[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 For the quarterly period ended June 30, 2004
 
 [   ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
 
 For the transition period from ______________ to ________________
 
 Commission File Number: 0-24857
 
 ITS NETWORKS INC.
 (Exact name of small business issuer as specified in its charter)
 
 Florida
52-2137517(State or other jurisdiction of
(I.R.S. Employer Identification No.)incorporation or organization)
 
 Edif. Marina Marbella, Severo Ochoa 28, Planta 9, 29600 Marbella, Spain
 (Address of principal executive offices)
 
 011-34-952-76-8600
 (Issuer's telephone number)
 
 Not Applicable
 
 (Former name, former address and former fiscal year, if changed since last report)
 
 APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS
 
 Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes No
 
 APPLICABLE ONLY TO CORPORATE ISSUERS
 
 State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 56,288,280 shares as of August 13, 2004.
 
 Transitional Small Business Disclosure Format (check one): Yes _  No  X
  
     ITS NETWORKS INC.
 INDEX
 
 PART I. FINANCIAL INFORMATIONItem 1. Consolidated Financial Statements:Consolidated Balance Sheet as of June 30, 2004
3Consolidated Statements of Operations for the threemonths and nine months ended June 30, 2004, and 2003
4Consolidated Statements of Cash Flows for the ninemonths ended June 30, 2004 and 2003
5Notes to the Consolidated Financial Statements
7Item 2. Management's Discussion and Analysis or Plan of Operations
11Item 3. Controls and Procedures
17PART II. OTHER INFORMATIONItem 1. Legal Proceedings
17Item 2. Changes in Securities
18Item 3. Defaults on Senior Securities
18Item 4. Submission of Matters to a Vote of Security Holders
18Item 5. Other Information
18Item 6. Exhibits and Reports on Form 8-K
18Signatures
19
  2
  PART I. FINANCIAL INFORMATION
 
 Item 1. Financial Statements





ITS NETWORKS INC.


CONSOLIDATED BALANCE SHEET


JUNE 30, 2004


(Unaudited)








ASSETSCURRENT ASSETS:Cash and cash equivalents

$
9,000Accounts receivable - trade, net of allowancefor doubtful accounts of $1,327,000


-Accounts receivable - other


145,000Inventory


69,000Prepaid expenses


6,000Total current assets


229,000PROPERTY AND EQUIPMENT, NET


820,000OTHER ASSETS:Vendor deposits


258,000$
1,307,000LIABILITIES AND STOCKHOLDERS' (DEFICIT)CURRENT LIABILITIES:Accounts payable - trade

$
3,951,000Accrued liabilities


169,000Obligation under capital lease


51,000Notes payable to bank


243,000Obligation to taxing authority


92,000Loans from related parties


2,696,000Deferred income


1,934,000Total current liabilities


9,136,000LONG TERM DEBTPayment obligation to tax agency, net of current portion shown above


218,000STOCKHOLDERS' DEFICIT:Preferred stock; par value of $0.001, 5,000,000 sharesauthorized, no shares outstanding


-Common stock; par value of $0.001, 100,000,000 sharesauthorized, 52,041,797 shares outstandingafter effect of reverse stock split, December 29, 2003


52,000Additional paid-in capital after effect of reverse stock split,


10,529,000Less: Prepaid syndication fees


(418,000
)Accumulated (deficit)


(16,300,000
)Effect of cumulative translation adjustment


(1,910,000
)Total stockholders' (deficit)


(8,047,000
)$
1,307,000See accompanying summary of accounting policies and notes to financial statements.




3




ITS NETWORKS INC.CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE PERIODS ENDED JUNE 30, 2004 AND 2003
(Unaudited)


For three months ended


For nine months endedJune 30,


June 30,2004


2003


2004


2003SALES

$
1,452,000

$
2,125,000

$
4,777,000

$
4,937,000COST OF GOODS SOLD


1,136,000


1,408,000


3,974,000


3,285,000GROSS PROFIT


316,000


717,000


803,000


1,652,000OPERATING EXPENSES:Selling, general and administrative expenses


868,000


1,183,000


2,212,000


3,218,000Depreciation


186,000


136,000


384,000


301,000Bad debt expense


-


3,000


-


21,000Impairment on goodwill


-


1,085,000


-


4,339,000Total operating expenses


1,054,000


2,407,000


2,596,000


7,879,000(LOSS) FROM OPERATIONS


(738,000
)

(1,690,000
)

