SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ x ] Quarterly report pursuant to section 13 of 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended June 30, 1999
[ ] Transition report pursuant to section 13 of 15(d) of the Securities
Exchange Act of 1934 for the transition period from
------------- to -------------
Commission File No. 0-21038
Network Six, Inc.
(Exact name of registrant as specified in its charter)
Rhode Island 05-0366090
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
475 Kilvert Street, Warwick, Rhode Island 02886
(Address of principal executive offices, including zip code)
(401) 732-9000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 of 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 .
As of June 30, 1999, there were 792,791 shares of the registrant's Common
Stock, $.10 par value, outstanding.
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Network Six, Inc.
Condensed Balance Sheets
<TABLE>
<CAPTION> June 30, 1999 Dec. 31, 1998
Assets (unaudited)
Current asset ------------ ------------
<S> <C> <C>
Cash $ 1,451,003 $ 1,442,035
Contract receivables, less allowance for
doubtful accounts of $69,175 at June 30,
1999 and December 31, 1998 2,087,976 1,966,788
Costs and estimated earnings in excess of
billings on contract 868,757 1,220,253
Refundable taxes on income 1,273,851 -
Other current assets 146,087 112,433
------------ ------------
Total current assets 5,827,674 4,741,509
------------ ------------
Property and equipment
Computers and equipment 634,774 590,527
Furniture and fixtures 162,606 163,532
Leasehold improvements 20,191 20,191
------------ ------------
817,571 774,250
Less: accum. depreciation and amortization 577,657 602,033
------------ ------------
Net property and equipment 239,914 172,217
Deferred taxes 37,097 37,097
Contract receivables and costs in excess
of billings on Hawaii contract - 3,459,382
Other assets 343,484 290,577
------------ -----------
Total assets $ 6,448,169 $ 8,700,782
=========== ===========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
June 30, 1999 Dec. 31, 1998
(unaudited)
Liabilities and Stockholders' Equity ------------ ------------
Current liabilities:
Current installment of obligations
<S> <C> <C>
under capital leases $ 34,535 $ 89,483
Current portion of long-term debt:
Vendors 100,000 200,000
Others 339,864 91,997
Accounts payable 197,094 58,456
Accrued salaries and benefits 420,950 579,320
Accrued subcontractor expense 8,158 24,950
Other accrued expenses 198,688 320,982
Billings in excess of costs and
estimated earnings on contracts 356,950 341,572
Income taxes payable - 780,066
Deferred taxes 42,491 42,491
Preferred stock dividends payable 954,057 795,992
------------ ------------
Total current liabilities 2,652,787 3,325,309
------------ ------------
Obligations under capital leases,
excluding current installments - 38,090
Long-term debt, less current portion:
Vendors 642,239 542,239
Others 866,408 409,778
Hawaii Payable - 576,483
------------ ------------
Total Liabilities 4,161,434 4,891,899
------------ ------------
Stockholders' equity:
Series A convertible preferred stock,
$3.50 par value. Authorized 857,142.85
shares; issued and outstanding 714,285.71
shares at June 30, 1999 and December 31,
1998; liquidation of $3.50 per share
plus unpaid and accumulated dividends 2,235,674 2,235,674
Common stock, $.10 par value. Authorized
4,000,000 shares; issued 780,156 shares
at June 30, 1999 and 764,663 at
December 31, 1998 79,278 76,466
Additional paid-in capital 1,886,130 1,796,284
Treasury stock, recorded at cost, 316
shares at June 30, 1999 (1,699) -
Retained earnings (accumulated deficit) (1,912,648) (299,541)
------------ ------------
Total stockholders' equity 2,286,735 3,808,883
------------ ------------
Total liabilities &
stockholders' equity $ 6,448,169 $ 8,700,782
=========== ===========
</TABLE>
<PAGE>
Network Six, Inc.
