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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarter ended September 30, 2000
[ ] 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. 1-13760
THE NETWORK CONNECTION, INC.
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(Exact Name of Small Business Issuer as Specified in Its Charter)
Georgia 58-1712432
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation of Organization) Identification Number)
1811 Chestnut Street, Suite 110
Philadelphia, Pennsylvania 19103
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(Address of Principal Executive Offices)
215-832-1046
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(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 October 25, 2000
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Common Stock, $.001 par value 20,654,344 shares
Transitional Small Business Disclosure Format
Yes [ ] No [X]
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<PAGE>
THE NETWORK CONNECTION, INC.
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2000
(unaudited) and June 30, 2000 (audited)................................3
Condensed Consolidated Statements of Operations for the Three
Months Ended September 30, 2000 and 1999 (unaudited)...................4
Condensed Consolidated Statements of Cash Flows for the Three
Months Ended September 30, 2000 and 1999 (unaudited)...................5
Notes to Condensed Consolidated Financial Statements...................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.....................................................14
Item 2. Changes in Securities.................................................16
Item 6. Exhibits and Reports on Form 8-K......................................16
SIGNATURES....................................................................17
2
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THE NETWORK CONNECTION, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
2000 2000
------------- -------------
Assets (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 111,676 $ 579,721
Restricted cash 483,379 475,915
Accounts receivable 82,584 55,951
Prepaid expenses 228,798 336,721
Due from affiliate 27,870 73,607
Other current assets 159,446 74,566
------------- ------------
Total current assets 1,093,753 1,596,481
Note receivable from related party 117,612 117,612
Property and equipment, net of accumulated depreciation of
$1,181,263 and $1,014,188, respectively 5,077,200 3,810,649
Intangibles, net of accumulated amortization of $1,419,705
and $987,534, respectively 6,265,785 6,697,955
Other assets 509,462 1,246,002
------------- ------------
Total assets $ 13,063,812 $ 13,468,699
============= ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 5,211,982 $ 4,338,943
Accrued liabilities 1,876,782 2,924,797
Accrued product warranties 141,614 141,796
Dividends payable 179,535 140,000
Notes payable 553,266 4,744
Notes payable to related parties 1,370,000 800,000
------------- ------------
Total current liabilities 9,333,179 8,350,280
Notes payable to related parties 2,450,000 2,350,000
------------- ------------
Total liabilities 11,783,179 10,700,280
------------- ------------
Due to affiliate 1,281,356 --
Stockholders' equity (deficiency):
Series B preferred stock par value $0.01 per share, 1,500 shares
designated, issued and outstanding 15 15
Series D preferred stock par value $0.01 per share, 2,495,400 shares
designated, 1,668,953 and 2,495,400 issued and outstanding, respectively 16,690 24,954
Series E preferred stock par value $0.01 per share, 500 shares designated,
100 shares issued and outstanding 1 --
Common stock par value $0.001 per share, 40,000,000 shares authorized;
19,973,117 and 14,460,212 issued and outstanding, respectively 19,973 14,460
Common stock subscribed 1,000,000 --
Additional paid-in capital 103,501,995 102,053,251
Accumulated other comprehensive income:
Loss on foreign currency translation (23,050) (11,521)
Accumulated deficit (104,516,347) (99,312,740)
------------- ------------
Total stockholders' equity (deficiency) (723) 2,768,419
------------- ------------
Total liabilities and stockholders' equity (deficiency) $ 13,063,812 $ 13,468,699
============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
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THE NETWORK CONNECTION, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
(Unaudited)
THREE MONTHS
ENDED SEPTEMBER 30,
-----------------------------
2000 1999
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Revenue:
Equipment sales $ 42,735 $ 5,550,560
Service income 12,501 59,827
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55,236 5,610,387
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Costs and expenses:
Cost of equipment sales 10,803 3,420,381
Cost of service income 90,758 8,580
General and administrative expenses 3,785,637 1,394,650
Non cash compensation expense 197,904 85,000
Amortization of intangibles 432,171 184,141
------------ ------------
4,517,273 5,092,752
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Operating income (loss) (4,462,037) 517,635
Other:
Interest income 13,190 40,420
Interest expense (755,114) (135,649)
Other income 354 7,270
------------ ------------
Net income (loss) (5,203,607) 429,676
Cumulative dividend on preferred stock (39,535) (46,000)
Beneficial Conversion on preferred stock (173,469) --
------------ ------------
Net income (loss) available to common
stockholders $ 5,416,611 $ 383,676
============ ============
Basic net income (loss) per common share $ (0.30) $ 0.06
============ ============
Weighted average number of shares outstanding 17,826,026 6,350,670
============ ============
Diluted net income (loss) per common share $ (0.30) $ 0.01
============ ============
Weighted average number of common and
dilutive shares outstanding 17,826,026 27,470,817
============ ============
See accompanying notes to condensed consolidated financial statements.
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THE NETWORK CONNECTION, INC.
