Filed Pursuant to Rule 424(b)(3)
File No. 333-30980
PROSPECTUS [LOGO]
2,846,933 SHARES
THE NETWORK CONNECTION, INC.
COMMON STOCK
This prospectus relates to the offer for sale from time to time of up to
286,933 shares of our common stock by some of our current shareholders who, in
some cases, hold warrants to purchase shares of common stock, as well as up to
2,560,000 shares, consisting of 2,110,000 shares which we currently estimate is
the maximum number of shares that are purchasable pursuant to a $12,000,000
equity purchase agreement entered into with Fusion Capital Fund II, LLC and
450,000 shares, of which we have already issued 300,000 shares, which we
currently estimate we will issue to Fusion Capital as a commitment fee. If more
than 2,110,000 shares are purchasable by Fusion Capital under the equity
purchase agreement, we have the right, and presently intend, to terminate the
equity purchase agreement without any payment to or liability to Fusion Capital.
For more information on the selling shareholders, please see "Selling Security
Holders" beginning on page 54. For more information on the Fusion financing,
please see "The Fusion Transaction" beginning on page 36.
We will not receive any of the proceeds from the resale of these shares by
these selling shareholders, although we would receive certain benefits from the
conversion of the Series D Convertible Preferred Stock and proceeds from
purchases under the equity purchase agreement and would possibly receive
exercise proceeds from the exercise of the warrants. For more information on
proceeds, please see "Use of Proceeds" on page 11.
The Network Connection's common stock is traded on the Nasdaq SmallCap
Market under the symbol TNCX. On June 16, 2000, the last reported sales price of
our common stock was $4.00 per share.
PLEASE SEE "RISK FACTORS" BEGINNING ON PAGE 1 FOR A DISCUSSION OF CERTAIN
FACTORS YOU SHOULD CONSIDER IN CONNECTION WITH ANY DECISION TO PURCHASE SHARES
IN THIS OFFERING.
The selling shareholders may sell the shares of common stock described in
this prospectus in public or private transactions, on or off the Nasdaq SmallCap
Market, at prevailing market prices, or at privately negotiated prices. The
selling shareholders may sell shares directly to purchasers or through brokers
or dealers. Brokers or dealers may receive compensation in the form of
discounts, concessions or commissions from the selling shareholders. Fusion
Capital is an "underwriter" within the meaning of the Securities Act of 1933.
For more information on how the shares may be distributed, see "Plan of
Distribution" on page 55.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED ON THE
ADEQUACY OR ACCURACY OF THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is June 16, 2000.
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TABLE OF CONTENTS
PAGE
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Forward-Looking Statements and Associated Risks........................... ii
Risk Factors.............................................................. 1
Use of Proceeds........................................................... 10
Market For Our Common Stock and Related Shareholder Matters............... 11
Our Business.............................................................. 12
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................................ 25
The Fusion Transaction.................................................... 34
Management................................................................ 40
Security Ownership of Certain Beneficial Owners and Management............ 47
Certain Relationships and Related Transactions............................ 49
Description of Securities................................................. 50
Selling Security Holders.................................................. 52
Plan of Distribution...................................................... 53
Disclosure of The SEC's Position on Indemnification
for Securities Act Liabilities........................................... 56
Experts................................................................... 57
Legal Matters............................................................. 57
Where You Can Find More Information....................................... 58
Index to Financial Statements............................................. F-1
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We are a Georgia corporation. Our principal executive offices are located
at 222 North 44th Street, Phoenix, Arizona 85034, and our telephone number is
(602) 629-6200. In this prospectus, "The Network Connection," "we," "us," and
"our," and other possessive and other derivations thereof, refer to The Network
Connection, Inc. and its consolidated subsidiary, unless the context otherwise
requires. All trademarks and tradenames appearing in this prospectus are the
property of The Network Connection, unless otherwise indicated.
We may amend or supplement this prospectus from time to time by filing
amendments or supplements as required. Please read this entire prospectus and
any amendments or supplements carefully before making your investment decision
to purchase shares in this offering. You should rely only on the information
provided in this prospectus and any amendments or supplements. We have
authorized no one to provide you with different information. We are not making
an offer of these securities in any jurisdiction where the offer is not
permitted.
DEALER PROSPECTUS DELIVERY OBLIGATION
Until September 13, 2000, all dealers that effect transactions in these
securities, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
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FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
This prospectus includes "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. This Act provides a "safe
harbor" for forward-looking statements to encourage companies to provide
prospective information about themselves as long as they identify these
statements as forward-looking and provide meaningful cautionary statements
identifying important factors that could cause actual results to differ from the
projected results.
All statements other than statements of historical fact we make in this
prospectus are forward-looking. In particular, the statements in this prospectus
regarding our future results of operations or financial position are
forward-looking statements. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "potential," or "continue"
or the negative of such terms or other comparable terminology.
Forward-looking statements reflect our current expectations but are
inherently uncertain. For these statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995. You should understand that future events, in
addition to those discussed elsewhere in this prospectus, particularly under
"Risk Factors," and also in prior filings made by us with the Securities and
Exchange Commission, could affect our future operations and cause our results to
differ materially from those expressed in our forward-looking statements. The
cautionary statements made in this prospectus should be read as being applicable
to all related forward-looking statements contained in this prospectus.
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RISK FACTORS
Investing in our common stock will subject you to risks inherent in our
business. The performance of our common stock will reflect the performance of
our business relative to, among other things, our competition, general economic
and market conditions and industry conditions. The value of your investment may
increase or decline and could result in a total loss. You should carefully
consider the following factors as well as other information contained in this
prospectus before deciding to invest in our common stock.
WE HAVE A LIMITED OPERATING HISTORY UNDER NEW MANAGEMENT AND ARE IMPLEMENTING A
NEW BUSINESS STRATEGY THAT MAY NOT PROVE SUCCESSFUL.
On May 18, 1999, Global Technologies, Ltd. acquired control of us. As of
the date of this prospectus, Global Technologies owned approximately 80% of our
common equity on a fully converted basis, without taking into effect any future
dilution on account of our financing with Fusion Capital (see "The Fusion
Transaction" on page 36). In connection with its acquisition, Global
Technologies elected a new board of directors which, in turn, put in place a new
management team. The new management team has modified our business strategy. We
used to focus solely on video server sales to the education market and
entertainment system sales to airlines and cruise ship lines. By contrast, our
focus under new management is sales of interactive information and entertainment
systems to four markets: the hotel and hospitality, cruise ship, educational
institutions and corporate training, and passenger rail markets. Because this
strategy has only been implemented recently, there is virtually no operating
history on which to evaluate the strategy's prospects and new management's
ability to implement it. There is no assurance that we will have success in
implementing our new strategy, or that we will obtain the financial returns
sufficient to justify the expenditures we have made, and will continue to make,
in hopes of penetrating our newly designated target markets.
WE HAVE A HISTORY OF LOSSES AND EXPECT CONTINUED LOSSES.
We generated revenues of $11.1 million and $18.8 million for the fiscal
years ended October 31, 1997 and 1998, respectively, and realized net losses for
those years of $53.2 million and $7.2 million, respectively. For the eight-month
transition period ended June 30, 1999, we generated revenues of $1 million, and
realized net income of $2.3 million (this net income was due entirely to
reversal of prior accruals). For the nine months ended March 31, 2000, we
generated revenues of $5.7 million on which we realized a net loss of $4.4
million. Almost all of the revenues generated came from the sale of 195
Cheetah(R) video servers in connection with the Georgia Metropolitan Regional
Education Services Agency (MRESA) Net 2000 project. Without these sales, we
would have had a loss of $6.4 million for the nine months ended March 31, 2000.
As of March 31, 2000, our accumulated deficit was $87.4 million and working
capital was $0.1 million.