Condensed Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
Three months Three months Six months Six months
ended 6/30/99 ended 6/30/98 ended 6/30/99 ended 6/30/98
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Contract revenue earned $ 2,550,370 $ 3,253,696 $ 5,238,770 $ 5,475,313
Cost of revenue earned 1,565,228 2,158,529 3,139,753 3,605,184
------------ ------------ ------------ -----------
Gross profit 985,142 1,095,167 2,099,017 1,870,129
Selling, general &
administrative expenses 694,439 562,467 1,356,359 1,120,292
Litigation settlement
(note 3) 3,176,665 - 3,176,665 -
------------ ------------ ------------ -----------
Income (loss)from
operations (2,885,962) 532,700 (2,434,007) 749,837
Other deductions (income)
Interest expense 29,408 10,530 59,364 39,715
Interest earned (17,770) (2,918) (31,698) (53,041)
------------ ------------ ------------ -----------
Income (loss)before
income taxes (2,897,600) 525,088 (2,461,673) 763,163
Income taxes (1,185,362) 215,290 1,006,631 312,900
------------ ------------ ------------ -----------
Net income (loss) $(1,712,238) $ 309,798 $(1,455,042) $ 450,263
============= ============= ============= =============
Net income (loss) per share:
Basic $ (2.27) $ 0.30 $ (2.06) $ 0.38
============= ============= ============= =============
Diluted $ (2.27) $ 0.30 $ (2.06) $ 0.38
============= ============= ============= =============
Shares used in computing net income (loss)per share:
Basic 788,573 756,176 781,774 752,839
============= ============= ============= =============
Diluted 788,573 756,176 781,774 752,839
============= ============= ============= =============
Preferred dividends
declared $ 79,469 $ 84,144 $ 158,065 $ 167,363
============= ============= ============= =============
</TABLE>
<PAGE>
Network Six, Inc.
Condensed Statements of Cash Flow
(Unaudited)
<TABLE> Six months Six months
<CAPTION> ended ended
6/30/99 6/30/98
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net Income (loss) $(1,455,042) $ 450,263
Adjustment to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 40,230 21,285
Loss on sale/disposal of fixed assets 704 6,399
Proceeds from CBSI settlement 300,000 -
Payments on Hawaii settlement (250,000) -
Changes in operating assets and liabilities:
Contract receivables (121,188) (30,187)
Cost and estimated earnings in excess
of billings on contracts 351,496 433,342
Refundable taxes on income (1,273,851) -
Other current assets (33,654) 112,067
Long term amounts due from Hawaii 3,459,382 -
Other assets (52,907) 29,936
Accounts payable 138,638 (51,897)
Accrued salaries and benefits (158,370) 9,872
Accrued subcontractor exp. (16,792) (576,139)
Hawaii settlement 950,000 -
Hawaii payable (576,483) -
Other notes payable - (63,871)
Other accrued expenses (122,294) 37,658
Billings in excess of costs
and estimated earnings on contracts 15,378 2,393
Income taxes payable (780,066) 306,291
----------- -----------
Net cash provided by
operating activities 415,181 687,412
----------- -----------
Cash flows from investing activities:
Cash Proceeds from Sale/Disposal
of Capital Assets 350 119
Capital expenditures (102,376) (57,633)
----------- -----------
Net cash used in investing activities (102,026) (57,514)
----------- -----------
</TABLE>
<PAGE>
<TABLE>
<captions>
Six months Six months
ended ended
6/30/99 6/30/98
----------- -----------
<C> <C> <C>
Cash flows from financing activities:
Principal payments on capital lease obligations (93,038) (29,649)
Payments on long term debt (302,108) -
Net payments on note payable to bank - (1,160,000)
Purchases of treasury stock (1,699) -
Proceeds from issuance of common stock 92,658 89,426
----------- -----------
Net cash used in financing activities (304,187) (1,100,223)
----------- ----------
Net increase (decrease) in cash 8,968 (470,325)
Cash at beginning of period 1,442,035 1,291,924
----------- ----------
Cash at end of period $ 1,451,003 $ 821,599
=========== ===========
Supplemental cash flow information:
Cash paid during the period for:
Income taxes $ 943,786 $ 7,460
=========== ===========
Interest $ 31,552 $ 39,715
=========== ===========
</TABLE>
<PAGE>
Network Six, Inc.
Notes to Financial Statements
June 30, 1999
(unaudited)
(1) Basis of Presentation
The interim financial statements have been prepared without audit, pursuant
to the rules and regulations of the Securities and Exchange Commission
(SEC). Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with generally accepted
accounting principles, have been condensed or omitted pursuant to SEC rules
and regulations; nevertheless, management believes that the disclosures
herein are adequate to make the information presented not misleading. These
financial statements should be read in conjunction with the financial
statements and notes thereto included in the Form 10K and Proxy Statement.
