SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB
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 Number: 1-13760
THE NETWORK CONNECTION, INC.
1324 Union Hill Road
Alpharetta, Georgia 30201
(770-751-0889)
A Georgia Corporation IRS Employer ID No. 58-1712432
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.001 par value per share Registered on The Nasdaq Stock
Market
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(b) of the Securities Exchange
Act of
1934 during the preceding 12 months, 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-KSB or
any
amendment of this Form 10-KSB. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based on the closing sale price of the Common Stock on
March
2, 1998, in the over-the-counter market as reported by The Nasdaq
SmallCap Market tier of The Nasdaq Stock Market, was approximately $17.0
million. Shares of Common Stock held by each officer and director and
by each person who owns 5% or more of the outstanding Common Stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination
for other purposes.
As of March 2, 1998, the registrant had outstanding 4,152,393 shares of
its Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
None
PART I
Item 1. Business
GLOSSARY
Superserver - a network computer designed to provide local area
networks with the performance, availability, scalability and
upgradability
characteristic of mainframes and minicomputers, as well as the
compatibility of a PC; superservers reduce the input/output bottlenecks
and
performance degradation typically associated with PC-based servers
attempting to perform multiple tasks concurrently using a single
microprocessor.
Compatibility - also called openness; supports industry-standard
network operating systems, applications and application development
tools,
and network connectivity products; non-proprietary.
Local Area Network or LAN - a network or connected group of
computers or workstations located within the confines of a single
physical
structure or related group of structures, all the members of which group
are in close proximity to each other.
Performance - a level of compute power, data I/O and communication
capability comparable to that provided by mainframes and
minicomputers; meets the requirements of large numbers of users running
compute and I/O- intensive applications and high-speed communication
functions.
Availability - providing the reliability, data integrity and
recoverability features required for business-critical applications;
providing
reliability features that increase the mean-time between failures and
promote the continuing operation of the superserver after failure;
offering data
integrity features that protect against data loss or corruption during
system operation; and incorporating recoverability features to
facilitate recovery
when a stoppage does occur.
Scalability - also called expandability; the ability to maintain
rapid response time to each client as the number of concurrent clients
or
applications increases; supported in the field through the incorporation
of an additional central processing unit subsystem, main memory chips,
mass
storage and other subsystems, such as network interface cards;
scalability extends the superserver's useful life and protects the end
user's initial
investment.
Upgradability - the ability to replace subsystems and disk drives
economically, within superserver product generations, with higher
performance products that either are available today or become available
in the future, without requiring alteration of the superserver's network
operating system, application software or other hardware.
Wide Area Network or WAN - a network of computers or workstations
the individual members of which are geographically dispersed and
generally interconnected through the facilities of a common carrier
telecommunications system.
General
The Company designs, manufactures and distributes computer
networking products and systems, including high performance superservers
and workstations, which provide users with video on demand applications
and support and full motion digital video, imaging and other multimedia
processes. The Company's networking products are used in connection with
employee training, academic, telecommunications, entertainment and
other industry applications. Video on demand permits new ways to employ
video as an instructional, entertaining and communications medium over
existing computer networks. Each user is given the ability to call-up
video content as needed, without affecting any other network
participant's
requirements on the system, and without requiring any other system
participant simultaneously to view the same content.
The Company was originally incorporated in 1986 to distribute
computer network products as a value added distributor ("VAD") of such
products. Although its principal business continued as a VAD, in 1987
the Company made a strategic shift in its business operations by moving
away
from the distribution of products manufactured by others and to seek to
become principally a manufacturer of its own superserver and workstation
products. This shift resulted from changing trends in the computer
industry, which included increased profit margin pressures on VADs due
to the
perception that VADs were offering simple commodities rather than value
added products for sale to their customers.
The Company's products are sold under the name TRIUMPH, and are
based upon non-proprietary PC hardware standards and utilize
standard major components and subsystems in order to provide flexibility
and reliability. The Company's products are designed to be compatible
with
industry standard network operating systems, such as Novell NetWare,
Microsoft LAN Manager, Windows NT, OS2, UNIX (SCO, SVR4, MPX) and
new network operating systems as they become available. Product design
allows compatibility with most applications running in such network
environments, and enables TRIUMPH superserver systems to operate
efficiently as servers and work stations for groups of interconnected
PCs
arranged in LANs and WANs. The Company currently distributes its
products worldwide principally through its own internal sales force and
strategic
resellers.
Background and Industry
During the 1980s, personal computers played an increasingly
significant role in the workplace. The need of PC users to share files,
applications and peripherals, such as printers, has resulted in the
widespread proliferation of LANs. Each LAN requires a network operating
system to
function. This need is being filled by such products as Microsoft
Windows NT, Novell NetWare, Microsoft LAN Manager, SCO UNIX and Banyan
VINES, among others. Each LAN also requires a computer to manage its
operations. In simple LANs, a dedicated personal computer acts as the
LAN's "server." Larger LANs have employed high-end PCs to act as
servers.
The number, size and complexity of LANs have increased
dramatically in recent years. New LANs are being developed that support
a greater
number of users than in the past, and groups of smaller LANs are being
replaced by single, larger LANs. In addition, multiple LANs are being
internetworked to form WANs. More sophisticated tasks, such as document
and image processing, employee training, academic teaching, medical
diagnostic services and multimedia publishing and broadcasting editing
are increasingly being implemented on LANs. Some applications, such as
groupware (e.g., Lotus' Notes and electronic mail), are implemented only
on networks. In addition, companies such as Oracle Systems Corporation,
Informix Corporation, Sybase, Inc. and Centura Software have recently
introduced network versions of sophisticated database management
applications that have traditionally been run on mainframes or
minicomputers.
Large organizations with multiple sites are creating enterprise-
wide networks to more fully integrate their various geographic
locations. In
this regard, enterprises are interconnecting their multiple LANs, WANs,
digital satellite communication channels, mainframes, minicomputers and
other computing resources to facilitate communication and information
sharing within the organization. Innovations such as multi-protocol
routing,
LAN-to-mainframe gateway software and network management products are
facilitating such interconnectivity. The Company believes that these
communication functions will increasingly be executed on network
servers.
As organizations continue to migrate toward enterprise networking,
superservers that perform more complex and business-critical tasks will
be required. Although PCs have adequately addressed simple file serving,
even high-end PCs do not have the required performance and input/output
("I/O") capability to meet the needs of large and complex networks
efficiently. In addition, as business-critical applications and
communication
functions are increasingly implemented on the network, network servers
need to offer the availability, scalability and upgradability that are
characteristic of mainframes and minicomputers.
One of the developing distribution functions that is increasingly
being demanded for LAN processing is video display and information
distribution. Video technology requires amounts of information (e.g.,
data per second) to be available and distributed which is in excess of
that
required by other applications, such as word processing, even when that
information is technologically compressed. Available hard disk storage
and
network bandwidth is consumed by video information at far faster rates
than by other types of processed data. Furthermore, to meet the demands
of
current applications video information also must be provided
continuously and smoothly to multiple users simultaneously. Thus, the
current challenge
for manufacturers and distributors of superservers is to create a cost
effective, standardized product to satisfy the demands of a marketplace
for
video/multimedia network equipment and software that Management of the
Company expects will experience rapid growth in the next three years.
The Company believes that mainframes and minicomputers are too
costly a means for satisfactory service of this emerging market, and
their
proprietary architectures are generally incompatible with the PC
networks which are increasingly used for information processing in
today's more
decentralized business environment. Thus, as networks increase in size
and complexity and as business-critical applications and communication
functions are increasingly implemented on networks, a need is emerging
for servers both designed specifically for the demands of this new
enterprise,
and video/multimedia, networking environment, and made available as a
cost-effective means for distributing the required information.
Sales of the Company's TRIUMPH superservers are made increasingly
as "turnkey" systems. The Company sells its products as a complete
solution to a customer's needs, rather than as only a "finger in the
dike" or a niche filler. In 1995, the Company introduced, hardware,
software and
services packaged as complete value added system solutions for the
travel and transportation commercial markets: (i) "AirView," an in-
flight
interactive entertainment and cabin management system mounted in
individual airline seats, (ii) "TrainView." an in-transit interactive
entertainment
and railcar management system mounted in individual railcar seats and
(iii) "InnView," an in-room interactive entertainment system for the
hotel
hospitality market and (iv) "CruiseView," an in-room interactive
entertainment system for the cruise ship market. This sales trend is
expected to
continue, and even to accelerate, as video/multimedia superserver
equipment become more and more of a commodity.
The Network Connection Solution
In 1987, the Company first introduced the initial entry of its
TRIUMPH family of superservers, which is designed to provide the
compatibility, performance, availability, scalability and upgradability
necessary for sophisticated networks. The Company believes that its
superservers
contain the following features.
* Compatibility
The TRIUMPH family is based upon PC hardware standards and is
designed to be compatible with industry standard network operating
systems, such as Windows NT, Novell NetWare, Microsoft LAN Manager, SCO
UNIX and Banyan VINES, and with new network operating systems
as they become available. In addition, the Company's products are
designed to be compatible with applications designed to run in such
network
environments. TRIUMPH superserver use of common PC "interfaces" (e.g.,
products utilized to increase system functionality in terms of system
power
and/or special or additional features availability), such as the Small
Computer System Interface ("SCSI"), and its employment of Peripheral
Component Interconnect ("PCI") and Extended Industry Standard
Architecture ("EISA"), also enables the Company's products to connect
with
hardware produced by third-party vendors. The TRIUMPH superserver also
provides for ease of support of a wide range of network connectivity
standards.
* Performance
The TRIUMPH architecture consists of independent subsystems
interfaced by a high-speed multiprocessor connection system. This
architecture is designed to reduce the I/O bottlenecks and performance
degradation typically associated with PC- based servers attempting to
perform
multiple tasks concurrently with a single microprocessor. The TRIUMPH
open systems architecture and RAID ("redundant array of independent
disks") technology incorporates the fault tolerance and high throughput
necessary to provide simultaneous services, such as video-on-demand,
LAN-based video training, and database/file imaging and printing. In
addition, as the TRIUMPH superservers can provide video/multimedia
systems
encompassing voice or sound, pictorial and graphic, live or recorded,
and touch technologies, the Company believes that easy access to
information in
a "user friendly" environment is made available. In this respect, the
TRIUMPH architecture is designed to provide features found in mainframes
and
minicomputers at a significantly lower cost. A single TRIUMPH
superserver may often be used to replace multiple high-end PCs acting as
LAN
servers. Returning these high- end PCs to the desktop to perform other
tasks reduces the effective cost of the TRIUMPH superserver.
* Availability
The TRIUMPH architecture is designed to permit systems to be
configured to provide the high level of availability required for
business-critical applications through reliability, data integrity and
recoverability features. Reliability features available for certain
TRIUMPH models
include power supply and other key module redundancy to promote
continued system operation, cooling system redundancy to protect against
premature component failure and disk mirroring and automatic disk backup
by providing an ability to replace hard disks during system operation
without interruption. The TRIUMPH data integrity features minimize the
potential for data loss during system operation and, in addition to the
disk
backup features described above, include data parity checking to enhance
data integrity. Recoverability features facilitate recovery when a
stoppage does occur and include subsystems which permit remote
diagnostics subsystems for TRIUMPH superservers running Novell NetWare
and
Microsoft NT Advanced Server.