(1,793,000
)

(6,227,000
)OTHER INCOME (EXPENSES):Interest expense


(219,000
)

(38,000
)

(414,000
)

(77,000
)(219,000
)

(38,000
)

(414,000
)

(77,000
)(LOSS) BEFORE INCOME TAXES


(957,000
)

(1,728,000
)

(2,207,000
)

(6,304,000
)PROVISION FOR INCOME TAXES


-


-


-


-NET (LOSS)

$
(957,000
)
$
(1,728,000
)
$
(2,207,000
)
$
(6,304,000
)BASIC EARNINGS (LOSS) PER SHARE

$
(0.03
)
$
(0.10
)
$
(0.07
)
$
(0.37
)AVERAGE COMMON AND COMMONEQUIVALENT SHARES OUTSTANDING


32,828,729


17,084,284


30,636,190


17,084,284THE COMPONENTS OF COMPREHENSIVE LOSS:Net (loss)

$
(957,000
)
$
(1,728,000
)
$
(2,207,000
)
$
(6,304,000
)Foreign currency translation adjustment


63,000


(233,000
)

(339,000
)

(1,387,000
)COMPREHENSIVE (LOSS)

$
(894,000
)
$
(1,961,000
)
$
(2,546,000
)
$
(7,691,000
)See accompanying summary of accounting policies and notes to financial statements

4
 
 ITS NETWORKS INC.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
  For nine months endedJune 30,2004


2003CASH FLOWS FROM OPERATING ACTIVITIES:Net (loss)

$
(2,207,000
)
$
(6,304,000
)Adjustments to reconcile net (loss) tonet cash used in operating activities:Depreciation


384,000


301,000Gain on sale of asset


(24,000
)

-Bad debt expense


-


21,000Non cash expenditures paid with stock





24,000Loss on impairment of goodwill


-


4,339,000Decrease (increase) in operating assets:Accounts receivable - trade


199,000


(1,468,000
)Accounts receivable - other


74,000


-Inventory


(10,000
)

(155,000
)Prepaid expenses


4,000


(120,000
)Vendor and other deposits


(49,000
)

(227,000
)Increase (decrease) in operating liabilities:Accounts payable and accrued liabilities


343,000


5,153,000Deferred income and deposits received


(816,000
)

1,930,000Net cash provided by (used in) operating activities


(2,102,000
)

3,494,000CASH FLOWS FROM INVESTING ACTIVITIES:Purchased goodwill


-


(4,339,000
)Purchase of property and equipment


(10,000
)

(1,381,000
)Net cash (used in) investing activities


(10,000
)

(5,720,000
)CASH FLOWS FROM FINANCING ACTIVITIES:Loan proceeds from related parties


2,147,000


3,635,000Loan proceeds from bank


10,000


-Payment on tax agency obligation


(170,000
)

-Proceeds from sale of common stock


314,000


-Net cash provided by financing activities


2,301,000


3,635,000EFFECT OF EXCHANGE RATE


(339,000
)

(1,265,000
)NET INCREASE (DECREASE) IN CASH ANDCASH EQUIVALENTS


(150,000
)

144,000CASH AND CASH EQUIVALENTS,BEGINNING OF PERIOD


159,000


48,000CASH AND CASH EQUIVALENTS,END OF PERIOD

$
9,000

$
192,000See accompanying summary of accounting policies and notes to the financial statements.








5
 ITS NETWORKS, INC.
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
  
 For nine months endedJune 30,2004


2003SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid during the year for:Interest

$
24,000

$
77,000SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS:Long-term debt converted to common stock

$
1,645,000

$
4,067,000Stock issued for services

$
35,000

$
24,000See accompanying summary of accounting policies and notes to financial statements.
   6


ITS NETWORKS INC. AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 June 30, 2004
 (Unaudited)
 
 
 1. THE COMPANY
 
 ITS Networks Inc. (the "Company") was incorporated in the State of Florida on November 23, 1998. On December 22, 2000, the Company issued 8,443,334 (post split) shares of common stock in exchange for 100% of the outstanding common stock of ITS Europe, S.L. ("ITS Europe"), a Spanish telecommunications company. For accounting purposes, the acquisition has been recorded as a recapitalization of ITS Europe, with ITS Europe as the acquirer. The 8,443,334 (post split) shares issued are treated as issued by ITS Europe for cash.
 
