased all of the capital stock of GenSource for $1,923. In conjunction with the acquisition, non cash consideration was paid and liabilities were assumed as follows: Notes payable issued to GenSource shareholders $1,638 Excess of liabilities over assets at closing 300
SUPPLEMENTAL DISCLOSURE The Company recorded the following in connection with the change in the method of accounting of RCI from the consolidated to the equity method Accounts receivable $ (1,139) Inventory (2,449) Prepaid expenses and other (245) Property and equipment - net (888) Intangible assets (1,241) Other assets (35) Accounts payable 2,656 Accrued expenses 862 Notes payable 3,630 Cash received from RCI private placement 2,449 ---------- Liability in excess of asset $3,600 ---------- ----------
See accompanying "Notes to Consolidated Financial Statements." 36 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS, EXCEPT SHARES DATA) Common Stock Common Stock Preferred Treasury Accumulated Shares Amount Stock Stock Deficit Total - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1994 10,482,854 $31,376 -- $(665) $(14,176) $16,535 Common stock issued upon exercise of warrants 489,582 4,343 -- -- -- 4,343 Common stock issued under private placement 157,500 1,890 -- -- -- 1,890 Common stock issued upon conversion of note 2,300,000 22,664 -- -- -- 22,664 Common stock issued in exchange for NTC shares 253,712 507 -- -- -- 507 Repurchase of treasury shares (451,000) -- (5,085) -- (5,085) Treasury shares sold 30,000 -- 362 -- 362 Change in valuation of marketable securities -- -- -- -- (34) (34) Other -- 104 -- (104) -- -- Net income -- -- -- -- 1,366 1,366 - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 13,262,648 $60,884 -- $(5,492) $(12,844) $42,548 Common stock issued upon settlement of litigation 107,033 436 -- -- -- 436 Issuance of preferred stock, net (2,440 shares issued) -- -- 2,355 -- -- 2,355 Cumulative effect -- -- -- -- 877 877 Change in valuation of marketable securities 86 86 Net loss -- -- -- -- (37,676) (37,676) - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 13,369,681 $61,320 $2,355 $(5,492) $(49,557) $8,626 Common stock issuable upon settlement of litigation 1,500,000 8,250 8,250 Preferred stock converted to Common stock 437,355 845 (845) -- Retirement of stock in connection with 16(b) settlement (1,047,966) Issuance of preferred stock, net (2,434 shares issued) 2,248 2,248 Issuance of warrants 36 36 Dividend with respect to beneficial conversion feature 360 (360) Dividends with respect to preferred stock (88) (88) Other-net 58 58 Net loss (13,601) (13,601) - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 14,259,070 70,811 3,758 $(5,492) (63,548) 5,529
See accompanying "Notes to Consolidated Financial Statements." 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company, its wholly- 37 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 owned subsidiary National Telephone & Communications-Registered Trademark-, Inc. (NTC), and its 100%-owned subsidiary GenSource Corporation (GenSource). The Company initially recorded the operations of its Rapid Cast subsidiary using the equity method of accounting, but changed in the first and second quarters of 1995 to the consolidation method when control became other than temporary. In the first quarter of 1997, outside equity investments in RCI reduced Incomnet's ownership interest to less than 50%, thereby requiring the equity method of accounting for RCI in 1997. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year amounts to conform to current year presentation. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant estimates made in preparing the consolidated financial statements include the allowance for doubtful accounts, deferred marketing reserve, income tax valuation allowance, investment reserves, litigation settlement costs and future undiscounted cash flows used in the analysis of the impairment of long- lived assets. REVENUE RECOGNITION - The Company recognizes revenue during the month in which services or products are delivered, as follows: (1) NTC's long distance telecommunications service revenues are generated when customers make long distance telephone calls from their business or residential telephones or by using any of NTC's telephone calling cards. Proceeds from prepaid telephone calling cards are recorded as deferred revenues when the cash is received, and recognized as revenue as the telephone service is utilized. The reserve for deferred revenues is carried on the balance sheet as an accrued liability. For the fiscal year ended December 31, 1997, long distance telephone service sales totaled $106.9 million versus $83.7 million for the year ended December 31, 1996. (2) NTC's marketing-related revenues are derived from programs and material sold to the Company's base of independent sales representatives, including forms and supplies, fees for representative and certified trainer renewals, and the Company's Certified Trainer, Independent Representative and Home Study programs. The Company requires that all such services and materials be paid at the time of purchase. Revenues from marketing-related materials, net of amounts deferred for future services provided to the representatives, are booked as cash sales when the revenues are received. A portion of the revenues from marketing-related programs and materials is deferred and recognized over a twelve month period to accrue the Company's obligation to provide customer support to its independent representatives. For the fiscal year ended December 31, 1997, marketing sales totaled $15.0 million versus $17.1 million for the year ended December 31, 1996. (3) Revenues from the Company's GenSource subsidiary are derived from the sale of computer software and from related services, such as software maintenance fees, custom programming and customer training. Revenues are recognized when software is shipped to customers and when services are performed and invoiced. Because the Company acquired GenSource on May 2, 1997, revenues and earnings only reflect GenSource's operations from May 2, 1997. Revenues in the fiscal year ended December 31, 1997 totaled $1.9 million. (4) The Company's revenues from its AutoNETWORK divison are recognized as sales as the service is delivered. Revenues from AutoNETWORK totaled $1.4 million in the fiscal year ended December 31, 1997. SERIES B PREFERRED STOCK - In connection with the sale of the Series B preferred stock in July 1997, a portion of the proceeds has been allocated to a beneficial conversion feature, which is the right of the preferred shareholder to convert the securities into common stock after the earlier of 120 days after the date of the issuance or the date the securities are registered. Accordingly, the difference between the conversion price and fair value of stock into which it is convertible, equal to $360,000, has been allocated to common stock. This amount has been recognized as a dividend to the preferred shareholders over the minimum period in which the shareholders could have realized that return, and net loss applicable to common stock has been increased in calculating loss per share. Net loss applicable to common stock has also been increased in calculating loss per share for the dividends accrued on both series of preferred stock. CONCENTRATION OF CREDIT RISK - The Company sells its telephone and network services to individuals and small businesses throughout the United States and does not require collateral. It sells its optical products both domestically and internationally. Allowances for uncollectible amounts are provided, which management believes are sufficient. 38 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 INCOME TAXES - The Company recognizes the amount of current and deferred taxes payable or refundable at the date of the financial statements as a result of all events that have been recognized in the financial statements and as measured by the provisions of enacted laws. Deferred income taxes result from temporary differences in the basis of assets and liabilities reported for financial statement and income tax purposes. COMPUTER HARDWARE, FURNITURE AND OFFICE EQUIPMENT - Computer hardware, furniture and office equipment are stated at cost. Depreciation is provided by the straight-line method over estimated useful lives ranging from five to ten years. COMPUTER SOFTWARE - The Company capitalizes the costs associated with purchasing, developing and enhancing its computer software. All software costs are amortized using the straight-line method over estimated useful lives ranging from three to ten years. LEASEHOLD IMPROVEMENTS - All leasehold improvements are stated at cost and are amortized using the straight-line method over the expected lease term. NET INCOME (LOSS) PER SHARE - The Company has adopted Statement of Financial Accounting Standard No. 128, Earnings per Share ("SFAS" No. 128"), which is effective for annual and interim financial statements issued for periods ending after December 15, 1997. SFAS No. 128 was issued to simplify the standards for calculating earnings per share ("EPS") previously in APB No. 15, Earnings Per Share. SFAS No. 128 replaces the presentation of primary EPS with a presentation of basic EPS. The new rules also require dual presentation of basic and diluted EPS on the face of the statement of operations. Net loss per common share has been increased by the dividends on preferred stock and the amount attributable to the beneficial conversion feature of the Series B Preferred Stock. Common equivalent shares, consisting of outstanding stock options and warrants, are not included for 1997 and 1996, since they are antidilutive. The adoption of this statement did not materially impact the consolidated financial statements. CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of cash-on-hand and short-term certificates of deposit. FAIR VALUES OF FINANCIAL INSTRUMENTS - Unless otherwise indicated, the fair values of all reported assets and liabilities which represent financial instruments (none of which are held for trading purposes) approximate the carrying values of such amounts. INVENTORIES - Inventory primarily consists of completed optical machines at the RCI subsidiary and is valued at the lower of cost (weighted average method) or market. INVESTMENTS - Marketable securities are considered available-for-sale and are stated at fair market value. The excess of fair market value over cost would be included as a separate component of Shareholders' Equity. During the fourth quarter of 1996, the Company deemed these investments permanently impaired and recorded a loss of $0.3 million to their estimated realizable value. INTANGIBLE ASSETS - Goodwill, representing the excess of purchase price over the fair value of the net assets of NTC, is amortized on a straight-line method basis over its estimated useful life of twenty years. Accumulated amortization at December 31, 1997 and 1996 was $5.1 million and $1.2 million, respectively. LONG-LIVED ASSETS - The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS No. 121), in March 1995. In accordance with SFAS No. 121, the Company reviewed its long-lived assets and certain identifiable intangibles for impairment. Patent rights obtained in the February 1995 acquisition of a controlling interest in RCI were evaluated by management and deemed to have been impaired. There was a significant decrease in market value of RCI as evidenced by an outside equity investment in January of 1997, the change in the market acceptance of products which were based on those patent rights, and actual and forecasted operating losses and cash flow losses which were significantly greater than originally anticipated. Accordingly, management estimated the fair value of the patent rights acquired in the RCI acquisition, based upon, among other valuation techniques, the present value of estimated expected cash flows. The carrying value of the patent rights exceeded management's estimates of the discounted present value of net cash 39 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 flows to be derived therefrom, and a writedown of approximately $39.1 million and elimination of a related deferred tax liability of $8.5 million was recorded as of December 31, 1996. STOCK OPTION PLANS - The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related Interpretations in accounting for the employee stock options, rather than adopt the alternative fair value accounting provided under The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." 