Condensed Consolidated Statement of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
THREE THREE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
----------- -----------
Cash flows from operating activities:
<S> <C> <C>
Net income (loss) $(5,203,607) $ 429,676
Adjustments to reconcile net income (loss) to net cash:
Depreciation and amortization 599,279 316,295
Non cash interest 635,017 --
Loss on sale of assets held for sale -- 4,506
Non cash compensation expense 197,904 85,000
Changes in net assets and liabilities:
Increase in accounts receivable (26,633) (5,002,677)
Due (from) to affiliate 1,327,093 (188,399)
Increase in inventories -- (1,584,708)
Decrease (increase) in prepaid expenses (3,804) 1,971
Decrease (increase) in other current assets (85,409) 69,169
Increase in other assets (17,882) --
Increase in accounts payable 877,797 3,146,969
Decrease in accrued liabilities (494,163) (47,668)
Increase in deferred revenue -- 789,577
(Decrease) increase in accrued product warranties (182) 144,750
----------- -----------
Net cash used in operating activities $(2,194,590) $(1,835,539)
----------- -----------
Cash flows from investing activities:
Purchases of investment securities -- 542
Purchases of property and equipment (1,443,694) (112,718)
Proceeds from sale of assets held for sale -- 395,494
Increase in restricted cash (7,464) (5,040)
Payments received on notes receivable -- 1,000
----------- -----------
Net cash provided by (used in) investing activities $(1,451,158) $ 279,278
----------- -----------
Cash flows from financing activities:
Payments on notes payable (1,478) (494,625)
Borrowings under revolving credit facility 100,000 --
Advances from related parties 570,000 --
Investment by officer 1,000,000 --
Issuance of common stock 610,000 --
Issuance of Series E Preferred Stock 908,750 --
----------- -----------
Net cash provided by (used in) financing activities $ 3,187,272 $ (494,625)
----------- -----------
Effect of exchange rate on cash and cash equivalents (9,569) --
----------- -----------
Net decrease in cash and cash equivalents (468,045) (2,050,886)
Cash and cash equivalents at beginning of period 579,721 2,751,506
----------- -----------
Cash and cash equivalents at end of period $ 111,676 $ 700,620
=========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
THE NETWORK CONNECTION, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
PART I. FINANCIAL INFORMATION
BASIS OF PRESENTATION
(1) PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of The
Network Connection, Inc. and its wholly-owned subsidiary TNCi UK Limited (the
"Company" or "TNCi"). All significant intercompany accounts have been
eliminated.
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 consolidated financial
statements and notes thereto for the year ended June 30, 2000, included in the
Company's Annual Report on Form 10-KSB.
The results of operations for the three months ended September 30, 2000 are
not necessarily indicative of the results to be expected for the entire fiscal
year. Certain reclassifications have been made to the amounts in the June 30,
2000 consolidated financial statements to conform with the September 30, 2000
presentation.
As of October 25, 2000, the Company is a 77% owned subsidiary of Global
Technologies, Ltd. ("Global"), whose ownership is represented by 1,500 shares of
the Company's Series B 8% Convertible Preferred Stock, 1,668,953 shares of the
Company's Series D Convertible Preferred Stock and approximately 13,768,822
million shares of the Company's Common Stock.
(2) USE OF ESTIMATES
The preparation of the consolidated 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 consolidated
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.
(3) FINANCIAL CONDITION AND LIQUIDITY
Our condensed consolidated 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. We have incurred a net loss from operations in the
current quarter ended September 30, 2000, plus have incurred losses from
operations in two of the last three fiscal years, and have an accumulated
deficit at September 30, 2000 as a result of efforts to build our customer base
and develop our operations.
Management believes that current cash balances, the $5.0 million credit
facility with Global (of which approximately $1.6 million remains available as
of November 1, 2000), and our other available financing sources (consisting of
an equity line of credit and a preferred stock offering) will not be sufficient
to meet currently anticipated cash requirements for the next 12 months. In
addition, we have significant expansion plans, which will exacerbate
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these liquidity issues. To the extent that available and prospective sources of
financing prove insufficient or unavailable, we will be required to modify our
expansion plans, scale back operations and/or modify our business strategy.
We are currently in discussions with equity and equipment financing
sources, which, if transactions are consummated, together with the
aforementioned available sources of financing, should provide sufficient funding
for us to meet our business plan requirements. There is no assurance that we
will be able to raise additional capital on terms acceptable to us or at all,
and, the inability to raise such capital would have a material adverse effect on
our operating results, financial condition and ability to continue as a going
concern.
