SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a)
of the Securities Exchange Act of 1934
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[ ] Preliminary Proxy Statement [ ] Confidential, For Use of the
[X] Definitive Proxy Statement Commission Only (as permitted
[ ] Definitive Additional Materials by Rule 14a-6(e)(2))
[ ] Soliciting Material Pursuant to
Rule 14a-11(c) or Rule 14a-12
THE NETWORK CONNECTION, INC.
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(Name of Registrant as Specified In Its Charter)
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(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[ ] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
1) Title of each class of securities to which transaction applies:
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2) Aggregate number of securities to which transaction applies:
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3) Per unit price or other underlying value of transaction computed pursuant
to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is
calculated and state how it was determined):
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4) Proposed maximum aggregate value of transaction:
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5) Total fee paid:
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[X] Fee paid previously with preliminary materials:
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the form or schedule and the date of its filing.
1) Amount previously paid:
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2) Form, Schedule or Registration Statement No.:
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3) Filing Party:
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4) Date Filed:
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THE NETWORK CONNECTION, INC.
222 NORTH 44TH STREET
PHOENIX, ARIZONA 85034
(602) 629-6200
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NOTICE AND PROXY STATEMENT
FOR SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON SEPTEMBER 17, 1999
-----------------------------------
To the Holders of Our Common Stock:
A Special Meeting of Stockholders (the "Meeting") of The Network
Connection, Inc. (the "Company") will be held at the offices of Streich Lang,
PA, Two North Central Avenue, Phoenix, Arizona, on September 17, 1999, at 9:00
am, local time, to consider and act upon the following matters:
1. A proposal to ratify and approve the acquisition of the interactive
entertainment business of Interactive Flight Technologies, Inc., a
Delaware corporation ("IFT"), and the related issuance of 1,055,745
shares of our Common Stock, par value $.001 per share, and 2,495,400
shares of our Series D Convertible Preferred Stock, par value $.01 per
share, pursuant to an Asset Purchase and Sale Agreement, dated as of
April 30, 1999, by and between the Company and IFT, as amended by the
First Amendment to Asset Purchase and Sale Agreement, dated as of May
14, 1999.
2. A proposal to amend the Company's Amended and Restated Articles of
Incorporation to increase the authorized number of shares of capital
stock of the Company to 42,500,000, of which 40,000,000 shares will be
Common Stock and 2,500,000 shares will be Preferred Stock.
The Board of Directors has fixed the close of business on August 13, 1999
as the record date for the determination of Stockholders entitled to receive
notice of and to vote at the Meeting or any adjournment thereof. Shares of
Common Stock can be voted at the Meeting only if the holder is present at the
Meeting in person or by valid proxy.
This Notice and Proxy Statement was mailed on or about August 19, 1999 to
all Stockholders of record as of the record date. The officers and directors of
the Company cordially invite you to attend the Meeting.
Your attention is directed to the attached Proxy Statement.
By Order of the Board of Directors,
MORRIS C. AARON
Executive Vice President and
Chief Financial Officer
Phoenix, Arizona
August 19, 1999
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IMPORTANT
STOCKHOLDERS ARE EARNESTLY REQUESTED TO DATE, SIGN AND MAIL THE ENCLOSED PROXY.
A POSTAGE PAID ENVELOPE IS PROVIDED FOR MAILING.
================================================================================
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THE NETWORK CONNECTION, INC.
222 NORTH 44TH STREET
PHOENIX, ARIZONA 85034
(602) 629-6200
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PROXY STATEMENT
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This Proxy Statement and the accompanying proxy are furnished to the
stockholders of The Network Connection, Inc., a Georgia corporation, (the
"Company") in connection with the solicitation of proxies by the Board of
Directors of the Company to be voted at the Company's Special Meeting of
Stockholders (the "Meeting") to be held on September 17, 1999 and at any and all
adjournments or postponements thereof (all holders of Common Stock and Preferred
Stock entitled to vote at the Special Meeting are referred to herein as the
"Stockholders"). THE ENCLOSED PROXY IS SOLICITED BY THE BOARD OF DIRECTORS (THE
"BOARD") OF THE COMPANY. The proxy materials were mailed on or about August 19,
1999 to the Stockholders of record at the close of business on August 13, 1999
(the "Record Date").
The purpose of the Meeting will be to consider and vote upon the following
proposals:
1. To approve a proposal to ratify and approve the acquisition of the
interactive entertainment business of Interactive Flight Technologies, Inc., a
Delaware corporation ("IFT") and the related issuance of 1,055,745 shares of the
Common Stock, par value $.001 per share, and 2,495,400 shares of the Series D
Convertible Preferred Stock, par value $.01 per share, pursuant to an Asset
Purchase and Sale Agreement, dated as of April 30, 1999, by and between the
Company and IFT, as amended by the First Amendment to Asset Purchase and Sale
Agreement, dated as of May 14, 1999 (the "Purchase Agreement").
2. To approve a proposal to amend the Company's Amended and Restated
Articles of Incorporation to increase the authorized number of shares of capital
stock of the Company to 42,500,000, of which 40,000,000 shares will be Common
Stock and 2,500,000 shares will be Preferred Stock.
A person giving the enclosed proxy has the power to revoke it at any time
before it is exercised by (i) attending the Meeting and voting in person, (ii)
duly executing and delivering a proxy bearing a later date, or (iii) sending a
written notice of revocation to the Company's Secretary at 222 North 44th
Street, Phoenix, Arizona 85034. The Company will bear the cost of soliciting
proxies. In addition to the use of the mail, proxies may be solicited by
personal interview, telephone, telegraph or tele-facsimile. The Company has
arranged for D.F. King & Co. Inc. to serve as its proxy solicitation agent. The
fee for these services is estimated to be $20,000.
VOTING SECURITIES OUTSTANDING
As of the Record Date, there were 6,338,076 issued and outstanding shares
of Common Stock, par value $.001 per share, 1,500 shares of Series B 8%
Convertible Preferred Stock, par value $.01 per share (the "Series B Stock"),
800 shares of Series C 8% Convertible Preferred Stock, par value $.01 per share
(the "Series C Stock") and 2,495,400 shares of Series D Preferred Stock, par
value $.01 per share (the "Series D Stock"). Each holder of Common Stock issued
and outstanding on the Record Date is entitled to one vote for each such share
held on each matter of business to be considered at the Meeting. The holder of
the Series B Stock has no voting rights. The Series C Stock and Series D Stock,
when issued, did not entitle their holder to any voting rights (other than
special protective rights with respect to certain extraordinary transactions),
although by their terms such shares became entitled to voting rights in the
<PAGE>
event that on or before July 15, 1999, the Company's Amended and Restated
Articles of Incorporation had not been amended to increase the number of
authorized shares of Common Stock sufficiently to permit the Company to issue to
IFT the number of shares of Common Stock necessary to satisfy the Company's
obligations upon the exercise of all options and warrants and conversion of all
convertible securities held by IFT. Such event has not occurred, and all such
shares are now entitled to certain voting rights. However, for purposes of the
Meeting only, IFT has agreed to vote such preferred shares at the Meeting with
respect to Proposal 1 in the same proportion as the shares of Common Stock
present at the meeting so that the actual votes cast will be in the same
proportion as if the Series C Stock and Series D Stock were not voting shares.
See "Proposal 1 - Required Vote." As of the Record Date, all issued and
outstanding shares of Common Stock represent a total of 6,338,076 votes. As of
the Record Date, all issued and outstanding shares of Preferred Stock represent
a total of 14,972,400 votes.
The holders of a majority of all issued and outstanding shares of Common
Stock entitled to vote, present in person or represented by proxy, shall
constitute a quorum at the Meeting. Treasury shares, if any, will not be voted
and are not counted in determining the number of outstanding shares for voting
purposes.
If the enclosed proxy is properly executed and returned to the Company in
time to be voted at the Meeting, it will be voted as specified in the proxy,
unless it is properly revoked prior thereto. Votes cast in person or by proxy at
the Meeting will be tabulated by the inspectors of elections appointed for the
Meeting and will determine whether or not a quorum is present. The inspectors of
elections will treat abstentions as shares that are present and entitled to vote
for purposes of determining the presence of a quorum, but as unvoted for
purposes of determining the approval of any matter submitted to the Stockholders
for a vote. If a broker indicates on the proxy that it does not have
discretionary authority as to certain shares to vote on a particular matter,
those shares will not be considered as present and entitled to vote with respect
to that matter. The information included herein should be reviewed in
conjunction with the exhibit accompanying this Proxy Statement.
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SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS
AND MANAGEMENT
The following table sets forth, as of July 23, 1999, the number and
percentage of outstanding shares of Common Stock and Preferred Stock
beneficially owned by (a) each person known by the Company to beneficially own
more than 5% of such stock, (b) each director of the Company, (c) each of the
executive officers of the Company required to be disclosed pursuant to Item
403(b) of Regulation S-K, and (d) all directors and executive officers of the
Company as a group.
<TABLE>
<CAPTION>
SHARES OF SHARES OF
COMMON PREFERRED
STOCK PERCENT OF STOCK PERCENT OF
NAME AND ADDRESS OF BENEFICIALLY COMMON BENEFICIALLY PREFERRED
BENEFICIAL OWNER OWNED (1) STOCK OWNED (1) STOCK
------------------- ------------ ---------- ------------ ----------
<S> <C> <C> <C> <C>
Irwin L. Gross -0- -0- -0- -0-
1811 Chestnut Street, Suite 120
Philadelphia, Pennsylvania 19103
Chairman of the Board of Directors
Morris C. Aaron (2) 10,000 * -0- -0-
222 North 44th Street
Phoenix, Arizona 85034
Director, Executive Vice President
and Chief Financial Officer
Frank E. Gomer (3) 10,000 * -0- -0-
222 North 44th Street
Phoenix, Arizona 85034
Director, President and Chief
Operating Officer
Wilbur Riner, Sr. (4) 11,100 * -0- -0-
1324 Union Hill Road
Alpharetta, Georgia 30201
Director, Executive Vice President
Business Development
Dr. Moshe M. Porat -0- -0- -0- -0-
1811 Chestnut Street, Suite 120
Philadelphia, Pennsylvania 19103
Director
Stephen Schachman -0- -0- -0- -0-
1811 Chestnut Street, Suite 120
Philadelphia, Pennsylvania 19103
Director
Interactive Flight Technologies, Inc. (5) 3,011,764 38.6 2,497,700 100(6)
222 North 44th Street
Phoenix, Arizona 85034
</TABLE>
3
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<TABLE>
<CAPTION>
SHARES OF SHARES OF
COMMON PREFERRED
STOCK PERCENT OF STOCK PERCENT OF
NAME AND ADDRESS OF BENEFICIALLY COMMON BENEFICIALLY PREFERRED
BENEFICIAL OWNER OWNED (1) STOCK OWNED (1) STOCK
------------------- ------------ ---------- ------------ ----------
<S> <C> <C> <C> <C>
Barbara Riner (7)
1324 Union Hill Road 514,543 8.1 -0- -0-
Alpharetta, Georgia 30201
All directors and executive officers
as a group (6 persons) 31,100 * -0- -0-
</TABLE>
- ----------
* Less than 1%.
(1) As used herein, the term beneficial ownership with respect to a security is
defined by Rule 13d-3 under the Securities Exchange Act of 1934 as
consisting of sole or shared voting power (including the power to vote or
direct the vote) and/or sole or shared investment power (including the
power to dispose or direct the disposition of) with respect to the security
through any contract, arrangement, understanding, relationship or
otherwise, including a right to acquire such power(s) within 60 days of
April 30, 1999. Unless otherwise noted, beneficial ownership consists of
sole ownership, voting and investment power with respect to all shares
shown as beneficially owned by them.
(2) Includes options currently exercisable to acquire 10,000 shares of the
Company's Common Stock.
(3) Includes options currently exercisable to acquire 10,000 shares of the
Company's Common Stock.
(4) Does not include 490,120 shares held by Barbara Riner, the wife of Wilbur
Riner. Also does not include options exercisable to purchase an aggregate
of 24,423 shares held by Barbara Riner. Mr. Riner has disclaimed all
beneficial interest in the shares held by his wife. Includes options
currently exercisable to acquire 11,100 shares of the Company's Common
Stock.
(5) Includes 1,155,899 shares of Common Stock issuable upon conversion of
certain shares of Series B Stock held by IFT and 310,000 shares of Common
Stock issuable upon exercise of warrants. Does not include 18,317,571
shares of Common Stock issuable as of July 23, 1999 upon conversion of (i)
the balance of the Series B Stock, (ii) the Series C Stock, (iii) the
Series D Stock and (iv) certain secured debt for which there is not a
sufficient number of authorized Common Stock available. Includes 490,120
shares held by Barbara Riner which are subject to a proxy in favor of two
officers of IFT.
(6) Does not include the shares of Series C Preferred Stock issuable upon
conversion of certain convertible debt.
(7) Includes options currently exercisable to acquire 24,423 shares of the
Company's Common Stock. Barbara Riner is the wife of Wilbur Riner. Does not
include options to acquire 11,100 shares of the Company's Common Stock held
by Wilbur Riner. Ms. Riner has disclaimed beneficial interest in the shares
held by her husband.
CHANGE OF CONTROL. A change in control of the Company occurred in
connection with the acquisition by the Company of substantially all of the
assets of the Interactive Entertainment Division of IFT, which was completed on
May 18, 1999. IFT acquired 1,055,745 shares of the common stock and 2,495,400
shares of the Series D Stock of the Company under the Purchase Agreement. The
4
<PAGE>
Common Stock of the Company acquired by IFT in the transaction (the
"Transaction") effected under the Agreement, when combined with the number of
shares of Common Stock of the Company into which the shares of Series D Stock
can be converted, constitute approximately 60% of the outstanding Common Stock
of the Company on a fully diluted basis, as that term is defined in the
Agreement. The Company does, however, not currently have a sufficient number of
shares of Common Stock authorized to permit such a conversion.
The consideration paid by IFT for all of such shares consisted of
substantially all of the assets of the IFT's Interactive Entertainment Division,
plus cash in the amount of $4,250,000. IFT obtained the cash portion of the
consideration from its working capital reserves. As part of the Transaction, the
Company also assumed certain liabilities related to the IFT assets transferred.
The Company did not assume any liabilities or obligations arising out of the
crash of Swissair Flight #111.
IFT now beneficially owns, directly or indirectly, 3,011,764 shares of
Common Stock, or 38.6% of the Common Stock of the Company, assuming conversion
of certain shares of Series B Stock held by IFT and exercise of warrants to
purchase shares of Common Stock. This amount does not include securities
convertible into 18,317,571 shares of Common Stock for which there is currently
not a sufficient number of authorized shares of Common Stock available. Included
in the foregoing figures are 490,120 shares of Common Stock subject to an
irrevocable limited proxy that IFT holds through two of its officers to vote the
shares in favor of certain transactions, as described in the Agreement, which
proxy will terminate no later than December 31, 1999. IFT also currently owns
all of the outstanding shares of Preferred Stock.
5
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CAUTIONARY STATEMENT REGARDING
FORWARD-LOOKING STATEMENTS
The following statements are or may constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"PSLRA"):
(i) certain statements, including possible or assumed future results of
operations of the Company, including operations subsequent to the Transaction
contained in "TERMS OF TRANSACTION," and certain statements regarding
discussions with Nasdaq contained in "REASONS FOR REQUEST FOR RATIFICATION";
(ii) any statements preceded by, followed by or that include the words
"believes," "expects," "anticipates," "intends" or similar expressions; and
(iii) other statements contained or incorporated by reference herein
regarding matters that are not historical facts.
Because such statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by such
forward-looking statements; factors that could cause actual results to differ
materially include, but are not limited to, the future market for the Company's
products, uncertainties in integrating the acquired operations with those of the
Company, and technological changes. Shareholders are cautioned not to place
undue reliance on such statements, which speak only as of the date thereof.
6
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PROPOSAL 1
RATIFICATION OF ACQUISITION OF ASSETS AND ISSUANCE OF STOCK
SUMMARY
Effective April 30, 1999, the Company entered into an Asset Purchase and
Sale Agreement, as amended by the First Amendment to Asset Purchase and Sale
Agreement, dated as of May 14, 1999 (the "Purchase Agreement"), between the
Company and IFT, pursuant to which the Company acquired substantially all of the
assets of the interactive entertainment business of IFT, including $4,250,000 in
cash (the "Transaction"). As part of the Transaction and in consideration for
the purchase, the Company issued to IFT 1,055,745 shares of the Company's Common
Stock and 2,495,400 shares of the Company's Series D Convertible Preferred
Stock, par value $.01 per share (the "Series D Stock").
A copy of the Asset Purchase and Sale Agreement was filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-QSB for the fiscal quarter ended
March 31, 1999, and the Asset Purchase and Sale Agreement, together with the
First Amendment to Asset Purchase and Sale Agreement dated as of May 14, 1999,
were filed as Exhibits 2.1 and 2.2 respectively to the Company's Current Report
on Form 8-K, filed June 2, 1999. A copy of the Series D Designations is attached
hereto as Exhibit A. Copies of the Purchase Agreement may be obtained free of
charge by contacting the Company at 222 North 44th Street, Phoenix, Arizona
85034, Attention Morris C. Aaron or through the Securities and Exchange
Commission EDGAR database located at http://www.sec.gov on the worldwide web.
The Board of Directors approved the terms of the Transaction. Although
there is no legal requirement that the stockholders ratify the Transaction, the
Board of Directors has directed that the Transaction be presented to the
stockholders for ratification. See "REASONS FOR REQUEST FOR RATIFICATION."
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR RATIFICATION OF THE TRANSACTION.
BACKGROUND
The Company incurred continued losses from operations and faced substantial
liquidity concerns in fiscal year 1998. In its annual report on Form 10-KSB for
the year ended December 31, 1998 the Company reported a net loss of $10.2
million and was substantially out of cash. In its quarterly report on Form
10-QSB for the quarter ended March 31, 1999, the Company reported a further net
loss of $1.3 million, bringing the accumulated deficit to $17.4 million
resulting in a shareholder deficit of $645,000. The audit report for the year
ended December 31, 1999, dated April 15, 1999 indicated substantial doubt about
the Company's ability to continue as a going concern. Due in part to these
financial concerns, and no available cash on hand, the Company's Board of
Directors approved the Transaction, which was completed on May 18, 1999.
REASONS FOR REQUEST FOR RATIFICATION
Each share of the Series D Stock issued to IFT as part of the Transaction
is convertible into 6.05 shares of the Company's Common Stock. The Series D
Stock when originally issued, did not entitle its holders to any voting rights
(other than special protective rights with respect to certain extraordinary
transactions). However, by its terms each share of the Series D Stock became
entitled to six votes because the Company's Articles of Incorporation were not
amended to increase the authorized shares of Common Stock sufficiently to permit
the Company to satisfy its obligations to issue shares of Common Stock under all
options and warrants and convertible securities held by IFT on or prior to July
15, 1999.
7
<PAGE>
Under the rules of the National Association of Securities Dealers (the
"NASD"), issuers whose securities are included in the Nasdaq SmallCap Market,
where the Common Stock is listed, are required to obtain stockholder approval
prior to the issuance of listed securities or in connection with an acquisition
(other than a public offering for cash) where the issuance of common stock (or
securities convertible into common stock) is or will equal or will be in excess
of 20% or more of the common stock or voting power prior to issuance or where
the issuance will cause a change in control (the "Rules").
The Company made an application to Nasdaq for an exception to the Rules
based on the Company's determination that the delay in securing stockholder
approval would seriously jeopardize the financial viability of the enterprise.
However, Nasdaq notified the Company that it would not grant the exception to
the Rules. At that point the Company determined that it had no choice but to
complete the proposed Transaction in May in light of its critical financial
condition.
The Company structured and closed the Transaction with the objective of
complying with the Rules. Specifically, the Company issued 1,055,745 shares of
its voting Common Stock to IFT, which equaled 19.9% of any shares of the
outstanding Common Stock prior to the closing of the transaction and prior to
the conversion of any shares of the Series D Stock into Common Stock. Further,
the Company deferred the commencement of the voting rights on the Series D Stock
to July 15, 1999. The Company believed that it would have held the Meeting and
received the ratification of the Stockholders before such date. Because the
Meeting has been delayed, IFT has voluntarily agreed to vote its Preferred Stock
at the Meeting for this Proposal in the same proportion as the Common Stock
voted by the other Stockholders at the Meeting (even though it has the right to
vote all of the Preferred Stock as it determines in its own discretion).
The Company has advised Nasdaq that it will seek Stockholder ratification
of the Transaction at the Meeting and that IFT has committed to vote its
Preferred Stock as indicated above. The Company hopes that Nasdaq will deem its
actions to be in compliance with the Rules, or if Nasdaq deems the Company
violated the Rules by closing the Transaction, that it will view such actions as
mitigating factors. If Nasdaq ultimately determines that the Company violated
the Rules, the Company could be subject to delisting from the Nasdaq SmallCap
Market. There can be no assurance that the Company's securities will remain
listed on Nasdaq even if the Stockholders ratify the Transaction at the Meeting.
A vote of "no" by the Stockholders on this Proposal will not affect the
Agreement or the Series D Stock issued thereunder.
TERMS OF TRANSACTION
As part of the Transaction, the Company acquired substantially all of the
assets of IFT's Interactive Entertainment Division ("IED") plus cash in the
amount of $4,250,000 (the "Acquired Business"). The assets transferred to the
Company included all rights in IED's interactive entertainment intellectual
property, fixed assets, inventory and other intangibles of IFT, prepaid
expenses, and other property used in its business, as described in Schedules to
the Agreement. As part of the Transaction, the Company also assumed certain
liabilities related to the IFT assets transferred. The Company assumed no
liabilities or obligations respecting possible claims, if any, from arising out
of crash of Swissair Flight #111.
8
<PAGE>
Through its Interactive Entertainment Division, IFT had been engaged in the
development, assembly, installation and operation of a computer-based in-flight
entertainment network. The Company intends to use the acquired assets, including
the intellectual property, trade secrets, and know-how, to continue to pursue
TNC's CruiseView(TM), TrainView(TM) and AirView(TM) entertainment opportunities.
The consideration for the acquisition of the Acquired Business consisted of
1,055,745 shares of the Company's Common Stock and 2,495,400 shares of the
Company's Series D Stock and the assumption of certain liabilities.
In the Agreement, IFT agreed for a three (3) year period not to (i) engage
in any Competitive Business (as defined in the Agreement), (ii) solicit or
accept business for any Competitive Business from anyone who is or becomes an
active or prospective customer of TNC or its affiliates or who was an active or
prospective customer of the Business at or prior to the Closing Date of the
Transaction, (iii) solicit for employment or hire any employee of TNC or its
affiliates, or (iv) attempt to do any of the things or assist anyone else in
doing any of the things specified in (i), (ii), or (iii) above.
TERMS OF THE SERIES D PREFERRED STOCK
The following description of the Series D Stock does not purport to be
complete and is subject to, and qualified in its entirety by, the provisions of
the Series D Designations.
DIVIDENDS
The holders of shares of Series D Stock are entitled to receive dividends
when, as and if declared by the Board out of funds legally available therefor.
CONVERSION AT OPTION OF HOLDER
The shares of Series D Stock are convertible, in whole or in part, at the
option of the holder thereof (subject to certain limitations), into shares of
Common Stock at an initial conversion rate of 6.05 shares of Common Stock for
each share of Series D Stock, subject to adjustment for certain capital events.
LIQUIDATION RIGHTS
In the event of the liquidation, dissolution, winding up or event of
bankruptcy of the business of the Company, the holders of Series D Stock are
entitled to receive a liquidation preference (together with other PARI PASSU
securities) for each share of Series D Stock in an amount equal to $10.00 per
share. At the option of each holder, certain sales of the assets or stock of the
Company or a merger or reorganization event may be deemed a liquidation event,
entitling the Holder to a liquidation preference of $12.00 per share.
VOTING RIGHTS
Except as otherwise provided by the Georgia Business Corporation Code and
except for certain special protective provisions, the holders shall have no
voting rights unless on or before July 15, 1999, the Articles of Incorporation
of the Company have not been amended to increase the number of authorized shares
of Common Stock sufficiently to permit the Company to issue to IFT the number of
shares of Common Stock necessary to satisfy the Company's obligations upon the
exercise of all options and warrants and conversion of all convertible
securities held by IFT. In the event such amendment has not occurred on or
before July 15, 1999, each share of Series D Stock shall be entitled to six (6)
votes.
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FAIRNESS OPINION
In connection with the Transaction, the Company engaged the firm,
ValueMetrics, Inc., a national valuation company, to advise the Company on the
fairness to the Stockholders from a financial standpoint of the consideration to
be paid to the Company under the terms of the Agreement. The Company's reasons
for selecting ValueMetrics, Inc. included such firm's availability of resources
to timely complete the engagement, cost, and expertise and knowledge of the
relevant market. ValueMetrics, Inc. provided the Company with its favorable
opinion that the consideration to be paid under the terms of the Agreement and
in connection with the Transaction was fair to the Company and its shareholders
from a financial standpoint. ValueMetrics had no relationship to the Company or
IFT prior to this engagement. The procedures and methodology used by
ValueMetrics, Inc. in reaching its determination are set forth in its opinion
delivered to the Board of Directors, which is annexed hereto as Exhibit C.
REQUIRED VOTE
The affirmative vote of a majority of the voting power of the Common Stock
and the Preferred Stock present at the Meeting in person or by proxy will be
required for the ratification of the Transaction and of the issuance of the
1,055,745 shares of the Common Stock and 2,495,400 shares of Series D Stock in
connection therewith. However, because the Series C Stock and the D Stock have
now become entitled to vote, IFT, the sole holder, has voluntarily decided to
vote such shares at the Meeting in the same proportion as the shares of Common
Stock present at the Meeting, such that the result obtained will be the same as
if the Preferred Stock were not voting. Such decision relates to the Meeting
only, and were a subsequent vote to occur, IFT would vote its shares in its sole
discretion.
PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS (UNAUDITED)
On May 18, 1999, Interactive Flight Technologies, Inc. ("IFT") received
from The Network Connection, Inc. (the "Company") 1,055,745 shares of its common
stock and 2,495,400 shares of its Series D Convertible Preferred Stock in
exchange for $4,250,000 in cash and substantially all the assets and certain
liabilities of IFT's Interactive Entertainment Division ("IED"), as defined in
the Asset Purchase and Sale Agreement dated April 30, 1999, as amended. The
transaction has been accounted for as a reverse merger whereby, for accounting
purposes, IFT is considered the accounting acquiror and the Company is treated
as the successor to the historical operations of IED. Accordingly, the
historical financial statements of the Company, which previously have been
reported to the Securities and Exchange Commission ("SEC") on Forms 10-KSB,
10-QSB, among others, as of and for all periods through March 31, 1999, will be
replaced with those of IFT. The Company will continue to file as a SEC
registrant and continue to report under the name The Network Connection, Inc.
IFT will continue to report as a separate SEC registrant, owning the shares of
the Company as described above. The historical financial statements of the
Company up to the date of the transaction will no longer be included in future
filings of the Company.
10
<PAGE>
The attached unaudited pro forma condensed combined balance sheet as of
April 30, 1999 and the unaudited pro forma condensed combined statements of
operations for the six months ended April 30, 1999(1) and the year ended October
31, 1998(2) give effect to the acquisition (as described above), as of April 30,
1999 for purposes of the balance sheet and as of the beginning of the periods
presented for purposes of the statements of operations. As a result of the
reverse merger, the assets and liabilities of IED are presented at their
historical cost basis and the assets and liabilities of the Company have been
recorded at their estimated fair market value at the date of the transaction for
purposes of the purchase price allocation. The unaudited pro forma condensed
combined statements of operations assume that the acquisition took place at the
beginning of each period presented and combine the results of operations of the
Company for the six months ended March 31, 1999 and IFT for the six months ended
April 30, 1999 and the results of operations of the Company for the year ended
December 31, 1998 and IFT for the year ended October 31, 1998. The unaudited pro
forma condensed combined balance sheet combines the balance sheets of the
Company as of March 31, 1999 and IFT as of April 30, 1999, giving effect to the
acquisition as if it had occurred on April 30, 1999.
The unaudited pro forma condensed combined statements of operations are
not necessarily indicative of the future results of operations of the Company or
the results of operations which would have resulted had the Company and IFT's
IED been combined during the periods presented. In addition, the unaudited pro
forma results of operations are not intended to be a projection of future period
results.
- ----------
(1) The Company reports on a calendar year basis, and as such, the underlying
balance sheet data and results of operations are as of and for the six
months ended March 31, 1999. The balance sheet data as of March 31, 1999
was derived from the Company's March 31, 1999 Form 10-QSB filed with the
SEC. The results of operations data for the six months ended March 31, 1999
was derived from the results of operations for the fourth quarter of 1998
(three months ended December 31, 1998) included in the Company's December
31, 1998 Form 10-KSB filed with the SEC and the results of operations for
the three months ended March 31, 1999 derived from the Company's March 31,
1999 10-QSB filed with the SEC. As such, the results of operations for the
fourth quarter of 1998 for the Company are included in both the Unaudited
Pro Forma Condensed Combined Statement of Operations for the six months
ended April 30, 1999 and the year ended October 31, 1998.
(2) The Company reports on a calendar year basis, and as such, the underlying
results of operations are for the period ended December 31, 1998, as filed
on Form 10-KSB.
11
<PAGE>
THE NETWORK CONNECTION, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED APRIL 30, 1999
(DOLLARS IN THOUSANDS)
Pro Forma Pro Forma
IFT TNCI Adjustments Combined
------- ------- ----------- -------
Revenues $ 627 $ (16) $ -- $ 611
Cost of revenues 374 257 -- 631
------- ------- ------- -------
Gross profit (loss) 253 (273) -- (20)
------- ------- ------- -------
Operating Expenses:
Selling, general and
administrative 3,645 1,952 (207)(E) 5,390
Research and development -- 290 -- 290
Provision for doubtful accounts
and inventory reserves -- 3,622 -- 3,622
Reversal of warranty, maintenance
and commission accruals (1,987) -- -- (1,987)
Expenses associated with
investments 300 -- -- 300
Special charges -- 595 -- 595
Amortization of goodwill -- -- 236 (E) 236
------- ------- ------- -------
1,958 6,459 29 8,466
------- ------- ------- -------
Operating loss (1,705) (6,732) (29) (8,466)
Interest income 845 -- -- 845
Interest expense (3) (525) -- (528)
Other income 49 -- -- 49
------- ------- ------- -------
Net loss (814) (7,257) (29) (8,100)
Preferred stock dividends -- 303 -- 303
Net loss to common shareholders $ (814) $(7,560) $ (29) $(8,403)
======= ======= ======= =======
Basic and diluted net loss per share $ (1.51) $ (1.39)
======= =======
Weighted average shares outstanding 5,006 1,056 (F) 6,062
======= ======= =======
See accompanying notes to unaudited pro forma condensed combined financial
statements.
12
<PAGE>
THE NETWORK CONNECTION, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED OCTOBER 31, 1998
(DOLLARS IN THOUSANDS)
Pro Forma Pro Forma
IFT TNCI Adjustments Combined
-------- -------- -------- --------
Revenues $ 19,143 $ 5,003 $ -- $ 24,146
Cost of revenues 15,762 3,005 -- 18,767
-------- -------- -------- --------
Gross profit 3,381 1,998 -- 5,379
-------- -------- -------- --------
Operating Expenses:
Selling, general and
administrative 11,388 3,966 (590)(E) 14,764
Research and development 1,092 397 -- 1,489
Provision for doubtful
accounts and inventory reserves 10 6,464 -- 6,474
Special charges 400 595 -- 995
Amortization of goodwill -- -- 473 (E) 473
-------- -------- -------- --------
12,890 11,422 (117) 24,195
-------- -------- -------- --------
Operating loss (9,509) (9,424) 117 (18,816)
Interest income 2,251 -- -- 2,251
Interest expense (12) (209) -- (221)
Other income 10 -- -- 10
-------- -------- -------- --------
Net loss (7,260) (9,633) 117 (16,776)
Preferred stock dividends -- 575 -- 575
-------- -------- -------- --------
Net loss to common shareholders $ (7,260) $(10,208) $ 117 $(17,351)
======== ======== ======== ========
Basic and diluted net loss per share $ (2.31) $ (3.16)
======== ========
Weighted average shares outstanding 4,427 (1,056)(F) 5,483
======== ======== ========
See accompanying notes to unaudited pro forma condensed combined financial
statements.
13
<PAGE>
THE NETWORK CONNECTION, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
APRIL 30, 1999
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
IFT-IED TNCI
April 30, March 31, Pro Forma Pro Forma
1999 1999 Adjustments Combined
--------- -------- ----------- --------
<S> <C> <C> <C> <C>
Current assets:
Cash & cash equivalents $4,369 $ 107 $ -- $ 4,476
Restricted cash 447 447 -- --
Notes receivable -- 229 -- 229
Accounts receivable 1,251 1,478 -- 2,729
Inventories, net 1,513 2,681 (1,281)(C) 2,913
Prepaid expenses 7 26 -- 33
Other current assets 109 -- -- 109
------ -------- -------- -------
Total current assets 7,696 4,521 (1,281) 10,936
Property and equipment, net 594 2,414 (806)(B) 2,202
Goodwill -- -- 4,728 (A) 4,728
Other assets 555 84 -- 639
------ -------- -------- -------
Total assets $8,845 $ 7,019 $ 2,641 $18,505
====== ======== ======== =======
Current liabilities:
Accounts payable and accrued
liabilities $2,682 $ 2,609 $ -- $ 5,291
Notes payable -- 2,293 -- 2,293
Deferred revenue 2,158 521 -- 2,679
Accrued product warranties 3,836 -- -- 3,836
------ -------- -------- -------
Total current liabilities 8,676 5,423 -- 14,099
Long term debt -- 693 -- 693
------ -------- -------- -------
Total liabilities 8,676 6,116 -- 14,792
Series B 8% preferred (1,500
shares $.01 par value) -- 1,549 (1,549)(D) --
Shareholders' equity:
Series B 8% preferred (1,500 shares
$.01 par value and $1,000 stated value) -- -- 15 (D) 15
Series C 8% preferred (800 shares
$.01 par value and $1,000 stated value) -- -- 8 (D) 8
Series D preferred (2,495,400 shares
$.01 par value and $10 stated value) -- -- 25 (D) 25
Common stock -- 5 1 (D) 6
Additional paid in capital -- 16,704 (13,214)(D) 3,490
Retained earnings (deficit) 169 (17,355) 17,355 (D) 169
------ -------- -------- -------
Total shareholders' equity 169 (646) 4,190 3,713
------ -------- -------- -------
Total liabilities and equity $8,845 $ 7,019 $ 2,641 $18,505
====== ======== ======== =======
</TABLE>
See accompanying notes to unaudited pro forma condensed combined financial
statements.
14
<PAGE>
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
1) BASIS OF ACCOUNTING
On May 18, 1999, The Network Connection, Inc. (the "Company") completed the
issuance of 1,055,745 shares of its common stock and 2,495,400 shares of its
Series D Convertible Preferred Stock in exchange for $4,250,000 in cash and all
the assets and certain liabilities of IFT's Interactive Entertainment Division
("IED"), as defined in the Asset Purchase and Sale Agreement, dated April 30,
1999, as amended. The transaction has been accounted for as a reverse merger
whereby, for accounting purposes, IFT is considered the accounting acquiror and
the Company is treated as the successor to the historical operations of IFT.
Accordingly, the historical financial statements of the Company, which
previously have been reported to the Securities and Exchange Commission ("SEC")
on Forms 10-KSB, 10-QSB, among others, as of and for all periods through March
31, 1999, will be replaced with those of IFT (IED).
The Company will continue to file as a SEC registrant and continue to
report under the name The Network Connection, Inc. IFT will also continue to
report as a separate SEC registrant, owning the shares of the Company as
described above.
The unaudited pro forma condensed combined balance sheet as of April 30,
1999, gives effect to the transaction as if the transaction had taken place on
April 30, 1999 and combines IED's unaudited April 30, 1999 contributed assets
and liabilities, as derived from IFT's unaudited April 30, 1999 financial
statements, with the Company's unaudited balance sheet as of March 31, 1999.
The unaudited pro forma condensed combined statement of operations for the
six months ended April 30, 1999 is presented using the Company's unaudited
statement of operations for the six months ended March 31, 1999 (see note 1 on
page 12) combined with IFT's unaudited statement of operations for the six
months ended April 30, 1999 as if the transaction had taken place on November 1,
1998.
The unaudited pro forma condensed combined statement of operations for the
year ended October 31, 1998 is presented using the Company's audited statement
of operations for the year ended December 31, 1998 combined with IFT's audited
statement of operations for the year ended October 31, 1998, as if the
transaction had taken place on November 1, 1997.
As a result, the Company's results of operations for the three months ended
December 31, 1998 are included in the unaudited pro forma condensed combined
statements of operations for both the six months ended April 30, 1999 and the
year ended December 31, 1998.
The unaudited pro forma condensed combined financial statements should be
read in conjunction with the Company's unaudited financial statements as of and
for the three months ended March 31, 1999 as filed on Form 10-QSB and the
audited financial statements as of and for the year ended December 31, 1998, as
filed on Form 10-KSB, and with IFT's unaudited consolidated financial statements
as of and for the six months ended April 30, 1999 as filed on Form 10-QSB and
the audited consolidated financial statements as of and for the year ended
October 31, 1998 as filed on Form 10-KSB.
15
<PAGE>
The unaudited pro forma condensed combined statements of operations are not
necessarily indicative of the future results of operations of the Company or the
results of operations which would have resulted had the Company and IFT's IED
been combined during the periods presented. In addition, the unaudited pro forma
results are not intended to be a projection of future period results. The
purchase price was allocated to assets and liabilities based on management's
current estimate of their value. The final allocation of the purchase price may
vary from the estimated allocation herein.
2) Unaudited Pro Forma Condensed Combined Balance Sheet and Unaudited Pro Forma
Condensed Combined Statements of Operations
The accompanying pro forma adjustments reflect adjustments for the
following items:
A. To reflect the excess of acquisition cost over the estimated fair
value of net liabilities assumed (goodwill). The purchase price and
purchase-price allocation are summarized as follows (all dollars in thousands):
Purchase price paid as:
Cash $ 4,250
Net fair value of assets of
IFT contributed per the Agreement (excluding
cash contribution but including other cash 4,595
equivalents)
Net fair value of liabilities of IFT contributed per
the Agreement (8,676)
-------
Total purchase consideration $ 169
Allocated to:
Historical book value of TNCI's net liabilities (971)
Adjustments to write-down assets to fair value:
Inventories, net (1,281)
Property and equipment (806)
Total fair value of net liabilities assumed (3,058)
Excess of fair value of TNCI Series B and Series C
preferred stock over its recorded or stated value (1,501)
-------
Excess of purchase price over fair value of net liabilities
assumed (goodwill) $ 4,728
=======
B. To reflect the write-down in property and equipment to fair value
based on new management's estimate of fair market value based on a review of
such assets and independent third party data where available.
C. To reflect adjustments to arrive at the fair market value of such
assets based on management's estimate of fair market value based on a review of
such assets and other available data. Adjustments to inventory reflect certain
changes in business strategy and potential customer orders since March 31, 1999,
with respect to market opportunities for the Company's future service offerings.
16
<PAGE>
D. To reflect the elimination of certain shareholders' equity and
mezzanine preferred stock accounts of TNCI, to reflect the issuance of TNCI
common stock and Series D preferred stock in connection with the Transaction and
to reflect the separate purchase (prior to the acquisition date) of the
Company's Series B and C preferred stock by IFT.
E. To reflect the decrease in depreciation and amortization expense
due to (1) the amortization of goodwill on a straight-line basis over ten years,
and (2) decrease in depreciation resulting from the write-down of property and
equipment, depreciated on a straight-line basis over periods of approximately
five years.
F. Weighted average common shares outstanding reflects the 1,055,745
common shares of the Company issued in connection with the Transaction as if
such shares were outstanding as of the beginning of each period presented.
REGULATORY AND LEGAL REQUIREMENTS
No federal or state approvals are required in connection with the
Transaction.
ACCOUNTING TREATMENT AND INCOME TAX CONSEQUENCES OF TRANSACTION
In accordance with generally accepted accounting principles, the
Transaction has been accounted for as a reverse merger. See, "Notes to Unaudited
Pro Forma Condensed Combined Financial Statements." The Company will not
recognize any gain or loss for federal income tax purposes on the acquisition of
the Acquired Business in consideration for Common Stock and Series D Stock of
the Company and the assumption of certain liabilities of IFT, and the Company's
adjusted basis in the non cash portion of the Acquired Business will be equal to
the fair market value of the consideration paid by the Company for such Assets.
The change in control of the Company that occurred in connection with the
Transaction may restrict the future utilization by the Company of its net
operating losses. As of December 31, 1998, the Company had net operating loss
carry forwards of approximately $5,338,000.
CERTAIN RELATIONSHIPS
Three of the directors of the Company, Messrs. Gomer, Gross and Aaron, are
also affiliates of IFT. Prior to the Transaction, there was no relationship
between the Company and IFT except:
(i) subsequent to signing the February 4, 1999 Letter of Intent with IFT,
the Company had significant cash flow and liquidity problems. To help remedy
these problems, IFT made a number of advances to the Company, which advances are
evidenced by a Secured Promissory Note dated January 26, 1999 and four separate
amendments, or Allonges, to the Secured Promissory Note dated January 29, March
19, March 24, and May 10. Prior to the Transaction, the approximate principal
balance of the Secured Promissory Note was $750,000;
(ii) pursuant to the Fourth Allonge to the Secured Promissory Note
evidencing such loan, the balance due from the Company to IFT is convertible
into shares of the Series C Preferred at a conversion price of $1,000 per share,
and such Series C Preferred Stock is convertible into Common Stock of the
Company at a conversion price equal to the lesser of (a) $2.6875 per share; (b)
66.67% of the Average Share Price per share of the Company's Common Stock, as
defined in the Articles of Amendment to Articles of Incorporation dated April
30, 1999 re Designations, Preferences and Rights of Series C Preferred Stock
filed May 5, 1999 (the "Series C Designations"); or (c) at a reduced price
pursuant to Section 6.5 of the Series C Designations, as described in the
Articles of Amendment to the Articles of Incorporation filed May 5, 1999. The
holders of the Series C Preferred have no voting power, except that in the event
that on or before July 15, 1999, the Company's Articles of Incorporation have
not been amended to increase the number of authorized shares of Common Stock
sufficiently to permit the Company to issue to IFT, upon the exercise of all
options and warrants and the conversion of all convertible securities held by
IFT, that number of shares of Common Stock necessary to satisfy the Company's
obligations under all such securities, then the shares of Series C Preferred, in
17
<PAGE>
combination with the shares of Series B Preferred, shall entitle the holders
thereof to cast that number of votes at any duly called meeting of the
stockholders of the Company which, when added to the shares of Common Stock held
by any of the holders of the Series B Preferred and Series C Preferred on the
record date for such stockholder meeting, shall be necessary to equal a majority
of the number of votes entitled to be cast at such stockholder meeting by the
holders of all voting shares of the Company; and
(iii) on May 11, 1999, IFT acquired 1,500 shares of Series B Preferred of
the Company and cash in the amount of $1,030,000 from a third party in exchange
for 3000 shares of IFT's Series A 8% Convertible Preferred Stock, par value $.01
per share, Stated Value $1,000 per share and warrants to purchase 87,500 shares
of IFT's Class A Common Stock at an exercise price of $3.00 per share, and
acquired 800 shares of the Series C Preferred from the Company in consideration
for waiving past arrearages and defaults under the Series B Preferred. The
Series C Preferred is convertible to Common Stock of the Company as described
above. The Series B Preferred is convertible into the Common Stock of the
Company at a conversion price equal to the lowest of (a) 75% of the Average
Price (as defined in the Articles of Amendment to the Articles of Incorporation
of the Company dated as of April 29, 1999) of TNC's Common Stock calculated at
the time of conversion; or (b) 75% of such Average Price calculated as if April
29, 1999 were the conversion date. The holders of Series B Preferred have no
voting power.
MARKET DATA
The per share closing sale price of TNCI Common Stock on Nasdaq on February
3, the last full trading day prior to the public announcement of the signing of
the Letter of Intent was $3.81. On May 17, 1999, the last trading day prior to
the public announcement of the signing of the Purchase Agreement, the per share
closing price of TNCI Common Stock as reported on Nasdaq was $3.00.
THE BOARD RECOMMENDS THAT YOU VOTE FOR THE RATIFICATION OF THE TRANSACTION.