* Scalability
The TRIUMPH platform is configurable to meet the less demanding
requirements of simpler LAN applications and may subsequently be
scaled up in the field as the user enlarges its network or implements
more sophisticated applications. An additional Intelligent I/O Processor
subsystem, an additional Central Processing Unit ("CPU") subsystem,
components such as memory chips and disk drives, and PCI/EISA-
compatible
subsystems such as network interface cards, may be added.
* Upgradability
The TRIUMPH superserver subsystems and disk drives may be replaced
economically in the field with higher performance products that
either are available today or, presumably become available in the
future, without requiring alteration of the network operating system,
application
software or other hardware.
Product Strategy
Technology and Product Strategy
* Support Popular Network Operating Systems
The Company intends to support new releases of popular network
operating systems that it currently supports as they become available.
The
Company also intends to support additional network operating systems as
their popularity increases. The TRIUMPH superserver open architecture
and
compatibility features permit ease of support. In addition, Windows NT
takes advantage of the TRIUMPH superserver shared memory architecture,
as
does SCO UNIX (and presumably as will other multi-processing network
operating systems as they become available).
* Develop Higher Performance Superservers While Maintaining
Compatibility
The Company's principal technological challenge with respect to
the development of its TRIUMPH family of superservers was to
simultaneously deliver high performance and compatibility with existing
PC hardware and software standards. The Company intends to continue
improving the performance of its superservers while maintaining
compatibility with popular network operating systems and hardware
interfaces.
* Offer Broad Product Line
The scalability of TRIUMPH superservers increases the desirability
of these products from the perspective of a user who currently has a
simple LAN that is anticipated to grow or to support new, more
sophisticated applications. As a result, the Company believes that it is
important to
offer a base configuration product at a relatively low price point to
induce these users to purchase the next level TRIUMPH superserver in
anticipation
of scaling up as network demands increase (e.g., video/multimedia). On
the other hand, users with sophisticated applications or complex LANs
typically require superservers configured with faster microprocessors
and other higher performance subsystems (e.g., video and other
multimedia
accessibility). Therefore, the Company also offers higher performance
TRIUMPH superservers at higher price points. In 1995, the Company
introduced, hardware, software and services packaged as complete value
added system solutions for the travel and transportation commercial
markets.
See "Turnkey Packaging" below.
* Turnkey Packaging
Sales of the Company's TRIUMPH superservers are made increasingly
as "turnkey" systems. The Company sells its products as a complete
solution to a customer's needs, rather than as only a "finger in the
dike" or a niche filler. In 1995, the Company introduced, hardware,
software and
services packaged as complete value added system solutions for the
travel and transportation commercial markets: (i) "AirView," an in-
flight
interactive entertainment and cabin management system mounted in
individual airline seats, (ii) "TrainView." an in-transit interactive
entertainment
and railcar management system mounted in individual railcar seats and
(iii) "InnView," an in-room interactive entertainment system for the
hotel
hospitality market and (iv) "CruiseView," an in-room interactive
entertainment system for the cruise ship market. This sales trend is
expected to
continue, and even to accelerate, as video/multimedia superserver
equipment become more and more of a commodity.
Technology
The Company believes that the TRIUMPH architecture allows its
products to provide the performance and availability advantages of a
mainframe without sacrificing compatibility with PC hardware and
software standards. This architecture consists of independent subsystems
interfaced by the Company's high-speed system Bus. These subsystems
include: the Company's proprietary TRIUMPH RAID Accelerated Controller
("TRAC"), an Intel Pentium-based Intelligent Input/Output Processor
subsystem; the Intel Pentium-based CPU subsystem; the PCI/EISA Bus
subsystem; and the main memory subsystem. These subsystems operate
independently and thus reduce the I/O bottlenecks and performance
degradation typically associated with PC-based servers attempting to
perform multiple tasks concurrently using a single microprocessor.
Network Operating System Compatibility Features. Network operating
systems are designed to work with architectures that incorporate
industry
standard connection features. When a server design features an
architecture that does not incorporate such industry standards, the
server manufacturer
must modify the network operating systems utilized in order for it to
work with its nonstandard architecture. Generally, the time, expense and
knowledge necessary to complete these modifications limit the number of
network operating systems supported by these proprietary servers and
restrict
their ability to respond quickly to new NOS releases. The TRIUMPH
superserver open architecture is compatible with the basic I/O system
that allows
computer hardware to connect to a network operating system. This enables
the TRIUMPH superserver to support any network operating systems with
the relatively simple addition of drivers specific to that network
operating system. TRIUMPH superservers are, therefore, compatible with
leading
network operating systems such as Windows NT, Novell NetWare, Microsoft
LAN Manager, SCO UNIX and Banyan VINES. The Company's
products are also designed to be compatible with new network operating
systems as they become available.
Application Compatibility Features. The TRIUMPH superserver open
architecture permits applications written for use with the network
operating
systems supported by the Company to run unmodified. TRIUMPH
superservers, therefore, support applications that require both network
operating
systems and basic I/O system compatibility.
Hardware Interface Protocols. Each TRIUMPH subsystem provides hardware
compatibility by supporting industry standard interfaces with simple
software drivers. The TRAC subsystem offers SCSI compatibility, the CPU
subsystem offers Intel compatibility and the Bus subsystem offers
PCI/EISA compatibility. SCSI peripherals, network interface cards or
other subsystems designed by third parties that incorporate
technological
advances in any of these standards-based product areas may be added
easily to TRIUMPH superservers.
Intelligent I/0 Processor Subsystem. The TRAC subsystem includes an
Intel processor, which is dedicated to managing mass storage and
consequently relieves the main CPU of that task and improves overall
system performance. With the TRAC, data is accessed from the disk drives
and
is more easily and economically (in terms of bandwidth usage) available
to the CPU and main memory. Each TRAC contains two SCSI channels, each
of which is capable of supporting up to seven fast SCSI disk drives or
other SCSI peripherals, including third-party disk arrays, tape backup
units,
printers and CD-ROM drives. Up to two TRACs can be configured in a
TRIUMPH superserver, allowing a maximum of 35 SCSI peripherals per
system.
The TRAC also incorporates RAID technology at the output and input
levels to help protect the system from data loss. This technology,
which is commonly referred to as data striping and disk mirroring, also
improves system performance by reducing data transfer and access times
from
disk drives.
Central Processing Unit Subsystem. The CPU subsystem runs the NOS and
applications in client-server environments. The CPUoffers complete Intel
compatibility. Each subsystem may be upgraded with a CPU that
incorporates a microprocessor operating at a higher clock speed.
Availability Features. The TRIUMPH superserver's architecture is
designed to permit systems to be configured to provide the high level of
availability required for business- critical applications through
reliability, data integrity and recoverability features. Reliability
features available for
certain TRIUMPH models include power supply and other key module
redundancy to promote continued system operation, cooling system
redundancy
to protect against premature component failure and disk mirroring and
automatic disk backup through duplexing and hot sparing supported at the
hardware level. The TRIUMPH superserver data integrity features minimize
the potential for data loss during system operation and, in addition to
the
disk backup features described above, include data parity checking to
enhance data integrity. Recoverability features facilitate recovery when
a
stoppage does occur and include systems providing a remote diagnostics
subsystem for TRIUMPH superservers running Novell NetWare.
Products
The current TRIUMPHr product line consists of: the Cheetah
Enterprise Video File Server, the M2r Enterprise File Server, the TNXr
Large Workgroup File Server, the T4000 Small Workgroup File Server, the
T300 and T5000 high end network work stations, and the TNX/C Video
File Encoder.
The following lists the basic features of each model in the
Company's current generation of TRIUMPH products:
VIDEO SERVERS
Cheetah? Enterprise Video File Server. The Cheetah? or MV2 has the
same capabilities as the M2r Enterprise File Server (see below), except
that
it contains certain configuration enhancements that allow for the
support of video applications across entire networks. It is designed to
serve up to 300
simultaneous video users per single system and can be rack mounted to
achieve up to 336 gigabytes of disk storage.
Cheetah? Large Workgroup Video File Server. The video capable version
of the TNX is very similar to Cheetah? described above, but with
reduced work station service capacity and reduced disk storage
capabilities. This product sells for between $25,000 to $50,000 per
system, depending
upon functions and configurations required.
FILE SERVERS
M2r Enterprise File Server. The Company's top-level non-video file
server, it is designed to serve over 1000 work stations. The M2 may
contain up
to six CPUs and has a disk storage capacity of up to 100 gigabytes. This
system contains an enhanced cooling system and RAID 5 and multiple power
supplies for support of its large disk hard drive capacity.
TNXr Large Workgroup File Server. The Company's mid-level file server,
it is designed to serve between 40-100 work stations. The TNX may
contain up to 6 processors and has a disk capacity of between 12-16
gigabytes. This system may or may not contain disk redundancy features
depending upon the needs of the particular customer.
T4000 Small Workgroup File Server. The Company's entry level file
server, it is designed as a "commodity" product to serve 10-20 work
stations. It
contains a single CPU processor and has a small disk capacity (between
4-8 gigabytes). This system may or may not contain disk redundancy
features
depending upon the needs of the particular customer.
WORK STATIONS
T3000. An entry level network work station, includes the capability of
providing normal office automation, graphics and word processing.
T5000. A high end, engineering work station, with single or multiple
processor configurations, designed for a range of desktop applications;
including - computer aided design, graphics, mathematical applications
and computer modeling.
OTHER PRODUCTS
TNX-C Encoder. The TNX-C is a real-time, networked Motion Pictures
Export Group (MPEG) encoder impression station. It converts analog video
data to digital files when conjoined with either of the Company's video
file servers. All encoded files are compressed and able to run
throughout an
associated network at 30 frames per second and near broadcast quality.
"TURN-KEY" PACKAGED SOLUTIONS
AirView. An in-flight interactive entertainment and cabin management
system mounted in individual airline seats.
TrainView. An in-transit interactive entertainment and railcar
management system mounted in individual railcar seats.
InnView. An in-room interactive entertainment system for the hotel
hospitality market.
CruiseView An in-room interactive entertainment system for the cruise
ship market.
These systems support live-feed, closed-circuit and satellite based
digital television programs in addition to personal interactive
entertainment and
video/audio on demand, shopping, multi-player games, gambling, shore
excursion/ event booking, karaoke and Internet access all
simultaneously,
independently and with full user control via a wireless television
remote control in each room or touch screen display at each seat. In
addition,
attendant interactive training can be provided at the same time.
Sales and Distribution
The Company currently distributes its products principally through
the efforts of its internal direct sales force and to a much lesser
extent
through independent sales representatives. In the future the Company
intends to offer its products through an augmented internal sales force.
The
Company also distributes its superserver products through a select group
of network-oriented resellers, including VADs and system integrators,
OEMs
and international distributors. Currently, the Company's principal means
of conducting its sales effort internationally is through trade show
attendance, holding end-user seminars to demonstrate Company products,
internal and a limited amount of customer on site demonstrations of
product
use (solely for superserver products), print advertising in trade
publications and telemarketing. The Company plans to continue and to
accelerate these
marketing efforts.
The Company is also attempting to develop relationships with
software and other product vendor "partners" capable of encouraging
their
customers to purchase the Company's systems in conjunction with their
own products on the basis that overall system or product performance
will be
enhanced. The Company would assist these partner-vendors by determining
the configuration of the Company's products that will deliver optimal
performance along with the partner-vendor's products.