In the opinion of management, all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial position of
the Company as of June 30, 1999, and the statements of income and cash flows
for the six month periods ended June 30, 1999 and 1998, have been included
herein. The results of operations for the interim periods are not
necessarily indicative of the results for the full years.
(2) Under the requirements in Statement of Financial Accounting
Standards (SFAS) No. 128 for calculating basic earnings per share, the
dilutive effect of stock options and warrants are excluded.
(3) Litigation Settlement
On May 11, 1999 the Company announced it had entered into a settlement
agreement with the State of Hawaii and Complete Business Solutions, Inc.
("CBSI"). See Item 1 - Legal Proceedings. Prior to the settlement, the
Company had assets related to the Hawaii project of $3.46 million and
liabilities of $856,000. After tax considerations are taken into effect,
the settlement will result in a reduction of net assets of $1.87 million.
The effect of the settlement on net income for the three months ended June
30, 1999 was as follows:
<TABLE>
<CAPTION>
<S> <C>
Write off of:
Contract receivables and costs in
excess of billings on Hawaii contract ($3,459,382)
Hawaii payable 576,483
Capital leases, short and long term portion 57,994
Other accrued expenses 217,197
Present value of litigation settlement ( 868,957)
Payment from CBSI 300,000
----------
Effect on income before income taxes ($3,176,665)
Tax effect 1,302,433
----------
Effect on net income ($1,874,232)
==========
</TABLE>
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Cautionary Statement Regarding Forward-Looking Statements
This report contains forward-looking statements reflecting the Company's
expectations or beliefs concerning future events that could materially affect
Company performance in the future. All forward-looking statements are subject
to the risks and uncertainties inherent with predictions and forecasts. They
are necessarily speculative statements, and unforeseen factors, such as
competitive pressures, litigation results and regulatory and state funding
changes could cause results to differ materially from any that may be
expected. In particular,adverse decisions in on-going material litigation
could have a material adverse effect on the Company's financial condition and
operating results. Actual results and events may therefore differ
significantly from those discussed in forward-looking statements. Moreover,
forward-looking statements are made in the context of information available
as of the date stated, and the Company undertakes no obligation to update or
revise such statements to reflect new circumstances or unanticipated events
as they occur.
General
In April 1999, the Company announced the resignation of Director Clifton
C. Dutton and the appointment of Director Peter C. Wallace.
In May 1999 the Company announced the settlement of its litigation with
the State of Hawaii (the "State") and Complete Business Solutions, Inc.("CBSI").
The Company agreed to pay the State $1 million over four years. CBSI agreed
to pay the Company $300,000 immediately. In both agreements, no party
admitted any wrongdoing. The Company has not settled with Maximus. Inc.,
the contract monitor on the project, against which the Company filed a
third-party complaint. To facilitate the settlement, Lockheed Martin IMS
Corporation, also a subcontractor on the Hawaii contract, agreed to modify
certain aspects of a promissory note issued to it by the Company in 1997.
See Item 1 - Legal Proceedings.
In June 1999, the Company announced that the State of Rhode Island,
Department of Administration, had awarded a contract to the Company valued at
approximately $5.25 million to support the State's InRHODES computer system,
used by the Department of Human Services and the Division of Taxation - Child
Support Enforcement. The State of Rhode Island has the option to renew the
contract for up to three additional years.
In July 1999, the Company announced that the State of Maine had extended
the Company's contract to support and enhance the MACWIS child welfare system
for another year. The value of the contract is approximately $2.6 million.
Year 2000 Disclosure
The Year 2000 issue concerns the inability of information systems,
primarily computer software programs, to recognize properly and process date
sensitive information subsequent to December 31, 1999. The Company has
committed resources (approximately $79,500) over the past year to improve its
information systems ("IS project"). The Company has used this IS project as
an opportunity to evaluate its state of readiness, estimate expected costs
and identify and quantify risks associated with any potential year 2000 issues.
State of Readiness:
In evaluating the Company's exposure to the year 2000 issue, management
first identified those systems that were critical to the ongoing business of
the Company and that would require significant manual intervention should those
systems be unable to process dates correctly following December 31, 1999.