(4) INCOME (LOSS) PER SHARE
For the three months ended September 30, 2000, no common stock equivalents
were considered in calculating diluted weighted average number of shares
outstanding as their effect would have been anti-dilutive. A summary of the
adjustments between basic and diluted weighted average number of shares
outstanding for the three months ended September 30, 2000 and 1999 follows:
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 1999
------------ ------------
Net income (loss) $ (5,203,607) $ 429,676
Less: preferred stock dividends (39,535) (46,000)
Less: beneficial conversion on preferred stock (173,469) --
------------ ------------
Income (loss) available to common
stockholders $ (5,416,611) $ 383,676
============ ============
Basic EPS - weighted average shares
outstanding 17,826,026 6,350,670
============ ============
Basic net income (loss) per share $ (0.30) $ 0.06
============ ============
Basic EPS - weighted average shares
outstanding 17,826,026 6,350,670
Effect of dilutive securities:
Stock Purchase Options - common stock -- --
Convertible preferred stock -- 17,030,500
Convertible debt -- 4,089,647
------------ ------------
Dilutive EPS - weighted average shares
outstanding 17,826,026 27,470,817
Net income (loss) available to common
shareholders $ (5,416,611) $ 383,676
------------ ------------
Diluted net income (loss) per share $ (0.30) $ 0.01
============ ============
Common stock equivalents not included
in dilutive EPS since antidilutive
- Convertible preferred stock 11,828,637 --
============ ============
- Convertible debt 1,761,254 --
============ ============
- Stock options and warrants 5,023,408 --
============ ============
(5) STOCKHOLDERS' EQUITY
CONVERSION OF SERIES D PREFERRED STOCK
On August 2, 2000, upon receipt of notice of conversion from Global, the
Company issued 5,000,000 shares of its Common Stock to Global upon conversion of
826,447 shares of the Company's Series D Preferred Stock held by Global. As of
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September 30, 2000, Global's ownership in the Company was 77% on an if-converted
common stock basis.
ISSUANCE OF SERIES E CONVERTIBLE PREFERRED STOCK
In August 2000, the Company designated 500 shares of Series E 6%
Convertible Preferred Stock ("Series E Stock"); stated value $10,000 per share
and liquidation value $10,000 per share plus accrued and unpaid dividends. At
the option of the Holder, beginning 180 days after the date of issue, each share
of Series E Stock is convertible into common stock at the lesser of $4.00 per
share or 80% of the Average Market Price for common stock for the five
consecutive trading days immediately preceding such date, as defined. The
Company may redeem the Series E Stock at prices ranging from 110% to 120% of
stated value, plus accrued dividends during the first 180 days from date of
issue. The redemption premium increases at a rate of 3% per month to a maximum
of 140% of stated value.
On August 3, 2000, the Company issued 100 shares of its Series E Stock,
with an aggregate stated value of $1.0 million, to a third party investor. The
Company received net proceeds of approximately $909,000.
(6) ISSUANCE OF NOTE PAYABLE AND WARRANTS
On September 12, 2000, the Board of Directors authorized the issuance of
common stock purchase warrants to purchase 311,560 shares of the Company's
Common Stock which have been divided equally between two trusts controlled by
Irwin L. Gross, the Chairman and Chief Executive Officer of the Company, as
compensation for various working capital advances made by the trusts to the
Company from May 2000 through September 2000. As of September 30, 2000, advances
totaled $1,300,000. On September 12, 2000, the Company's Board of Directors also
approved the conversion of $1,050,000 of these advances into promissory notes
from the Company. The number of warrants issued for each advance was based upon
the amount advanced divided by the closing market price of the Company's common
stock on the date of each advance. The warrants have an exercise price based
upon the closing market price of the Company's Common Stock on the date of the
advance and a term of five years from such date. The fair value of the warrants
issued is $1,047,000, of which $137,000 and $444,000 have been recorded as a
non-cash charge to interest expense in the year ended June 30, 2000 and the
quarter ended September 30, 2000, respectively.
(7) INVESTMENT BY OFFICER
On October 16, 2000, the Company's Executive Vice President purchased
500,000 units, consisting of 500,000 shares of the Company's common stock and
warrants exercisable for 166,667 shares of the Company's common stock. The
warrants have an exercise price of $3.50 per share and a term of four years. The
purchase price for these units was $2.00 per unit resulting in aggregate
consideration of $1.0 million, which was paid to the Company in installments in
August and September 2000. The market price per share of the Company's Common
Stock on October 16, 2000, was $2.00.
(8) SEGMENT INFORMATION
For the three months ended September 30, 2000 and 1999, respectively, the
Company operated principally in one industry segment; development, manufacturing
and marketing of computer-based entertainment and data networks.
For the three months ended September 30, 2000 and 1999, respectively, six
customers accounted for approximately 100% and a separate customer accounted for
approximately 96% of the Company's sales. Outstanding receivables from these
customers were $22,202 and $4,923,843 respectively, at September 30, 2000 and
1999.
8
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(9) COMMITMENTS AND CONTINGENCIES
(a) LAWSUITS
Swissair/MDL-1269, In Regards to an Air Crash Near Peggy's Cove, Nova
Scotia. This multi-district litigation, which is being overseen by the United
States District Court for the Eastern Division of Pennsylvania, relates to the
crash of Swissair Flight No. 111 on September 2, 1998. The Swissair MD-11
aircraft involved in the crash was equipped with an entertainment network system
that had been sold to Swissair by Global's predecessor company, Interactive
Flight Technologies, Inc. Estates of the victims of the crash have filed
lawsuits throughout the United States against Swissair, Boeing, Dupont and
various other parties, including Global and TNCi, which has been named in some
of the lawsuits filed on a successor liability theory. TNCi and Global deny all
liability for the crash. TNCi and Global are being defended by Global's aviation
insurer.