PROPOSAL 2
AMENDMENT TO THE COMPANY'S ARTICLES OF INCORPORATION TO INCREASE
THE NUMBER OF AUTHORIZED SHARES OF CAPITAL STOCK
The Company's Amended and Restated Articles of Incorporation currently
authorizes the Company to issue Twelve Million Five Hundred Thousand shares of
capital stock including Ten Million shares of Common Stock, par value $.001 per
share. The Board of Directors has approved, subject to shareholder approval, an
amendment to Article V of the Company's Amended and Restated Articles of
Incorporation, as amended, to increase the total number of authorized shares of
capital stock to 42,500,000 shares, of which 40,000,000 shares will be Common
Stock and 2,500,000 shares will be Preferred Stock.
The text of the proposed amendment to Article V of the Company's Amended
and Restated Articles of Incorporation is attached hereto as Exhibit C.
In connection with the Transaction (see PROPOSAL 1), the Company issued
2,495,400 shares of its Series D Stock to IFT. Such shares are convertible into
shares of the Company's Common Stock. As of July 23, 1999, 6,338,076 shares of
Common Stock are issued and outstanding.
The proposed increase in the number of shares of authorized Common Stock
will ensure that shares will be available for future financings, acquisitions,
stock splits, stock dividends and other corporate purposes and for issuance upon
conversion of the Series D Stock and other outstanding convertible preferred
shares, options and warrants. Except as set forth above, the Company has no
immediate plans, arrangements, commitments, or understandings with respect to
the issuance of any of the additional shares of Common Stock which would be
authorized by the proposed amendment.
No further action by the Company's stockholders would be necessary to issue
the additional shares of Common Stock unless required by applicable law or
regulatory agencies or by the rules of any stock exchange on which the Company's
securities may then be listed.
18
<PAGE>
The holders of any of the additional shares of Common Stock issued in the
future would have the same rights and privileges as the holders of the shares of
Common Stock currently authorized and outstanding.
Except as stated above, the Company has no immediate plans, arrangements,
commitments, or understandings with respect to the issuance of any additional
shares of Common Stock which would be authorized by the proposed amendment.
However, the increased authorized shares could be used to make a takeover
attempt more difficult such as by using the shares to make a counteroffer for
the shares of the bidder or by selling shares to dilute the voting power of the
bidder.
The Company is not proposing any increase in the number of shares of
authorized preferred stock.
CHARACTERISTICS OF COMMON STOCK
The holders of Common Stock elect all directors and are entitled to one
vote per share on all matters submitted to a vote of the Stockholders.
Stockholders are entitled to receive dividends when, as and if declared by the
Board out of funds legally available for that purpose, subject to satisfaction
of any preferences of the Preferred Stock. Upon any liquidation, dissolution or
winding up of the Company, holders of Common Stock are entitled to share
pro-rata in any distribution to Stockholder, subject to satisfaction of any
preferences of the Preferred Stock. Holders of Common Stock have no preemptive,
subscription or conversion rights.
Shares of Common Stock generally may be issued by the Board for any proper
corporate purpose without further Stockholder action, unless required by
applicable laws, rules or regulations.
REQUIRED VOTE
The affirmative vote of a majority of the outstanding Common Stock and
Preferred Stock is required for the approval of the amendment to the Company's
Certificate of Incorporation. The Series C Stock and the Series D Stock are
entitled to vote at the Meeting and IFT intends to vote such shares at the
Meeting in favor of Proposal 2.
THE BOARD RECOMMENDS THAT YOU VOTE FOR THE AMENDMENT TO THE ARTICLES OF
INCORPORATION.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
For additional information regarding the Company and IFT, please see
the following documents filed with the Commission that accompany this Proxy
Statement and are incorporated by reference in this Proxy Statement:
By the Company (File No. 001-13760)
1. The Company's Annual Report on Form 10-KSB for the fiscal year ended
December 31, 1998, as amended by Amendment No. 1, filed April 15, 1999 (the
"TNCI 10-KSB");
2. The Company's Quarterly Report on Form 10-QSB for the quarter ended
March 31, 1999.
3. The Company's Current Report on Form 8-K, filed August 3, 1999.
By IFT (File No. 0-25668)
1. IFT's Annual Report on Form 10-KSB for the fiscal year ended October 31,
1998, filed January 20, 1999.
19
<PAGE>
2. The Company's Quarterly Report on Form 10-QSB for the quarter ended
April 30, 1999, filed June 14, 1999.
All documents filed by the Company and IFT pursuant to Sections 13, 14 or
15 of the 1934 Act, since the end of the most recent fiscal year for which a
Form 10-KSB was filed and prior to the date on which the Meeting is held, shall
be deemed to be incorporated by reference in this Proxy Statement and to be a
part hereof from the date of filing of such documents.
Any statement contained in a document incorporated by reference herein
shall be deemed to be modified or superseded for purposes of this Proxy
Statement to the extent that a statement contained herein or in any other
subsequently filed document which is also incorporated by referenced herein
modifies or supersedes such statement. Any statement so modified or superseded
shall not be deemed, except as modified or superseded, to constitute a part of
this Proxy Statement.
The Company will provide without charge to each person, including any
beneficial owner, to whom this Proxy Statement is delivered, upon written or
oral request of such person, and by first class mail or other equally prompt
means within one business day of receipt of such request, a copy of any or all
of the information incorporated by reference herein including subsequently filed
documents, other than exhibits to such information (unless such exhibits are
specifically incorporated by reference into such documents). Requests for
information concerning the Company should be directed to Morris C. Aaron.
Requests for information concerning IFT should be directed to David Shevrin.
INDEPENDENT PUBLIC ACCOUNTANTS
PricewaterhouseCoopers, LLP has served as independent auditors of the
Company since December 1997. KPMG LLP has served as independent auditors of IFT
since October 1995. A representative of each of PricewaterhouseCoopers and KPMG
LLP is expected to be present at the Meeting and will be available to respond to
appropriate questions.
OTHER BUSINESS
The Special Meeting is being held for the purposes set forth in the Notice
that accompanies this Proxy Statement. The Board is not presently aware of any
business to be transacted at the Special Meeting other than as set forth in the
Notice.
SHAREHOLDER PROPOSALS
Any shareholder desiring to have a proposal included in the Proxy Statement
for the 1999 annual meeting must deliver such proposal (which must comply with
the requirements of Rule 14a-8 promulgated under the Securities Exchange Act of
1934) to the Company's principal executive offices no later than October 15,
1999.
By Order of the Board of Directors,
MORRIS C. AARON
Executive Vice President and
Chief Financial Officer
Phoenix, Arizona
20
<PAGE>
EXHIBIT A
Interactive Flight Technologies, Inc.
Asset Purchase and Sale Agreement
ARTICLES OF AMENDMENT TO THE ARTICLES
OF INCORPORATION OF
THE NETWORK CONNECTION, INC.
---------------
These Articles of Amendment (the "Amendment") are being executed as of
May 5, 1999, for the purpose of amending the Articles of Incorporation of The
Network Connection, Inc. (the "Company"), pursuant to Section 14-2-602 of the
Georgia Business Corporation Code.
NOW, THEREFORE, the undersigned hereby certifies as follows:
FIRST: The name of the corporation is The Network Connection, Inc.
SECOND: Pursuant to authority conferred upon the Board of Directors by
the Articles of Incorporation, the Board of Directors, adopted the following
resolution providing for the creation of Two Million Four Hundred Ninety-Five
Thousand Four Hundred (2,495,400) shares of Series D Convertible Preferred
Stock:
RESOLVED, that pursuant to Article V of the Articles of Incorporation
of the Company, there be and hereby is authorized and created a series of
Preferred Stock, hereby designated as Series D Convertible Preferred Stock to
consist of Two Million Four Hundred Ninety-Five Thousand Four Hundred
(2,495,400) shares with a par value of $.01 per share and a Stated Value of
$10.00 per share (the "Stated Value"), and that the designations, preferences
and relative, participating, optional or other rights of the Series D
Convertible Preferred Stock (the "Series D Preferred Stock") and qualifications,
limitations or restrictions thereof, shall be as follows:
ARTICLE 1
DEFINITIONS
SECTION 1.1 DEFINITIONS. The terms defined in this Article whenever
used in this Amendment have the following respective meanings:
(a) "ADDITIONAL CAPITAL SHARES" has the meaning set forth in
Section 6.1(c).
(b) "AFFILIATE" has the meaning ascribed to such term in Rule
12b-2 under the Securities Exchange Act of 1934, as amended.
(c) "AGREEMENT" means that certain Asset Purchase and Sale
Agreement dated April 29, 1999 between the Corporation and IFT.
<PAGE>
(d) "BUSINESS DAY" means a day other than Saturday, Sunday or any
day on which banks located in the State of New York are authorized or obligated
to close.
(e) "CAPITAL SHARES" means the Common Shares and any other shares
of any other class or series of common stock, whether now or hereafter
authorized and however designated, which have the right to participate in the
distribution of earnings and assets (upon dissolution, liquidation or
winding-up) of the Corporation.
(f) "CLOSING DATE" means the date of closing under the Agreement.
(g) "COMMON SHARES" or "COMMON STOCK" means shares of common
stock, $.001 par value, of the Corporation.
(h) "COMMON STOCK ISSUED AT CONVERSION" when used with reference
to the securities issuable upon conversion of the Series D Preferred Stock,
means all Common Shares now or hereafter Outstanding and securities of any other
class or series into which the Series D Preferred Stock hereafter shall have
been changed or substituted, whether now or hereafter created and however
designated.
(i) "CONVERSION DATE" means any day on which all or any portion of
shares of the Series D Preferred Stock is converted in accordance with the
provisions hereof.
(j) "CONVERSION NOTICE" has the meaning set forth in Section 6.2.
(k) "CONVERSION PRICE" means on any date of determination the
applicable price for the conversion of shares of Series D Preferred Stock into
Common Shares on such day as set forth in Section 6.1.
(l) "CORPORATION" means The Network Connection, Inc., a Georgia
corporation, and any successor or resulting corporation by way of merger,
consolidation, sale or exchange of all or substantially all of the Corporation's
assets, or otherwise.
(m) "CURRENT MARKET PRICE" on any date of determination means the
closing bid price of a Common Share on such day as reported on the NASDAQ or
such other exchange or quotation system where such Common Stock is traded.
(n) "HOLDER" means IFT, any successor thereto, or any Person to
whom the Series D Preferred Stock is subsequently transferred in accordance with
the provisions hereof.
(o) "IFT" means Interactive Flight Technologies, Inc., a Delaware
corporation.
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(p) "OUTSTANDING" when used with reference to Common Shares or
Capital Shares (collectively, "Shares"), means, on any date of determination,
all issued and outstanding Shares, and includes all such Shares issuable in
respect of outstanding scrip or any certificates representing fractional
interests in such Shares; PROVIDED, HOWEVER, that any such Shares directly or
indirectly owned or held by or for the account of the Corporation or any
Subsidiary of the Corporation shall not be deemed "Outstanding" for purposes
hereof.
(q) "PERSON" means an individual, a corporation, a partnership, an
association, a limited liability company, a unincorporated business
organization, a trust or other entity or organization, and any government or
political subdivision or any agency or instrumentality thereof.
(r) "SUBSIDIARY" means any entity of which securities or other
ownership interests having ordinary voting power to elect a majority of the
board of directors or other persons performing similar functions are owned
directly or indirectly by the Corporation.
(s) "VALUATION EVENT" has the meaning set forth in Section 6.1.
All references to "cash" or "$" herein means currency of the
United States of America.
ARTICLE 2
RESERVED
ARTICLE 3
RANK
The Series D Preferred Stock shall rank (i) prior to the Common Stock;
(ii) prior to any class or series of capital stock of the Corporation hereafter
created other than "Pari Passu Securities" (collectively, with the Common Stock,
"Junior Securities"); (iii) pari passu with Corporation's Series B 8%
Convertible Preferred Stock and with Corporation's Series C 8% Convertible
Preferred Stock, and (iv) pari passu with any class or series of capital stock
of the Corporation hereafter created specifically ranking on parity with the
Series D Preferred Stock ("Pari Passu Securities").
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ARTICLE 4
DIVIDENDS
The Holder shall be entitled to receive dividends and distributions on
or with respect to the Series D Preferred Stock if, as, when, and in the amounts
declared by Corporation's Board of Directors.
ARTICLE 5
LIQUIDATION PREFERENCE
(a) If the Corporation shall commence a voluntary case under the
Federal bankruptcy laws or any other applicable Federal or State bankruptcy,
insolvency or similar law, or consent to the entry of an order for relief in an
involuntary case under any law or to the appointment of a receiver, liquidator,
assignee, custodian, trustee, sequestrator (or other similar official) of the
Corporation or of any substantial part of its property, or make an assignment
for the benefit of its creditors, or admit in writing its inability to pay its
debts generally as they become due, or if a decree or order for relief in
respect of the Corporation shall be entered by a court having jurisdiction in
the premises in an involuntary case under the Federal bankruptcy laws or any
other applicable Federal or state bankruptcy, insolvency or similar law
resulting in the appointment of a receiver, liquidator, assignee, custodian,
trustee, sequestrator (or other similar official) of the Corporation or of any
substantial part of its property, or ordering the winding up or liquidation of
its affairs, and any such decree or order shall be unstayed and in effect for a
period of thirty (30) consecutive days and, on account of any such event, the
Corporation shall liquidate, dissolve or wind up, or if the Corporation shall
otherwise liquidate, dissolve or wind up (each such event being considered a
"Liquidation Event"), no distribution shall be made to the holders of any shares
of capital stock of the Corporation upon liquidation, dissolution or winding up
unless prior thereto, the holders of shares of Series D Preferred Stock shall
have received the Liquidation Preference (as defined below) with respect to each
share. If upon the occurrence of a Liquidation Event, the assets and funds
available for distribution among the holders of the Series D Preferred Stock and
holders of Pari Passu Securities shall be insufficient to permit the payment to
such holders of the preferential amounts payable thereon, then the entire assets
and funds of the Corporation legally available for distribution to the Series D
Preferred Stock and the Pari Passu Securities shall be distributed ratably among
such shares in proportion to the ratio that the Liquidation Preference payable
on each such share bears to the aggregate Liquidation Preferences payable on all
such shares.
(b) At the option of each Holder, the sale, conveyance of disposition
of all or substantially all of the assets of the Corporation, the effectuation
by the Corporation of a transaction or series of related transactions in which
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more than 50% of the voting power of the Corporation is disposed of, or the
consolidation, merger or other business combination of the Corporation with or
into any other Person (as defined below) or Persons when the Corporation is not
the survivor shall be deemed to be a liquidation, dissolution or winding up of
the Corporation pursuant to which the Corporation shall be required to
distribute, upon consummation of and as a condition to, such transaction an
amount equal to 120% of the Liquidation Preference with respect to each
outstanding share of Series D Preferred Stock in accordance with and subject to
the terms of this Article 5; PROVIDED, that all holders of Series D Preferred
Stock shall be deemed to elect the option set forth above if at least a majority
in interest of such holders elect such option. "Person" shall mean any
individual, corporation, limited liability company, partnership, association,
trust or other entity or organization.
(c) For purposes hereof, the "Liquidation Preference" with respect to a
share of the Series D Preferred Stock shall mean an amount equal to the Stated
Value thereof.
ARTICLE 6
CONVERSION OF SERIES D PREFERRED STOCK
SECTION 6.1 CONVERSION; CONVERSION PRICE. Each share of Series D
Preferred Stock shall be convertible into the number of shares of Common Stock
(rounded to the nearest 1/100 of a share) equal to a fraction, the numerator of
which is (a) the product of One Hundred Fifty Percent (150%) multiplied by the
number of outstanding shares of Common Stock on the Closing Date (excluding the
shares of Common Stock and Preferred Stock issued to IFT on the Closing Date
pursuant to the Agreement), treating all convertible securities (other than the
Series D Preferred Stock), options, warrants, and other rights to acquire
securities of Corporation outstanding on the Closing Date as if they had been
converted or exercised (whether or not actually converted or exercised), as the
case may be, minus (b) the number of shares of Common Stock issued to IFT on the
Closing Date pursuant to the Agreement, and the denominator of which is
2,495,400.
Notwithstanding anything to the contrary contained herein, if a
Valuation Event occurs after the date hereof as a result of which the number of
Common Shares Outstanding (assuming for purposes of such determination, the
issuance of all such shares pursuant to an exercise or conversion (as the case
may be) of options, warrants, and other securities issued as part of such
Valuation Event) shall be increased or decreased, then the Conversion Price
shall automatically be proportionately decreased or increased, respectively, and
the number of Common Shares reserved for issuance pursuant to the conversion of
the then Outstanding Series D Preferred Stock shall be automatically
proportionately increased or decreased respectively, so as appropriately to
reflect the effects of such Valuation Event, effective immediately upon the
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effectiveness of such Valuation Event. The adjustment required by the foregoing
sentence shall be effectuated each time a separate Valuation Event shall occur,
and such adjustments shall therefore be cumulative.
For purposes of this Section 6.1, a "VALUATION EVENT" shall mean an event in
which the Corporation at any time takes any of the following actions:
(a) subdivides or combines its Capital Shares;
(b) makes any distribution or dividend of its Capital Shares in respect
of Outstanding Capital Shares;
(c) issues any additional Capital Shares (the "Additional Capital
Shares"), otherwise than as provided in the foregoing Sections 6.1(a) and 6.1(b)
above, at a price per share less, or for other consideration lower, than the
Current Market Price in effect immediately prior to such issuances, or without
consideration, except for issuances under employee benefit plans consistent with
those presently in effect and issuances under presently outstanding warrants,
options or convertible securities, to officers, directors or employees of the
Corporation, or otherwise under the Corporation's 1994 Employee Stock Option
Plan or non-employee Director Stock Option Plan;
(d) issues any warrants, options or other rights to subscribe for or
purchase any Additional Capital Shares and the price per share for which
Additional Capital Shares may at any time thereafter be issuable pursuant to
such warrants, options or other rights shall be less than the Current Market
Price in effect immediately prior to such issuance;
(e) issues any securities convertible into or exchangeable or
exercisable for Capital Shares and the consideration per share for which
Additional Capital Shares may at any time thereafter be issuable pursuant to the
terms of such convertible, exchangeable or exercisable securities shall be less
than the Current Market Price in effect immediately prior to such issuance;
(f) makes a distribution of its assets or evidences of indebtedness to
the holders of its Capital Shares as a dividend in liquidation or by way of
return of capital or other than as a dividend payable out of earnings or surplus
legally available for the payment of dividends under applicable law or any
distribution to such holders made in respect of the sale of all or substantially
all of the Corporation's assets (other than under the circumstances provided for
in the foregoing Sections 6.1(a) through 6.1(e)); or
(g) takes any action affecting the number of Outstanding Capital
Shares, other than an action described in any of the foregoing Sections 6.1(a)
through 6.1(f), inclusive, which in the opinion of the Corporation's Board of
Directors, determined in good faith, would have a material adverse effect upon
the rights of the Holder at the time of a conversion of the Series D Preferred
Stock.
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SECTION 6.2 EXERCISE OF CONVERSION PRIVILEGE. (a) Conversion of the
Series D Preferred Stock may be exercised, in whole or in part, by the Holder by
telecopying an executed and completed notice of conversion in the form annexed
hereto as Annex I (the "Conversion Notice") to the Corporation. Each date on
which a Conversion Notice is telecopied to and received by the Corporation in
accordance with the provisions of this Section 6.2 shall constitute a Conversion
Date. The Corporation shall convert the Series D Preferred Stock and issue the
Common Stock Issued at Conversion effective as of the Conversion Date. The
Conversion Notice also shall state the name or names (with addresses) of the
persons who are to become the holders of the Common Stock Issued at Conversion
in connection with such conversion. The Holder shall deliver the shares of
Series D Preferred Stock to the Corporation by express courier within 30 days
following the date on which the telecopied Conversion Notice has been
transmitted to the Corporation. Upon surrender for conversion, the Series D
Preferred Stock shall be accompanied by a proper assignment hereof to the
Corporation or be endorsed in blank. As promptly as practicable after the
receipt of the Conversion Notice as aforesaid, but in any event not more than
five Business Days after the Corporation's receipt of such Conversion Notice, or
such Series D Preferred Stock, whichever is later, the Corporation shall (i)
issue the Common Stock issued at Conversion in accordance with the provisions of
this Article 6, and (ii) cause to be mailed for delivery by overnight courier to
the Holder (X) a certificate or certificate(s) representing the number of Common
Shares to which the Holder is entitled by virtue of such conversion and (Y)
cash, as provided in Section 6.3, in respect of any fraction of a Share issuable
upon such conversion. Holder shall indemnify the Corporation for any damages to
third parties as a result of a claim by such third party to ownership of the
Series D Preferred Stock converted prior to the receipt of the Series D
Preferred Stock by the Corporation. Such conversion shall be deemed to have been
effected at the time at which the Conversion Notice indicates as long as the
Series D Preferred Stock shall have been surrendered as aforesaid at such time,
and at such time the rights of the Holder of the Series D Preferred Stock, as
such, shall cease and the Person and Persons in whose name or names the Common
Stock Issued at Conversion shall be issuable shall be deemed to have become the
holder or holders of record of the Common Shares represented thereby. The
Conversion Notice shall constitute a contract between the Holder and the
Corporation, whereby the Holder shall be deemed to subscribe for the number of
Common Shares which it will be entitled to receive upon such conversion and, in
payment and satisfaction of such subscription (and for any cash adjustment to
which it is entitled pursuant to Section 6.4), to surrender the Series D
Preferred Stock and to release the Corporation from all liability thereon. No
cash payment aggregating less than $1.50 shall be required to be given unless
specifically requested by the Holder.
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(b) If, at any time (i) the Corporation challenges, disputes or denies
the right of the Holder hereof to effect the conversion of the Series D
Preferred Stock into Common Shares or otherwise dishonors or rejects any
Conversion Notice delivered in accordance with this Section 6.2 or (ii) any
third party who is not and has never been an Affiliate of the Holder commences
any lawsuit or proceeding or otherwise asserts any claim before any court or
public or governmental authority which seeks to challenge, deny, enjoin, limit,
modify, delay or dispute the right of the Holder hereof to effect the conversion
of the Series D Preferred Stock into Common Shares, then the Holder shall have
the right but not the obligation, by written notice to the Corporation, to
require the Corporation promptly to redeem the Series D Preferred Stock for cash
at a redemption price equal to, in the case of (i), one hundred and twenty-five
percent (125%) of the Stated Value thereof and, in the case of (ii), one hundred
and fifteen percent (115%) of the Stated Value thereof (each, the "Mandatory
Purchase Amount"). Under any of the circumstances set forth above, the
Corporation shall be responsible for the payment of all costs and expenses of
the Holder, including reasonable legal fees and expenses, as and when incurred
in disputing any such action or pursuing its rights hereunder (in addition to
any other rights of the Holder).
SECTION 6.3 FRACTIONAL SHARES. No fractional Common Shares or scrip
representing fractional Common Shares shall be issued upon conversion of the
Series D Preferred Stock. Instead of any fractional Common Shares which
otherwise would be issuable upon conversion of the Series D Preferred Stock, the
Corporation shall pay a cash adjustment in respect of such fraction in an amount
equal to the same fraction. No cash payment of less than $1.50 shall be required
to be given unless specifically requested by the Holder.
SECTION 6.4 RECLASSIFICATION, CONSOLIDATION, MERGER OR MANDATORY SHARE
EXCHANGE. At any time while the Series D Preferred Stock remains outstanding and
any shares thereof have not been converted, in case of any reclassification or
change of Outstanding Common Shares issuable upon conversion of the Series D
Preferred Stock (other than a change in par value, or from par value to no par
value per share, or from no par value per share to par value or as a result of a
subdivision or combination of outstanding securities issuable upon conversion of
the Series D Preferred Stock) or in case of any consolidation, merger or
mandatory share exchange of the Corporation with or into another corporation
(other than a merger or mandatory share exchange with another corporation in
which the Corporation is a continuing corporation and which does not result in
any reclassification or change, other than a change in par value, or from par
value to no par value per share, or from no par value per share to par value, or
as a result of a subdivision or combination of Outstanding Common Shares upon
conversion of the Series D Preferred Stock), or in the case of any sale or
transfer to another corporation of the property of the Corporation as an
entirety or substantially as an entirety, the Corporation, or such successor,
resulting or purchasing corporation, as the case may be, shall, without payment
of any additional consideration therefor, execute a new Series D Preferred Stock
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providing that the Holder shall have the right to convert such new Series D
Preferred Stock (upon terms and conditions not less favorable to the Holder than
those in effect pursuant to the Series D Preferred Stock) and to receive upon
such exercise, in lieu of each Common Share theretofore issuable upon conversion
of the Series D Preferred Stock, the kind and amount of shares of stock, other
securities, money or property receivable upon such reclassification, change,
consolidation, merger, mandatory share exchange, sale or transfer by the holder
of one Common Share issuable upon conversion of the Series D Preferred Stock had
the Series D Preferred Stock been converted immediately prior to such
reclassification, change, consolidation, merger, mandatory share exchange or
sale or transfer. The provisions of this Section 6.4 shall similarly apply to
successive reclassifications, changes, consolidations, mergers, mandatory share
exchanges and sales and transfers.
SECTION 6.5 COMPLIANCE WITH SECTION 13(D). Notwithstanding anything
herein to the contrary, until the Holder shall have filed a Schedule 13D or
Schedule 13G under the Securities Exchange Act of 1934 (the "Exchange Act") and
otherwise complied with the requirements of Section 13 of the Exchange Act with
respect to its beneficial ownership of the Common Stock, the Holder shall not
have the right, and the Corporation shall not have the obligation, to convert
all or any portion of the Series D Preferred Stock if and to the extent that the
issuance to the Holder of shares of Common Stock upon such conversion would
result in the Holder's being deemed the "beneficial owner" of more than 5% of
the then outstanding shares of Common Stock within the meaning of Section 13(d)
of the Exchange Act, and the rules promulgated thereunder. If any court of
competent jurisdiction shall determine that the foregoing limitation is
ineffective to prevent a Holder from being deemed the beneficial owner of more
than 5% of the then outstanding shares of Common Stock, then the Corporation
shall redeem so many of such Holder's shares (the "Redemption Shares") of Series
D Preferred Stock as are necessary to cause such Holder to be deemed the
beneficial owner of not more than 5% of the then outstanding shares of Common
Stock. Upon such determination by a court of competent jurisdiction, the
Redemption Shares shall immediately and without further action be deemed
returned to the status of authorized but unissued shares of Series D Preferred
Stock and the Holder shall have no interest in or rights under such Redemption
Shares. Any and all dividends paid on or prior to the date of such determination
shall be deemed dividends paid on the remaining shares of Series D Preferred
Stock held by the Holder. Such redemption shall be for cash at a redemption
price equal to the sum of (i) the Stated Value of the Redemption Shares and (ii)
any accrued and unpaid dividends to the date of such redemption.
SECTION 6.6 SHAREHOLDER APPROVAL. Unless the Corporation shall have
obtained approval by its voting stockholders in accordance with the rules of the
NASDAQ or such other stock market or quotation system as the Corporation shall
be required to comply with, of the issuance of Common Shares to the Holder
pursuant to a conversion of Series D Preferred Stock, then the Corporation shall
not issue shares of Common Stock upon any such conversion if such issuance of
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Common Stock, when added to the number of shares of Common Stock previously
issued by the Corporation upon conversion of shares of the Series D Preferred
Stock, would equal or exceed twenty percent (20%) of the number of shares of the
Corporation's Common Stock which were issued and outstanding on the Closing
Date. The limitation on the Holder's right of conversion contained in the
preceding sentence shall terminate on July 15, 1999.
ARTICLE 7
VOTING RIGHTS
Except as otherwise provided by the Georgia Business Corporation Code
("GCL"), in this Article 7, or in Article 8 below, the Holders of the Series D
Preferred Stock shall have no voting power.
In the event that on or before July 15, 1999, the Corporation's
Articles of Incorporation have not been amended to increase the number of
authorized shares of Common Stock sufficiently to permit the Corporation to
issue to IFT, upon the exercise of all options and warrants and the conversion
of all convertible securities held by IFT, that number of shares of Common Stock
necessary to satisfy the Corporation's obligations under all such securities,
then each share of Series D Preferred Stock shall be entitled to cast six (6)
votes at any duly called meeting of the stockholders of the Corporation on any
matter presented for consideration of such stockholders.
During the period in which the Series D Preferred Stock shall be
non-voting, the Corporation shall nonetheless provide each Holder of Series D
Preferred Stock with prior notification of any meeting of the stockholders (and
copies of proxy materials and other information sent to stockholders). In the
event of any taking by the Corporation of a record of its stockholders for the
purpose of determining stockholders who are entitled to receive payment of any
dividend or other distribution, any right to subscribe for, purchase or
otherwise acquire (including by way of merger, consolidation or
recapitalization) any share of any class or any other securities or property, or
to receive any other right, or for the purpose of determining stockholders who
are entitled to vote in connection with any proposed liquidation, dissolution or
winding up of the Corporation, the Corporation shall mail a notice to each
Holder, at least thirty (30) days prior to the consummation of the transaction
or event, whichever is earlier), of the date on which any such action is to be
taken for the purpose of such dividend, distribution, right or other event, and
a brief statement regarding the amount and character of such dividend,
distribution, right or other event to the extent known at such time.
To the extent that under the GCL the vote of the holders of the Series
D Preferred Stock, voting separately as a class or series as applicable, is
required to authorize a given action of the Corporation, the affirmative vote or
consent of the holders of at least a majority of the shares of the Series D
Preferred Stock represented at a duly held meeting at which a quorum is present
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or by written consent of a majority of the shares of Series D Preferred Stock
(except as otherwise may be required under the GCL) shall constitute the
approval of such action by the class. To the extent that under the GCL holders
of the Series D Preferred Stock are entitled to vote on a matter with holders of
Common Stock, voting together as one class, each share of Series D Preferred
Stock shall be entitled to a number of votes equal to the number of shares of
Common Stock into which it is then convertible using the record date for the
taking of such vote of shareholders as the date as of which the Conversion Price
is calculated. Holders of the Series D Preferred Stock shall be entitled to
notice of all shareholder meetings or written consents (and copies of proxy
materials and other information sent to shareholders) with respect to which they
would be entitled to vote, which notice would be provided pursuant to the
Corporation's bylaws and the GCL.
ARTICLE 8
PROTECTIVE PROVISIONS
As long as shares of Series D Preferred Stock are Outstanding, the
Corporation shall not, without first obtaining the approval (by vote or written
consent, as provided by the GCL) of the holders of at least a majority of the
then outstanding shares of Series D Preferred Stock:
(a) alter or change the rights, preferences or privileges of the Series
D Preferred Stock;
(b) create any new class or series of capital stock having a preference
over the Series D Preferred Stock as to distribution of assets upon liquidation,
dissolution or winding up of the Corporation ("Senior Securities") or alter or
change the rights, preferences or privileges of any Senior Securities so as to
affect adversely the Series D Preferred Stock;
(c) increase the authorized number of shares of Series D Preferred
Stock; or
(d) do any act or thing not authorized or contemplated by this
Amendment which would result in taxation of the holders of shares of the Series
D Preferred Stock under Section 305 of the Internal Revenue Code of 1986, as
amended (or any comparable provision of the Internal Revenue Code as hereafter
from time to time amended).
In the event holders of at least a majority of the then outstanding
shares of Series D Preferred Stock agree to allow the Corporation to alter or
change the rights, preferences or privileges of the shares of Series D Preferred
Stock, pursuant to subsection (a) above, so as to affect the Series D Preferred
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Stock, then the Corporation will deliver notice of such approved change to the
holders of the Series D Preferred Stock that did not agree to such alteration or
change (the "Dissenting Holders") and Dissenting Holders shall have the right
for a period of thirty (30) days to convert pursuant to the terms of this
Amendment as they exist prior to such alteration or change or continue to hold
their shares of Series D Preferred Stock.
ARTICLE 9
MISCELLANEOUS
SECTION 9.1 LOSS, THEFT, DESTRUCTION OF SERIES D PREFERRED STOCK. Upon
receipt of evidence satisfactory to the Corporation of the loss, theft,
destruction or mutilation of shares of Series D Preferred Stock and, in the case
of any such loss, theft or destruction, upon receipt of indemnity or security
reasonably satisfactory to the Corporation, or, in the case of any such
mutilation, upon surrender and cancellation of the Series D Preferred Stock, the
Corporation shall make, issue and deliver, in lieu of such lost, stolen,
destroyed or mutilated shares of Series D Preferred Stock, new shares of Series
D Preferred Stock of like tenor. The Series D Preferred Stock shall be held and
owned upon the express condition that the provisions of this Section 10.1 are
exclusive with respect to the replacement of mutilated, destroyed, lost or
stolen shares of Series D Preferred Stock and shall preclude any and all other
rights and remedies notwithstanding any law or statute existing or hereafter
enacted to the contrary with respect to the replacement of negotiable
instruments or other securities without the surrender thereof.
SECTION 9.2 WHO DEEMED ABSOLUTE OWNER. The Corporation may deem the
Person in whose name the Series D Preferred Stock shall be registered upon the
registry books of the Corporation to be, and may treat it as, the absolute owner
of the Series D Preferred Stock for the purpose of receiving payment of
dividends on the Series D Preferred Stock, for the conversion of the Series D
Preferred Stock and for all other purposes, and the Corporation shall not be
affected by any notice to the contrary. All such payments and such conversion
shall be valid and effectual to satisfy and discharge the liability upon the
Series D Preferred Stock to the extent of the sum or sums so paid or the
conversion so made.
SECTION 9.3 NOTICE OF CERTAIN EVENTS. In the case of the occurrence of
any event described in Section 6.1 of this Amendment, the Corporation shall
cause to be mailed to the Holder of the Series D Preferred Stock at its last
address as it appears in the Corporation's security registry, at least twenty
(20) days prior to the applicable record, effective or expiration date
hereinafter specified (or, if such twenty (20) days notice is not practicable,
at the earliest practicable date prior to any such record, effective or
expiration date), a notice stating (x) the date on which a record is to be taken
for the purpose of such dividend, distribution, issuance or granting of rights,
options or warrants, or if a record is not to be taken, the date as of which the
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holders of record of Series D Preferred Stock to be entitled to such dividend,
distribution, issuance or granting of rights, options or warrants are to be
determined or (y) the date on which such reclassification, consolidation,
merger, sale, transfer, dissolution, liquidation or winding-up is expected to
become effective, and the date as of which it is expected that holders of record
of Series D Preferred Stock will be entitled to exchange their shares for
securities, cash or other property deliverable upon such reclassification,
consolidation, merger, sale transfer, dissolution, liquidation or winding-up.
SECTION 9.4 REGISTER. The Corporation shall keep at its principal
office a register in which the Corporation shall provide for the registration of
the Series D Preferred Stock. Upon any transfer of the Series D Preferred Stock
in accordance with the provisions hereof, the Corporation shall register such
transfer on the Series D Preferred Stock register.
The Corporation may deem the person in whose name the Series D
Preferred Stock shall be registered upon the registry books of the Corporation
to be, and may treat it as, the absolute owner of the Series D Preferred Stock
for the purpose of receiving payment of dividends on the Series D Preferred
Stock, for the conversion of the Series D Preferred Stock and for all other
purposes, and the Corporation shall not be affected by any notice to the
contrary. All such payments and such conversions shall be valid and effective to
satisfy and discharge the liability upon the Series D Preferred Stock to the
extent of the sum or sums so paid or the conversion or conversions so made.
SECTION 9.5 WITHHOLDING. To the extent required by applicable law, the
Corporation may withhold amounts for or on account of any taxes imposed or
levied by or on behalf of any taxing authority in the United States having
jurisdiction over the Corporation from any payments made pursuant to the Series
D Preferred Stock.
SECTION 9.6 HEADINGS. The headings of the Articles and Sections of this
Amendment are inserted for convenience only and do not constitute a part of this
Amendment.
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IN WITNESS WHEREOF, the Corporation has caused this Amendment to the
Certificate of Incorporation to be signed by its duly authorized officers as of
the day first above written.
THE NETWORK CONNECTION, INC.
By:
------------------------------------
Name:
Title:
By:
------------------------------------
Name:
Title:
INITIAL HOLDER
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
By:
------------------------------------
Name:
Title:
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ANNEX I
[FORM OF CONVERSION NOTICE]
TO:
The undersigned owner of this Series D Preferred Stock (the "Series C
Preferred Stock") issued by The Network Connection, Inc. (the "Corporation")
hereby irrevocably exercises its option to convert __________ shares of the
Series D Preferred Stock into shares of the common stock, $.001 par value, of
the Corporation ("Common Stock"), in accordance with the terms of the Amendment.
The undersigned hereby instructs the Corporation to convert the number of shares
of the Series D Preferred Stock specified above into Shares of Common Stock
Issued at Conversion in accordance with the provisions of Article 6 of the
Amendment. The undersigned directs that the Common Stock issuable and
certificates therefor deliverable upon conversion, the Series D Preferred Stock
recertificated, if any, not being surrendered for conversion hereby, together
with any check in payment for fractional Common Stock, be issued in the name of
and delivered to the undersigned unless a different name has been indicated
below. All capitalized terms used and not defined herein have the respective
meanings assigned to them in the Amendment.
Dated:
---------------------------
- ---------------------------------
Signature
Fill in for registration of Series D Preferred Stock:
Please print name and address
(including zip code number) :
- --------------------------------------------------------------------------------
<PAGE>
EXHIBIT B
FAIRNESS OPINION
May 14, 1999
Board of Directors
The Network Connection, Inc.
1324 Union Hill Road
Alpharetta, GA 30201
Attention: Mr. Wilbur Riner
Dear Sirs:
We understand that The Network Connection, Inc. (the "Company" or
"TNCI"), and Interactive Flight Technologies, Inc. ("IFT") have entered into an
Asset Purchase and Sale Agreement, (the "Agreement"), whereby, among other
things, the Company will purchase all, or substantially all, of the tangible and
intangible assets relating to the IFT interactive entertainment device business
(the "Business") and assume specific liabilities relating to the business (the
"Transaction"). The difference between the purchased assets and assumed
liabilities is defined herein as the "Net Assets".
As consideration for the Transaction, (the "Consideration") the Company
will issue to IFT (i) 1,055,745 restricted shares of its voting common stock
$.001 par value ("Common Stock"); and (ii) a number of shares of Series D
Preferred Stock such that the total of the number of shares of Common Stock into
which the Series D Preferred Stock is convertible plus the number of shares of
Common Stock issued to IFT set forth in subparagraph (i) is equal to sixty
percent (60%) of the outstanding shares of capital stock of TNCI immediately
following the Closing Date, taking into account the issuance of such Common
Stock to IFT under subparagraph (i.) and the conversion of Series D Preferred
Stock into Common Stock, and treating all convertible securities, options,
warrants or other rights to acquire securities of TNCI as if converted or
exercised as of the close of business on the date immediately preceding the
Closing Date without consideration of any limits on conversion imposed under
rules of the Nasdaq Stock Market, Inc. without stockholder approval (whether or
not actually converted or exercised as of the Closing Date) into Common Stock.
The shares of Common Stock and Series D Preferred Stock to be issued to IFT as
consideration for the transaction contemplated in the Agreement are collectively
referred to as the "TNCI Shares".
<PAGE>
The Network Connection, Inc.
May 14, 1999
Page 2
You have requested our opinion, as financial advisors, as to the
fairness, from a financial point of view, to the Company and its stockholders of
the Consideration to be paid in the Transaction.
In conducting our analysis of the Company and arriving at our opinion
as expressed herein, we have reviewed and analyzed certain financial and other
information of the Company that was publicly available; including filings made
with the Securities and Exchange Commission (the "SEC"). The documents reviewed
by Valuemetrics include, but are not limited to:
(i) Forms 10-KSB for the years ended December 31, 1996, December 31, 1997,
December 31, 1998;
(ii) Forms 10-QSB for the quarter ended September 30, 1998;
(iii) Forms S-3 Registration Statements filed on May 17, 1996, June 28, 1996
and May 1, 1998;
(iv) Form 8-K filed with SEC on June 9, 1998 in connection with the sale of
Convertible Debentures;
(v) Form DEF - 14A Proxy Statement as of April 30, 1998, filed on June 11,
1998;
(vi) Internally prepared list of Promissory Notes, Stock Options and Warrants
outstanding;
(vii) TNCI Investor Information Kit;
(viii) Turnkey Agreement between TNCI and Carnival Cruise Lines;
(ix) Financial forecast for TNCI on a stand-alone basis for the fiscal years
ending December 31, 1999, December 31, 2000 and December 31, 2001;
(x) Articles of Amendment to the Articles of Incorporation of TNCI in
connection with issuance of Series C and Series D Preferred Stock
(xi) Publicly reported trading activity in the common stock of TNCI for the
period from February 1, 1997 through May 14, 1999; and
(xii) Public news releases by TNCI for the period from February 1, 1998 through
May 14, 1999.
In addition, Valuemetrics has reviewed available industry and market
research and publicly available financial and stock performance data of
companies that we deemed comparable to the Company.
In conducting our analysis and arriving at our opinion as expressed
herein, we have reviewed and analyzed certain financial and other information of
the Company and IFT. The documents reviewed by Valuemetrics include, but are not
limited to:
(i) Form DEF 14A Proxy Statement of IFT filed as of January 20, 1999;
(ii) Form 10 KSB of IFT filed with SEC as of January 20, 1999 for the fiscal
year ended October 31, 1998;
(iii) Form 10 QSB of IFT filed with SEC as of February 26, 1999 for the quarter
ended January 31, 1999;
<PAGE>
The Network Connection, Inc.
May 14, 1999
Page 3
(iv) Presentation to IFT Shareholders as of February 4, 1999 in connection
with the Proposed Transaction;
(v) Forecasted Financial performance of TNCI post Transaction for the years
ended December 31, 1999, December 31, 2000 and December 31, 2001;
(vi) Complaint filed by Philip Arnaldi, individually surviving father and in
his representative capacity as the Administrator of the Estate of Adriene
Valerie Neuweiler against SIAR GROUP, SWISSAIR TRANSPORT COMPANY, SR
TECHNICS LTD., DELTA AIRLINES, INC., McDONNELL DOUGLAS CORPORATION, THE
BOEING COMPANY and IFT ("Arnaldi v. IFT")
(vii) Aviation Products - Completed Operations and Grounding Liability
Insurance Policy produced by Near North Insurance Brokerage, policy
number APG 156315;
(viii) Draft Schedule 1.1.1 - Assets of the Asset Purchase and Sale Agreement as
of April 22. 1999;
(ix) Internally Prepared List of all Fixed Assets and Inventory owned by IFT
as of April 22, 1999;
(x) A detailed internally prepared list of Fixed Assets of IFT as of October
31, 1999;
(xi) Letter of Intent as of February 4, 1999 that documents the mutual intent
of TNCI and IFT regarding the Proposed Transaction;
(xii) Asset Purchase and Sale Agreement as of April 29, 1999 in connection with
the Proposed Transaction
(xiii) Asset Purchase and Sale Agreement as amended as of May 14, 1999 in
connection with the Proposed Transaction
(xiv) Exhibits to Asset Purchase and Sale Agreement as of May 14, 1999 in
connection with the Proposed Transaction
(xv) Securities Purchase Agreement as of May 10, 1999 between TNCI and IFT;
(xvi) Supporting Data for IFT claim v. Avnet, Inc. prepared by management of
IFT;
(xvii) Memo from Nixon, Hargrave, Devans & Doyle LLP in connection with IFT
claim v. Avnet;
(xviii)Fourth, Fifth and Sixth Alonges to Secured Promissory Note between TNCI
and IFT;
(xix) TNCI Pro Forma Capital Structure schedule prepared by IFT
In addition, we have reviewed available industry and market research pertaining
to IFT's operations and various assets.
In rendering our opinion, we have conducted on site due diligence and
held discussions with certain officers, employees and representatives (including
counsel) of the Company and IFT, respectively, concerning the business and
operations, assets, present condition and future prospects of the Company and
IFT and undertook such other studies, analyses and investigations as we have
deemed appropriate.
In arriving at our opinion, we have assumed and relied upon the
accuracy and completeness of the financial and other information supplied to or
otherwise used by us in arriving at our opinion and have not attempted
independently to verify such information. We have not assumed any responsibility
<PAGE>
The Network Connection, Inc.
May 14, 1999
Page 4
for the independent verification of any such information or projections provided
to us and we have further relied upon the assurance of the management of the
Company and IFT that they are unaware of any facts that would make the
information or projections provided to us incomplete or misleading. In arriving
at our opinion, we have not performed or obtained any independent appraisal of
the assets or liabilities of the Company, the Purchased Assets or Assumed
Liabilities. We have also assumed that the transactions described in the
Agreement, as amended, would be consummated on the terms set forth therein,
without waiver of any such terms.
We have assumed, with the consent of the Company and IFT, that the
Transaction will comply with applicable federal and state laws, including,
without limitation laws relating to bankruptcy, insolvency, reorganization,
fraudulent conveyance, fraudulent transfer or other similar laws now or
hereafter in effect affecting creditors' rights generally.