These systems were the Company's internal time tracking system and internal
administrative system. Once these systems were identified, management
identified and agreed to undertake the following steps to ascertain the
Company's state of readiness:
I. Obtaining letters from software and hardware vendors concerning the
ability of their products to properly process dates after December
31, 1999;
II. Testing the operating systems of all hardware used in the Company,
and internal administration systems to determine if dates after
December 31, 1999 can be processed correctly;
III. Surveying other parties who provide or process information in
electronic format to the Company as to their state of readiness and
ability to process dates after December 31, 1999; and
IV. Testing the identified information systems to confirm that they will
properly recognize and process dates after December 31, 1999.
The Company anticipates completion of Step I - Step IV above for all
material software and hardware by the end of August 1999. Any software or
hardware determined to be noncompliant will be modified, repaired or replaced.
The Company estimates the costs of such modifications, repairs and replacements
to be $100,000 at this time.
Costs:
As noted above, the Company spent approximately $79,500 over the past year
to improve its information systems. In addition, the Company anticipates
that it will spend approximately $20,500 over the next six months to improve
its information systems further.
Risks:
Effective August 4, 1998, the Securities and Exchange Commission issued
Release No. 33-7558 (the "Release") in an effort to provide further guidance
to reporting companies concerning disclosure of the year 2000 issue. In this
Release, the Commission required that registrants include in its year 2000
disclosure a reasonable description of its "most reasonably likely worst case
scenario." Based on the Company's assessment and the results of remediation
performed to date as described above, the Company believes that all problems
related to the year 2000 will be addressed on a timely basis so that the
Company will experience little or no disruption in its business immediately
following December 31, 1999. However, if unforeseen difficulties arise, or if
compliance testing is delayed or necessary remediation efforts are not
accomplished in accordance with the Company's plans described above, the
Company anticipates that its "most reasonably likely worst case scenario" (as
required to be described by the Release) is that some percentage of the
Company's time tracking related to contract labor costs would need to be
processed manually for some limited period of time. In addition, the Company
anticipates that all businesses (regardless of their state of readiness),
including the Company, will encounter some minimal level of disruption in its
business (e.g., phone and fax systems, alarm systems, etc.) as a result of the
year 2000 issue. However, the Company does not believe that it will incur any
material expenses or suffer any significant loss of revenues in connection
with such minimal disruptions.
Contingency Plans:
As discussed above, in the event of the occurrence of the "most reasonably
likely worst case scenario" the Company could hire an appropriate level of
temporary staff to manually assist with the time tracking process.
Forward Looking Statements:
Certain information set forth above regarding the year 2000 issue and the
Company's plans to address those problems are forward looking statements under
the Securities Act and the Exchange Act. See the second paragraph of
Management's Discussion and Analysis of Financial Condition and Results of
Operations for a discussion of forward-looking statements and related risks and
uncertainties. In addition, certain factors particular to the year 2000 issue
could cause actual results to differ materially from those contained in the
forward looking statements, including, without limitation: failure to identify
critical information systems which experience failures, delays and errors in
the compliance and remediation efforts described above, unexpected failures
by key vendors, software providers or business partners to be year 2000
compliant or the inability to repair critical information systems. In any
such event, the Company's results of operations and financial condition could
be adversely affected. In addition, the failure to be year 2000 compliant of
third parties outside of our control such as electric utilities or financial
institutions could adversely effect the Company's results of operations and
financial condition.
The Company has conducted a comprehensive review of its internal computer
systems to identify the systems that could be affected by the "Year 2000" issue
and is developing an implementation plan to resolve the issue. The Year 2000
problem is the result of computer programs being written using two digits
rather than four to define the applicable year. Any of the Company's
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather that the year 2000. This could result in a major system
failure or miscalculations. The Company presently believes that, with
modifications to existing software and converting to new software, the Year
2000 problem will not pose significant operational problems for the Company's
computer systems as so modified and converted. However, if such
modifications and conversions are not completed timely, the Year 2000 may
have a material impact on the operations of the Company.
Results of Operations - Six Months Ended June 30, 1999 Compared to 1998
Contract revenue decreased $236,543 or 4% from $5,475,313 in the six
months ended June 30, 1998 to $5,238,770 in the six months ended June 30, 1999
primarily due to the completion of the development and implementation of the
Maine child welfare project (MACWIS) in April 1998. This was partially offset
by increased revenues on information technology consulting and systems
development activities in both the private sector and in higher education.
Cost of revenue earned, consisting of direct employee labor, direct
contract expense and subcontracting expense, decreased $465,431 or 13% from
$3,605,184 in the six months ended June 30, 1998 to $3,139,753 in the six
months ended June 30, 1999 due to a reduction in information technology
subcontractor cost as a result of the completion of the MACWIS project.