On September 1, 1999, SAir Group invited the Company to participate in a
conciliation hearing before the Justice of the Peace in Kloten, Switzerland,
which is the customary manner in which civil litigation is initiated in
Switzerland. The document informing the Company of the proceeding states that
the request has been filed in connection with the crash of Swissair Flight 111
primarily in order to avoid the expiration of any applicable statutes of
limitations and to reserve the right to pursue further claims. The document
states that the relief sought is "possibly the equivalent of CHF 342,000,000 -
in a currency to be designated by the court; each plus 5% interest with effect
from September 3, 1998; legal costs and a participation to the legal fees (of
the plaintiff) to be paid by the defendant."
Bryan R. Carr V. The Network Connection, Inc. and Global Technologies,
Ltd., Superior Court of Georgia, Civil Action No. 99-CV-1307. Bryan R. Carr,
TNCi's former Chief Operating and Financial Officer and a former Director, filed
a claim on November 24, 1999 alleging a breach of his employment agreement with
TNCi. Mr. Carr claims that he is entitled to the present value of his base
salary through October 31, 2001, a share of any "bonus pool," the value of his
stock options and accrued vacation time. TNCi and Global filed a motion to
compel arbitration of the claims pursuant to an arbitration provision in the
employment agreement and to stay the State Court action pending the arbitration
proceeding. The Company's motion was granted on August 9, 2000. On November 7,
2000, Mr. Carr filed his claim for arbitration in Georgia.
A suit captioned Avnet, Inc. V. The Network Connection, Inc., was filed May
17, 2000 in Maricopa County Superior Court, CV2000-009416. The suit relates to
invoices for inventory purchased by TNCi in late 1998 and early 1999. Avnet,
Inc. seeks payment of the invoices, interest and legal fees. TNCi has not paid
for the inventory purchased primarily for the following reasons: (i) the
inventory purchased did not meet specifications and thus was not accepted by
TNCi's customer, and (ii) TNCi was pursuing a separate warranty claim against
Avnet regarding certain other inventory purchased from Avnet. On October 11,
2000 TNCi won a jury verdict of $1.8 million in the warranty suit. The court is
expected to enter its final judgment in December 2000 which may include legal
fees and costs of approximately $290,000, plus prejudgement interest. The
Company expects payment in December, subject to the defendants not appealing the
ruling.
The Company is subject to other lawsuits and claims arising in the ordinary
course of its business. In the Company's opinion, as of September 30, 2000, the
effect of such matters will not have a material adverse effect on the Company's
results of operations and financial position.
(b) CARNIVAL AGREEMENT
In September 1998, the Company entered into a Turnkey Agreement (the
"Carnival Agreement") with Carnival Corporation ("Carnival") for the purchase,
installation and maintenance of its advanced cabin entertainment and management
system for the cruise industry ("CruiseView(TM)") on a minimum of one Carnival
Cruise Lines ship. In December 1998, Carnival ordered the installation of
CruiseView(TM) on one Carnival Cruise Lines "Fantasy" class ship which has been
in operational use since August 1999. In August 1999, Carnival ordered the
installation of CruiseView(TM) on one Carnival Cruise Lines "Destiny" class ship
which was in operational use from October 1999 through March 2000.
9
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On September 25, 2000, the Company entered into a Master Settlement
Agreement and Mutual Release with Carnival (the "Settlement Agreement"). The
Settlement Agreement specifies that the Company and Carnival agree: (i) to
terminate the Carnival Agreement; (ii) to negotiate in good faith to enter into
a new agreement for the purchase, installation and maintenance of CruiseView
(TM) systems; (iii) that the Company will issue to Carnival a one-year
convertible note payable in the principal amount of $550,000; (iv) to mutually
release each party from any prior claims; and (v) the Company shall retain
ownership of any and all equipment (other than wiring and switching equipment
installed for networking purposes which Carnival purchased and paid in full
pursuant to the Carnival Agreement) installed on any Carnival ship.
Pursuant to the Settlement Agreement, the Company and Carnival have
continued discussions with respect to a new agreement which would cover the
installation of the Company's latest CruiseView(TM) technology on the "Fantasy"
class ship discussed above, and contractual terms more favorable to the Company
than the Carnival Agreement, including a longer-term and multiple ship
arrangement. The Company believes its new technology improves the Company's
ability to create multiple new content and commerce-based revenue streams, and
to establish a business relationship providing appropriate returns to each
partner. There is no assurance that the Company will be successful in securing a
new, more favorable long-term contract with Carnival. Notwithstanding the above,
the Company continues to operate its CruiseView(TM) system aboard one Carnival
Fantasy class ship on a month-to-month basis and will continue to do so as long
as the economics are beneficial to the Company and Carnival.
ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ TOGETHER WITH THE CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS AND THE RELATED NOTES INCLUDED IN ANOTHER PART OF THIS REPORT AND
WHICH ARE DEEMED TO BE INCORPORATED INTO THIS SECTION. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL
RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THOSE FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING BUT NOT LIMITED TO, THOSE
SET FORTH UNDER AND INCLUDED IN OTHER PORTIONS OF THIS REPORT. SEE
"FORWARD-LOOKING STATEMENTS".
DESCRIPTION OF BUSINESS
The Network Connection, Inc. is a provider of broadband entertainment,
information and e-commerce systems for the "away-from-home" marketplace, which
encompasses hotels, cruise ships and long-haul passenger trains, as well as
schools, training facilities and institutions. The Network Connection's
fully-interactive, all-digital and high speed information and entertainment
platforms are designed to provide consumers and students Internet and e-mail
access with such customizable services as on-demand films, videos and music,
video games and casino gaming, tour and reservation information, as well as IP
telephony, courseware and lectures, and other Internet-based content and
commerce applications. The Network Connection has developed specific systems for
the hospitality market (InnView(TM)), the cruise ship industry (CruiseView(TM)),
the long haul passenger train market (Projectrainbow(TM)), as well as for
corporate training and educational institutions (EduView(R)). These systems
provide "away from home" industries with technology solutions for the
information and entertainment needs of today's "connected" marketplace.
BACKGROUND AND BASIS OF PRESENTATION
On May 18, 1999, we obtained substantially all of the assets and certain
liabilities of the interactive entertainment division of Global Technologies,
Ltd. (formerly known as Interactive Flight Technologies, Inc.) and $4,250,000 in
10
<PAGE>
cash in exchange for 1,055,745 shares of our common stock and 2,495,400 shares
of our Series D Convertible Preferred Stock. For accounting purposes, this
acquisition was treated as a reverse merger pursuant to which Global
Technologies was deemed to have acquired us as of May 1, 1999.
As of October 25, 2000, we were a 77% owned subsidiary of Global
Technologies, whose ownership was represented by 1,500 shares of our Series B 8%
Convertible Preferred Stock, approximately 1.7 million shares of our Series D
Preferred Stock and approximately 13.8 million shares of our common stock.
Our condensed consolidated 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. We have incurred a net loss from operations in the
current quarter ended September 30, 2000, plus have incurred losses from
operations in two of the last three fiscal years, and have an accumulated
deficit at September 30, 2000 as a result of efforts to build our customer base
and develop our operations.
Management believes that current cash balances, the $5.0 million credit
facility with Global Technologies (of which approximately $1.6 million remains
available as of November 1, 2000), and our other available financing sources
(consisting of an equity line of credit and a preferred stock offering) will not
be sufficient to meet currently anticipated cash requirements for the next 12
months. In addition, we have significant expansion plans, which will exacerbate
these liquidity issues. To the extent that available and prospective sources of
financing prove insufficient or unavailable, we will be required to modify our
expansion plans, scale back operations and/or modify our business strategy.
We are currently in discussions with equity and equipment financing
sources, which, if transactions are consummated, together with the
aforementioned available sources of financing, should provide sufficient funding
for us to meet our business plan requirements. There is no assurance that we
will be able to raise additional capital on terms acceptable to us or at all,
and, the inability to raise such capital would have a material adverse effect on
our operating results, financial condition and ability to continue as a going
concern.
RESULTS OF OPERATIONS
REVENUES
Revenue for the quarter ended September 30, 2000 was $55,236, a decrease of
$5,555,151 (or 99%) compared to revenue of $5,610,387 for the three months ended
September 30, 1999. Equipment sales of $42,735 for the quarter ended September
30, 2000 is comprised of $17,900 generated from the sale of servers to
educational institutions and $24,835 generated from the sale of spare equipment
parts. Equipment sales for the quarter ended September 30, 1999 were comprised
principally of approximately $5.4 million generated from the sale of 195
Cheetah(R) video servers in connection with the Georgia Metropolitan Regional
Education Services Agency Net 2000 project. Service income of $12,501 for the
quarter ended September 30, 2000 is comprised of our share of content revenue
generated by our installed systems, compared to $59,827 generated from design
services provided to Alstom Transport Ltd. in the quarter ended September 30,
1999. We provided these services to Alstom, but expect no further business from
Alstom.
COST OF SALES
Cost of equipment sales and service income for the three months ended
September 30, 2000 were $101,561, a decrease of $3,327,400 (or 97%) compared to
cost of equipment sales of $3,428,961 for the three months ended September 30,
1999. Cost of equipment sales of $10,803 for the current quarter is comprised
principally of costs associated with server sales to educational institutions.
Cost of equipment sales in the three months ended September 30, 1999 was
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comprised principally of material costs and estimated warranty costs for the 195
video servers for the Georgia schools project. Cost of service income of $90,758
for the quarter ended September 30, 2000 is principally attributable to video
content costs. We expect that these costs as a percentage of revenue will
decrease over time as our installed base of systems grows. Cost of service
income of $8,580 for the three months ended September 30, 1999 is comprised of
miscellaneous costs associated with services provided to Alstom.