2. FUNDING OF MARKETING COMMISSIONS AND DEFERRED INCOME: The Company's subsidiary, NTC, maintains a separate bank account for the payment of marketing commissions. Funding of this account is adjusted regularly to provide for management's estimates of required reserve balances. NTC estimates the total commissions owed to active independent representatives ("IR Earned Compensation") each week for all monies collected that week due to the efforts of those active independent representatives. All IR Earned Compensation is then paid to the independent representatives, when due, directly out of the separate bank account. 3. RELATED PARTY TRANSACTIONS: The Company has a note receivable from an officer of approximately $340,000 in connection with the exercise of stock options to purchase the Company's Common Stock in 1995. The Company has agreed to look only to the shares held by the officer as a source of loan repayment and has also agreed to pay any tax liabilities that may be incurred by the officer should the loan, or a portion of the loan, be forgiven. Included in accounts receivable is approximately $0.3 million and $0.5 million at December 31, 1996 and 1995, respectively, due from companies controlled by an individual who is an Incomnet shareholder and a founding shareholder of RCI. A director of the Company has defaulted on a note payable to the Company in the principal amount of $265,000, plus approximately 18 months accrued interest at the rate of 10% per annum. On the maturity date of the note in February 1998, the Company sent a demand letter to the director for full payment. The note is secured by a perfected security interest in 208,000 shares of the Company common stock owned by them. The note has not been repaid and the Company is preparing to foreclose and cancel the 208,000 shares securing the note, as well as seeking to collect the balance owed. As of April 10, 1998, the outstanding balance of the note, including interest, was approximately $304,050. The director has informed the Company that the director does not believe a default has occurred on either the principal or interest that is purportedly due the Company. Reserves of $378,000 and $208,000 have been provided at December 31, 1997 and 1996, respectively, for notes receivable from officers, directors and former officers. 4. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, at cost, including capitalized lease assets, consist of the following:
(IN THOUSANDS) DECEMBER 31, ------------ 1997 1996 ---- ---- Computer hardware and software $ 9,539 $ 7,100 Furniture and office equipment 3,872 3,456 Leasehold improvements 9,647 7,595 -------- -------- 23,058 18,151 Less accumulated depreciation 6,810 3,794 -------- -------- $ 16,248 $ 14,357 -------- -------- -------- --------
40 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 5. PATENT RIGHTS FROM ACQUISITION OF RCI During the third and fourth quarters of 1996, the Company evaluated the carrying value of its patent rights in comparison with management's estimates of discounted net present values of cash flows from those patents, and provided impairment losses of approximately $8.0 million and $31.1 million, respectively. 6. INVESTMENTS AND OTHER ASSETS Investments, notes receivable and other assets consist of the following:
DECEMBER 31, ------------ (IN THOUSANDS) 1997 1996 ---- ---- Marketable securities available-for-sale $ 35 $ 35 Deposits 525 -- Organization Costs 159 -- Other assets 169 208 ------ ----- $ 888 $ 243 ------ ----- ------ -----
Marketable securities available-for-sale consist of shares of common stocks of publicly traded companies. During the fourth quarter of 1996, the Company deemed these investments permanently impaired and recorded a loss of $0.3 million to their estimated realizable value. 7. NOTES PAYABLE: Notes payable consists of the following:
(IN THOUSANDS) DECEMBER 31, ------------ 1997 1996 ---- ---- Current Portion of Notes Payable: Capitalized lease obligations, payable in varying installments to 2000 $ 570 $ 288 Revolving line of credit of NTC, interest at bank reference rate (approximately 10% at December 31, 1997) 8,440 -- Notes payable to former owners of GenSource Corporation, interest at 8% at December 31, 1997 373 -- Notes payable to founding shareholders of RCI, interest at 7%, due in July 1996, $1,091 of which was exchanged for RCI shares in January 1997, balance repaid -- 1,205 Notes payable to certain shareholders, officers and directors of RCI, interest at 10%, $543 repaid in January 1997 from the proceeds of private placement (see Note 17) balances exchanged for equity shares of RCI -- 1,587 Revolving line of credit of RCI, interest at bank reference rate (approximately 10% at December 31, 1996), repaid in January 1997 from the proceeds of private placement -- 500 Convertible notes payable to certain shareholders and officers of RCI, interest at 8%, exchanged for equity shares of RCI
41 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 in January of 1997 -- 322 Miscellaneous 16 ------------- ------------ Total current portion of notes payable 9,383 3,918 ------------- ------------ Long Term Portion of Notes Payable: Notes payable to former owners of GenSource Corporation, interest at 8% 1,537 -- Capitalized lease obligations, payable in varying installments to 2000 1,318 1,002 Miscellaneous -- 38 ------------- ------------ Total long term portion of notes payable 2,855 1,040 ------------- ------------ Total notes payable $12,238 $4,958 ------------- ------------ ------------- ------------
Interest paid for 1997 amounted to $373,000, and in 1996 and 1995 was approximately $200,000 in each year. Interest resulted primarily from interest paid on Notes used to acquire RCI and from interest paid by RCI on its bank revolving line of credit. The following is a table that summarizes the scheduled payments of principal and interest to the former owners of GenSource Corporation. At the discretion of the Company, the notes may be paid off sooner than scheduled, which would result in a payment of lesser interest:
YEAR PAYMENT AMOUNT ($000S) ---- ---------------------- 1998 $ 403 1999 570 2000 570 2001 535 2002 172 -------- $2,250 -------- --------
The revolving line of credit of NTC is subject to certain restrictive covenants as to tangible net worth and profitability, which were not satisfied at December 31, 1997. The lender expects to be repaid from the proceeds of the sale of NTC [see "Note 13. Subsequent Events" and "Item 1. Business - Sale of National Telephone & Communications, Inc. (NTC)"]. 42 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 8. INCOME TAXES: Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the deferred income tax assets and liabilities are as follows:
(IN THOUSANDS) DECEMBER 31, -------------- 1997 1996 ---- ---- Deferred tax assets Allowance for doubtful accounts $ 2,505 $ 3,205 Nondeductible provisions/accruals 4,084 67 Net operating loss carryforwards 8,799 11,526 Other 126 -- --------- --------- Subtotal 15,514 14,798 --------- --------- Deferred tax liabilities Property and equipment, principally due to differences in depreciation 2,345 1,847 --------- --------- Subtotal 2,345 1,847 --------- --------- Total 13,169 12,951 Less valuation allowance (13,169) (12,951) --------- --------- Net deferred tax liability $ -- $ -- --------- --------- --------- ---------
The following is a reconciliation of the federal statutory tax rate and the effective tax rate:
1997 1996 ---- ---- Federal statutory tax rate (34.0)% (34.0)% Goodwill 0.1 0.6 Loss producing no current tax benefit 33.9 17.0 State taxes, net of federal benefits -- Benefit from net operating loss carryforward -- Other, net 1.2 --------- --------- Effective tax rate 0.0% (15.2)% --------- --------- --------- ---------
Income tax benefits are recognized only when their realization is assured. Accordingly, potential future income tax benefits resulting from net operating losses incurred to date are not reflected in the consolidated financial statements. At December 31, 1997, Incomnet had available net operating loss carryforwards for federal income tax purposes of approximately $22 million, expiring in various years between 2000 and 2012. 43 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 9. SHAREHOLDERS' EQUITY: STOCK OPTIONS - In July 1996, the Company's shareholders adopted a stock option plan that replaced a previous plan adopted by shareholders in 1994. The plan is for executives at the Company's parent company level. The plan allows for the issuance of up to 1,500,000 shares at an exercise price equal to the price of the last sale of the Company's common stock on the date of issuance. To date, the Company has issued 685,000 stock options that are now vested and can be exercised at prices from $4.25 to $4.87 up to May 31, 2002. The Company has also issued 300,000 stock options at prices from $4.37 to $4.85 that will vest when the Company's RCI subsidiary reaches certain financial goals. These options have not yet vested. The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans. The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: divided yield of 0.0%; expected annual volatility of 66.1%; risk-free interest rate of 6.0% and expected lives of 3 years for options. The weighted average per share fair value of options granted in 1996 was approximately $2.50. Proforma information regarding net income and earnings per share under the fair value method has not been presented as the amounts are immaterial. WARRANTS - Since 1995, the Company has issued warrants to purchase the Company's common stock to key employees, directors or other individuals or organizations as follows:
Dollar Canceled or Issued Number Price Exercised Amount Expired Expiration ------ ------ ----- --------- ------ ----------- ----------- 1/10/95 500,000 10.25 500,000 1/10/95 500,000 11.25 500,000 6/30/95 900,000 14.00 900,000 8/29/95 250,000 11.00 250,000 8/29/95 35,000 4.875 (1) 35,000 8/29/95 35,000 4.875 (1) 35,000 8/29/95 25,000 4.875 (1) 25,000 12/20/95 2,000 5.125 (1) 2,000 12/20/95 3,000 5.125 (1) 3,000 12/20/95 1,000 5.125 (1) 1,000 12/20/95 1,000 5.125 (1) 1,000 5/9/96 100,000 6.00 (2) 5/9/01 5/9/96 50,000 7.00 (2) 5/9/01 5/9/96 75,000 5.37 (2) 12/31/98 12/9/96 360,000 3.75 (2) 12/9/99 12/17/96 12,500 2.94 (2) 12/17/01 7/29/97 50,000 3.50 (3) 7/29/99 11/3/97 55,000 2.00 (3) 11/3/99 --------- --------- ---------- ---------- 2,954,500 -- -- 2,252,000