As part of our professional services, we are regularly engaged in the
valuation of businesses and securities in connection with mergers, acquisitions,
leveraged buyouts, sales of unlisted securities, and valuations for estate,
corporate and other purposes. We have also taken into account our assessment of
general economic, market and financial conditions and our experience in similar
transactions, as well as our experience in securities valuation in general. Our
opinion necessarily is based upon conditions as they exist and can be evaluated
on the date hereof. Subsequent developments may affect this opinion, and we
disclaim any obligation to update, revise or reaffirm this opinion.
This letter and our opinion as expressed herein are for the benefit and
use of the Board of Directors of the Company in its consideration of the
Transaction. The Board of Directors of the Company may rely upon this opinion
with respect to the Transaction. This letter does not constitute a
recommendation of the Transaction over any other alternative transactions which
may be available to the Company and does not address the underlying business
decision of the Board of Directors of the Company to proceed with or effect the
Transaction. In addition, in rendering this opinion, we do not express any view
as to the prices at which the Company's securities may trade prior to or
following the Transaction. This letter does not constitute a recommendation by
our firm to any particular member of the Board of Directors or to any
stockholder as to how such member or stockholder should vote in connection with
the Transaction. We understand that this Opinion will be filed with the SEC and
distributed to IFT stockholders as part of a Proxy Statement relating to the
Transaction. We hereby consent to the foregoing use of this letter. Otherwise,
this letter and the contents hereof may not be published, disseminated, referred
to, summarized, described or otherwise used, nor shall any public reference to
Valuemetrics, Inc. be made, without our prior written consent (except in
documents or communications filed with SEC and NASDAQ, including any proxy
statements). As you are aware, we will receive a fee for our services to the
Board of Directors in connection with rendering this opinion, and the Company
has indemnified Valuemetrics for certain liabilities arising out of this
engagement including the rendering of this opinion.
<PAGE>
The Network Connection, Inc.
May 14, 1999
Page 5
Based upon and subject to the foregoing, it is our opinion that, as of
the date hereof, the Consideration to be paid under the terms of the Agreement
and in connection with the Transaction is fair, from a financial point of view,
to the Company and to its stockholders.
Very truly yours,
VALUEMETRICS, INC.
<PAGE>
EXHIBIT C
PROPOSED AMENDMENT TO ARTICLE V OF THE NETWORK CONNECTION,
INC. AMENDED AND RESTATED ARTICLES OF INCORPORATION
RESOLVED, that the first paragraph of Article V. of the Corporation's Second
Amended and Restated Articles of Incorporation be, and hereby is, amended in its
entirety to read as follows:
ARTICLE V.
THE AGGREGATE NUMBER OF SHARES OF CAPITAL STOCK WHICH THE CORPORATION SHALL
HAVE AUTHORITY TO ISSUE IS FORTY TWO MILLION FIVE HUNDRED THOUSAND (42,500,000)
SHARES CONSISTING OF:
(A) 40,000,000 SHARES OF COMMON STOCK, $.001 PAR VALUE PER SHARE (THE
"COMMON STOCK"); AND
(B) 2,500,000 SHARES OF PREFERRED STOCK, $.01 PAR VALUE PER SHARE (THE
"PREFERRED STOCK").
<PAGE>
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, 1998
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 and non-voting common equity held by
non-affiliates of the registrant, based on the closing sale price of the Common
Stock on March 31, 1999, in the over-the-counter market as reported by The
Nasdaq SmallCap Market tier of The Nasdaq Stock Market, was approximately $10.0
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 31, 1999, the registrant had outstanding 5,179,646 shares of its
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
None
<PAGE>
PART I
Item 1. Business
General
The Company designs, manufactures and distributes computer networking
products and systems, including complete video and data entertainment systems,
high stream count videoservers 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 names TRIUMPH, Cheetah, and
related sub product names. These systems 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 and new network
operating systems as they become available. Product design allows compatibility
with most applications running in such network environments, and enables the
Company's systems to operate efficiently as servers and work stations for groups
of interconnected PCs arranged in LANs, WANs, intranets and the Internet. The
Company currently distributes its products worldwide principally through its own
internal sales force and strategic resellers.
The Network Connection Solution
In 1987, the Company first introduced the initial entry of its TRIUMPH
family of multimedia information and entertainment systems, which are designed
to provide the compatibility, performance, availability and scalability
necessary for sophisticated interactive capable systems. The Company believes
that its systems contain the following features.
* Compatibility
The TRIUMPH family is based upon 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, Banyan VINES and Linux, 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 familty systems use of common
"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"), FCAL (FiberChannel Arbitrated Loop), Gigabit
ethernet and Fast ethernet, also enables the Company's products to connect with
hardware produced by third-party vendors. The TRIUMPH systems also provide 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 symmetric/asymmetric multiprocessor connected 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
<PAGE>
systems architecture and critical data flow design 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 systems 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 abilities and features not found in
mainframes and minicomputers at a significantly lower cost.
* 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
redundancy 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 systems.
* Scalability
The TRIUMPH systems can scale from just a few interactive users to hundreds
or thousands of interactive users providing an array of interactive services,
which include internet, intranet, audio, audio/video, commerce and transactional
information systems.
* Upgradability
The TRIUMPH systems allow for upgrading without obsolescence of existing
Triumph products. Upgrades may include architecture to allow increase in the
number of interactive users, concurrent video streams, or other interactive
applications.
Product Strategy
Technology and Product Strategy
* Support Popular Network Operating Systems
The Company intends to support additional network operating systems if they
augment the capabilities of the Triumph interactive systems. The TRIUMPH systems
open architecture and compatibility features permit ease of support for new and
emerging software technologies to leverage the time critical interactive data
nature of the systems. As any new operating system or software technology is
introduced, the Triumph architecture is readily capable to incorporate such as
it may relate to the benefit of the Triumph family of interactive systems.
* Develop Higher Performance Systems While Maintaining Compatibility
The Company's principal technological challenge with respect to the
development of its TRIUMPH family of interactive systems is to simultaneously
deliver high performance and compatibility with existing PC hardware and
software standards. The Company intends to continue improving the performance of
its systems while maintaining compatibility with popular network operating
systems and hardware interfaces.
<PAGE>
* Offer Broad Product Line
The scalability of TRIUMPH systems is key to providing a diverse range of
services for the educational, and transportation related markets. The product
line, while broad within a given market segment, is specifically targeted to
provide an easily deliverable custom system to meet the needs of the given
customer. The flexibility of the Triumph interactive systems allows for quick
and easy customization for any given customer within a target market.
* Packaging
Sales of the Company's TRIUMPH systems are made as complete integrated, yet
customizable, 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, (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.
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 a high-speed
system bus. These subsystems include: the Company's TRIUMPH RAID Accelerated
Controller ("TRAC"), an intelligent Input/Output Processor subsystem; the
primary CPU subsystem; the systembus subsystem; and the main memory subsystem.
These subsystems operate independently and thus reduce the I/O bottlenecks and
performance degradation typically associated with other approaches.
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 system 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 system to support any network operating systems
with the relatively simple addition of drivers specific to that network
operating system. The TRIUMPH system's are, therefore, compatible with leading
network operating systems such as Linux, 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 system's open architecture
permits applications written for use with the network operating systems
supported by the Company to run unmodified. The TRIUMPH systems, 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, FCAL, IDE, and SAN compatibility, the
CPU subsystem offers CISC/RISC compatibility and the bus subsystem offers PCI
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 systems.
<PAGE>
Intelligent I/0 Processor Subsystem. The TRAC subsystem utilizes an
asymmetric approach 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. Multiple TRACs can be
configured in a TRIUMPH server system, allowing an almost unlimited number of
peripherals per system.
The TRAC may also incorporate RAID technology based on the need of the
system design 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 CPU offers CISC/RISC
compatibility. Each subsystem may be upgraded with a CPU that incorporates a
microprocessor operating at a higher clock speed.
Availability Features. The TRIUMPH system architecture is designed to
permit systems to be configured to provide the high level of availability
required for critical applications through reliability, data integrity and
recoverability features. Reliability features available for certain TRIUMPH
models offer key module redundancy to promote continued system operation. The
TRIUMPH systems data integrity features minimize the potential for data loss
during system operation.
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
CheetahO Enterprise Video File Server. The CheetahO or M2V 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.
CheetahO Large Workgroup Video File Server. The video capable version of
the TNX is very similar to CheetahO described above, but with reduced work
station service capacity and reduced disk storage capabilities.
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.
<PAGE>
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 can 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.
<PAGE>
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. An example is the Company's relationship with
Tandberg Educational for the sale of the Company's superserver products in
conjunction with Tandberg products for use in educational digital multimedia
instruction applications.
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.
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 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 and
Ncube. 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,
Allin Interactive, Interactive Flight Technologies and Trans Digital. The
<PAGE>
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
survive the sales cycle and support the receivables collection cycle 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, transportation operators and end-users operating in various other
industries.
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. Most sales
efforts in 1998 were focused on larger system sales into niche markets of the
Company's "turn-key" packaged solutions, AirView, CruiseView and TrainView,
which have longer sales cycles. Sales of such products will contribute to sales
backlog for revenues derived from multiple roll-out deliveries over 12 to 36
months. The Company currently has agreements (see "AirView", "CrusieView",
"TrainView" below) for and has responded to major requests for proposal for
CruiseView, AirView and TrainView systems with some of the world's largest
travel and transportation-related companies. There can be no assurance, however,
that the Company will successfully negotiate definitive agreements for the
purchase of these systems. 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.
<PAGE>
AirView
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 airline, for the
purchase of up to ten AirView systems for installation on ten Fairlines
aircraft. The costs of purchase from the Company include the cost of training
Fairlines employees for system use, and the cost of system installation, which
installation is provided by Hollingsead International and its subsidiaries
("Hollingsead") on behalf of the Company under a separate agreement with the
Company (see "PART I Manufacturing"). Delivery of all AirView systems under the
terms of the agreement was originally expected to be completed by December 31,
1998. Due to Fairlines repeated delays in securing additional aircraft, it is
unclear as to when, if ever, any additional systems will be sold to and
installed by Fairlines. In March 1999, the Company filed to revoke the
Supplemental Type Certificate (STC) (see "PART I -- Government Regulation")
issued in connection with the two Fairlines aircraft on which AirView systems
are installed and in operation due to Fairlines default in payment under terms
of the AirView Agreement. Revocation of the STC would result in the inability
for Fairlines to operate the aircraft commercially with the AirView system
installed on the aircraft. The Company is pursuing its remedies, contractual and
otherwise, in respect to collection of amounts due and damages incurred under
the AirView Agreement. (see "PART I - ITEM 3 - Legal Proceedings")
In April 1998, the Boeing Company specified the Company's AirView Video/Audio on
Demand server as part of the airplane manufacturer's completion Request For
Proposal (RFP) for the new B737-73Q Business Jet. In November 1998 the Company
received an order from Raytheon Systems Company, a unit of Raytheon Company,
which was contracted by Boeing Company, to equip the Boeing Business Jet (BBJ)
B737-73Q "Demonstrator" aircraft with the Company's AirView for an Integrated
Business and Entertainment System (IBES). Installation began in late 1998. There
can be no assurance however, that any additional orders for the Company's
AirView system other than the Demonstrator will be received.
CruiseView
The Company entered into a CruiseView Purchase Agreement, dated as of February
13, 1998 (the "Star Agreement"), with Continuous Network Advisors ("CNA") on
behalf of Star Cruises Management Limited ("Star"), an Isle of Man corporation
engaged in the operation of a commercial cruise line, for the purchase of
CruiseView systems for installation on up to two Star cruise vessels. The costs
of purchase from the Company include the cost of training Star employees for
system use and the cost of system installation. Delivery and installation of the
CruiseView systems under the terms of the agreement for the first ship was
completed and began commercial operation in October 1998, with the second ship
originally expected to be completed by September 30, 1999. In March 1999, the
Company filed for arbitration to enforce its rights under the terms of the Star
Agreement. The Company claims that Star and CNA are in default under the payment
obligations of the Star Agreement and intends to aggressively pursue its rights
under the terms of the Star Agreement through arbitration and all remedies
available, including repossession of inventory, contractual and otherwise. (see
"PART I - ITEM 3 - - Legal Proceedings") The Company increased its provision for
doubtful accounts by approximately $2.6 million in the fourth fiscal quarter of
1998 due to the uncertainty of recovery of certain amounts due the Company under
the Star Agreement.
In September 1998, the Company entered into a Turnkey Agreement (the "Carnival
Agreement") with Carnival Corporation ("Carnival"), a Panamanian registered
corporation, for the purchase, installation and maintenance of CruiseView on a
minimum of one Carnival Cruse Lines ship, and an unspecified maximum number of
Carnival Cruse Line ships. During the four-year period commencing on the date of
the Carnival Agreement, Carnival has the right to designate an unspecified
number of additional ships for the installation of CruiseView by the Company.
The cost per cabin for CruiseView purchase and installation on each ship is
provided for in the Carnival Agreement, as is the minimum software license and
installation cost per ship, with additional per ship costs charged based upon
the number of actual cabins installed and operational. The cost of training up
to ten Carnival personnel per ship for system operation is included in the
contract cost for licensing and installation of CruiseView, with the cost of
additional training and maintenance billed separately by the Company. The
Carnival Agreement initially called for delivery of the CruiseView system for
use aboard one ship, the Carnival Cruise Lines "M/S Triumph" currently under
<PAGE>
construction, which system is expected to be installed in mid 1999. In December
1998, Carnival exercised its right and ordered the installation of a CruiseView
system on the Carnival Cruise Lines "M/S Sensation". Delivery and installation
of CruiseView for the Sensation began in December 1998 and is expected to begin
commercial operation in April 1999. The Company anticipates gross revenues of
over $4.0 million from the purchase, installation and maintenance of CruiseView
on these two Carnival cruise ships. There can be no assurance however, that
Carnival will exercise its right under the Carnival agreement to order
CruiseView for installation on any additional ships.
TrainView
In February 1999, the Company received an engineering design order from Alstom
Transport Limited ("Alstom"), a unit of ALSTOM SA, to incorporate the design of
TrainView, the Company's advanced Infoactive Business and Entertainment System,
into Alstom's concept high speed train design. The TrainView all-digital system
proposed is an adaptation of the Company's existing system currently installed
for various in-flight and cruise customers. The system is expected to deliver
personal interactive entertainment, video/audio on demand, E-Commerce for
shopping, event booking, Internet and business services to the seat through the
Company's TransPORTAL applications. There can be no assurance however, that
Alstom will purchase a TrainView system for installation on any train.
Customer Concentration
In 1998, two customers accounted for an aggregate of 96% (76% and 20%,
respectively) of the Company's revenues. In 1997, three customers accounted for
an aggregate of 79% (38%, 30% and 11%, 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.
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, in-house 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.
<PAGE>
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.
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", "CRUISEVIEW" and "BATTLEVIEW" and
has trademark applications pending for the mark "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.
<PAGE>
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 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.
Potential Change of Control Transaction
On February 4, 1999, the Company, entered into a non-binding Letter of Intent
with Interactive Flight Technologies, Inc., a Delaware corporation ("IFT")
regarding the acquisition by the Company of all or substantially all of the
assets and specified liabilities of IFT (the "Net Assets") relating to IFT's
interactive entertainment business (the "Business") in consideration for the
Company's issuance to IFT of that number of shares of its Common Stock as would
constitute 60% of the Company's fully-diluted equity (the "Acquisition"). The
Net Assets will include: $5 million in cash; accounts receivable owing to IFT
from Swissair; the proceeds and other recoveries generated by certain litigation
brought by IFT; the Swissair warranty contract; the Swissair customer
relationship; all IFT interactive entertainment intellectual property, and other
tangible assets related to the Business (including but not limited to customer
lists and files, trade secrets, trademarks, service marks, assignable government
permits and other rights under leases and rights under specified contracts);
inventory, furniture, fixtures, computers and equipment related to the Business;
other infrastructure (including FAA certified repair station) relating to the
Business; IFT's engineering and technical staff; and the benefit of all IFT
research and development efforts. The Acquisition will be effected in accordance
with a definitive agreement (the "Agreement") to be subsequently negotiated and
signed following the completion of due diligence investigations by the Company
and IFT. In addition to the usual and customary representations, covenants and
conditions contained in agreements of the type used to consummate transactions
like the Acquisition, the definitive agreement will provide that closing of the
Acquisition is subject (i) to approval by the shareholders of the Company, if
required under the rules of The Nasdaq Stock Market, and (ii) the receipt of a
"fairness opinion" with respect to the terms of the Acquisition to the effect
that the Acquisition is fair from a financial point of view, to the Company
shareholders. Although the Letter of Intent is otherwise not binding, the
Company has agreed to refrain from entering into negotiations with any other
party for the sale of all or substantially all of its assets, or for the sale of
control of the Company, until May 15, 1999. IFT similarly agreed not to enter
into negotiations for the acquisition of control of any other company engaged in
<PAGE>
the interactive entertainment business until May 15, 1999. There is no guarantee
that the Acquisition will be consummated on the terms set forth in the Letter of
Intent. IFT developed interactive entertainment products for use in the airline
and travel industry, and it has ceased all research and development activities
with respect to such products except as required under contract. It currently
maintains only one ongoing contract for its interactive entertainment products,
and is currently engaged in the redirection of its business activities into new
markets. IFT is a Nasdaq: NMS registrant and trades under the ticker symbol
FLYT.
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 1998 and 1997, research and
development expenses totaled $397,196 and $277,527, respectively. The Company
intends to continue to invest in research and development.
Employees
As of April 15, 1999, the Company had 22 full-time employees and 2
part-time employees. None of the employees are 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.
<PAGE>
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 two institutional lenders as of December 31, 1998, in the aggregate
amount of $227,102 and $470,000, respectively, for the purchase of this primary
operating facility. These loans are secured by the purchased real estate and
bear annual interest at the rate of such lender's prime rate plus 2% and 16%,
respectively.
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
On December 1, 1998, Sigma Designs, Inc. ("Sigma"), filed a complaint against
the Company in the United States District Court, Northern District of
California, San Jose Division, Civil Action File No. 98-21149J(EAI) alleging
breach of contract and action on account. Sigma claims that the Company failed
to pay for goods shipped to the Company by Sigma. The matter was settled by
written agreement dated January 22, 1999, contingent upon registration of
Company stock issued to Sigma as a part of such settlement, and payment by the
Company of $50,000, in two installments, the latter which was due on February 5,
1999. The Company made the $50,000 settlement payments and is in the process of
filing for registration of the stock issued to Sigma, subject to penalty
payments for late filing. Management of the Company expects to fully comply with
the terms of the settlement agreement and expects that the claim will be
dismissed with prejudice.
Hollingsead filed a complaint against the Company on January 28, 1999, in the
State Court of Forsyth County, State Court of Georgia, Civil Action File No.
99sc0053, alleging the Company failed to pay invoices submitted for installation
and service of audio-visual systems in certain aircraft. In its complaint
Hollingsead requests $357, 850 in damages plus interest, costs, attorneys fees,
and punitive damages of no less than $250,000. The Company filed an answer and a
counterclaim on March 29, 1999 with the court alleging that any amounts
allegedly owed Hollingsead should be set-off and/or recouped against damages
incurred by the Company as a result of Hollingsead's negligence and/or breach of
contract. The Company is seeking settlement of such claims with Hollingsead.
On March 29, 1999, the Company filed for arbitration under the rules of the
United Nations Commission on International Trade Law and the Rules of
Arbitration of the Kuala Lumpur Regional Centre for Arbitration, to enforce its
rights under the terms of the Star Agreement with CNA and Star for the delivery,
installation and maintenance of a CruiseView system on the Star cruise ship the
SuperStar Leo. The CruiseView system on the SuperStar Leo was installed and has
been in commercial operation since October 1998. The Company claims that Star
and CNA are in default under the payment obligations of the Star Agreement and
intends to aggressively pursue its remedies, including repossession of
inventory, contractual and otherwise, to enforce its rights under the terms of
the Star Agreement.
On March 29, 1999, the Company filed to revoke the Supplemental Type Certi
ficate (STC) issued by the FAA and DGAC in connection with the two Fairlines
aircraft on which AirView systems are installed and in operation due to
Fairlines default in payment under terms of the AirView Agreement. Revocation of
the STC would result in the inability for Fairlines to operate the aircraft
commercially with the AirView system installed on the aircraft. The Company is
pursuing its remedies, contractual and otherwise, in respect to collection of
amounts due and damages incurred under the AirView Agreement.
Item 4. Submission of Matters to a Vote of Security Holders
None
<PAGE>
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 1997 and fiscal 1998 as reported by The Nasdaq Stock Market:
High Low
---- ---
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
Fiscal 1998:
First Quarter $ 7.125 $3.625
Second Quarter 5.688 3.188
Third Quarter 4.938 1.813
Fourth Quarter 4.125 2.000
Holders of Record
At March 12, 1999, 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.
<PAGE>
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.
Overview
The Company has incurred net losses from operations for several years, has an
accumulated deficit at December 31, 1998, and has used substantial cash in its
operations which raises substantial doubt about the Company's ability to
continue as a going concern. The company has entered into negotiation with IFT
in a change of control transaction that is expected to close by May 15, 1999.
The Company believes the IFT transaction will generate sufficient cash to fund
currently anticipated future cash requirements during the next twelve months. If
the proposed change of control should not be completed, the Company will require
additional cash from alternative external sources in order to fund currently
anticipated cash requirements, including performance under existing contracts,
repayment of indebtedness and ongoing payroll expense. If future financing is
not available when needed, the Company will be forced to curtail or discontinue
operations. In such event, the stockholders may lose, or experience a
substantial reduction in, the value of their investment in the Company. (see
"Liquidity and Capital Resources; Certain Transactions")
In 1998, two customers accounted for an aggregate of 96% (76% and 20%,
respectively) of the Company's revenues. During 1997, three customers accounted
for an aggregate of 79% (38%, 30% and 11%, 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 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 and also,
customer payment of invoices and customer product satisfaction which determines
when, after shipment and installation, the product is accepted by the customer
for payment. 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.
AirView
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 airline, for the
purchase of up to ten AirView systems for installation on ten Fairlines
aircraft. The costs of purchase from the Company include the cost of training
Fairlines employees for system use, and the cost of system installation, which
installation is provided by Hollingsead International and its subsidiaries
("Hollingsead") on behalf of the Company under a separate agreement with the
Company (see "PART I Manufacturing"). Delivery of all AirView systems under the
terms of the agreement was originally expected to be completed by December 31,
1998. Due to Fairlines repeated delays in securing additional aircraft, it is
unclear as to when, if ever, any additional systems will be sold to and
installed by Fairlines. In March 1999, the Company filed to revoke the
Supplemental Type Certificate (STC) (see "PART I - - Government Regulation")
issued in connection with the two Fairlines aircraft on which AirView systems
are installed and in operation due to Fairlines default in payment under terms
of the AirView Agreement. Revocation of the STC would result in the inability
for Fairlines to operate the aircraft commercially with the AirView system
installed on the aircraft. The Company is pursuing its remedies, contractual and
otherwise, in respect to collection of amounts due and damages incurred under
the AirView Agreement. (see "PART I - ITEM 3 - Legal Proceedings")
<PAGE>
In April 1998, the Boeing Company specified the Company's AirView Video/Audio on
Demand server as part of the airplane manufacturer's completion Request For
Proposal (RFP) for the new B737-73Q Business Jet. In November 1998 the Company
received an order from Raytheon Systems Company, a unit of Raytheon Company,
which was contracted by Boeing Company, to equip the Boeing Business Jet (BBJ)
B737-73Q "Demonstrator" aircraft with the Company's AirView for an Integrated
Business and Entertainment System (IBES). Installation began in late 1998. There
can be no assurance however, that any additional orders for the Company's
AirView system other than for the Demonstrator will be received.
CruiseView
The Company entered into a CruiseView Purchase Agreement, dated as of February
13, 1998 (the "Star Agreement"), with Continuous Network Advisors ("CNA") on
behalf of Star Cruises Management Limited ("Star"), an Isle of Man corporation
engaged in the operation of a commercial cruise line, for the purchase of
CruiseView systems for installation on up to two Star cruise vessels. The costs
of purchase from the Company include the cost of training Star employees for
system use and the cost of system installation. Delivery and installation of the
CruiseView systems under the terms of the agreement for the first ship was
completed and began commercial operation in October 1998, with the second ship
originally expected to be completed by September 30, 1999. In March 1999, the
Company filed for arbitration to enforce its rights under the terms of the Star
Agreement. The Company claims that Star and CNA are in default under the payment
obligations of the Star Agreement and intends to aggressively pursue its rights
under the terms of the Star Agreement through arbitration and all remedies
available, including repossession of inventory, contractual and otherwise. (see
"PART I - ITEM 3 -- Legal Proceedings") The Company increased its provision for
doubtful accounts by approximately $2.6 million in the fourth fiscal quarter of
1998 due to the uncertainty of recovery of certain amounts due the Company under
the Star Agreement.
In September 1998, the Company entered into a Turnkey Agreement (the "Carnival
Agreement") with Carnival Corporation ("Carnival"), a Panamanian registered
corporation, for the purchase, installation and maintenance of CruiseView on a
minimum of one Carnival Cruse Lines ship, and an unspecified maximum number of
Carnival Cruse Line ships. During the four-year period commencing on the date of
the Carnival Agreement, Carnival has the right to designate an unspecified
number of additional ships for the installation of CruiseView by the Company.
The cost per cabin for CruiseView purchase and installation on each ship is
provided for in the Carnival Agreement, as is the minimum software license and
installation cost per ship, with additional per ship costs charged based upon
the number of actual cabins installed and operational. The cost of training up
to ten Carnival personnel per ship for system operation is included in the
contract cost for licensing and installation of CruiseView, with the cost of
additional training and maintenance billed separately by the Company. The
Carnival Agreement initially called for delivery of the CruiseView system for
use aboard one ship, the Carnival Cruise Lines "M/S Triumph" currently under
construction, which system is expected to be installed in mid 1999. In December
1998, Carnival exercised its right and ordered the installation of a CruiseView
system on the Carnival Cruise Lines "M/S Sensation". Delivery and installation
of CruiseView for the Sensation began in December 1998 and is expected to begin
commercial operation in April 1999. The Company anticipates gross revenues of
over $4.0 million from the purchase, installation and maintenance of CruiseView
on these two Carnival cruise ships. There can be no assurance however, that
Carnival will exercise its right under the Carnival agreement to order
CruiseView for installation on any additional ships.
<PAGE>
TrainView
In February 1999, the Company received an engineering design order from Alstom
Transport Limited ("Alstom"), a unit of ALSTOM SA, to incorporate the design of
TrainView, the Company's advanced Infoactive Business and Entertainment System,
into Alstom's concept high speed train design. The TrainView all-digital system
proposed is an adaptation of the Company's existing system currently installed
for various in-flight and cruise customers. The system is expected to deliver
personal interactive entertainment, video/audio on demand, E-Commerce for
shopping, event booking, Internet and business services to the seat through the
Company's TransPORTAL applications. There can be no assurance however, that
Alstom will purchase a TrainView system for installation on any train.
Results of Operations
Revenues decreased 36% to $5.0 million for the fiscal year ended December 31,
1998 from $7.8 million for the fiscal year ended December 31, 1997. This
decrease primarily resulted from deliveries in 1997 of the Company's larger
AirView systems to Fairlines and shipments on the South Korean Government High
School Program, which did not occur in the 1998 period.
Gross profit as a percentage of revenues increased by 4% to 40% for the fiscal
year ended December 31, 1998 as compared to 36% for the 1997 year. This increase
was primarily due to revenues generated during the 1998 period from larger
system sales with higher margins and technology licensing fees that were not
realized in the same 1997 periods. Gross margins for any particular period are
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.
Selling, general and administrative expenses decreased $638,710 (14%) for the
fiscal year ended December 31, 1998, as compared to the same 1997 period. This
decrease related to expenses which were incurred in the respective periods in
1997 and not in 1998, primarily for additional (i) marketing expenses (including
advertising, trade show, public relations, bidding and proposal and
demonstration expenses) associated with the introduction of new products for
Courseware on Demand, 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 (which office was eliminated in
December 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.
Provision for doubtful accounts and inventory reflect an increase from fiscal
1997 of $6.5 million for the fiscal year ended December 31, 1998; $2.4 million
resulted from a writedown of inventories and a reserve for the uncertainty and
possible uncollectibility of outstanding receivables due to (i) repeated program
schedule delays by Fairlines and (ii) the length of time that accounts
receivable for extended programs with Fairlines and the South Korean Government
High School Program have been past due; $1.0 million resulted from a reserve
taken for a fixed fee arrangement with a major aeronautical electronics company
negotiated in June 1998 with respect to the licensing of the Company's
technology, the value of which licensing cannot now be considered fixed and
determinable due to a change in facts and circumstances; and $2.6 million for
uncertainty in collectibility of accounts receivable from the delivery and
installation of a system under the Star Agreement.
Special charges in the fourth fiscal quarter resulted from $595,263 for the
impairment of other assets capitalized in 1997 related to costs for obtaining
Federal Aviation Administration (FAA) certification for the Company's AirView
system which were being amortized over 10 years. These assets were written off
<PAGE>
due to the uncertainty of recoverability resulting from the termination of the
Fairlines Agreement and the absence of any additional orders received for the
AirView system for use in commercial aircraft requiring FAA certification.
Changes in interest are attributable to changes in average outstanding
borrowings during the periods presented and interest income on restricted cash
and short-term securities.
Liquidity and Capital Resources; Certain Transactions
The Company has entered into negotiation with IFT in a change of control
transaction that is expected to close by May 15, 1999. The Company believes the
IFT transaction will generate sufficient cash to fund currently anticipated
future cash requirements during the next twelve months. If the proposed change
of control should not be completed, the Company will require additional cash
from alternative external sources in order to fund currently anticipated cash
requirements, including performance under existing contracts, repayment of
indebtedness and ongoing payroll expense. It is uncertain as to the Company's
ability to obtain additional capital.
At December 31, 1998, the Company had working capital of approximately $1.4
million compared to $5.5 million as of December 31, 1997. The Company's primary
source of funding was principally due to the net proceeds from the issuance of
convertible preferred stock of $3.3 million, proceeds from the issuance of $2.2
million of debt and the sale of short term investments of $557,725. Cash used in
operating activities was $5.6 million and the purchase of property and equipment
was $534,084. The negative change in cash from operating activities primarily
resulted from a net loss of $9.6 million, a decrease in accounts payable and
accrued expenses of $1.2 million, and an increase of $3.1 million in accounts
receivable, offset by a decrease in inventory of $424,827 and an increase in
deferred revenue of $521,232. The reduction in cash from operating activities
was offset by depreciation and amortization of $1.0 million and an increase in
provision for doubtful accounts and inventory of $6.5 million.
The Company's primary source of funds at December 31, 1998 consisted of $1.1
million in cash and 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 the fact that they are
pledged as collateral for the availability of the line of credit. The line of
credit was to expire in May 1999, and bore interest at an annual rate of 7.05%.
At December 31, 1998, the Company had $669,000 borrowings outstanding under the
line of credit. On January 27, 1999, the line of credit was terminated and the
restricted cash was used to payoff the borrowings of $1.0 million outstanding
under the line of credit.
Capital expenditures for the purchase of property and equipment for the fiscal
year ended December 31, 1998 were $534,084, primarily for the purchase of
additional equipment and software in order to expand product demonstration and
development capabilities for CruiseView and TrainView. During 1999, capital
expenditures, if any, are anticipated to be funded through existing working
capital or other financing.
Real Estate Indebtedness
The Company is indebted to an institutional lender, as of December 31, 1998, in
the aggregate amount of $227,102, 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 May 19, 1998, the Company entered into a promissory note with an
institutional lender in the amount of $470,000. This note is secured by the real
estate of the Company. The note is due and payable on April 19, 2001 and bears
interest, payable monthly, at an annual rate of 16%.
Redeemable Convertible Preferred Stock
On March 11, 1998, the Company raised gross proceeds of $2.2 million in a
private placement to a single institutional investor, KA Investments LDC (the
"KA"), of five-year convertible debt securities (the "Debentures") pursuant to
the terms of a Convertible Debenture Purchase Agreement, dated March 11, 1998,
<PAGE>
by and between the Company and the KA (the "Debenture Purchase Agreement"). Each
Debenture was sold for $50,000.00, accrued interest at a rate of 4% per annum,
and was 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 (as
adjusted for stock splits). On June 9, 1998, the KA and the Company entered into
a Convertible Preferred Stock Purchase Agreement (the "Purchase Agreement A"),
pursuant to which the KA agreed to exchange all of its Debentures for 220,000
shares of the Company's 4% Series A Convertible Preferred Stock (the "Series A
Preferred Stock"). The financial terms of the Series A Preferred Stock were
identical to the financial terms of the Debentures for which they were
exchanged. The Company was obligated to file and have declared effective by the
Securities and Exchange Commission (the "Commission"), on or prior to June 24,
1998, a registration statement with respect to the resale of the Common Stock
issuable upon conversion of the Series A Preferred Stock. The Company originally
filed such Registration Statement on May 1, 1998, and such Registration
Statement was declared effective by the Commission on June 8, 1998. As of
December 31, 1998, holders of the Company's Series A Preferred Stock had
exercised their right and converted all 220,000 shares of the Series A Preferred
Stock into 746,653 shares of the Company's Common Stock.
On June 29, 1998, the Company entered into a promissory note (the "Investor
Note") with an institutional investor in the amount of $1,250,000. This note was
unsecured and was due and payable with accrued interest at an annual rate of 8%
on August 28, 1998. The Company, in its sole discretion, could elect to pay this
note on August 28, 1998, subject to a payment charge of $87,500, or exchange
this note for a series of convertible preferred stock or convertible debentures
of the Company. Repayment of the Investor Note was orally extended and made
payable on demand.
On October 23, 1998, the Company elected to exchange the Investor Note for 1,500
shares of the Company's Series B 8% Convertible Preferred Stock (the " Series B
Preferred Stock") and warrants to acquire 100,000 shares of Common Stock issued
to the holder of the Series B Preferred Stock (the "Warrants"). The $1,000
stated value per share of Series B Preferred Stock is convertible at the option
of the holder into shares of Common Stock, at a price per share equal to the
lesser of $ 3.66 per share of Common Stock (the "Closing Price") or 75% of the
average of the closing bid prices as reported on the Nasdaq SmallCap Market
("Nasdaq") for the lowest five of the 20 trading days immediately preceding the
date of Series B Preferred Stock conversion (the "Average Price"). The Warrants
are exercisable to acquire shares of Common Stock at a price per share equal to
$4.125.
The shares of Series B Preferred Stock were issued pursuant to a Securities
Purchase Agreement, dated as of October 23, 1998 (the "Purchase Agreement B"),
entered into between the Company and a single institutional investor upon the
exchange of outstanding loan principal and accrued interest pursuant to the
Investor Note, plus certain premiums, owed by the Company to that investor. In
connection with such exchange of indebtedness, the Company also issued the
Warrant to the same institutional investor. The Company is obligated to file and
have declared effective by the Commission, a registration statement with respect
to the resale of the Common Stock issuable upon conversion of the Series B
Preferred Stock pursuant to the terms of a Registration Rights Agreement entered
into between the Company and the holder of the Series B Preferred Stock and the
Warrants (the "Registration Agreement"). Pursuant to the Registration Agreement,
the Company is required to use its best efforts to maintain a continuously
effective Registration Statement, with respect to the Common Stock underlying
the Series B Preferred Stock and the Warrants until the earlier of three years
after the Registration Statement is declared effective or until such earlier
date on which such Common Stock may be sold pursuant to Rule 144(k) under the
Securities Act of 1933, as amended (the "Securities Act"). The Company will not
receive any proceeds from the resale by the holders of any of the Common Stock
issuable to the holders upon conversion of the Series B Preferred Stock.
Pursuant to the terms of the Registration Agreement, the Registration Statement
will cover up to 20% of the number of shares of Common Stock outstanding on the
issue date of the Series B Preferred Stock under the Purchase Agreement B. The
terms of the Purchase Agreement B require that the Company maintain a reserve of
up to 20% of the number of shares of Common Stock outstanding on the issue date
of the Series B Preferred Stock under the Purchase Agreement B for issuance upon
conversion.
<PAGE>
Through October 23, 2001, the Company may redeem all outstanding shares of the
Series B Preferred Stock at 135% of the aggregate stated value ($1,000 per
share) thereof, plus accrued and unpaid dividends on such shares (the
"Redemption Price"), as long as the then Current Market Price (as defined) of
the Common Stock at the time of optional redemption is less than $3.66 per
share. Furthermore, all shares of Series B Preferred Stock that have not been
converted to Common Stock prior to October 23, 2001 shall be converted to Common
Stock on that date on the assumption that the Common Stock is listed on Nasdaq.
Notwithstanding such mandatory conversion, however, absent approval of the
Purchase Agreement B by Company Stockholders in satisfaction of applicable
Nasdaq rules, rather than conversion of all then outstanding Series B Preferred
Stock the Company shall be required to make cash redemption payments equal to
the Redemption Price of such shares to the extent that any common shares
issuable upon conversion, when aggregated with (i) all common shares previously
issued on Series B Preferred Stock conversion, (ii) all common shares issued as
stock dividends on the Preferred Stock, and (iii) all common shares issuable on
exercise of the Warrants, would equal 20% or more of the number of outstanding
shares of Common Stock on October 23, 1998.
Indebtedness
On August 12, 1998, the Company entered into promissory notes (collectively
"Series Notes") with five individual investors in the aggregate amount of
$650,000. The Series Notes were unsecured and were due and payable with accrued
interest at an annual rate of 8% on October 14, 1998. The Company, in its sole
discretion, could elect to pay these Series Notes on October 12, 1998, subject
to a payment charge equal to 7% of the principal amount, or exchange the Series
Notes for a series of convertible preferred stock or convertible debentures of
the Company. On October 12, 1998, the Company entered into new promissory notes
(collectively "Series A Notes") in the aggregate amount of $704,082 with the
holders of the Series Notes to replace and rollover the Series Notes. The Series
A Notes are unsecured and are due and payable with accrued interest at an annual
rate of 8% on December 11, 1998. The Company, in its sole discretion, may elect
to pay these Series A Notes on December 11, 1998, subject to a payment charge
equal to 7% of the principal amount, or exchange the Series A Notes for a series
of convertible preferred stock or convertible debentures of the Company. On
December 11, 1998, the Company and the holders of the Series A Notes agreed to
extend the due date for repayment of the Series A Notes until February 25, 1999.
On February 25, 1999 the Series A Notes were orally extended and made payable on
demand. The Company is currently in negotiation with the holders for the
exchange of the Series E Notes into equity of the Company.
On October 20, 1998, the Company entered into promissory notes (collectively
"Series D Notes") with three individual investors in the aggregate amount of
$350,000. The Series D Notes were unsecured and were due and payable with
accrued interest at an annual rate of 8% on January 18, 1999. The Company, in
its sole discretion, could elect to pay these Series D Notes on January 18,
1999, subject to a payment charge equal to 5% of the principal amount, or
exchange the Series D Notes for a series of convertible preferred stock or
convertible debentures of the Company. On January 18, 1999, the Company and the
holders of the Series D Notes agreed to extend the due date for repayment of the
Series D Notes until April 15, 1999, subject to a payment charge equal to 5% of
the principal amount plus an additional 2.5% of the principal amount for each 30
day period after January 18, 1999 the Series D Notes are outstanding. The
Company is currently in negotiation with the holders for the exchange of the
Series E Notes into equity of the Company.
From November 17 to December 17, 1998, the Company entered into promissory notes
(collectively "Series E Notes") with five individual investors in the aggregate
amount of $550,000. The Series E Notes were unsecured and were due and payable
with accrued interest at an annual rate of 8% from January 18 to February 8,
1999. The Company, in its sole discretion, could elect to pay these Series E
Notes on the due date, subject to a payment charge equal to 7% of the principal
amount, or exchange the Series E Notes for a series of convertible preferred
stock or convertible debentures of the Company. On February 12, 1999, the
Company and the holders of the Series E Notes agreed to extend the due date for
repayment of the Series E Notes until March 15, 1999. On March 15, 1999 the
Series E Notes were orally extended and made payable on demand. The Company is
currently in negotiation with the holders for the exchange of the Series E Notes
into equity of the Company.
<PAGE>
On January 25, 1999, the Company entered into a loan transaction with IFT,
pursuant to (i) a promissory note in the principal amount of $750,000, bearing a
rate of interest of 9.5% per annum, for a term ending on the earlier of May 15,
1999, or the closing date of a change of control transaction between the Company
and IFT and (ii) a security agreement granting IFT a security interest in all
accounts receivable of the Company.
Equity Sale
On December 29, 1998, in consideration for $280,000 in cash the Company sold in
a private placement to a single institutional investor, 80,000 shares of its
Common Stock (the "Initial Shares") in association with the right to acquire up
to 80,000 additional Repricing Shares of Common Stock without the payment of
additional consideration (collectively, the "Shares"), pursuant to the terms of
a Common Stock Purchase Agreement, dated as of December 28, 1998, by and between
the Company and the Investor (the "Purchase Agreement C"). Under the terms of
the Purchase Agreement C, Repricing Shares are issuable to the investor in the
event that on the 45th day (with respect to 25% of the Initial Shares), the 90th
day (with respect to 25% of the Initial Shares) and the 135th day (with respect
to 50% of the Initial Shares) subsequent to the closing date for sale of the
Initial Shares (with each such date being referred to as a "Repricing Date"),
the average of the lowest twenty closing sale prices during each such 45-day
period, respectively (each a "Discounted Share Price"), does not exceed $4.22
per share (the "Multiple Share Price"). The number of Repricing Shares to be
issued on each Repricing date, subject to the maximum of 80,000 Repricing
Shares, equals the product of (i) the difference between the Multiple Share
Price and the relevant Discounted Share Price, and (ii) a fraction equal to the
number of Initial Shares subject to repricing (e.g., 25% of 80,000 shares, or
20,000) divided by the relevant Discounted Share Price. The Company intends to
limit the number of Repricing Shares which will be issued by, from time to time,
exercising its right to repurchase Repricing Shares at the Call Price
established in the Purchase Agreement C, which is a minimum of $4.49 per share.
The Company is obligated to file with the Securities and Exchange Commission, a
registration statement with respect to the shares issuable under the Purchase
Agreement C and to use its best efforts to keep the registration statement
effective for a period of five (5) years after the registration statement is
declared effective, or until such earlier date when the Offered Shares may be
sold pursuant to Rule 144(k) under the Securities Act. At any time prior to sale
by the Investor, the Company may redeem the Shares at the Call Price established
in the Purchase Agreement C, which price is the greater of $4.49 per share, or
100% of the closing bid price per share on the date of redemption minus $3.50.
Outlook: Issues and Risks
Potential Change of Control Transaction
On February 4, 1999, the Company, entered into a non-binding Letter of Intent
with Interactive Flight Technologies, Inc., a Delaware corporation ("IFT")
regarding the acquisition by the Company of all or substantially all of the
assets and specified liabilities of IFT (the "Net Assets") relating to IFT's
interactive entertainment business (the "Business") in consideration for the
Company's issuance to IFT of that number of shares of its Common Stock as would
constitute 60% of the Company's fully-diluted equity (the "Acquisition"). The
Net Assets will include: $5 million in cash; accounts receivable owing to IFT
from Swissair; the proceeds and other recoveries generated by certain litigation
brought by IFT; the Swissair warranty contract; the Swissair customer
relationship; all IFT interactive entertainment intellectual property, and other
tangible assets related to the Business (including but not limited to customer
lists and files, trade secrets, trademarks, service marks, assignable government
permits and other rights under leases and rights under specified contracts);
inventory, furniture, fixtures, computers and equipment related to the Business;
other infrastructure (including FAA certified repair station) relating to the
Business; IFT's engineering and technical staff; and the benefit of all IFT
research and development efforts. The Acquisition will be effected in accordance
with a definitive agreement (the "Agreement") to be subsequently negotiated and
signed following the completion of due diligence investigations by the Company
<PAGE>
and IFT. In addition to the usual and customary representations, covenants and
conditions contained in agreements of the type used to consummate transactions
like the Acquisition, the definitive agreement will provide that closing of the
Acquisition is subject (i) to approval by the shareholders of the Company, if
required under the rules of The Nasdaq Stock Market, and (ii) the receipt of a
"fairness opinion" with respect to the terms of the Acquisition to the effect
that the Acquisition is fair from a financial point of view, to the Company
shareholders. Although the Letter of Intent is otherwise not binding, the
Company has agreed to refrain from entering into negotiations with any other
party for the sale of all or substantially all of its assets, or for the sale of
control of the Company, until May 15, 1999. IFT similarly agreed not to enter
into negotiations for the acquisition of control of any other company engaged in
the interactive entertainment business until May 15, 1999. There is no guarantee
that the Acquisition will be consummated on the terms set forth in the Letter of
Intent. IFT developed interactive entertainment products for use in the airline
and travel industry, and it has ceased all research and development activities
with respect to such products except as required under contract. It currently
maintains only one ongoing contract for its interactive entertainment products,
and is currently engaged in the redirection of its business activities into new
markets. IFT is a Nasdaq: NMS registrant and trades under the ticker symbol
FLYT.