 In December 2002, the Company acquired Teleconnect Comunicaciones, S.A. ("Teleconnect") for up to 1,500,000 (post split) shares of the Common Stock of the Company the assumption of approximately 2,200,000 Euros of net debt. This agreement was subsequently amended giving the former Teleconnect shareholders a total of 2,500,000 (post split) shares of the Companys common stock.
 
 This resulted in the creation of $6,637,000 in goodwill associated with this acquisition. There was substantial doubt about the Companys ability to realize the goodwill associated with this acquisition and the goodwill was considered fully impaired and charged to operations during the year ended September 30, 2003.
 
 Results for the nine months ended June 30, 2004, are not necessarily indicative of the results that may be expected for the year ending September 30, 2004. For further information, refer to the Company's consolidated financial statements and footnotes thereto included in its annual report on Form 10-KSB for its fiscal year ended September 30, 2003.
 
 The Company is a provider of pre-paid telephone cards and other telecommunication services and products primarily within Spain. Significant inter-company balances and transactions have been eliminated in consolidation.
 
 2. GOING CONCERN
 
 The accompanying financial statements have been prepared assuming that the Company will continue as a going concern.
 
 As shown in the accompanying financial statement, the Company incurred losses of $(2,207,000) and $(6,304,000) for the nine months ended June 30, 2004 and 2003, respectively. In addition, the Company has incurred substantial losses since its inception. As of June 30, 2004, current liabilities exceed current assets by $8,907,000 and total liabilities exceed total assets by $8,047,000. These factors raise substantial doubts about the Company's ability to continue as a going concern.
 
 These financial statements do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be necessary in the event the Company cannot continue as a going concern.
 
 7
  Management anticipates that it will be able to convert certain outstanding debt into equity and that it will be able to raise additional working capital through the issuance of stock and through additional loans from investors.
 
 The ability of the Company to continue as a going concern is dependent upon the Company's ability to attain a satisfactory level of profitability and obtain suitable and adequate financing. There can be no assurance that management's plan will be successful.
 
 3. SIGNIFICANT ACCOUNTING POLICIES
 
 Cash and cash equivalents. The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.
  Property and equipment. Property and equipment are stated at cost. Depreciation is provided primarily by the straight-line method over the estimated useful lives of the assets.
 
 Impairment of long-lived assets. The Company evaluates its long-lived assets to determine whether later events and circumstances warrant revised estimates of useful lives or reduction in carrying value due to impairment.
 
 Income taxes. The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", which requires an asset and liability approach to determine deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based upon the differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are assumed to reverse.
 
 Revenue recognition. Revenue from the sale of prepaid calling cards is recognized as the cards are used. Deferred revenues are recorded to reflect the unused portion of calling cards that have been issued to customers.
 
 Loss per share. Loss per common and common equivalent share is computed based on the weighted average number of shares of Common Stock outstanding.
 
 Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
 Foreign Currency Translation/Transactions. The current assets and current liabilities of ITS Europe, S.L. and Teleconnect, whose functional currencies are the Euro (formerly the Peseta), are generally translated into U.S. dollars at the June 30, 2004 exchange rate. Long-term assets are translated at the exchange rate in effect on the date of acquisition. The revenues and expenses are translated at average exchange rates for the period. Resulting translation adjustments are accumulated and reflected as a separate component of stockholders' equity.
 
 8
  4. INCOME TAXES
 
 The Company's wholly-owned subsidiaries, ITS Europe, S.L. and Teleconnect file their income taxes on a calendar year basis. Statutory tax laws of Spain allow net losses from operations to be carried forward for a period of ten years. For the year ended September 30, 2003, the available tax loss ITS Europe has accumulated is $3,771,000, which may be used to offset future taxable income. Teleconnect, which was acquired in December 2002, has available tax losses of approximately $9,777,000 as of December 31, 2003. The utilization of the loss expires in years from 2005 to 2017. The Company cannot use any of the tax losses of ITS Europe or Teleconnect to offset any future U.S. taxable income. The U.S. parent Company has net operating loss carry forwards totaling approximately $739,000, which is available to offset any future parent Company taxable income in the United States in years 2021 to 2023.
 
 The Company has a deferred tax asset principally due to net operating loss carry forwards. This deferred tax asset has been offset in full by a valuation allowance, as the Company can not be assured at this time that it will be able to utilize these loss carryforwards.
 