(1) The exercise price on these warrants was adjusted pursuant to a redemption of old stock options and a reissuance of an equivalent number of new stock options with the same expiration date. (2) These warrants were issued pursuant to legal settlements in 1996. (3) These warrants were issued as part of two Series B Convertible Preferred Stock offerings issued by the Company on July 29, 1997 and November 3, 1997, respectively. Since 1995, the Company has issued warrants to purchase 2,954,500 shares of the Company's common stock. As of December 31, 1997, warrants to purchase 2,252,000 of those shares have been cancelled or have expired, while warrants to purchase 702,500 shares remain outstanding. WARRANT - OPTION TABLE - The number and weighted average exercise prices of options and warrants from each of the 44 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 three years ended December 31, 1997, 1996 and 1995, respectively, are as follows:
1995 1996 1997 ------ ------ ------ AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE NUMBER PRICE NUMBER PRICE NUMBER PRICE ------ -------- ------ -------- ------ --------- OUTSTANDING AT BEGINNING OF THE YEAR 2,609,582 $8.94 3,872,000 $10.72 5,029,500 9.30 OUTSTANDING AT END OF THE YEAR 3,872,000 10.72 5,029,500 9.30 1,687,500 4.39 EXERCISABLE AT END OF THE YEAR 3,872,000 10.72 4,729,500 10.26 1,387,000 4.31 GRANTED DURING THE YEAR 2,252,000 11.81 1,402,500 4.64 123,000 2.48 EXERCISED DURING THE YEAR 989,582 8.49 0 -- 0 -- FORFEITED/EXPIRED DURING THE YEAR 0 -- 245,000 5.00 3,219,000 11.05
The range of exercise price of outstanding options and warrants at December 31, 1997 is $2.00 to $4.87, and the average contractual life is approximately three years. SHORT SWING PROFITS - In January 1996, the Company was served with a derivative shareholders lawsuit entitled RICHARD MORALES VS. INCOMNET, INC. AND SAM D. SCHWARTZ, 96 Civil 0225 in the United States District Court for the Southern District of New York, alleging violations of Section 16(b) of the Securities Exchange Act of 1934, as amended, and demanding that the Company assert claims against Mr. Schwartz for the payment of short-swing profits plus interest. Mr. Schwartz has retained separate counsel for this action. In early July 1996, Mr. Schwartz deposited 800,000 shares of his Incomnet, Inc. Common Stock into a court-approved escrow account with the Company's New York counsel as security for his obligation to pay short swing profits. On February 21, 1997, the plaintiffs and Sam Schwartz entered into a stipulated settlement pursuant to which Mr. Schwartz agreed to pay $4,250,000 to the Company as full payment of his short swing profit obligation to the Company. On July 10, 1997, the United States District Court for the Southern District of New York gave final approval to the settlement of the lawsuit. In the final settlement, Mr. Schwartz delivered to the Company 1,047,966 shares of the Company's common stock and $600,000 in cash. Under the agreement, the Company paid $626,450 in attorney's fees and expenses to the shareholder's counsel. 10. COMMITMENTS, CONTINGENCIES AND OTHER: LITIGATION - The Company is a defendant in a class action matter and related lawsuits alleging securities violations with respect to alleged false denial and non-disclosure of a Securities and Exchange Commission investigation and alleged non-disclosure of purchases and sales of the Company's stock by an affiliate of the former Chairman of the Board. Counsel for the Company is unable to estimate the ultimate outcome of these matters and is unable to predict a range of potential loss. Accordingly, no amounts have been provided for the class action lawsuit in the accompanying financial statements. The Company is under investigation by the Securities and Exchange Commission under a non-public "formal order of private investigation." Management has furnished all information requested by the Commission and does not believe that the matter will have a material adverse impact on its financial position or results of operations. The Company and its wholly-owned subsidiary, NTC, are defendants in a complaint for arbitration by Paul Yao, Dennis Wong and their affiliates, who are prior independent sales representatives of NTC. In the complaint, the plaintiffs are alleging breach of contract, discrimination and other causes of action against NTC. NTC has filed an answer to the complaint and has attempted to engage in settlement discussions with the plaintiffs' counsel. The case is 45 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 currently in the discovery phase and no settlement agreement has been made to date. As part of the sale of NTC [see "Item 1. Business - Agreement to Sell National Telephone & Communications, Inc. (NTC)"], it is anticipated that this action will be resolved. One of the terms of the sale is that the participants in the complaint will sign releases expressing that the matter has been resolved to their satisfaction. Counsel for the company is unable to estimate the ultimate outcome of these matters and is unable to predict a range of potential loss. Accordingly, no amounts have been provided for the complaint in the accompanying financial statements. ALLOWANCE FOR DOUBTFUL ACCOUNTS - The total Company allowance for doubtful accounts totaled $2.8 million or 16.6% of gross accounts receivable at December 31, 1997 and $2.0 million or 13.2.% of gross accounts receivable at December 31, 1996. The following table summarizes the Company's year-to-year reserve balances by subsidiary and segment:
$ IN THOUSANDS DECEMBER 31, ------------ SUBSIDIARY SEGMENT 1997 1996 - ---------- ------- ---- ---- NTC Telephone & marketing 2,741 1,908 GenSource Software 23 -- AutoNETWORK Network -- -- ------- ------- Total Company 2,764 $1,908 ------- ------- ------- ------- % of Gross Accounts Receivables 16.6% 13.2% ------- ------- ------- -------
Reserves for NTC's telecommunications service accounts receivable relate primarily to its direct billed and LEC billed long distance telephone services. Delinquent direct billed receivables are collected by a combination of NTC's internal collection department and by external collection agencies. Delinquent LEC billed receivables are collected by the LEC's. The estimated percentage of accounts which will become uncollectible is reviewed periodically by management and is adjusted in accordance with historical experience. Reserves for NTC's marketing program accounts receivable are provided at 100% of the expected bad debt. These receivables result from payments for marketing programs which have been denied due to returned checks and rejected credit card payments. Reserves for GenSource are provided at 100% of the expected bad debt. These receivables result from the sale of GenSource's computer software programs and related installation, maintenance and customized programming services. BUILDING LEASES - Rent expense for the years ended December 31, 1997, 1996 and 1995 was $2.1 million, $0.8 million and $0.8 million, respectively. The Company leases its office and operating facilities, equipment and automobiles under noncancellable operating leases. The aggregate future minimum annual rental payments required under these leases are as follows (in thousands):
For years ending December 31, ----------------- 1998 $ 2,176 1999 1,656 2000 1,471 2001 1,394 2002 478 Thereafter 2,125 ----------- $ 9,300 ----------- -----------
46 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 WORLDCOM CONTRACT - In September 1995, NTC entered into a new carrier contract with WorldCom, Inc. of Tulsa, Oklahoma, formerly Wiltel, Inc., covering a potential volume purchase of $600 million of long distance telephone time over a five year period commencing in November 1995. Effective February 1996, NTC entered into a revised multiple-year $1.0 billion contract with WorldCom, Inc., which has a fixed term expiring January 2002. On May 12, 1997, NTC entered into an amendment to the contract under which the minimum purchase requirement was increased to $1.1 billion and the contract was extended through February 2003. As in the prior carrier contract with WorldCom, Inc., NTC has committed to purchase the designated volume of telephone time in accordance with a schedule over the term of the contract. NTC currently relies in part on the purchases of another unaffiliated long distance telephone service provider to meet its volume purchase requirements under the new contract. As of April 10, 1998, NTC was in default on its contract with WorldCom for approximately $2 million for services and also has a $4.3 million shortfall through February 28, 1998 on the take or pay provisions of the contract. NTC is in discussion with WorldCom, which has expressed a willingness to extend NTC relief from deficiency charges to the extent of NTC's overperformance. Pursuant to terms of the agreement to sell NTC, NTC and WorldCom have entered into an agreement under which WorldCom has deferred action on the default of the contract and has agreed to extend credit to NTC of up to $3 million that can be temporarily deducted from payments owing to WorldCom under terms of the carrier contract [see "Item 1. Business. Sale of National Telephone & Communications, Inc."]. As of April 10, 1998, NTC has deferred $2 million of payments to WorldCom under the contract and anticipates that it will use the remaining $1 million deferral. 11. NETWORK MARKETING COSTS: NTC's net cost to operate its network marketing program consist of the following: (IN $ MILLIONS)
1997 1996 ------ ------ Sales 15.0 $17.4 Cost of sales 12.4 13.7 Operating expenses for support services 4.8 4.3 ------ ------ Total marketing-related costs 17.2 18.0 ------ ------ Net marketing cost 2.2 $0.6 ------ ------ ------ ------ % of total NTC (long distance & marketing) sales 1.8% 0.6%
Marketing sales are generated by the sale of materials, training and support services to assist NTC independent sales representatives in selling new retail customers and enrolling other representatives in the NTC program. Beginning in January 1996, NTC began to accrue its obligation to provide customer support to its representatives. These reserved marketing revenues are reflected as deferred income on the Company's balance sheet and are amortized over the succeeding twelve months. The marketing-related costs include commissions paid to independent sales representatives for acquiring new retail telephone customers, as well as the cost of sales materials, salaries and wages of marketing department personnel, services required to support the independent sales representatives, and other directly identifiable support costs, but do not include residual commissions paid on continuing long distance telephone usage or the typical indirect cost allocations, such as floor-space and supporting departments. Marketing-related costs for 1997 and 1996, of $17.2 million and $18.0 million, respectively, are compared against marketing-related revenues for 1997 and 1996 of $15.0 million and $17.4 million, respectively. The results are a net loss in marketing-related activities for 1997and 1996 of $2.2 million and $0.6 million, or 1.8% and 0.6%, respectively, of total NTC sales. 12. COMPENSATION OF INDEPENDENT SALES REPRESENTATIVES: The Company's subsidiary, NTC, compensates its independent sales representatives by an earned commission structure based upon signing up new telephone customers and based upon the telephone usage generated by those customers. Expenses associated with commissions, bonuses and overrides paid out to NTC's independent sales representatives for 1997 and 1996 were $18.4 million and $18.0 million, respectively. 