We expect to incur losses in the future as we focus on developing,
installing and maintaining interactive information and entertainment systems in
our four targeted markets. Each system installation is a capital-intensive
project. The majority of these systems will be installed at our cost and
recorded as our assets. Our revenues will be generated primarily from future
usage of these systems. It will take a significant amount of time before we can
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generate sufficient revenues to cover our operating costs, including
depreciation, expenses related to the costs of installing systems and corporate
overhead expenses. There can be no assurance that usage of the systems will ever
generate sufficient revenues to cover the costs of maintaining these systems.
IF WE CANNOT RENEGOTIATE AN AGREEMENT WITH CARNIVAL, WE MAY INCUR SIGNIFICANT
LOSSES.
Prior management entered into an agreement with Carnival Cruise Lines for
the purchase, installation and maintenance of our CruiseView(TM) system on a
minimum of one Carnival Cruise Lines ship. The Carnival agreement obligates us
to install and maintain CruiseView(TM) on an unspecified number of additional
ships designated by Carnival through December 2002. Pursuant to this agreement,
we installed systems on two Carnival ships, one on a Fantasy class ship and one
on a Destiny class ship. Under the terms of the agreement, we receive payment
for 50% of the sales price of the system in installments through commencement of
operation of the system for passenger use, with the remainder recovered through
receipt of our 50% share of net profits generated if any from the use of the
system.
Furthermore, the terms of the Carnival agreement provide that Carnival may
return the CruiseView(TM) system within an acceptance period, as established for
each order, or for breach of warranty. The acceptance period for the Fantasy and
Destiny class ships are twelve months and three months, respectively, from
completion of installation and testing, which occurred in February 1999 and
October 1999, respectively. The initial warranty period for these systems is
three years.
We have determined that the cost of building and installing the
CruiseView(TM) systems on the existing two Carnival ships pursuant to the
current Carnival agreement exceeds the revenue that can be earned in connection
therewith. Should we be required to build and install CruiseView(TM) on
additional ships pursuant to the current agreement, such arrangements could
prove unprofitable and have a negative effect on our working capital.
Given these costs, and ongoing technical issues, we notified Carnival of
our desire to renegotiate the current agreement and have been endeavoring to do
so. During these discussions, Carnival notified us in a letter dated April 24,
2000 that it sought to terminate the agreement and to assert certain remedies
thereunder, including a refund of amounts paid to us, potential
warranty/de-installation obligations and other matters. We continue to seek to
resolve issues under the Carnival agreement. There is no assurance that we will
be able to reach a mutually satisfactory resolution of the Carnival agreement
and secure a new, more favorable long-term contract with Carnival.
While we are optimistic about our discussions with Carnival, if we cannot
renegotiate a mutually satisfactory agreement with Carnival, or if we should
have to refund amounts paid to us or remove our CruiseView(TM) systems from the
Carnival ships, we would incur substantial losses. Such losses could have a
material adverse effect on our business, operating results and financial
condition.
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WE WILL REQUIRE ADDITIONAL FINANCING.
We will need to invest a great deal of capital in the implementation of our
new business strategy. The sales-cycle time for our products and services is
long and could exceed one year in certain cases. Consequently, even if our new
strategy is successful, unless we can obtain additional sales orders in the
short-term from the education market, we will continue to incur losses in the
foreseeable future. In addition, we will require substantial capital to purchase
and install equipment for sales in our other markets. Our contracts with hotels
require us to invest in the necessary equipment to operate our systems. Such
costs are expected to be recovered from revenues generated by the system over
the course of the contract, which approximate seven years. Furthermore, because
of the long sales cycle for our systems, we will require additional working
capital to fund operations, including inventory and accounts receivable. There
is no assurance we will be able to obtain such working capital. Therefore, our
accumulated deficit will probably increase, working capital will probably
decrease, and we will need to obtain financing to implement our business plan.
As of June 2, 2000, we have drawn $3.6 million against our $5.0 million
revolving credit facility agreement with Global Technologies. Absent alternative
sources of financing, we will likely continue to draw on the credit facility to
finance the production of some or all of the product development necessary for
our interactive information and entertainment systems, as well as to cover other
commitments and operating expenses. Global does not currently have sufficient
cash for us to borrow the full $5.0 million under the credit facility. Should we
be unable to borrow funds under the facility, it could have a material adverse
effect on our operating results and financial condition.
We recently signed an agreement with an investment fund pursuant to which
we have established a $12 million private equity line. We may draw against this
private equity line up to approximately $1,000,000 a month over a twelve month
period. See "The Fusion Transaction" on page 36.
WE HAVE A VERY SMALL BACKLOG OF ORDERS.
We have received only four orders for installation of our InnView(TM)
system - two for hotels in California, one for a hotel in Arizona and one for a
hotel in Indiana. We have no additional orders from Carnival Cruise Lines or
from MRESA. We do not believe our sales to date are sufficient to determine
whether there is meaningful demand for our products. We intend to continue to
devote significant resources to our sales and marketing efforts in an effort to
promote interest in our products. There is no assurance that we will be
successful with these efforts or that significant market demand for our products
will ever develop.
WE MAY NOT BE ABLE TO MANAGE OUR PLANNED GROWTH.
We have expanded and plan to continue to expand our business operations
during fiscal year 2000. This expansion could strain our limited personnel,
financial, management and other resources. To implement our new business
strategy, we will need to, among other things, maintain and expand our current
sales and marketing efforts. In addition, we will need to adapt our financial
planning, accounting systems and management structure to accommodate the growth
if it occurs. Our failure to anticipate or manage our growth, if any, could
adversely affect our business, operating results and financial condition.
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OUR SYSTEMS MAY SUFFER FROM DEFECTS.
The systems we sell incorporate a combination of sophisticated computer
chip, electronic circuit and network technology. To enhance the operation of our
systems and adapt them for the various environments in which they are installed,
we modify and reconfigure our systems from time to time. In addition, we rely on
subcontractors to manufacture, assemble and install many components of our
systems. Although we have quality control procedures designed to detect
manufacturing and system design errors and although we test our products before
marketing them, any component product may contain flaws which we may not detect
through these procedures. There is no assurance that we will identify all
defects. We believe that reliable operation will be an important purchase
consideration for our customers. Failure to detect and prevent design flaws or
flaws within components of our systems could adversely affect our business,
financial condition and operating results.
WE FACE SIGNIFICANT COMPETITION.
The market for our systems, products and services is highly competitive and
competition is likely to intensify.
* The major competitors in our hotels and hospitality market are On
Command Corporation, LodgeNet Entertainment Corporation and Quadriga.
On Command currently serves an estimated 960,000 rooms and LodgeNet,
approximately 680,000 rooms. We are unable to determine the extent of
Quadriga's market. On Command and LodgeNet focus their sales and
marketing efforts on North American properties, whereas Quadriga
markets its products primarily to European hotels and, to a much
lesser extent, Middle Eastern and African hotels.
* In the cruise ship market, we compete primarily with Allin Corporation
and Siemens. We estimate that Allin currently has systems installed on
seven cruise ships, and Siemens has a system installed on one. Allin
Corporation may have orders for additional cruise ships.
* In the education and corporate training market, our servers compete
primarily with those of other companies that manufacture video server
products, such as Sony, Dell, Gateway, Silicon Graphics, Compaq and
Hewlett Packard. Many regional competitors provide technology services
which may be similar to ours to the education and corporate training
markets.
* SmartWorld, a UK-based company, has announced its intention to develop
and offer a limited video-on-demand system for the passenger rail
market. In addition, we are aware that another UK-based company,
ALSTOM, is planning to create a subsidiary to develop systems
competitive with ours for the passenger rail industry.