The Company is currently using its working capital to finance its current
expenses, including installations, equipment purchases, product development,
inventory and other expenses associated with the delivery and installation of
systems for Carnival. Cash liquidity from external sources will be required to
finance existing and anticipated growth in the Company's accounts receivable and
inventories resulting from performance under outstanding orders, including
ongoing payroll expenses. The Company believes that its working capital
requirements will increase throughout 1999 and beyond, particularly as its focus
continues on large, long-term projects. The Company is in discussions with
commercial and private lenders to obtain the availability of borrowings secured
by assets of the Company and with investors for equity financing to prepare for
future operating needs in the event that the IFT transaction is not completed.
(see "Potential Change of Control Transaction" above) Even if the IFT
transaction is completed, maintaining an adequate level of working capital
through the end of 1999, and thereafter, will depend in part on collection of
accounts receivable on a timely basis, successful litigation with non-paying
customers already delinquent, satisfactory settlements with vendor-creditors
(including those already suing the Company) (see "PART I Item 3 - Legal
Proceedings"), 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. Following completion of the IFT transaction, the Company may
still 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 sites or major
long-term projects. There can be no assurance that the IFT transaction will be
completed and that if not any financing will be available on terms acceptable to
the Company, if at all. If future financing is not available when needed, the
Company will be forced to curtail or discontinue operations. In such event, the
stockholders may lose, or experience a substantial reduction in, the value of
their investment in the Company.
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, but 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
<PAGE>
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, the risks
of not being able to obtain additional future financing by sale of securities
due to the inability to maintain Nasdaq listing for Company Common Stock, and
the other risks and uncertainties detailed herein.
Risks Associated With Year 2000
The commonly referred to Year 2000 ("Y2K") problem results from the fact that
many existing computer programs and systems use only two digits to identify the
year in the date field. These programs were designed and developed without
considering the impact of a change in the century designation. If not corrected,
computer applications that use a two-digit format could fail or create erroneous
results in any computer calculation or other processing involving the Year 2000
or a later date. The Company has identified two main areas of Y2K risk:
1. Internal computer systems or embedded chips could be disrupted or
fail, causing an interruption or decrease in productivity in the
Company's operations and
2. Computer systems or embedded chips of third parties including (without
limitation) financial institutions, suppliers, vendors, landlords,
customers and service providers and others ("Material Third Parties")
could be disrupted or fail, causing an interruption or decrease in the
Company's ability to continue operations.
The Company has developed, or is in the process of developing, detailed plans
for implementation and testing of any necessary modifications to its key
computer systems and equipment with embedded chips to ensure that it is Y2K
compliant. The Company estimates that its internal systems will be Y2K ready by
September 30, 1999. The Company believes that with these detailed plans and
completed modifications, the Y2K issue will not pose significant operational
problems for it. However, if the modifications and conversions are not made, or
completed in a timely fashion, the Y2K could have a material impact on its
operations. The Company has performed an assessment of its Triumph products for
Y2K issues. The Triumph products use a four digit identifier and is, therefore,
Y2K compliant.
The Company's cost of addressing Y2K has been insignificant to date. The
financial impact of making any required systems changes or other remediation
efforts cannot be known precisely at this time, but it is not expected to be
material to the Company's financial position, results of operations, or cash
flows.
In addition, the Company has identified and prioritized and is communicating
with Material Third Parties to determine their Y2K status and any probable
impact on them. The Company will continue to track and evaluate its long-term
relationships with Material Third Parties based on the responses it receives
from such persons and on information learned from other sources. If any of the
Company's Material Third Parties are not Y2K ready and such non-compliance
causes a material disruption to any of their respective businesses, the
Company's business could be materially adversely affected. Disruptions could
include, among other things: the failure of a Material Third Party's business; a
financial institution's inability to take and transfer funds; an interruption in
delivery of supplies from vendors; a loss of voice and data connections; a loss
of power to the Company's facilities; and other interruptions in the normal
course of the Company's operations, the nature and extent of which the Company
cannot foresee. The Company will continue to evaluate the nature of these risks,
but at this time the Company is unable to determine the probability that any
such risk will occur, or if it does occur, what the nature, length or other
effects, if any, that it may have on the Company. If a significant number of
Material Third Parties experience failures in their computer systems or
operations due to Y2K non-compliance, it could affect the Company's ability to
process transactions or otherwise engage in similar normal business activities.
For example, while the Company expects its internal systems to be Y2K ready in
<PAGE>
September 1999, the Company and its customers will be dependant upon the Y2K
readiness of many providers of communications services and in turn, those
providers' vendors and suppliers. If, for example, such providers and others are
not Y2K ready, the Company and its customers may not be able to send and receive
data and electronic transmissions, which would have a material adverse effect on
the business and revenues of the Company and its customers. While many of these
risks are outside the Company's control, the Company has instituted a program to
identify Material Third Parties and to address any non-compliance issues.
While the Company believes that it is adequately addressing the Y2K issue, there
can be no assurance that its Y2K analysis will be completed on a timely basis,
or that the cost and liabilities associated with the Y2K issue will not
materially adversely impact its business, prospects, revenues or financial
position. The Company is uncertain as to its most reasonably likely worst case
Y2K scenario, and it has not yet developed a contingency plan to handle a worst
case scenario. The Company expects to have a contingency plan to handle this
situation by September 30, 1999.
<PAGE>
Item 7. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
Page
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Report of Independent Accountants 27
Balance Sheet as of December 31, 1998 28
Statements of Operations for the years ended December 31, 1998 and 1997 30
Statements of Changes in Shareholders' Equity for the years ended
December 31, 1998 and 1997 31
Statements of Cash Flows for the years ended December 31,
1998 and 1997 32
Notes to Financial Statements 33
<PAGE>
Report of Independent Accountants
To the Board of Directors and Shareholders of
The Network Connection, Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations, of changes in shareholders' equity and of cash flows present fairly,
in all material respects, the financial position of The Network Connection, Inc.
at December 31, 1998, and the results of its operations and its cash flows for
each of the two years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has incurred net losses from operations and
has an accumulated deficit that raises substantial doubt about its ability to
continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
PricewaterhouseCoopers LLP
April 15, 1999
Atlanta, Georgia
<PAGE>
THE NETWORK CONNECTION, INC.
BALANCE SHEET
December 31,
1998
-----------
ASSETS
Current assets:
Restricted cash $ 1,015,000
Short term investments 80,834
Accounts receivable, less allowance of $2,792,000 1,874,779
Inventories:
Raw materials, less allowance of $262,000 1,357,674
Work in process 1,400,494
Prepaid expenses 245,360
-----------
Total current assets 5,974,141
Property and equipment:
Land 150,000
Building and improvements 763,055
Furniture, fixtures and equipment 2,602,303
Software 60,192
Vehicles 162,773
-----------
3,738,323
Less accumulated depreciation (1,383,635)
-----------
2,354,688
Other assets, net 86,972
-----------
Total assets $ 8,415,801
===========
<PAGE>
THE NETWORK CONNECTION, INC.
BALANCE SHEET
December 31,
1998
------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 2,924,132
Payable to shareholders 74,429
Borrowings under bank line of credit 669,000
Notes payable 1,604,082
Deferred revenues 521,332
Current portion of long-term debt
and capital lease obligations 36,974
------------
Total current liabilities 5,829,949
Long-term debt, less current portion 699,998
------------
Total liabilities 6,529,947
Commitments and contingencies (Note 2)
Redeemable convertible
preferred stock, $.01 par
value, $1,000 stated value:
Authorized, 1,500 shares;
Issued and outstanding, 1,522,667
1,500
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, 5,069,646 shares 5,070
Additional paid-in capital 16,443,552
Accumulated deficit (16,085,435)
------------
Total shareholders' equity 363,187
------------
Total liabilities and shareholders' equity $ 8,415,801
============
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENTS OF OPERATIONS
For the years ended
December 31,
------------------------------
1998 1997
------------ ------------
Revenues $ 5,003,290 $ 7,848,444
Cost of revenues 3,005,151 5,044,258
------------ ------------
Gross profit 1,998,139 2,804,186
Selling, general and administrative 3,965,878 4,346,318
Provision for doubtful
accounts and inventory reserve 6,464,064 258,270
Special charges 595,263 0
Research and development 397,196 277,527
------------ ------------
Operating loss (9,424,262) (2,077,929)
Interest, net (209,036) 52,301
------------ ------------
Net loss (9,633,298) (2,025,628)
Preferred stock dividends 574,951 0
------------ ------------
Net loss to common shareholders $(10,208,249) $ (2,025,628)
============ ============
Basic and Diluted Net loss per share $ (2.31) $ (0.53)
============ ============
Weighted average shares outstanding 4,426,535 3,845,097
============ ============
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
<TABLE>
<CAPTION>
Common Stock Additional Accumulated
Shares Amount PIC Deficit Total Equity
------ ------ ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1997 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
Common stock sold 80,000 80 213,350 213,430
Conversion of preferred
stock to common stock 746,653 747 1,984,575 1,985,322
Stock option plan 90,600 91 198,189 198,280
Preferred stock dividends (574,951) (574,951)
Net Loss (9,633,298) (9,633,298)
---------- ------- ----------- ------------ -----------
Balance at December 31, 1998 5,069,646 $ 5,070 $16,443,552 ($16,085,435) $ 363,187
</TABLE>
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENTS OF CASH FLOWS
For the years ended
December 31,
---------------------------
1998 1997
----------- -----------
Operating activities
Net loss ($9,633,298) ($2,025,628)
----------- -----------
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,030,265 334,029
Provision for doubtful accounts 6,202,064 0
Provision for inventory 262,000 0
Changes in operating assets and liabilities:
Accounts receivable (3,140,341) (3,131,223)
Inventories 424,827 (2,336,585)
Prepaids and other assets 11,328 (728,070)
Accounts payable and accrued expenses (1,243,985) 2,990,205
Payable to shareholders 3,500 2,078
Deferred revenues 521,332 0
----------- -----------
Net cash used in operating activities (5,562,308) (4,895,194)
Investing activities:
Purchase of property and equipment (534,084) (417,291)
Purchase of short-term investments 557,725 (142,846)
----------- -----------
Net cash (used in) provided by investing
activities 23,641 (560,137)
Financing activities:
Proceeds from bank line of credit 143,000 30,000
Proceeds from issuance of promissory notes 1,601,600 0
Proceeds from issuance of long-term debt 470,000 18,077
Net proceeds from issuance of stock 3,344,749 5,443,679
Payment of long-term debt and capital lease
obligations (30,330) (11,777)
----------- -----------
Net cash provided activities 5,529,019 5,479,979
----------- -----------
Net change in cash (9,648) 24,648
Cash at beginning of year 1,024,648 1,000,000
----------- -----------
Cash at end of year $ 1,015,000 $ 1,024,648
=========== ===========
Supplemental Information:
Conversion of debt to convertible preferred stock 3,450,000 0
Preferred stock dividends 574,951 0
<PAGE>
1. Significant Accounting Policies
Description of Business
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.
Basis of Presentation - Going Concern
The Company's financial statements are prepared using generally accepted
accounting principles applicable to a going concern which contemplate the
realization of assets and liquidation of liabilities in the normal course of
business. The Company has incurred net losses from operations for several years,
has an accumulated deficit at December 31, 1998, and has used substantial cash
in its operations which raises substantial doubt about the Company's ability to
continue as a going concern. Management believes that the completion of the
change of control transaction with Interactive Flight Technologies, Inc. ("IFT")
described in Note 9, future debt and equity offerings and successful
commercialization of its products and services will generate the required
capital necessary to continue as a going concern.
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. Trade accounts receivable are generally unsecured; therefore, the
Company is at risk to the extent such amounts become uncollectible.
In 1998, two customers accounted for an aggregate of 96% (76% and 20%,
respectively) of the Company's revenues. In 1997, three customers accounted for
an aggregate of 79% (38%, 30% and 11%, 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
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.
<PAGE>
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 or installed based upon
the terms of the contract, expiration of rights of acceptance or return and
determination that the related receivables are collectible. Revenues pursuant to
contracts that provide for revenue sharing with customers or others is
recognized as cash is received in the amount of the Company's retained portion
of the cash pursuant to the revenue sharing agreement.
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 of up to 180 days based on the nature of the project.
Deferred Revenue
Deferred revenue represents the advance billings of equipment sales as allowed
under purchase and installation contracts.
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.
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 $234,000 and $656,000 in 1998 and 1997,
respectively.
<PAGE>
2. Commitments and Contingencies
The Company leases certain equipment and office space. Property and equipment
includes $15,230 of equipment under capital lease agreements at December 31,
1998. Accumulated amortization was $13,707 at December 31, 1998. 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 2001.
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, 1998:
Year ending December 31, Capital Operating
------------------------ ------- ---------
1999 970 15,288
2000 0 15,288
2001 0 7,644
Total minimum lease payments $970 $38,220
Less amounts representing interest 90
Present value of minimum capital lease payments 880
Less current portion 880
Long-term obligations under capital leases $ 0
During 1998 and 1997, total rental expense for all operating leases was
approximately $33,574 and $36,000, respectively.
To date, the Company has not experienced significant claims under product
warranties due to the pass through to end users of the warranties that the
Company receives from vendors.
On December 1, 1998, Sigma Designs, Inc. ("Sigma"), filed a complaint against
the Company in the United States District Court, Northern District of
California, San Jose Division, Civil Action File No. 98-21149J(EAI) alleging
breach of contract and action on account. Sigma claims that the Company failed
to pay for goods shipped to the Company by Sigma. The matter was settled by
written agreement dated January 22, 1999, contingent upon registration of
Company stock issued to Sigma as a part of such settlement, and payment by the
Company of $50,000, in two installments, the latter which was due on February 5,
1999. The Company has made the $50,000 settlement payments and is in the process
of filing for registration of the stock issued to Sigma. Management of the
Company expects to fully comply with the terms of the settlement agreement and
the claim will be dismissed with prejudice.
Hollingsead International, Inc. ("Hollingsead") filed a complaint against the
Company on January 28, 1999, in the State Court of Forsyth County, State Court
of Georgia, Civil Action File No. 99sc0053, alleging the Company failed to pay
invoices submitted for installation and service of audio-visual systems in
certain aircraft. In its complaint Hollingsead requests $357, 850 in damages
plus interest, costs, attorneys fees, and punitive damages of no less than
$250,000. The Company filed an answer and a counterclaim with the court on March
29, 1999 alleging that any amounts allegedly owed Hollingsead should be set-off
and/or recouped against damages incurred by the Company as a result of
Hollingsead's negligence and/or breach of contract. The Company is seeking
settlement of such claims with Hollingsead.
On March 29, 1999, the Company filed for arbitration under the rules of the
United Nations Commission on International Trade Law and the Rules of
Arbitration of the Kuala Lumpur Regional Centre for Arbitration, to enforce its
rights under the terms of the Star Agreement with CNA and Star for the delivery,
installation and maintenance of a CruiseView system on the Star cruise ship the
SuperStar Leo. The CruiseView system on the SuperStar Leo was installed and has
been in commercial operation since October 1998. The Company claims that Star
and CNA are in default under the payment obligations of the Star Agreement and
intend to aggressively pursue its remedies, including repossession of inventory,
contractual and otherwise, to enforce its rights under the terms of the Star
Agreement.
<PAGE>
On March 29, 1999, the Company filed to revoke the Supplemental Type Certi
ficate (STC) issued by the FAA and DGAC in connection with the two Fairlines
aircraft on which AirView systems are installed and in operation due to
Fairlines default in payment under terms of the AirView Agreement. Revocation of
the STC would result in the inability for Fairlines to operate the aircraft
commercially with the AirView system installed on the aircraft. The Company is
pursuing its remedies, contractual and otherwise, in respect to collection of
amounts due and damages incurred under the AirView Agreement.
3. Debt Obligations
Debt obligations consist of the following:
1998 1997
-------- --------
Note payable due in varying installments through
2009, interest at prime (7.5% at December 31, 1998)
plus 2%, collateralized by certain commercial
property and personally guaranteed by two
shareholders $227,102 $238,767
Note payable due in varying installments through 2000,
interest at 6.9%, collateralized by a vehicle. 31,456 40,845
Note payable due and payable April 19, 2001, interest
at 16% payable monthly, collateralized by certain
commercial property 470,000 0
Note payable due in varying installments through 2000,
interest at 11.0%, collateralized by a vehicle. 7,444 12,458
-------- --------
736,002 292,070
-------- --------
Less current portion 36,004 32,964
-------- --------
$699,998 $259,106
======== ========
Aggregate maturities of long-term debt as of December 31, 1998 are as follows:
1999 36,004
2000 31,072
2001 486,457
2002 18,848
2003 22,050
Thereafter 141,571
--------
$736,002
========
On May 28, 1998, the Company entered into a $1.0 million line of credit
agreement with a bank. Outstanding advances bear interest at 7.05% per annum
through the maturity date of May 28, 1999. Interest is payable monthly in
arrears, commencing January 1, 1998. As of December 31, 1998, there was $669,000
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.
On August 12, 1998, the Company entered into promissory notes (collectively
"Series Notes") with five individual investors in the aggregate amount of
$650,000. The Series Notes were unsecured and were due and payable with accrued
interest at an annual rate of 8% on October 14, 1998. The Company, in its sole
discretion, could elect to pay these Series Notes on October 12, 1998, subject
to a payment charge equal to 7% of the principal amount, or exchange the Series
Notes for a series of convertible preferred stock or convertible debentures of
the Company. On October 12, 1998, the Company entered into new promissory notes
(collectively "Series A Notes") in the aggregate amount of $704,082 with the
holders of the Series Notes to replace and rollover the Series Notes. The Series
A Notes are unsecured and are due and payable with accrued interest at an annual
rate of 8% on December 11, 1998. The Company, in its sole discretion, may elect
to pay these Series A Notes on December 11, 1998, subject to a payment charge
equal to 7% of the principal amount, or exchange the Series A Notes for a series
of convertible preferred stock or convertible debentures of the Company. On
December 11, 1998, the Company and the holders of the Series A Notes agreed to
extend the due date for repayment of the Series A Notes until February 25, 1999.
On February 25, 1999 the Series A Notes were orally extended and made payable on
demand.
<PAGE>
On October 20, 1998, the Company entered into promissory notes (collectively
"Series D Notes") with three individual investors in the aggregate amount of
$350,000. The Series D Notes were unsecured and were due and payable with
accrued interest at an annual rate of 8% on January 18, 1999. The Company, in
its sole discretion, could elect to pay these Series D Notes on January 18,
1999, subject to a payment charge equal to 5% of the principal amount, or
exchange the Series D Notes for a series of convertible preferred stock or
convertible debentures of the Company. On January 18, 1999, the Company and the
holders of the Series D Notes agreed to extend the due date for repayment of the
Series D Notes until April 15, 1999, subject to a payment charge equal to 5% of
the principal amount plus an additional 2.5% of the principal amount for each 30
day period after January 18, 1999 the Series D Notes are outstanding.
From November 17 to December 17, 1998, the Company entered into promissory notes
(collectively "Series E Notes") with five individual investors in the aggregate
amount of $550,000. The Series E Notes were unsecured and were due and payable
with accrued interest at an annual rate of 8% from January 18 to February 8,
1999. The Company, in its sole discretion, could elect to pay these Series E
Notes on the due date, subject to a payment charge equal to 7% of the principal
amount, or exchange the Series E Notes for a series of convertible preferred
stock or convertible debentures of the Company. On February 12, 1999, the
Company and the holders of the Series E Notes agreed to extend the due date for
repayment of the Series E Notes until March 15, 1999. On March 15, 1999 the
Series E Notes were orally extended and made payable on demand.
The Company paid interest of approximately $311,000 and $62,000 during fiscal
years 1998 and 1997, respectively.
4. Common Stock, Preferred Stock and Warrants
On March 11, 1998, the Company raised gross proceeds of $2.2 million in a
private placement to a single institutional investor, KA Investments LDC (the
"KA"), of five-year convertible debt securities (the "Debentures") pursuant to
the terms of a Convertible Debenture Purchase Agreement, dated March 11, 1998,
by and between the Company and KA (the "Debenture Purchase Agreement"). Each
Debenture was sold for $50,000.00, accrued interest at a rate of 4% per annum,
and was 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 (as
adjusted for stock splits). On June 9, 1998, KA and the Company entered into a
Convertible Preferred Stock Purchase Agreement (the "Purchase Agreement A"),
pursuant to which KA agreed to exchange all of its Debentures for 220,000 shares
of the Company's 4% Series A Convertible Preferred Stock (the "Series A
Preferred Stock"). The financial terms of the Series A Preferred Stock were
identical to the financial terms of the Debentures for which they were
exchanged. The Company was obligated to file and have declared effective by the
Securities and Exchange Commission (the "Commission"), on or prior to June 24,
1998, a registration statement with respect to the resale of the Common Stock
issuable upon conversion of the Series A Preferred Stock. The Company originally
filed such Registration Statement on May 1, 1998, and such Registration
Statement was declared effective by the Commission on June 8, 1998. As of
December 31, 1998, holders of the Company's Series A Preferred Stock had
exercised their right and converted all 220,000 shares of the Series A Preferred
Stock into 746,653 shares of the Company's Common Stock.
On June 29, 1998, the Company entered into a promissory note (the "Investor
Note") with an institutional investor in the amount of $1,250,000. This note was
unsecured and was due and payable with accrued interest at an annual rate of 8%
on August 28, 1998. The Company, in its sole discretion, could elect to pay this
note on August 28, 1998, subject to a payment charge of $87,500, or exchange
this note for a series of convertible preferred stock or convertible debentures
of the Company. Repayment of the Investor Note was orally extended and made
payable on demand. On October 23, 1998, the Company elected to exchange the
Investor Note for 1,500 shares of the Company's non-voting Series B 8%
Convertible Preferred Stock (the " Series B Preferred Stock") and warrants to
acquire 100,000 shares of Common Stock issued to the holder of the Series B
Preferred Stock (the "Warrants") pursuant to a Securities Purchase Agreement of
even date ("Purchase Agreement B"). The $1,000 stated value per share of Series
<PAGE>
B Preferred Stock is convertible at the option of the holder into shares of
Common Stock, at a price per share equal to the lesser of $ 3.66 per share of
Common Stock (the "Closing Price") or 75% of the average of the closing bid
prices as reported on the Nasdaq SmallCap Market ("Nasdaq") for the lowest five
of the 20 trading days immediately preceding the date of Series B Preferred
Stock conversion (the "Average Price"). The Warrants are exercisable to acquire
shares of Common Stock at a price per share equal to $4.125.
On December 29, 1998, in consideration for $280,000 in cash the Company sold in
a private placement to a single institutional investor, (the "Investor"), 80,000
shares of its Common Stock (the "Initial Shares") in association with the right
to acquire up to 80,000 additional Repricing Shares of Common Stock without the
payment of additional consideration (collectively, the "Shares"), pursuant to
the terms of a Common Stock Purchase Agreement, dated as of December 28, 1998,
by and between the Company and the Investor (the "Purchase Agreement C"). Under
the terms of the Purchase Agreement C, Repricing Shares are issuable to the
Investor in the event that on the 45th day (with respect to 25% of the Initial
Shares), the 90th day (with respect to 25% of the Initial Shares) and the 135th
day (with respect to 50% of the Initial Shares) subsequent to the closing date
for sale of the Initial Shares (with each such date being referred to as a
"Repricing Date"), the average of the lowest twenty closing sale prices during
each such 45-day period, respectively (each a "Discounted Share Price"), does
not exceed $4.22 per shares (the "Multiple Share Price"). The number of
Repricing Shares to be issued on each Repricing date, subject to the maximum of
80,000 Repricing Shares, equals the product of (i) the difference between the
Multiple Share Price and the relevant Discounted Share Price, and (ii) a
fraction equal to the number of Initial Shares subject to repricing (e.g., 25%
of 80,000 shares, or 20,000) divided by the relevant Discounted Share Price. The
Company intends to limit the number of Repricing Shares which will be issued by,
from time to time, exercising its right to repurchase Repricing Shares at the
Call Price established in the Purchase Agreement C, which is a minimum of $4.49
per share. At any time prior to sale by the Investor, the Company may redeem the
Shares at the Call Price established in the Purchase Agreement C, which price is
the greater of $4.49 per share, or 100% of the closing bid price per share on
the date of redemption minus $3.50.
See also Note 2 and Note 9.
5. Income Taxes
The Company 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, 1998, the
Company had a net deferred tax asset of approximately $6,491,000 which was
totally offset by a valuation allowance because the assets do not meet the
criteria for recognition in SFAS 109. Significant components of the Company's
deferred tax liabilities and assets as of December 31, 1998 and 1997 are as
follows:
1998 1997
----------- -----------
Deferred tax liabilities:
Tax over book depreciation ($ 188,000) ($ 122,000)
Tax over book amortization 0 0
----------- -----------
Total deferred tax liabilities ($ 188,000) ($ 122,000)
----------- -----------
Deferred tax assets:
Bad debt reserve $ 1,061,000 $ 57,000
Uniform capitalization 81,000 10,000
Book over tax amortization 195,000 9,000
Charitable contributions 4,000 3,000
Net operating loss 5,338,000 3,013,000
----------- -----------
Total deferred tax assets $ 6,679,000 $ 3,092,000
----------- -----------
Net deferred tax assets 6,491,000 2,970,000
Valuation allowance (6,491,000) (2,970,000)
----------- -----------
Net deferred taxes $ 0 $ 0
=========== ===========
<PAGE>
The valuation allowance for deferred tax assets as of January 1, 1998 was
approximately $2,970,000. The net change in the total valuation allowance for
1998 was approximately $3,521,000. 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, 1998 and 1997, respectively. The following table
provides a reconciliation between the Federal income tax rate and the Company's
effective income tax rate:
1998 1997
---- ----
Statutory Federal income tax rate 34% 34%
Disallowed meals and entertainment (0) (1)
Increase in valuation allowance (36) (51)
Other, net 2 18
Effective tax rate 0% 0%
At December 31, 1998, the Company has net operating loss (NOL) carryforwards of
approximately $14,049,000. 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 $2,438,000
December 31, 2018 $6,345,000
6. Related Party Transactions
The Company was owed approximately $68,000 from two shareholders/officers as of
December 31, 1998.
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, 1998, $74,429 of principal and accrued
interest remained outstanding under these notes.
7. 401(k) Plan
During 1996, the Company established a defined contribution 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.
<PAGE>
8. 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 1998, options to purchase 355,000 shares were granted at per share price
of $2.00. Options to purchase 652,478 shares were outstanding at December 31,
1998. Options to purchase 265,578 shares under the Plan were exercisable at
December 31, 1998. There were 712,328 options outstanding as of December 31,
1997.
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 5,000 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 1998, options
to purchase 10,000 shares were granted at per share prices ranging from $2.59 to
$3.25. Options to purchase 24,000 shares under the Directors Plan were
outstanding at December 31, 1998. Options to purchase 9,000 shares under the
Directors Plan were exercisable at December 31, 1998. There were 14,000 options
to purchase shares under the Directors Plan outstanding at December 31, 1997.
Shares Average Exercise
Weighted Share Price
-------- ----------------
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
Granted 365,000 2.03
Canceled or expired (344,250) 8.73
Exercised (90,600) 2.00
Options outstanding at December 31, 1998 676,478 5.00
<PAGE>
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:
1998 1997
---- ----
Net loss: (millions)
As reported ($10.21) ($2.03)
Pro forma ($10.64) ($3.44)
Net loss per share:
As reported ($2.31) ($0.53)
Pro forma ($2.40) ($0.89)
The fair value was determined using the Black-Sholes option pricing model
incorporating the following range of assumptions in the calculations:
1998 1997
---- ----
Expected life 5.0 years 9.8 years
Interest rate at grant date 4.57% 6.19%
Volatility at grant date 86% 78%
Dividend yield 0% 0%
The following table summarizes information about all options outstanding as of
December 31, 1998:
<TABLE>
<CAPTION>
Outstanding Average Exercisable
Weighted Remaining Weighted
Average Years in Average
Outstanding Share Contractual Exerciseable Share
Range of Exercise Prices Shares Price Life Shares Price
- ------------------------ ------ ----- ---- ------ -----
<S> <C> <C> <C> <C> <C>
$2.00 - $2.15 319,728 $2.09 4.61 131,478 3.25
4.17 - 6.00 99,000 6.07 3.83 84,000 6.75
7.13 - 7.40 169,750 7.43 6.91 93,500 8.00
8.75 - 8.81 32,000 8.78 7.40 16,500 9.82
10.25 - 10.42 56,000 10.42 7.57 53,500 13.26
$2.00 - $5.76 676,478 $5.05 5.46 378,978 13.26
</TABLE>
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.
<PAGE>
9. Subsequent Events
On January 22, 1999, in consideration for the settlement of outstanding
litigation brought by Sigma Designs, Inc., a vendor to the Company (the "Sigma")
and the mutual release of claims, under the terms of the Settlement Agreement,
the Company agreed to pay $50,000 in cash to Sigma and to issue to Sigma 110,000
Initial Shares of Common Stock. The Company also issued to Sigma a warrant to
acquire 40,000 shares of Common Stock, exercisable at $3.44 per share. The
Company is obligated to file with the Securities and Exchange Commission, a
Registration Statement and to use its best efforts to keep the Registration
Statement effective for a period of five (5) years after the Registration
Statement is declared effective, or until such earlier date when the Offered
Shares may be sold pursuant to Rule 144(k) under the Securities Act. Under the
terms of the Settlement Agreement, the Company may be required to pay an
additional cash amount to the holder of the Shares in the event that on the date
of Registration (the "Repricing Date"), the market price for the Initial Shares
(the "Market Price") is not at least $319,850 (the "Repricing Price").
The Company is currently using its working capital to finance its current
expenses, including installations, equipment purchases, product development,
inventory and other expenses associated with the delivery and installation of
current systems. Cash liquidity from external sources will be required to
finance existing and anticipated growth in the Company's accounts receivable and
inventories resulting from performance under outstanding orders, including
ongoing payroll expenses. The Company believes that its working capital
requirements will increase throughout 1999 and beyond, particularly as its focus
continues on large, long-term projects. The Company is in discussions with
commercial and private lenders to obtain the availability of borrowings secured
by assets of the Company and with investors for equity financing to prepare for
future operating needs in the event that the IFT transaction is not completed.
Even if the IFT transaction is completed, maintaining an adequate level of
working capital through the end of 1999, and thereafter, will depend in part on
collection of accounts receivable on a timely basis, successful litigation with
non-paying customers already delinquent, satisfactory settlements with
vendor-creditors (including those already suing the Company), 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. Following
completion of the IFT transaction, the Company may still 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 sites or major long-term projects. There can be no
assurance that the IFT transaction will be completed and that if not any
financing will be available on terms acceptable to the Company, if at all. If
future financing is not available when needed, the Company will be forced to
curtail or discontinue operations.
On February 4, 1999, the Company, entered into a non-binding Letter of Intent
with Interactive Flight Technologies, Inc., a Delaware corporation ("IFT")
regarding the acquisition by the Company of all or substantially all of the
assets and specified liabilities of IFT (the "Net Assets") relating to IFT's
interactive entertainment business (the "Business") in consideration for the
Company's issuance to IFT of that number of shares of its Common Stock as would
constitute 60% of the Company's fully-diluted equity (the "Acquisition"). The
Net Assets will include: $5 million in cash; accounts receivable owing to IFT
from Swissair; the proceeds and other recoveries generated by certain litigation
brought by IFT; the Swissair warranty contract; the Swissair customer
relationship; all IFT interactive entertainment intellectual property, and other
tangible assets related to the Business (including but not limited to customer
lists and files, trade secrets, trademarks, service marks, assignable government
permits and other rights under leases and rights under specified contracts);
inventory, furniture, fixtures, computers and equipment related to the Business;
other infrastructure (including FAA certified repair station) relating to the
Business; IFT's engineering and technical staff; and the benefit of all IFT
research and development efforts. The Acquisition will be effected in accordance
with a definitive agreement (the "Agreement") to be subsequently negotiated and
signed following the completion of due diligence investigations by the Company
and IFT. In addition to the usual and customary representations, covenants and
<PAGE>
conditions contained in agreements of the type used to consummate transactions
like the Acquisition, the definitive agreement will provide that closing of the
Acquisition is subject (i) to approval by the shareholders of the Company, if
required under the rules of The Nasdaq Stock Market, and (ii) the receipt of a
"fairness opinion" with respect to the terms of the Acquisition to the effect
that the Acquisition is fair from a financial point of view, to the Company
shareholders. Although the Letter of Intent is otherwise not binding, the
Company has agreed to refrain from entering into negotiations with any other
party for the sale of all or substantially all of its assets, or for the sale of
control of the Company, until May 15, 1999. IFT similarly agreed not to enter
into negotiations for the acquisition of control of any other company engaged in
the interactive entertainment business until May 15, 1999. There is no guarantee
that the Acquisition will be consummated on the terms set forth in the Letter of
Intent. IFT developed interactive entertainment products for use in the airline
and travel industry, and it has ceased all research and development activities
with respect to such products except as required under contract. It currently
maintains only one ongoing contract for its interactive entertainment products,
and is currently engaged in the redirection of its business activities into new
markets. IFT is a Nasdaq: NMS registrant and trades under the ticker symbol
FLYT.
The Company also entered into a loan transaction with IFT, pursuant to (i) a
promissory note in the principal amount of $750,000, bearing a rate of interest
of 9.5% per annum, for a term ending on the earlier of May 15, 1999, or the
closing date of a change of control transaction between the Company and IFT and
(ii) a security agreement granting IFT a security interest in all accounts
receivable of the Company.
10. Fourth Quarter Adjustments
The Company increased its provision for doubtful accounts and inventory reserve
by approximately $3.6 million in the fourth fiscal quarter primarily due to the
uncertainty of recovery of certain amounts due from Continuous Network Advisors
("CNA") related to the sale and installation of CruiseView on a cruise ship for
Star Cruises Management Ltd. ("Star"). In March 1999, the Company filed for
arbitration to enforce its rights under the terms of the Star Agreement. The
CruiseView system on the vessel was installed and has been in commercial
operation since November 1998. The Company claims that Star and CNA are in
default under the payment obligations of the Star Agreement and intends to
aggressively pursue its rights under the terms of the Star Agreement through
arbitration and all remedies available, including repossession of inventory,
contractual and otherwise.
Special charges in the fourth fiscal quarter resulted from $595,263 for the
impairment of other assets capitalized in 1997 related to costs for obtaining
Federal Aviation Administration (FAA) certification for the Company's AirView
system which were being amortized over 10 years. These assets were written off
due to the uncertainty of recoverability resulting from the termination of the
Fairlines Agreement and the absence of any additional orders received for the
AirView system for use in commercial aircraft requiring FAA certification.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None
<PAGE>
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, 1999.
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). (7)
3.2 Amended and Restated By-laws of Registrant. (5)
4.3 1994 Employee Stock Option Plan , including form of Stock Option
Agreement. (1)
10.1 Employment Agreement, dated October 31, 1998, by and between the
Registrant and Wilbur L. Riner.
10.3 Employment Agreement, dated October 31, 1998, by and between the
Registrant and James E. Riner.
10.5 Employment Agreement, dated October 31, 1998, by and between the
Registrant and Bryan R. Carr.
10.10 Promissory Note, dated September 1, 1994, made by the Company to the order
of Wilbur Riner. (1)
10.12 Promissory Note, dated September 1, 1994, made by the Company to the order
of James Riner. (1)
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)
10.22 Note and Security Agreement, dated May 26, 1995, by and between the
Company and Wachovia Bank of Georgia N.A. (4)
10.25 Securities Purchase Agreement dated as of October 23, 1998, between the
Shaar Fund Ltd. (the "Shaar") and the Registrant (7)
10.26 Registration Rights Agreement dated as of October 23, 1998, between Shaar
and the Registrant (7)
10.27 Warrant Agreement dated October 23, 1998, between Shaar and the Registrant
(7)
10.28 Securities Purchase Agreement dated as of December 28, 1998, between Cache
Capital and the Registrant
10.29 Registration Rights Agreement dated as of December 28, 1998, between Cache
Capital and the Registrant
10.30 Letter of Intent, dated as of February 4, 1999, among The Network
Connection, Inc. and Interactive Flight Technologies, Inc.
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
7. Incorporated by reference, filed as an exhibit with the Company's Quarterly
Report on Form 10-QSB for the fiscal quarter ended September 30, 1998 on
November 16, 1998.
(b) Reports on form 8-K for the fourth quarter ended December 31, 1998:
None
<PAGE>
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: April 15, 1999 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
has 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 April 15, 1999
Wilbur L. Riner and Director
/s/ Bryan R. Carr Vice President - Finance, Chief April 15, 1999
Bryan R. Carr Financial and Principal Accounting
Officer and Director
/s/ James E. Riner Vice President - Engineering, April 15, 1999
James E. Riner Secretary and Director
Marc Doyle Director April 15, 1999
Arthur Bauer Director April 15, 1999
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-KSB/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998
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 and non-voting common equity held by
non-affiliates of the registrant, based on the closing sale price of the Common
Stock on April 15, 1999, in the over-the-counter market as reported by The
Nasdaq SmallCap Market tier of The Nasdaq Stock Market, was approximately $12.7
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 April 15, 1999, the registrant had outstanding 5,179,646 shares of its
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
None
This filing amends the Report on Form 10-KSB for the fiscal year ended December
31, 1998, filed on April 15, 1999, by adding Part III which was omitted from the
original filing.
<PAGE>
PART III
Item 9. Directors and Executive Officers of the Registrant
The following table sets forth information with respect to directors,
executive officers and key employees of the Company as of April 30, 1999.
Name Age Position
---- --- --------
Wilbur Riner(1)(2)(3)(4) 71 Chief Executive Officer and Chairman of
the Board of Directors since 1986;
President since 1997
James Riner(3) 34 Vice President - Research and Development
and Engineering; Director since 1986
Bryan Carr(3) 44 Vice President-Finance; Chief Financial
Officer; Chief Operating Officer;
Treasurer; Director since 1996
(1) Member of the Employee Stock Option Committee.
(2) Member of the Audit Committee.
(3) Member of the Director Stock Option Committee.
(4) Member of the Compensation Committee.
Wilbur Riner - Chairman, President and Chief Executive Officer. Mr. Riner
co-founded the Company with his son, James Riner, in 1986, at which time he
became Chairman and Chief Executive Officer. He is responsible for the overall
direction of the Company and its operating divisions. Prior to joining the
Company, from 1984 to 1986, Mr. Riner was the CEO of Asher Technologies, which
was a manufacturer of telecommunications products. Prior to that, Mr. Riner had
served as Executive Vice President for OKI Telecom's operations in the United
States (1981-1984), Vice President /United States Sales and Marketing for Mitel
Corp. (1979 to 1981), and General Manager of ITT North Microsystems for ITT
Telecommunication (1975 to 1979). In all of these positions, Mr. Riner has
combined technical expertise in telecommunications engineering with sales and
marketing business acumen. Mr. Riner is the husband of Barbara Riner and the
father of James Riner.
James Riner-Vice President-Research and Development and Engineering,
Secretary and Director. Mr. Riner co-founded the Company in 1986, joining the
Company on a full-time basis as Vice President - Engineering and Research and
Development, Secretary and Treasurer in 1987. In that capacity he is responsible
for all product technical support, as well as all new product development. Mr.
Riner co-developed the Company's TRIUMPH family of servers, including the TRAC
asymmetric I/0 processor to provide RAID level protection (1992). Mr. Riner is
the son of Wilbur Riner and the stepson of Barbara Riner.
Bryan Carr-Vice President-Finance, Chief Financial Officer, Chief Operating
Officer, Treasurer and Director. Mr. Carr joined the Company in July 1995 as
Chief Financial Officer and was appointed Vice President - Finance in November
1995. Mr. Carr was appointed a director of the Company in April of 1996,
Treasurer of the Company in November of 1996 and Chief Operating Officer in
August of 1997. He is responsible for the Company's overall financial and
operational management and policy making and conduct of the Company's
relationship with creditors, shareholders and the financial community. Prior to
joining the Company, from 1988 to 1995, Mr. Carr was Director of Business
Administration for LXE, Inc., a public company providing wireless data
communications products worldwide. From 1981 to 1988 he was Controller for UTL
Corporation, a public company providing advanced communications systems for
Government and commercial applications internationally. Prior to 1981 he was a
senior auditor with Coopers & Lybrand.
<PAGE>
Director's Terms
The Company has a classified Board of Directors. Messr. James Riner
currently serves as director under a three-year term ending at the date of the
2001 Annual Meeting of Shareholders. Messrs. Wilbur Riner and Bryan Carr
currently serve as directors under three-year terms ending at the date of the
1999 Annual Meeting of Shareholders.
Compliance with Section 16(a) of the Securities Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and officers, and persons who own beneficially more than ten percent
(10%) of the Common Stock of the Company, to file reports of ownership and
changes of ownership with the Securities and Exchange Commission. Copies of all
reports are required to be furnished to the Company pursuant to Section 16(a).
Based solely on the reports received by the Company and on written
representations from reporting persons, the Company believes that persons
subject to the reporting requirements complied with all applicable Section 16(a)
filing requirements during the fiscal year ended December 31, 1998.
PART III
Item 10. Executive Compensation
The following table sets forth certain information, for the years ended
December 31, 1998, 1997 and 1996, with respect to compensation paid or accrued
by the Company to the Company's Chief Executive Officer and to each of the most
highly compensated other executive officers whose combined salary and bonus
compensation for 1998 exceeded $100,000.
SUMMARY COMPENSATION TABLE
Annual Compensation
Long Term Compensation
Other Securities
Name and Annual Underlying
Principal Position Year Salary Bonus Compensation Options/SARs(#)
- ------------------ ---- ------ ----- ------------ ---------------
Wilbur Riner, 1998 $156,000 -0- $22,900(1) 100,000
Chairman, 1997 104,322 -0- 23,400(1) 100,000
President and 1996 101,414 -0- 24,375(1) 20,000
Chief Executive
Officer
Bryan Carr, Vice 1998 $120,000 -0- $10,501(1) 50,000
President - 1997 101,667 -0- 30,171(1) 80,000
Finance and Chief 1996 95,625 -0- 18,888(1) 99,000
Financial Officer
(1) Consists of the following:
Automobile
Allowance Commissions Total
--------- ----------- -----
Wilbur Riner - 1998 $5,400 $17,500 $22,900
Wilbur Riner - 1997 5,400 18,000 23,400
Wilbur Riner - 1996 5,625 18,750 24,375
Bryan Carr - 1998 $4,800 $10,501 $15,301
Bryan Carr - 1997 5,000 25,171 30,171
Bryan Carr - 1996 4,800 14,088 18,888
<PAGE>
Mr. Riner and Mr. Carr, from time to time, provided significant assistance
to the Company's sales and marketing staff in effecting sales of the Company's
products, for which sales they received commission compensation.
Option/SAR Grants in Last Fiscal Year
The following table sets forth certain information with respect to
individual grants of stock options and freestanding SARs made to the named
executive officer during the year ended December 31, 1998.
Individual Grants
% of Total
Number of Options/
Securities SARs Exercise
Underlying Granted to of Base
Options/ Employees in Price Expiration
Name SARs Granted Fiscal Year ($/Sh) Date
---- ------------ ----------- ------ ----
Wilbur Riner 100,000 27.4% $2.00 9/10/08
Bryan Carr 50,000 13.7% $2.00 9/10/08
Aggregated Option/SAR Exercises in Last Fiscal Year and
FY-End Option/SAR Values
The following table sets forth certain information with respect to the
exercise of stock options and freestanding SARs by each of the named executive
officers during the last completed fiscal year, and the fiscal year-end value of
unexercised options and SARs for the last completed fiscal year.
Number of
Securities Value of
Underlying Unexercised
Unexercised In -the-Money
Options/SARs Options/SARs
Shares at FY-End (#) at FY-End ($)
Acquired on Value Exercisable/ Exercisable/
Name Exercise (#) Realized ($) Unexercisable Unexercisable
---- ------------ ------------ ------------- -------------
Wilbur Riner 38,100 $39,429 21,900/81,900 $14,875/$62,500
Bryan Carr -0- -0- 132,000/197,000 $31,250/$62,500
Compensation of Directors
Directors who are employees of the Company receive no remuneration for
their service as directors of the Company. Pursuant to the Company's 1995 Stock
Option Plan for Non-Employee Directors, 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 5,000 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. The Company reimburses
directors for travel and lodging expenses, if any, in connection with attendance
at Board meetings. Employment and Consulting Arrangements
<PAGE>
All of the Company's executive officers are employed under contracts
approved by the Board of Directors.