13. SUBSEQUENT EVENTS: On March 20, 1998, the Company sold its Auto Dismantler Network (known under the tradename "AutoNETWORK") to AutoSkill, Inc., a newly-formed corporation owned by Jeffrey Rubin of Rosslyn, NY and Robert Cohen of New York City, NY. The operations were sold for $1.3 million in cash as follows: $800,000 in cash was paid on the close of the transaction and a note for $500,00 was issued that is due on May 20, 1998. The note bears interest at 8%. As part of the transaction, the Company repaid $42,500 of a note for $185,000 that is payable to Mr. Rubin and Mr. Cohen. The Company has agreed to repay the remaining balance of $142,500 on or before May 20, 1998, although the Company 47 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 also has an option to delay payment of $100,000 of the note until July 31, 1998 provided that the Company secures the balance of the note with 300,000 shares of stock that the Company owns in its Rapid Cast, Inc. subsidiary. On March 31, 1998, National Telephone & Communications, Inc. ("NTC"), a wholly owned subsidiary of Incomnet, Inc. (the "Company"), entered into a definitive Asset Purchase Agreement, dated March 31, 1998 (the "Agreement"), with NTC Acquisition, Inc., a newly formed unaffiliated buyer (the "Buyer"), pursuant to which NTC has agreed to sell substantially all of its assets to the Buyer, and the Buyer has agreed to assume certain liabilities, subject to the terms and conditions of the Agreement. In order for the sale of the assets to close, certain conditions must be satisfied [see Item 1. Business - Agreement to Sell National Telephone & Communications, Inc. (NTC)"]. 14. CHANGE IN ACCOUNTING: Effective January 1, 1996, the Company changed its accounting procedures to defer a portion of marketing revenues, which had previously been recognized upon receipt. The Company believes that the change is preferable because it provides a better matching of revenues with services provided to the marketing representatives. The cumulative effect of this change and certain other changes for the periods prior to January 1, 1996 of approximately $0.9 million is shown as a cumulative effect adjustment. The effect of the changes on 1996 is to increase income before cumulative effect adjustment by $0.03 per share. 15. SEGMENT INFORMATION: In 1997, the Company conducted its business operations in three industry segments, including Telephone Services, Computer Software and Network Services. In 1995 and 1996, the Company conducted business in three segments, including Network Services, Telephone Services and Optical Systems. No one customer accounted for as much as 10% of the revenues of any segment in 1997, 1996 or 1995. 48 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997
(IN THOUSANDS) TELEPHONE COMPUTER NETWORK GENERAL YEAR ENDED DECEMBER 31, 1997 SERVICES SOFTWARE SERVICES CORPORATE CONSOLIDATED - ---------------------------- --------- --------- -------- --------- ------------ Sales $ 121,832 $ 1,865 $1,440 $ 7 $ 125,144 --------- -------- -------- --------- ----------- Operating income (Loss) (2,418) 48 400 (11,430) (13,400) Income taxes (201) -- -- -- (201) --------- -------- -------- --------- ----------- Income (loss) $(2,618) $ 48 $400 $ (11,430) $ (13,601) --------- -------- -------- --------- ----------- --------- -------- -------- --------- ----------- Identifiable assets $ 34,469 $ 1,807 $1,580 $2,658 $40,514 Depreciation and amortization 2,812 44 255 $ -- 3,111 Capital expenditures 5,051 716 107 12 5,886
TELEPHONE OPTICAL NETWORK GENERAL YEAR ENDED DECEMBER 31, 1996 SERVICES SYSTEMS SERVICES CORPORATE CONSOLIDATED - ---------------------------- --------- --------- -------- --------- ------------ Sales $ 100,811 $ 4,660 $1,426 $ 8 $ 106,905 --------- -------- -------- --------- ----------- Operating income (loss) 3,735 (26,495) 475 (29,232) (51,517) Income taxes 374 (8,449) 263 -- (7,812) --------- -------- -------- --------- ----------- Income (loss) before minority interest and extraordinary items $3,361 $ (18,046) $212 $ (29,232) $ (43,705) --------- -------- -------- --------- ----------- --------- -------- -------- --------- ----------- Identifiable assets $ 32,987 $ 5,951 $1,562 $87 $40,587 Depreciation and amortization 1,630 118 265 $ 2,334 4,347 Capital expenditures 6,412 669 143 -- 7,224
TELEPHONE OPTICAL NETWORK GENERAL YEAR ENDED DECEMBER 31, 1995 SERVICES SYSTEMS SERVICES CORPORATE CONSOLIDATED - ---------------------------- --------- --------- -------- --------- ------------ Sales $ 83,127 $ 1,993 $1,370 $75 $86,565 --------- -------- -------- --------- ----------- Operating income (loss) 5,060 (1,040) 369 (3,324) 1.065 Income taxes 365 -- (102) $(152) 111 --------- -------- -------- --------- ----------- Income (loss) before minority interest and extraordinary items $4,695 $(1,040) $471 $(3,172) $ 954 --------- -------- -------- --------- ----------- --------- -------- -------- --------- ----------- Identifiable assets $ 21,758 $ 25,345 $1,569 $ 25,434 $74,106 Depreciation and amortization 593 317 167 $ 987 2,064 Capital expenditures 6,681 199 509 -- 7,389
49 SCHEDULE II INCOMNET, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 1996 AND 1995 (IN THOUSANDS)
Balance at Amounts Balance beginning charged to costs at end Classification of period an expenses Write-offs(1) of period - ------------------ ------------- ----------------- ------------- ---------- Year ended December 31, 1997 Deducted from asset accounts: Accounts receivable reserve $1,993 $5,242 $(4,471) $2,764 Patent reserves 44 (44) Notes receivable reserve 209 169 378 Inventory reserves 170 194 364 Reserve for marketable securities 225 (35) 190 ------ ------ -------- ------ Total $2,641 $5,605 $(4,550) $3,696 ------ ------ -------- ------ ------ ------ -------- ------ Year ended December 31, 1996 Deducted from asset accounts: Accounts receivable reserve $1,063 $9,517 $(8,587) $1,993 Patent reserves 2,019 7,916 (9,891) 44 Notes receivable reserve 209 1,472 (1,472) 209 Inventory reserves 100 70 170 Reserve for marketable securities 34 225 (34) 225 ------ ------ -------- ------ Total $3,425 $19,200 $(19,984) $2,641 ------ ------ -------- ------ ------ ------ -------- ------ Year ended December 31, 1995 Deducted from asset accounts: Accounts receivable reserve $991 $7,590 $(7,518) $1,063 Patent reserves 0 2,019 -- 2,019 Notes receivable reserve 0 209 -- 209 Inventory reserves 0 100 -- 100 Reserve for marketable securities 2,000 -- (1,966) 34 ------ ------ -------- ------ Total $2,991 $ 9,918 $(9,484) $3,425 ------ ------ -------- ------ ------ ------ -------- ------
(1) Amounts are net of recoveries. 50 EX-10.24 2 EXHIBIT 10.24 EXHIBIT 10.24 AGREEMENT TO PURCHASE AUTONETWORK ASSETS BETWEEN INCOMNET, INC. AND AUTOSKILL, INC. AGREEMENT dated as of March 20, 1998 between Incomnet, Inc., a California corporation, having an address at 21031 Ventura Boulevard, Woodland Hills, California, 91364 ("SELLER"), and Autoskill, Inc., a California corporation, having an address at 1500 Hempstead Turnpike, East Meadow, New York 11554 ("BUYER"). W I T N E S S E T H : WHEREAS, Seller is engaged in various businesses, including the business of providing interactive computer networking products and services, and computerized data communications networks provided under the name AutoNETWORK; WHEREAS, Buyer desires to purchase from Seller substantially all of the assets of the AutoNETWORK division of Seller and the business related thereto (the "BUSINESS"), including all equipment, software and know-how relative to the AutoSearch Interchange System and the AutoSearch Inventory System, and Seller desires to sell substantially all of the assets of the Business to Buyer, upon the terms and subject to the conditions hereinafter set forth; NOW, THEREFORE, in consideration of the foregoing and the representations, warranties, covenants and agreements herein contained, the parties hereto agree as follows: ARTICLE I DEFINITIONS Section 1.01. DEFINITIONS. The following terms, as used herein, have the following meanings: "AFFILIATE" means, with respect to any Person, any Person directly or indirectly controlling, controlled by, or under common control with such other Person. "BENEFIT ARRANGEMENT" means an employment, severance or similar contract, arrangement or policy and each plan or arrangement providing for severance benefits, insurance coverage (including any self-insured arrangements), workers' compensation, disability benefits, supplemental unemployment benefits, vacation benefits, pension or retirement benefits or for deferred compensation, profit-sharing, bonuses, stock options, stock appreciation rights or other forms of incentive compensation or post-retirement insurance, compensation or benefits that (i) is not an Employee Plan and (ii) is maintained or contributed to by Seller or any of its ERISA Affiliates. "CLOSING DATE" means the date of the Closing. "EMPLOYEE PLANS" means each "employee benefit plan", as such term is defined in Section 3(3) of ERISA, that (i) is subject to any provision of ERISA and (ii) is maintained or contributed to by Seller or any of its ERISA Affiliates. "ERISA" means the Employment Retirement Income Security Act of 1974, as amended. "ERISA AFFILIATE" of any entity means any other entity that, together with such entity, would be treated as a single employer under Section 414 of the Code. "LIEN" means, with respect to any asset, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such asset. "MATERIAL ADVERSE CHANGE" means a material adverse change in the business, assets, condition (financial or otherwise), results of operations or prospects of the Business taken as a whole. "MATERIAL ADVERSE EFFECT" means a material adverse effect on the business, assets, condition (financial or otherwise), results of operations or prospects of the Business taken as a whole. "PERSON" means an individual, corporation, partnership, association, trust or other entity or organization, including a government or political subdivision or an agency or instrumentality thereof. "PROPRIETARY RIGHTS" means all (A) patents, patent applications, patent disclosures and all related continuation, continuation-in-part, divisional, reissue, re-examination, utility, model, certificate of invention and design patents, patent applications, registrations and applications for registrations, (B) trademarks, service marks, trade dress, logos, tradenames, service names and corporate names and registrations and applications for registration thereof, (C) copyrights and registrations and applications for registration thereof, (D) mask works and registrations and applications for registration thereof, (E) computer software, data and documentation, (F) trade secrets and confidential business information, whether patentable or nonpatentable and whether or not reduced to practice, know-how, manufacturing and product processes and techniques, research and development information, copyrightable works, financial, marketing and business data, pricing and cost information, business and marketing plans and customer and supplier lists and information, (G) other proprietary rights relating to any of the foregoing (including without limitation associated goodwill and remedies against infringements thereof and rights of protection of an interest therein under the laws of all jurisdictions) and (H) copies and tangible embodiments thereof. ARTICLE II PURCHASE AND SALE 2.01. PURCHASE AND SALE Upon the terms and subject to the conditions of this Agreement, Buyer agrees to purchase from Seller and Seller agrees to sell, transfer, assign and deliver, or cause to be sold, transferred, assigned and delivered, to Buyer at the Closing, free and clear of all Liens, all of the assets, properties and business of every kind and description, wherever located, 2 and which is owned, held or used by Seller