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Most of these companies have greater financial, technical and marketing
resources than we do. Moreover, each of them is well established in its
respective market and has developed customer and end user goodwill and brand
recognition that may be difficult for us to overcome. We expect that, to the
extent that the market for our systems, services and products develops,
competition will intensify and new competitors will enter our designated target
markets. For example, large manufacturers of in-flight entertainment systems may
consider entry into any of our markets.
We may not be able to compete successfully against existing and new
competitors as the market for our systems, products and services evolves and the
level of competition increases. A failure to compete successfully against
existing and new competitors would have a materially adverse effect on our
business and results of operations.
GLOBAL TECHNOLOGIES EXERCISES SUBSTANTIAL CONTROL OVER US.
Global Technologies owns shares of our capital stock which entitles it to
elect a majority of our directors. Consequently, Global Technologies will be
able to exert virtually unlimited influence over the direction of our business
and policies.
WE DEPEND ON KEY EXECUTIVES.
Our potential for success depends significantly on certain key management
employees, including our Chairman and Chief Executive Officer, Irwin L. Gross,
our President and Chief Operating Officer, Robert Pringle, our Chief Financial
Officer, Morris C. Aaron, our Executive Vice President, Jay Rosan, and our Chief
Technology Officer, Richard Genzer. The loss of the services of any one of them
or of any of our other key employees would have a materially adverse effect on
us. We also believe that our future success will depend in large part on our
ability to attract and retain additional highly skilled content, technical,
management, sales and marketing personnel. Competition for quality, highly
skilled employees is intense. We give no assurance that we will be successful in
retaining our key personnel or in attracting and retaining the personnel we
require for expansion.
WE MAY NOT BE SUCCESSFUL IN PROCURING AND PROVIDING COMPELLING CONTENT FOR OUR
SYSTEMS.
Being able to procure and provide compelling content for our interactive
information and entertainment systems is integral to our success. Our revenue
models in each of our target markets, other than the education and corporate
training market, involve providing system infrastructure by us with little or no
upfront cost to our customers. In fact, in the hotel and hospitality market, the
model involves provision of the system infrastructure at no cost to our
customers. Our plan is to receive a share of the revenue generated from the
content that we procure and provide for use through the systems pursuant to a
multi-year contract.
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We are in the process of acquiring the rights to and packaging suites of
content to be provided through our systems, each suite being specific to the
environment in which the system is being installed. For example, the content
provided through CruiseView(TM) will be intended to appeal to cruise ship
travelers, the content provided through InnView(TM) will be intended to appeal
to hotel guests, and the content provided through TrainView(R) will be intended
to appeal to rail passengers. We give no assurance that we will be able to
develop, procure or integrate a compelling suite of content for any of our
systems. If we are unable to do so, system-users will not use the system and we
will not earn content revenues. Our business would be adversely affected because
we rely on the content revenue to make up for the discount we allow on the
system infrastructure. In addition, if we were unable to provide compelling
content, our target customers would not likely be receptive to our systems,
which would adversely affect our business, as well.
OUR QUARTERLY OPERATING RESULTS WILL VARY.
We expect to experience significant fluctuations in our operating results.
Fluctuations in operating results may cause the price of our common stock to be
volatile. Our operating results may vary as a result of many factors, including:
* our ability to implement our new business strategy, which requires the
commitment of a great deal of capital, developing new applications for
our interactive information and entertainment systems and penetrating
newly designated target markets, such as the passenger rail, hotel and
hospitality and corporate training industries;
* our ability to integrate, retain and manage our new management team;
* our ability to generate further revenues on a profitable basis from
the markets in which we currently operate, such as the education and
cruise ship markets;
* our ability to procure and provide desirable content for our
interactive information and entertainment systems;
* our ability to generate orders so as to manage the long sales cycle
for our systems. This sales cycle involves evaluation and
customization of a system for each project, a test installation of
each customized system, and negotiation of related agreements from
other providers, such as movie and Internet access providers. All of
this is prior, in most cases, to a contract being signed between us
and a prospective purchaser of our systems; and
* our ability to compete successfully in our designated target markets.
Each of these factors is difficult to control and forecast. Thus, they
could have a material effect on our business, financial condition and results of
operations. For example, during the quarter ended September 30, 1999, we
recorded revenue of approximately $5.3 million from sales in connection with the
Georgia MRESA Net 2000 project. We have not received any additional orders in
connection with that project, nor have we recorded significant revenue in
connection with any project since then.
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Notwithstanding the difficulty in forecasting future sales, we nonetheless
must undertake research and development and sales and marketing activities and
other commitments months or years in advance. Accordingly, any shortfall in
product revenues in a given quarter may have a materially adverse effect on our
business, because we are unable to adjust expenses during the quarter to match
the level of product revenues, if any, for the quarter. We believe that
period-to-period comparisons of our operating results are not meaningful. If our
operating results in one or more quarters do not meet expectations, the price of
our stock could decrease.
OUR STOCK PRICE MAY BE VOLATILE.
The market price for our common stock may be affected by a number of
factors, including the announcement of orders for our products or product
enhancements by us or competitors, the loss of services of one or more of our
key employees, quarterly variations in our results of operations or those of our
competitors, changes in earnings estimates, developments in our industry, sales
of substantial numbers of shares of our common stock in the public market,
general market conditions and other factors, including factors unrelated to our
operating performance or the operating performance of our competitors. To date,
the market price for our common stock has been volatile and has fluctuated
significantly. The trading price of our common stock is likely to continue to be
highly volatile. In addition, the stock market in general and the market for
technology-oriented companies in particular, have experienced extreme price and
volume fluctuations. These broad market and industry factors may materially and
adversely affect the market price of our common stock, regardless of our actual
operating performance.
DELISTING OF OUR COMMON STOCK FROM TRADING ON THE NASDAQ SMALLCAP MARKET WOULD
REDUCE THE MARKETABILITY OF OUR SHARES.
Our common stock is listed for trading on the Nasdaq SmallCap Market under
the symbol TNCX. A listed company may be delisted if it fails to maintain
minimum levels of stockholders' equity, shares publicly held, bid price, number
of stockholders or aggregate market value, or if it violates other aspects of
its listing agreement. At March 31, 2000 we did not satisfy the minimum level of
net tangible assets required to be listed ($2 million), nor did we have
sufficient non-affiliate market capitalization ($35 million) or net income
($500,000 for two of the past three years). We are seeking additional capital
and attempting to effect other equity transactions to, among other things,
increase our net tangible assets to at least the minimum level required. There
can be no assurance that we will be able to raise this additional capital, or if
we are able to raise additional capital it will be on terms satisfactory to us,
or to effect other equity transactions currently under consideration. If we fail
to satisfy the criteria for continued listing, our common stock may be delisted.
If our common stock is delisted, public trading, if any, would thereafter
be conducted in the over-the-counter market in the so-called "pink sheets," or
on the NASD's "Electronic Bulletin Board." In this event, it may be more
difficult to dispose of, or even to obtain quotations as to the price of, our
common stock and the price, if any, offered for our common stock may be
substantially reduced.
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In addition, if our common stock is delisted from trading on the Nasdaq
SmallCap Market, and the market price of our common stock is less than $5.00 per
share, subject to certain exceptions, trading in our common stock would be
subject to the requirements of Rule 15g-9 promulgated under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Under this rule,
broker/dealers who recommend such securities to persons other than established
customers and accredited investors (generally institutions or high-net worth
individuals) must make a special written suitability determination for the
purchaser and receive the purchaser's written agreement to a transaction prior
to sale. The requirements of Rule 15g-9, if applicable, may affect the ability
of broker/dealers to sell our securities and may also affect the ability of
purchasers in this offering to sell their shares in the secondary market.