 5. LITIGATION
 
 In the normal course of its operations, the Company has, from time to time, been named in legal actions seeking monetary damages. While the outcome of these matters cannot be estimated with certainty, management does not expect, based upon consultation with legal counsel, that they will have a material effect on the Company's business or financial condition or results of operations, except that as of June 30, 2004, the Company has accrued $148,922 for the settlement of pending litigation.
 
 6. LOANS PAYABLE
 
 At June 30, 2004, the Company has a bank loan and loans payable to related parties totaling $243,000 and $2,696,000, respectively, all of which is due within the next twelve months. Interest on the bank loan is computed and paid monthly at an interest rate of 7.5%. Interest computed on the loans to the related parties range from 0% to 24%.
 
 7. REVERSE STOCK SPLIT
 
 On December 29, 2003, the Company had a one-for-two reverse stock split of its common stock. The effects of this reverse split are shown retroactively in these financial statements and the notes thereto.
 
 8. SALE OF POST PAID BUSINESS
 
 Effective November 1, 2003, the Company sold its post paid business accounts to a third party. This sale was not recognized for financial reporting purposes as the sale price is not determinable at the current time. Terms of the sale call for the purchase price to be 550,000 euro subject to the following adjustment: if revenues generated from this business are less than 137,000 euro for the month of April 2004, the sales price will be reduced to four times April 2004 revenues; likewise, if revenues for April 2004 exceed 137,000 euro, the purchase price will be adjusted upwards to four times April revenues. On November 20, 2003, the Company received a 400,000 euro payment towards this sale, the proceeds of which went directly to one of the Company's carriers in partial payment of past due charges.
 
 9
  For financial reporting purposes, the Company did not recognize the sale during the period ended March 31, 2004 but recorded deferred income in the amount of 505,000 euro representing the estimated sales price of 550,000 euro less 45,000 euro in related costs. The sale will be recognized for financial reporting purposes at such time as the sales price is determinable. At the date of this filing, the actual billing for April 2004 is being reviewed and discussed between both parties in order to reach an agreement on the exact billable amount. For this purpose, both parties will study the billing for the months previous to, and after, April 2004 in order to establish the expected pattern and compare to the billing figures supplied. Any deviation resulting from this item would be represented as an extraordinary income or expense since it is not related to the ongoing activity.
 
 9. AGREEMENT TO SELL ADDITIONAL SHARES OF COMMON STOCK
 
 On November 28, 2003 the Company entered into an agreement with an investor whereby the investor agreed to acquire sufficient shares to give the investor 60% of the issued and outstanding shares of the Company's common stock at closing in consideration for a purchase price of 2,900,000 euros. This transaction had not been finalized as of the date of this report.
 
 During February 2004, and due to the delays with the above-mentioned investor, ITS Networks hired Europartners Company Ltd to assist with the raising of funds as a precautionary measure. In May 2004, ITS Networks signed a formal Placement Agreement whereby Europartners Company Ltd would raise up to $5,000,000 to be injected into ITS Networks. Various potential sources of the funds have been identified by Europartners but at the date of this filing the negotiations are still ongoing and there is no clear date of culmination of their efforts and the transfer of the funds.
10.  NEW ACCOUNTING PRONOUNCEMENTS

In November 2002, the FASB issued Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). The interpretation requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee and expands the disclosures required. Initial recognition and measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN 45 had no effect on the Companys financial position, results of operations, or cash flows.

In December 2002, the FASB issued Statement No. 148, Accounting for Stock-Based CompensationTransition and Disclosure, (SFAS 148). SFAS 148 amends Statement 123, Stock-Based Compensation, with respect to Statement 123s transition provisions and required disclosures. The adoption of SFAS 148 had no impact on the Companys financial position, results of operations or cash flows.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities  an Interpretation of ARB No. 51 (FIN 46). FIN 46 clarifies the consolidation requirements of variable interest entities. The adoption of FIN 46 had no effect on the Companys financial position, results of operations, or cash flows.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities  (SFAS 149). SFAS 149 amends and clarifies certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. SFAS 149 is effective for certain contracts entered into or modified by the Company after June 30, 2003. The adoption of SFAS 149 had no impact on the Companys financial position, results of operations, or cash flows.