GENERAL AND ADMINISTRATIVE COSTS
General and administrative expenses for the quarter ended September 30,
2000 were $3,785,637, an increase of $2,390,987 (or 171%) compared to expenses
of $1,394,650 for the three months ended September 30, 1999. Significant
components attributable to the increase in the current quarter include the
addition of our Philadelphia office and related personnel, expenses incurred by
our UK subsidiary related to development of the passenger rail market, and an
increase in payroll and benefit costs generated by an approximately 200%
increase in personnel in the current quarter over the comparable quarter ended
level. Significant components of general and administrative expenses include
payroll costs and legal and professional fees.
NON-CASH COMPENSATION EXPENSE
Non-cash compensation expense of $197,904 for the quarter ended September
30, 2000 is related to the prior issuance of warrants and common stock for
financial advisory services. Non-cash compensation expense of $85,000 for the
quarter ended September 30, 1999 is the result of a former employee's severance
package.
AMORTIZATION OF INTANGIBLES
Amortization expense for the quarter ended September 30, 2000 was $432,171,
an increase of $248,030 (or 135%) compared to amortization expense of $184,141
for the three months ended September 30, 1999. The increase in intangible
amortization in the current quarter is due to a revision made effective May 1,
2000 to our estimate of the remaining useful life of goodwill from ten years to
five years as a result of economic events which occurred during the previous
fiscal year.
INTEREST EXPENSE
Interest expense for the quarter ended September 30, 2000 was $755,114
compared to $135,649 for the three months ended September 30, 1999. Interest
expense for the current period can be attributed principally to non-cash
expenses related to warrants issued in connection with cash advances to us for
working capital purposes as well as beneficial conversions attributed to the
revolving credit facility with Global and the convertible note with Carnival.
Interest expense for the three months ended September 30, 1999 can be attributed
to long-term debt obligations.
INTEREST INCOME
Interest income for the quarter ended September 30, 2000 was $13,190
compared to $40,420 for the three months ended September 30, 1999. Interest
income for both periods was principally generated from short-term investments of
working capital.
OTHER INCOME
Other income for the quarter ended September 30, 2000 was $354 compared to
$7,270 for the three months ended September 30, 1999. Other income in the
current quarter resulted from the sale of scrapped inventory parts to employees,
whereas other income in the quarter ended September 30, 1999 resulted
principally from the sale of office furniture.
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LIQUIDITY AND CAPITAL RESOURCES
We expect to use a significant amount of cash in the next 12 months. Cash
will be used primarily to repay existing vendors, finance anticipated operating
losses resulting from efforts to increase our customer base and develop
operations, and to make capital expenditures required for sales of our systems.
We are currently using our working capital to finance equipment purchases and
other expenses associated with the delivery and installation of our products,
and general and administrative costs. Working capital will continue to decrease
as we continue to invest in equipment for orders under agreements with hotels,
invest in business development, and invest in additional equipment to the extent
we are successful in generating additional orders for sales of our systems,
returns on which are longer term by nature.
Our condensed consolidated 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. We have incurred a net loss from operations in the
current quarter ended September 30, 2000, plus have incurred losses from
operations in two of the last three fiscal years, and have an accumulated
deficit at September 30, 2000 as a result of efforts to build our customer base
and develop our operations.
Management believes that current cash balances, the $5.0 million credit
facility with Global Technologies (of which approximately $1.6 million remains
available as of November 1, 2000), and our other available financing sources
(consisting of an equity line of credit and a preferred stock offering) will not
be sufficient to meet currently anticipated cash requirements for the next 12
months. We are currently past due on many accounts payable, and certain
suppliers have imposed cash on delivery terms. In addition, we have significant
expansion plans, which will exacerbate these liquidity issues. To the extent
that available and prospective sources of financing prove insufficient or
unavailable, we will be required to modify our expansion plans, scale back
operations and/or modify our business strategy.
We are currently in discussions with equity and equipment financing
sources, which, if transactions are consummated, together with the
aforementioned available sources of financing, should provide sufficient funding
for us to meet our business plan requirements. There is no assurance that we
will be able to raise additional capital on terms acceptable to us or at all,
and, the inability to raise such capital would have a material adverse effect on
our operating results, financial condition and ability to continue as a going
concern.
During the three months ended September 30, 2000, we used $2.2 million of
cash for operating activities, an increase of $400,000 from the $1.8 million of
cash used for the three months ended September 30, 1999. The cash utilized in
operations during the quarter ended September 30, 2000 resulted primarily from
the net loss, partially offset by increases in accounts payable, payments due to
affiliate, and non-cash interest. The cash utilized in operations during the
three months ended September 30, 1999 resulted primarily from increases in
accounts receivable and inventories, offset by increases in accounts payable and
deferred revenue.