The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the
"Penny Stock Rule") also requires additional disclosure in connection with any
trades involving a stock defined as penny stock (any non-Nasdaq equity security
that has a market price or exercise price of less than $5.00 per share, subject
to certain exceptions). Unless exempt, the rules require the delivery, prior to
any transaction involving a penny stock, of a disclosure schedule prepared by
the SEC explaining important concepts involving the penny stock market, the
nature of such market, terms used in such market, the broker/dealer's duties to
the customer, a toll-free telephone number for inquiries about the
broker/dealer's disciplinary history and the customer's rights and remedies in
case of fraud or abuse in the sale. Disclosure must also be made about
commissions payable to both the broker/dealer and the registered representative,
and current quotations for the securities. Finally, monthly statements must be
sent disclosing recent price information for the penny stock held in the account
and information on the limited market in penny stocks.
THE MARKETS IN WHICH WE OPERATE ARE CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE.
The markets in which we operate are characterized by rapid technological
change, frequent new product and service introductions and evolving industry
standards. Significant technological changes could render our existing
technologies, products and services obsolete. The networking solutions, content
and server markets' growth and intense competition exacerbate these conditions.
If we are unable successfully to respond to these developments or do not respond
in a cost-effective way, our business, financial condition and operating results
will be adversely affected. To be successful, we must adapt to these rapidly
changing markets by continually improving the responsiveness, services and
features of our products and services and by developing new features and
gathering new and appealing content to meet the needs of our customers. We also
need to respond to technological advances and emerging industry standards in a
cost-effective and timely manner.
OUR INTELLECTUAL PROPERTY MAY NOT BE ADEQUATELY PROTECTED AND WE MAY INFRINGE
THE RIGHTS OF OTHERS.
Our success will depend in part on our ability to protect our proprietary
technology. We rely primarily on a combination of trademark laws and employee
and third-party nondisclosure agreements to protect our proprietary rights.
Further, we intend to distribute our products in a number of foreign countries.
The laws of those countries may not protect our proprietary rights to the same
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extent as the laws of the United States. We may be involved from time to time in
litigation to determine the enforceability, scope and validity of our
proprietary rights, or to defend ourselves from third parties asserting
infringement claims against us. Any such litigation could result in substantial
costs to us and could divert our management and technical personnel away from
their normal responsibilities.
WE MAY NOT BE ABLE TO OBTAIN CRITICAL COMPONENTS FROM OUR SUPPLIERS.
Currently, we obtain certain key components used in our systems and
products from a number of sources. We do not have long term supply contracts
with these or any other component vendors and we purchase all of our components
on a purchase order basis. Component shortages may occur and we may not be able
to obtain the components we need in a timely manner or on a commercially
reasonable basis. In addition, we subcontract for the manufacture, assembly and
installation of many components of our systems. If we were unable to obtain
sufficient quantities of key components used in our systems or products due to
availability of raw material and labor or to other constraints beyond our
control, we could experience delays in the development of our systems or in
product shipments, or be forced to redesign our systems or products. Any of
these scenarios would have a materially adverse affect on our business. In
addition, there is no assurance that our subcontractors will be able to support
our manufacturing, assembly and installation requirements in the future.
THE MARKET PRICE OF OUR COMMON STOCK COULD BE DEPRESSED BECAUSE OF SHARES
ELIGIBLE FOR FUTURE SALE AND SHARES RESERVED FOR FUTURE ISSUANCE UPON THE
EXERCISE OF OPTIONS AND WARRANTS AND THE CONVERSION OF PREFERRED SHARES.
Sales of a substantial number of shares of common stock in the public
market in connection with and following this offering could adversely affect the
market price for our common stock. On the date of this prospectus, we had
12,911,479 shares of common stock outstanding. Approximately 44% of these shares
are, and upon effectiveness of this registration statement 45% of these shares
will be, freely tradeable without restriction under the Securities Act of 1933.
The remaining shares may be sold in accordance with Rule 144 promulgated under
the Securities Act when the applicable holding period has been satisfied. In
addition, we have registered a total of 1.3 million shares of our common stock
reserved for issuance under our stock option plans, of which an aggregate of
approximately 358,974 shares had been issued as of the date of this prospectus.
The remaining 941,026 shares, when and if issued, would be freely tradeable
(unless acquired by any of our affiliates, in which case they would be subject
to volume and other limitations under Rule 144). In addition, we are registering
179,500 shares underlying warrants pursuant to this prospectus which will be
freely tradable upon effectiveness of this registration statement. We are also
permitted to issue up to $12 million of our common stock under the Fusion
financing during the remainder of its term. The shares we sell under the Fusion
financing will be available for resale in the public market pursuant to this
prospectus. The market price of our common stock could fall as a result of the
sale of any of these shares.
WE MAY BE SUBJECT TO REGULATION.
In the United States, we are not currently subject to direct regulation
other than federal and state regulation applicable to businesses generally.
However, changes in the regulatory environment relating to the
telecommunications and media industry could have an adverse effect on our
business as it relates to the procurement of content for our systems.
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Other legislative proposals from international, federal and state
governmental bodies in the areas of content regulation, intellectual property,
privacy rights and state tax issues could impose additional regulations and
obligations on us. We cannot predict whether or not any legislation of these
types might pass, nor the financial impact, if any, the resulting regulation may
have on us. Moreover, the applicability to content, online service and Internet
access providers of existing laws governing issues such as intellectual property
ownership, libel and personal privacy is uncertain. The law relating to the
liability of online service companies and Internet access providers for
information carried on or disseminated through their systems is also currently
unsettled and has been the subject of several recent private lawsuits. If
similar actions were to be initiated against us, costs incurred as a result of
such actions could have a material adverse effect on our business.
We may offer gaming activities from time to time through our interactive
information and entertainment systems in those jurisdictions where we may do so
legally. Gaming activities are highly regulated and illegal in most
jurisdictions in the United States. Complying with gaming laws and regulations
at both the state and federal levels could result in added expense, lower
margins and delays in implementing gaming options for use through our systems.
Additionally, we must generally comply with various safety regulations when
installing our systems. Compliance with these regulations may increase the
expense of a system and decrease our margins, or delay, or even prevent,
installation, any of which could have an adverse effect on our business.
WE ARE A DEFENDANT IN A MULTI-DISTRICT, MASS-TORT CLASS ACTION LAWSUIT.
On September 2, 1998, Swissair flight 111 crashed. The aircraft involved in
the crash was a McDonnell Douglas MD-11 equipped with an in-flight interactive
entertainment system developed by the Interactive Entertainment Division we
acquired from Global Technologies. Since then, a number of claims have been
filed by the families of the victims of the crash. We have been named as one of
the many defendants, including Swissair, Boeing, DuPont and Global Technologies,
in this consolidated multi-district litigation. Global Technologies' aviation
insurer is defending us in the action. Global Technologies has $10.0 million in
insurance coverage related to the action. Global Technologies also has an
umbrella policy for an additional $10.0 million in coverage, however, Global
Technologies and the umbrella carrier are currently litigating the applicability
of this policy to the action. We did not assume any liability of Global
Technologies in connection with the Swissair crash. If liability is assessed
against us directly, to the extent this liability exceeds the available
insurance, our business will be adversely affected.
USE OF PROCEEDS
We will not receive any proceeds from the sale of the shares of our common
stock being sold pursuant to this prospectus. The selling shareholders will
receive all net proceeds from any sale of such shares.
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MARKET FOR OUR COMMON STOCK AND RELATED SHAREHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock is listed on the Nasdaq SmallCap Market under the symbol
"TNCX." The table below sets forth the range of quarterly high and low closing
prices for our common stock on the Nasdaq SmallCap Market during the quarters
indicated.