Gross profit increased $228,888 or 12% from $1,870,129 for the six months
ended June 30, 1998 to $2,099,017 for the six months ended June 30, 1999.
Gross profit as a percentage of revenue earned increased from 34% for the six
months ended June 30, 1998 to 40% for the six months ended June 30, 1999.
The increase in gross profit percentage is due to higher margins on new
projects commencing in the second half of 1998.
Selling, general and administrative (SG&A) expenses increased $236,067 or
21% from $1,120,292 in the six months ended June 30, 1998 to $1,356,359 in the
six months ended June 30, 1999 due to an increase in marketing and business
development related activities. On a percentage of revenues basis, SG&A
expenses increased from 21% to 26%.
The litigation settlement, consisting of (1) the write off of Hawaii
related receivables, work in process and liabilities, (2) the present value of
the payment due to Hawaii and (3) a $300,000 payment from CBSI, is $3,176,665.
See Item 1 - Legal Proceedings and Note 3 to Notes to Financial Statements.
Interest expense increased $19,649 to $59,364, or 49.5%, from $39,715 due
to a higher level of borrowings under term loans. See Liquidity and Capital
Resources.
As a result, income before income taxes decreased $3,224,836 from $763,163
for the six months ended June 30, 1998 to a loss of $2,461,673 for the six
months ended June 30, 1999.
Net income decreased $1,905,305 from $450,263 for the six months ended
June 30, 1999 to a loss of $1,455,042 for the six months ended June 30, 1999.
Results of Operations - Three Months Ended June 30, 1999 Compared to 1998
Contract revenue decreased $703,326 or 22% from $3,253,696 in the three
months ended June 30, 1998 to $2,550,370 in the three months ended June 30,
1999 primarily due to the completion of the development and implementation of
the Maine child welfare project (MACWIS).
Cost of revenue earned, consisting of direct employee labor, direct
contract expense and subcontracting expense, decreased $593,301, or 28%, from
$2,158,529 in the three months ended June 30, 1998 to $1,565,228 in the three
months ended June 30, 1999 due to a reduction in IT project related activities.
Gross profit decreased $110,025 or 10% from $1,095,167 for the three
months ended June 30, 1998 to $985,142 for the three months ended June 30, 1999.
Gross profit as a percentage of revenue earned increased from 33.7% for the
three months ended June 30, 1998 to 38.6% for the three months ended June 30,
1999. The increase in gross profit percentage is due to higher margins on new
projects.
Selling, general and administrative (SG&A) expenses increased $131,972 or
24% from $562,467 in the three months ended June 30, 1998 to $694,439 in the
three months ended June 30, 1999 due to an increase in sales, marketing and
business development related expenses. On a percentage of revenues basis, SG&A
expenses increased from 17.3% to 27.2%.
The litigation settlement, consisting of (1) the write off of the Hawaii
related receivables, work in process and liabilities, (2) the present value of
the payment due to Hawaii and (3) a $300,000 payment from CBSI is $3,176,665.
See Item 1 - Legal Proceedings.
Interest expense increased $18,878 to $29,408, or 179%, from $10,530 due
to a higher level of borrowings.
As a result, income before income taxes decreased $3,422,688 from $525,088
for the three months ended June 30, 1998 to a loss of $2,897,600 for the three
months ended June 30, 1999.
Net income decreased $2,022,036 from $309,798 for the three months ended
June 30, 1999 to a loss of $1,712,238 for the three months ended June 30, 1999.
Liquidity and Capital Resources
In order to finance bid preparation costs and to obtain sufficient
collateral to support performance bonds required by some customers, the Company
has, in the past, entered into joint ventures with other firms with greater
financial resources when bidding for contracts. The Company expects to continue
and expand this practice prospectively as well as to pursue more time and
material contracts than it has historically pursued. Time and materials
contracts generally do not require performance bonds and almost always involve
less risk to deliver what the customer requires.
The Company has historically not received its first contract progress
payments until approximately three to six months after contract award, which
itself was as much as 12 months after proposal preparation commences. The
Company was therefore required to fund substantial costs well before the
receipt of related income, including marketing and proposal costs and the
cost of a performance bond. Prospectively, the Company expects to tighten up
this timetable, thereby reducing the requirement for additional working capital.