The Company's marketing efforts focus on holding end-user seminars
and attending trade shows (including international trade shows) as the
primary method to create market awareness of the Company and its
products. At December 31, 1997, the Company had remote sales offices
internationally in Singapore and the United Kingdom.
The purchase price for the Company's "turn-key" packaged systems
for the travel related entertainment market is relatively high depending
upon various factors such as the size and type of airplane, train, hotel
or ship, and the requested system features. The high system purchase
price is
anticipated to result in a relatively extensive sales cycle, which will
include the evaluation of the Company's technology, a test installation
of the
system and negotiation of related agreements. The sales cycle is also
dependent upon a number of factors beyond the Company's control, such as
the
financial condition, safety and maintenance concerns, regulatory issues
and purchasing patterns of particular operators, and the respective
industry
generally. As a result, this can result in extremely cyclical buying
patterns for the Company's travel related entertainment products. (see
"Management's Discussion and Analysis of financial Condition and
Operating Results")
Competition
The Company faces substantial competition from the manufacturers
of several different types of products used as network servers. The
Company expects competition to intensify as more firms enter the market
and compete for market share. In addition, companies currently in the
server
market will continue to change product offerings in order to capture
further market share. Many of these companies have substantially greater
financial resources, research and development staffs, manufacturing,
marketing and distribution facilities than the Company. The Company also
expects its competitors to continue to improve their network-oriented
distribution channels.
With respect to base configuration TRIUMPH superservers for simple
LANs, the Company competes with manufacturers of high-end PCs
used as network servers. Competitors offering products in this market
include International Business Machines Corporation ("IBM"), Compaq
Computer, Inc.and Dell Corporation. One of the principal competitive
factors in the market for simple LANs is price, and the economies of
scale
available to high-end PC manufacturers may permit them to offer their
products at a lower price. The Company expects its competitors to
continue to
improve the performance, availability, scalability and upgradability
features of their products. The Company expects all of its competitors
in the
simple LAN market to improve the distribution channels for their
products used as servers.
With respect to more fully configured TRIUMPH superservers for
larger and more complex LANs and more sophisticated or business-critical
applications, the Company competes indirectly with manufacturers of
mainframes and minicomputers. In addition, certain manufacturers promote
their mainframes and minicomputers as being appropriate for use as
network servers. Competitors offering products in this market include
IBM,
Digital Equipment Corporation, Hewlett-Packard Corporation, National
Cash Register Corporation and UNYSIS, Inc. The Company believes that the
positive competitive factors in this market include the Company's
ability to provide server products with performance and availability
characteristic of
mainframes and minicomputers, at a significantly reduced cost, as well
as with the compatibility to support current and future networking
solutions
built around industry standard hardware and software. The Company's
operating results could, however, be adversely affected if one or more
of these
competitors elects to compete more aggressively with respect to price or
product features of their mainframes or minicomputers. The Company
competes in the market for complex LANs with other manufacturers of
superservers, including Sun, Silicon Graphics, Ncube, NetFrame and
Tricord.
The Company competes in the market for "turn-key" systems for travel
related entertainment with other manufacturers of complete systems,
including
Rockwell Collins Passenger Systems, BE Aeorspace, Sony Transcom,
Matsushita, Interactive Flight Technologies, Allin-Seavision and Trans
Digital.
The Company believes that it competes favorably with other manufacturers
of superservers and "turn-key" systems with respect to the
compatibility,
performance, availability, scalability, upgradability and technical
support required for sophisticated network computing available with the
Company's
products. In addition, components of the company's products are smaller,
weigh considerably less and consume much less power than those of
several
competitors. Because these factors affect operating costs for the
operator, they may be critical factors for customers.
The Company does not believe that its server products will compete
in the near future with those manufactured by IBM, Compaq
Computers, Inc. or the other "major players" in the industry. The
Company believes that the major computer manufacturers will generally
seek to
produce and service higher production-lower margin commodity products,
and will refrain from producing lower production-higher margin products
(like the Company's video servers) until the market for each related
product and product series is perceived to be large enough to support
the sizable
investments in production capability and advertising that the "major
players" must make prior to launching new products. Nevertheless, based
upon
the perceived size of the market for video capable network equipment,
the Company's management recognizes that it will only be a matter of
time
before the "major players" will start to produce higher margin network
equipment products which will compete directly with those produced by
the
Company.
There can be no assurance that alternative technologies will not
be developed in the future that will be capable of providing certain
services
now performed by network servers. The development of such technologies
could reduce the need for network servers and adversely affect the
Company's operating results.
As many of the Company's competitors are more established, benefit
from greater market recognition and have greater financial,
technological, production and marketing resources than the Company,
establishing and maintaining the Company's competitive position will
require
continued investment by the Company in research and development and
sales and marketing. There can be no assurance that the Company will
have
sufficient resources to make such investments or that the Company will
be able to make the necessary technological advances. In addition, if
more
manufacturers of PCs, mainframes or minicomputers were to develop and
market their own superserver class of products, the Company's operating
results could be adversely affected.
End Users
The Company's products are sold to end users in a wide range of
industries. Customers that have purchased the Company's products are
financial institutions, health care companies, academic institutions,
communications/broadcasting companies, governmental agencies and other
bureaucracies, entertainment providers and end-users operating in
various other industries.
More sales efforts in 1997 were focused on larger system sales
into niche markets of the Company's "turn-key" packaged solutions
AirView
and CruiseView which have longer sales cycles and will contribute to
sales backlog for revenues derived from multiple roll-out deliveries
over 12 to 36
months. As a result, the Company has been awarded programs on: (i)
Fairlines, a French commercial airline, for the purchase, installation,
maintenance and content management of AirView on ten Fairlines MD81
aircraft, of which eight systems had been shipped as of December 31,
1997
and (ii) Star Cruises, an Asian cruise line, for the purchase,
installation and maintenance of CruiseView on two cruise ships in August
of 1998 and
mid-1999, respectively. The Company has not yet received any firm orders
for TrainView systems. The Company currently has responded to major
requests for proposal and is in various stages of negotiation for
CruiseView, InnView, AirView and TrainView systems with multi-year
deliveries
from some of the world's largest travel related companies. There can be
no assurance however, that the Company will successfully negotiate
definitive
agreements for the purchase of these systems.
In 1997, three customers accounted for an aggregate of 79% (38%
from Fairlines, 30% from Conhan, Ltd. and 11% from the United States
government, respectively) of the Company's revenues. The Company's
products are often used with other products in large complex projects
with long
delivery cycles. The Company believes that its sales to the United
States government, as well as to state governments and their agencies
that make
purchases in accordance with federal Government Services Administration
("GSA") guidelines, will continue to grow. The Company is on the GSA
list of qualified vendors and descriptions of the Company's products
have been recently included as the required design specifications
identified in
federal government request for proposals distributed to potential
vendors.
In an Agreement dated as of June 19, 1997, the Company entered into an
AirView Purchase Agreement (the "AirView Agreement") with
Fairlines, a French corporation engaged in the start-up operation of a
commercial airlines, for the purchase of 10 AirView systems for
installation on
10 Fairlines aircraft. It is estimated by the Company that in the event
that all 10 AirView systems are sold to Fairlines under the terms of the
AirView
Agreement, the Company will generate over $10 million in gross revenues.
Delivery of all AirView systems under the terms of the agreement is
expected to be completed by December 31, 1998. The costs of purchase
from the Company include the cost of training Fairlines employees for
system
use, but do not include the cost of system installation which will be
provided by Hollingsead under a separate agreement with Fairlines.
In an Agreement dated as of February 13, 1998, the Company entered into
a CruiseView Purchase Agreement (the "CruiseView Agreement")
with Continuous Network Advisors ("CNA"), on behalf of Star Cruises
Management Limited ("Star"), an Ilse of Man corporation engaged in the
operation of a commercial cruise line, for the purchase of 2 CruiseView
systems for installation on 2 Star cruise vessels. It is estimated by
the
Company that in the event that both CruiseView systems are sold to Star
under the terms of the CruiseView Agreement, the Company will generate
over $5 million in gross revenues. Delivery of both CruiseView systems
under the terms of the agreement is expected to be completed by
September
30, 1999. The costs of purchase from the Company include the cost of
training Star employees for system use and the cost of system
installation.
Customer Support
The Company believes that customer service and support is a
significant competitive factor in the network server market which will
become
increasingly important as LANs become more complex and as more
enterprises implement business-critical applications on their networks.
The
Company supports its customers by providing rapid problem resolution
both during and after the installation process. The Company maintains a
small
technical support organization that assists customers in troubleshooting
problems and providing replacement parts. The Company provides a toll-
free
hotline to help diagnose and correct system interruptions as they occur
at customer sites and its support staff is available seven days a week.
The Company warrants all of its TRIUMPH superservers against
defects in materials and workmanship for one year (three years for disk
drives). During the warranty period the Company will repair or replace,
within four days, any TRIUMPH server component(s) which the Company
identifies as containing defects which do not prevent the continued use
of the server. For defects that do prevent the continued use of the
server, the
Company will attempt to repair or replace the identified defective
component within 24-hours. The Company's product warranties do not
materially
differ from those generally available in the industry.
To date, the Company has not experienced significant claims under
such warranties, and its ability to meet the full demands of having a
significant number of units sold to customers who require such service
has not been tested. The Company also passes through to end users the
warranties that it receives from vendors on any separate hardware,
software or component parts that it sells independently of full systems.
Manufacturing
The Company currently manufactures all of its TRIUMPH products in
the United States at its Atlanta, Georgia metropolitan area facility.
The Company obtains electronic components for its TRIUMPH products
"off-the-shelf" from a number of wholesalers and performs at its own
facility the assembly and test of the printed circuit boards and
mechanical components incorporated into its products. The only
significant
subcontracted manufacturing work performed for the Company is the
manufacture of cabinets for its file servers. The Company has
established a
comprehensive testing and qualification program with the goal of
ensuring that all subassemblies meet the Company's specifications and
standards
before final assembly and testing.
Diagnostic tests, assembly, burn-in, final configuration and final
quality assurance tests currently are completed at the Company's
manufacturing facility. The Company employs statistical process controls
at its manufacturing facility. The Company has also implemented quality
control policies that are reviewed and accepted by the Company's major
customers. The Company believes that this procedure helps ensure a
high-quality product.
The Company has elected to assemble into its products principally
off the shelf component parts available from multiple sources. The
Company believes that this practice helps to ensure better quality
control and pricing, by allowing the Company to select the best
manufactured and
best performing components available on the market (rather than a
proprietary product that may fall behind the "curve" in terms of either
such
characteristic) and to purchase such components from marketplace sources
that offer the best prices at the time that the particular components
are
needed for production (rather than to have prices dictated by the
limited sources able to provide a proprietary component). The Company
obtains
component parts on a purchase order basis and does not have long-term
contracts with any of its suppliers. To date, the Company has not
experienced
interruptions in the supply of such component parts, and believes that
numerous qualified suppliers are available. The inability of any of its
current
suppliers, except as identified below, to provide component parts to the
Company would not adversely affect the Company's operations. Alternate
sources could be readily established.