QUARTER ENDED HIGH LOW
------------- ---- ---
June 30, 2000
(to the date of this prospectus) $8.719 $3.000
March 31, 2000 13.375 5.375
December 31, 1999 7.000 1.438
September 30, 1999 2.906 1.250
June 30, 1999 3.375 1.375
March 31, 1999 3.938 2.125
December 31, 1998 4.125 2.000
September 30, 1998 4.938 1.813
June 30, 1998 5.688 3.188
March 31, 1998 7.125 3.625
RECORD HOLDERS OF OUR COMMON STOCK
As of the date of this prospectus, there were approximately 100 holders of
record of our common stock, and we believe there are approximately 2,200
beneficial holders of our common stock, based on broker requests for
distribution.
DIVIDEND POLICY
We have not paid any dividends on our common stock in the last two years
and we do not expect to do so in the foreseeable future. We currently intend to
retain future earnings, if any, to finance operations and the expansion of our
business. Any future determination to pay dividends will be at the discretion of
our board of directors and will depend upon our financial condition, operating
results, capital requirements and such other factors as the board of directors
deems relevant.
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OUR BUSINESS
GENERAL DESCRIPTION OF OUR BUSINESS AND RECENT DEVELOPMENTS
We design, manufacture, install and maintain advanced, high-end,
high-performance computer servers and interactive, broad-band information and
entertainment systems, and procure and provide the content available through the
systems. These all-digital systems deliver an on-demand multimedia experience
via high-speed, high-performance Internet Protocol (IP) networks. These systems
are designed to provide users access to information, entertainment and a wide
array of service options, such as shopping for goods and services, computer
games, access to the World Wide Web and on-line gambling where permitted by
applicable law. The service options available are customized for each
installation and generally vary depending on the environment in which each
system is installed. Our targeted markets for these systems are hotels and
time-share properties, cruise ships, educational institutions and corporate
training, and passenger trains.
We have had the following recent developments:
* EXECUTIVE MANAGEMENT -- In March 2000, we announced the appointment of
a new executive management team, including Robert S. Pringle,
President and Chief Operating Officer, Dr. Jay R. Rosan, Executive
Vice President, and Richard E. Genzer, Chief Technology Officer. These
well-regarded Internet executives have broad experience in building
branded Internet portals, creating successful e-commerce solutions,
and aggregating information and entertainment content.
* CONTENT DIVISION - In March 2000, we formed a new division to focus on
creating long-term business models for content, commerce, community
and connectivity. This division will create an enhanced away-from-home
experience where people can access and customize content and date.
* HOTEL & HOSPITALITY DIVISION - Since December 1999, we have recruited
five national and regional sales executives and several third-party
agents. Gregory Varey leads our U.S. sales team and Theodore P. Racz
leads our international sales efforts. In this timeframe, we have
signed contracts from four hotels for installation of our interactive
information and entertainment systems for hotel and time-share
properties, which we call "InnView(TM)."
* CRUISE SHIP DIVISION - We have developed an enhanced version of our
CruiseView(TM) technology platform, increasing its performance and
capabilities, and are in advanced discussions with several major
cruise companies about installing this interactive system, including
Carnival. We have created a portable demonstration system, which we
use to demonstrate the system's capabilities to industry players and
are exhibiting at the Posidonia Sea Trade conference in Greece in
June. Walter O. Gerber leads this division.
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We are currently negotiating with Carnival to resolve issues regarding
recovery of amounts paid to us (recorded as deferred revenue), our
recovery of our inventory costs, potential warranty/de-installation
obligations and other matters (see Risk Factors regarding Carnival on
page 2 above).
* EDUCATION & CORPORATE TRAINING DIVISION- In September 1999, we
completed delivery and installation of 195 Cheetah(R) video servers to
Georgia schools in connection with the Georgia Metropolitan Regional
Education Services Agency (MRESA) Net 2000 project. We received
payment of $5.3 million in connection with the project. In December
1999, we hired James D. Oots to lead the division.
* PASSENGER RAIL DIVISION- In September 1999, we hired Stephen J. Ollier
to lead the division. We have submitted pricing proposals to two of
the world's largest train operators for new and retrofit installations
of TrainView(R) systems. We intend to launch our new TrainView(R)
showroom and demonstration system in June in the United Kingdom and
have invited key industry executives to an opening reception.
Guest Services available through our CruiseView(TM) and InnView(TM) Systems
include:
* on-demand films, short video features and music videos;
* free-to-guest television programs;
* concierge information and reservations;
* in-room guest messaging and bulletin boards; and
* in-room folio review, express check-out and guest surveys.
Eventually, we also plan to include the following guest services through
our InnView(TM) System:
* high-speed access to the World Wide Web and e-mail;
* voice-over IP (i.e., long distance telephone calls over the Internet);
* e-commerce services, such as interactive shopping;
* interactive games and casino-style gambling where permitted by law;
and
* interactive advertising and promotion of customer events, shops and
restaurants.
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BUSINESS STRATEGY
Our primary objective is to be a leading provider of scaleable multimedia,
interactive information and entertainment systems. To this end, we have
developed the following strategies:
* BE RECOGNIZED AS A TOTAL SOLUTION PROVIDER. We will continue to
develop our content division, which will acquire, package and monitor
a broad range of compelling multimedia content tailored to appeal to
the typical end-users in each of our market segments. We believe this
is necessary so that we can be viewed by our customers not as a system
infrastructure provider, but rather as a total solution provider.
* LEVERAGE OUR CORE TECHNOLOGY ACROSS MARKET SEGMENTS. We will pursue
new markets and applications for our systems, products and
technologies.
* NURTURE KEY BUSINESS PARTNERS AND STRATEGIC ALLIANCES. We will nurture
our existing business relationships, and develop new ones with
partners with strong national and international presences. We will use
these business relationships to further penetrate our targeted
markets.
* DEVELOP OUR NEWLY CREATED DIVISIONS AND PENETRATE FURTHER THE MARKETS
THEY SERVE. We will continue to invest in our newly created divisions
and staff them with the skilled professionals necessary to effectively
and efficiently maximize order generation for our systems, products
and services in the markets they serve.
* INVEST IN OUR CORE COMPETENCIES. We will continue to attract and
retain highly skilled professionals in these critical disciplines:
industry specific marketing and sales; multimedia content development,
acquisition and management; systems and software engineering; supplier
management; finance; contracts administration; and program management
applied to large-scale systems.
PRODUCTS AND SERVICES
TECHNOLOGY
The hardware for our interactive systems consists of high speed Cheetah(R)
servers, multiple disk drives, switches, cabling, set-top personal computers,
and televisions or other electronic displays to serve as monitors for our
systems. Our TransPORTAL(TM) system software is based on standardized Web
browser component technology. Our systems provide a variety of informative,
entertainment and interactive content which may be accessed and viewed in the
hotel room or cruise ship cabin on demand. Our systems are 100% digital and
offer our customers flexibility in adding new content to the system, as well as
the ability to brand their marketing vision via the "look and feel" of the
underlying graphical user interface.
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Dual, fault-tolerant Cheetah(R) servers serve as the heart of our systems.
One Cheetah(R) server serves as the local area network backbone and can provide
100 megabit connectivity to each user on the system. The scaleable architecture
of our server is based on Intel processors and Microsoft operating systems. Our
systems interface with both color flat panel computer monitors and television
displays.
The design for our interactive information and entertainment systems are
proprietary to us, as are our Cheetah(R) video servers and TransPORTAL(TM)
software tools. However, other hardware used in our systems is predominantly
commercial, off-the-shelf hardware, based on non-proprietary or open-system
computer and Internet Protocol (IP) network standards. We believe that this use
of available commercial hardware allows us to outsource component product
manufacturing to suppliers without compromising overall product quality and
reliability. We believe that it also allows us to focus our operations resources
on supplier management, final assembly and testing.
Each of our servers can serve up to 300 simultaneous users. We install
enough servers in each customer location so that the total number of servers,
when multiplied by 300 users per server, will meet customer specifications in
terms of the maximum number of expected users at any time.