The Company has funded its operations through cash flows from operations,
bank borrowings, borrowings from venture partners, and private placements of
equity securities. Net cash provided by operating activities was $415,181 and
$687,412 in the six months ended June 30, 1999 and 1998 respectively.
Fluctuations in net cash provided by operating activities are primarily the
result of changes in net income, accounts receivable and income tax receivable,
legal settlements, accounts payable and costs and estimated earnings in excess
of billings on contracts due to differences in contract milestones and payment
dates.
On December 31, 1997 the Company signed a $1.5 million line of credit with
a commercial lender (the "Line of Credit"). Accounts receivable from three of
the Company's contracts secure the new Line of Credit. The Company can borrow
up to 80% of the aggregate invoice amounts and is required to repay any
borrowings within 90 days. The interest rate is prime plus five percent on
balances below $1 million and prime plus one and one half percent on balances
over $1 million. The Line of Credit also carries a six- percent annual service
fee on borrowed balances. At June 30, 1999 the Line of Credit had an outstanding
balance of zero.
On September 21, 1998 the Company entered into two five-year term loans,
each for $250,000. One lender was the Small Business Loan Fund Corporation,
("SBLFC"), a subsidiary of the Rhode Island Economic Development Corporation.
The other lender was the Business Development Corporation of Rhode Island
("BDC"). The SBLFC loan carries an annual interest rate of 9.5% and must be
repaid over five years. The BDC loan carries an annual interest rate of
10.25%, and an annual deferred fee of $5,000, and must be paid back over five
years. Both term loans are secured by substantially all the assets of the
Company. The BDC was also issued five-year warrants to purchase 11,500
unregistered shares of the Company's Common Stock at a price of $4.50 per share.
The warrants expire on September 20, 2003. The fair value of the warrants was
estimated by the Company to be $36,806 using the Black-Scholes model and is
being amortized ratably over the exercise period. Such amount is included in
other noncurrent assets on the accompanying balance sheet.
The Company believes that cash flows generated by operations will be
sufficient to fund continuing operations through the end of 1999. The Company
believes that inflation has not had a material impact on its results of
operations to date.
PART 11 - OTHER INFORMATION
Item 1. Legal Proceedings
In June 1995, the Company began negotiating a significant amendment to its
contract for a child support enforcement ("CSE") system with the State of
Hawaii ("the State") when it determined that the total estimated cost to
complete the system would be significantly greater than expected. In March
1996, the Company received final State and federal government approval for this
contract amendment totaling $4.4 million. As a result of numerous in-depth
reviews of this contract amendment, management determined that remaining
contract costs would exceed the contract value by $440,000, and therefore,
accrued this loss in December 1995.
In June 1996 the Company announced a new subcontract agreement with
Complete Business Solutions, Inc ("CBSI") to expand CBSI's role in the Hawaii
CSE contract. CBSI, at the request of Hawaii, was contracted to lead a
detailed review of the current system under development. Hawaii, in turn,
agreed to pay CBSI $1.2 million from the Company's remaining contract budget
when various milestones were achieved. The Company had a significant role in
the detailed review and had hoped that its results would facilitate the
resolution of open contractual scope issues.
On September 13, 1996, the State of Hawaii terminated its contract with
the Company, effective September 23, 1996, claiming that the Company had
failed to fulfill its obligations under the contract. In response, the
Company also terminated the contract with the State effective September 23,
1996. The Hawaii contract, originally estimated to be a $20.7 million
contract, was increased to $25.2 million by the State in February 1996, and
was the Company's largest contract at the time. Prior to termination,
approximately $16.5 million of costs had been incurred towards completion of
the contract, and $11 million had been billed and substantially paid.
On November 12, 1996 the State of Hawaii filed a lawsuit in the Circuit
Court of the First Circuit of the State of Hawaii against the Company and Aetna
Casualty and Surety and Federal Insurance Company for damages due to breach of
contract (the "Hawaii litigation"). Aetna Casualty and Surety and Federal
Insurance Company provided the $10.3 million performance bond on the Company's
contract with the State of Hawaii to develop and install the State's child
support enforcement system. The suit alleged that the Company failed to meet
contractual deadlines, provided late, incomplete and/or unsuitable
deliverables,materially breached the contract by never completing the design,
the application programming, and the system test and systems implementation.
The State sought an unspecified amount for general damages, consequential and
special damages, liquidated damages, attorneys' fees, reimbursement for the
cost of the suit and interest costs that the court might deem just and proper.