The Company has developed a manufacturing relationship with
Hollingsead International for AirView in connection with the Fairlines
program in order to permit performance of higher level system
manufacturing, integration and test functions to meet the regulatory
requirements of
the Federal Aviation Administration ("FAA") (See "Government
Regulation"). Such arrangements enable the Company to manufacture its
other
products in its existing facility, thereby avoiding the need to provide
for specialized manufacturing processes and additional capacity to meet
the needs
of the Fairlines program.
Due to the high cost of grounding an airplane, the Company
anticipates that installations are more likely to be scheduled during
the off-
season for the airline customer, generally the winter months. Because of
the manpower and experience required to perform installations, and due
to
the inherent relationship between installation and the Supplemental Type
Certificate ("STC") application and compliance process, the Company has
contracted with Hollingsead International to perform system installation
on all Fairlines aircraft. The Company anticipates that future
installations, if
any, will be performed by an experienced third-party subcontractor such
as Hollingsead International. (See "-- Government Regulation.")
Intellectual Property
The Company currently holds no patents, but has a patent
application pending with respect to its AirView products and technology.
The
Company currently holds federal trademarks, for the marks "TNX",
"TRIUMPH", "THE NETWORK CONNECTION", "M2", "M2V" and
"T.R.A.C.", "CHEETAH", "QUAD-CHEETAH", "CHEETAH WORKGROUP", "EDUVIEW",
"AIRVIEW", "TRAINVIEW", and has trademark
applications pending for the marks, "CRUISEVIEW", "BATTLEVIEW" and
"INNVIEW". The Company also relies on a combination of trade secret
and other intellectual property law, nondisclosure agreements with all
of its employees and other protective measures, to establish and protect
its
proprietary rights in its products. The Company believes that because of
the rapid pace of technological change in the networking industry, legal
protection of its proprietary information is less significant to the
Company's competitive position than factors such as the Company's
strategy, the
knowledge, ability and experience of the Company's personnel, new
product development, market recognition and ongoing product maintenance
and
support. Without legal protection, however, it may be possible for third
parties to copy aspects of the Company's products or technology or to
obtain
and use information that the Company regards as proprietary. In
addition, the laws of some foreign countries do not protect proprietary
rights in
products and technology to the same extent as do the laws of the United
States. Although the Company continues to implement protective measures
and intends to defend its proprietary rights vigorously, there can be no
assurance that these efforts will be successful. The failure or
inability of the
Company to effectively protect its proprietary information could have an
adverse effect on the Company's business.
There can be no assurance that third parties will not assert
intellectual property infringement claims against the Company. Although
no
claims or litigation related to any such matter are currently pending
against the Company, there can be no assurance that none will be
initiated, that
the Company would prevail in any such litigation seeking damages or an
injunction against the sale of the Company's products, or that the
Company
would be able to obtain any necessary licenses on reasonable terms if at
all.
Government Regulation
The installation and use of AirView on any particular aircraft
requires prior certification and approvals from the FAA and
certification and
approvals from aeronautical agencies of foreign governments. Because the
installation of the AirView is considered a major modification to an
aircraft, the Company must apply for and be granted an STC from the FAA.
This is a multi-step process involving required interim approvals. A
separate STC will be required with respect to each aircraft type on
which AirView will be installed. Once an STC is issued with respect to
an aircraft
type, the unit may be installed on other aircraft of the same type with
the same configuration provided each installation is performed in a
manner as
specified by the aircraft specific STC. To date, the Company has
obtained an STC for Fairlines MD-81 aircraft.
Because the process of obtaining an STC is highly technical,
the Company has entered into agreements with Hollingsead International
and its
subsidiary Elsinore Aerospace Services (collectively, "Hollingsead") to
assist the Company in the application and approval process (see ITEM 1 -
- -
"Manufacturing"). Hollingsead is an FAA designated engineering
representative experienced in in-flight entertainment systems and has
the authority
to approve, subject to final FAA review, certain aspects of the
Company's STC applications.
Once the Company identifies the specific aircraft type on which
AirView will be installed, it will, through the subcontractor, make
application to
the FAA for the STC for that aircraft type. Thereafter, the FAA will
initially establish the certification criteria required to be met for
approval, which
will include an in-flight test. The FAA, or its designee (such as
Hollingsead), subject to FAA review, will review all necessary
certification and
technical drawings, manuals and procedures for adequacy and compliance;
issue necessary interim approvals including permission to conduct a
flight
test of AirView; review the results of the flight test; perform
inspections to ensure that both the components of AirView and their
installation and
operation conform to the certification requirements; and issue the STC.
The FAA, in the issuance of the STC, will consider such factors as
whether
AirView will interfere with the operational and navigational equipment
installed on the aircraft; whether the electrical components of AirView
are
compatible with those of the aircraft; whether the components of AirView
installed in the passenger seats will interfere with emergency egress
from
the aircraft; whether the components of AirView will, if subjected to
heat or fire, emit toxic fumes; and similar safety and flight-related
concerns.
In addition, the Company or its subcontractor must obtain from the
FAA a Parts Manufacturer Approval ("PMA") with respect to the
components of AirView to be installed on each specific aircraft type for
which an STC is granted. There can be no assurance that the Company will
be
issued the STC's and PMA's for which it applies or that if such
approvals are granted, that they will be granted within a reasonable
time frame or
within the amount budgeted by the Company for such approvals. Federal
law grants to the FAA the authority to reexamine at any time the basis
upon
which certification and approval of AirView may be granted and, if
appropriate, to amend or revoke such certifications and approvals,
subject to
certain appeal rights.
The Company may also be required to obtain certification and
approval of AirView from the aeronautical authorities of foreign
countries. In
many cases, through technical working agreements between the FAA and the
foreign aeronautical authorities, such authorities will accept the FAA
issuance of the STC as approval, although certain countries authorities
reserve the right to independently review the data and the compliance
criteria
which support the issuance of the STC and to reach an independent
determination on whether to approve the equipment for installation and
operation.
There can be no assurance that necessary foreign government approvals
will be obtained, or if obtained, within a reasonable time frame or
within the
amount budgeted by the Company for this aspect of the project.
Research and Development
The market for the Company's products is characterized by rapid
technological change and evolving industry standards, and it is highly
competitive with respect to timely product innovation. The introduction
of products embodying new technology and the emergence of new industry
standards can render existing products obsolete and unmarketable. The
Company believes that its future success will depend upon its ability to
develop, manufacture and market new products and enhancements to
existing products on a cost-effective and timely basis.
If the Company is unable, for technological or other reasons, to
develop products in a timely manner in response to changes in the
industry,
or if products or product enhancements that the Company develops do not
achieve market acceptance, the Company's business will be materially and
adversely affected. The Company has in the past experienced delays in
introducing certain of its products and enhancements, and there can be
no
assurance that it will not encounter technical or other difficulties
that could in the future delay the introduction of new products or
enhancements.
Such delays in the past have generally resulted from the Company's need
to obtain a requisite component from a third-party vendor whose own
development process has been delayed (e.g., 9 month delay in Microsoft's
development in 1992 of Microsoft Windows NT, the primary operating
software system used in the Company's superserver products).
The Company performs all of its research and development
activities at its headquarters in Alpharetta, Georgia. During 1997 and
1996,
research and development expenses totaled $277,527 and $160,276,
respectively. The Company intends to continue to invest in research and
development.
Employees
As of December 31, 1997, the Company had 34 full-time employees
and 4 part-time employees. None of the employees is covered by a
collective bargaining agreement. The Company's success depends to a
significant extent upon the performance of its executive officers and
other key
personnel. The Company considers its relations with its employees to be
good.
Item 2. Property
The Company's primary operations are performed in its 20,000
square foot, owned facilities located on two acres in Alpharetta,
Georgia. The
Company is indebted to an institutional lender as of December 31, 1997,
in the aggregate amount of $238,767, for the purchase of this primary
operating facility. This loan is secured by the purchased real estate
and the personal guarantees of Wilbur and Barbara Riner, and bears
annual
interest at the rate of such lender's prime rate plus 2%.
The Company believes that its current facilities described above
are adequate for its immediate and near-term needs and does not
anticipate
the need for significant expansion in the near future.
Item 3. Legal Proceedings
Except for ordinary, routine proceedings incidental to its
business, there are no pending legal proceedings to which the Company or
any of its
property is subject.
Item 4. Submission of Matters to a Vote of Security Holders
None
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
Market for Common Stock
The Company's common stock trades on The Nasdaq SmallCap Market tier of
The Nasdaq Stock Market under the symbol "TNCX." The following
table sets forth the high and low sale prices for the Company's common
stock for each quarter of fiscal 1996 and for fiscal 1997 as reported by
The
Nasdaq Stock Market:
High Low
Fiscal 1996:
First Quarter $25.375 $7.625
Second Quarter 26.125 9.875
Third Quarter 14.750 8.500
Fourth Quarter 13.750 8.750
Fiscal 1997:
First Quarter $12.375 $5.750
Second Quarter 12.000 6.000
Third Quarter 10.500 7.000
Fourth Quarter 10.375 5.750
Holders of Record
At March 2, 1998, there were approximately 59 shareholders of
record of the Company's common stock, but the Company believes that
there
are over 1,000 beneficial shareholders, based upon broker requests for
distribution of annual meeting materials.
Dividends
Other than prior to September 22, 1994 when the Company made
distributions to shareholders as an S Corporation, the Company has not
declared or paid any cash dividends on its Common Stock and does not
intend to do so in the foreseeable future.
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion and analysis should be read in
conjunction with the information set forth in the Financial Statements
and notes
thereto included elsewhere in this report.
Company Overview
The Company designs, manufactures and distributes computer
networking products, including high performance superservers and
workstations, which provide full motion digital video, imaging and other
multimedia processes. The Company's products are used in employee
training, academic, telecommunications, entertainment and other industry
applications. Sold under the name TRIUMPH, the Company's products
utilize standard PC hardware, major components and subsystems, and are
designed to be compatible with industry standard network operating
systems, such as Novell NetWare, Microsoft LAN Manager, Windows NT, OS2,
UNIX (SCO, SVR4, MPX) and new network operating systems as
they become available. The Company has always focused on the single
factor which has made LANs so successful, which is the ability to use
"open
systems," which principally consist of standard interfaces between
system components and standard operating systems. In today's market, and
for the
foreseeable future, the Company believes that its place in the market
for network equipment results from its ability to produce high
performing LAN
systems for demanding combined video and data applications using an open
systems, standards based design. The Company believes that its
equipment may be distinguished from the products of competitors by the
Company's attention to constant shifts in the developing market for
network
equipment, and by the design quality of the equipment the Company
produces to take advantage of those shifts. The Company believes that
its
principal "value added contribution" is its ability to design standards
based equipment that provides higher performance than that designed and
offered
by its competitors, an advantage that the Company intends to maintain in
the future.
The market niches for the Company's high-end, high performance,
video capable products currently encompass, but are not limited to,
applications for education and corporate skills training, product
training, hotel, train, ship and airplane video-on-demand and retail
facility
information kiosks. More sales efforts in 1997 were focused on larger
system sales into niche markets of the Company's "turn-key" packaged
solutions
AirView and CruiseView, which have longer sales cycles and will
contribute to sales backlog for revenues derived from multiple roll-out
deliveries
over 12 to 36 months. As a result, the Company has been awarded programs
on: (i) Fairlines, a French commercial airline, for the purchase,
installation, maintenance and content management of AirView on ten
Fairlines MD81 aircraft, of which two systems had been installed on
Fairlines
aircraft and eight systems had been shipped as of December 31, 1997 and
(ii) Star Cruises, an Asian cruise line, for the purchase, installation
and
maintenance of CruiseView on two cruise ships in August of 1998 and mid-
1999, respectively. Due to the fact that all of the markets for this
type of
product are in their infancy, and their actual aggregate size is
impossible to measure accurately, the Company is unable to determine the
shares of
these markets held by its own products. Nevertheless, Management of the
Company expects the video server market to experience significant
growth,
with the growth to come principally from the high-performance
superserver segment of the market.