Wilbur L. Riner serves as Chief Executive Officer and President of the
Company pursuant to the terms of a three-year employment agreement that
terminates on October 31, 2001. Mr. Riner receives a minimum annual base salary
of $156,000 per year. The employment agreement provides for a severance payment
in the event of termination due to certain events; including a change-in-control
or the disposition of substantially all of the business and/or assets of the
Company and any event which has the effect of significantly reducing the duties
or authority of Mr. Riner. The severance payment amount would equal the greater
of the present value of his base annual salary for one year or the remainder of
his term. The employment agreement also provides for payment of bonuses and for
such other fringe benefits as are paid to other executive officers of the
Company. Such fringe benefits take the form of medical coverage and an
automobile expense allowance of $450 per month, the aggregate value of which is
estimated at approximately $5,400 per year.
James E. Riner serves as Vice President of Research and Development and
Engineering and Secretary of the Company pursuant to the terms of a three-year
employment agreement that terminates on October 31, 2001. Mr. Riner receives a
minimum annual base salary of $86,790 per year. The employment agreement
provides for a severance payment in the event of termination due to certain
events; including a change-in-control or the disposition of substantially all of
the business and/or assets of the Company and any event which has the effect of
significantly reducing the duties or authority of Mr. Riner. The severance
payment amount would equal the greater of the present value of his base annual
salary for one year or the remainder of his term. The employment agreement also
provides for payment of bonuses and for such other fringe benefits as are paid
to other executive officers of the Company. Such fringe benefits take the form
of medical coverage and an automobile expense allowance of $300 per month, the
aggregate value of which is estimated at approximately $3,600 per year.
Bryan Carr serves as Vice President - Finance, Treasurer, Chief Financial
Officer and Chief Operating Officer of the Company pursuant to the terms of an
employment agreement that terminates on October 31, 2001. Mr. Carr receives a
minimum annual base salary of $120,000 per year. Mr. Carr also receives
commissions of .5% for net sales that exceed $500,000 in any calendar month. The
employment agreement provides for a severance payment in the event of
termination due to certain events; including a change-in-control or the
disposition of substantially all of the business and/or assets of the Company
and any event which has the effect of significantly reducing the duties or
authority of Mr. Carr. The severance payment amount would equal the greater of,
the present value of his base annual salary for one year or the remainder of his
term. The employment agreement also provides for payment of bonuses and for such
other fringe benefits as are paid to other executive officers of the Company.
Such fringe benefits take the form of medical coverage and an automobile expense
allowance of $400 per month, the aggregate value of which is estimated at
approximately $4,800 per year.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information concerning shares of the
Company's Common Stock beneficially owned as of April 30, 1999 by the Company's
directors and named officers, and as of December 31, 1998 by persons who
beneficially own more than 5% of the Common Stock. Except as otherwise
indicated, the named person has sole voting power and sole investment power of
the securities.
<PAGE>
Name and Address of Beneficial Owner Number
Shares
Beneficially
Owned Percent
----- -------
Wilbur Riner (2)(3) 21,900 *
Barbara Riner (2)(4) 514,543 9.8
James Riner (2)(5) 31,948 *
Bryan Carr (2)(6) 166,000 3.1
Officers and Directors as a Group 734,391 14.0
(3 Persons) (7)
(1) As used herein, the term beneficial ownership with respect to a security is
defined by Rule 13d-3 under the Securities Exchange Act of 1934 as consisting of
sole or shared voting power (including the power to vote or direct the vote)
and/or sole or shared investment power (including the power to dispose or direct
the disposition of) with respect to the security through any contract,
arrangement, understanding, relationship or otherwise, including a right to
acquire such power(s) within 60 days of April 30, 1999. Unless otherwise noted,
beneficial ownership consists of sole ownership, voting and investment power
with respect to all shares shown as beneficially owned by them.
(2) The business address for the named person is 1324 Union Hill Road,
Alpharetta, Georgia 30004.
(3) Does not include 490,120 shares held by Barbara Riner, the wife of Wilbur
Riner. Also does not include options exercisable to purchase an aggregate of
24,443 shares held by Barbara Riner. Mr. Riner has disclaimed all beneficial
interest in the shares held by his wife. Includes options currently exercisable
to acquire 21,900 shares of the Company's common stock.
(4) Includes options currently exercisable to acquire 24,443 shares. Barbara
Riner is the wife of Wilbur Riner. Does not include options to acquire 21,900
shares of the Company's common stock held by Wilbur Riner. Ms. Riner has
disclaimed beneficial interest in the shares held by her husband.
(5) Includes options currently exercisable to acquire 31,948 shares of the
Company's common stock.
(6) Includes options currently exercisable to acquire 132,000 shares of the
Company's common stock.
(7) Includes options, which are exercisable to acquire 178,848 shares of the
Company's common stock by officers and directors of the Company.
* Less than 1%.
Certain Relationships and Related Transactions
None
<PAGE>
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: April 30, 1999 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
has 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 April 30, 1999
- ----------------------- and Director
Wilbur L. Riner
/s/ Bryan R. Carr Vice President - Finance, Chief April 30, 1999
- ----------------------- Financial and Principal Accounting
Bryan R. Carr Officer and Director
/s/ James E. Riner Vice President - Engineering, April 30, 1999
- ----------------------- Secretary and Director
James E. Riner
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
QUARTERTLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31,1999
Commission File Number: 1-13760
THE NETWORK CONNECTION, INC.
1324 Union Hill Road
Alpharetta, Georgia 30004
(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 [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
As of May 10, 1999, the registrant had outstanding 5,278,737 shares of its
Common Stock.
Transitional Small Business Disclosure Format (Check One): Yes [ ] No [ X ]
<PAGE>
TABLE OF CONTENTS
PAGE(S)
-------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited)
Balance Sheet March 31,1999 3,4
Statements of Operations Three Months Ended
March 31,1999 and 1998 5
Statements of Cash Flows Three Months Ended
March 31,1999 and 1998 6
Notes to Financial Statements March 31,1999 7
2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-12
PART II. OTHER INFORMATION
5. Other Information 13
6. Exhibits and Reports on Form 8-K 13
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE NETWORK CONNECTION, INC.
BALANCE SHEET (Unaudited)
March 31,
1999
-----------
ASSETS
Current assets:
Cash 106,629
Short-term investments 45,834
Accounts receivable, less 1,478,496
allowance of $2,792,000 Inventories:
Raw materials, less allowance of $205,000 1,162,778
Work in process 1,518,069
Prepaid expenses 209,120
-----------
Total current assets 4,520,926
-----------
Property and equipment:
Land 150,000
Building and improvements 763,055
Furniture, fixtures and equipment 2,468,918
Software 40,734
Vehicles 162,773
-----------
3,585,479
Less accumulated depreciation (1,170,741)
-----------
2,414,738
Other assets, net 83,618
-----------
Total assets $ 7,019,282
===========
<PAGE>
THE NETWORK CONNECTION, INC.
BALANCE SHEET (Unaudited)
March 31,
1999
-----------
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable and $ 2,497,200
accrued expenses
Payable to shareholders 74,429
Notes payable 2,293,082
Deferred revenue 521,332
Current portion of long-term debt and capital
lease obligations 36,974
------------
Total current liabilities 5,423,017
Long-term debt, less current portion 693,002
------------
Total liabilities 6,116,018
Commitments and contingencies (Notes)
Redeemable convertible preferred
stock, $.01 par value, $1,000 stated value:
Authorized, 1,500 shares;
Issued and outstanding, 1,500 1,548,667
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, 5,200
5,199,646 shares
Additional paid-in capital 16,704,015
Accumulated deficit (17,354,618)
------------
Total shareholders' deficit (645,403)
------------
Total liabilities and shareholders' deficit $ 7,019,282
============
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENTS OF OPERATIONS
(Unaudited)
Three Three
Months Months
Ended Ended
March 31, March 31,
1999 1998
----------- -----------
Revenues $ 121,764 $ 111,907
Cost of revenues 93,926 102,206
----------- -----------
Gross profit 27,838 9,701
Selling, general and administrative 842,189 1,028,426
Research and development 94,519 52,380
----------- -----------
Operating (loss) income (908,870)
Interest, net (360,313) (85,160)
----------- -----------
Net loss (1,269,183) (1,156,265)
Preferred stock dividends 26,000 0
----------- -----------
Net loss to common shareholders $(1,295,183) $(1,156,265)
=========== ===========
Basic and Diluted Net loss per share $ (0.25) $ (0.28)
=========== ===========
Shares used in per share calculation 5,192,979 4,152,393
=========== ===========
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
Three Three
months months
Ended Ended
March 31, March 31,
1999 1998
----------- -----------
Operating activities
Net loss $(1,269,183) $(1,156,265)
Adjustments to reconcile net loss to net cash used
In operating activities
Depreciation and amortization 108,524 153,598
Changes in operating assets and liabilities:
Accounts receivable 396,283 518,444
Inventory (81,117) 44,609
Prepaid expenses and other assets 36,070 (101,340)
Accounts payable and accrued expenses (105,339) (1,458,554)
----------- -----------
Net cash used in operating activities (914,762) (1,999,508)
Investing activities:
Purchase of property and equipment (6,612) (16,994)
Sale of short-term investments 0 531,275
----------- -----------
Net cash (used in) provided by investing activities (6,612) 514,281
Financing activities:
Payment of bank borrowings under line of credit (669,000) (526,000)
Net proceeds from issuance of promissory notes 689,000 0
Net proceeds from issuance of convertible debt 0 2,037,722
Payment of long-term debt and
capital lease obligations (6,997) (11,143)
----------- -----------
Net cash provided by financing activities 13,003 1,500,579
----------- -----------
Net change in cash (908,371) 15,352
Cash at beginning of period 1,015,000 1,024,648
----------- -----------
Cash at end of period $ 106,629 $ 1,040,000
=========== ===========
Supplemental Information:
Fully depreciated assets written off $ 317,894 0
Preferred stock dividends $ 26,000 0
Inventory transferred to
property and equipment $ 158,438 0
Common Stock issued in lieu of
payment of accounts payable $ 321,593 0
<PAGE>
THE NETWORK CONNECTION, INC.
CONDENSED NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
Description of Business
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.
Basis of Presentation - Going Concern
The Company's financial statements are prepared using generally accepted
accounting principles applicable to a going concern which contemplate the
realization of assets and liquidation of liabilities in the normal course of
business. The Company has incurred net losses from operations for several years,
has an accumulated deficit at March 31, 1999, and has used substantial cash in
its operations which raises substantial doubt about the Company's ability to
continue as a going concern. Management believes that the completion of the
change of control transaction with Interactive Flight Technologies, Inc. ("IFT")
described below, future debt and equity offerings and successful
commercialization of its products and services will generate the required
capital necessary to continue as a going concern.
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. Trade accounts receivable are generally unsecured; therefore, the
Company is at risk to the extent such amounts become uncollectible.
Inventories
Inventories consist primarily of components purchased for assembly into products
and work in process 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.
<PAGE>
Revenue Recognition
Revenues are recognized when the products are shipped or installed based upon
the terms of the contract, expiration of rights of acceptance or return and
determination that the related receivables are collectible. Revenues pursuant to
contracts that provide for revenue sharing with customers or others is
recognized as cash is received in the amount of the Company's retained portion
of the cash pursuant to the revenue sharing agreement.
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 of up to 180 days based on the nature of the project.
Deferred Revenue
Deferred revenue represents the advance billings of equipment sales as allowed
under purchase and installation contracts.
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.
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.
Potential Change of Control Transaction
On April 29, 1999, the Company, entered into a definitive agreement ("IFT
Agreement") with Interactive Flight Technologies, Inc., a Delaware corporation
("IFT"), regarding the acquisition by the Company of all or substantially all of
the assets and specified liabilities of IFT (the "Net Assets") relating to IFT's
interactive entertainment business (the "Business") in consideration for the
Company's issuance to IFT of that number of shares of its Capital Stock as would
constitute 60% of the Company's fully-diluted equity as defined in the IFT
Agreement (the"Acquisition").The NetAssets will include:$4.25 million in cash
benefit of accounts receivable and warranty contracts owing to IFT; the proceeds
and other recoveries generated by certain litigation brought by IFT; all IFT
interactive entertainment intellectual property, and other tangible assets
related to the Business (including but not limited to customer lists and files,
trade secrets, trademarks, service marks, assignable government permits and
other rights under leases and rights under specified contracts); inventory,
furniture, fixtures, computers and equipment related to the Business; other
infrastructure (including FAA certified repair station) relating to the
Business; IFT's engineering and technical staff; and the benefit of all IFT
research and development efforts. In addition to the usual and customary
representations, covenants and conditions contained in agreements of the type
used to consummate transactions like the Acquisition, the definitive agreement
provides that closing of the Acquisition is subject to the receipt of a
"fairness opinion" with respect to the terms of the Acquisition to the effect
that the Acquisition is fair from a financial point of view, to the Company
shareholders. The Company has agreed to refrain from entering into negotiations
with any other party for the sale of all or substantially all of its assets, or
for the sale of control of the Company, until May 15, 1999. IFT similarly agreed
not to enter into negotiations for the acquisition of control of any other
<PAGE>
company engaged in the interactive entertainment business until May 15, 1999.
The tansaction is expected to be treated as a reverse acquisition of the Company
by IFT under the purchase method of accounting. There is no guarantee that the
Acquisition will be consummated on the terms set forth in the IFT Agreement. IFT
developed interactive entertainment products for use in the airline and travel
industry. It currently maintains only one ongoing contract for its interactive
entertainment products, and is currently engaged in the redirection of its
business activities into new markets. IFT is a Nasdaq: NMS registrant and trades
under the ticker symbol FLYT.
Settlement of Litigation
On January 22, 1999, in consideration for the settlement of outstanding
litigation brought by Sigma Designs, Inc., a vendor to the Company (the "Sigma")
and the mutual release of claims, under the terms of the Settlement Agreement,
the Company agreed to pay $50,000 in cash to Sigma and to issue to Sigma 110,000
Initial Shares of Common Stock. The Company also issued to Sigma a warrant to
acquire 40,000 shares of Common Stock, exercisable at $3.44 per share. The
Company is obligated to file with the Securities and Exchange Commission, a
Registration Statement and to use its best efforts to keep the Registration
Statement effective for a period of five (5) years after the Registration
Statement is declared effective, or until such earlier date when the Offered
Shares may be sold pursuant to Rule 144(k) under the Securities Act. Under the
terms of the Settlement Agreement, the Company may be required to pay an
additional cash amount to the holder of the Shares in the event that on the date
of Registration (the "Repricing Date"), the market price for the Initial Shares
(the "Market Price") is not at least $319,850 (the "Repricing Price").
Subsequent Events
In April 1999, the Company issued to an institutional investor $400,000 face
amount of short-term indebtedness due September 5, 1999 for $320,000, which
indebtedness bears interest at 7% per annum, and which indebtedness the Company
may repay (at its option) with the issuance of shares of its common stock at a
discount to the then market price per share.
Effective May 10, 1999, the Company entered into a Securities Purchase Agreement
with IFT pursuant to which, in consideration for the waiver of any prior
defaults under the terms of the Company's Series B Preferred Stock (then owned
by IFT), the Registration Rights Agreement related to the shares of Common Stock
into which the Series B Preferred Stock is convertible and any other agreements
under which IFT had rights with respect to the Series B Preferred Stock, the
Company issued to IFT 800 shares of the Company's newly created Series C 8%
Convertible Preferred Stock, $1,000 stated value, which shares are convertible
into shares of the Company's common Stock at a 33.3% discount to the market
price of the Company's Common Stock at the time of conversion and subject to
mandatory redemption for cash under certain circumstances. Also effective May
10, 1999, the Company entered into a Fourth Allonge to its January 25, 1999
$750,000 note made in favor of IFT, as amended (the "IFT Note"), whereby in
consideration for IFT's waiver of all prior defaults under the terms of the IFT
Note, the Company agreed to make principal and accrued interest under the IFT
Note convertible into shares of the Company's Series C Preferred Stock. Pursuant
to Amendment No.1 to the Registration Rights Agreement originally entered into
with the prior holder of the Series B Preferred Stock, the shares of Common
Stock to be owned by IFT following conversion of its shares of the Company's
Series C Preferred Stock will be subject to registration rights under the terms
of such registration Rights Agreement, rights under which have been assigned to
IFT. Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
Revenues increased $9,857 to $121,764 for the quarter ended March 31, 1999 from
$111,907 for the quarter ended March 31, 1998. This increase primarily resulted
from revenues on an engineering contract with Alstom.
<PAGE>
Selling, general and administrative expenses decreased by $186,237 (18%) for the
quarter ended March 31, 1999, as compared to the same 1998 period. This decrease
related primarily to a reduction (i) marketing expenses (including advertising,
trade show, public relations, bidding and proposal and demonstration expenses),
and (ii) employment of sales and marketing personnel and related payroll.
Changes in interest expense are attributable to changes in average outstanding
borrowings and default interest and penalties on promissory notes during the
1999 period and changes in average outstanding borrowings during the 1998
period.
The net loss of $1,269,183 was greater than that of for the comparable 1998
quarter by $112,918 due primarily to reduced selling, general and administrative
expenses offset by higher interest expense.
Liquidity and Capital Resources; Certain Transactions
The Company entered into a definitive agreement with IFT in a change of control
transaction that is expected to close by May 15, 1999. The Company believes the
IFT transaction will generate sufficient cash to fund currently anticipated
future cash requirements during the next twelve months. If the proposed change
of control should not be completed, the Company will require additional cash
from alternative external sources in order to fund currently anticipated cash
requirements, including performance under existing contracts, repayment of
indebtedness and ongoing payroll expense. It is uncertain as to the Company's
ability to obtain additional capital.
The Company's primary source of funding was principally due to the net proceeds
from the issuance of $689,000 of debt. Cash used in operating activities was
$914,762 and the purchase of property and equipment was $6,612. The negative
change in cash from operating activities primarily resulted from a net loss of
$1.3 million and a decrease in accounts payable and accrued expenses of $105,339
and an increase in inventory of $81,117, offset by a decrease in accounts
receivable of $396,283. The reduction in cash from operating activities was
offset by depreciation and amortization of $108,524.
Capital expenditures for the purchase of property and equipment for the fiscal
period ended March 31, 1999 were $6,612, primarily for the purchase of
additional equipment and software in order to expand product demonstration and
development capabilities for CruiseView and TrainView. During 1999, capital
expenditures, if any, are anticipated to be funded through existing working
capital or other financing.
On January 25, 1999, the Company entered into a loan transaction with IFT,
pursuant to (i) a promissory note in the principal amount of $750,000, bearing a
rate of interest of 9.5% per annum, for a term ending on the earlier of May 15,
1999, or the closing date of a change of control transaction between the Company
and IFT and (ii) a security agreement granting IFT a security interest in all
accounts receivable of the Company.
On January 22, 1999, in consideration for the settlement of outstanding
litigation brought by Sigma Designs, Inc., a vendor to the Company (the "Sigma")
and the mutual release of claims, under the terms of the Settlement Agreement,
the Company agreed to pay $50,000 in cash to Sigma and to issue to Sigma 110,000
Initial Shares of Common Stock. The Company also issued to Sigma a warrant to
acquire 40,000 shares of Common Stock, exercisable at $3.44 per share. The
Company is obligated to file with the Securities and Exchange Commission, a
Registration Statement and to use its best efforts to keep the Registration
Statement effective for a period of five (5) years after the Registration
Statement is declared effective, or until such earlier date when the Offered
Shares may be sold pursuant to Rule 144(k) under the Securities Act. Under the
terms of the Settlement Agreement, the Company may be required to pay an
additional cash amount to the holder of the Shares in the event that on the date
of Registration (the "Repricing Date"), the market price for the Initial Shares
(the "Market Price") is not at least $319,850 (the "Repricing Price").
In April 1999, the Company issued to an institutional investor $400,000 face
amount of short-term indebtedness due September 5, 1999 for $320,000, which
indebtedness bears interest at 7% per annum, and which indebtedness the Company
may repay (at its option) with the issuance of shares of its common stock at a
discount to the then market price per share.
<PAGE>
Effective May 10, 1999, the Company entered into a Securities Purchase Agreement
with IFT pursuant to which, in consideration for the waiver of any prior
defaults under the terms of the Company's Series B Preferred Stock (then owned
by IFT), the Registration Rights Agreement related to the shares of Common Stock
into which the Series B Preferred Stock is convertible and any other agreements
under which IFT had rights with respect to the Series B Preferred Stock, the
Company issued to IFT 800 shares of the Company's newly created Series C 8%
Convertible Preferred Stock, $1,000 stated value, which shares are convertible
into shares of the Company's common Stock at a 33.3% discount to the market
price of the Company's Common Stock at the time of conversion and subject to
mandatory redemption for cash under certain circumstances. Also effective May
10, 1999, the Company entered into a Fourth Allonge to its January 25, 1999
$750,000 note made in favor of IFT, as amended (the "IFT Note"), whereby in
consideration for IFT's waiver of all prior defaults under the terms of the IFT
Note, the Company agreed to make principal and accrued interest under the IFT
Note convertible into shares of the Company's Series C Preferred Stock. Pursuant
to Amendment No.1 to the Registration Rights Agreement originally entered into
with the prior holder of the Series B Preferred Stock, the shares of Common
Stock to be owned by IFT following conversion of its shares of the Company's
Series C Preferred Stock will be subject to registration rights under the terms
of such registration Rights Agreement, rights under which have been assigned to
IFT.
Outlook: Issues and Risks
Potential Change of Control Transaction
On April 29, 1999, the Company, entered into a definitive agreement ("IFT
Agreement") with Interactive Flight Technologies, Inc., a Delaware corporation
("IFT"), regarding the acquisition by the Company of all or substantially all of
the assets and specified liabilities of IFT (the "Net Assets") relating to IFT's
interactive entertainment business (the "Business") in consideration for the
Company's issuance to IFT of that number of shares of its Capital Stock as would
constitute 60% of the Company's fully-diluted equity as defined in the IFT
Agreement (the"Acquisition").The NetAssets will include:$4.25 million in cash;
the benefit of accounts receivable and warranty contracts owing to IFT; the
proceeds and other recoveries generated by certain litigation brought by IFT;
all IFT interactive entertainment intellectual property, and other tangible
assets related to the Business (including but not limited to customer lists and
files, trade secrets, trademarks, service marks, assignable government permits
and other rights under leases and rights under specified contracts); inventory,
furniture, fixtures, computers and equipment related to the Business; other
infrastructure (including FAA certified repair station) relating to the
Business; IFT's engineering and technical staff; and the benefit of all IFT
research and development efforts. In addition to the usual and customary
representations, covenants and conditions contained in agreements of the type
used to consummate transactions like the Acquisition, the definitive agreement
provides that closing of the Acquisition is subject to the receipt of a
"fairness opinion" with respect to the terms of the Acquisition to the effect
that the Acquisition is fair from a financial point of view, to the Company
shareholders. The Company has agreed to refrain from entering into negotiations
with any other party for the sale of all or substantially all of its assets, or
for the sale of control of the Company, until May 15, 1999. IFT similarly agreed
not to enter into negotiations for the acquisition of control of any other
company engaged in the interactive entertainment business until May 15, 1999.
The tansaction is expected to be treated as a reverse acquisition of the Company
by IFT under the purchase method of accounting. There is no guarantee that the
Acquisition will be consummated on the terms set forth in the IFT Agreement. IFT
developed interactive entertainment products for use in the airline and travel
industry. It currently maintains only one ongoing contract for its interactive
entertainment products, and is currently engaged in the redirection of its
business activities into new markets. IFT is a Nasdaq: NMS registrant and trades
under the ticker symbol FLYT.
<PAGE>
Potential Nasdaq and Boston Stock Exchange Delisting
The Company received notification from both NASDAQ and the Boston Stock Exchange
that it no longer meets the requirements for continued listing based upon net
assets and shareholder equity listing requirements. The Company must submit to
NASDAQ and the Boston Stock Exchange its proposal for achieving compliance
within a specified date. The Company believes that the transaction with IFT,
which is expected to close by May 15, 1999, should allow TNCi to meet the
continued listing requirements.
The Company is currently using its working capital to finance its current
expenses, including installations, equipment purchases, product development,
inventory and other expenses associated with the delivery and installation of
systems for Carnival. Cash liquidity from external sources will be required to
satisfy its indebtedness which is currently in default and to finance existing
and anticipated growth in the Company's accounts receivable and inventories
resulting from performance under outstanding orders, including ongoing payroll
expenses. The Company believes that its working capital requirements will
increase throughout 1999 and beyond, particularly as its focus continues on
large, long-term projects. The Company believes the IFT transaction will
generate sufficient cash to fund currently anticipated future cash requirements
during the next twelve months. Even if the IFT transaction is completed,
maintaining an adequate level of working capital through the end of 1999, and
thereafter, will depend in part on collection of accounts receivable on a timely
basis, successful litigation with non-paying customers already delinquent,
satisfactory settlements with vendor-creditors (including those already suing
the Company), 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. Following completion of the IFT transaction, the Company may
still 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 sites or major
long-term projects. There can be no assurance that the IFT transaction will be
completed and that if not that any financing will be available on terms
acceptable to the Company, if at all. If future financing is not available when
needed, the Company will be forced to curtail or discontinue operations. In such
event, the creditors and stockholders may lose, or experience a substantial
reduction in, the value of their indebtedness or investment in the Company.
Forward-Looking Statements
Statements in this Quarterly Report on Form 10QSB that are not descriptions of
historical facts may be forward-looking statements that are subject to risks and
uncertainties, including economic, competitive and technological factors
affecting the Company's operations, markets, products, services and prices, as
well as other specific factors discussed in the Company's filings with the
Securities and Exchange Commission. These and other factors may cause actual
results to differ materially from those anticipated.
<PAGE>
PART II. OTHER INFORMATION
Item 5. Other Information
On April 25, 1999 and April 26, 1999 respectively, Marc Doyle and Arthur
Bauer resigned as members of the Company's Board of Directors. These directors
will be replaced with IFT appointed directors, after completion of the change of
control transaction.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1.1 the Articles of Amendment to the Articles of Incorporation re Series B
Preferred Stock
3.1.2 the Articles of Amendment to the Articles of Incorporation re Series C
Preferred Stock
10.1 Asset Purchase and Sale Agreement with Interactive Flight Technologies
dated April 29, 1999
10.2 Securities Purchase Agreement, dated as of May 10, 1999, between the
Company and IFT
10.3 Secured Promissory Note, dated January 25, 1999, made in favor of IFT
10.4 First Allonge to Secured Promissory Note, dated May 10, 1999, made in
favor of IFT
10.5 Second Allonge to Secured Promissory Note, dated May 10, 1999, made in
favor of IFT
10.6 Third Allonge to Secured Promissory Note, dated May 10, 1999, made in
favor of IFT
10.7 Fourth Allonge to Secured Promissory Note, dated May 10, 1999, made in
favor of IFT
10.8 Amendment No. 1 to Registration Rights Agreement, dated May 10, 1999,
between the Company and IFT.
27. Financial Data Schedule
(b) Reports on Form 8-K
None
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
THE NETWORK CONNECTION, INC.
(Registrant)
Date: May 13, 1999 By: /s/ Wilbur Riner
------------------------------------
Wilbur Riner
Chairman and Chief Executive Officer
By: /s/ Bryan R. Carr
-------------------------------------
Bryan R. Carr
Chief Financial and Principal
Accounting Officer
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): July 30, 1999
THE NETWORK CONNECTION, INC..
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Georgia
--------------------------------------------
(State or other jurisdiction of incorporation)
1-13760 58-1712432
- ------------------------ ------------------------------------
(Commission File Number) (IRS Employer Identification Number)
222 North 44th Street, Phoenix, Arizona 85034
- --------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (602) 200-8900
4041 North Central Avenue, Suite B-200, Phoenix, Arizona 85012
--------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE>
ITEM 4. CHANGES IN REGISTRANTS CERTIFYING ACCOUNTANTS
a. The Company has determined to terminate its engagement of
PricewaterhouseCoopers, LLP, as a result of the reverse acquisition of The
Network Connection, Inc., effective as of July 30, 1999 as independent
accountants. However, PricewaterhouseCoopers, LLP will be available to answer
questions at the Special Meeting of Shareholders on September 17, 1999.
None of the reports of PricewaterhouseCoopers, LLP on the financial
statements of the Company contained an adverse opinion or disclaimer of opinion,
or was modified as to uncertainty, audit scope or accounting principles, except
that such financial statements for the period ended December 31, 1998 contained
a modification as to the Company's ability to continue as a going concern.
There were no disagreements with PricewaterhouseCoopers, LLP, whether
or not resolved, on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which if not resolved to
the satisfaction of PricewaterhouseCoopers, LLP, would have caused it to make
reference to the subject matter of the disagreement in connection with its
report.
PricewaterhouseCoopers, LLP did not note any reportable conditions for
the period ended December 31, 1998. PricewaterhouseCoopers, LLP has not been
engaged nor has performed any audit procedures subsequent to their audit of the
December 31, 1998 financial statements and up to the date of their termination.
The Board of Directors has approved the decision to change accountants.
b. The Company has engaged the firm of KPMG LLP effective July 30, 1999
to audit the Company's financial statements commencing with the financial
statements to be included in the transition report to be filed on Form 10-KSB
for the period ended June 30, 1999.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) EXHIBITS:
16. Letters of PricewaterhouseCoopers, LLP
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereto duly authorized.
THE NETWORK CONNECTION, INC.
Registrant
By: /s/ Morris C. Aaron
---------------------------------------------
Morris C. Aaron, Executive Vice President and
Chief Financial Officer
Date: August 3, 1999
<PAGE>
[PricewaterhouseCoopers LLP Letterhead]
July 30, 1999
Mr. Morris C. Aaron
Chief Financial Officer
The Network Connection, Inc.
222 North 44th Street
Phoenix, Arizona 85034
Dear Mr. Aaron:
This is to confirm that the client-auditor relationship between The Network
Connection, Inc. (Commission File Number 1-13760) and PricewaterhouseCoopers LLP
has ceased.
Very truly yours,
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
cc: Chief Accountant
SECPS Letter File, Mail Stop 11-3
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
<PAGE>
[PricewaterhouseCoopers LLP Letterhead]
July 30, 1999
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Commissioners:
We have read the statements made by The Network Connection, Inc. (copy
attached), which we understand will be filed with the Commission, pursuant to
Item 4 of Form 8-K, as part of the Company's Form 8-K report dated July 30,
1999. We agree with the statements concerning our Firm in such Form 8-K.
Very truly yours,
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
------------------------
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended October 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ____________.
COMMISSION FILE NO. 0-25668
-------
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
----------------------------------------------
(Name of Small Business Issuer in Its Charter)
DELAWARE 11-3197148
------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
4041 N. CENTRAL AVENUE
PHOENIX, ARIZONA 85012
----------------------------------------
(Address of Principal Executive Offices)
(602) 200-8900
------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Title of each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Class A Common Stock, Nasdaq National Market
$0.01 par value per share
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-K contained in this form, and no disclosure will be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
The Issuer's revenues for the fiscal year ended October 31, 1998 were
$19,142,961.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on January 8, 1999 was approximately $15,967,494, based on the
closing sales price of the Class A Common Stock on such date as reported by the
Nasdaq National Market.
The number of shares outstanding of each of the Issuer's classes of common
equity, as of January 8, 1999 was 5,317,900 shares of Class A Common Stock,
$0.01 par value, and 1,185,186 shares of Class B Common Stock, $0.01 par value.
------------------------
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Definitive Proxy Statement relating to the Registrant's
1999 Annual Meeting of Stockholders, to be filed by the Registrant with the
Securities and Exchange Commission on or before February 28, 1999, is hereby
incorporated by reference into Part III of this Annual Report on Form 10-KSB.
Transitional Small Business Disclosure Format:
Yes [ ] No [X]
================================================================================
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-KSB
TABLE OF CONTENTS
PAGE
----
PART I.................................................................... 1
ITEM 1 -- DESCRIPTION OF BUSINESS....................................... 1
ITEM 2 -- DESCRIPTION OF PROPERTY....................................... 7
ITEM 3 -- LEGAL PROCEEDINGS............................................. 7
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 8
PART II................................................................... 9
ITEM 5 -- MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...... 9
ITEM 6 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................... 9
ITEM 7 -- FINANCIAL STATEMENTS.......................................... 15
ITEM 8 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................... 15
PART III.................................................................. 16
ITEMS 9 -12 -- DOCUMENTS INCORPORATED BY REFERENCE..................... 16
ITEM 13 -- EXHIBITS AND REPORTS ON FORM 8-K............................. 16
SIGNATURES................................................................ 18
FINANCIAL STATEMENTS...................................................... F-1
<PAGE>
PART I
ITEM I -- DESCRIPTION OF BUSINESS
THE COMPANY
Interactive Flight Technologies, Inc. and subsidiary (the "Company") has
been engaged in the development, assembly, installation and operation of a
computer-based in-flight entertainment network (the "Entertainment Network" or
the "IFEN-2").
On September 15, 1998, the former management and Board of Directors
resigned and elected the current directors as the Board of the Company. The
current Board was reelected by the stockholders of the Company at the Annual
Meeting held on October 30, 1998. The new management of the Company has been
evaluating the in-flight entertainment business and the opportunities presented
by technology related to such business and is developing a strategic plan to
take advantage of the opportunities associated with the in-flight entertainment
business and the technologies related thereto for alternative markets. New
management is pursuing a sale to or a strategic alliance with other entities in
the in-flight entertainment business in order to maximize the potential of the
Entertainment Network. In addition, new management is currently evaluating
technology related businesses that may build upon the Company's core
competencies, as well as other technology related business opportunities. New
management is evaluating how to re-deploy the Company's capital to exploit such
potential alliance and business opportunities. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Outlook: Issues and
Risks."
On July 24, 1998, the Company acquired the assets and business of Johnny
Valet, Inc., a retail dry cleaning plant in San Diego, California. The Company
paid $688,736 in cash and signed a non-interest bearing note for $125,000. The
acquisition represented the Company's initial foray into the dry cleaning
business. In October 1998, the Company's new Board of Directors decided to not
pursue the strategy of consolidating the dry cleaning industry. The Company is
presently attempting to sell this business and will no longer be in the dry
cleaning business.
The Company was incorporated in Delaware in August 1994 and is the
successor by merger to In-Flight Entertainment Services Corp., a New York
corporation incorporated in February 1994. The Company completed an initial
public offering of its securities in March 1995.
Unless the context requires or as otherwise indicated, all references to
the "Company" include the predecessor company. The Company's principal executive
offices are located at 4041 N. Central Avenue, Suite B-200, Phoenix, Arizona
85012, and its telephone number is (602) 200-8900.
SWISSAIR
The Entertainment Network provides aircraft passengers the opportunity to
view movies, to play computer games and, in certain cases where permitted by
applicable law, to gamble through an in-seat video touch screen. The IFEN-2
system can also support interactive advertising and shopping once arrangements
are made with advertisers and vendors and once programming for particular
products is created. See "The Entertainment Network."
The Company's only agreement for the Entertainment Network is with Swissair
VKB ("Swissair") which required the Company to install and maintain the
Entertainment Network in the first, business and economy class sections of three
aircraft at no cost to Swissair and in the first and business class of another
sixteen aircraft at an average price of $1.7 million per aircraft. As of October
31, 1998, the Company had completed all installations under the initial Swissair
program. The Company was responsible for maintenance costs through September
1998 for all nineteen aircraft. The Swissair agreement also provides a one-year
warranty (which is extended to three years under the letter of intent described
below) on all of the Entertainment Networks and requires specific software and
hardware upgrades to the Entertainment Networks. Development of these upgrades
is not complete. If the upgrades are not completed by specified deadlines, the
Company may face significant penalties. The Company must also meet operational
reliability criteria for the Entertainment Network through the year 2003 or be
subject to penalties.
<PAGE>
The Company has a letter of intent from Swissair for $4,700,000, which is
for first and business class installations on four Swissair MD-11 aircraft that
were scheduled to be added to the Swissair fleet beginning in November 1998. The
Company has also received a letter of intent from Swissair for $3,975,000 to
extend the warranty on all installed systems for a second and third year. The
Company has had no success in pursuing other major airlines to fill its pipeline
following the completion of the installation phase of the initial Swissair
program in March 1998. Because of the lack of prospects for success in obtaining
additional orders, and in order to reduce its expenses further, prior management
terminated almost all sales and marketing efforts as of May 29, 1998. Although
the Company may respond to any requests for proposals it receives from airlines,
the decision not to continue to invest resources in sales and marketing reflects
the fact that the Company has no significant prospects for additional revenue
from in-flight entertainment other than those related to the two letters of
intent from Swissair. Moreover, the Company's prior decision not to expend money
on developing the next generation of the Entertainment Network means that any
technological leads it had in this area can be expected to dissipate quickly. As
a consequence, the Company may well not be able to compete in the in-flight
entertainment business even if market conditions were to improve.
On October 29, 1998, the Company was notified by Swissair of its decision
to deactivate the Entertainment Networks on all Swissair aircraft. Swissair told
the Company that this precautionary action was taken in response to technical
investigations conducted by the Canadian Transportation Safety Board following
the crash of Swissair Flight No. 111 on September 2, 1998. However, based on
investigation findings, the Company has been informed by representatives of the
Canadian Transportation Safety Board and Swissair that its Entertainment Network
has not been related, in any way, to the cause of the crash of Swissair Flight
No. 111. The Federal Aviation Administration is conducting a review of the
system's installation certification and to date, has found no safety hazards or
violations of Federal Aviation Regulations. The Company and its system
integrator/installation contractor are working closely with Swissair to take the
necessary steps that will allow Swissair to reactivate all systems as quickly as
possible. On December 9, 1998, the Company was notified by Swissair of their
intent to reactivate the system in October 1999. The Company has submitted a
plan to Swissair for earlier reactivation of the Entertainment Network, which is
currently under discussion.
On December 9, 1998, the Company received notice from Swissair stating
their intent to cancel the order for the four additional installations. As of
January 5, 1999, Swissair has paid $645,000 of the $4.7 million order for the
four installations and continues to engage in active discussions with the
Company regarding outstanding financial matters and a reactivation process.
BUSINESS BACKGROUND
The potential market for in-flight entertainment networks developed as the
number and length of long-haul flights has increased, as passengers on these
flights seek additional and more sophisticated entertainment options and as
airlines compete for passengers. Several domestic and international airlines
have installed or are in the process of installing video displays that allow
passengers to view movies of their choice, with several movies to choose from.
However, since movies are traditionally provided free of charge to first-class
and business-class passengers, and the potential revenue source available from
interactive services, including secure casino gaming, pay-per-view movies,
advertising, and shopping channels are still unproven, airlines must currently
justify purchases on increasing passenger satisfaction. The airline industry as
a whole has been experiencing record high passenger load factors during recent
times. As a result, airlines must consider whether to make capital investments
for additional aircraft or to make capital investments in passenger amenity
features such as in-flight entertainment. It has been widely reported that the
airline industry is making significant investments in additional aircraft. This
may possibly have a negative effect on the in-flight entertainment industry as
airlines determine capital expenditure priorities. Moreover, it has been
reported that certain in-flight entertainment systems installed in aircraft by
other entities have not proven reliable. In addition, the experience of Swissair
and the Company to date indicates that the revenue generating ability of
in-flight entertainment equipment, especially from secure casino gaming, is not
sufficient to provide a compelling case for the purchase of in-flight
entertainment equipment.
2
<PAGE>
The Company believes that its Entertainment Network combines improved hardware,
software and communications technologies to meet the requirements of passengers
for additional in-flight entertainment options; however, it is unclear whether
airlines will purchase systems that satisfy passenger desires while passenger
load factors remain at historically high levels.
THE ENTERTAINMENT NETWORK
General
The Company believes that the Entertainment Network is the most
technologically advanced interactive in-flight entertainment system currently
available on a commercial airline. The Entertainment Network is a distributed
network that combines computer, video and audio technologies in an interactive
system capable of providing a variety of entertainment options for airline
passengers on an in-seat terminal. These options currently include secure casino
gaming, video-on-demand and video-in-progress movies, audio-on-demand, arcade
games, the ability for passengers to pay for gaming and other features directly
through their credit cards, and the ability (subject to arrangements with
advertisers and vendors) to support in-flight interactive advertising. However,
the Company has decided to reduce its expenditures on the development of its
system. There can be no assurance that competitors will not be able to develop
newer and more technologically advanced in-flight entertainment systems in the
future. Indeed, this can be expected if expenditures by the Company are not
increased.
Technological Aspects of the Entertainment Network
General. The Entertainment Network was designed to provide a network
system platform that permits the distribution of flexible multimedia (audio and
visual) content to individual users on a highly interactive basis. The
Entertainment Network also provides valuable statistical data concerning
end-user access to different entertainment and information options. This type of
network system has applications in alternative markets, which may create new
business opportunities for the Company, although no assurances can be made. The
software architecture that has been developed is a Web-browser architecture,
which readily supports many Internet applications.
Distributed Network Architecture. The capabilities and reliability of any
interactive system are determined, to a large extent, by the architecture of the
communication network. The Entertainment Network is based on a distributed
network designed to provide centralized control while reducing the possibility
that a single point of failure will disrupt the operation of more than a small
portion of the network. The Entertainment Network is centrally controlled on an
aircraft by the cabin file server. The cabin file server is the central computer
designed to coordinate and control all functions of the Entertainment Network.
The cabin file server provides security for transactions on the Entertainment
Network by providing multiple layers of software and hardware security systems.
These security systems are designed to record all transactions for later
downloading to the Central Ground System, as well as control the generation of
all random factors that determine the outcome of any casino games being played
by the passengers.
The cabin file server controls a number of cluster controllers, and each
cluster controller controls a group of approximately 32 in-seat video terminals.
Consequently, the failure of one in-seat video terminal should not affect the
operation of other terminals on the aircraft. Similarly, the failure of an
individual cluster controller is expected to affect only the in-seat video
terminals controlled by that cluster controller, and not the operation of the
other in-seat video terminals on the aircraft. Further, even if the cabin file
server fails, each cluster controller is designed to continue to operate
autonomously without the cabin file server, except for certain gaming management
functions which are performed by the cabin file server.
The distributed network architecture is also designed to permit the
Entertainment Network to deliver the short transaction response time required
for interactive applications, while using lightweight and inexpensive hardware.
Since interactive applications generally require several computerized
3
<PAGE>
communications transactions per event, an ordinary cabin file server can
experience software overload, thereby creating a system failure at some or all
of the in-seat video terminals. By designing the Entertainment Network to shift
a portion of the workload to each cluster controller, the Company believes the
distributed network architecture can reduce those performance problems.
Central Ground System. Located at the Company's executive offices in
Phoenix, Arizona, the Central Ground System is a computer system developed by
the Company to serve as the control focal point for all of the Company's
installed Entertainment Networks. The Central Ground System is provided with
accounting and statistical data accumulated by the Entertainment Networks during
flight. The Central Ground System can then process this data in order to, among
other things, post the passenger transactions to their respective credit card
processing centers and provide airline management with a variety of accounting
and statistical reports. In addition, the Central Ground System can upload new
information to the Entertainment Networks as needed, such as new games, shopping
catalogs or other programming software. If real time downloading is not
implemented, the data interchange between the aircraft and the Central Ground
System will occur on the ground via a direct local telephone or radio link, or
by using a removable magnetic cartridge. The Central Ground System is intended
to store the complete history of all passenger transactions and allow airline
management to access comprehensive data logs for each individual in-seat video
terminal, subject to applicable privacy rules governing credit card processing.
The Company is currently assessing other uses for the technology involved
in the Entertainment Network besides the in-flight entertainment business.
PRODUCT DEVELOPMENT
During fiscal 1998, the Company continued to expand the functionality of
the Entertainment Network to include features which were contractually committed
to Swissair. Research and development expenses during fiscal 1998 and fiscal
1997 were approximately $1.1 Million and $7.8 Million, respectively. Such
amounts have not been borne by customers. The Company anticipates that research
and development expenses will continue to substantially decrease in the future
as the Company does not plan on developing any new generations of the
Entertainment Network for airlines. Research and development efforts of the
Company will include primarily those efforts that are required by contractual
obligations. Due to the decision to not develop the next generation of the
Entertainment Network, the Company has reduced the number of personnel involved
in product development. Due to this decision and the significant shortage of
qualified product development and program management personnel, many employees
have departed the Company. While the Company has attempted to institute an
employee retention program, there can be no assurance that these efforts will be
successful. The Company will have to retain contract employees to complete some
or all of its obligations to Swissair. This would result in a significant
increase in the expected development costs as well as negatively impact the
expected delivery schedule.