The Company denied the State's allegation and, on January 23, 1997,
filed a counter claim against the State alleging that the State has breached
the contract. The Company sought $70 million in damages and alleged that the
State fraudulently induced the Company into designing and building a system
having capabilities and features far beyond the scope of the Company's
contract. The fraudulent inducement was in the form of withholding payments,
improper rejection of work that satisfied the requirements of the contract
and verbal and written abuse of the Company's employees and management.
In addition, Unisys, a vendor providing equipment under the Company's
Hawaii contract, submitted a $896,000 claim against the $10.3 million
performance bond. In February of 1997, the State released all but $1.1
million of the performance bond; the remainder is intended to cover amounts
payable to Unisys and other subcontractors. In April of 1997, after a detailed
review of their records and discussions with the Company, Unisys agreed to
lower their claim to $859,602 and Aetna Casualty and Surety paid that claim.
Lockheed Martin IMS ("Lockheed"), who guaranteed the performance bond,
reimbursed Aetna for that claim. In December 1997, the Company reached an
agreement with Lockheed to repay the $859,602 over a five-year period.
On December 13, 1996 CBSI filed a lawsuit in the Superior Court of the
State of Rhode Island for $517,503, which the Company had previously accrued,
plus interest costs and attorney's fees. The Company disputed the $517,503
owed to CBSI and filed a counterclaim against CBSI on January 13, 1997
alleging, among other things, that CBSI failed to complete its duties
required under the subcontract with the Company in a timely manner,
improperly engaged in negotiations with the State of Hawaii to complete the
project, hired and attempted to hire employees of the Company in violation of
its subcontract agreement with the Company and obtained and utilized
confidential information and proprietary intellectual property inappropriately.
Also, the Company alleged that CBSI owed the Company $482,750 as of December 31,
1996 for which the Company did not establish a reserve for uncollectibility.
On February 3, 1997, the Company filed a third-party complaint ("TPC") as
part of the Hawaii litigation against MAXIMUS Corporation ("MAXIMUS") and
CBSI. MAXIMUS had been the State of Hawaii's contract supervisor and advisor
since the inception of the Hawaii project. The allegations the Company made
against CBSI in this TPC were substantially similar to the allegations made
against CBSI in the Company's counterclaim to CBSI's December 13, 1996 lawsuit
brought against the Company in Rhode Island. The Company alleged that MAXIMUS
was liable to the Company on grounds that: (i) the Company was an intended
third party beneficiary under the contract between MAXIMUS and Hawaii; (ii)
MAXIMUS tortuously interfered in the contract between the Company and Hawaii;
(iii) MAXIMUS negligently breached duties to the Company, and (iv) MAXIMUS
aided and abetted Hawaii in Hawaii's breach of contract. The Company's
complaint sought $70 million in damages.
In connection with the Hawaii litigation, the Company was ordered to
assign all Hawaii related leases to the State.
Due to the significant uncertainty created by these events, the Company
ceased recognition of revenue on the Hawaii contract in 1996. An adjustment of
$1.8 million was recorded in the fourth quarter of 1996 to reverse revenue of
$1 million, $400 thousand and $400 thousand recorded previously in the first,
second and third quarters, respectively. In addition, 1996 costs incurred
related to the Hawaii contract of $1.96 million have been charged to expense.
On May 11, 1999 the Company reached a settlement agreement with both the
State and CBSI, which was approved by the court on July 22, 1999. All claims
of the Company, the State and CBSI will be dismissed, except the Company's
claims against MAXIMUS. Per the settlement, the Company agreed to pay the State
$1 million over four years as follows: June 1999 - $250,000, June 2000 -
$250,000, June 2001 - $250,000, June 2002 - $125,000 and June 2003 - $125,000.
The first payment was reduced by a $50,000 credit for the settlement of a lease
obligation on computer equipment. The equipment lessor, who had filed suit
against the Company, accepted $50,000 from the Company in full payment of that
obligation. CBSI agreed to pay the Company $300,000 immediately, which the
Company has received. Neither party to these agreements admitted any
wrongdoing. To facilitate the settlement, Lockheed agreed to modify certain
aspects of a promissory note issued to it by the Company in 1997. Lockheed
agreed to extend the note's maturity several years, to reschedule favorably
certain principal payments and to reduce the interest rate on the remaining
principal, which is $742,000 as of June 30, 1999.