in connection with the Business, including all assets shown on the Asset Schedule annexed hereto as SCHEDULE 2.01, all as of the close of business on the date immediately preceding the date hereof (the "PURCHASED ASSETS"), and including, without limitation, all right, title and interest of Seller in, to and under the following: (i) all computer hardware and software relative to Seller's interactive communications networking business, including the Seller's central message switching computer and front-end network processor, and all related products and services of the Business; (ii) all personal property and interests therein, including machinery, equipment, furniture, office equipment, communications equipment and other tangible property; (iii) all subscriber lists and customer lists, together with rights under all subscriptions, contracts, agreements, leases, licenses, commitments and other instruments (collectively, the "CONTRACTS"); (iv) all telephone systems and telephone numbers used in connection with the Business; (v) all of Seller's rights, claims, credits, causes of action or rights of set-off against third parties relating to the Purchased Assets, including all accounts receivable from users of the AutoNETWORK system, except outstanding judgments in favor of the Seller, or accounts receivable accrued for periods prior to the Closing; (vi) the names "AutoNetwork", "AutoSearch" and all other Proprietary Rights owned or licensed or used by Seller, including the AutoSearch Interchange System, and AutoSearch Inventory System; (vii) all transferable licenses, permits or other governmental authorizations; (viii) all books, records, files and papers, whether in hard copy or computer format, including, without limitation, sales and promotional literature, manuals and data, sales and purchase correspondence, lists of present and former suppliers, lists of present and former customers, personnel and employment records, and any information relating to Tax imposed on the Purchased Assets; and (ix) all bank accounts containing subscriber or user deposits; (x) all goodwill associated with the Business or the Purchased Assets. 2.02. EXCLUDED ASSETS Buyer expressly understands and agrees that the following assets and properties of Seller (the "EXCLUDED ASSETS") shall be excluded from the Purchased Assets: all of Seller's cash and cash equivalents on hand and in banks, any assets related to any other business of Seller, and any assets not described in Section 2.01. 2.03. LICENSE FOR NAME INCOMNET It is agreed that, from and after the Closing, Buyer shall, subject to the terms herein, have the non-exclusive right to do business under the name 3 Incomnet. In addition to the Purchased Assets, at Closing, Seller is granting to Buyer a continuing non-exclusive license to use the name Incomnet; provided Seller shall not use, license, or permit any person to use or license, the name Incomnet in connection with any business similar to the Business. Said license shall require that Buyer pay to Seller, an annual license fee of $100 per year. Seller agrees that it will not sell or transfer the name Incomnet to any third-party. Buyer shall have the absolute right to sell, assign, or transfer said license in connection with any subsequent transfer of the Business or the Purchased Assets. If, at any time, Seller elects to cease use of the name Incomnet, Seller shall so notify Buyer, and upon request of Buyer, Seller shall, without additional charge, assign and transfer all trademarks and proprietary rights to said name to Buyer. 2.04. LIABILITIES Except as otherwise specifically set forth in this Agreement, Buyer is not assuming any liability or obligation of Seller (or any predecessor owner of all or part of its business and assets), of whatever nature, whether presently in existence, or arising or asserted hereafter, including, but not limited to, obligations to customers, vendors, governmental authorities, employees, or any obligation related to any other business of Seller. All such liabilities and obligations shall be retained by, and remain obligations and liabilities of, Seller. 2.05. PURCHASE PRICE The purchase price for the Purchased Assets is $1,300,000.00, subject to the adjustments described herein, which amount is to be paid as follows: (a) $757,500 by Buyer's delivering to Seller, at Closing, of a certified or bank cashier's check, or by Buyer's wire transfer of immediately available federal funds, to a bank account to be designated by Seller; (b) $42,500 by Buyer's delivering said sum, collectively to Jeffrey Rubin, Alan Cohen and Robert Cohen (the "DEBENTURE HOLDERS") and on behalf of Seller, for amounts due to said Debenture Holders, pursuant to a Convertible Debenture and Warrant Subscription and Security Agreement, dated as of the 5th day of January, 1998 (the "CONVERTIBLE DEBENTURE"); (c) by Buyer's delivering to Seller, at Closing, a secured promissory note (the "NOTE"), in the principal amount of $457,500, which Note shall be payable, together with interest at nine (9%) percent per annum, on the sixtieth (60th) day following the Closing; the Note shall be in the form annexed hereto as Exhibit "A", and simultaneously with delivery of the Note, Buyer shall execute UCC-1 Financing State-ments to permit Seller to perfect its security interest in the Purchased Assets; and (d) $42,500, by Buyer's delivering said sum on or before the sixtieth (60th) day following the Closing, and on behalf of the Seller to the Debenture Holders, on account of the Convertible Debenture. The Purchase Price shall be adjusted in accordance with the provisions of Paragraph 2.06 below. 2.06 CLOSING ADJUSTMENTS (a) The parties shall estimate and settle at the Closing, to the extent practicable, the amount of all routine closing adjustments arising from operating expenses that relate to periods before and after the Closing, such as lease payments, utilities and rent, with Seller being responsible for amounts relating to the period prior to the Closing Date and Buyer being responsible for amounts relating to periods on and after the Closing Date. Bills for such items received prior to the Closing shall be paid by Seller; and bills for such items received after the Closing will be paid by Buyer, but Seller shall promptly reimburse Buyer for its allocable share of such items. The parties shall continue to effect such settlements after the Closing on a periodic basis. 4 (b) In addition to the adjustments specified in Subparagraph (a) above, for each AutoNetwork User's Contract in effect, as described in Section 3.12, at Closing, the parties shall provide any payments received during the month that the Closing occurs, so that Seller will be entitled to a pro-rata portion of the payments attributable to the period prior to the Closing, and Buyer shall be entitled to a pro-rata portion of the payments attributable to the period from and after the Closing. The parties shall continue to effect such settlements after the Closing. (c) Buyer shall have a right to deduct from the amounts payable, pursuant to Section 2.05, any amounts due from Seller under this Section 2.06. (d) Buyer shall have the right to deduct from the Note any interest due to the Debenture Holders, whether arising prior or subsequent to the Closing. 2.07. CLOSING (a) The closing (the "CLOSING") of the purchase and sale of the Purchased Assets shall be held on March 20, 1998, at the offices of Mark J. Richardson, Esq., 1299 Ocean Avenue, Suite 900, Santa Monica, California 90401; (b) Seller shall deliver such bills of sale, endorsements, consents, assignments and other good and sufficient instruments of conveyance and assignment (the "CONVEYANCE DOCUMENTS") as the parties and their respective counsel shall deem reasonably necessary or appropriate to vest in Buyer all right, title and interest in, to and under the Purchased Assets; and (c) Seller and Buyer shall also execute and deliver all such instruments, documents and certificates as may be reasonably requested by the other party that are necessary, appropriate or desirable for the consummation at the Closing of the transactions contemplated by this Agreement. 2.08. ALLOCATION OF PURCHASE PRICE The Seller agrees to accept and utilize the allocation of the Purchase Price, as set forth by the Buyer, within sixty (60) days of the Closing, for all purposes, including reporting the allocation for purposes of Section 1060 of the Internal Revenue Code. ARTICLE III REPRESENTATIONS AND WARRANTIES OF SELLER Seller hereby represents and warrants to Buyer that: 3.01. CORPORATE EXISTENCE AND POWER Seller is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation, and has all corporate powers and all governmental licenses, authorizations, consents and approvals required to carry on its business as now conducted except to the extent same would not have a Material Adverse Effect. Seller is duly qualified to do business as a foreign corporation and is in good 5 standing in each jurisdiction where the character of the property owned or leased by it or the nature of its activities make such qualification necessary, except for those jurisdictions where failure to be so qualified would not, individually or in the aggregate, have a Material Adverse Effect. Seller has heretofore delivered to Buyer true and complete copies of the corporate charter and bylaws of Seller as currently in effect. 3.02. CORPORATE AUTHORIZATION The execution, delivery and performance by Seller of this Agreement, and the consummation by Seller of the transactions contemplated hereby are within Seller's corporate powers and have been duly authorized by all necessary corporate action on the part of Seller. This Agreement constitutes the valid and binding agreement of Seller. 3.03. GOVERNMENTAL OR THIRD-PARTY AUTHORIZATION The execution, delivery and performance by Seller of this Agreement do not require any action by or in respect of, or filing with, any governmental body, agency, official or authority, nor does it require consent or authorization from any third-party, except as may otherwise be listed on SCHEDULE 3.03 annexed hereto. 3.04. NON-CONTRAVENTION The execution, delivery and performance by Seller of this Agreement do not and will not (i) contravene or conflict with the corporate charter or bylaws of Seller, (ii) contravene or conflict with or constitute a violation of any provision of any law, regulation, judgment, injunction, order or decree binding upon or applicable to Seller; (iii) to the best of Seller's knowledge, after due investigation, constitute a default under or give rise to any right of termination, cancellation or acceleration, under any provision of any agreement, contract or other instrument binding upon Seller, or by which any of the Purchased Assets is or may be bound, or (iv) result in the creation or imposition of any Lien on any Purchased Asset, except pursuant to this Agreement. 3.05. REQUIRED CONSENTS SCHEDULE 3.05 sets forth each agreement, contract or other instrument binding upon Seller, which is being acquired or assumed by Buyer, which requires a consent, authorization or notice, as a result of the execution, delivery and performance of this Agreement or the consummation of the transactions contemplated hereby (each such consent, authorization or notice is hereinafter referred to as a "REQUIRED CONSENT"). All Required Consents have been obtained, except for the consent of Woodland-Clarendon Associates and BioMedical Applications Management Company, Inc. (the "MASTER LANDLORD" and "SUBLANDLORD", respectively), for the Sublease of the Premises described in Section 6.02(a), and the assignment of the Roof License described on Schedule 3.05. 