The Company has arrangements with certain movie distributors pursuant to
which the Company chooses from lists of available movies from each distributor
and compiles the lists for presentation to the airlines. However, with the
exception of certain casino gaming software licensed from FortuNet which is not
being utilized by the Company and a limited number of casino and arcade games
developed to date by the Company, the Company does not currently own or have
rights to use or include any entertainment or other programming software for use
on the Entertainment Network. The Company intends to evaluate additional
programming software for availability on the Entertainment Network. Although the
Company has had discussions with certain entertainment software developers, it
has not yet entered into any long-term agreements or arrangements to obtain
rights to any such programming software other than "Reversi."
4
<PAGE>
COMPETITION
The Company believes that the market for technologically advanced in-flight
entertainment systems is emerging quite slowly. The Company believes that
airlines are currently more interested in acquiring less technologically
advanced in-flight entertainment systems at a lower cost than the Entertainment
Network. The competition to provide technologically advanced in-flight
entertainment systems to the airlines is intense. The Company is aware of
several other companies that provide systems that compete with the Entertainment
Network, some of which have been installed on aircraft. These competitors have
substantially greater financial, customer support, marketing, engineering and
other resources than the Company and, accordingly, have a significant
competitive advantage over the Company. The Company's principal competitors
include Sony, Matsushita, Rockwell-Collins (Hughes-Avicom), BE Aerospace, and
The Network Connection.
The Company believes that it competes with other companies primarily on the
basis of its advanced hardware and software technology, the variety of
entertainment options available for the Entertainment Network, and the fact that
it has delivered technologically advanced in-flight entertainment systems to
Swissair. There can be no assurance, however, that the Company will be able to
compete successfully for additional sales in the in-flight entertainment market.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
Since the commencement of operations, the Company has developed a catalogue
of proprietary technology and know-how relating to the Entertainment Network and
its related systems. To date, the Company has not filed any patent applications
with respect to such proprietary technology and know-how, but may elect in the
future to do so.
CUSTOMER MAINTENANCE AND SUPPORT
The Company's airline contracts call for the Company to provide airline
customers with periodic upgrades of the software incorporated in the
Entertainment Network. The Company trains airline personnel on the use of the
Entertainment Network after an initial airline installation and for a short
period thereafter. The Company is also generally obligated to provide support
for the installed systems over the life of the contracts and, in the case of
Swissair, provide maintenance for a specific time period. The Company's strategy
is to contract with one or more third parties to provide international customer
support and maintenance service for the Entertainment Network. In addition to
service and repair functions, it is expected that such entity would be
responsible for removing and replacing, on a regular basis, any software
products which are not transmitted via the Central Ground System and for
removing and transmitting to the Central Ground System the removable magnetic
cartridge containing transaction data and billing information generated by the
aircraft's Entertainment Network. Because the Company is not expected to have
the personnel or financial resources to perform this function directly, the
failure to obtain such an arrangement could have a material adverse affect on
the Company's ability to perform under its contracts or to obtain purchase
commitments from additional airlines.
MANUFACTURING, ASSEMBLY AND INSTALLATION
The Company obtains most of the components of the Entertainment Network
from commercially available sources. To date, the Company has engaged in only
limited manufacturing operations and, when required components have not been
commercially available, has subcontracted out substantially all component
manufacturing. The Company has leased manufacturing and warehouse facilities in
Phoenix that it uses to assemble the Entertainment Networks. The Company
anticipates that this facility will be sufficient to satisfy the Company's needs
through 1999. See "Item 2 -- Description of Property."
The Company has contracted with Hollingsead International to perform system
installation on all Swissair aircraft. The Company anticipates that future
installations, if any, will be performed by an
5
<PAGE>
experienced third-party subcontractor such as Hollingsead International. See
"Government Regulation."
GOVERNMENT REGULATION
The installation and use of the Entertainment Network on any particular
aircraft requires prior certification and approvals from the Federal Aviation
Administration ("FAA") and certification and approvals from aeronautical
agencies of foreign governments. Because the installation of the Entertainment
Network 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 the Entertainment Network 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 STCs for Swissair B747 and MD-11
aircraft, Debonair RJ-146 aircraft and Alitalia MD-11 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. 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 the
Entertainment Network 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,
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 the
Entertainment Network; review the results of the flight test; perform
inspections to ensure that both the components of the Entertainment Network and
their installation and operation conform to the certification requirements; and
issue the STC. In addition, the Company or its subcontractor must obtain from
the FAA a Parts Manufacturer Approval ("PMA") with respect to the components of
the Entertainment Network 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 STCs and PMAs 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. See "Item 6 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Forward Looking Information."
The FAA, in the issuance of the STC, will consider such factors as whether
the Entertainment Network will interfere with the operational and navigational
equipment installed on the aircraft; whether the electrical components of the
Entertainment Network are compatible with those of the aircraft; whether the
components of the Entertainment Network installed in the passenger seats will
interfere with emergency egress from the aircraft; whether the components of the
Entertainment Network will, if subjected to heat or fire, emit toxic fumes; and
similar safety and flight-related concerns.
Federal law grants to the FAA the authority to reexamine at any time the
basis upon which certification and approval of the Entertainment Network may be
granted and, if appropriate, to amend or revoke such certifications and
approvals, subject to certain appeal rights.
In addition to approvals required to be obtained from the FAA, the Company
may be required to obtain certification and approval of the Entertainment
Network from the aeronautical authorities of foreign countries. In many cases,
through technical working agreements between the FAA and the foreign
aeronautical authorities, such authorities accept the FAA issuance of the STC as
approval, although certain country authorities reserve the right to
independently review the data and the
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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.
United States law, with certain exceptions, currently prohibits the knowing
transportation of gaming devices on aircraft operated in interstate air
transportation. In addition, states may prohibit the transportation and use of
gaming devices on flights operating between two points in a single state.
Federal law also prohibits the installation, transportation or operation of
gaming devices by any U.S. or foreign air carrier or for such carriers to permit
their use on aircraft operated to or from the United States in foreign air
transportation. However, Federal law does not restrict flights by foreign air
carriers between non-U.S. points, even if the aircraft routing includes a
segment to or from the U.S. Federal law does not restrict the transportation of
gaming devices installed on aircraft operating into or out of the U.S., provided
that such devices are disabled. The United States Secretary of Transportation
was directed by law to conduct a study and to report to Congress on the safety,
commercial and operational issues posed by gaming devices aboard commercial
aircraft. However, in a study released in 1996, the Secretary did not recommend
that Congress take any action to revise current law and recommended that further
studies be conducted to determine, among other things, the competitive need for
gaming devices on such flights. Moreover, the laws regarding the transmission of
gaming data into, out of, or within United States territory, even where such
data was lawfully obtained in another jurisdiction, are unclear. As a result,
there can be no assurance that the transmission of such data will not be
restricted or prohibited. Because gaming can generally be expected to generate
greater revenues and profitability than other entertainment options expected to
be available on the Entertainment Network, the inability to offer gaming on
flights may have a material adverse impact on the Company's business and on the
market acceptance by airlines of the Entertainment Network. The Company will
also be subject to the laws of foreign jurisdictions which may similarly
restrict or prohibit the gaming or other activities offered on the Entertainment
Network.
EMPLOYEES
As of January 8, 1999, the Company employed 23 people on a full-time basis
and 3 people on a temporary basis. None of the employees is covered by a
collective bargaining agreement. The Company considers its relations with its
employees to be good.
ITEM 2 -- DESCRIPTION OF PROPERTY
The Company's principal executive offices and assembly and warehouse
facilities, located in Phoenix, Arizona, contain approximately 45,000 square
feet of space and are occupied pursuant to three separate leases providing for
monthly rent of approximately $51,700. The leases expire in July 1999. The
Company subleases approximately 4,200 square feet of space to an unrelated party
at a monthly rent of $5,950. As a result of reductions in its work force, the
Company is attempting to sublease additional space under one of its leases.
However, the Company has been mostly unsuccessful in this effort and there can
be no assurance that the Company will be able to sublet its facilities on terms
that are favorable to the Company.
The Company also leases facilities for its dry cleaning operations in San
Diego, California pursuant to a lease that expires in August 2000. The lease
provides for monthly rent of approximately $4,900.
The Company has no policy regarding investments in real estate, real estate
mortgages or securities of persons primarily engaged in real estate activities.
However, the Company currently holds no such investments.
ITEM 3 -- LEGAL PROCEEDINGS
The Company is not currently a party to any pending legal proceedings.
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ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 30, 1998, the Company held its 1998 Annual Meeting of
Stockholders. At the Annual Meeting, the following matters were submitted to a
vote of stockholders:
1. The following five individuals, constituting the full Board of Directors
of the Company, were nominated and elected to serve as the directors of the
Company:
Irwin L. Gross FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
Charles T. Condy FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
Stephen Schachman FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
M. Moshe Porat FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
James W. Fox FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
2. The holders of 6,575,259 shares of Common Stock voted in favor of, the
holders of 6,505 shares of Common Stock voted against, and the holders of 64,139
shares of Common Stock abstained with respect to the proposed amendment to the
Amended and Restated Certificate of Incorporation of the Company for a Staggered
Board.
3. The holders of 6,575,259 shares of Common Stock voted in favor of, the
holders of 132,900 shares of Common Stock voted against, and the holders of
12,103 shares of Common Stock abstained with respect to the proposed amendment
to the Amended and Restated Certificate of Incorporation of the Company for the
Reverse Stock Split.
4. The holders of 6,651,926 shares of Common Stock voted in favor of, the
holders of 25,252 shares of Common Stock voted against, and the holders of
10,367 shares of Common Stock abstained with respect to the ratification of the
selection of KPMG LLP, independent certified public accountants, to serve as
independent accountants for the Company.
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PART II
ITEM 5 -- MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Class A Common Stock and Class B Warrants traded on the
Nasdaq SmallCap Market under the symbols FLYT and FLYTZ, respectively, beginning
March 7, 1995, the date of the Company's initial public offering. The Class B
Warrants were called by the Company and ceased trading on January 16, 1997. The
Class A Common Stock began trading on the Nasdaq National Market on May 19,
1997. The following table sets forth the high and low last sale prices for the
Company's securities as reported by the Nasdaq SmallCap Market and the Nasdaq
National Market. These prices do not reflect retail mark-ups, markdowns, or
commissions and may not necessarily represent actual transactions.
On December 17, 1997 and October 30, 1998, the Board of Directors
authorized the Company to repurchase shares of its Class A Common Stock on the
open market. As of January 8, 1999, the Company had repurchased 867,267 shares
at prices ranging from $0.75 to $3.00 per share. The Company expects to make
additional open market purchases of its shares in the future.
CLASS A COMMON STOCK HIGH LOW
- --------------------- -------- --------
November 1, 1996 through January 31, 1997................. 39 22 7/8
February 1, 1997 through April 30, 1997................... 25 7/8 9 15/16
May 1, 1997 through July 31, 1997......................... 22 1/8 9 15/16
August 1, 1997 through October 31, 1997................... 10 7/8 3
November 1, 1997 through January 31, 1998................. 4 5/8 1 7/8
February 1, 1998 through April 30, 1998................... 3 11/16 2 6/16
May 1, 1998 through July 31, 1998......................... 3 1/2 1 7/8
August 1, 1998 through October 31, 1998................... 3 1/8 1 7/8
The closing sales price of the Class A Common Stock as of January 8, 1999
as reported by the Nasdaq National Market was $3.125 per share.
As of January 8, 1999, there were 33 record holders of Class A Common
Stock.
On October 30, 1998, the stockholders of the Company approved a
one-for-three reverse stock split on the Company's Class A Common Stock and
Class B Common Stock. The reverse stock split was effective as of the close of
business on November 2, 1998. All references to the number of common shares,
price per share and stock option data elsewhere herein have been restated as
appropriate to reflect the effect of the reverse stock split for all periods
presented.
ITEM 6 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with, and is
qualified in its entirety by, Interactive Flight Technologies, Inc. and
subsidiary (the "Company") Consolidated Financial Statements and the Notes
thereto appearing elsewhere herein. Historical results are not necessarily
indicative of trends in operating results for any future period.
HISTORICAL OVERVIEW
Interactive Flight Technologies, Inc. and subsidiary has been engaged in
the development, manufacture, installation and operation of a computer-based
in-flight entertainment network ("Entertainment Network" or "system"), which
provides aircraft passengers the opportunity to view movies, purchase goods and
services, play computer games and, in certain cases where permitted by
applicable law, gamble through an in-seat video touch screen. The Company also
operates a retail dry cleaning facility in San Diego, California which it is in
the process of selling.
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Former management had determined to exit the in-flight entertainment
business in May 1998, except for continuing efforts associated with meeting its
contractual obligations with its only customer, Swissair. This decision was
based on a number of factors including industry trends, financial resources of
the Company and the Company's inability to attract new customers.
SWISSAIR
The Company's main agreement with Swissair required the Company to install
and maintain the Entertainment Network in the first, business and economy class
sections of three aircraft at no cost to Swissair and in the first and business
classes of another sixteen aircraft at an average price of $1.7 million per
aircraft. As of October 31, 1998, the Company had completed all installations
under the initial Swissair program. The Company was responsible for maintenance
costs through September 1998 for all nineteen aircraft and specific software and
hardware upgrades to the Entertainment Networks that are not yet completed. The
Swissair agreement also provided for a one-year warranty on all of the
Entertainment Networks. The Company has also received a letter of intent dated
April 1, 1998, from Swissair to extend the warranty on all installed systems for
a second and third year at a price of $3,975,000.
On April 1, 1998, the Company also entered into a letter of intent with
Swissair for a $4.7 million order for first and business class installations on
four Swissair MD-11 aircraft that are being added to the Swissair fleet. As of
October 31, 1998, none of the installations on the four aircraft were completed
though the Company had purchased or contracted for purchase, the majority of
materials required for the installations. On December 9, 1998, the Company
received notice from Swissair stating their intent to cancel the order for the
four additional installations. Inventory on-hand and outstanding purchase
commitments for inventory relating to the four additional installations totaling
$1,005,427 and $1,800,000, respectively, have been reflected in the Company's
consolidated financial statements and notes thereto, as of October 31, 1998. As
of January 8, 1999, Swissair had paid $645,000 of the $4.7 million order for the
four installations and continues to engage in active discussions with the
Company regarding outstanding financial matters related to current receivables,
inventory, purchase commitments and extended warranty obligations. Significant
uncertainty exists surrounding these matters and no assurances can be given that
such events will be resolved on favorable terms to the Company.
RESULTS OF OPERATIONS
Revenue for the year ended October 31, 1998 was $19,142,961, an increase of
$8,042,252 (or 72%) over revenue of $11,100,709 for the year ended October 31,
1997. Revenues in each year consist of equipment sales (principally from the
installation of the Entertainment Networks on Swissair aircraft) and service
income. During the year ended October 31, 1998, the Company completed
installations under the initial Swissair program in ten business classes and
eighteen first classes whereas installations completed in fiscal 1997 were in
nine business classes and one first class. Revenues from equipment sales rose
71% from $10.5 million in fiscal 1997 to $18.0 million in fiscal 1998 due to the
increased installations in fiscal 1998. Service income of $1,104,342 for the
year ended October 31, 1998 was principally generated from programming services
provided to Swissair, the Company's share of gaming profits generated by the
Swissair systems and revenue earned under the Swissair extended warranty Letter
of Intent. Also included in service income for the year ended October 31, 1998
is revenue of $326,000 generated by the Company's dry cleaning operations
acquired on July 24, 1998. Service income of $575,881 for the year ended October
31, 1997 was primarily derived from a Product Identification/Product Development
Agreement with an airline and entertainment programming services provided to
customers.
Cost of equipment sales and service income for the year ended October 31,
1998 was $15,762,119, a decrease of $9,116,341 (or 37%) over the comparable
figure of $24,878,460 for the fiscal year ended October 31, 1997. Cost of
equipment sales includes materials, installation and maintenance costs, as well
as estimated one-year warranty costs and costs of upgrades to the Swissair
Entertainment Networks that the Company is contractually committed to providing
to Swissair. The
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decrease in cost of equipment sales is primarily a result of the inclusion of
provisions for inventory obsolescence, unusable inventory and rework adjustments
of $11,496,748 in cost of equipment sales for fiscal 1997. The 1997 provision
for inventory obsolescence was a result of the Company purchasing inventory for
installation in the economy sections of Swissair aircraft and actually
completing only three economy installations. The unusable inventory and rework
adjustments primarily resulted from the Company's redesign of the tray table
utilized in the Entertainment Networks for the economy section of an aircraft.
The decrease in cost of equipment sales for fiscal 1998 is also attributable to
reductions in maintenance costs and estimated one-year warranty costs as the
reliability of the Entertainment Networks has improved. Additionally, the
Company recognized a reduction in installation costs from its subcontractor
during fiscal 1998. Included in cost of service income for fiscal 1998 is
$225,047 of production costs related to the Company's dry cleaning operations.
Provisions for doubtful accounts for the year ended October 31, 1998 were
$9,869 compared to $216,820 for the year ended October 31, 1997. Fiscal 1998
provisions resulted from the Company's dry cleaning operations and fiscal 1997
provisions resulted from entertainment programming services provided to a
previous customer.
Bad debt recoveries of $1,064,284 during the year ended October 31, 1997
resulted from the recovery of accounts receivable under a customer agreement
which were reserved for during the Company's fourth quarter of its fiscal year
ended October 31, 1996.
Research and development expenses for the year ended October 31, 1998 were
$1,092,316, a decrease of $6,729,324 (or 86%) over expenses of $7,821,640 for
the year ended October 31, 1997. The decrease in expenses reflects the Company's
decision not to develop the next generation of the Entertainment Network and the
resulting reduction in staff and professional fees. The Company does not plan to
continue its research and development in the in-flight entertainment business
beyond those efforts that are required contractually by the Swissair agreement.
The Swissair agreement requires the Company to provide specific upgrades to the
Entertainment Network currently installed on Swissair aircraft. The Company
expects to complete the development of these upgrades in the first quarter of
fiscal 1999 and does not plan to develop any further upgrades to the
Entertainment Network. The anticipated costs of developing these upgrades were
included as cost of equipment sales in the Company's consolidated statements of
operations at the time of installation. The Company expects to continue any
development efforts that are required to support the Swissair system reliability
guarantees through the year 2003, subject to the development of a successful
reactivation plan.
General and administrative expenses for the year ended October 31, 1998
were $11,387,872, a decrease of $1,186,351 (or 9%) over expenses of $12,574,223
for the year ended October 31, 1997. The decrease in expenses reflects the
Company's reduction in staff in administrative areas, including production,
marketing and program management departments. As of May 29, 1998, the Company
terminated almost all sales and marketing efforts related to the Entertainment
Network. The decrease in expenses during fiscal 1998 was partly offset by the
payment of $3,053,642 in severance to three former executives of the Company.
Special charges for the year ended October 31, 1998 were $400,024 compared
to $19,649,765 for the year ended October 31, 1997. Special charges in fiscal
1998 primarily resulted from equipment write-offs of $1,006,532. The write-offs
were for excess computers, furniture and other equipment that the Company is not
utilizing in its operations and is in the process of disposing. The equipment
write-offs were partly offset by a recovery of special charges expensed in
fiscal 1997. During fiscal 1998, a recovery of $190,000 was recognized as a
special charge credit as a result of a reduction in the number of Entertainment
Networks requiring maintenance. The Company also recognized a recovery of
$416,508 related to Swissair's decision to not develop the system for the front
row in the economy sections of its aircraft. Special charges in fiscal 1997
primarily resulted from the installment of the Entertainment Networks on three
Swissair aircraft and installations required by the Debonair agreement. The
Company was responsible for the costs of installing the system on three Swissair
aircraft, including materials, installation, upgrades, a one-year warranty and
maintenance through
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September of 1998. The costs for these three systems of $14,292,404 were
recorded as a special charge during fiscal 1997. Due to the termination of the
Debonair agreement, the costs of the installed system ($956,447) and all
inventory on-hand under the Debonair agreement ($2,881,962) were written off as
a special charge in fiscal 1997. Additionally, the Company recorded a special
charge of $1,518,952 for the write-off of a system integration lab utilized in
software development and testing. The lab equipment will not be utilized in the
Company's future operations.
Interest expense was $11,954 for the year ended October 31, 1998 compared
to $13,423 for the year ended October 31, 1997. The expense is attributable to
the Company's capital leases for furniture that expire in September of 1999.
Interest income for the year ended October 31, 1998 was $2,251,055, an
increase of $80,380 (or 4%) over income of $2,170,675 for the year ended October
31, 1997. The interest arose principally out of short-term investments of
working capital. The increase in income is due to the higher average cash
balance during fiscal 1998 compared to fiscal 1997.
Other income of $10,179 for the year ended October 31, 1998 represents
proceeds from the sale of scrapped inventory. Other expense of $203,649 for the
year ended October 31, 1997 represents the loss on disposals of property and
equipment.
LIQUIDITY AND CAPITAL RESOURCES
At October 31, 1998, the Company had working capital of approximately $23.1
million. The Company's primary source of funding has been through equity
offerings. Excluding any payments to be received under the Swissair Letter of
Intent to extend the warranty, the Company's backlog consisted only of
installations on four Swissair aircraft, which have subsequently been cancelled
as discussed above. Therefore, the Company does not expect any significant
profit from its in-flight entertainment business for the foreseeable future. As
a result, working capital may continue to decrease.
During the year ended October 31, 1998, the Company used $3.2 million of
cash in operating activities, a decrease of $31 million from the $34.2 million
of cash utilized in operating activities during fiscal 1997. The decrease in
cash utilized in operations in fiscal 1998 compared to fiscal 1997 is primarily
a result of a decrease in the net loss. The cash utilized in operations during
fiscal 1998 resulted from decreases in accounts receivable and inventories and
an increase in accrued product warranties, partly offset by the net loss and
decrease in accounts payable, accrued liabilities and deferred revenue.
Purchases of property and equipment for the year ended October 31, 1998
were $77,013 compared to $10.3 million for the year ended October 31, 1997.
Capital expenditures for fiscal 1997 were primarily related to the manufacture
of the system under the Debonair agreement, the installation of systems on three
aircraft under the Swissair Agreement, and research and development equipment.
During fiscal 1998, the Company's restricted cash increased by $1.0 million
for payments required under consulting and severance agreements with three
former executives of the Company. The Company also loaned $447,939 to a related
party for the purchase of 99,542 shares of the Company's Class A Common Stock.
The note is secured by 99,542 shares of the Company's Class A Common Stock,
bears interest at the prime rate plus 1% and is due in October 2001.
In connection with a stock repurchase program during the year ended October
31, 1998, the Company purchased a total of 844,667 shares of the Company's Class
A Common Stock in open market activities at a total cost of $2,315,983. On
October 30, 1998, the Board of Directors authorized another repurchase program
whereby the Company may repurchase up to 666,667 shares of its Class A Common
Stock on the open market.
At October 31, 1998, the Company's material capital commitments were
purchase orders of approximately $1.8 million relating primarily to inventory
purchases for its obligations under the Swissair Agreements.
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The Company is currently using its working capital to finance its current
expenses, including product development, inventory purchases, repairs and other
expenses associated with the delivery and installation of the Swissair systems
and general and administrative costs. The Company believes that its current cash
balances plus interest received on such balances will be sufficient to meet the
Company's currently anticipated cash requirements for at least the next twelve
months.
OUTLOOK: ISSUES AND RISKS
On September 15, 1998 the former Board of Directors of the Company resigned
and elected the current directors as the new Board of the Company. On October
30, 1998, the stockholders reelected the new Board at the Annual Stockholders'
Meeting. The Company and its Board of Directors are in the process of developing
a strategic plan for the Company to maximize shareholder value, though no
assurances can be given as to the ultimate implementation and success of such
plan. The Company is developing strategies to leverage off certain core
competencies developed in the in-flight entertainment business to enter new
markets with the technology. Further, the Company is investigating strategic
alliances for the in-flight entertainment business and other technology related
business opportunities. The Company believes its in-flight entertainment system
core technology has value and the Company has begun a process to actively market
the system and its related technology to or to form strategic alliances with
respect thereto with its competitors and other avionics manufacturers. There can
be no assurances that the Company will be successful in locating a buyer or a
strategic partner for its system and technology.
In November 1998, the Company entered into a Letter of Intent to acquire a
27.5% equity interest in Inter Lotto Ltd. (Inter Lotto). Inter Lotto is a United
Kingdom company involved in the operation of lotteries. Pursuant to the Letter
of Intent, the Company would pay pounds 200,000 to an unrelated third party for
the 27.5% equity interest and enter into a management agreement with Inter Lotto
whereby the Company would have the authority and responsibility for the
management of Inter Lotto's operations. Prior to the closing of the transaction,
the Company has committed to providing advances to Inter Lotto to fund their
current operations. The closing is subject to completion of due diligence and
other conditions.
In December 1998, the Company entered into a Letter of Intent to acquire a
55% interest in Information Paradigms, Inc. (IPI). IPI has developed software
for use by investment management companies. Pursuant to the Letter of Intent,
the Company would commit up to $3,000,000 of capital in the form of a secured
convertible interest-bearing note. The note would be convertible to equity of
IPI at the Company's option. The closing of the transaction is subject to
completion of due diligence and other conditions.
The Company believes that it has cash and liquidity resources in excess of
that required to fulfill its current contractual commitments, although this will
depend in large part on the ability of the Company to fulfill those obligations
in an efficient manner. There can be no assurances that the Company will be
successful in developing an alternative business strategy or that it will be
successful in locating, evaluating, purchasing and operating other businesses.
In addition, the Company has used in the past, and may continue to use, a
portion of its cash to repurchase its own shares.
The Company's contract with Swissair requires the Company to support the
Entertainment Networks installed on Swissair aircraft through 2003. The Company
must meet operational reliability criteria for the systems and the Company is
working to further improve the reliability of the systems through software
revisions and through design improvements. The Company believes that the
reliability goals for the system can be met; however, there can be no assurance
that technical obstacles may not prove more difficult than anticipated or that
as yet undetermined issues will not appear. The Company is subject to certain
penalties, which could be substantial, if the Entertainment Networks do not meet
these operational reliability criteria through the year 2003. Avoiding these
penalties may require the Company to continue to maintain a presence in the
in-flight entertainment business. The Company believes that Swissair's decision
to deactivate the Entertainment Networks will not result in penalties.
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On July 24, 1998, pursuant to a strategic initiative of former management,
the Company acquired the assets and business of Johnny Valet, Inc., a retail dry
cleaning plant in San Diego, California, for $813,736. The acquisition
represented the Company's initial foray into the dry cleaning business. In
October 1998, the Company's new Board of Directors decided to not pursue the
strategy of consolidating the dry cleaning industry and determined that it would
sell the assets of Johnny Valet, Inc. There can be no assurances that the
Company will be successful in divesting its dry cleaning operation in a timely
manner or that the Company will be able to recover its investment.
YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the year, thus rendering them incapable of
properly managing and manipulating data that includes 21st century dates. The
Company has performed an assessment of its Entertainment Network for year 2000
issues. The Entertainment Network is a Microsoft based network system that uses
a four-digit year identifier and is therefore year 2000 compliant. The Company
believes that its products have no inherent date sensitive features. The Company
has also reviewed its existing software systems utilized in the planning,
purchasing, manufacturing, product development and accounting areas and believes
these systems are all year 2000 compliant. The Company does not believe the year
2000 issue will pose significant operational problems for the Company.
The Company continues to evaluate the estimated costs associated with its
year 2000 compliance efforts and does not expect the future costs to be
material. However, no assurance can be given that the Company will not incur
additional expenses pursuing year 2000 compliance. Furthermore, even if the
Company's systems are year 2000 compliant, there can be no assurance that the
Company will not be adversely affected by the failure of others to become year
2000 compliant. For example, the Company may be adversely affected by, among
other things, warranty and other claims made by the Company's customers related
to product failures caused by the year 2000 problem, the disruption or
inaccuracy of data provided to the Company by non-year 2000 compliant third
parties, and the failure of the Company's service providers to become year 2000
compliant. The Company will continue to monitor the progress of its material
vendors and customers and formulate a contingency plan at that point in time
when the Company does not believe a material vendor or customer will be
compliant. Despite the Company's efforts to date, there can be no assurance that
the year 2000 problem will not have a material adverse effect on the Company in
the future.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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, which will be effective for the Company
for the fiscal year ending October 31, 1999, is currently anticipated to be
applicable for the unrealized gains or losses on investment securities included
in the consolidated statement of stockholders' equity.
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,
which will be effective for the Company for the fiscal year ending October 31,
1999, may 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 will result in more detailed information
in the notes to the Company's financial statements than is currently required
and provided.
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FORWARD-LOOKING INFORMATION
Except for historical information contained herein, the matters discussed
in this ITEM 6 and elsewhere in this Annual Report on Form 10-KSB are
forward-looking statements (within the meaning of Section 27A of the Securities
Act of 1993, as amended and Section 21E of the Securities Exchange Act of 1934,
as amended) 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, but are not limited to, cost
overruns in connection with the Company's current contracts, failure of
installed systems to perform in accordance with system specifications, the
failure of the Company to resolve its differences with Swissair on a favorable
basis, the impact of competition and downward pricing pressures, the effect of
changing economic conditions and conditions in the airline industry, the
inability of the Company to evaluate other businesses, the risks and
uncertainties involved in the Company's other proposed business ventures, 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
The audited consolidated financial statements of the Company for the fiscal
year ended October 31, 1998 are located beginning at page F-1 of this Annual
Report on Form 10-KSB.
ITEM 8 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There are no items or circumstances to be disclosed under this Item 8.
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PART III
ITEMS 9-12 -- DOCUMENTS INCORPORATED BY REFERENCE
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 1999 Annual
Meeting of Stockholders to be filed by the Registrant with the Securities and
Exchange Commission on or before February 28, 1999.
ITEM 13 -- EXHIBITS AND REPORTS ON FORM 8-K
The exhibits listed in the Index to Exhibits below are filed as part of the
Annual Report on Form 10-KSB.
(A) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
-- ----- -- ---------
1.1(1) -- Revised Form of Underwriting Agreement
3.1(1) -- Certificate of Ownership and Merger
3.2(1) -- Amended and Restated Certificate of Incorporation of the
Registrant
3.3(1) -- Certificate of Amendment of Amended and Restated Certificate
of Incorporation of Registrant
3.4(1) -- By-laws of the Registrant
4.1(1) -- Warrant Agreement, dated as of March 7, 1995, by and among
the Registrant, D. H. Blair Investment Banking Corp. and
American Stock Transfer & Trust Company
4.2(4) -- Form of Amendment to March 7, 1995 Warrant Agreement, to be
entered into by and among the Registrant, D. H. Blair
Investment Banking Corp., and American Stock Transfer &
Trust Company
4.3(4) -- Warrant Agreement, dated as of October 24, 1996, by and
among the Registrant, D. H. Blair Investment Banking Corp.,
and American Stock Transfer & Trust Company
4.4(4) -- Form of Amendment to October 24, 1996 Warrant Agreement, to
be entered into by and among the Registrant, D. H. Blair
Investment Banking Corp., and American Stock Transfer &
Trust Company
4.5(1) -- Form of Underwriter's Unit Purchase Option
4.6(1) -- Specimen of Class A Common Stock Certificate
4.7(1) -- Specimen of Class B Common Stock Certificate
4.10(2) -- Specimen of Class D Warrant Certificate
4.11(4) -- Stock Purchase Warrant, dated as of November 7, 1996, issued
to FortuNet, Inc.
4.12(4) -- Stock Purchase Warrant, dated as of November 12, 1996,
issued to Houlihan Lokey Howard & Zukin
10.1(3) -- Amended and Restated 1994 Stock Option Plan
10.2(4) -- Severance Agreement between the Registrant and Steven M.
Fieldman dated as of November 4, 1996
10.3(l) -- Employment Agreement between the Registrant and Michail
Itkis dated as of October 31, 1994
10.4(4) -- Employment Agreement between the Registrant and John
Alderfer, dated as of October 2, 1996
10.5(4) -- Severance Agreement between the Registrant and Lance
Fieldman dated as of November 4, 1996
10.6(l) -- Amended and Restated Shareholders' Agreement by and among
Yuri Itkis, Michail Itkis, Boris Itkis, Steven M. Fieldman,
Donald H. Goldman, Lance Fieldman and Registrant dated as of
October 6, 1994
10.7(4) -- Amended and Restated Intellectual Property License and
Support Services Agreement by and between FortuNet, Inc. and
Registrant dated as of November 7, 1996
16
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
10.8(1) -- Amended and Restated Escrow Agreement by and between the
Registrant, American Stock Transfer & Trust Company, Yuri
Itkis, Michail Itkis, Boris Itkis, Steven M. Fieldman,
Donald H. Goldman and Lance Fieldman
10.9(4) -- Sublease and Consent, dated July 16, 1996 between the
Registrant and AGF 4041 Limited Partnership
10.10(4) -- Office Lease, dated July 15, 1996, between the Registrant
and AGF 4041 Limited Partnership
10.11(4) -- Standard Industrial/Commercial Single-Tenant Lease-Net,
dated as of June 27, 1996, between the Registrant and 44th
Street and Van Buren Limited Partnership
10.12(1) -- Form of Indemnification Agreement
10.14(4) -- Strategic Alliance Agreement, dated as of November 12, 1996,
between the Registrant and Hyatt Ventures, Inc.
10.15(4) -- Registration Rights Agreement, dated as of November 12,
1996, between the Registrant and Hyatt Ventures, Inc.
10.16(4) -- Amendment No. 2 to Amended and Restated Shareholders'
Agreement, dated as of November 12, 1996
10.18(5) -- Employment Agreement between the Registrant and Thomas
Metzler, dated as of November 18, 1996
10.19 -- Termination Agreement, dated November 10, 1997, between the
Registrant and Hyatt Ventures, Inc.
10.20(6) -- Debonair Termination Agreement, dated as of February 13,
1998
10.21(6) -- Lease Termination Agreement, dated as of May 27, 1998
10.22(6) -- Lease Surrender Agreement, dated as of May 12, 1998
10.23(7) -- Amendment to Severance Compensation Agreement, dated as of
August 28, 1998
10.24(7) -- Second Amendment to Employment Agreement, dated as of August
28, 1998
10.25(7) -- Second Amendment to Employment Agreement, dated as of August
28, 1998
23 -- Consent of KPMG LLP
27 -- Financial Data Schedule
- -------------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form SB-2, Registration No. 33-86928.
(2) Incorporated by reference from the Registrant's Quarterly Report on Form
1O-QSB for the fiscal period ended July 31, 1996, filed with the Securities
and Exchange Commission on September 16, 1996, File No. 0-25668.
(3) Incorporated by reference from the Registrant's Registration Statement on
Form SB-2, Registration No. 333-02044.
(4) Incorporated by reference from the Registrant's Registration Statement on
Form S-3, Registration No. 333-14013.
(5) Incorporated by reference from the Registrant's Quarterly Report on Form
10-QSB for the fiscal quarter ended January 31, 1997, filed with the
Securities and Exchange Commission on March 17, 1997, File No. 0-25668.
(6) Incorporated by reference from the Registrant's Quarterly Report on Form
10-QSB for the fiscal quarter ended April 30, 1998, filed with the
Securities and Exchange Commission on June 5, 1998, File No. 0-25668.
(7) Incorporated by reference from the Registrant's Quarterly Report on Form
10-QSB for the fiscal quarter ended July 31, 1998, filed with the Securities
and Exchange Commission on September 15, 1998, File No. 0-25668.
(B) REPORTS ON FORM 8-K.
During the quarter ended October 31, 1998, the Company filed a Current
Report on Form 8-K dated September 1, 1998, in which the Company disclosed
information under "Item 5 -- Other Events" and a Current Report on Form 8-K
dated October 29, 1998, in which the Company disclosed information under "Item 5
- ---Other Events."
17
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
has caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Dated: January 14, 1999 By: /s/ IRWIN L. GROSS
---------------------------------
Irwin L. Gross,
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
-- ------- -- --- -- --
<S> <C> <C>
/s/ IRWIN L. GROSS Chief Executive Officer and Director January 14, 1999
- ------------------------------
Irwin L. Gross
/s/ JAMES W. FOX President and Director January 14, 1999
- ------------------------------
James W. Fox
/s/ MORRIS C. AARON Chief Financial Officer January 14, 1999
- ------------------------------ (Principal Financial Officer)
Morris C. Aaron
/s/ MARCHEA E. MALONE Vice President -Finance January 14, 1999
- ------------------------------ (Chief Accounting Officer)
Marchea E. Malone
/s/ CHARLES T. CONDY Director January 14, 1999
- ------------------------------
Charles T. Condy
/s/ STEPHEN SCHACHMAN Director January 14, 1999
- ------------------------------
Stephen Schachman
/s/ M. MOSHE PORAT Director January 14, 1999
- ------------------------------
M. Moshe Porat
</TABLE>
18
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report...................................... F-2
Consolidated Balance Sheets as of October 31, 1998 and 1997....... F-3
Consolidated Statements of Operations for the years ended
October 31, 1998 and 1997....................................... F-4
Consolidated Statements of Stockholders' Equity for the
years ended October 31, 1998 and 1997........................... F-5
Consolidated Statements of Cash Flows for the years ended
October 31, 1998 and 1997....................................... F-6
Notes to Consolidated Financial Statements........................ F-7 to F-23
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Interactive Flight Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Interactive
Flight Technologies, Inc. and subsidiary as of October 31, 1998 and 1997, and
the related consolidated statements of operations, stockholders' equity and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Interactive Flight
Technologies, Inc. and subsidiary as of October 31, 1998 and 1997, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
KPMG LLP
Phoenix, Arizona
December 11, 1998
F-2
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
OCTOBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $27,914,551 36,890,454
Restricted cash........................................... 1,039,311 --
Short-term investment securities.......................... 1,762,049 1,697,023
Accounts receivable....................................... 1,135,342 5,654,118
Inventories, net.......................................... 1,005,427 6,110,761
Prepaid expenses.......................................... 567,601 253,771
Assets held for use....................................... 699,196 --
Other current assets...................................... 379,046 606,883
----------- -----------
Total current assets.................................. 34,502,523 51,213,010
Investment securities....................................... 1,928,555 440,061
Note receivable from related party.......................... 447,939 --
Property and equipment, net................................. 780,035 2,959,539
Other assets................................................ 605,150 166,845
----------- -----------
Total assets.......................................... $38,264,202 54,779,455
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,447,815 5,747,833
Accrued liabilities....................................... 3,939,633 5,590,095
Deferred revenue.......................................... 453,022 2,383,904
Accrued product warranties................................ 5,369,008 4,610,687
Current maturities of capital lease obligations........... 76,840 80,753
Note payable.............................................. 125,000 --
----------- -----------
Total current liabilities............................. 11,411,318 18,413,272
Accrued severance costs, noncurrent......................... -- 55,000
Capital lease obligations, less current maturities.......... -- 76,840
----------- -----------
Total liabilities..................................... 11,411,318 18,545,112
----------- -----------
Stockholders' equity:
Preferred stock, par value $0.01 per share, 5,000,000
shares authorized, none issued.......................... -- --
Class A common stock, one vote per share, par value $0.01
per share, 40,000,000 shares authorized; 6,125,908 and
6,063,332 shares issued and outstanding, respectively... 183,777 181,900
Class B common stock, six votes per share, par value $0.01
per share, 4,000,000 shares authorized; 1,244,445 shares
issued and outstanding including 1,066,667 shares placed
in escrow............................................... 37,334 37,334
Additional paid-in capital................................ 112,223,734 112,037,882
Net unrealized gains on investment securities............. 6,754 --
Accumulated deficit....................................... (83,282,732) (76,022,773)
Treasury stock, at cost; 844,667 shares................... (2,315,983) --
----------- -----------
Total stockholders' equity............................ 26,852,884 36,234,343
----------- -----------
Total liabilities and stockholders' equity............ $38,264,202 54,779,455
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenue:
Equipment sales.......................................... $18,038,619 10,524,828
Service income........................................... 1,104,342 575,881
----------- -----------
19,142,961 11,100,709
----------- -----------
Costs and expenses:
Cost of equipment sales.................................. 15,523,282 24,646,334
Cost of service income................................... 238,837 232,126
Provision for doubtful accounts.......................... 9,869 216,820
Research and development expenses........................ 1,092,316 7,821,640
General and administrative expenses...................... 11,387,872 12,574,223
Special charges.......................................... 400,024 19,649,765
Bad debt recoveries...................................... -- (1,064,284)
----------- -----------
28,652,200 64,076,624
----------- -----------
Operating loss..................................... (9,509,239) (52,975,915)
Other:
Interest expense......................................... (11,954) (13,423)
Interest income.......................................... 2,251,055 2,170,675
Other income (expense)................................... 10,179 (203,649)
----------- -----------
Net loss........................................... $(7,259,959) (51,022,312)
=========== ===========
Basic and diluted net loss per share of common stock....... $ (1.22) (8.89)
=========== ===========
Weighted average shares outstanding........................ 5,933,004 5,738,987
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CLASS A CLASS B
COMMON STOCK COMMON STOCK ADDITIONAL
-------------------- ------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- -------- --------- ------- ------------
<S> <C> <C> <C> <C> <C>
Balance as of October 31, 1996...... 2,700,683 $ 81,020 1,320,000 $39,600 $ 42,587,712
Class A common stock issued for
services received (20,000
shares)......................... 20,000 600 -- -- 466,275
Class A common stock issued
pursuant to Class B warrant
exercise offer.................. 3,266,587 97,998 -- -- 73,491,777
Registration costs................ -- -- -- -- (4,481,164)
Redemption of Class B warrants.... -- -- -- -- (40,576)
Class A common stock issued under
stock option plan pursuant to
cashless exercise option........ 507 16 -- -- 13,858
Automatic conversion of Class B
shares to Class A shares upon
sale to non-holder of Class B
shares.......................... 75,555 2,266 (75,555) (2,266) --
Net loss.......................... -- -- -- -- --
--------- -------- --------- ------- ------------
Balance as of October 31, 1997...... 6,063,332 181,900 1,244,445 37,334 112,037,882
Net unrealized gains on investment
securities...................... -- -- -- -- --
Issuance of common stock pursuant
to bonus plan................... 62,576 1,877 -- -- 185,852
Treasury stock purchases (844,667
shares)......................... -- -- -- -- --
Net loss.......................... -- -- -- -- --
--------- -------- --------- ------- ------------
Balance as of October 31, 1998...... 6,125,908 $183,777 1,244,445 $37,334 $112,223,734
========= ======== ========= ======= ============
NET UNREALIZED
GAINS ON TOTAL
INVESTMENT ACCUMULATED TREASURY STOCKHOLDERS'
SECURITIES DEFICIT STOCK EQUITY
-------------- ------------ ----------- -------------
Balance as of October 31, 1996...... $ -- $(25,000,461) $ -- $17,707,871
Class A common stock issued for
services received (20,000
shares)......................... -- -- -- 466,875
Class A common stock issued
pursuant to Class B warrant
exercise offer.................. -- -- -- 73,589,775
Registration costs................ -- -- -- (4,481,164)
Redemption of Class B warrants.... -- -- -- (40,576)
Class A common stock issued under
stock option plan pursuant to
cashless exercise option........ -- -- -- 13,874
Automatic conversion of Class B
shares to Class A shares upon
sale to non-holder of Class B
shares.......................... -- -- -- --
Net loss.......................... -- (51,022,312) -- (51,022,312)
------ ------------ ----------- -----------
Balance as of October 31, 1997...... -- (76,022,773) -- 36,234,343
Net unrealized gains on investment
securities...................... 6,754 -- -- 6,754
Issuance of common stock pursuant
to bonus plan................... -- -- -- 187,729
Treasury stock purchases (844,667
shares)......................... -- -- (2,315,983) (2,315,983)
Net loss.......................... -- (7,259,959) -- (7,259,959)
------ ------------ ----------- -----------
Balance as of October 31, 1998...... $6,754 $(83,282,732) $(2,315,983) $26,852,884
====== ============ =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(7,259,959) (51,022,312)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 1,338,017 1,815,779
Expense recognized upon issuance of stock options,
warrants and shares of Class A common stock............ -- 480,749
Provision for doubtful accounts......................... 9,869 216,820
Provision for inventory valuation....................... -- 8,297,933
Special charges......................................... (606,507) 19,649,765
Loss on disposals of property and equipment............. 1,006,531 203,649
Changes in assets and liabilities, net of acquisition:
Decrease (increase) in accounts receivable............ 4,505,074 (3,815,139)
Decrease in provision for doubtful accounts........... -- (1,949,197)
Decrease (increase) in inventories.................... 5,105,334 (12,563,721)
Increase in note receivable........................... (447,939) --
(Increase) decrease in prepaid expenses, other current
assets and other assets.............................. (532,338) 183,394
(Decrease) increase in accounts payable............... (4,284,167) 1,673,893
Decrease in accrued liabilities....................... (892,345) (584,655)
(Decrease) increase in deferred revenue............... (1,930,882) 2,383,904
Increase in accrued product warranties................ 758,321 836,667
----------- -----------
Net cash used in operating activities.............. (3,230,991) (34,192,471)
----------- -----------
Cash flows from investing activities:
Maturities of investment securities....................... 2,468,880 6,810,275
Purchases of investment securities........................ (4,015,616) (2,137,084)
Purchases of property and equipment....................... (77,013) (10,341,561)
Proceeds from sale of equipment........................... 3,620 --
Increase in restricted cash............................... (1,039,311) --
Purchase of Johnny Valet, Inc............................. (688,736) --
----------- -----------
Net cash used in investing activities.............. (3,348,176) (5,668,370)
----------- -----------
Cash flows from financing activities:
Payments on capital lease obligations..................... (80,753) (53,085)
Repurchase of common stock................................ (2,315,983) --
Proceeds from issuance of common stock.................... -- 73,589,775
Registration costs........................................ -- (4,481,164)
Redemption of Class A and Class B warrants................ -- (40,576)
----------- -----------
Net cash provided by (used in) financing
activities....................................... (2,396,736) 69,014,950
----------- -----------
Net increase (decrease) in cash and cash
equivalents...................................... (8,975,903) 29,154,109
Cash and cash equivalents at beginning of year.............. 36,890,454 7,736,345
----------- -----------
Cash and cash equivalents at end of year.................... $27,914,551 36,890,454
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) DESCRIPTION OF BUSINESS
Interactive Flight Technologies, Inc. and subsidiary (the "Company" or
"IFT") is engaged in the development, manufacturing and marketing of a
computer-based in-flight entertainment network (entertainment network or
shipsets) which provides aircraft passengers the opportunity to view movies,
purchase goods and services, play computer games and, in certain cases where
permitted by applicable law, gamble through an in-seat video touch screen. The
Company also operates a retail dry cleaning facility in San Diego, California.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Interactive
Flight Technologies, Inc. and its wholly-owned subsidiary. All significant
intercompany accounts and transactions have been eliminated in consolidation.