TURNKEY INTERACTIVE INFORMATION AND ENTERTAINMENT SYSTEMS
We currently market three customized turnkey systems. Each of these systems
is built on our Cheetah(R) servers and TransPORTAL(TM) software package. We
customize the content available through our systems to provide the best total
solution for our respective market purchasers:
* CruiseView(TM) is our system solution for the cruise ship market. The
system is designed to provide information, entertainment, gaming,
shore excursions and free-to-guest services. The system is also
designed to provide Internet access over the television, voice over
IP, and concierge and other guest services. Some of the content can be
available free of charge, some can be advertising supported, and some
can be available on a pay-per-use basis. We will share revenues from
advertising and pay-per-use with the cruise lines on a negotiated
percentage basis.
* InnView(TM) is our system solution for the hotel and time-share
market. In accordance with our three hotel agreements, we will provide
interactive and entertainment content for use by the hotel guests. The
system is also designed to provide Internet access over the
television, voice over IP, and concierge and other guest services.
Some of the content can be available free of charge, some can be
advertising supported, and some can be available on a pay-per-use
basis. We will share revenues from advertising and pay-per-use with
the hotels on a negotiated percentage basis.
* TrainView(R) is our newest system solution. We anticipate that our
TrainView(R) system will provide interactive, entertainment and other
content to be determined in conjunction with future customers, if any.
We have developed a TrainView(R) prototype, which we are currently
marketing to train operators in Europe and Asia.
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SERVER SALES
Our current business strategy is to offer and sell complete, turnkey
interactive information and entertainment systems. However, a substantial
portion of our revenues generated since June 30, 1999 have come from the sale of
our Cheetah(R) video servers which have been installed as part of a system
designed and installed by others. Although we will continue to offer and sell
the servers as stand-alone, high-end, video servers, we are endeavoring to be
known as a total system solution provider in the education market as well as in
the other markets we serve.
CONTENT
We obtain the content which we show on our systems in several different
ways. Movies are obtained by licensing products from industry suppliers. Other
content is purchased or licensed from other providers.
We expect to expand all of our systems to include additional content and
features, such as Internet access, on-line shopping and local entertainment
guides. We are currently developing our content division which will oversee this
development. Our content division is also looking to provide a total solution
system for the education and corporate training markets.
OUR HISTORY
We were incorporated in Georgia in 1985. Our common stock is listed on the
Nasdaq SmallCap Market under the ticker symbol "TNCX." Our primary focus under
prior management from inception to 1995 was providing video products and
services to the educational market. After an initial public offering in 1995,
prior management began to market interactive information and entertainment
systems to the commercial airline and passenger cruise ship industries.
Our AirView(R) product was installed on two Fairlines Airlines aircraft. In
addition, the in-flight entertainment system developed by the Interactive
Entertainment Division we acquired from Global Technologies was installed on 19
Swissair aircraft, two Debonair Airlines aircraft and three Alitalia aircraft.
The heavily regulated nature of the airline market prohibitively increased our
costs. Fairlines filed for bankruptcy protection and we were never able to
collect the amounts owed to us. These facts, together with the Swissair
litigation, led us and Global Technologies to stop pursuing this market in 1998.
See "Risk Factors - We are a defendant in a multi-district, mass tort class
action lawsuit."
In addition, prior management entered into agreements with Carnival Cruise
Lines and Star Cruises to install our systems on their cruise ships. Operational
problems on the Star cruise ship led Star to cancel its agreement, and we were
unable to recover our investment. Prior management also installed a system on
one Carnival ship. Under the Carnival agreement, we are obligated to remove any
installed system and refund Carnival's payments for that system for a period of
time after installation. We are currently endeavoring to renegotiate our
agreement with Carnival. See "RISK FACTORS -- If we cannot renegotiate an
agreement with Carnival, we may incur significant losses" on page 2.
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Early in 1999, prior management's inability to collect receivables and
other administrative problems left us struggling financially and in need of
capital. In May 1999, Global Technologies, Ltd., a Delaware corporation listed
on the Nasdaq National Market under the ticker symbol "GTLL," acquired majority
control of us by exchanging the assets of its Interactive Entertainment Division
and approximately $4.25 million in cash for 1,055,745 shares of our common stock
and 2,945,400 shares of our Series D Convertible Preferred Stock. This
transaction gave Global Technologies ownership of approximately 60% of our then
outstanding common equity on a fully diluted basis. Through a series of
additional transactions, Global Technologies acquired additional shares of our
common stock and shares of our Series B Convertible Preferred Stock so that, on
a fully converted basis, it now owns approximately 80% of our outstanding common
equity, without taking into effect any future dilution on account of our
financing with Fusion Capital (see "The Fusion Transaction" on page 36). The
transaction brought together synergistic technologies, and the engineering and
program management capabilities of two companies experienced in the field of
developing, manufacturing, marketing and installing interactive information and
entertainment systems.
In connection with the acquisition, Global Technologies elected a new board
of directors, which put in place our current management team. The board of
directors was re-elected, with the exception that Robert Pringle was elected to
take the place of Morris Aaron, at the 2000 annual meeting of shareholders on
May 11, 2000.
OUR DIVISIONS AND MARKETS
Under new management, we have identified four primary markets for our
products and services. We believe these markets represent opportunities to
achieve substantial market share and profitability. These markets are hotels and
time-share properties, cruise ships, educational institutions and corporate
training, and long-haul passenger trains. In an effort to capitalize on
opportunities in these markets, we have formed separate sales and marketing
divisions, and have recently hired experienced executives to lead each of the
four divisions.
HOTELS AND TIME-SHARE PROPERTIES
We have begun to market our products and services to "land-based" hotels
and time-share properties in North America. In addition, we are in the process
of developing sales and marketing strategies for hotels and time-share
properties in Europe, Asia and South America. We call the system we market to
the hotel and time-share market "InnView(TM)." Initially, we are focusing our
efforts on hotels with 100 or more rooms.
We formed our Hotel & Hospitality Division in December 1999. Management
believes there are approximately 3.6 million rooms in the domestic hotel market,
approximately 1.9 million of which do not have in-room information and
entertainment systems. Management also believes there are almost 0.5 million
time-share properties which also do not have installed information and
entertainment systems. Of the unserved hotel rooms, we estimate that
approximately 0.8 million would meet the economic criteria for installation of
our InnView(TM) systems. In addition, we estimate that contracts covering
approximately 1.7 million domestic hotel rooms currently served by a
competitor's system will come up for renewal over the next five years.
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Since forming this division, we have retained several national and
international sales executives. To date, we have entered into agreements for our
InnView(TM) system for the following locations:
* Radisson Resorts' Knott's Berry Farm Hotel in Buena Park, California;
* Embassy Suites Resort Paradise Valley, Arizona;
* Radisson Resorts' SFO Airport Hotel in San Francisco, California; and
* Marriott's Fairfield Inn in Indianapolis, Indiana.
Our InnView(TM) system installed in the Embassy Suites Resort Paradise
Valley became operational in May 2000. Generally, we expect our InnView(TM)
systems to become operational within four months after entering into an
agreement with a particular hotel. Our systems in the Radisson hotels are
expected to become operational in June 2000. We have not installed InnView(TM)
in any time-share properties. We provide the systems at no cost to the hotel in
exchange for a revenue share agreement in which we retain the majority of such
revenues.
CRUISE SHIPS
Management estimates that there are currently more than 70 cruise ships in
revenue service with 500 or more guest cabins. We estimate that the current
construction schedules for ships of this size show more than 30 new ships
entering service between now and the end of 2004. In total, we estimate the
market to host over 10 million passenger cruises annually, the vast majority of
which are hosted by one of a handful of leading cruise operators. We believe
that only about ten ships to date have had interactive entertainment and
information systems installed.