In May 2003, the FASB issued SFAS No. 150, Accounting for Instruments with Characteristics of Both Debt and Equity (SFAS 150). Statement 150 requires liability classification for three types of instruments: 1) mandatory redeemable shares that obligate the company to deliver cash or other assets to shareholders on fixed or determinable dates; 2) freestanding written put options and forward purchase contracts on a companys own shares that obligate the company to deliver cash or other assets, and 3) contracts that obligate a company to issue its own shares in amounts that are unrelated to, or inversely related to, the value of the shares. The adoption of SFAS 150 had no impact on the Companys financial position, results of operations, or cash flows.
 10


Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS





IN ADDITION TO HISTORICAL INFORMATION, MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS MAY INCLUDE CERTAIN FORWARD-LOOKING STATEMENTS, INCLUDING, BUT NOT LIMITED TO, THOSE RELATED TO THE GROWTH AND STRATEGIES, FUTURE OPERATING RESULTS AND FINANCIAL POSITION AS WELL AS ECONOMIC AND MARKET EVENTS AND TRENDS OF THE COMPANY. ALL FORWARD-LOOKING STATEMENTS MADE BY THE COMPANY, INCLUDING SUCH STATEMENTS HEREIN, INCLUDE MATERIAL RISKS AND UNCERTAINTIES AND ARE SUBJECT TO CHANGE BASED ON FACTORS BEYOND THE CONTROL OF THE COMPANY. ACCORDINGLY, THE COMPANY'S ACTUAL RESULTS AND FINANCIAL POSITION COULD DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN ANY FORWARD-LOOKING STATEMENT AS A RESULT OF VARIOUS FACTORS, INCLUDING WITHOUT LIMITATION FACTORS DESCRIBED IN THE COMPANY'S PREVIOUS FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION REGARDING RISKS AFFECTING THE COMPANY'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS.





The following discussion of the Company's consolidated financial condition and results of operations should be read in connection with the Company's condensed consolidated financial statements and notes thereto appearing elsewhere herein. Factors that could cause or contribute to differences from the condensed consolidated financial statements include, but are not limited to risks and uncertainties related to the need for additional funds, the growth of its operations and the ability of the Company to operate profitably.





Significant Accounting Estimates and Policies





The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates including the allowance for doubtful accounts, the saleability and recoverability of inventory, income taxes and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable


under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.





We must make estimates of the collectability of accounts receivable. We analyze historical write-offs, changes in our internal credit policies and customer concentrations when evaluating the adequacy of our allowance for doubtful accounts. Differences may result in the amount and timing of expenses for any period if we make different judgments or use difference estimates.





Property and equipment are evaluated for impairment whenever indicators of impairment exist. Accounting standards require that if an impairment indicator is present, the Company must assess whether the carrying amount of the asset is unrecoverable by estimating the sum of the future cash flows expected to result from the asset, undiscounted and without interest charges. If the carrying amount is less than the recoverable amount, an impairment charge must be recognized, based on the fair value of the asset. Management assumed the Company was a going concern for purposes of evaluating the possible impairment of its property and equipment. Should the Company not be able to continue as a going concern, there may be significant impairment in the value of the Company's property and equipment.





11





Goodwill is reviewed at least annually for impairment, or more frequently if indicators of impairment exist, goodwill is tested by comparing net book value of the reporting entity to fair value. Management's assumptions about fair values require significant judgment because broad economic factors, industry factors and technology considerations can result in variable and volatile fair values.





As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent that we establish a valuation allowance or increase this allowance in a period, we must include a tax provision or reduce our tax benefit in the statements of operations. We use our judgment to determine our provision or benefit for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We believe, based on a number of factors including historical operating losses, that we will not realize the future benefits of a significant portion of our net deferred tax assets and we have accordingly provided a full valuation allowance against our deferred tax assets. However, various factors may cause those assumptions to change in the near term.





We cannot predict what future laws and regulations might be passed that could have a material effect on our results of operations. We assess the impact of significant changes in laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when we deem it necessary.





We have determined the significant principles by considering accounting policies that involve the most complex or subjective decisions or assessments. Our most significant accounting policies are those related to revenue recognition and accounting for stock-based compensation.





Revenue Recognition. Our revenue recognition policies are based on the requirements of SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements.





Revenue from sales of telecommunication services is generally recognized during the period when the services are rendered. Prepaid services which have not yet been rendered are reflected in deferred income until such time as the services are rendered.