Cash flows used in investing activities were $1.5 million during the three
months ended September 30, 2000, an increase of $1.8 million from the $279,000
of cash provided for the three months ended September 30, 1999. The increase in
cash used resulted primarily from the purchase of equipment used for
installations of our systems into hotel properties.
During the quarter ended September 30, 2000, cash provided by financing
activities was $3.2 million, an increase of $3.7 million from the $495,000 of
cash used in the three months ended September 30, 1999. The increase in cash
provided in the current fiscal period resulted primarily from advances from
related parties, as well as the issuance of common stock and Series E Preferred
Stock.
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INFLATION AND SEASONALITY
We do not believe that we are significantly impacted by inflation or that
our operations are seasonal in nature.
RISKS ASSOCIATED WITH YEAR 2000
Through September 30, 2000, we have experienced no significant disruptions
in critical information technology and non-information technology systems and
believe those systems successfully responded to the Year 2000 date change. We
are not aware of any material problems resulting from Year 2000 issues, either
with our products, our internal systems, or the products and services of third
parties. We will continue to monitor our mission critical computer applications
and those of our suppliers and vendors throughout the year 2000.
FORWARD-LOOKING INFORMATION
This Report contains certain forward-looking statements and information
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The cautionary statements made in this
Report should be read as being applicable to all related forward-looking
statements wherever they appear in this Report. Forward-looking statements, by
their very nature, include risks and uncertainties. Accordingly, our actual
results could differ materially from those discussed herein. A wide variety of
factors could cause or contribute to such differences and could adversely impact
revenues, profitability, cash flows and capital needs. Such factors, many of
which are beyond our control, include, among others, the following: our success
in meeting our capital needs; success in obtaining new contracts; the volume and
type of work orders that are received under such contracts; the accuracy of the
cost estimates for the projects; our ability to complete projects on time and
within budget; levels of, and ability to collect accounts receivable;
availability of trained personnel and utilization of our capacity to complete
work; competition and competitive pressures on pricing; and economic conditions
in the United States and in other regions served us.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivatives Instruments and for Hedging Activities." ("SFAS
133"). SFAS No. 133 requires companies to record derivatives on the balance
sheet as assets and liabilities, measured at fair value. Gains and losses
resulting from changes in the values of those derivatives would be accounted for
in earnings. Depending on the use of the derivative and the satisfaction of
other requirements, special hedge accounting may apply. At June 30, 2000,
management believes that we had no freestanding derivative instruments in place
and had no material amount of embedded derivative instruments. We adopted SFAS
133 on July 1, 2000. Based upon our application of SFAS no. 133, its adoption
had no materially adverse effect on our consolidated financial statements.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation (an interpretation of APB 25). This interpretation clarifies the
application of APB No. 25 by clarifying the definition of an employee, the
determination of non-compensatory plans and the effect of modifications to stock
options. This interpretation is effective July 1, 2000 and is not expected to
have a material effect on our consolidated financial statements.
PART II. OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS
Swissair/MDL-1269, In Regards to an Air Crash Near Peggy's Cove, Nova
Scotia. This multi-district litigation, which is being overseen by the United
States District Court for the Eastern Division of Pennsylvania, relates to the
crash of Swissair Flight No. 111 on September 2, 1998. The Swissair MD-11
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aircraft involved in the crash was equipped with an entertainment network system
that had been sold to Swissair by Global's predecessor company, Interactive
Flight Technologies, Inc. Estates of the victims of the crash have filed
lawsuits throughout the United States against Swissair, Boeing, Dupont and
various other parties, including Global and us. We have been named in some of
the lawsuits filed on a successor liability theory. We and Global deny all
liability for the crash, and are being defended by Global's aviation insurer.
On September 1, 1999, SAir Group invited us to participate in a
conciliation hearing before the Justice of the Peace in Kloten, Switzerland,
which is the customary manner in which civil litigation is initiated in
Switzerland. The document informing us of the proceeding states that the request
has been filed in connection with the crash of Swissair Flight 111 primarily in
order to avoid the expiration of any applicable statutes of limitations and to
reserve the right to pursue further claims. The document states that the relief
sought is "possibly the equivalent of CHF 342,000,000 - in a currency to be
designated by the court; each plus 5% interest with effect from September 3,
1998; legal costs and a participation to the legal fees (of the plaintiff) to be
paid by the defendant."
Bryan R. Carr V. The Network Connection, Inc. and Global Technologies,
Ltd., Superior Court of Georgia, Civil Action No. 99-CV-1307. Bryan R. Carr, our
former Chief Operating and Financial Officer and a former Director, filed a
claim on November 24, 1999 alleging a breach of his employment agreement with
us. Mr. Carr claims that he is entitled to the present value of his base salary
through October 31, 2001, a share of any "bonus pool," the value of his stock
options and accrued vacation time. We and Global filed a motion to compel
arbitration of the claims pursuant to an arbitration provision in the employment
agreement and to stay the State Court action pending the arbitration proceeding.
Our motion was granted on August 9, 2000. On November 7, 2000, Mr. Carr filed
his claim for arbitration in Georgia.