3.06. SOLVENCY Seller is not subject to any pending or threatened bankruptcy or insolvency or similar proceeding, nor has Seller made, or is threatening to make, any assignment for the benefit of creditors, bulk sale of assets nor is it (or any of its property) subject to any receiver, assignee, custodian, liquidator, conservator, committee, trustee or similar officer. Seller is neither insolvent, nor will the consummation of the transactions contemplated hereunder render it insolvent, subject to the potential impact of any contingencies described in Seller's Form 10K Reports for the year ended December 31, 1996, or on any of Seller's Form 10Q Reports for the periods ending March 31, 1997, June 30, 1997, or September 30, 1997 (the "SEC REPORTS"), copies of which Buyer has received and examined, and such disclosure shall be deemed to have been made to Buyer. 6 3.07. ABSENCE OF CERTAIN CHANGES Annexed hereto are true, complete and correct statements of the balance sheets of the Business, as of December 31, 1995, 1996 and 1997, and the statements of income and cash flow for each of the years ended on said dates. Since December 31, 1997, Seller has conducted the Business in the ordinary course consistent with past practices, and, with respect to the Business, there has not been: (a) Any Material Adverse Change or any event, occurrence, development or state of circumstances or facts which could reasonably be expected to result in a Material Adverse Change; (b) any damage, destruction or other casualty loss (whether or not covered by insurance) affecting the Business or any Purchased Asset which, individually or in the aggregate, has had or could reasonably be expected to have a Material Adverse Effect; (c) any material transaction, contract, agreement or other instrument entered into, or commitment made, by Seller (including the acquisition or disposition of any assets) or any relinquishment by Seller of any contract or other right; (d) any material change in the number of network subscriber contracts in full force and effect; or (e) any material increase in the expenses detailed on said statements. 3.08. PROPERTIES (a) Seller is the lessee of the premises at 21031 Ventura Boulevard, Woodland Hills, California (the "PREMISES"), pursuant to the terms of the lease, a true and complete copy of which is annexed as SCHEDULE 3.08(a) (the "LEASE"). There are no amendments or modifications to the Lease. To the best of Seller's knowledge, after due investigation, the Lease is in good standing and is valid, binding and enforceable in accordance with its terms, and there does not exist under the Lease any default or any event that, with notice or lapse of time or both, would constitute a default thereunder. Other than the Lease, Seller does not own or lease any real property in connection with the Business. Seller shall be obligated, pursuant to Section 3.05, to obtain the consents for the Sublease and Roof License, as described in Section 6.02. (b) SCHEDULE 2.01 describes all of the Purchased Assets being transferred, pursuant to Section 2.01 above, including, but not limited to computer equipment, other machinery and equipment, telephone systems, and software programs, together with the location of all of such Purchased Assets. Seller has good and marketable, indefeasible, fee simple title to all Purchased Assets. No Purchased Asset is subject to any Lien, except for the lien held by the Debenture Holders. (c) Seller has not received any notice of, nor to the best of Seller's knowledge, is there any actual or alleged violation of any law, regulation or ordinance (including, without limitation, laws, regulations or ordinances relating to computer software property or products, proprietary rights, zoning, environmental, or similar matters) relating to the Business or any Purchased Asset. To the 7 best of Seller*s knowledge, there are no developments affecting any of the Purchased Assets pending, or, to the knowledge of Seller threatened, which might materially detract from the value of such Purchased Assets, materially interfere with any present or intended use of any such Purchased Assets or materially adversely affect the marketability of such Purchased Assets. 3.09. LITIGATION Except as set forth on the SEC Reports, there is no action, suit, investigation or proceeding (or any basis therefor) pending against, or to the knowledge of Seller, or threatened against or affecting, Seller, any Purchased Asset or the Business before any court or arbitrator or any governmental body, agency or official that, if determined or resolved adversely in accordance with the plaintiff's demands, would reasonably be expected to adversely effect the Business or the Purchased Assets or that in any manner challenges or seeks to prevent, enjoin, alter or materially delay the transactions contemplated hereby. Except as set forth on the SEC Reports, there has been no material change in any of the existing litigation disclosed in the SEC Reports which could materially adversely effect the Business, the Purchased Assets, or this transaction. 3.10. CONTRACTS (a) Seller is not, in connection with the operation of the Business, a party to or subject to, nor will Purchaser become subject to, any telephone contract, or any other contract or agreement, except as otherwise described on SCHEDULE 3.10 OR 3.11. (b) Each Contract disclosed on SCHEDULE 3.10 OR 3.11 is valid and binding agreement of Seller and is in full force and effect, and, to the best of the knowledge of Seller, after due investigation, neither Seller nor, to the knowledge of Seller, any other party thereto is in default in any respect under the terms of any such contract, nor, to the knowledge of Seller, has any event or circumstance occurred that, with notice or lapse of time or both, would constitute any event of default thereunder. 3.11. NETWORK SUBSCRIBER AGREEMENTS SCHEDULE 3.11 is a true and correct list of all AutoNetwork User's contracts or other network subscriber agreements of Seller, the monthly fees due under each said agreement, and the security deposit paid to Seller under said contract, the full amount of which is held in the bank account(s) transferred pursuant to Section 2.01(ix). All of said agreements are in full force and effect; each agreement is in the form annexed to SCHEDULE 3.11; except as otherwise noted on SCHEDULE 3.11, no user has notified Seller of its election to terminate said agreement or made any other claim thereunder; all amounts due under each said agreement, to the date hereof, have been paid in full; and each agreement can be assigned by Seller to Buyer, without notice to, or consent of, said user, or any other party. 3.12. LICENSES AND PERMITS SCHEDULE 3.12 correctly describes each license, franchise, permit or other similar authorization affecting, or relating in any way to, Seller or the Business, together with the name of the government agency or entity issuing such license or permit (the "PERMITS"). Except as set forth on the SCHEDULE 3.12, such Permits are valid and in full force and effect and are transferable by Seller and will not be terminated or impaired or become terminable as a result of the transactions contemplated hereby. 3.13. INSURANCE COVERAGE Seller has furnished to Buyer a list of, and true and complete 8 copies of, all insurance policies and fidelity bonds covering the Purchased Assets and the Business. To the best of Seller's knowledge, after due investigation, there is no claim by Seller pending under any of such policies or bonds as to which coverage has been questioned, denied or disputed by the underwriters of such policies or bonds. All premiums payable under all such policies and bonds have been paid and Seller is otherwise in full compliance with the terms and conditions of all such policies and bonds. 3.14. PROPRIETARY RIGHTS (a) SCHEDULE 3.14 sets forth a list of all Proprietary Rights owned or licensed by Seller and described in clauses (A) through (D) of the definition of Proprietary Rights in Section 1.01, specifying as to each, as applicable: (i) the nature of such Proprietary Right; and (ii) the owner of such Proprietary Right; including the respective registration or application numbers; and (iii) material licenses, sublicenses and other agreements as to which Seller is a party and pursuant to which any Person is authorized to use any of Seller*s Proprietary Rights, including the identity of all parties thereto, a description of the nature and subject matter thereof, the applicable royalty and the term thereof. (b) (i) Seller has not at any time prior to the date hereof been sued or charged in writing with or been a defendant in any claim, suit, action or proceeding that has not been finally terminated prior to the date hereof and that involves a claim of infringement of any Proprietary Rights; and (ii) Seller has no knowledge of any other claim or infringement by Seller of any other Person, and Seller has no knowledge of any other claim or infringement by any other Person of any Proprietary Rights of Seller. No Proprietary Right of Seller is subject to any outstanding order, judgment, decree, stipulation or agreement restricting the use thereof by Seller or restricting the licensing thereof by Seller to any Person. Seller has not entered into any agreement to indemnify any other Person against any charge of infringement of any Proprietary Right of Seller. (c) None of the software, hardware, research and development results and other know-how of Seller relative to the Business is contingent upon maintenance of the confidentiality thereof, has been disclosed by Seller to any Person other than on a confidential basis. 3.15. EMPLOYEES SCHEDULE 3.15 sets forth a true and complete list of the names of all employees or consultants of Seller employed by or otherwise providing services to Seller in connection with the Business, all Benefit Arrangements and Employee Plans to which such employees may be subject. Seller shall, at or prior to Closing, terminate all of said employees or 9 consultants, and pay all amounts due to them (other than accrued vacation, set forth on Schedule 3.15, for which Buyer shall be responsible), including, but not limited to, amounts for wages, Benefit Plans and Employee Plans. Buyer shall not be obligated to hire any of such employees or consultants, nor shall it become subject to any Benefit and/or Employee Plans or any other agreement relative to such employees or consultants, provided Buyer agrees to provide the employees listed on Schedule 3.15 the outstanding vacation benefits described therein. 3.16. FINDERS' FEES There is no investment banker, broker, finder or other intermediary which has been retained by or is authorized to act on behalf of Seller who might be entitled to any fee or commission from Buyer upon consummation of the transactions contemplated by this Agreement. 3.17. ENVIRONMENTAL COMPLIANCE To the best of Seller*s knowledge: (i) Seller and the Business have complied with all federal, state and local laws (including without limitation case law, rules, regulations, orders, judgments, decrees, permits, licenses and governmental approvals) which are intended to protect the environment and/or human health or safety (collectively, AEnvironmental Laws@); and (ii) neither Seller nor the Business has handled, generated, used, stored, transported or disposed of any substance or waste which is regulated by Environmental Laws, except in compliance with Environmental Laws. 3.18. REPRESENTATIONS The representations and warranties of Seller contained in this Agreement, disregarding all qualifications and exceptions contained therein relating to materiality or Material Adverse Effect, are true and correct with only such exceptions as would not in the aggregate reasonably be expected to have a Material Adverse Effect. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF BUYER Buyer hereby represents and warranties to Seller that: 4.01. ORGANIZATION AND EXISTENCE Buyer is a corporation duly incorporated, validly existing and in good standing under the laws of California. 4.02. CORPORATE AUTHORIZATION The execution, delivery and performance by Buyer of this Agreement and the Note and the consummation by Buyer of the transactions contemplated hereby are within the corporate powers of Buyer and have been duly authorized by all necessary corporate action on the part of Buyer. This Agreement constitutes the valid and binding obligation of Buyer. 4.03. GOVERNMENTAL AUTHORIZATION The execution, delivery and performance by Buyer of this Agreement and the Note require no action by or in respect of, or filing with, any governmental body, agency, official or authority. 4.04. NON-CONTRAVENTION The execution, delivery and performance by Buyer of this Agreement and the Note does not and will not (i) contravene or conflict with the corporate charter 10 or bylaws of Buyer or (ii) contravene or conflict with any provision of any law, regulation, judgment, injunction, order or decree binding upon Buyer, (iii) constitute a default under or give rise to any right of termination, cancellation or acceleration of any right or obligation of Buyer. 4.05. FINDERS' FEES There is no investment banker, broker, finder or other intermediary that has been retained by or is authorized to act on behalf of Buyer who might be entitled to any fee or commission from Seller or any of its Affiliates upon consummation of the transactions contemplated by this Agreement. 4.06. LITIGATION There is no action, suit, investigation or proceeding (or any basis therefor) pending against, or to the knowledge of Buyer threatened against or affecting, Buyer before any court or arbitrator or any governmental body, agency or official that, if determined or resolved adversely in accordance with plaintiff*s demands would reasonably be expected to have a Material Adverse Effect or which in any matter challenges or seeks to prevent, enjoin, alter or materially delay the transactions contemplated hereby. 4.07. SOLVENCY Buyer is not subject to any pending or threatened bankruptcy or insolvency or similar proceeding, nor has Buyer made, or is threatening to make, any assignment for the benefit of creditors or bulk sale of assets or is it (or any of its property) subject to any receiver, assignee, custodian, liquidator, conservator, committee, trustee or similar officer. Buyer is neither insolvent, nor will the consummation of the transactions contemplated hereunder, render it insolvent. 4.08. REQUIRED CONSENTS Buyer has obtained all consents and other approvals required to be obtained by it in connection with this Agreement and the Note and the consummation of the transactions contemplated hereby. 4.09. REPRESENTATIONS The representations and warranties of Buyer contained in this Agreement, disregarding all qualifications and exceptions contained therein relating to materiality or Material Adverse Effect, are true and correct with only such exceptions as would not in the aggregate reasonably be expected to have a Material Adverse Effect. ARTICLE V COVENANTS OF SELLER 5.01. NONCOMPETITION (a) Seller agrees that neither it nor any of its Affiliates shall, for a period of two (2) full years from the Closing Date, engage, either directly or indirectly, as a principal or for its own account, solely or jointly with others, or as a stockholder in any corporation or joint stock association, or otherwise, in any business similar to the Business. (b) It is expressly agreed that the provisions of Paragraphs 5.01(a) shall not apply to the ownership of securities listed on a stock exchange or traded on the over-the-counter market which represent ten percent (10%) or less of the shares of that class of securities which are issued 11 and outstanding. (c) If any provision contained in this Section shall for any reason be held invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not affect any other provisions of this Section, but this Section shall be construed as if such invalid, illegal or unenforceable provision had never been contained herein. It is the intention of the parties that if any of the restrictions or covenants contained herein is held to cover a geographic area or to be for a length of time which is not permitted by applicable law, or in any way construed to be too broad or to any extent invalid, such provision shall not be construed to be null, void and of no effect, but to the extent such provision would be valid or enforceable under applicable law, a court of competent jurisdiction shall construe and interpret or reform this Section to provide for a covenant having the maximum enforceable geographic area, time period and other provisions (not greater than those contained herein) as shall be valid and enforceable under such applicable law. Seller acknowledges that Buyer would be irreparably harmed by any breach of this Section and that there would be no adequate remedy at law or in damages to compensate Buyer for any such breach. Seller agrees that Buyer shall be entitled to injunctive relief requiring specific performance by Seller of this Section, and Seller consents to the entry thereof. 5.02 CONFIDENTIALITY Seller will hold, and will use its best efforts to cause its officers, directors, stockholders, accountants, counsel, consultants, advisors and agents to hold, in confidence, unless compelled to disclose by judicial or administrative process, or by other requirements of law, all confidential documents and information concerning the Business, except to the extent that same is now public knowledge, or which hereafter becomes public knowledge, through no fault of Seller. ARTICLE VI COVENANTS OF BOTH PARTIES The parties hereto agree that: 6.01. BEST EFFORTS; FURTHER ASSURANCES (a) Subject to the terms and conditions of this Agreement, each party will use its best efforts to take, or cause to be taken, all actions and to do, or cause to be done, all things necessary or desirable under applicable laws and regulations to consummate the transactions contemplated by this Agreement. Seller and Buyer each agree to execute and deliver such other documents, certificates, agreements and other writings and to take such other actions as may be necessary or desirable in order to consummate or implement expeditiously the transactions contemplated by this Agreement and to vest in Buyer good and marketable title to the Purchased Assets. (b) Seller hereby constitutes and appoints, effective as of the Closing Date, Buyer and its successors and assigns as the true and lawful attorney of Seller with full power of substitution in the name of Buyer or in the name of Seller, but for the benefit of Buyer (i) to collect for the account of Buyer any items of Purchased Assets and (ii) to institute and prosecute all proceedings which Buyer may in its sole discretion deem proper in order to assert or enforce any right, title or 12 interest in, to or under the Purchased Assets, and to defend or compromise any and all actions, suits or proceedings in respect of the Purchased Assets. Buyer shall be entitled to retain for its account any amounts collected pursuant to the foregoing powers, including any amounts payable as interest in respect thereof. The foregoing actions shall be at no cost to Seller, except that the rights of the parties contained in Article IX are not intended to be impaired by this paragraph. 6.02. OCCUPANCY OF THE PREMISES AFTER THE CLOSING (a) From and after the Closing Date, until July 31, 1998, or such later date as the parties may agree upon, Seller shall sublease to Buyer one-half (2) of its space at the Premises, and Buyer shall be obligated to pay to Seller the sum of Five Thousand Eight Hundred ($5,800) Dollars per month for such space; Seller shall be obligated to obtain consent of the Master Landlord and the Sublandlord, in accordance with the provisions of Section 3.05 of this Agreement. Seller shall further be obligated to maintain said lease in full force and effect until July 31, 1998, or such later date as the parties may agree upon. In the event Seller elects not to renew the lease to the Premises for the period after July 31, 1998, Seller shall so notify Buyer, who shall have the right to negotiate to lease all or a portion of the Premises from the landlord thereunder. It is agreed that, as between Seller and Buyer, Seller shall retain the right to the rent security deposit, except to the extent that Buyer may have advanced amounts under the lease on behalf of Seller. 6.03. CONSENT TO BE OBTAINED POST-CLOSING Promptly after Closing, and in no more than thirty (30) days following the Closing: (a) Seller shall obtain all necessary consents of Master Landlord and Sublandlord to the subleasing of the Premises and the assignment of the Roof License, in accordance with the provisions of Sections 3.05 and 6.02(a); and (b) Seller shall obtain the consent of Microspace Communications Corporation ("MICROSPACE") to an assignment to Buyer of the agreement between Microspace and Incomnet. (c) Seller agrees to indemnify and hold Buyer harmless from any cost, claim or liability arising out of the failure to obtain the consents described in this Section 6.03. ARTICLE VII TAX MATTERS 7.01. PAYMENT OF TAXES (a) Seller hereby represents and warrants to Buyer that Seller has timely paid all taxes of any nature, including, but not limited to, income, real property, sales, use, license, employment, payroll, and withholding, and all interest and penalties due thereon (the "TAXES") and payable by it, which will have been required to be paid on or prior to the Closing Date, the non-payment of which would result in a Lien on any Purchased Asset, would otherwise adversely affect the 13 Business or would result in Buyer becoming liable or responsible therefor. (b) Seller has established, in accordance with generally accepted accounting principles applied on a basis consistent with that of preceding periods, adequate reserves for the payment of, and will timely pay all tax liabilities, assessments, interest and penalties which arise from or with respect to the Purchased Assets or the operation of the Business and are incurred in or attributable to the period prior to the Closing Date, the non-payment of which would result in a Lien on any Purchased Asset, would otherwise adversely affect the Business or would result in Buyer becoming liable therefor. (c) Any transfer, documentary, sales, use or other taxes assessed upon or with respect to the transfer of the Purchased Assets to Buyer and any recording or filing fees with respect thereto shall be the responsibility paid, at Closing, one-half (2) by Buyer, and one-half (2) by Seller. Seller shall be obligated to deliver its check within five (5) days after notice from Buyer of the amount due. In the event that Seller has not paid any such amounts within sixty (60) days following the Closing, Buyer shall be authorized to deduct from the Note the amounts due from Seller hereunder. ARTICLE VIII CONDITIONS TO CLOSING 8.01. CONDITIONS TO THE OBLIGATIONS OF EACH PARTY The obligations of Buyer and Seller to consummate the Closing are subject to the satisfaction of the following conditions: (a) No provision of any applicable law or regulation and no judgment, injunction, order or decree shall prohibit the consummation of the Closing. (b) No proceeding challenging this Agreement or the transactions contemplated hereby or seeking to prohibit, alter, prevent or materially delay the Closing shall have been instituted by any Person before any court, arbitrator or governmental body, agency or official and be pending. (c) All actions by or in respect of or filings with any governmental body, agency, official or authority required to permit the consummation of the Closing shall have been made or obtained, except such as would not result in a Material Adverse Effect. 