Accounting for Stock-Based Compensation. We have elected to apply the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. In accordance with the provisions of SFAS 123, we apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and will use related interpretations in accounting for stock option plans. We account for stock issued to non-employees in accordance with the provisions of SFAS 123 and the Emerging Issues Task Force consensus in Issue No. 96-18, Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring or in Conjunction with Selling, Goods or Services. Generally, under APB 25, if the option exercise price for a fixed award to an employee is equal to the fair value of the common stock at the date of the grant of the stock option, no compensation expense is recorded. Under SFAS 123 and EITF 96-18, the amount of compensation expense that is recorded is based on an option pricing model which incorporates such factors as the expected volatility of future movements in the price of the underlying stock, risk-free interest rates, the term of the options and any dividends expected to be paid. As a result, under SFAS 123 and EITF 96-18, we would generally expect to record a greater amount of compensation expense than under APB 25.





12




Segment Reporting. We have adopted SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS 131 requires companies to disclose certain information about reportable segments. Based on the criteria within SFAS 131, we have determined that we currently have only one reportable segment, telecommunications systems and related services.





Going Concern. These financial statements have been prepared assuming the Company is a going concern. As of June 30, 2004, the Company has negative working capital of $(8,907,000) and a deficit net worth of $(8,047,000). This gives rise to substantial doubts about the Company's ability to continue as a going concern. The financial statements do not reflect any adjustments which might be required should the Company discontinue as a going concern.




RESULTS OF OPERATIONS





Prior to December 2000, the Company was a development stage technology company and had no revenues. After the Company's acquisition of ITS Europe, S.L. ("ITS Europe"), through a share exchange agreement entered on December 22, 2000, the Company's previous business plan was implemented. For information concerning the Company's prior full fiscal year, the Company refers the reader to the financial statements provided in its previous annual report on Form 10-KSB filed for its fiscal year ended September 30, 2001.





On December 22, 2000, the Company acquired 100% ownership of ITS Europe, S.L., a telecommunications company based in Malaga, Spain. ITS Europe is a provider of various telecommunications services and products primarily within Spain; all of the operations of ITS Europe were founded prior to the deregulation of the telecommunications industry in Spain in 1998.





Effective November 11, 2002, the Company acquired Teleconnect Comunicaciones, S.A. (Teleconnect) based in Marbella, Spain, in exchange for 2,500,000 post-split shares of the Common Stock of the Company. Teleconnect is a provider of pre-paid telephone cards.





COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003





We incurred a $(957,000) net loss for the three months ended June 30, 2004 as compared to a net loss of $( 1,728,000 ) during the comparable period in 2003. A comparison of revenues and expenses for the two periods is as follows:





REVENUES





Sales for the three months ended June 30, 2004, decreased 32% to $1,452,000 from $2,125,000 for the quarter ended June 30, 2003. This decrease in revenues is attributable primarily to the sale of our postpaid business in November 2003. In addition, due to the restructuring of the debt and the shortage of operating cash on a monthly basis, no money was injected during this period into the marketing of products and no aggressive sales campaigns were designed or implemented.





13




COST OF GOODS SOLD





Cost of goods sold decreased by 19% to $1,136,000 during the three months ended June 30, 2004 from $1,408,000 during the same period in 2003. This decrease was due to the decrease in sales volumes associated with the sale of the fixed line business.




SELLING, GENERAL AND ADMINISTRATIVE EXPENSES





Selling, general and administrative expenses decreased by 27% to $868,000 during the three months ended June 30, 2004 as compared to $1,183,000 for the comparable period in 2003. This decrease was due primarily to cost cutting measures implemented by management.





DEPRECIATION





Depreciation expense increased by 37% to $186,000 during the three months ended June 30, 2004 as compared to $136,000 for the comparable period in 2003.





BAD DEBTS EXPENSE





The Company had no bad debts expense during the three months ended June 30, 2004 as compared to $3,000 during the comparable period in 2003. This was due to being involved with a purely prepaid business during the last three months, and having no post paid activity which is where the credit risk existed.





IMPAIRMENT OF GOODWILL





During the quarter ended June 30, 2003, the Company recognized an impairment loss of $1,085,000 associated with the write down of goodwill acquired with the Teleconnect acquisition. The Company had no impairment loss during the same period in 2004.





INTEREST EXPENSE





Interest expense increased by 476% to $219,000 during the three months ended June 30, 2004 as compared to $38,000 during the comparable period in 2003. This increase was due to our acquisition of Teleconnect and the associated loans assumed, notwithstanding the conversion of $1,465,000 of long term debt to equity during 2003. In addition, more interest-bearing bridge loans were made available by shareholders during this period.