In 1997, three customers accounted for an aggregate of 79% (38%
from Fairlines, 30% from Conhan, Ltd. and 11% from the United States
government, respectively) of the Company's revenues. During 1996, three
customers accounted for 67% (38%, 15% and 14%, respectively) of the
Company's revenues. The Company's products are often used with other
products in large complex projects with long delivery cycles. The
Company
deferred $3.9 million in revenue and $1.2 million in profit from the
shipment of four Airview systems in the fourth fiscal quarter due to
notification by
Fairlines, in March 1998, of an unexpected delay in procuring the four
aircraft on which the AirView systems will be installed. As a result,
four
AirView shipments in the fourth fiscal quarter did not meet the revenue
and profit recognition requirements of the Company. The Company expects
to
experience significant fluctuations in its future quarterly operating
results that may be caused by many factors, including the Company's
current
dependence on and timing issues, not within the Company's control, for
large shipments to a limited number of customers in the travel related
entertainment market. Accordingly, quarterly revenues and operating
results will be difficult to forecast, and the Company believes that
period-to-
period comparisons of its operating results will not necessarily be
meaningful and should not be relied upon as an indication of future
performance.
Enhanced video capability differentiates the Company's products
from competing lower cost PC-based server products. To maintain its
competitive position the Company is committed to expanding the range of
equipment and software features available to its customers. The current
principal markets for the Company's superservers are corporate training,
education and travel related interactive entertainment. Although
training and
education applications have in the past been considered a non-critical
function that does not appear to be an accurate assessment of the
importance of
training and education in today's environment. Management of the Company
believes that both corporations and academic institutions have
significantly expanded their training budgets in recent years, and that
a significant percentage of the resulting training and education
applications will
be provided with video content distributed by network superservers. Such
applications demand high performance equipment. Given the magnitude of
these budgeted expenditures, despite the high price and technical, high
performance requirements of the equipment necessary to meet this
application's demands, management believes that departments responsible
for administering these budgets will not settle for low performance,
PC-based equipment. Travel related entertainment systems generally have
been based on broadcast analog distribution rather than digital
technology,
are not designed for full interactive use and have not been successful
in meeting the requirements of today's market applications. Management
of the
Company believes this to be a rapid growth market where proven LAN
interactive technology which supports the high performance demands of
video
data, like the Company's products, will become dominant. Management of
the Company further believes that although the market for network
equipment is currently cost driven, with PC- based servers
predominating, the future market for server equipment will be dictated
by performance and
available features, with video capability being a primary sales
motivator.
The purchase price for the Company's "turn-key" packaged systems
for the travel related entertainment market is relatively high depending
upon various factors such as the size and type of airplane, train, hotel
or ship, and the requested system features. The high system purchase
price is
anticipated to result in a relatively extensive sales cycle, which will
include the evaluation of the Company's technology, a test installation
of the
system and negotiation of related agreements. The sales cycle is also
dependent upon a number of factors beyond the Company's control, such
safety
and maintenance concerns, regulatory issues and purchasing patterns of
particular operators, and the respective industry generally. As a
result, this
can result in extremely cyclical buying patterns for the Company's
travel related entertainment products.
Insofar as the systems being offered by the Company have not been
incorporated as original equipment by airplane, cruise ship, train and
hotel manufacturers or builders, the Company's sales of its products to
such purchasers are dependent upon its ability to convince major
airline, cruise
line, train or hotel owners or operators ( the "Operators") to purchase
Company systems in connection with initiation of major cabin or room
upgrades,
a decision over which the Company has little or no control. Once such a
decision has been reached by the Operator, the Company must compete with
other vendors on the basis of such factors as price, size, weight and
features. The Company believes that it presently compares favorably with
other
competitors in these matters; however, the Company must find ways to
overcome concerns about the Company's limited financial resources
compared
to the significant investment of dollars involved in an interactive
entertainment purchase decision by an Operator. In addition, as with all
technically-
oriented purchases, the Company must contend with the Operators
inclination to defer purchase decisions pending future developments.
There can be
no assurance that customers will decide to buy now rather than wait,
that the Company will in fact be able to compete successfully on price,
size,
weight and features, or that the Company can find a way to adequately
address concerns about its own resources.
The Company does not believe that its server products will compete
in the near future with those manufactured by IBM, Compaq
Computers, Inc. or the other "major players" in the industry. The
Company believes that the major computer manufacturers will generally
seek to
produce and service higher production-lower margin commodity products,
and will refrain from producing lower production-higher margin products
(like the Company's video servers) until the market for each related
product and product series is perceived to be large enough to support
the sizable
investments in production capability and advertising that the "major
players" must make prior to launching new products. Nevertheless, based
upon
the perceived size of the market for video capable network equipment,
the Company's management recognizes that it will only be a matter of
time
before the "major players" will start to produce higher margin network
equipment products which will compete directly with those produced by
the
Company.
It is expected that print advertising, other than publicity for
new product announcements and technical journal analyses of product
capabilities, will not play the most significant role in developing a
customer base for the Company's products. The Company's management
believes
that its greatest success can be gained through informational seminars
and hands-on product demonstrations, at which potential customers can
experience directly the capabilities of the Company's products.
The Company's marketing strategy encompasses attendance and
presentations at targeted trade shows. The Company also targets the
establishment of demonstration projects at customer facilities. The
latter allows the Company to show-off product capabilities in a specific
customer's
operational setting. This marketing method is intended to give the
prospective customer a "reality" experience at minimal economic or other
risk, with
the equipment being operated by its own personnel. This method of
marketing has an adverse impact on the Company's results of operations
in the
short-run, by requiring the Company to build the demonstration equipment
at its own expense, obtain a minimal rental charge, if any, during the
demonstration period, and achieve recoupment of expenses and any
"profit" only upon the ultimate sale of the equipment to the customer.
Management estimates that approximately one-third of its demonstration
projects result in system sales, and believes that this ratio of
demonstration
projects to actual sales should continue in the future. The proceeds of
the Company's 1997 public warrant redemption call and the Private
Placement
in 1998 (see "Liquidity and Capital Resources") boosted the Company's
resources available for additional sales generation (in terms of
increased
advertising budgets, larger sales and demonstration project personnel
and equipment and increased funds to support seminar and trade show
attendance), and Management believes that expenditure of the proceeds of
such offerings for such marketing activities can lead to increasing
levels of
revenues from operations in the future.
To enhance product awareness, image and market credibility, the
Company continually considers strategic business alliances and OEM
arrangements (original equipment manufacturer agreements) with larger
companies in the computer, and other types of equipment, manufacturing
industries. Management believes strategic business alliances will play a
vital role in achieving success for the Company's products in the travel
related
entertainment market. The Company will continue to evaluate the
advantages and disadvantages to the Company from such arrangements.
Management of the Company believes that such strategic relationships
will provide the Company with enhanced credibility and access to the
greater
resources that are needed to be successful in the travel related
entertainment markets.
Results of Operations: Year Ended December 31, 1997 Compared With Year
Ended December 31, 1996.
Revenues increased 92% to $7.9 million for the year ended December 31,
1997 from $4.1 million for the year ended December 31, 1996. This
increase
in revenues primarily resulted from initial deliveries in connection
with the startup of larger programs awarded in the first half of fiscal
1997, from the
initial implementation of long-term larger system programs with
Fairlines, the Department of Defense Breast Cancer Awareness, and from
increased
shipments to the South Korean Government High School Program.
Gross profit as a percentage of revenues increased by 2 % to 33% during
the year ended December 31, 1997 as compared to 31% for the same period
in 1996. This increase was primarily due to a higher percentage of
revenues generated during the 1997 period from larger server and AirView
system
sales which have higher average gross profit levels. Gross profit for
any particular period is not necessarily indicative of the results that
may occur in
any future period due to factors including, but not limited to, changes
in product mix, fluctuating component cost, critical component
availability and
industry competition.
The Company obtained FAA certification for the Company's AirView system
in 1997, which system utilizes its "Cheetah" high performance video
servers. Since 1996, research and development activities have been
limited to products which represent enhancements of the existing
"Cheetah" server
to meet the needs of specific market applications. Research and
development expense is comprised primarily of the salaries of employees
devoted to
development. However, fluctuations in the periods presented are due to
increased material and outside labor costs associated with the further
development in 1997 of the travel related entertainment products.
Selling, general and administrative expenses increased $588,237 (15%)
for the year ended December 31, 1997, as compared to the same 1996
period.
This increase related primarily to expenses, which were not incurred in
the respective period in 1996, for additional (i) marketing (including
advertising, trade show, public relations, bidding and proposal and
demonstration expenses) associated with the introduction of new products
for
Courseware on Demand and increased activity in the cruise line market,
and (ii) employment of sales and marketing personnel and related payroll
and
non-recurring legal and administrative expenses related to establishing
a sales office in Singapore. Management of the Company believes that
these
investments in sales and marketing will result in increased revenues and
sales backlog for 1998.
The Company anticipates that it will continue to invest in its marketing
and sales generation strategy (increasing advertising, trade show,
demonstration and proposal expenses and sales and marketing personnel,
with related payroll costs) to increase revenues and increase net income
from
operations in the future; such investment may adversely affect short-
term operating performance.
Changes in interest expense are attributable to changes in average
outstanding borrowings during the periods presented. Other income
results from
interest income on restricted cash and short-term securities.
Liquidity and Capital Resources
During the year ended December 31, 1997, the Company's cash increased
$24,648 principally due to the net proceeds from the issuance of common
stock of $5.4 million as a result of the 1997 warrant redemption call,
which was offset by cash used in operating activities of $4.9 million,
the
payment of bank borrowings under the line of credit of $30,000, the
purchase of short-term investments of $142,846 and the purchase of
property and
equipment of $417,291. The negative change in cash from operating
activities primarily resulted from a net loss of $2.0 million and an
increase of
$3.1 million in accounts receivable, an increase of $2.3 million in
inventory, an increase in prepaid expenses and other assets of $728,070
and an
increase in accounts payable and accrued expenses of $3.0 million. The
reduction in cash from operating activities was offset by depreciation
and
amortization of $334,029.
The Company's primary source of funds at December 31, 1997 consisted of
$1.2 million in cash, $638,559 from short-term investments and funds
available under a $1.0 million revolving line of credit. $1.0 million of
cash represents two certificates of deposit which are restricted from
use by being
pledged as collateral for the availability of the line of credit. The
line of credit, which expires in May 1998, bears interest at an annual
rate of 7.16%.
At December 31, 1997, the Company had $526,000 of outstanding borrowings
under the line of credit.
On May 8, 1997, the Company announced that holders of 99.7% of the
Company's publicly traded Redeemable Common Stock Purchase Warrants
(the "Warrants") elected to exercise and acquire common stock at $5.00
per share rather than have their Warrants redeemed, at the redemption
price
of $.25 per Warrant. The Company realized net proceeds of $5.3 million
from the exercise of the Warrants.