A suit captioned Lodgenet Entertainment Corporation V. The Network
Connection, Inc. was filed April 5, 2000 in the Circuit Court for the Second
Judicial Circuit of the State of South Dakota. The action arose out of our
hiring of Theodore P. Racz, a former LodgeNet Entertainment Corporation
employee, as our Senior Vice President of the Hotels & Hospitality division.
LodgeNet alleged tortious interference with contract and tortious interference
with business relationships. LodgeNet sought to prohibit Mr. Racz from being
employed by us, as well as damages, and fees and costs. This case was
voluntarily dismissed without prejudice on August 30, 2000 by LodgeNet because
there was no jurisdiction in South Dakota.
A suit captioned Avnet, Inc. v. The Network Connection, Inc., was filed May
17, 2000 in Maricopa County Superior Court, CV2000-009416. The suit relates to
invoices for inventory purchased by us in late 1998 and early 1999. Avnet, Inc.
seeks payment of the invoices, interest and legal fees. We have not paid for the
inventory purchased primarily for the following reasons: (i) the inventory
purchased did not meet specifications and thus was not accepted by our customer,
and (ii) we were pursuing a separate warranty claim against Avnet regarding
certain other inventory purchased from Avnet. On October 11, 2000 we won a jury
verdict of $1.8 million in the warranty suit. The court is expected to enter its
final judgment in December 2000 which may include legal fees and costs of
approximately $290,000 plus prejudgement interest. We expect payment in
December, subject to the defendants not appealing the ruling.
We are subject to other lawsuits and claims arising in the ordinary course
of its business. In our opinion, as of September 30, 2000, the effect of such
matters will not have a material adverse effect on our results of operations and
financial position.
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ITEM 2 -- CHANGES IN SECURITIES
UNREGISTERED ISSUANCES
(a) CONVERSION OF SERIES D PREFERRED STOCK
On August 2, 2000, upon receipt of notice of conversion from Global, we
issued 5,000,000 shares of common stock to Global upon conversion of 826,447
shares of our Series D Preferred Stock held by Global. These securities were
issued in a transaction exempt from the registration provisions of the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereof.
(b) ISSUANCE OF SERIES E CONVERTIBLE PREFERRED STOCK
On August 3, 2000, we issued 100 shares of our Series E 6% Convertible
Preferred Stock for net proceeds of approximately $909,000 to certain third
party investors. Beginning 180 days after the date of issuance, each share of
this preferred stock is convertible into common stock at the lesser of $4.00 per
share or a price based on 80% of the average market price of shares of our
common stock for the five consecutive trading days preceding the date of
conversion. Placement agent fees were approximately $90,000. These securities
were issued in a transaction exempt from the registration provisions of the
Securities Act of 1933, as amended, pursuant to Section 4(2) thereof.
(c) ISSUANCE OF NOTE PAYABLE AND WARRANTS
On September 12, 2000, the Board of Directors authorized the issuance of
warrants to purchase 311,560 shares of common stock, which have been divided
equally between two trusts controlled by Irwin L. Gross, our Chairman and Chief
Executive Officer, as compensation for various working capital advances made to
us by the trusts from May 2000 through September 2000. As of September 30, 2000,
advances totaled $1,300,000. On September 12, 2000, the Board of Directors also
approved the conversion of $1,050,000 of these advances into promissory notes.
The number of warrants issued for each advance was based upon the amount
advanced divided by the closing market price of our common stock on the date of
each advance, which is also the exercise price per warrant. The warrants have
five-year terms. These securities were issued in transactions exempt from the
registration provisions of the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereof.
(d) INVESTMENT BY OFFICER
On October 16, 2000, our Executive Vice President purchased 500,000 units,
consisting of 500,000 shares of our common stock and warrants exercisable for
166,667 shares of our common stock. The warrants have an exercise price of $3.50
per share and a term of four years. The purchase price for these units was $2.00
per unit resulting in aggregate consideration of $1.0 million, which was paid to
us in installments in August and September 2000. The market price per share of
our common stock was $2.00 on October 16, 2000. These securities were issued in
a transaction exempt from the registration provisions of the Securities Act of
1933, as amended, pursuant to Section 4(2) thereof.
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
EXHIBIT NO. DESCRIPTION REFERENCE
----------- ----------- ---------
27 Financial Data Schedule. *
----------
* Filed herewith.
(b) REPORTS ON FORM 8-K
We did not file any reports on Form 8-K during the quarter ended September
30, 2000.
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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: November 14, 2000 THE NETWORK CONNECTION, INC.
By: /s/ IRWIN L. GROSS
------------------------------------
Irwin L. Gross
Chief Executive Officer
By: /s/ MORRIS C. AARON
------------------------------------
Morris C. Aaron
Executive Vice President &
Chief Financial Officer
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INDEX OF EXHIBITS
EXHIBIT NO. DESCRIPTION REFERENCE
----------- ----------- ---------
27 Financial Data Schedule. *
----------
* Filed herewith.