COMPARISON OF THE NINE MONTHS ENDED JUNE 30, 2004 AND 2003





We incurred a net loss of $(2,207,000) for the nine months ended June 30, 2004 as compared to a net loss of $(6,304,000) for the comparable period in 2003. A comparison of revenues and expenses for the two periods is as follows:





14




REVENUES





Sales for the nine months ended June 30, 2004, decreased by 3% to $4,777,000 from $4,937,000 for comparable period in 2003. This decrease in revenues is due primarily to our sale of our postpaid business.





COST OF GOODS SOLD





Cost of goods sold increased by 21% to $3,974,000 during the nine months ended June 30, 2004 from $3,285,000 during the same period in 2003. This increase in cost of goods sold is attributable to lower profit margins on cards sold prior to June 30, 2004, which were recognized in 2004 as the cards were utilized.





SELLING, GENERAL AND ADMINISTRATIVE EXPENSES





Selling, general and administrative expenses decreased by 31% to $2,212,000 during the nine months ended June 30, 2004 as compared to $3,218,000 for the comparable period in 2003. This decrease was due primarily to cost cutting measures implemented by management.





DEPRECIATION





Depreciation expense increased by 28% to $384,000 during the nine months ended June 30, 2004 as compared to $301,000 for the comparable period in 2003.  This increase was due primarily to the addition of Teleconnect equipment in December 2003.





BAD DEBT EXPENSE





The Company had no bad debt expense during the nine months ended June 30, 2004 as compared to $21,000 during the comparable period in 2003. This decrease was due to the prepaid nature of itsbusiness and the sale our post paid business.





IMPAIRMENT OF GOODWILL





During the quarters ending December, 2002 and June 30, 2003, the Company wrote down goodwill acquired in connection with our acquisition of Teleconnect by $3,254,000 and $1,085,000, respectively. This impairment is a result of the Company's inability to obtain the levels of operating principles provided for in its business plan. The Company had no impairment loss in fiscal 2004.





INTEREST EXPENSE





Interest expense increased by 438% to $414,000 during the nine months ended June 30, 2004 as compared to $77,000 during the comparable period in 2003. This increase in interest expense was due to interest and penalties for bridge loans obtained from related parties.





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PLAN OF OPERATIONS FOR THE COMPANY





Since the approval of the new business plan by the Board , the Company has taken the necessary steps to comply with the actions defined. As such, it has decreased the debt on its balance sheet and looked for additional debt/equity funding. The services have been redefined as a part of a new marketing mix and certain services relaunched with a new image and brand name associated with the pre-paid telephone card business of Teleconnect. The Company has constantly focused on reducing its operating costs to a maximum and is still taking measures which will further reduce its monthly expenses. The Companys objective is to have a monthly breakeven situation before year end even if no additional funds from investors were to arrive.





In parallel to the cost reductions, the Company has developed a new rechargeable card which it will launch with its major accounts in September 2004 after the summer holidays. Other marketing actions are being planned to bring up sales levels to help reach breakeven as quickly as possible.










LIQUIDITY AND CAPITAL RESOURCES





At June 30, 2004, the Company had negative working capital of $(8,907,000), compared to negative working capital of $(9,026,000) at June 30, 2003.





The ability of the Company to satisfy its obligations will depend in part upon its ability to raise funds through the sale of additional shares of its Common Stock, increase borrowings, and in part upon its ability to reach a profitable level of operations of which there can be no assurance.





The Company's capital resources have been provided primarily by capital contributions from stockholders, stockholder loans, the exchange of outstanding debt into Common Stock of the Company, and services rendered in exchange for Common Stock.





The Company intends to sell its Common Stock and/or borrow additional funds from investors to pay debts and for working capital. However, there is no assurance that such capital will be raised, and the Company may seek bank financing and other sources of financing to complete the payment of additional debts of Teleconnect.





Effective November 1, 2003, the Company sold its post paid business accounts to a third party. This sale has not been recognized for financial reporting purposes as the sale price is not determinable at the current time. Terms of the sale call for the purchase price to be 550,000 euro subject to the following adjustment: if revenues generated from this business are less than 137,000 euro for the month of April 2004, the sales price will be reduced to four times April 2004 revenues; likewise, if revenues for April 2004 exceed 137,000 euro, the purchase price will be adjusted upwards to four times April revenues. On November 20, 2003, the Company received a 400,000 euro payment towards this sale, the proceeds of which went directly to one of the Company's carriers in partial payment of past due charges.