Historically, the cruise line industry has not embraced the installation of
interactive systems in individual cabins like their hotel counterparts. The
major reason for this reluctance is not related to a lack of demand. Only
recently has the technology of interactive guest systems progressed to levels
that enable them to profitably and logistically contribute to cruise line
profits and the vacation experience. In fact, the most significant hurdles have
been adapting the system to the compact configuration and harsh environment of
cruise ships, while maintaining adequate levels of price and performance.
We have had over a year's experience with our systems aboard Carnival
Cruise Lines, and have recently developed an enhanced version of our
CruiseView(TM) technology platform, increasing its performance and capabilities.
We are in advanced discussions with several major cruise companies about
installing this interactive system, including Carnival.
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We are currently negotiating with Carnival to resolve issues regarding
recovery of amounts paid to us (recorded as deferred revenue), our recovery of
our inventory costs, potential warranty/de-installation obligations and other
matters (see risk factors regarding Carnival on page 2 above).
EDUCATION AND CORPORATE TRAINING
We continue to manufacture our Cheetah(R) family of multimedia servers for
the interactive education and corporate training markets. Sales of servers have
historically been a core business of ours, with over 2,000 Cheetah(R) video
servers sold worldwide.
In August 1999, we sold multimedia servers in connection with the first
phase of the Georgia school system's Net 2000 project. We supplied our
Cheetah(R) video servers as the central backbone of 193 Georgia schools'
multimedia networks. Two other Cheetah(R) servers were delivered in connection
with the order and installed at the Georgia schools' network operating center.
Using our servers, students and teachers are able to access, on-demand, hundreds
of hours of digitally stored multimedia content, access the Internet and build
interactive courses. The total value of orders received under the program to
date is $5.3 million. We believe that this installation is the largest of its
kind in the country and that it may well be a model for the expansion of this
type of program. Our sales to MRESA were limited to our Cheetah(R) video
servers. In the future, we hope to be able to sell entire interactive systems,
which we call "EduView(R)," to school related purchasers.
In 1999, the Federal government instituted the E-Rate Program, which has a
primary goal of bringing the Internet and various forms of multimedia content
directly to elementary and secondary classrooms. The program makes $2.25 billion
available to schools to obtain the technology necessary to achieve this goal. To
obtain these funds, a school district must make application and pay a portion of
the equipment cost. A significant amount of the funding for our delivery of 195
Cheetah(R) video servers to Georgia schools in connection with the Georgia MRESA
Net 2000 project came from the E-Rate Program.
We formed our Education & Corporate Training Division in December 1999 to
promote our interactive products and services to educational institutions and
corporate training departments. In addition, we hired James D. Oots as Senior
Vice President of this new division. Mr. Oots brings to us a great deal of
experience in the corporate training and education markets. Under the leadership
of Mr. Oots, we plan to begin marketing our systems and servers to the corporate
training market.
PASSENGER RAIL
There are currently 11 operators of long-haul passenger trains in the
world. We believe that each of these operators are potential customers for our
TrainView(R) system over the next several years. The fleets operated by these
companies contain an aggregate of approximately 981,000 seats that could be
fitted with our TrainView(R) systems. However, to date, no trains have been
fitted with information or entertainment systems.
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In September 1999, we formed a Passenger Rail Division to promote our
interactive information and entertainment systems for installation at individual
seats on long-haul and cross-country passenger trains in the U.S., European and
Asian markets. This system is called "TrainView(R)." We announced the
appointment of Stephen J. Ollier, the former General Manager of ALSTOM Railway
Maintenance Services, Ltd., as President of the division. We believe that Mr.
Ollier is uniquely qualified for the position, offering both the technical and
industry experience we believe necessary to bring TrainView(R) to the
international rail market.
In May 1999, ALSTOM Transport Ltd., a unit of ALSTOM SA, which is one of
the largest train manufacturers in the world, contracted with us to engineer
TrainView(R) into ALSTOM's high-speed train design. We were paid in connection
with the contract but expect no further business from ALSTOM because we have
become aware that ALSTOM is in the process of creating a subsidiary to compete
with us in the passenger rail market.
Under the direction of Mr. Ollier, we have submitted pricing proposals to
two train operators in the United Kingdom for installation of TrainView(R)
systems. To date, we have not installed TrainView(R) on any passenger train.
ACQUISITION, PACKAGING AND MONITORING OF BROADBAND, MULTIMEDIA CONTENT
In an effort to capitalize on what we believe to be the advantages of our
system architecture and technology, we are developing a division to acquire,
package and monitor a broad range of compelling multimedia content tailored to
appeal to the typical end-users in each of our market segments. We believe that
the provision of compelling content through our systems will encourage user
interaction with the system, which, in turn, should maximize pay-for-use revenue
generation for us and for our vertical market partners.
We believe that our content division will be integral to our success. The
revenue generated from content can be long-term and should span the life-cycle
of our systems. In addition, because it is generally industry practice in the
markets we serve to share the cost of system hardware, and in the hotel market
to provide the hardware free of charge, content revenue will be an essential
revenue source.
OUR SALES, MARKETING AND DISTRIBUTION
We currently market our systems, products and services worldwide through
the efforts of our sales people in each operating division. We also plan to
market our systems through value-added resellers, distributors and alliance
partners. System installation and on-site customer support are provided through
internal customer engineering personnel and may, in the future, be provided
through the efforts of value-added resellers and alliance partners.
The sales arrangements for our systems depends upon various factors, such
as the size and type of hotel, time-share property, ship or train, and the
system features and other requested customization. There is generally a long
sales-cycle for our systems because of the need to design the system
configuration for the particular environment in which the system will be
installed, test each installed system and to negotiate any necessary agreements
with other providers. The sales cycle is also dependent upon a number of factors
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beyond our control, such as the financial condition of the customer, safety and
maintenance concerns, regulatory issues, and purchasing patterns of particular
operators and the industry generally. This is expected to result in long and
unpredictable buying patterns for our systems.
OUR COMPETITION
We face substantial competition in each of our markets. Some general
factors which we believe will influence whether we succeed include:
* the ability to deliver total system solutions for our customers,
including, in particular, content acquisition and management;
* system quality, reliability and performance;
* product hardware and software that can easily be upgraded during the
product life cycle;
* market-driven pricing of our systems, products and services; and
* the ability to deliver new sources of revenue generation for our
customers.
There are three major providers of interactive guest services systems in
the hospitality market. On Command has the greatest market share with
approximately 960,000 rooms, followed by LodgeNet Entertainment Corporation with
approximately 680,000 rooms, and Quadriga. On Command and LodgeNet focus their
sales and marketing efforts on North American properties, whereas Quadriga
markets its products primarily to European hotels and to a much lesser extent
Middle Eastern and African Hotels. All of these competitors employ a technology
which is different from ours. We believe our systems designs are superior to
those of our competitors because the scalability of our servers permits us to
provide the content at each site such that all selections are always available.
By contrast, our competitors are sometimes required to omit titles which are
temporarily unavailable because the number of copies of those titles at the site
are all in use. In addition, we believe that our system designs are superior
based on the content and features offered, such as Internet connectivity and
voice-over IP that can be made available through the systems. Our two primary
competitors in the cruise ship market are Allin Interactive and Siemens. We
estimate that Allin has systems installed on seven to ten cruise ships, while
Siemens has a system installed on one.
Although we have an opportunity to be first-to-market in providing train
operators with interactive multimedia information and entertainment system
solutions, SmartWorld, a UK-based company, has announced its intention to
develop and offer a limited video-on-demand system for the passenger rail
market. Matsushita, a leading provider of in-flight entertainment systems in the
long-haul commercial airplane market, is considering an entry into this market.
In addition, we are aware that ALSTOM is creating a subsidiary in an effort to
compete in this market.