(C) REVERSE STOCK SPLIT
On October 30, 1998, the stockholders of the Company approved a
one-for-three reverse stock split on the Company's Class A common stock and
Class B common stock. One share will be issued for three shares of Common Stock
held by stockholders of record as of the close of business on November 2, 1998.
All references to the number of common shares, per share amounts and stock
option data elsewhere in the consolidated financial statements and related
footnotes have been restated as appropriate to reflect the effect of the reverse
split for all periods presented.
(D) CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities at the date of purchase of three months or less to be cash and cash
equivalents.
(E) RESTRICTED CASH
At October 31, 1998, the Company held restricted cash of $1,039,311 in a
trust fund for payments required under consulting and severance agreements with
three former executives of the Company. See Note 13.
(F) INVESTMENT SECURITIES
Investment securities consist of debt securities with a maturity greater
than three months at the time of purchase. In accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" ("SFAS No. 115") the debt securities are classified
as available-for-sale and carried at fair value, based on quoted market prices
or classified as held-to-maturity and carried at amortized cost. The net
unrealized gains or losses on these investments are reported in stockholders'
equity, net of tax. The specific identification method is used to compute the
realized gains and losses on the debt securities.
F-7
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES -- (CONTINUED)
(G) INVENTORIES
Inventories consisting principally of entertainment network components are
stated at the lower of cost (first-in, first-out method) or market.
(H) GOODWILL
The Company classifies as goodwill the excess of the purchase price over
the fair value of the net assets acquired in a purchase transaction and goodwill
is amortized over 10 years using the straight line method. At October 31, 1998,
goodwill is included in assets held for sale on the consolidated balance sheet.
See Note 5.
(I) PROPERTY AND EQUIPMENT
Property and equipment are stated at the lower of cost or net realizable
value. Depreciation and amortization are provided using the straight-line method
over the estimated useful lives of the assets ranging from three to seven years.
Leasehold improvements are depreciated using the straight-line method over the
shorter of the underlying lease term or asset life.
Assets acquired under capital lease arrangements have been recorded at the
present value of the future minimum lease payments and are being amortized on a
straight line basis over the estimated useful life of the asset or lease term,
whichever is shorter. Amortization of this equipment is included in depreciation
and amortization expense.
(J) REVENUE RECOGNITION
The Company's revenue derived from sales and installation of equipment is
recognized upon installation and acceptance by the customer. Fees derived from
servicing installed shipsets is recognized when earned, according to the terms
of the service contract. Revenue pursuant to contracts that provide for revenue
sharing with the airlines and/or others is recognized as cash is received in the
amount of IFT's retained portion of the cash pursuant to the revenue sharing
agreement. Revenue earned pursuant to extended warranty agreements is recognized
ratably over the warranty period.
(K) DEFERRED REVENUE
Deferred revenue represents the gross profit on advance billings of
equipment sales as allowed under installation and extended warranty contracts.
(L) RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred except for
development costs required by a customer contract. Development costs incurred
pursuant to contractual obligations are allocated to aircraft based on seat
installations. These development costs are expensed as cost of goods sold upon
installation of the complete aircraft and acceptance by the customer.
(M) WARRANTY COSTS
The Company provides, by a current charge to income, an amount it estimates
will be needed to cover future warranty obligations for products sold with an
initial warranty period. Revenue and expenses under extended warranty agreements
are recognized ratably over the term of the extended warranty.
F-8
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES -- (CONTINUED)
(N) IMPAIRMENT OF LONG-LIVED ASSETS
The Company records impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
(O) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(P) LOSS PER SHARE
In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
128, "Earnings per Share". SFAS No. 128 replaced the calculation of primary and
fully diluted loss per share with basic and diluted loss per share. Unlike
primary loss per share, basic loss per share excludes any dilutive effects of
options, warrants and convertible securities. Diluted loss per share is very
similar to the previously reported fully diluted loss per share. All loss per
share amounts for all periods have been presented, and where appropriate,
restated to conform to the SFAS No. 128 requirements. Weighted average shares
for purposes of the loss per share calculation do not include 1,066,667 shares
placed in escrow at October 31, 1998 and 1997 due to the fact that they are
contingently issuable and 685,610 and 710,717 stock options outstanding at
October 31, 1998 and 1997, respectively, because their inclusion would have been
anti-dilutive.
(Q) STOCK-BASED COMPENSATION
In accordance with the provisions of Accounting Principals Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), the Company
measures stock-based compensation expense as the excess of the market price at
the grant date over the amount the employee must pay for the stock. The
Company's policy is to generally grant stock options at fair market value at the
date of grant; accordingly, no compensation expense is recognized. As permitted,
the Company has elected to adopt the pro forma disclosure provisions only of
SFAS No. 123, "Accounting for Stock-Based Compensation". See Note 9.
(R) RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 consolidated financial
statements to conform to the 1998 presentation.
(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 date of the financial
statements. Additionally, such estimates and assumptions affect the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates.
F-9
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES -- (CONTINUED)
(T) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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, which will be effective for the Company for the
fiscal year ending October 31, 1999, is currently anticipated to be applicable
for the unrealized gains or losses on investment securities included in the
consolidated statement of stockholders' equity.
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,
which will be effective for the Company for the fiscal year ending October 31,
1999, will 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) INVESTMENTS
A summary of investments by major security type at October 31, 1998 and
1997 follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
OCTOBER 31, 1998
Available-for-sale:
Corporate debt securities................ $3,683,850 $6,754 $ -- $3,690,604
========== ====== ===== ==========
OCTOBER 31, 1997
Held-to-maturity:
Corporate debt securities................ $2,137,084 $ 306 $(131) $2,137,259
========== ====== ===== ==========
</TABLE>
Maturities of securities at October 31, 1998 and 1997 follow:
<TABLE>
<CAPTION>
1998 1997
----------------------- -----------------------
AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Available-for-sale:
Due within one year.................. $1,759,728 $1,762,049 $ -- $ --
Due after one year................... 1,924,122 1,928,555 -- --
---------- ---------- ---------- ----------
$3,683,850 $3,690,604 $ -- $ --
========== ========== ========== ==========
Held-to-maturity:
Due within one year.................. $ -- $ -- $1,697,023 $1,697,062
Due after one year................... -- -- 440,061 440,197
---------- ---------- ---------- ----------
$ -- $ -- $2,137,084 $2,137,259
========== ========== ========== ==========
</TABLE>
A one-time reclassification was made effective October 31, 1998 upon
reassessment of the appropriateness of the classifications of all securities
held. Securities with an amortized cost of $3,683,850 were transferred from
securities classified as held-to-maturity to securities classified as
available-for-sale. The unrealized gain on the securities transferred was
$6,754. The Company
F-10
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
OCTOBER 31, 1998 AND 1997
(2) INVESTMENTS --(CONTINUED)
reclassified the securities since they may be sold in response to needs for
liquidity or changes in interest rates.
(3) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following as of October 31, 1998 and
1997:
1998 1997
---------- ----------
Trade accounts receivable.................... $1,130,648 $4,883,043
Other........................................ 4,694 771,075
---------- ----------
Accounts receivable..................... $1,135,342 $5,654,118
========== ==========
(4) INVENTORIES
Inventories consist of the following as of October 31, 1998 and 1997:
1998 1997
---------- -----------
Raw materials............................... $2,192,442 $ 4,074,492
Work in process............................. 3,439,888 4,828,173
Finished goods.............................. 4,102,702 8,387,991
---------- -----------
9,735,032 17,290,656
Less provision for inventory valuation...... (8,729,605) (11,179,895)
---------- -----------
Inventories, net....................... $1,005,427 $ 6,110,761
========== ===========
(5) ASSETS HELD FOR USE
On July 24, 1998, the Company purchased the assets of Johnny Valet, Inc. a
retail dry cleaning plant in San Diego, California. The Company paid $688,736 in
cash and signed a note payable for $125,000. The non-interest-bearing note is
due on January 10, 1999. The acquisition was accounted for utilizing the
purchase method of accounting with the purchase price being allocated to the
assets acquired and liabilities assumed based on their fair values. The excess
of the purchase price over the fair value of assets acquired of $543,150 was
recorded as goodwill and is being amortized over ten years.
In October 1998, the Company decided to not continue to pursue its strategy
of consolidating the dry cleaning industry and determined that it would sell the
assets of Johnny Valet, Inc. Goodwill was written down by $106,000 to reflect a
reduction in the estimated amortizable life of the goodwill. The net assets held
for use total $699,196 and have been classified as current assets on the
consolidated balance sheet as of October 31, 1998. Operations of Johnny Valet,
Inc. for the period from July 24, 1998 to October 31, 1998 resulted in a loss of
$134,820 net of tax, including goodwill write-downs, and are included in the
consolidated statement of operations for the year ended October 31, 1998.
(6) NOTE RECEIVABLE
On October 21, 1998, the Company loaned Ocean Castle Investments, LLC
(Ocean Castle) $447,939 to execute a block purchase of shares of the Company's
Class A common stock from an unrelated third party. The Company's Chief
Executive Officer is a principal of Ocean Castle. The note bears interest at the
prime rate plus 1% with all interest and principal due October 21, 2001. The
note is secured by 99,542 shares of the Company's Class A common stock.
F-11
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(7) PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of October 31, 1998 and
1997:
1998 1997
---------- -----------
Leasehold improvements...................... $ 237,551 $ 472,901
Purchased software.......................... 149,703 274,617
Furniture................................... 138,609 526,900
Equipment................................... 903,873 2,744,073
Shipsets and shipsets under construction.... -- 8,496,431
---------- -----------
1,429,736 12,514,922
Less accumulated depreciation............... (649,701) (9,555,383)
---------- -----------
Property and equipment, net............ $ 780,035 $ 2,959,539
========== ===========
During the year ended October 31, 1998, the Company recorded equipment
write-offs of $1,006,532 which are included in special charges on the
consolidated statement of operations. The write-offs are principally related to
excess computers, furniture and other equipment that the Company is not
utilizing.
During the year ended October 31, 1997, the Company recorded equipment
write-offs of $1,518,952 which are included in special charges in the
consolidated statement of operations. The write-offs principally related to a
system integration lab utilized in software development and testing. The lab
equipment will not be utilized in the Company's future operations. Additionally,
as of October 31, 1997, shipsets and shipsets under construction were fully
reserved.
(8) ACCRUED LIABILITIES
Accrued liabilities consist of the following as of October 31, 1998 and
1997:
1998 1997
---------- ----------
Accrued development and support costs........ $1,845,915 $2,534,689
Accrued maintenance costs.................... 402,418 1,286,873
Due to related parties (see note 13)......... 880,000 55,000
Other accrued expenses....................... 811,300 1,713,533
---------- ----------
Accrued liabilities..................... $3,939,633 $5,590,095
========== ==========
(9) STOCK OPTION PLANS
In October 1994, the Company adopted a Stock Option Plan (the 1994 Plan)
which provides for the issuance of both incentive and nonqualified stock options
to acquire up to 200,000 shares of the Company's Class A common stock. In
November 1996, the Company amended and restated the 1994 Plan to increase the
maximum shares that may be issued and sold under the plan to 800,000. The
Company has granted options to purchase stock to various parties. All options
were issued at a price equal to or greater than the market price of the
Company's common stock at the date immediately prior to the grant and have a
term of ten years. Options generally become exercisable after one to three years
at the discretion of the Board of Directors. No further options will be granted
under this plan.
F-12
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(9) STOCK OPTION PLANS -- (CONTINUED)
In June 1997, the Company established a 1997 Stock Option Plan (the 1997
Plan). Options exercisable for a total of 500,000 shares of the Company's Class
A common stock are issuable under the 1997 Plan. The 1997 Plan is administered
by the Board of Directors of the Company (or a committee of the Board) which
determines the terms of options granted under the 1997 Plan, including the
exercise price and the number of shares subject to the option. The 1997 Plan
provides the Board of Directors with the discretion to determine when options
granted thereunder shall become exercisable. During fiscal 1998, 240,499 stock
options with up to a three-year vesting period were granted at exercise prices
ranging from $1.875 to $4.50. As of October 31, 1998, 258,557 stock options
under the 1997 Plan remained available for grant.
On February 10, 1998, the Company adopted a plan to reduce the exercise
price on the stock options under the Company's 1994 and 1997 Plans on specified
dates to $2.625 provided the holder is a current employee on the applicable
future dates. The exercise price on one-half of each outstanding option was
reduced to $2.625 on October 10, 1998 pursuant to the plan. A similar reduction
in the exercise price for the remaining half of the options will occur on April
10, 1999, provided the option holder is still employed by the Company at that
time.
During the year ended October 31, 1998, the Company granted stock options
to purchase 33,333 shares of Class A common stock at an exercise price of $4.50
to each of three stockholders of the Company. The options were granted in
exchange for consulting services. See Note 13.
In accordance with the provisions of APB 25, the Company measures
stock-based compensation expense as the excess of the market price at the grant
date over the amount the employee must pay for the stock. The Company's policy
is to generally grant stock options at fair market value at the date of grant,
so no compensation expense is recognized. As permitted, the Company has elected
to adopt the disclosure provisions only of SFAS No. 123.
Had compensation cost for the Company's stock-based compensation plans been
determined consistent with SFAS No. 123, the Company's net loss and net loss per
share on a pro forma basis would be as indicated below:
YEARS ENDED OCTOBER 31,
-----------------------------
1998 1997
----------- ------------
Net loss:
As reported............................. $(7,259,959) $(51,022,312)
=========== ============
Pro forma............................... $(7,666,463) $(53,486,930)
=========== ============
Basic and diluted net loss per share:
As reported............................. $ (1.22) $ (8.89)
=========== ============
Pro forma............................... $ (1.29) $ (9.32)
=========== ============
Pro forma net losses reflect only options granted in fiscal 1998, 1997 and
1996. Therefore, the full impact of calculating compensation cost for stock
options under SFAS No. 123 is not reflected in the pro forma net loss amounts
presented above because compensation cost is reflected over the options' vesting
period and compensation cost for options granted prior to November 1995 are not
considered under SFAS No. 123.
F-13
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(9) STOCK OPTION PLANS -- (CONTINUED)
For purposes of the SFAS No. 123 pro forma net loss and net loss per share
calculations, the fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in fiscal 1998 and 1997:
YEARS ENDED OCTOBER 31,
------------------------
1998 1997
------ ------
Dividend yield.................................. 0% 0%
Expected volatility............................. 71.62% 71.62%
Risk free interest rate......................... 5.65% 6.12%
Expected lives (years).......................... 5.0 5.0
Activity related to the stock option plans is summarized below:
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
------------------------------------------------------
1998 1997
------------------------ ------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE
---------- -------- ---------- --------
<S> <C> <C> <C> <C>
Balance at the beginning of year............. 710,717 $24.15 534,900 $29.43
Granted...................................... 240,499 3.01 282,233 22.32
Exercised.................................... -- -- (2,983) 21.72
Forfeited.................................... (265,606) 21.94 (103,433) 23.82
-------- --------
Balance at the end of year................... 685,610 17.42 710,717 24.15
======== ========
Exercisable at the end of year............... 426,311 24.70 428,928 24.48
======== ========
Weighted-average fair value of options
granted during the year.................... $ 1.91 $ 14.04
======== ========
</TABLE>
The following table summarizes the status of outstanding stock options as
of October 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------- ----------- ------------ -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 1.87 -$13.50....................... 279,029 9.58 $ 4.20 42,533 $10.60
$15.00 -$23.82....................... 7,750 7.83 19.55 5,250 18.94
$24.00................................ 249,582 7.92 24.00 246,113 24.00
$28.86 -$43.14....................... 149,249 7.67 31.00 132,415 30.75
------- -------
685,610 426,311
======= =======
</TABLE>
At the discretion of the Board of Directors, the Company may allow
optionees to elect to receive shares equal to the market value of the option, in
lieu of delivery of the exercise price in cash. The market value of the shares
issued is charged to compensation expense. As a result of optionees selecting
this exercise option, 507 shares of stock were issued upon the exercise of 2,950
options during the fiscal year ended October 31, 1997. Compensation expense of
$13,874 is included in the accompanying consolidated statement of operations for
the year ended October 31, 1997.
(10) BENEFIT PLAN
The Company has adopted a defined contribution benefit plan that complies
with section 401(k) of the Internal Revenue Code and provides for discretionary
Company contributions. Employees who
F-14
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(10) BENEFIT PLAN -- (CONTINUED)
complete three months of service are eligible to participate in the Plan. The
Company did not make any contributions to the Plan for the years ended October
31, 1998 or 1997.
(11) STOCKHOLDERS' EQUITY
The Company's capital stock consists of Class A and Class B common stock.
Holders of Class A common stock have one vote per share and holders of Class B
common stock have six votes per share. Shares of Class B common stock are
automatically convertible into an equivalent number of shares of Class A common
stock upon the sale or transfer of such shares to a non-holder of Class B common
stock.
(A) STOCK REPURCHASE ACTIVITY
In connection with a stock repurchase program authorized by the Board of
Directors on December 17, 1997, the Company purchased a total of 844,667 shares
of the Company's Class A common stock in open market activities at a total cost
of $2,315,983. On October 30, 1998, the Board of Directors authorized another
repurchase program whereby the Company may repurchase up to 666,667 shares of
its Class A common stock on the open market.
(B) ESCROW SHARES
As a condition of the Company's initial public offering in March 1995, the
underwriter required that an aggregate of 1,066,667 shares of the Company's
Class B common stock be designated as escrow shares. The escrow shares are not
assignable or transferable until certain earnings or market price criteria have
been met. If the conditions are not met by January 31, 1999, such shares will be
canceled and contributed to the Company's capital.
Of the escrow shares, 416,667 shares will be released from escrow, on a pro
rata basis, if and only if, one or more of the following conditions is/are met:
* the Company's pretax income, exclusive of extraordinary items amount to
at least $5,900,000 for fiscal 1995 or fiscal 1996, $8,000,000 for fiscal
1997 or $10,100,000 for fiscal 1998;
* the closing bid price of the Company's Class A common stock is in excess
of $48.00 for a 30-day period during the 18-month period following the
public offering or in excess of $60.00 for a 30-day period in the
subsequent 18-month period.
The remaining 650,000 escrow shares will be released from escrow, if and
only if, one or more of the following conditions is/are met:
* the Company's pretax income, exclusive of extraordinary items, amounts to
at least $8,500,000 for fiscal 1995 or fiscal 1996, $11,500,000 for
fiscal 1997 or $14,500,000 for fiscal 1998;
* the closing bid price of the Company's Class A common stock is in excess
of $66.00 for a 30-day period during the 18-month period following the
public offering or in excess of $84.00 for a 30-day period in the
subsequent 18-month period.
The shares will also be released under certain circumstances if the Company
is acquired or merged.
As restrictions on such shares are removed, they will be accounted for as
issued for services rendered and the fair value of such shares will be charged
to operations as compensation expense. Management believes the criteria will not
be met and such shares would then revert to the Company's treasury.
F-15
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(11) STOCKHOLDERS' EQUITY -- (CONTINUED)
(C) WARRANTS
The following table summarizes warrant activity for the years ended October
31, 1998 and 1997:
<TABLE>
<CAPTION>
CLASS B CLASS C CLASS D CLASS E
----------- ------- ------- -------
<S> <C> <C> <C> <C>
Outstanding as of October 31, 1996............ 3,536,482 55,000 55,000 --
Issued in connection with advisory services... -- -- -- 50,000
Issued in connection with amendment of license
agreement................................... -- -- -- 16,667
Exercise of Class B warrants.................. (3,266,587) -- -- --
Redemption of Class B warrants................ (269,895) -- -- --
----------- ------- ------- -------
Outstanding as of October 31, 1997 and
October 31, 1998............................ -- 55,000 55,000 66,667
=========== ======= ======= =======
Exercise price................................ $ 29.25 $ 33.00 $ 42.00 $ 24.00
=========== ======= ======= =======
</TABLE>
Each Class B, Class C, Class D and Class E warrant entitles the holder to
one share of Class A common stock. All outstanding warrants are exercisable as
of October 31, 1998.
On November 22, 1996, the Company offered to the holders of its Class B
warrants to reduce the exercise price of the Class B warrants to $22.50 per
share from $29.25 per share upon the exercise of each Class B warrant exercised
by December 24, 1996. As a result of this offer, 3,266,587 shares of Class A
common stock were issued upon the exercise of 3,266,587 Class B warrants,
yielding net proceeds of approximately $69,100,000, net of commissions and
expenses approximating $4,480,000. Previously on October 23, 1996, the Company
had notified the remaining Class B warrant holders of its intent to call all
outstanding Class B warrants for redemption on January 17, 1997. The Company
redeemed 269,895 Class B warrants at $.15 per warrant.
In November 1996, the Company issued stock purchase warrants to purchase
50,000 shares of Class A common stock at $29.63 per share to Houlihan Lokey
Howard & Zukin in exchange for advisory services. The exercise period of the
warrants expires in November 2001. On January 6, 1997, the Company lowered the
exercise price of the stock purchase warrants to $24 per share, such price being
the trading price of the Class A common stock at the close of the previous
business day.
In November 1996, the Company issued stock purchase warrants to purchase
16,667 shares of Class A common stock at $32.25 per share in connection with the
amendment and restatement of a License Agreement with FortuNet. The exercise
period of the warrants expires in November 2001. On January 6, 1997, the Company
lowered the exercise price of the stock purchase warrants to $24 per share, such
price being the trading price of the Class A common stock at the close of the
previous business day.
(D) UNIT PURCHASE OPTIONS
In conjunction with the Company's initial public offering in March 1995,
the Company agreed to sell to the underwriter and its designees, for nominal
consideration, a unit purchase option to purchase up to 93,333 units. Each unit
consists of one share of Class A common stock, one redeemable Class A warrant
and one redeemable Class B warrant. The warrants are not subject to redemption
by the Company unless, on the redemption date, the unit purchase option has been
exercised and the underlying warrants are outstanding. The unit purchase option
is exercisable during the four-year period commencing one year from the date of
the initial public offering at an exercise price of $18.00 per unit, subject to
certain events.
F-16
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(12) INCOME TAXES
Income tax benefit differed from the amounts computed by applying the U.S.
Federal corporate income tax rate of 34% to net loss as a result of the
following:
1998 1997
----------- ------------
Computed expected tax benefit...................... $ 2,468,386 $ 17,347,586
Change in valuation allowance...................... (2,127,293) (17,328,254)
Nondeductible severance payments................... (416,498) --
Other.............................................. 75,405 (19,332)
----------- ------------
$ -- $ --
=========== ============
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax asset are presented below:
1998 1997
----------- ------------
Deferred tax assets:
Net operating loss carryforward.................. $18,836,132 $ 13,014,307
Property and equipment........................... 1,135,837 3,088,482
Deferred start-up costs.......................... 825,091 1,159,948
Accrued product warranty costs................... 1,825,463 1,567,634
Issuance of stock options and warrants........... 864,577 866,879
Provision for inventory valuation................ 2,968,066 3,801,164
Accrued liabilities.............................. 1,198,426 1,299,329
Deferred revenue................................. 154,027 810,527
Other............................................ 133,205 205,261
----------- ------------
27,940,824 25,813,531
Less valuation allowance........................... (27,940,824) (25,813,531)
----------- ------------
Net deferred tax asset..................... $ -- $ --
=========== ============
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management has provided a
valuation allowance for 100% of the deferred tax assets as the likelihood of
realization cannot be determined. As of October 31, 1998, the Company has a net
operating loss (NOL) carryforward for federal income tax purposes of
approximately $55,400,000, which begins to expire in 2009, and a research and
experimentation tax credit of approximately $247,000. The Company likely
underwent a change in ownership in accordance with Internal Revenue Code Section
382, the effect of which has not yet been determined by the Company. This change
would effect the timing of the utilization of the NOL, as well as the amount of
the NOL which may ultimately be utilized, though it is not expected to
materially effect the amount of the NOL carryforward.
(13) RELATED PARTY TRANSACTIONS
During the year ended October 31, 1998, the Company executed severance
agreements with three former officers, pursuant to which the Company paid the
former officers $3,053,642. In addition, the
F-17
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(13) RELATED PARTY TRANSACTIONS -- (CONTINUED)
Company executed consulting agreements with the three former officers with
varying terms expiring through September 1999. The consulting agreements require
payments totaling $735,000 over the various terms. As of October 31, 1998,
$133,750 has been paid under the consulting agreements, $175,000 has been
included in accrued liabilities in the consolidated balance sheet and $308,750
has been included in general and administrative expenses in the consolidated
statement of operations. Additionally, the Company's stockholders' agreement
with principal stockholders covering certain corporate governance matters was
canceled.
The Company's Chief Executive Officer is a principal of Ocean Castle
Investments, LLC (Ocean Castle) which maintains administrative offices for the
Company's Chief Executive Officer, Corporate Secretary and certain other
employees of the Company. The Company has an agreement with Ocean Castle whereby
the Company will pay for all reasonable and ordinary expenses incurred by Ocean
Castle in operating such offices and furthering the Company's business.
During the year ended October 31, 1998, Ocean Castle executed consulting
agreements with two principal stockholders of the Company. The rights and
obligations of Ocean Castle under the agreements were assumed by the Company.
The consulting agreements require payments aggregating $1,000,000 to each of the
consultants through December 2003 in exchange for advisory services. Each of the
consultants also received stock options to purchase 33,333 shares of Class A
common stock at an exercise price of $4.50. Additionally, the Company also
granted stock options to purchase 33,333 shares of Class A common stock at an
exercise price of $4.50 to another stockholder of the Company. The options were
granted in exchange for consulting services.
During the year ended October 31, 1998, the Company extended by one year a
consulting agreement with a former officer of the Company pursuant to which the
Company will pay $55,000 for services received during the period November 1999
through October 2000.
The Company has entered into a consulting agreement with First Lawrence
Capital Corp. (First Lawrence) to perform various financial advisory services
related to ongoing business development and management. The managing director of
First Lawrence is also a director of the Company. After the date of the
independent auditors' report, the Company retained, on a full time basis as
President and Chief Operating Officer, the services of the managing director of
First Lawrence effective December 12, 1998. Accordingly, the Company will enter
into an employment contract with such individual. During the year ended October
31, 1998, the Company paid $11,846 under the First Lawrence consulting
agreement. The Company executed a consulting agreement with the Whitestone
Group, LLC, a shareholder of First Lawrence. Pursuant to the agreement, the
Company will pay $250,000 for consulting services received during fiscal 1998.
The Company has an Intellectual Property License and Support Services
Agreement (the License Agreement) for certain technology with FortuNet, Inc.
(FortuNet). FortuNet is owned by a principal stockholder and previous director
of the Company. The License Agreement provides for an annual license fee of
$100,000 commencing in October 1994 and continuing through November 2002. The
Company paid FortuNet $100,000 during each of the years ended October 31, 1998
and 1997. As of October 31, 1998, the remaining commitment of $400,000 is
included in accrued liabilities on the consolidated balance sheet.
The Company had a letter agreement dated May 28, 1996 with a specialty
investment-banking firm (the Firm) to act as the Company's financial advisor.
The senior managing director of this Firm is also a former director of the
Company. The Company paid the Firm $811,687 during the year ended October 31,
1997.
F-18
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(13) RELATED PARTY TRANSACTIONS -- (CONTINUED)
The Company had a consulting agreement with Worldwide Associates
(Worldwide) to perform various consulting services. The chairman and president
of Worldwide is also a former director of the Company. The Company paid
Worldwide $56,063 during the year ended October 31, 1997.
In November 1996, the Company executed a Strategic Alliance Agreement
(Alliance Agreement) with Hyatt Ventures, Inc. (Hyatt), an affiliate of Hyatt
Corporation. The president of Hyatt is also a former director of the Company.
Under the terms of the Alliance Agreement, Hyatt, directly and through certain
of its affiliates, agreed to use its best commercial efforts to assist the
Company in advancing the Company's business with respect to the entertainment
network. The Alliance Agreement was terminated in November 1997 as a result of
changing market conditions. In January 1997, the Company issued 20,000
unregistered shares of Class A common stock to Hyatt in connection with Hyatt
acting as a guarantor on behalf of the Company in certain contract negotiations.
As a result of the stock issuance, a charge of $466,875 is included in the
consolidated statement of operations for the year ended October 31, 1997.
During the year ended October 31, 1996, the Company executed severance
agreements with three former officers pursuant to which the Company will pay
severance of $752,500 over a three-year period. As of October 31, 1998, $55,000
remains to be paid under these agreements.
(14) COMMITMENTS AND CONTINGENCIES
(A) LAWSUIT
On March 6, 1998, the Company was named as a nominal defendant in a
derivative action filed in the Supreme Court of the State of New York, County of
New York, entitled Barington Capital Group, L.P. et al. v. Yuri Itkis et al.
(No. 98103878). The lawsuit named ten former officers and directors of the
Company and alleged various breaches of fiduciary duty. On October 21, 1998, the
Company settled the lawsuit with Barington Capital Group, L.P. ("Barington"). As
part of the settlement, the Company engaged Barington to provide investment
banking services for a period of twelve months and has paid Barington a retainer
of $250,000 and a twelve-month consulting fee of $360,000. The Company also paid
Barington $150,000 for reimbursement of litigation and proxy solicitation
expenses. The agreement requires the payment of additional fees should the
Company utilize the services of Barington through October of 1999.
(B) LEASE OBLIGATIONS
The Company leases office space and furniture under operating and capital
leases that expire at various dates through August 2000. The future minimum
lease commitments under these leases and sublease rentals are as follows:
F-19
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(14) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
CAPITAL OPERATING SUBLEASE
YEAR ENDING OCTOBER 31, LEASES LEASES RENTALS
- ------------------------ ------- --------- --------
1999............................................ $80,548 $ 459,008 $ 53,550
2000............................................ -- 48,970 --
------- --------- --------
Total minimum lease payments.................... 80,548 $ 507,978 $ 53,550
========= ========
Less amount representing interest............... (3,708)
-------
Present value of net minimum lease payments..... $76,840
=======
Rental expense under operating leases totaled $960,745 and $920,412 for the
years ended October 31, 1998 and 1997, respectively.
Amounts capitalized under capital lease agreements are as follows as of
October 31, 1998 and 1997:
1998 1997
--------- --------
Furniture.............................................. $ 302,085 $302,085
Less accumulated amortization.......................... (293,794) (83,334)
--------- --------
$ 8,291 $218,751
========= ========
(C) SALES COMMITMENTS AND SPECIAL CHARGES
The Company has entered into sales contracts with three airlines,
Schweizerische Luftverkehr AG (Swissair), Debonair Airways, Ltd. (Debonair) and
Alitalia Airlines, S.p.A. (Alitalia) for the manufacture and installation of its
in-flight entertainment network, and to provide hardware and software upgrades,
as defined in the agreements.
Pursuant to an agreement with Swissair, Swissair purchased shipsets for the
first and business class sections of sixteen aircraft for an average of $1.7
million per aircraft. Included in the purchase price was material, installation,
maintenance through September 1998, one-year warranty and upgrade costs for the
sixteen aircraft. As of October 31, 1998, the Company had completed
installations of the entertainment network on all of these aircraft. The
agreement also required the Company to install the entertainment network in the
first, business and economy class sections of three additional aircraft, at no
charge to Swissair. The Company was responsible for all costs including
entertainment network components, installation and maintenance through September
1998 for the three aircraft. As of October 31, 1998, the Company had completed
installations of the entertainment network on all of these aircraft and title to
each of these three shipsets had been transferred to Swissair. The estimated
material, installation, maintenance and one-year warranty and upgrade costs for
these three shipsets of $14,292,404 is included in the accompanying consolidated
statement of operations as a special charge for the year ended October 31, 1997.
During the fiscal year ended October 31, 1998, the Company recognized a recovery
of special charges of $606,508. The recovery of special charges resulted from a
reduction in the number of entertainment networks requiring maintenance in the
economy class sections of the Swissair aircraft and a reduction in development
expenses. The Company has also entered into two letters of intent with Swissair.
The first relates to a $4,700,000 order for first and business class
installations on four Swissair MD-11 aircraft that are being added to the
Swissair fleet.
F-20
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(14) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
The Company has also received a letter of intent from Swissair to extend the
warranty on all installed systems for a second and third year at a price of
$3,975,000. On December 9, 1998, the Company received notice form Swissair
stating their intent to cancel the order for the four additional installations.
As a result, the Company and Swissair are engaged in discussions regarding
outstanding financial matters. The Swissair agreement also subjects the Company
to certain penalties, which could be substantial, if the entertainment networks
do not meet certain operational reliability criteria.
On October 29, 1998, the Company was notified by Swissair of its decision
to deactivate the entertainment networks on all Swissair aircraft. Swissair told
the Company that this precautionary action was taken in response to recent
technical investigations conducted by the Canadian Transportation Safety Board
following the crash of Swissair Flight No. 111 on September 2, 1998 off the
coast of Nova Scotia. However, based on investigation findings, the Company has
been informed by representatives of the Canadian Transportation Safety Board and
Swissair that its entertainment network has not been related, in any way, to the
cause of the crash of Swissair Flight No. 111. The Company and its system
integrator/installation contractor are working closely with Swissair to take the
necessary steps that will allow Swissair to reactivate the systems as quickly as
possible.
Pursuant to an agreement with Debonair, the Company was to manufacture,
install, operate, and maintain the entertainment network on six Debonair
aircraft for a period of eight years from installation. In February 1998, the
Company and Debonair signed a Termination Agreement. Pursuant to the agreement,
Debonair removed the entertainment network from its aircraft and the Company
paid Debonair $134,235 as full and final settlement of all of its obligations
with Debonair. Included in the accompanying consolidated statement of operations
for the year ended October 31, 1997 are special charges of $956,447 for the cost
of the first completed shipset and $2,881,962 to write-down all inventory
related to the Debonair program.
In connection with these current agreements with Swissair and Debonair and
the absence of any new entertainment network orders for the Company, property
and equipment write-downs of $1,006,532 and $1,518,952 were recorded as special
charges during fiscal 1998 and 1997, respectively.
Pursuant to an agreement with Alitalia, the Company delivered five first
generation shipsets for installation on Alitalia aircraft during fiscal 1996.
Alitalia has notified the Company that it does not intend to continue operation
of the shipsets, and the Company has indicated that it will not support the
shipsets. As of October 31, 1998, the Company has accrued for estimated product
warranty costs that were to be incurred under the original agreement.
(D) PURCHASE COMMITMENTS
As of October 31, 1998, the Company had approximately $1,800,000 of
purchase commitments with various vendors in anticipation of the fulfillment of
the Company's sales commitments.
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 "Disclosure about Fair
Value of Financial Instruments" requires that the Company disclose estimated
fair values for its financial instruments. The following summary presents a
description of the methodologies and assumptions used to determine such amounts.
Fair value estimates are made at a specific point in time and are based on
relevant market information and information about the financial instrument; they
are subjective in nature and involve
F-21
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED)
uncertainties, matters of judgment and, therefore, cannot be determined with
precision. These estimates do not reflect any premium or discount that could
result from offering for sale, at one time, the Company's entire holdings of a
particular instrument. Changes in assumptions could significantly affect these
estimates.
Since the fair value is estimated as of October 31, 1998, the amounts that
will actually be realized or paid at settlement or maturity of the instruments
could be significantly different.
The carrying amount of cash and cash equivalents approximates fair value
because their maturity is generally less than three months. The fair value of
investment securities is approximately $3,690,604. The carrying amount of
accounts receivable, accounts payable and accrued liabilities approximate fair
value as they are expected to be collected or paid within ninety days of
year-end. The fair value of capital lease obligations and note payable
approximate the terms in the marketplace at which they could be replaced.
Therefore, the fair value approximates the carrying value of these financial
instruments.
(16) RISK RELATED TO CONCENTRATION IN THE VOLUME OF BUSINESS
Sales of entertainment networks by the Company are typically made to a
relatively few number of customers. This concentration of business among a few
customers exposes the Company to significant risk. For the year ended October
31, 1998, one customer accounted for 98% of the Company's sales and outstanding
accounts receivable from this customer was approximately $1,100,000. For the
year ended October 31, 1997, one customer accounted for 95% of the Company's
sales and outstanding accounts receivable from this customer were approximately
$4,900,000.
(17) SUPPLEMENTAL FINANCIAL INFORMATION
A summary of additions and deductions related to the provisions for
doubtful accounts and inventory valuation for the years ended October 31, 1998
and 1997 are as follows:
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING END
OF YEAR ADDITIONS DEDUCTIONS OF YEAR
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
PROVISIONS FOR DOUBTFUL ACCOUNTS:
Year ended October 31, 1998....... $ -- $ -- $ -- $ --
=========== =========== ========== ===========
Year ended October 31, 1997....... $ 1,732,377 $ 216,820 $1,949,197 $ --
=========== =========== ========== ===========
</TABLE>
During the year ended October 31, 1998, the Company recorded a provision
for doubtful accounts of $9,869 which is included in assets held for use.
<TABLE>
<S> <C> <C> <C> <C>
PROVISIONS FOR INVENTORY VALUATION:
Year ended October 31, 1998....... $11,179,895 $ -- $2,450,290 $ 8,729,605
=========== =========== ========== ===========
Year ended October 31, 1997....... $ -- $11,179,895 $ -- $11,179,895
=========== =========== ========== ===========
</TABLE>
F-22
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(17) SUPPLEMENTAL FINANCIAL INFORMATION -- (CONTINUED)
Supplemental disclosure of cash flow information is as follows:
YEARS ENDED OCTOBER 31,
-----------------------
1998 1997
---------- --------
Cash paid for interest................................ $ 11,954 $ 13,423
======== ========
Noncash investing and financing activities:
Acquisition:
Fair value of assets acquired.................... $813,736 $ --
Cash paid........................................ 688,736 --
Note payable..................................... 125,000 --
======== ========
Capital lease obligations incurred.................. $ -- $210,678
======== ========
Issuance of stock under stock option plan pursuant
to cashless exercise option...................... $ -- $ 13,874
======== ========
Issuance of stock for services received............. $187,729 $466,875
======== ========
Certain assets including accounts receivable, prepaid expenses, and
property and equipment totaling $699,196 have been reclassified in the October
31, 1998 consolidated balance sheet to assets held for use.
F-23
<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
--------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarter ended April 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______ to _______
Commission File No. 0-25668
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
-----------------------------------------------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 11-3197148
- ------------------------------- ----------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation of Organization) Identification Number)
4041 North Central Avenue
Suite B-200
Phoenix, Arizona 85012
----------------------------------------
(Address of Principal Executive Offices)
(602) 200-8900
------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding at June 7, 1999
----- ---------------------------
Class A Common Stock, $.01 par value 5,342,117 shares
Class B Common Stock, $.01 par value 118,519 shares
Transitional Small Business Disclosure Format
Yes [ ] No [X]
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Index to Consolidated Financial Statements
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of April 30, 1999
(unaudited) and October 31, 1998 (audited).......................... 3
Condensed Consolidated Statements of Operations for the Three
Months and Six Months Ended April 30, 1999 and 1998 (unaudited)..... 4
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended April 30, 1999 and 1998 (unaudited).................... 5
Notes to Condensed Consolidated Financial Statements................ 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................. 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................... 18
Item 6. Exhibits and Reports on Form 8-K.................................... 18
SIGNATURES................................................................... 20
2
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
April 30, October 31,
Assets 1999 1998
------------ ------------
(unaudited)
Current assets:
Cash and cash equivalents $ 19,732,520 $ 27,914,551
Restricted cash 581,525 1,039,311
Short-term investment securities 7,990,056 1,762,049
Accounts receivable, net 1,281,255 1,135,342
Note receivable from related party -- 447,939
Inventories, net 1,513,298 1,005,427
Prepaid expenses 439,143 567,601
Assets held for use 522,591 699,196
Other current assets 1,042,707 379,046
------------ ------------
Total current assets 33,103,095 34,950,462
------------ ------------
Investment securities 1,674,132 1,928,555
Property and equipment, net 636,113 780,035
Notes receivable, long-term 1,050,000 --
Other assets 1,097,038 605,150
------------ ------------
Total assets $ 37,560,378 $ 38,264,202
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,051,358 $ 1,447,815
Accrued liabilities 2,299,090 4,016,473
Deferred revenue 2,158,028 453,022
Accrued product warranties 3,836,471 5,369,008
Note payable -- 125,000
------------ ------------
Total current liabilities 9,344,947 11,411,318
------------ ------------
Stockholders' equity:
Preferred stock, par value $0.01 per share,
5,000,000 shares authorized, none issued -- --
Class A common stock, one vote per share,
par value $0.01 per share, 40,000,000 shares
authorized; 5,342,117 and 6,125,908 shares
issued, respectively 53,421 61,259
Class B common stock, six votes per share,
par value $0.01 per share, 4,000,000 shares
authorized; 118,519 and 1,244,445 shares issued
and outstanding respectively 1,185 12,445
Additional paid-in capital 110,078,500 112,371,141
Accumulated other comprehensive income:
Net unrealized gains on investment securities 2,373,893 6,754
Accumulated deficit (84,097,578) (83,282,732)
Treasury stock, at cost; 78,600 and 844,667
shares, respectively (193,990) (2,315,983)
------------ ------------
Total stockholders' equity 28,215,431 26,852,884
------------ ------------
Total liabilities and stockholders' equity $ 37,560,378 $ 38,264,202
============ ============
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
Unaudited
<TABLE>
<CAPTION>
Three Months Six Months
Ended April 30, Ended April 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Equipment sales $ -- $ 4,569,337 $ -- $ 17,860,563
Service income 301,990 162,825 626,748 281,264
------------ ------------ ------------ ------------
301,990 4,732,162 626,748 18,141,827
------------ ------------ ------------ ------------
Costs and expenses:
Cost of equipment sales -- 3,768,459 -- 15,335,854
Reversal of warranty, maintenance
and commission accruals (1,986,972) -- (1,986,972) --
Cost of service income 187,705 7,257 374,147 12,957
Expenses associated with investments -- -- 300,000 --
Research and development expenses -- 482,389 -- 1,092,316
General and administrative expenses 1,764,202 1,271,967 3,645,151 2,878,398
------------ ------------ ------------ ------------
(35,065) 5,530,072 2,332,326 19,319,525
------------ ------------ ------------ ------------
Operating profit (loss) 337,055 (797,910) (1,705,580) (1,177,698)
Other:
Interest income 401,710 526,180 844,686 1,071,312
Interest expense (1,191) (3,234) (2,880) (6,995)
Other income 19,350 500 48,926 500
------------ ------------ ------------ ------------
Net income (loss) 756,924 (274,464) (814,846) (112,881)
============ ============ ============ ============
Basic and diluted net income (loss)
per share $ 0.14 $ (0.05) $ (0.15) $ (0.02)
============ ============ ============ ============
Weighted average shares outstanding 5,493,698 5,997,656 5,427,612 6,121,234
============ ============ ============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
Unaudited
<TABLE>
<CAPTION>
Six Months Ended April 30,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (814,846) $ (112,881)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Provision for doubtful accounts 18,778 --
Depreciation and amortization 205,270 641,419
Reversal of warranty, maintenance and commission accruals 1,986,972 --
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (133,894) 5,109,893
Decrease (increase) in inventories (507,871) 5,003,382
Increase in prepaid expenses, other current assets,
other assets and notes receivable (1,620,701) (616,121)
Decrease in accounts payable (396,159) (3,868,360)
Decrease in notes payable (125,000) --
Decrease in accrued liabilities (863,559) (218,437)
Increase (decrease) in deferred revenue 1,705,006 (2,193,060)
Decrease in accrued severance costs -- (27,500)
Increase (decrease) in accrued product warranties (251,304) 2,245,816
------------ ------------
Net cash provided by (used in) operating activities (4,771,252) 5,964,151
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (39,686) (26,390)
Proceeds from sale of equipment 10,805 --
Purchases of investment securities (6,338,159) (1,305,593)
Maturities of investment securities 1,049,995 234,615
Proceeds from sale of investment securities 1,681,720 --
Decrease in restricted cash 457,786 --
------------ ------------
Net cash used in investing activities (3,177,539) (1,097,368)
------------ ------------
Cash flows from financing activities:
Payments on capital lease obligations (43,494) (39,371)
Purchases of treasury stock (193,990) (1,010,979)
Employee stock option purchase 4,244 --
------------ ------------
Net cash used in financing activities (233,240) (1,050,350)
------------ ------------
Increase (decrease) in cash and cash equivalents (8,182,031) 3,816,433
Cash and cash equivalents at beginning of period 27,914,551 36,890,454
============ ============
Cash and cash equivalents at end of period $ 19,732,520 $ 40,706,887
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(1) Basis of Presentation
The accompanying condensed consolidated financial statements include the
accounts of Interactive Flight Technologies, Inc. and its wholly owned
subsidiary (the "Company"). All intercompany balances and transactions have been
eliminated in consolidation. Certain reclassifications have been made to the
amounts in the October 31, 1998 Balance Sheet to conform with the April 30, 1999
presentation.