8.02. CONDITIONS TO OBLIGATIONS OF BUYER The obligation of Buyer to consummate the Closing is subject to the satisfaction of the following further conditions (unless waived by Buyer in writing): (a) (i) Seller shall have performed in all material respects all of its obligations hereunder required to be performed by it at or prior to the Closing Date; (ii) the representations and warranties of Seller contained in this Agreement as of the date hereof and in any certificate or other writing delivered by Seller pursuant 14 hereto shall be true and correct in all material respects at and as of the Closing Date as if made at and as of such date; and (iii) Buyer shall have received a certificate signed by the President of Seller to the foregoing effect. (b) No provision of any applicable law or regulation and no judgment, injunction, order or decree shall restrain, prohibit or otherwise interfere with the effective operation or enjoyment by Buyer of all or any material portion of the Purchased Assets. (c) Buyer shall have received an opinion of counsel to Seller, dated the Closing Date, to the effect specified in Sections 3.01, 3.02, 3.03, 3.04 and 3.09, and with respect to such other matters as Buyer shall reasonably request. In rendering such opinion, such counsel may, where appropriate, rely upon certificates of public officers, upon opinions of counsel reasonably satisfactory to Buyer, copies of which shall be contemporaneously delivered to Buyer, and as to matters of fact, upon certificates of officers of Seller. (d) Except as otherwise provided in this Agreement, Seller shall have received all Required Consents in each case in form and substance reasonably satisfactory to Buyer, and no such consent, authorization or approval shall have been withdrawn. (e) Buyer shall have received such closing documents as it may reasonably request, all in form and substance reasonably satisfactory to Buyer. 8.03. CONDITIONS TO OBLIGATIONS OF SELLER The obligation of Seller to consummate the Closing is subject to the satisfaction of the following further conditions (unless waived in writing by Seller): (a) (i) Buyer shall have performed in all material respect all of its obligations hereunder required to be performed by it at or prior to the Closing Date; (ii) the representations and warranties of Buyer contained in this Agreement as of the date hereof and in any certificate or other writing delivered by Buyer pursuant hereto shall be true and correct in all material respects at and as of the Closing Date, as if made at and as of such date; and (iii) Seller shall have received a certificate signed by the President of Buyer to the foregoing effect. (b) Seller shall have received an opinion of counsel to Buyer, dated the Closing Date to the effect specified in Sections 4.01 through 4.04 and 4.06. In rendering such opinion, such counsel may, where appropriate, rely upon certificates of public officers, or the federal laws of the United States of America, upon opinions of counsel reasonably satisfactory to Seller, copies of which shall be contemporaneously delivered to Seller, and as to matters of fact, upon certificates of officers of Buyer. 15 (c) Seller shall have received such other closing documents as it may reasonably request, all in form and substance reasonably satisfactory to Seller. ARTICLE IX SURVIVAL; INDEMNIFICATION 9.01. SURVIVAL The covenants, agreements, representations and warranties of the parties hereto contained in this Agreement or in any certificate or other writing delivered pursuant hereto or in connection herewith shall survive the Closing. 9.02. INDEMNIFICATION (a) Seller hereby indemnifies Buyer and its Affiliates against and agrees to hold each of them harmless from any and all damage, loss, liability and expense (including, without limitation, reasonable expenses of investigation and reasonable attorneys' fees and expenses in connection with any action, suit or proceeding) (collectively, "LOSS") incurred or suffered by Buyer or any of its Affiliates arising out of (i) any misrepresentation or breach of warranty, covenant or agreement made or to be performed by Seller pursuant to this Agreement; or (ii) the enforcement of this indemnity. (b) Buyer hereby indemnifies Seller and its Affiliates against and agrees to hold each of them harmless from any and all Loss incurred or suffered by Seller or any of its Affiliates arising out of (i) any misrepresentation or breach of warranty, covenant or agreement made or to be performed by the Buyer pursuant to this Agreement and the Note; or (ii) the enforcement of this indemnity. 9.03. PROCEDURES; NO WAIVER (a) The party seeking indemnification under Section 9.02 (the "INDEMNIFIED PARTY") agrees to give prompt notice to the party against whom indemnity is sought (the "INDEMNIFYING PARTY") of the assertion of any claim, or the commencement of any suit, action or proceeding in respect of which indemnity may be sought under such Section. The Indemnifying Party may, and at the request of the Indemnified Party shall, participate in and control the defense of any such suit, action or proceeding at its own expense. The Indemnifying Party shall not be liable under Section 9.02 for any settlement effected without its consent of any claim, litigation or proceeding in respect of which indemnity may be sought hereunder. (b) No waiver of a closing condition by either Buyer or Seller shall limit its rights under Section 9.02. 16 ARTICLE X MISCELLANEOUS 10.01. NOTICES All notices, requests and other communications to either party hereunder shall be in writing (including telex, telecopy or similar writing) and shall be given, if to Buyer, to: President Incomnet, Inc. 21031 Ventura Boulevard Woodland Hills, CA 91364 Telecopy: with a copy to: Mark J. Richardson, Esq. 1299 Ocean Avenue - Suite 900 Santa Monica, CA 90401 Telecopy: (310)-393-2004 if to Seller, to: Autoskill, Inc. 1500 Hempstead Turnpike East Meadow, NY 11554 with a copy to: Arlene Flohr, Esq. Hockert Pressman & Flohr 880 Third Avenue New York, New York 10022 Telecopy: (212)-688-0066 10.02. AMENDMENTS; NO WAIVERS (a) Any provisions of this Agreement may be amended or waived prior to the Closing Date if, and only if, such amendment or waiver is in writing and signed, in the case of an amendment, by Buyer and Seller, or in the case of a waiver, by the party against whom the waiver is to be effective. (b) No failure or delay by either party in exercising any right, power or privilege hereunder shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The rights and remedies herein provided shall be cumulative and not exclusive of any rights or 17 remedies provided by law. 10.03. EXPENSES Except as otherwise provided herein, all costs and expenses incurred in connection with this Agreement shall be paid by the party incurring such cost or expense. 10.04. SUCCESSORS AND ASSIGNS The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. 10.05. GOVERNING LAW This Agreement shall be construed in accordance with and governed by the laws of California, without regard to the conflicts of law rules of such state. 10.06. COUNTERPARTS; EFFECTIVENESS This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement shall become effective when each party hereto shall have received a counterpart hereof signed by the other party hereto. It is agreed that the parties may exchange signature pages via facsimile, provided each party shall be obligated to deliver signed originals within five (5) days following the Closing. 10.07. ENTIRE AGREEMENT This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and supersedes all prior agreements, understandings and negotiations, both written and oral, between the parties with respect to the subject matter of this Agreement. No representation, inducement, promise, understanding, condition or warranty not set forth herein has been made or relied upon by either party hereto. This Agreement is not intended to confer upon any Person other than the parties hereto any rights or remedies hereunder. 10.08. BULK SALES LAWS Buyer hereby waives compliance by Seller with the provisions of the "bulk sales", "bulk transfer" or similar laws of any state. Seller agrees to indemnify and hold Buyer harmless against any and all claims, losses, damages, liabilities, costs and expenses incurred by Buyer or any of its Affiliates as a result of any failure to comply with any such "bulk sales", "bulk transfer" or similar laws. 10.09. BUYER'S RIGHTS OF OFFSET Buyer, at its option, shall have the right to offset against the payments required to be made by Buyer pursuant to this Agreement any amounts owing to Buyer by Seller pursuant to this Agreement or otherwise, including all amounts due under any indemnification provision set forth herein. In addition, Buyer, in consideration of the release of lien to be issued by the Debenture Holders, shall, in addition to the payments due to the Debenture Holders pursuant to Section 2.05 above, have the right to pay to the Debenture Holders and/or offset against the Note, all interest owed to the Debenture Holders for any period prior to, or subsequent to, the date of the Closing. In addition, unless Seller shall have timely and validly extended the Maturity Date of a certain convertible promissory note ("CONVERTIBLE NOTE"), in the amount of $100,000, being delivered to the Debenture Holders simultaneously on the execution of this Agreement, and in accordance with the terms of the Convertible Note, and as collateral therefore, delivered to the Escrow Agent described thereunder 300,000 shares of the Common Stock of RapidCast, Inc., owned by Seller, which shall be free and clear of all liens and encumbrances, Buyer shall be authorized and directed to deduct from the amounts due under the Note, and pay to the Debenture Holders, on behalf of Seller, all amounts due to the Debenture 18 Holders under the Convertible Note. 10.10. CAPTIONS The captions herein are included for convenience of reference only and shall be ignored in the construction or interpretation hereof. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. INCOMNET, INC. By: /S/ MELVYN REZNICK ---------------------- Name: Melvyn Reznick Title: President AUTOSKILL, INC. By: /S/ ROBERT COHEN -------------------- Name: Robert Cohen Title: President EX-21 3 EXHIBIT 21 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 EXHIBIT 21 INCOMNET, INC. SUBSIDIARIES OF THE REGISTRANT
State or other jurisdiction of Percentage of voting Name incorporation or organization securities owned - ------- ------------------------------ -------------------- National Telephone & Communications, Inc. Delaware 100% GenSource Corporation California 100% Incomnet India Limited India 32% Rapid Cast, Inc. New Jersey 29%
EX-27 4 EXHIBIT 27
5 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 776 0 13,850 2,764 16,894 0 16,248 0 40,514 28,530 0 0 3,758 70,811 0 40,514 125,144 125,144 88,163 138,544 12,810 5,495 0 (13,400) 201 (13,601) 0 0 0 (13,601) (1.03) (1.03)
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