The Company's products are often used with those produced by other
companies in large complex projects. As a result, the Company may grant
extended payment terms for certain sales. Accounts receivable at
December 31, 1997 consisted of approximately $3.9 million from sales to
such
customers with extended credit terms of up to 180 days, with the
specific credit terms made available being based on the nature of the
project.
Management believes that the concentration of credit risk with respect
to trade accounts receivable is high due to the limited number of
customers
whose purchases require large shipments.
The Company's inventory increased between December 31, 1996 and December
31, 1997 primarily due to an increased level of finished goods related
to deferred revenue and related costs of shipment of four AirView
systems to Fairlines in the fourth quarter of 1997. The associated
revenue and profit
related to such products was also deferred as the result of a delay by
Fairlines to secure aircraft necessary for the installation of the
AirView systems.
Management believes that this increase in inventory does not have a
material effect on the Company's liquidity due to the fact that
substantially all of
the Company's current inventory is useable, saleable and readily liquid,
and is closely matched with orders in process.
Capital expenditures for the purchase of property and equipment for the
year ended December 31, 1997 were $417,291, primarily for the purchase
of
additional equipment and software in order to expand product
demonstration and development capabilities and AirView test equipment.
During 1998,
capital expenditures are anticipated to be funded through existing
working capital or other financing.
Costs incurred to obtain Federal Aviation Association (FAA)
certification for the Company's AirView system in the amount of
approximately
$615,000 were capitalized in 1997 and are being amortized on a straight-
line basis over 10 years, the estimated service life of the AirView
system.
The Company is indebted to an institutional lender as of December 31,
1997, in the aggregate amount of $238,787, for the purchase of its
primary
operating facility. This loan is secured by the purchased real estate
and the personal guarantees of Wilbur and Barbara Riner, and bears
annual
interest at the rate of such lender's prime rate plus 2%. A default by
the Company in payment of this mortgage loan could result in foreclosure
against
the property.
On March 11, 1998, the Company raised gross proceeds of $2.2 million in
a private placement to a single institutional investor (the "Private
Placement") of five-year convertible debt securities (the "Debentures").
Each Debenture was sold for $50,000 and will accrue interest at a rate
of 4%
per annum, and is convertible at the option of the holder into shares of
the Company's Common Stock at a price per share equal to the lesser of
(i)
$8.02 or (ii) 80% of the average closing market price of the Company's
Common Stock during the 21 trading days prior to conversion, but in no
event
less than $3.00 per share. The Company is obligated to file with the
Securities and Exchange Commission, within 45 days of the issuance of
the
Debentures, a registration statement with respect to the resale of the
shares issuable upon conversion of the Debentures. Each Debenture is
convertible,
in whole or in part, from time to time upon a date (the "Conversion
Date") which is the earlier to occur of (1) 105 days after the March 11,
1998
Original Issue Date or (2) the date that a registration statement with
respect to the resale of the Common Stock which may be acquired upon
conversion of the Debentures is declared effective by the Securities and
Exchange Commission (the "Commission"), subject to the restriction that
the
Debenture holder shall be entitled to convert up to 25% of Debentures
principal on the Conversion Date, up to 50% of Debentures principal on
the
first month anniversary of the Conversion Date, up to 75% of Debentures
principal on the second month anniversary of the Conversion Date and the
entire Debentures principal on the third month anniversary of the
Conversion Date.
The Company believes that its working capital requirements will increase
throughout 1998 and beyond. The Company believes that currently
available cash, including the proceeds already received from the
exercise of Warrants, the proceeds from the Private Placement of
convertible debt in
March of 1998, funds generated from operations, if any, further
expansion of terms with trade creditors and the existing line of credit
will be sufficient
to satisfy its cash needs for the foreseeable future. However,
maintaining an adequate level of working capital through mid 1998, and
thereafter, will
depend in part on the success of the Company's products in the
marketplace, the relative profitability of those products, continued
availability of
memory and storage components at favorable pricing and the Company's
ability to control operating expenses. The Company may seek or require
additional financing for growth opportunities, including any expansion
that the Company may undertake internally, for strategic acquisitions or
partnerships or for expansion of additional sales locations and
demonstration projects. There can be no assurance that any such
financing will be
available on terms acceptable to the Company, if at all.
Forward Looking Statements
Except for historical information contained herein, the matters
discussed in this ITEM 6 and elsewhere in this annual Report on Form
10KSB are
forward-looking statements (within the meaning of Section 27 of the
Securities Act of 1933, as amended (the "Securities Act") and Section
21 of the
Securities Exchange Act of 1934, as amended (the "Exchange Act") ) that
are subject to certain risks and uncertainties that could cause actual
results
to differ materially from those set forth in such forward-looking
statements. Such risks and uncertainties include, bet are not limited
to, the failure to
execute definitive agreements with additional customers on favorable
terms or at all, the failure of the Company to receive sufficient
financing to
perform under any new contracts or to perform sufficient research and
development, the impact of competition and downward pricing pressures,
the
effect of changing economic conditions and conditions in the specific
industries the Company has targeted, the impact of any changes in
domestic and
foreign regulatory environments or the Company's inability to obtain
requisite government approvals, risks in technology development, the
risks
involved in currency fluctuations, and the other risks and uncertainties
detailed herein.
Item 7. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
Page
Report of Independent Accountants
24
Balance Sheet as of December 31, 1997
25
Statements of Operations for the years ended December 31, 1997 and 1996
27
Statements of Shareholders' Equity for the years ended
December 31, 1997 and 1996 28
Statements of Cash Flows for the years ended December 31, 1997 and 1996
29
Notes to Financial Statements 30
Report of Independent Accountants
To the Shareholders and Board of Directors
of The Network Connection, Inc.
We have audited the accompanying balance sheet of The Network
Connection, Inc. as of December 31, 1997, and the
related statements of operations, shareholder's equity, and cash flows
for the years ended December 31, 1997 and 1996.
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion
on these financial statements 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 are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of
The Network Connection, Inc. as of December 31, 1997, and the results of
its operations and its cash flows for the years
ended December 31, 1997 and 1996, in conformity with generally accepted
accounting principles.
COOPERS & LYBRAND L.L.P.
Atlanta, Georgia
March 25, 1998
THE NETWORK CONNECTION, INC.
BALANCE SHEET
December 31,1997
ASSETS
Current assets:
Cash
$24,648
Restricted cash
1,000,000
Short term investments
638,559
Accounts receivable, less allowance of $149,385
4,936,502
Inventories
3,444,995
Prepaid expenses
266,092
- ------------------
Total current assets
10,310,796
Property and equipment:
Land
150,000
Building and improvements
761,566
Furniture, fixtures and equipment
2,081,171
Software
50,395
Vehicles
161,107
- ------------------
3,204,239
Less accumulated depreciation
(961,564)
- ------------------
2,242,675
Other assets, net
685,762
- ------------------
Total assets
$13,239,233
==========
THE NETWORK CONNECTION, INC.
BALANCE SHEET
December 31,1997
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses
$4,168,117
Payable to shareholders
70,929
Borrowings under bank line of credit
526,000
Current portion of long-term debt and capital lease obligations
39,455
- --------------------
Total current liabilities
4,804,501
Long-term debt, less current portion
259,106
Obligations under capital leases, less current portion
1,222
- --------------------
Total liabilities
5,064,829
Commitments and contingencies (Note 3)
Shareholders' equity:
Preferred stock, $.01 par value:
Authorized, 2,500,000 shares;
Issued and outstanding, none
Common stock, $.001 par value:
Authorized, 10,000,000 shares;
Issued and outstanding, 4,152,393 shares
4,152
Additional paid-in capital
14,622,389
Accumulated deficit
(6,452,137)
- --------------------
Total shareholders' equity
8,174,404
- --------------------
Total liabilities and shareholders' equity
$13,239,233
============
THE NETWORK CONNECTION, INC.
STATEMENTS OF OPERATIONS
For the years ended December 31, 1997
1996
Revenues
$7,848,444
$4,092,023
Cost of revenues
5,044,258
3,050,596
- --------------------
- --------------------
Gross profit
2,804,186
1,041,427
Selling, general and administrative
4,604,588
4,016,351
Loan origination expense
0
60,000
Research and development
277,527
160,276
- --------------------
- --------------------
Operating loss
(2,077,929)
(3,195,200)
Interest expense
(61,737)
(99,026)
Other income
114,038
41,327
- --------------------
- --------------------
Net loss
($2,025,628)
($3,252,899)
============
===========
Basic and Diluted Net loss per share
($0.53)
($1.14)
============
===========
Weighted average shares outstanding
3,845,097
2,846,715
============
===========
THE NETWORK CONNECTION, INC.
STATEMENTS OF SHAREHOLDERS EQUITY
Common
Stock
Additional
Accumulated
Total
Shares
Amount
PIC
Equity
Balance at January 1, 1996
$2,450,000
$2,450
$4,498,669
(1,173,610)
3,327,509
Common Stock sold
300,000
300
2,945,155
2,945,455
Exercise of warrants to acquire common stock
214,950
215
1,433,685
1,433,900
Stock option plan
71,760
72
302,316
302,388
Net Loss
(3,252,899)
(3,252,899)
_________
__________
__________
____________
____________
Balance at December 31, 1996
3,036,710
3,037
9,179,825
(4,426,509)
4,756,353
Exercise of warrants to acquire common stock
1,065,392
1,065
5,276,763
5,277,828
Stock option plan
50,291
50
165,801
165,851
Net Loss
(2,025,628)
(2,025,628)
_________
__________
__________
____________
____________
Balance at December 31, 1997
4,152,393
$4,152
$14,622,389
($6,452,137)
$8,174,404
THE NETWORK CONNECTION, INC.
STATEMENTS OF CASH FLOWS
Twelve Months
Ended
Twelve Months
Ended
December 31,
December 31,
1997
1996
Operating activities
Net loss
($2,025,628)
($3,252,899)
Adjustments to reconcile net loss to net cash used
in operating activities
Depreciation and amortization
334,029
271,000
Allowance for doubtful accounts
0
150,064
Noncash expenses charged for issuance of common stock options
0
0
Changes in operating assets and liabilities:
Accounts receivable
(3,131,223)
(331,826)
Inventories
(2,336,585)
(360,585)
Prepaids and other assets
(728,070)
(664)
Accounts payable and accrued expenses
2,990,205
236,665
Payable to shareholders
2,078
(1,293)
- -------------------
- -------------------
Net cash used in operating activities
(4,895,194)
(3,289,538)
Investing activities:
Purchase of property and equipment
(417,291)
(1,279,152)
Purchase of short-term investments
(142,846)
(495,713)
- -------------------
- -------------------
Net cash (used in) provided by investing activities
(560,137)
(1,774,865)
Financing activities:
Proceeds from bank line of credit
30,000
496,000
Proceeds from issuance of long-term debt
18,077
0
Net proceeds from issuance of stock
5,443,679
4,681,743
Payment of long-term debt and capital lease obligations
(11,777)
(140,785)
- -------------------
- -------------------
Net cash provided by financing activities
5,479,979
5,036,958
- -------------------
- -------------------
Net change in cash
24,648
(27,445)
Cash at beginning of year
1,000,000
1,027,445
- -------------------
- -------------------
Cash at end of year
$1,024,648
$1,000,000
===========
===========
1. Significant Accounting Policies
Basis of Presentation
The Network Connection, Inc. (the "Company") was incorporated on
December 30, 1986. The Company designs, manufactures and distributes
computer networking products for use in employee training, academic,
telecommunications, entertainment and other industry applications. The
Company's products are based upon a proprietary engineered process
utilizing non-proprietary personal computer hardware standards with
standard
major components and subsystems. The Company's products are designed to
be compatible with industry-standard network operating systems.