The Company's litigation against MAXIMUS is continuing and is in the
discovery phase. The Company is seeking $75 million in damages. The Company
believes that its claims against MAXIMUS have substantial merit and will
vigorously pursue these claims.
Item 2. Change in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Shareholders held on May 19, 1999, shareholders
voted 828,634 shares (including voting preferred stock) as follows:
1) Election of Kenneth C. Kirsch, Nicholas R. Supron, Peter C. Wallace and
Ralph O. Cote as Directors to serve until the next annual meeting of the
stockholders or until their successors are elected and qualified.
<TABLE>
<CAPTION>
For Against Abstain No Vote
<S> <C> <C> <C> <C>
Kenneth C. Kirsch 818,676 0 3,556 6,402
Nicholas R. Supron 818,676 0 3,556 6,402
Peter C. Wallace 818,676 0 3,556 6,402
Ralph O. Cote 818,676 0 3,556 6,402
</TABLE>
2) Approval of a non-qualified stock option to purchase 50,000 shares of
the Company's Common Stock issued to Kenneth C. Kirsch.
<TABLE>
<CAPTION>
For Against Abstain No Vote
<S> <C> <C> <C> <C>
202,397 90,957 195,443 339,837
</TABLE>
Per the terms of the Company's agreement with its preferred shareholder,
the preferred shareholder, which entered an "abstain" vote has to approve the
option before they can be exercised and therefore the option is not approved at
this time.
Item 5. Other Materially Important Events
None
Item 6. Exhibits and Reports
(a) None
(b) The following reports on Form 8-K have been filed during the quarter for
which this report is filed.
A current report on Form 8-K, dated April 1, 1999 was filed by the Company
and included the press release dated April 1, 1999, announcing the
resignation of Director Clifton C. Dutton and the appointment of Director
Peter C. Wallace.
A current report on Form 8-K, dated April 27, 1999 was filed by the Company
and included the press release dated April 27, 1999, announcing the
Company's results for the quarter ended March 31, 1999. A Statement of
Operations (without notes) for the quarters ended March 31, 1999 and 1998
was included with the filing. A Balance Sheet as of March 31, 1999 and
December 31, 1998 was also included with the filing.
A current report on Form 8-K, dated May 13, 1999 was filed by the Company
and included the press release dated May 13, 1999, announcing the
settlement of the Hawaii litigation.
A current report on Form 8-K, dated June 30, 1999 was filed by the Company
and included the press release dated June 30, 1999, announcing the
extension of the Rhode Island support contract.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Network Six, Inc.
Date: July 29, 1999 By: /s/ Kenneth C. Kirsch
Kenneth C. Kirsch
Chairman, President and
Chief Executive Officer
By: /s/ Dorothy M. Cipolla
Dorothy M. Cipolla
Chief Financial Officer and Treasurer
(principal financial officer)
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1999
<PERIOD-END> JUN-30-1999 JUN-30-1999
<CASH> 1,451,003 1,451,003
<SECURITIES> 0 0
<RECEIVABLES> 2,157,151 2,157,151
<ALLOWANCES> 69,175 69,175
<INVENTORY> 0 0
<CURRENT-ASSETS> 5,287,674 5,287,674
<PP&E> 817,571 817,571
<DEPRECIATION> 577,657 577,657
<TOTAL-ASSETS> 6,448,169 6,448,169
<CURRENT-LIABILITIES> 2,652,787 2,652,787
<BONDS> 0 0
<COMMON> 79,278 79,278
0 0
2,235,674 2,235,674
<OTHER-SE> (28,217) (28,217)
<TOTAL-LIABILITY-AND-EQUITY> 6,448,169 6,448,169
<SALES> 2,550,370 5,238,770
<TOTAL-REVENUES> 2,550,370 5,238,770
<CGS> 1,565,228 3,139,753
<TOTAL-COSTS> 5,436,332 7,672,777
<OTHER-EXPENSES> (17,770) (31,698)
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 29,408 59,364
<INCOME-PRETAX> (2,897,600) (2,461,673)
<INCOME-TAX> (1,185,362) (1,006,631)
<INCOME-CONTINUING> (1,712,238) (1,455,042)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,712,238) (1,455,042)
<EPS-BASIC> (2.27) (2.06)
<EPS-DILUTED> (2.27) (2.06)
</TABLE>