The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles, pursuant
to the rules and regulations of the Securities and Exchange Commission. In the
opinion of management, the accompanying condensed consolidated financial
statements reflect all adjustments (consisting of normal recurring accruals)
which are necessary for a fair presentation of the results for the interim
periods presented. Certain information and footnote disclosures normally
included in financial statements have been condensed or omitted pursuant to such
rules and regulations. It is suggested that these condensed consolidated
financial statements be read in conjunction with the financial statements and
notes thereto for the fiscal year ended October 31, 1998, included in the
Company's Annual Report on Form 10-KSB.
The results of operations for the three months and six months ended April
30, 1999 are not necessarily indicative of the results to be expected for the
entire fiscal year.
In the period ended April 30, 1999, the Company revised certain warranty,
maintenance and commission accruals that were recorded in prior fiscal years
which totaled $1,986,972. Such adjustments to prior period estimates resulted
from an evaluation of specific contractual obligations and discussions between
the new management of the Company and other parties related to such contracts.
Based on the results of the Company's findings during this quarter, such
accruals were no longer considered necessary.
(2) Stockholders' Equity
(a) Stock Repurchase Program
On October 30, 1998, the Board of Directors authorized the Company to
repurchase up to 666,667 more shares of its Class A Common Stock on the open
market. On January 11, 1999 the Company retired 844,667 shares of Class A Common
Stock which were repurchased pursuant to a previous stock repurchase program
authorized by the Board of Directors and held in treasury. As of April 30, 1999,
the Company had repurchased an additional 78,600 shares at prices ranging from
$1.49 to $2.94 per share for a total cost of $193,990.
(b) Reverse Stock Split
On October 30, 1998, the stockholders of the Company approved a
one-for-three reverse stock split of the Company's Class A common stock and
Class B common stock. One share was issued for three shares of common stock held
by stockholders of record as of the close of business on November 2, 1998.
6
<PAGE>
All references to the number of common shares, per share amounts and stock
option data elsewhere in the condensed consolidated financial statements and
these notes have been restated as appropriate to reflect the effect of the
reverse split for all periods presented.
(c) Earnings (Loss) Per Share
Basic earnings (loss) per share is computed using the weighted average
number of common shares outstanding during each period presented as shown in the
accompanying condensed consolidated statements of operations. Diluted earnings
(loss) per share is the same as basic earnings (loss) per share for all periods
presented due to the immaterial amount of common stock equivalents for the three
months ended April 30, 1999 and due to the antidilutive nature of such common
stock equivalents for the other periods presented.
(3) Investments
(a) U.S. Wireless Corporation
On March 4, 1999, the Company made a $3.0 million investment in U.S.
Wireless Corporation ("U.S. Wireless") (NASDAQ: USWC). U.S. Wireless provides
wireless network infrastructure add-on systems for the emerging wireless
Geo-location services marketplace. In exchange for its investment, the Company
received 30,000 shares of Series B Preferred Stock of U.S. Wireless ("Series B
Preferred"). Each share of the Series B Preferred of U.S. Wireless is
convertible into 100 shares of Common Stock of U.S. Wireless, at the option of
the Company, at any time commencing 90 days after the Closing Date; however,
should the Company voluntarily convert prior to March 2000, the Series B
converts into approximately 67 shares of Common Stock of U.S. Wireless. The
Series B Preferred Stock is also subject to mandatory conversion into Common
Stock at any time at a conversion rate of 100 shares of Common Stock of U.S.
Wireless in the event the closing price for U.S. Wireless' Common Stock as
reported on the NASDAQ is at least $5.00 per share for 30 consecutive trading
days. The Series B Preferred Stock entitles the Company to $100 per share
liquidation preference before any distributions to the holders of Common Stock
of U.S. Wireless in the event of a liquidation of U.S. Wireless. In addition,
the Company and other holders of the Series B Preferred Stock have, as a
separate class, elected one member to U.S. Wireless' Board of Directors and one
additional individual as an observer to such Board. As a condition to making the
investment, the Company also obtained certain registration rights relating to
the registration under the Securities Act of 1933 of those shares of Common
Stock of U.S. Wireless into which the Series B Preferred Stock is convertible.
The Series B Preferred is classified as a short-term investment security at its
fair market value as of April 30, 1999. Unrealized gains on this investment are
reflected as a separate component of stockholders' equity. Fair market value was
determined on an as-converted basis on April 30, 1999 into 2,000,000 shares of
USWC common stock at a per share price of $2.688, resulting in a total fair
market value of $5,376,000.
(b) Inter Lotto (UK) Ltd.
On May 5, 1999, the Company completed the acquisition of a 27.5% equity
interest in Inter Lotto (UK) Ltd. ("ILL"). ILL has a license with the exclusive
right to provide for the operation of daily lotteries in Great Britain, by way
of a management contract with an outside third party, and will be responsible
for developing, installing, marketing and operating the lottery, selecting the
game and managing the network. In exchange, the Company will receive a
percentage of the revenues generated by the sale of lottery tickets. ILL is a
company licensed, by the Gaming Board for Great Britain, to operate daily
lotteries on behalf of United Kingdom Charities.
7
<PAGE>
As of April 30, 1999 the Company has advanced ILL $428,364 to fund
operational obligations of ILL in accordance with a November 9, 1998 letter of
intent. Such advances have been classified in Other Assets. In addition, the
Company has paid ILL a standstill fee of $150,000 which was expensed in the
fiscal quarter ended January 31, 1999.
Further, the Company had deposited $487,500 into an escrow account prior to
April 30, 1999, which deposit is classified as an Other Current Asset. On May 5,
1999, $325,540 and $161,960, respectively were distributed out of escrow to
obtain the 27.5% interest in ILL from an unrelated third party and to fund a
newly formed wholly-owned subsidiary of the Company in the United Kingdom.
(4) Comprehensive Income
The Company has adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" which establishes standards for the
reporting and presentation of comprehensive income and its components in
financial statements. Comprehensive income encompasses net income and "other
comprehensive income", which includes all other non-owner transactions and
events which change stockholders' equity. Other comprehensive income consists
only of net unrealized gains on investment securities for the Company and
totaled $2,370,792 and $2,367,139 for the three and six months ended April 30,
1999, respectively.
(5) Contingencies
Phillip J. Arnaldi, Individually as surviving father and in his
representative capacity as the Administrator of the Estate of Adrienne Valerie
Neuweiler, deceased v. SAIR Group, Swissair Transport Company, Ltd., SR Technics
Ltd., Delta Airlines, Inc., McDonnell Douglas Corporation, The Boeing Company
and Interactive Flight Technologies, Inc., United States District Court, Eastern
District of New York, CV 99-1265 - The family of a victim of the air crash
involving Swissair Flight No. 111 has alleged that the IFT in-flight
entertainment system aboard the involved MD-11 was improperly installed and a
cause of the crash. IFT denies all liability and has tendered the defense of
this claim to its avionics insurer who has accepted the defense and is
vigorously defending the claim.
First Lawrence Capital Corp. v. James Fox, Irwin Gross, Interactive Flight
Technologies, Inc., and John Doe Nos. 1 through 10. Supreme Court of the State
of New York, County of Westchester, No. 7196/99 - This is an unliquidated claim
by an investment banking firm that alleges its former employee, James Fox,
wrongfully brought certain corporate opportunities to IFT when he left his
employment with First Lawrence. IFT denies the allegations of the Complaint and
is vigorously defending the claim.
See Part II., Item 1. Legal Proceeding.
(6) Subsequent Events
(a) The Network Connection, Inc.
As of April 30, 1999, The Network Connection, Inc. ("TNCi") was indebted to
the Company in the approximate principal amount of $750,000. On May 10, 1999,
TNCi executed a Fourth Allonge to the Secured Promissory Note evidencing such
loan. Pursuant to such Fourth Allonge the balance due from TNCi to the Company
became convertible into shares of TNCi's Series C 8% Convertible Preferred
Stock, par value $.01 per share, $1,000 per share (the "Series C Preferred") at
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a conversion price of $1,000 per share. The Series C Preferred, in turn, is
convertible into common stock of TNCi as described in the Series C Designations.
As additional consideration for the Note, the Company received warrants to
purchase 200,000 shares of the common stock of TNCi at an average price per
share of $3.04. The warrants expire in 2004.
On May 11, 1999, the Company acquired from a third party investor 1,500
shares of Series B 8% Convertible Preferred Stock of TNCi, par value $.01 per
share, stated value $1,000 per share (the "Series B Shares") and cash in the
amount of $1,030,000 in exchange for (a) 3,000 shares of the Company's Series A
8% Convertible Preferred Stock, par value $.01 per share, stated value $1,000
per share and (b) warrants to purchase 87,500 shares of the Company's Class A
Common Stock, $.01 par value per share, at an exercise price of $3.00 per share.
On May 17, 1999, the Company acquired 1,055,745 shares of the common stock
and 2,495,400 shares of the Series D Convertible Preferred Stock of TNCi, par
value $.01 per share, stated value $10 per share, pursuant to the terms of the
Asset Purchase and Sale Agreement (the "Agreement") by and between the Company
and TNCi dated April 29, 1999 (the "Transaction"). The consideration paid by the
Company for all of such shares consisted of certain assets relating to the
Company's Interactive Entertainment Division, including all fixed assets,
inventory, intellectual property rights and other intangibles, prepaid expenses
and other property of the Company used in such division, plus cash in the amount
of $4,250,000. The cash which comprised a portion of the assets transferred to
TNCi was taken from the Company's working capital reserves. As part of the
Transaction, TNCi also assumed certain liabilities related to the the Company
assets transferred.
The TNCi common shares acquired by the Company in the Transaction, when
combined with the number of TNCi common shares into which the shares of Series D
Convertible Preferred Stock acquired by the Company in the Transaction can be
converted, equal 60% of all of the then outstanding common stock of TNCi on a
fully diluted basis, as defined in the Agreement. However, TNCi does not
currently have a sufficient number of common shares authorized to permit such a
conversion. The common stock of TNCi trades on the NASDAQ Small Cap Market under
the symbol "TNCX."
Each share of common stock of TNCi is entitled to one vote. Each share of
Series D Convertible Preferred Stock of TNCi is entitled to six votes; however,
notwithstanding the voting rights, the shares of Series D Convertible Preferred
Stock cannot be voted if the number of voting shares which would then be held by
TNCi as a result of the Transaction would exceed 19.99% of the voting shares
then outstanding until the TNCi shareholders have approved of the Transaction or
until July 15, 1999, whichever first occurs.
TNCi develops and manufactures networked computer systems to provide
customers with interactive, video-on-demand information and entertainment
content on commercial aircraft, cruise ships, and trains. TNCi has also sold
multimedia servers and has networked customer computers to educational
institutions and to corporations to support interactive, video-based training
programs.
(b) Mexican Entertainment and Gaming Activities
On May 14, 1999, the Company loaned $1,600,000 (of which $300,000 was
advanced on February 25, 1999) to a Mexican Corporation which was formed for the
purpose of operating a gaming and entertainment center in Monterrey, Nuevo Leon,
Mexico. The loan bears interest at a rate equal to the Prime Rate plus three
percent (3%) and matures on April 30, 2001.
The Company has also issued a letter of credit in the amount of $950,000 to
secure repayment of the purchase price of certain gaming equipment to be
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acquired by the Company and leased to the Mexican Corporation. The Mexican
Corporation will lease such equipment from the Company at the rate of $37,500
per month until the earlier of (i) the waiver or release of the requirement that
the Company maintain such letter of credit or (ii) the payment in full by the
Company of the purchase price, including all finance charges, of such equipment.
Thereafter, the Mexican Corporation will pay as rent for the equipment the sum
of $25,000 per month for as long as it uses any of the machines, provided that
the Mexican Corporation's obligation to pay such $25,000 per month fee shall
continue at least (i) until such time as the Company has paid the purchase price
for the equipment, or (ii) May 14, 2001.
In consideration for making the loan and issuing the letter of credit, the
Company has been issued 24.5% of the capital stock of the Mexican Corporation
and the Company will receive 25% of all of the profits generated by the Mexican
Corporation. Furthermore, for a term of ten years following the closing of the
loan to the Mexican Corporation, Regal Gaming and Entertainment, Inc. ("Regal"),
the holder of 24.5% of the equity of the Mexican Corporation has agreed to issue
to the Company, at no cost to the Company, 24.5% of the equity interest in any
gaming venture in which Regal, it subsidiaries or affiliates is an investor and
which relates to gaming activities in Mexico.
(c) Dry Cleaning Operations
On May 14, 1999 the Company completed the sale of the assets of its dry
cleaning operations for $750,000 in cash less fees and expenses of approximately
$50,000.
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INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Management's Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion should be read in conjunction with, and is
qualified in its entirety by the Condensed Consolidated Financial Statements and
Notes thereto of Interactive Flight Technologies, Inc. and subsidiary (the
"Company") appearing elsewhere herein. Historical results are not necessarily
indicative of trends in operating results for any future period.
Historical Overview
The Company has been engaged in the development, manufacture, installation
and operation of a computer-based in-flight entertainment network
("Entertainment Network" or "system"), which provides aircraft passengers the
opportunity to view movies, purchase goods and services, play computer games
and, in certain cases where permitted by applicable law, gamble through an
in-seat video touch screen.
Former management of the Company had determined to exit the in-flight
entertainment business in May 1998, except for continuing efforts associated
with meeting its contractual obligations with its only customer, Swissair. This
decision was based on a number of factors including industry trends, financial
resources of the Company and the Company's inability to attract new customers.
The Company has recently completed several transactions which the Company
believes will generate future earnings and cash flow. Such transactions include
an acquisition of The Network Connection, Inc., the operations of which
complement those of the Company's in-flight entertainment business, and
investments in U.S. Wireless Corporation, Inter Lotto UK, Ltd. and a Mexican
corporation focused on gaming and entertainment. See below discussion, "Outlook:
Issues and Risks" for a description of each investment. No assurances can be
made that the above investments will be successful.
Swissair
On October 29, 1998, the Company was notified by Swissair of the airline's
decision to deactivate the Entertainment Network on all Swissair aircraft.
Swissair told the Company that this precautionary action was taken in response
to technical investigations conducted by the Canadian Transportation Safety
Board following the crash of Swissair Flight No. 111 on September 2, 1998 off
the coast of Nova Scotia. However, based on investigation findings, the Company
has been informed by representatives of the Canadian Transportation Safety Board
and Swissair that its Entertainment Network has not been related, in any way, to
the cause of the crash of Swissair Flight No. 111. The Federal Aviation
Administration is conducting a review of the system's installation certification
and to date, has found no safety hazards or violations of Federal Aviation
Regulations. Until April 1999, the Company and its system
integrator/installation contractor had been working closely with Swissair to
take the necessary steps that will allow Swissair to reactivate the systems as
quickly as possible. On December 9, 1998, the Company was notified by Swissair
of its intent to reactivate the system in October 1999.
The Company's main agreement with Swissair required the Company to install
and maintain the Entertainment Network in the first, business and economy class
sections of three aircraft at no cost to Swissair and in the first and business
classes of another sixteen aircraft at an average price of $1.7 million per
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aircraft. As of October 31, 1998, the Company had completed all installations
under the initial Swissair program. The Company was responsible for maintenance
costs through September 1998 for all nineteen aircraft and specific software and
hardware upgrades to the Entertainment Network that are not yet completed. The
Swissair agreement also provided for a one-year warranty on the Entertainment
Network. The Company also received a letter of intent, dated April 1, 1998, from
Swissair for $3,975,000 to extend the warranty on the installed system for a
second and third year. Through April 30, 1999, the Company has been paid
$707,500 under this letter of intent.
On April 1, 1998, the Company also entered into a contract with Swissair
for a $4.7 million order for first and business class installations on four
Swissair MD-11 aircraft that are being added to the Swissair fleet. Though none
of the installations on the four aircraft were completed the Company's contract
allows for billing of the full contract amount if installation schedules are not
met due to no fault of the Company. Inventory on-hand at April 30, 1999 of
$1,513,298 relates primarily to the above contract with Swissair. As of February
26, 1999, Swissair has made payments of $1,450,000 on the $4.7 million order for
the four installations and continues to engage in active discussions with the
Company regarding outstanding financial matters related to current receivables,
inventory, purchase commitments and extended warranty obligations.
On May 6, 1999, the Company filed a lawsuit against Swissair in the United
States District Court for the District of Arizona seeking over $100 million in
damages for Swissair's failure to honor its obligations for payment and
reactivation of the Company's Entertainment Network. Swissair has failed to make
payments to the Company under installation and warranty contracts and has harmed
the Company's business and reputation by failing to honor its commitments to
reactivate the Entertainment Network on Swissair aircraft. Even though there has
been no evidence that the Entertainment Network contributed in any way to the
crash of Swissair Flight No. 111 on September 2, 1998, Swissair has continued to
use the unfortunate circumstances of the crash as an excuse to avoid its
obligations.
Results of Operations
Revenues for the quarter ended April 30, 1999 were $301,990, a decrease of
$4,430,172 or 94% compared to revenues of $4,732,162 for the corresponding
quarter of the previous fiscal year. Revenues for the six months ended April 30,
1999 were $626,748, a decrease of $17,515,079 or 97% compared to revenues of
$18,141,827 in the corresponding period of the previous fiscal year. Equipment
sales generated during the three months and six months ended April 30, 1998 were
principally from the installation of the Entertainment Network on Swissair
aircraft. Service income of $301,990 and $626,748 for the three months and six
months ended April 30, 1999 was principally generated from the Company's dry
cleaning plant acquired on July 24, 1998. Service income of $162,825 and
$281,264 for the three months and six months ended April 30, 1998, respectively,
was principally generated from services provided to Swissair pursuant to a Media
Programming Services Agreement, the Company's share of gaming profits generated
by the Swissair systems and revenue earned under the Swissair Letter of Intent
to extend the warranty.
Cost of equipment sales and service income for the quarter ended April 30,
1999 was zero, a decrease of 100% compared to cost of sales of $3,768,459 for
the corresponding quarter of the previous fiscal year. Cost of equipment sales
and service income for the six months ended April 30, 1999 was zero, a decrease
of 100% versus cost of sales of $15,335,854 in the corresponding period of the
previous fiscal year. Cost of equipment sales includes materials, installation
and maintenance costs, as well as estimated warranty costs and costs of upgrades
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to the Swissair Entertainment Network that the Company is contractually
committed to providing to Swissair. The decrease in cost of sales is primarily
due to the lack of any installations of equipment for the three months and six
months ended April 30, 1999 compared to the installation of equipment in nine
Swissair aircraft during the corresponding period of the previous fiscal year.
The cost of service income for fiscal 1999 is primarily related to the Company's
dry cleaning operations.
For the three and six months ended April 30, 1999 the Company recorded
warranty, maintenance and commission accrual adjustments of $1,281,233, $402,418
and $303,321 respectively. Such adjustments to prior period estimates, which
totaled $1,986,972, resulted from an evaluation of specific contractual
obligations and discussions between the new management of the Company and other
parties related to such contracts. Based on the results of the Company's
findings during this quarter, such accruals were no longer considered necessary.
Expenses associated with investments of $300,000 for the six months ended
April 30, 1999 represent a $150,000 write-off of an investment deemed to have no
value, and a $150,000 standstill fee related to the Inter Lotto transaction.
There were no research and development expenses for the three and six
months ended April 30, 1999, compared to $482,389 and $1,092,316, respectively
for the corresponding periods of the previous fiscal year. The decrease in
expenses reflects the Company's decision not to develop the next generation of
the Entertainment Network and the resulting reduction in staff and professional
fees. The Company currently does not plan to continue its research and
development beyond those efforts that are required contractually by the Swissair
agreement. The Swissair agreement requires the Company to provide specific
upgrades to the Entertainment Network currently installed on Swissair aircraft.
The Company has completed the development of these upgrades and does not
currently plan to develop any further upgrades to the Entertainment Network. The
costs of developing these upgrades have previously been included in the
Company's statements of operations as a cost of equipment sales. The Company
will continue any development efforts that are required to support system
reliability guarantees through the year 2003, subject to the development of a
successful reactivation plan with Swissair.
General and administrative expenses for the quarter ended April 30, 1999
were $1,764,202, an increase of $492,235 or 39% over expenses of $1,271,967 for
the corresponding quarter of the previous fiscal year. General and
administrative expenses for the six months ended April 30, 1999 were $3,645,151,
an increase of $766,753 or 27% over expenses of $2,878,398 for the corresponding
period of the previous fiscal year. Significant components of general and
administrative expenses include the costs of consulting agreements, legal and
professional fees, consulting fees related to the Inter Lotto transaction (see
"Outlook-Issues and Risks"), personnel costs, and corporate insurance costs.
Interest income of $401,710 and $844,686 for the three months and six
months ended April 30, 1999 decreased from $526,180 and $1,071,312 for the three
months and six months ended April 30, 1998, respectively. The interest arose
principally out of short-term investments of working capital. The decrease in
income is due to the lower average cash balance during the first six months of
fiscal 1999 compared to fiscal 1998.
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Interest expense was $1,191 and $2,880 for the three months and six months
ended April 30, 1999 compared to $3,234 and $6,995 for the three months and six
months ended April 30, 1998, respectively. The expense is attributable to the
Company's capital leases for furniture that expire in September 1999.
Other income of $19,350 and $48,926 for the three and six months ended
April 30, 1999 represent sublet income for the sublease of office space as well
as proceeds from the sale of office equipment and office furniture to employees.
Other income of $500 for the three months and six months ended April 30, 1998
represents the net gain on sales of equipment.
Liquidity and Capital Resources
At April 30, 1999, the Company had working capital of approximately $23.8
million. The Company's primary source of funding has been through equity
offerings. Excluding any payments to be received under the Swissair agreement to
extend the warranty, the Company's backlog consisted only of installations on
four Swissair aircraft which are currently being negotiated. Working capital may
continue to decrease as the Company continues to complete transactions which are
longer term by nature.
During the six months ended April 30, 1999, the Company used $4.8 million
of cash for operating activities, a decrease of $10.7 million from the 6.0
million of cash provided by operating activities for the corresponding period of
the previous fiscal year. The cash utilized in operations during the six months
ended April 30, 1999 resulted primarily from the period's loss and decreases in
accrued liabilities and reversal of prior period warranty, maintenance and
commission accruals, and an increase in other assets, partly offset by the
increase in deferred revenue. The cash provided by operations during the six
months ended April 30, 1998 is primarily a result of decreases in accounts
receivable and inventories and an increase in accrued product warranties, partly
offset by decreases in accounts payable and deferred revenue.
Purchases of investment securities for the six months ended April 30, 1999
were $6.3 million compared to $1.3 million for the six months ended April 30,
1998. The increase in investment securities purchases for the first six months
of fiscal 1999 includes a $3.0 million investment in U.S. Wireless Corporation
(See "Outlook: Issues and Risks").
During the six months ended April 30, 1999, the Company's restricted cash
decreased by $457,786 for payments made under consulting and severance
agreements with three former executives of the company.
On October 30, 1998, the Board of Directors authorized the Company to
repurchase shares of its Class A common stock on the open market. As of April
30, 1999, the Company had repurchased 78,600 shares at prices ranging from $1.49
to $2.94 per share.
At April 30, 1999, the Company's material capital commitments were (i) its
obligations under the Swissair agreements, and (ii) its obligations in
connection with the closing of the TNCi transaction (as discussed elsewhere
herein).
The Company is currently using its working capital to finance recent
transactions, inventory purchases, repair and other expenses associated with the
delivery and installation of the Swissair system and general and administrative
costs. The Company believes that its current cash balances plus interest
received on such balances are sufficient to meet the Company's currently
anticipated cash requirements for at least the next twelve months.
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Outlook: Issues and Risks
The Company has established a process for identifying new investment and
operational opportunities that will capitalize on the core competencies,
experiences and contacts of the Company's new management team. The industries
that management has chosen to concentrate on include the Internet, networking
solutions, telecommunications and gaming entertainment. In assessing the
viability of a potential transaction, the Company will focus on three major
criteria - (1) the size of the market opportunity, (2) proprietary aspects of
the business which offer strong competitive advantages and potentially
sustainable competitive advantages and (3) the quality of the current management
team. If all three of these criteria are in place and the Company can complete a
transaction on favorable terms, then the Company will look to move forward with
such transaction.
On February 4, 1999, the Company signed a letter of intent to merge the
business of its Interactive Entertainment Division ("IED") with The Network
Connection, Inc. ("TNCi"). On May 17, 1999 under the terms of the transaction,
the Company merged the business of its IED plus a $4.25 million cash payment in
exchange for a fully diluted 60% interest in TNCi, as defined in the Agreement.
TNCi develops and manufactures networked computer systems to provide customers
with interactive, video-on-demand information and entertainment content on
commercial aircraft, cruise ships, and trains. TNCi has also sold multimedia
servers and networked client computers to educational institutions and to
corporations to support interactive, video-based training programs. TNCi is a
NASDAQ registrant and trades under the ticker symbol TNCX. The merged business
will operate as TNCi.
On May 5, 1999, the Company completed the acquisition of a 27.5% interest
in Inter Lotto(UK) Ltd. ("ILL"). ILL has a license with the exclusive right to
provide for the operation of daily lotteries in Great Britain, by way of a
management contract with an outside third party, and will be responsible for
developing, installing, marketing and operating the lottery, selecting the game
and managing the network. In exchange, the Company will receive a percentage of
the revenues generated by the sale of lottery tickets. ILL is a company
licensed, by the Gaming Board for Great Britain, to operate daily lotteries on
behalf of United Kingdom Charities.
As of April 30, 1999, the Company has advanced ILL $428,364 in accordance
with the letter of intent and has paid ILL a standstill fee of $150,000. The
Company has retained a third party consultant with significant experience in
lottery operations to assist the Company with the development of operations of
ILL. The Company's agreement with the consultant calls for payments of
approximately $500,000 through implementation and startup which is projected for
the last quarter of 1999, beginning with a region in the UK having a population
of about 12 million. Thereafter, a national expansion could take place over the
subsequent two-year period. The Company has paid the consultant $261,000 through
April 30, 1999 which has been included in general and administrative expenses.
On March 4, 1999, the Company made an investment in U.S. Wireless
Corporation (NASDAQ: USWC), which provides wireless network infrastructure
add-on systems for the emerging wireless Geo-location services marketplace, of
$3 million in exchange for 30,000 shares of Series B Preferred Stock. Each share
of the Series B Preferred Stock of U.S. Wireless is convertible into 100 shares
of Common Stock of U.S. Wireless, at the option of the Company, at any time
commencing 90 days after the Closing Date, subject to adjustment upon occurrence
of certain events. The Series B Preferred Stock is also subject to mandatory
conversion into Common Stock at any time at the same conversion rate in the
event the closing price for U.S. Wireless' Common Stock as reported on the
NASDAQ is at least $5.00 per share for 30 consecutive trading days. The Series B
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Preferred Stock entitles the Company to $100 per share liquidation preference
before any distributions to the holders of Common Stock of U.S. Wireless in the
event of a liquidation of U.S. Wireless. In addition, the Company and other
holders of the Series B Preferred Stock have, as a separate class, elected one
member to U.S. Wireless' Board of Directors and one additional individual as an
observer to such Board. As a condition to making the investment, the Company
also obtained certain registration rights relating to the registration under the
Securities Act of 1933 of those shares of Common Stock of U.S. Wireless into
which the Series B Preferred Stock is convertible.
On May 14, 1999 the Company invested in a newly formed Mexican joint
venture created to pursue gaming and entertainment opportunities in Mexico.
Under the terms of the agreement, the Company will receive a 24.5% equity
interest in the joint venture, in exchange for a $1.6 million loan by the
Company. The loan is structured to mature on April 30, 2001. The loan of $1.6
million, of which $300,000 was advanced on February 25, 1999, is being used to
finance equipment purchases and start-up costs. In addition, the Company has
issued a letter of credit of $950,000 to secure repayment of certain equipment
purchased.
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the year, thus rendering them incapable of
properly managing and manipulating data that includes a 21st century date. The
Company has performed an assessment of its Entertainment Network for year 2000
issues. The Entertainment Network is a Microsoft based network system that uses
a four-digit year identifier and is therefore year 2000 compliant. The Company
believes that its products have no inherent date sensitive features. The Company
has also reviewed its existing software systems utilized in the planning,
purchasing, manufacturing, product development and accounting areas and believes
these systems are all year 2000 compliant. The Company does not believe the year
2000 issue will pose significant operational problems for the Company.
The Company continues to evaluate the estimated costs associated with its
year 2000 compliance efforts and does not expect the future costs to be
material. However, no assurance can be given that the Company will not incur
additional expenses pursing year 2000 compliance. Furthermore, even if the
Company's systems are year 2000 compliant, there can be no assurance that the
Company will not be adversely affected by the failure of others to become year
2000 compliant. For example, the Company may be adversely affected by, among
other things, warranty and other claims made by the Company's customer related
to product failures caused by the year 2000 problem, the disruption or
inaccuracy of data provided to the Company by non-year 2000 compliant third
parties, and the failure of the Company's service providers to become year 2000
compliant. The Company will continue to monitor the progress of its material
vendors and customers and formulate a contingency plan at that point in time
when the Company does not believe a material vendor or customer will be
compliant. Despite the Company's efforts to date, there can be no assurance that
the year 2000 problem will not have a material adverse effect on the Company in
the future.
Forward-looking Information
Except for historical information contained herein, the matters discussed
in this Quarterly Report on Form 10-QSB are forward-looking statements (within
the meaning of Section 27A of the Securities Act of 1933, as amended and Section
21E of the Securities Exchange Act of 1934, as amended) 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, but are not limited to, cost overruns in connection
with the Company's current contracts, failure of installed systems to perform in
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accordance with system specifications, the failure of the Company to resolve its
differences with Swissair on a favorable basis, the impact of competition and
downward pricing pressures, the effect of changing economic conditions and
conditions in the airline industry, the inability of the Company to evaluate
other businesses, the risks and uncertainties involved in the Company's other
proposed business ventures, the impact of any changes in domestic and foreign
regulatory environments or the Company's inability to obtain requisite
government approvals to conduct its regulated business (such as gaming), the
rapidity with which technology in general, and the Company's technology, in
particular, are being developed and the possible inability of the Company to
maintain its competitveness as a result, the risks involved in currency
fluctuation because of the Company's increasing investment in other countries,
and the other risks and uncertainties detailed herein and in the Company's
Annual Report on Form 10-KSB for the fiscal year ended October 31, 1998.
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PART II. OTHER INFORMATION
Item 1: Legal Proceedings
Phillip J. Arnaldi, Individually as surviving father and in his
representative capacity as the Administrator of the Estate of Adrienne Valerie
Neuweiler, deceased v. SAIR Group, Swissair Transport Company, Ltd., SR Technics
Ltd., Delta Airlines, Inc., McDonnell Douglas Corporation, The Boeing Company
and Interactive Flight Technologies, Inc., United States District Court, Eastern
District of New York, CV 99-1265 - The family of a victim of the air crash
involving Swissair Flight No. 111 has alleged that the IFT in-flight
entertainment system aboard the involved MD-11 was improperly installed and a
cause of the crash. IFT denies all liability and has tendered the defense of
this claim to its avionics insurer who has accepted the defense and is
vigorously defending the claim.
First Lawrence Capital Corp. v. James Fox, Irwin Gross, Interactive Flight
Technologies, Inc., and John Doe Nos. 1 through 10. Supreme Court of the State
of New York, County of Westchester, No. 7196/99 - This is an unliquidated claim
by an investment banking firm that alleges its former employee, James Fox,
wrongfully brought certain corporate opportunities to IFT when he left his
employment with First Lawrence. IFT denies the allegations of the Complaint and
is vigorously defending the claim.
Item 6: Exhibits and Reports on Form 8-K
Exhibits
Exhibit No. Description Page No.
- ----------- ----------- --------
2.1 Asset Purchase and Sale Agreement dated as of *
April 29, 1999 by and between Interactive
Flight Technologies, Inc. and The Network Connection, Inc.
2.2 First Amendment to Asset Purchase and Sale Agreement dated *
as of May 14, 1999 by and between Interactive Flight
Technologies, Inc. and The Network Connection, Inc.
3.3 Certificate of Amendment of Amended and Restated *
Certificate of Incorporation of Registrant
3.4 By-law of the Registrant *
3.5 Certificate of Amendment to Amended and Restated 24
Certificate of Incorporation of Registrant dated November
2, 1998
3.6 Certificate of Designations, Preferences, and Rights of **
Series A Convertible Preferred Stock of Interactive
Flight Technologies, Inc.
3.7 Certificate of Designations, Preferences, and Rights of **
Series B Convertible Preferred Stock of Interactive
Flight Technologies, Inc.
4.5 Form of Underwriter's Unit Purchase Option *
4.6 Specimen of Class A Common Stock Certificate *
4.7 Specimen of Class B Common Stock Certificate *
4.10 Specimen of Class D Warrant Certificate *
4.11 Stock Purchase Warrant, dated as of November 7, 1996, *
issued to FortuNet, Inc.
4.12 Stock Purchase Warrant, dated as of November 12, 1996, *
issued to Houlihan Lokey Howard & Zukin
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4.13 Certificate of Designations, Preferences and Rights of 27
Series A Convertible Preferred Stock of Interactive Flight
Technologies, Inc.
4.14 Certificate of Designations, Preferences and Rights of 52
Series B Convertible Preferred Stock of Interactive Flight
Technologies, Inc.
10.21 Lease Termination Agreement, dated as of May 27, 1998 *
10.22 Lease Surrender Agreement, dated as of May 12, 1998 *
10.23 Securities Purchase Agreement dated as of May 6, 1999 by 80
and between Interactive Flight Technologies, Inc. and The
Shaar Fund, Ltd.
27 Financial Data Schedule 108
99.1 Certificate of Designations of Series B Convertible *
Preferred Stock of TNC dated October 23, 1998
99.2 Amendment dated as of April 29, 1999 to Certificate of *
Designations of Series B Convertible Preferred Stock of TNC
99.3 Certificate of Designation of Series C Convertible *
Preferred Stock of TNC dated as of April 30, 1999
99.4 Certificate of Designations of Series D Convertible *
Preferred Stock of TNC dated as of May 5, 1999
99.5 Secured Promissory Note Dated January 26, 1999 made by TNC *
and payable to the order of the Company
99.6 Allonge to Secured Promissory Note Dated January 29, 1999 *
99.7 Second Allonge to Secured Promissory Note Dated March 19, *
1999
99.8 Third Allonge to Secured Promissory Note Dated March 24, *
1999
99.9 Fourth Allonge to Secured Promissory Note Dated May 10, 1999 *
- ---------
* Incorporated by reference from Registrant's Annual Report on Form 10-KSB for
the fiscal year ended October 31, 1998 and Current Report on Form 8-K dated
May 17, 1999 filed with the Securities and Exchange Commission.
** See Exhibits 4.13 and 4.14.
(b) Reports on Form 8-K
The Company did not file any reports on Form 8-K during the quarter ended
April 30, 1999.
19
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: June 14, 1999 INTERACTIVE FLIGHT TECHNOLOGIES, INC.
By: /s/ Irwin L. Gross
--------------------------------
Irwin L. Gross
Chief Executive Officer
By: /s/ Morris C. Aaron
---------------------------------
Morris C. Aaron
Chief Financial Officer
20
<PAGE>
INDEX OF EXHIBITS
Exhibit No. Description Page No.
- ----------- ----------- --------
2.1 Asset Purchase and Sale Agreement dated as of *
April 29, 1999 by and between Interactive
Flight Technologies, Inc. and The Network Connection, Inc.
2.2 First Amendment to Asset Purchase and Sale Agreement dated *
as of May 14, 1999 by and between Interactive Flight
Technologies, Inc. and The Network Connection, Inc.
3.3 Certificate of Amendment of Amended and Restated *
Certificate of Incorporation of Registrant
3.4 By-law of the Registrant *
3.5 Certificate of Amendment to Amended and Restated 24
Certificate of Incorporation of Registrant dated November
2, 1998
3.6 Certificate of Designations, Preferences, and Rights of **
Series A Convertible Preferred Stock of Interactive
Flight Technologies, Inc.
3.7 Certificate of Designations, Preferences, and Rights of **
Series B Convertible Preferred Stock of Interactive
Flight Technologies, Inc.
4.5 Form of Underwriter's Unit Purchase Option *
4.6 Specimen of Class A Common Stock Certificate *
4.7 Specimen of Class B Common Stock Certificate *
4.10 Specimen of Class D Warrant Certificate *
4.11 Stock Purchase Warrant, dated as of November 7, 1996, *
issued to FortuNet, Inc.
4.12 Stock Purchase Warrant, dated as of November 12, 1996, *
issued to Houlihan Lokey Howard & Zukin
4.13 Certificate of Designations, Preferences and Rights of 27
Series A Convertible Preferred Stock of Interactive Flight
Technologies, Inc.
4.14 Certificate of Designations, Preferences and Rights of 52
Series B Convertible Preferred Stock of Interactive Flight
Technologies, Inc.
10.21 Lease Termination Agreement, dated as of May 27, 1998 *
10.22 Lease Surrender Agreement, dated as of May 12, 1998 *
10.23 Securities Purchase Agreement dated as of May 6, 1999 by 80
and between Interactive Flight Technologies, Inc. and The
Shaar Fund, Ltd.
27 Financial Data Schedule 108
99.1 Certificate of Designations of Series B Convertible *
Preferred Stock of TNC dated October 23, 1998
99.2 Amendment dated as of April 29, 1999 to Certificate of *
Designations of Series B Convertible Preferred Stock of TNC
99.3 Certificate of Designation of Series C Convertible *
Preferred Stock of TNC dated as of April 30, 1999
99.4 Certificate of Designations of Series D Convertible *
Preferred Stock of TNC dated as of May 5, 1999
99.5 Secured Promissory Note Dated January 26, 1999 made by TNC *
and payable to the order of the Company
99.6 Allonge to Secured Promissory Note Dated January 29, 1999 *
21
<PAGE>
99.7 Second Allonge to Secured Promissory Note Dated March 19, *
1999
99.8 Third Allonge to Secured Promissory Note Dated March 24, *
1999
99.9 Fourth Allonge to Secured Promissory Note Dated May 10, 1999 *
- ---------
* Incorporated by reference from Registrant's Annual Report on Form 10-KSB for
the fiscal year ended October 31, 1998 and Current Report on Form 8-K dated
May 17, 1999 filed with the Securities and Exchange Commission.
** See Exhibits 4.13 and 4.14.
22
<PAGE>
THE NETWORK CONNECTION, INC.
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned hereby constitutes and appoints MORRIS C. AARON, FRANK E.
GOMER, and IRWIN L. GROSS, or any of them acting in the absence of the others,
with full power of substitution, the true and lawful attorneys and proxies of
the undersigned, to attend the Special Meeting of the Stockholders of The
Network Connection, Inc. (the "Company") to be held at the office of Streich
Lang, PA, Two North Central Avenue, Phoenix, Arizona on September 17, 1999, at
9:00 am, local time, and any adjournments thereof, and to vote the shares of
Common Stock of the Company standing in the name of the undersigned, as directed
below, with all the powers the undersigned would possess if personally present
at the meeting.
Proposal No. 1: To ratify and approve the acquisition of the interactive
entertainment business of Interactive Flight Technologies,
Inc., a Delaware corporation and the related issuance of
1,055,745 shares of the Common Stock, par value $.001 per
share and 2,495,400 shares of the Series D Convertible
Preferred Stock, par value $.01 per share pursuant to an
Asset Purchase and Sale Agreement, dated as of April 30,
1999 by and between the Company and IFT, as amended by the
First Amendment to Asset Purchase and Sale Agreement, dated
as of May 14, 1999.
____ VOTE FOR ____ VOTE AGAINST ____ VOTE WITHHELD
Proposal No. 2: A proposal to amend the Company's Amended and Restated
Articles of Incorporation to increase the authorized number
of shares of capital stock of the Company to 42,500,000, of
which 40,000,000 shares will be Common Stock and 2,500,000
shares will be Preferred Stock.
____ VOTE FOR ____ VOTE AGAINST ____ VOTE WITHHELD
PLEASE PROMPTLY DATE, SIGN AND RETURN IN THE ENCLOSED ENVELOPE.
This proxy will be voted in accordance with the directions indicated
herein. If no specific directions are given, this proxy will be voted for
approval of all nominees listed herein, for approval of the proposals listed
herein and, with respect to any other business as may properly come before the
meeting, in accordance with the discretion of the proxies.
DATED: , 1999
------------
----------------------------------------
(Signature)
----------------------------------------
(Signature)
When signing as executor, administrator,
attorney, trustee or guardian, please
give full title as such. If a
corporation, please sign in full
corporate name by president or other
authorized officer. If a partnership,
please sign in partnership name by
authorized person. If a joint tenancy,
please have both joint tenants sign.
<PAGE>
August 12, 1999
Dear Stockholder:
We will be holding a Special Meeting of The Network Connection's stockholders on
Friday, September 17, 1999 at 9:00 a.m., local time, at the offices of Streich
Lang, P.A., Two North Central Avenue, Phoenix, Arizona.
Enclosed with this letter is a Notice of the Special Meeting, a Proxy Statement,
a proxy card, and a return envelope. Both the Notice of Special Meeting and the
Proxy Statement provide details of the business that we will conduct at the
Special Meeting and other information about The Network Connection, Inc.
The enclosed information contains the Company's Proxy Statement, along with
additional copies of certain previously filed annual reports and quarterly
reports for the Company and Interactive Flight Technologies, Inc.
Whether or not you plan to attend the Special Meeting, please sign, date and
promptly return the proxy card in the enclosed prepaid return envelope. Your
shares will be voted at the Special Meeting in accordance with your proxy
instructions. Of course, if you attend the Special Meeting you may vote in
person.
On behalf of the Board of Directors and the employees of the Company, I
cordially invite you to attend the Special Meeting.
Sincerely,
Irwin L. Gross
Chairman of the Board of Directors and
Chief Executive Officer
YOUR VOTE IS IMPORTANT
Please Sign, Date and Return Your Proxy Card Before the Special Meeting
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in this Proxy statement of The
Network Connection, Inc. of our report, which includes an explanatory paragraph
relating to the uncertainty of the Company's ability to continue as a going
concern, dated April 15, 1999, on our audits of the financial statements of the
Network Connection, Inc. as of December 31, 1998 and for each of the two years
in the period ended December 31, 1998.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Atlanta Georgia
August 12, 1999
INDEPENDENT AUDITORS' CONSENT
The Stockholders and Board of Directors
Interactive Flight Technologies, Inc.:
We consent to the use of our report dated December 11, 1998 incorporated herein
by reference.
KPMG LLP
Phoenix, Arizona
August 13, 1999