Concentration of Credit Risk
The Company's principal financial instruments subject to potential
credit risk are cash and equivalents and trade accounts receivable. The
Company
invests its cash and credit instruments with highly rated financial
institutions and performs periodic evaluations of the relative standing
of these
financial institutions. Other than for international sales trade
accounts receivable are generally unsecured; therefore, the Company is
at risk to the
extent such amounts become uncollectible.
In 1997, three customers accounted for 79% (38%, 30% and 11%,
respectively) of the Company's revenues. In 1996, three customers
accounted for
67% (38%, 15% and 14%, respectively) of the Company's revenues.
Management believes that the concentration of credit risk with respect
to trade
accounts receivable is high due to the limited number of customers
requiring large shipments.
Inventories
Inventories consist primarily of components purchased for assembly into
products (except for finished goods per Note 12) and are stated at the
lower of
cost or market using the first-in, first-out (FIFO) method.
Property and Equipment
Property and equipment are recorded at cost. Depreciation and
amortization are calculated using the straight-line method over the
estimated useful
lives of the assets, principally five years, except for buildings for
which the life is forty years.
Income Taxes
Under the Statement of Financial Accounting Standards No. 109 (SFAS
109), "Accounting for Income Taxes", the liability method is used in
accounting for income taxes. Under this method, deferred tax assets and
liabilities are determined based on differences between financial
reporting
and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences
are expected to
reverse.
The Company provides a valuation allowance for deferred tax assets which
are determined by management to be below the threshold for realization
established by SFAS 109.
Revenue Recognition
Revenues are recognized when the products are shipped, expiration of
rights of acceptance or return and determination that the related
receivables are
collectible.
Other Assets
Costs incurred to establish and defend trademarks and patents are
capitalized. Such costs are amortized using the straight-line method
over 20 years.
Costs incurred to obtain Federal Aviation Association (FAA)
certification for production and installation on aircraft of the
Company's AirView system
in the amount of approximately $615,000 were capitalized in 1997. These
costs are being amortized on a straight-line basis over 10 years of the
estimated service life of the AirView system.
Basic and Diluted Net Loss Per Common Share
Basic and Diluted net loss per common share have been computed by
dividing net loss by the weighted average number of common shares
outstanding
during each period.
Management's 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 reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the dates of the
financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Advertising Costs
Costs of advertising are expensed when incurred. The Company recognized
advertising expenses of approximately $656,000 and $646,000 in 1997
and 1996, respectively.
Recently Issued Accounting Pronouncements
In February 1997, the FASB issued SFAS No. 129, "Disclosure of
Information about Capital Structure," to consolidate existing disclosure
requirements. This new standard contains no change in disclosure
requirements for the Company.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," to establish standards for reporting and display of
comprehensive
income (all changes in equity during a period except those
resulting from investments by and distributions to owners) and its
components in financial statements. This new standard does not currently
have a
significant impact on the Company's financial statements based on the
current financial structure and operations of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information," to establish standards for
reporting information about operating segments in annual financial
statements, selected information about segments in interim financial
reports and
disclosures about products and services, geographic areas and major
customers. This new standard may in future periods require the Company
to
report financial information on the basis that is used internally for
evaluating segment performance and deciding how to allocate resources to
segments, which may result in more detailed information in the notes to
the Company's financial statements than is currently required and
provided.
2. Accounts Receivable
The Company's products are often used with other products in large
complex projects. As a result, the Company may grant extended payment
terms
for certain sales. Accounts receivable at December 31, 1997 consisted of
approximately $3.9 million from sales to such customers with extended
credit
terms of up to 180 days based on the nature of the project. Management
believes that the concentration of credit risk with respect to trade
accounts
receivable is high due to the limited number of customers requiring
large shipments.
3. Commitments and Contingencies
The Company leases certain equipment and office space. Property and
equipment includes $102,476 of equipment under capital lease agreements
at
December 31, 1997. Accumulated amortization was $26,151 at December 31,
1997. Amortization of leased assets is included in depreciation and
amortization expense. The Company also leases certain equipment under
noncancelable operating leases that expire in various years through
2002.
Future minimum lease payments required under capital lease obligations
and noncancelable operating leases with initial or remaining terms of
one
year or more are summarized as follows at December 31, 1997:
Year ending December 31, Capital
Operating
1998 7,102 23,288
1999 1,392 19,960
2000 0 15,288
2001 0 7,644
Total minimum lease payments $8,494
$66,180
Less amounts representing interest 781
Present value of minimum capital lease payments 7,713
Less current portion 6,491
Long-term obligations under capital leases $ 1,222
During 1997 and 1996, total rental expense for all operating leases was
approximately $36,000 and $36,000, respectively.
To date, the Company has not experienced significant claims under
product warranties due to the pass through to end users the warranties
that the
Company receives from vendors.
4. Debt Obligations
Debt obligations consist of the following:
1997
1996
Note payable due in varying installments through 2009, interest at
prime (8.5% at December 31, 1997) plus 2%, collateralized by
certain commercial property and personally guaranteed by two
shareholders $238,767
$249,350
Note payable due in varying installments through 2000, interest
at 6.9%, collateralized by a vehicle. 40,845
0
Note payable due in varying installments through 2000, interest at
11.0%, collateralized by a vehicle. 12,458
16,577
292,070 265,927
Less current portion 32,964
15,327
$259,106 $250,600
Aggregate maturities of long-term debt as of December 31, 1997 are as
follows:
1998 32,964
1999 36,004
2000 24,537
2001 16,457
2002 18,848
Thereafter 163,260
$292,070
On May 28, 1997, the Company entered into a $1.0 million line of credit
agreement with a bank. Outstanding advances bear interest at 7.16% per
annum through the maturity date of May 28, 1998. Interest is payable
monthly in arrears, commencing January 1, 1998. As of December 31, 1997,
there was $526,000 advanced under this line of credit. This line of
credit is collateralized by two certificates of deposit in the total
amount of $1.0
million and are presented in the balance sheet as restricted cash.
The Company paid interest of approximately $62,000 and $99,000 during
fiscal years 1997 and 1996, respectively.
5. Common Stock and Warrants
On May 8, 1997, the Company announced that holders of 99.7% of the
Company's publicly traded Redeemable Common Stock Purchase Warrants
(the "Warrants") elected to exercise and acquire common stock at $5.00
per share rather than have their Warrants redeemed, at the redemption
price
of $.25 per Warrant. The Company realized net proceeds of $5.3 million
from the exercise of the Warrants.
6. Income Taxes
The Company has accounted for income taxes under the liability method
required by SFAS 109. Deferred income taxes reflect the net effect of
temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for
income tax
purposes. At December 31, 1997, the Company had a net deferred tax asset
of approximately $2,940,000 which was totally offset by a valuation
allowance because the assets do not meet the criteria for recognition in
SFAS 109. Significant components of the Company's deferred tax
liabilities
and assets as of December 31, 1997 and 1996 are as follows:
1997 1996
Deferred tax liabilities:
Tax over book depreciation ($122,000) ($27,000)
Tax over book amortization 0
(31,000)
Total deferred tax liabilities ($122,000)
($58,000)
Deferred tax assets:
Bad debt reserve $ 57,000 $
27,000
Uniform capitalization 10,000
22,000
Book over tax amortization 9,000
0
Charitable contributions 3,000
0
Net operating loss 3,013,000
1,918,000
Total deferred tax assets $3,092,000
$1,967,000
Net deferred tax assets 2,970,000 1,909,000
Valuation allowance (2,970,000)
(1,909,000)
Net deferred taxes $ 0 $
0
The valuation allowance for deferred tax assets as of January 1, 1997
was approximately $1,909,000. The net change in the total valuation
allowance
for 1997 was approximately $1,061,000. This change resulted primarily
from increases in the above described temporary differences on which a
valuation allowance was provided.
The Company did not record any income tax expense or benefit from
operations for the years ended December 31, 1997 and 1996, respectively.
The
following table provides a reconciliation between the Federal income tax
rate and the Company's effective income tax rate:
1997 1996
Statutory Federal income tax rate 34% 34%
Disallowed meals and entertainment (1) (1)
Increase in valuation allowance (51) (32)
Other, net 18 (1)
Effective tax rate 0% 0%
At December 31, 1997, the Company has net operating loss (NOL)
carryforwards of approximately $7,928,000. The NOL's expire, if not
utilized, as
follows:
December 31, 2009 $ 168,000
December 31, 2010 $1,027,000
December 31, 2011 $4,071,000
December 31, 2012 $2,662,000
7. Related Party Transactions
The Company was owed $27,562 from a shareholder/officer as of December
31, 1997.
On September 1, 1994, the Company entered into four promissory notes in
the aggregate amount of $69, 290 payable to certain
shareholders/officers for accrued and unpaid salaries owed through
August 31, 1994. Under the terms of the notes, outstanding amounts bear
interest
at 5% per annum, with payments of principal and accrued interest being
payable to the extent certain operating cash flow requirements are met.
As of
December 31, 1997, $60,248 remained outstanding under these notes.
8. 401(k) Plan
During 1996, the Company established a deferred compensation plan (the
401(k) Plan) pursuant to Section 401(k) of the Internal Revenue Code,
whereby substantially all employees are eligible to contribute up to 15%
of their pre-tax earnings, not to exceed amounts allowed under the
Internal
Revenue Code. The Company may make contributions to the 401(k) Plan at
the discretion of the Board of Directors. No employer contributions
have
been made to the 401(k) Plan by the Company.
9. Stock Options
Under the Company's 1994 Employee Stock Option Plan (the "Plan"), as
amended, the Company has reserved an aggregate of 1,200,000 shares of
Common Stock for issuance under the Plan. Options granted under the
Plan are for periods not to exceed ten years. Under the Plan, incentive
and
non-qualified stock options may be granted. All option grants under the
Plan are subject to the terms and conditions established by the Plan and
the
Stock Option Committee of the Board of Directors. Options must be
granted at not less than 100% of fair value for incentive options and
not less than
85% of fair value of non-qualified options of the stock as of the date
of grant and generally are exerciseable in increments of 25% each year
subject to
continued employment with the Company. Options generally expire five
years from the date of grant. Options canceled represent the unexercised
options of former employees, returned to the option pool in accordance
with the terms of the Plan upon departure from the Company. The Board
of
Directors may terminate the Plan at any time at their discretion.
During 1997, options to purchase 415,000 shares were granted at per
share prices
ranging from $6.50 to $10.38. Options to purchase 712,328 shares were
outstanding at December 31, 1997. Options to purchase 260,578 shares
under the Plan were exercisable at December 31, 1997. There were 575,869
options outstanding as of December 31, 1996.