For financial reporting purposes, the Company did not recognize the sale during the period ended March 31, 2004 but recorded deferred income in the amount of 505,000 euro representing the estimated sales price of 550,000 euro less 45,000 euro in related costs. The sale will be recognized for financial reporting purposes at such time as the sales price is determinable.





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On November 28, 2003 the Company entered into an agreement with an investor whereby the investor agreed to acquire sufficient shares to give the investor 60% of the issued and outstanding shares of the Company's Common Stock at closing in consideration for a purchase price of 2,900,000 euros. This transaction had not been finalized as of the date of this report. Subsequently, Euro Partners Company Ltd. and ITS Networks signed a Placement Agreement on May 13, 2004 whereby the former reserves itself the option on 60% of the total share capital of the Company in exchange for the full injection of $5,000,000, Euro Partners has advanced negotiations with investor parties which are expected to come to fruition before the end of 2004.





CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS





The following table is a recap of the Company's contractual obligations as of September 30, 2003.




Contractual Obligations


Payments Due by PeriodLess Than


One ToTotal


One Year


Three YearsLong-term Debt

$
1,137,000

$
846,000

$
291,000Operating Leases


472,000


232,000


240,000Service Agreements


988,000


290,000


698,000Total Contractual CashObligations

$
2,597,000

$
1,368,000

$
1,229,000





Item 3.  CONTROLS AND PROCEDURES





The Company's President and is Chief Operating Officer/principal accounting officer (collectively, the "Certifying Officers") are responsible for establishing and maintaining disclosure controls and procedures for the Company. Such officers have concluded (based upon their evaluation of these controls and procedures as of a date within 90 days of the filing of this report) that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in this report is accumulated and communicated to the Company's management, including its principal executive officers as appropriate, to allow timely decisions regarding required disclosure. The Certifying Officers also have indicated that there were no significant changes in the Company's internal controls or other factors that could significantly affect such controls subsequent to the date of their evaluation, and there were no corrective actions with regard to significant deficiencies and material weaknesses.





PART II - OTHER INFORMATION





Item 1. Legal Proceedings





None





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Item 2. Changes in Securities





The following sets forth a description of certain sales and issuances of the Company's securities during the three month period ended June 30, 2004, covered by this report. The Company relied upon one or more exemptions from registration under the Securities Act of 1933, including Section 4(2) of the Securities Act of 1933 and Regulation S with respect to certain sales to non-U.S. persons, as defined by Regulation S.





During the three months ended June 30, 2004, the Company issued 17,130,000 shares of restricted common stock to Geeris Holding Nederland B.V. (GHN), a company owned by Leonardus Geeris, a director of the Company, in exchange for outstanding debt, interest and penalties owed to GNH in the amount of $786,500 and as compensation for the guarantee of loans to the Company.





During the three months ended June 30, 2004, the Company issued 1,900,000 shares of restricted common stock to Volim Holdings Nederland B.V. (VHN) in exchange for outstanding debt and interest owned to VHN in the amount of $165,000.





During the three months ended June 30, 2004, the Company issued 500,000 shares of restricted common stock in exchange for consulting services totaling $35,000.





Item 3. Defaults Upon Senior Securities





None





Item 4. Submission of Matters to a Vote of Security Holders





No matter was submitted to a vote of the security holders of the Company during the three-month period ended June 30, 2004.





Effective July 29, 2004, the majority stockholders of the Company held a special meeting of stockholders by a written memorandum which: (1) approved an amendment to the Articles of Incorporation of the Company to increase the authorized number of shares of its common stock from 100,000,000 to 200,000,000 shares of common stock; and (2) approved the adoption of the 2004 Stock Option, SAR and Stock Bonus Plan for the Company which covers 15,000,000 shares of the common stock of the Company for future issuance to its directors, officers, employees and consultants of the Company from time to time.





Item 5. Other Information





N/A





Item 6. Exhibits and Reports on Form 8-K





There were no reports on Form 8-K filed by the Company during the three-month period ended June 30, 2004.





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(a) EXHIBITS








99.1 Certificate of Gustavo Gomez and Herman de Haas





99.2 Certificate of Gustavo Gomez





99.3 Certificate of Herman de Haas





(b) REPORTS ON FORM 8-K
















In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.ITS NETWORKS INC.Date: August 16, 2004
By:
/s/ Gustavo GomezGustavo Gomez,President ****By:
/s/ Herman de HaasHerman de HaasExecutive Vice President, Chief Operating Officer and principal    accountingand financial officer






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