On August 16, 1995, the Company adopted the 1995 Stock Option Plan For
Non-Employee Directors (the "Directors Plan") and reserved 100,000
shares of unissued common stock for issuance to all non-employee
directors of the Company. The Directors Plan is administered by a
committee
appointed by the Board of Directors consisting of directors who are not
eligible to participate in the Directors Plan. Pursuant to the Directors
Plan,
directors who are not employees of the Company receive for their
services, on the date first elected as a member of the Board and on each
anniversary
thereafter, if they continue to serve on the Board of Directors, an
automatically granted option to acquire 1,000 shares of the Company's
common
stock at its fair market value on the date of grant; such options become
exercisable in two equal annual installments if the individual continues
at that
time to serve as a director, and once exercisable remain so until the
fifth anniversary of the date of grant. During 1997, options to purchase
10,000
shares were granted at per share prices ranging from $8.00 to $10.25.
Options to purchase 14,000 shares under the Directors Plan were
outstanding at
December 31, 1997. Options to purchase 3,000 shares under the Directors
Plan were exercisable at December 31, 1997. There were 4,000 options to
purchase shares under the Directors Plan outstanding at December 31,
1996.
Shares Weighted Average
Exercise Share Price
Options outstanding at December 31, 1994
208,629
4.22
Granted
542,500
8.67
Canceled or expired
(99,500)
8.36
Exercised
(71,760)
4.21
Options outstanding at December 31, 1996
579,869
7.67
Granted
425,000
7.51
Canceled or expired
(208,300)
7.60
Exercised
(50,291)
4.19
Options outstanding at December 31, 1997
746,328
7.85
The Company accounts for its employee stock option plans in accordance
with the provisions of Accounting Principles Board Opinion No. 25. In
October 1995, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No, 123, "Accounting for Stock Based
Compensation" ("SFAS 123") which requires that companies with stock-
based compensation plans either recognize compensation expense based on
new fair value accounting methods or continue to apply existing
accounting rules and disclose pro forma net income and earnings per
share assuming
the fair value method had been applied. The Company elected to adopt
the disclosure method of SFAS 123. Had compensation cost for the
Company's
option plans been determined based on the fair value at the grant dates,
as prescribed in SFAS 123, the Company's net loss and pro forma net loss
per
share would have been as follows:
1997 1996
Net loss: (millions)
As reported ($2.03) ($3.25)
Pro forma ($3.44) ($3.98)
Net loss per share:
As reported ($0.53) ($1.14)
Pro forma ($0.89) ($1.40)
The fair value was determined using the Black-Sholes option pricing
model incorporating the following range of assumptions in the
calculations:
1997 1996
Expected life 9.8 years 4.3 years
Interest rate at grant date 6.19% 5.93%
Volatility at grant date 78% 72%
Dividend yield 0% 0%
The following table summarizes information about all options outstanding
as of December 31, 1997:
Range of
Exercise Prices
Outstanding
Shares
Outstanding
Weighted
Average Share
Price
Weighted
Average
Remaining
Years In
Contractual
Life
Exerciseable
Shares
Exerciseable
Weighted
Average Share
Price
$2.59 - 2.85
47,078
$2.77
3.61
47,078
$2.77
4.17 - 6.75
99,000
6.07
4.83
64,250
6.15
7.12 - 9.38
492,250
8.15
8.62
94,250
8.85
9.75 - 13.26
108,000
10.35
6.27
62,500
10.83
$2.59 - 13.26
746,328
$7.85
7.46
268,078
$7.39
Because additional stock options are expected to be granted each year,
the above pro forma disclosures are not representative of pro forma
effects on
reported financial results for future years.
10. Subsequent Events
On March 11, 1998, the Company raised gross proceeds of $2.2 million in
a private placement to a single institutional investor (the "Private
Placement") of five-year convertible debt securities (the "Debentures").
Each Debenture was sold for $50,000 and will accrue interest at a rate
of 4%
per annum, and is convertible at the option of the holder into shares of
the Company's Common Stock at a price per share equal to the lesser of
(i)
$8.02 or (ii) 80% of the average closing market price of the Company's
Common Stock during the 21 trading days prior to conversion, but in no
event
less than $3.00 per share. The Company is obligated to file with the
Securities and Exchange Commission, within 45 days of the issuance of
the
Debentures, a registration statement with respect to the resale of the
shares issuable upon conversion of the Debentures.
11. Fourth Quarter Adjustments
The Company deferred $3.9 million in revenue and $1.2 million in profit
from the shipment of four Airview systems in the fourth fiscal quarter
due to
notification by the customer, in March 1998, of an unexpected delay by
the customer in procuring the four aircraft required for AirView
installation.
As a result four AirView shipments in the fourth fiscal quarter did not
meet the revenue and profit recognition requirements of the Company.
$2.7
million for the direct costs of these AirView systems is reported as
inventory in the financial statements at December 31, 1997.
Item 8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure
None
PART III
Information with respect to Items 9, 10, 11 and 12 of Form 10-KSB is
hereby incorporated by reference into this Part III of Form 10-KSB from
the
Registrant's Definitive Proxy Statement relating to the Registrant's
1998 Annual Meeting of Stockholders to be filed by the Registrant with
the
Securities and
Exchange Commission on or before April 30, 1998.
Item 13. Exhibits and Reports on Form 8-K
(a) The following documents are filed as part of this report:
Exhibit
Description_______________________________________________
3.1 Amended and Restated Certificate of Incorporation of Registrant
(including all
amendments thereto). (5)
3.2 Amended and Restated By-laws of Registrant. (5)
4.3 Stock Option Plan , including form of Stock Option Agreement. (1)
10.1 Employment Agreement, dated November 1, 1993, by and between the
Registrant
and Wilbur L. Riner. (1)
10.2 Employment Agreement, dated November 1, 1993, by and between the
Registrant
and Barbara L. Riner. (1)
10.3 Employment Agreement, dated November 1, 1993, by and between the
Registrant
and James E. Riner. (1)
10.4 Employment Agreement, dated November 1, 1993, by and between the
Registrant
and Stephen H. Stethers. (1)
10.5 Employment Agreement, dated July 15, 1995, by and between the
Registrant
and Bryan R. Carr.
10.6 Employment Agreement, dated December 31, 1995, by and between the
Registrant
and Allan Regenbaum.
10.7 Employment Agreement, dated January 11, 1996, by and between the
Registrant
and Luther Del Maners.
10.8 $20,000 Demand Promissory Note of the Registrant, dated April 1,
1993, made to
the order of Barbara L. Riner. (1)
10.9 Letter Agreement with Barbara Riner dated September 15, 1994. (1)
10.10 Promissory Note, dated September 1, 1994, made by the Company to
the order of
Wilbur Riner. (1)
10.11 Promissory Note, dated September 1, 1994, made by the Company to
the order of
Barbara Riner. (1)
10.12 Promissory Note, dated September 1, 1994, made by the Company to
the order of
James Riner. (1)
10.13 Promissory Note, dated September 1, 1994, made by the Company to
the order of
Stephen Stethers. (1)
10.14 Securities Purchase Agreement, dated as of June 15, 1994, by and
between the
Company and Stanhope Capital, Inc. (1)
10.15 Right of First Refusal Agreement, dated as of June 15, 1994, by
and between the
Company and Stanhope Capital, Inc. (1)
10.16 Subcontract Agreement, dated as of September 28, 1994, by and
between the
Registrant and Wang Laboratories, Inc. (3)
10.17 Agreement, dated January 10, 1994, by and between the Company and
Computer
Alliance (Pty) Ltd. (South Africa distribution). (3)
10.18 Business Partner Agreement, dated February 24, 1995, by and
between the Company
and Conhan Co. Ltd. (South Korea distribution). (3)
10.19 1995 Stock Option Plan for Non-Employee Directors. (4)
10.20 Note and Security Agreement, dated November 27, 1995, by and
between the Company and Wachovia Bank of Georgia N.A. (4)
10.21 Collateral Assignment Agreement, dated November 27, 1995, by and
between the the Company and Wachovia Bank of Georgia N.A. (4)
10.22 Note and Security Agreement, dated May 26, 1995, by and between the
Company and Wachovia Bank of Georgia N.A. (4)
10.22 Debenture Purchase Agreement, dated March 11, 1998,
by and between The Network Connection, Inc. and KA Investments LDC
(without schedules) (6)
10.23 Form of Convertible Debenture, dated March 11, 1998, made
by The Network Connection, Inc. (6)
10.24 Registration Rights Agreement, dated March 11, 1998,
by and between The Network Connection, Inc. and KA Investments LDC (6)
27 Financial Data Schedule.
______________________
1. Incorporated by reference, filed as an exhibit with the Company's
Registration Statement on Form
SB-2 on October 26, 1994. SEC File No. 33-85654.
2. Incorporated by reference, filed as an exhibit with Amendment No. 1 to
the Company's Registration
Statement on Form SB-2 on March 24, 1994.
3. Incorporated by reference, filed as an exhibit with Amendment No. 2 to
the Company's Registration
Statement on Form SB-2 on April 27, 1995.
4. Incorporated by reference, filed as an exhibit with the Company's
Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995
on April 12, 1996.
5. Incorporated by reference, filed as an exhibit with the Company's
report on Form 8-K on June 21,1996.
6. Incorporated by reference, filed as an exhibit with the Company's
report on Form 8-K on March 17, 1998.
(b) Reports on form 8-K for the fourth quarter ended December 31, 1997:
None
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 hereto duly authorized, in the
city of Alpharetta, State of Georgia.
THE NETWORK CONNECTION, INC.
Dated: March 27, 1998 By: /s/ Wilbur R.
Riner___________________
Wilbur L. Riner
Chairman and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report ha been signed below by the following persons on behalf of
the
Registrant and in the capacities and on the dates indicated.
Signature Title
Date
/s/ Wilbur L. Riner________________ Chairman, Chief Executive Officer
March 27, 1998
Wilbur L. Riner and Director
/s/ Bryan R. Carr_________________ Vice President - Finance, Chief
Financial March 27, 1998
Bryan R. Carr and Principal Accounting Officer and
Director
/s/ James E. Riner________________ Vice President - Engineering,
Secretary March 27, 1998
James E. Riner and Director
/s/ Marc Doyle___________________ Director
March 27, 1998
Marc Doyle
/s/ Arthur Bauer_________________ Director
March 27, 1998
Arthur Bauer
<TABLE> <S> <C>
<S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM THE FINANCIAL STATEMENTS OF THE NETWORK
CONNECTION, INC. FOR THE YEARS ENDED DECEMBER 31, 1997 AND
1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-1-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,024,648
<SECURITIES> 638,559
<RECEIVABLES> 5,085,887
<ALLOWANCES> 149,385
<INVENTORY> 3,444,995
<CURRENT-ASSETS> 10,310,796
<PP&E> 3,204,239
<DEPRECIATION> 961,564
<TOTAL-ASSETS> 13,239,233
<CURRENT-LIABILITIES> 4,804,501
<BONDS> 0
0
0
<COMMON> 4,152
<OTHER-SE> 8,170,252
<TOTAL-LIABILITY-AND-EQUITY> 13,239,233
<SALES> 7,848,444
<TOTAL-REVENUES> 7,848,444
<CGS> 5,044,258
<TOTAL-COSTS> 4,016,351
<OTHER-EXPENSES> 178,949
<LOSS-PROVISION> (71,407)
<INTEREST-EXPENSE> 61,737
<INCOME-PRETAX> (2,025,628)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,025,628)
<EPS-PRIMARY> (0.53)
<EPS-DILUTED> (0.53)
</TABLE>