Our Cheetah(R) video servers apply hardware control of video streaming to
achieve high-integrity, MPEG-2 quality images and pause, fast-forward, and
rewind capabilities. These servers are scaleable to provide up to 300
simultaneous video streams. Competitor video server products in this market,
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such as are provided by Sony, Dell, Gateway, Silicon Graphics, Compaq and
Hewlett Packard, are high-speed, general-purpose servers, with software control
of limited video streams (typically less than 10 to 15).
All of these companies have greater financial, technical and marketing
resources than we do. Moreover, our competitors have developed goodwill and name
recognition among the hospitality operators whom we call on to solicit sales,
and also among end users who have grown accustomed to their offerings. In
addition, we expect that to the extent that the market for our systems, services
and products develops, competition will intensify and new competitors will enter
our designated target markets. We may not be able to compete successfully
against existing and new competitors as the market for our systems, products and
services evolves and the level of competition increases. A failure to compete
successfully against existing and new competitors would have a materially
adverse effect on our business and results of operations.
OUR OPERATIONS AND MANUFACTURING
Contract manufacturers assemble our proprietary systems in the United
States. Final assembly, integration, burn-in and functional testing are
conducted at our facilities in Phoenix, Arizona or at supplier or customer
locations.
We obtain electronic components and finished sub-assemblies for our system
components "off-the-shelf" from a number of qualified suppliers. We have
established a testing protocol in an effort to ensure that components and
sub-assemblies meet our specifications and standards before final assembly and
integration. We have elected to procure off-the-shelf component parts and
sub-assemblies from suppliers in an effort to ensure better quality control and
pricing. To date, we have experienced some interruptions in the supply of
component parts and sub-assemblies due to the lack of availability of certain
electronic components, and are identifying additional qualified suppliers. The
inability of our current suppliers to provide component parts to us, coupled
with our inability to find alternative sources, would adversely affect our
operations.
RESEARCH AND DEVELOPMENT
The market for our systems and 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. We believe that our
future success will depend upon our ability to develop, manufacture and market
new systems and products and enhancements to existing systems and products on a
cost-effective and timely basis. The system architecture for our interactive
information and entertainment systems has been designed to permit hardware and
software upgrades over time. Moreover, we believe that the current architecture
presents no known limits on a customer's ability to offer compelling content to
the user in a rapid and reliable manner. Therefore, a major focus of our
research and development efforts is to reduce the cost of network and client
hardware and to enhance the core software of the system to permit even easier
integration of new content.
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If we are unable, for technological or other reasons, to develop new
systems and products in a timely manner in response to changes in the industry,
or if systems and products or system and product enhancements that we develop do
not achieve market acceptance, our business will be materially adversely
affected. There can be no assurance that technical or other difficulties in the
future will not delay the introduction of new systems, products or enhancements.
PROTECTING OUR INTELLECTUAL PROPERTY
We rely on a combination of trade secret and other intellectual property
law, nondisclosure agreements with most of our employees and other protective
measures to establish and protect our proprietary rights in our systems and
products. We believe that because of the rapid pace of technological change in
the open systems networking industry, legal protection of our proprietary
information is less significant to our competitive position than factors such as
our strategy, the knowledge, ability and experience of our personnel, new system
and product development and enhancement, market recognition and ongoing product
maintenance and support. Without legal protection, however, it may be possible
for third parties to copy aspects of our systems and products or technology or
to obtain and use information that we regard 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 we
continue to implement protective measures and intend to defend our proprietary
rights vigorously, we give no assurance that these efforts will be successful.
Our failure or inability to effectively protect our proprietary rights could
have an adverse affect on our business.
OUR FACILITIES
We lease the following facilities, which we believe are adequate and
suitable for current operations:
* approximately 17,000 square feet of office and production space
located at 222 North 44th Street, Phoenix, Arizona;
* approximately 1,000 square feet of space in Derby, England where our
Passenger Rail Division is headquartered;
* approximately 1,500 square feet of office space located at 1811
Chestnut Street, Philadelphia, Pennsylvania used for executive and
administrative purposes; and
* approximately 16,000 square feet of office space in Conshohocken,
Pennsylvania used for administrative purposes and our content
operations.
OUR EMPLOYEES
We employ 60 full-time staff at our various locations and sales offices and
we are adding skilled personnel in the following fields: content procurement and
development; software, systems and hardware engineering; program management;
contracts administration; supplier management; customer engineering; and sales
and marketing.
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We have formed separate vertical sales and marketing divisions for each of
our four target markets. These divisions are anchored by the recent hiring of
experienced executives from within each of these markets. We anticipate that
these executives will be able to leverage our core technology in broadband,
multimedia content distribution and IP network solutions to increase sales of
our systems, products and services. We have recognized the need to create an
additional internal operating division to provide our customers with the
personalized programming necessary to bring users a broad range of content
options. We are in the process of hiring personnel to anchor this new division.
LEGAL PROCEEDINGS
BRYAN R. CARR V. THE NETWORK CONNECTION, INC. AND GLOBAL TECHNOLOGIES,
LTD., Superior Court of Georgia, Civil Action No. 99-CV-1307. Bryan Carr, a
former director and our former Chief Operating Officer and Chief Financial
Officer, has filed a claim alleging a breach of his employment agreement. Carr
claims he is entitled to the present value of his base salary through October
31, 2001, a share of our "bonus pool," the value of his stock options and
accrued vacation time. We deny any liability and are defending the claims.
Swissair/MDL-1269, IN RE: AIR CRASH NEAR PEGGY'S COVE, NOVA SCOTIA. This
multi-district litigation relates to the crash of Swissair Flight 111 on
September 2, 1998. The Swissair MD-11 aircraft involved in the crash was
equipped with an in-flight entertainment system sold to it by Interactive Flight
Technologies, Inc., which was merged into Global Technologies. Estates of the
victims of the crash have filed lawsuits throughout the United States against
Swissair, Boeing, Dupont and various other parties, including Global
Technologies as successor to the business of Interactive Flight. Because we
bought the assets of Interactive Flight's in-flight entertainment division from
Global Technologies, we have been named in some of the lawsuits on a claim of
successor liability. We are being defended by the aviation insurer for Global
Technologies.
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 arises out of the
Company's hiring of Theodore P. Racz, a former LodgeNet employee, as its Senior
Vice President of the Hotels & Hospitality division. LodgeNet is alleging
tortious interference with contract and tortious interference with business
relationships. LodgeNet is seeking to prohibit Mr. Racz from being employed by
the Company, damages, and fees and costs.
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
unpaid invoices for inventory purchased in December 1998 for which the Company
has included in accounts payable. Avnet, Inc. seeks payment of the invoices,
interest and legal fees. The Company has a separate warranty claim against
Avnet, Inc. To date, we have not paid such amounts claimed by Avnet, Inc. on
account of our pending warranty claims against Avnet, Inc.
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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 CONSOLIDATED FINANCIAL STATEMENTS
AND THE RELATED NOTES INCLUDED IN ANOTHER PART OF THIS PROSPECTUS 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 PROSPECTUS. SEE
"FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS" ON PAGE II.
BACKGROUND AND BASIS OF PRESENTATION
We design, manufacture, install and maintain advanced, high-performance
computer servers and interactive, broad-band information and entertainment
systems. We also procure and provide the content available through the systems.
These all-digital systems deliver an on-demand, multimedia experience via
high-speed, high-performance Internet Protocol (IP) networks. These systems are
designed to provide users access to information, entertainment and a wide array
of service options, such as shopping for goods and services, computer games,
access to the World Wide Web and on-line gambling, where permitted by applicable
law. The targeted markets for our products are hotels and time-share properties,
cruise ships, educational institutions and corporate training, and passenger
trains.
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
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 is treated as a reverse merger. Global Technologies is deemed to
have acquired us. As a result, we are treated as the successor to the historical
operations of the Interactive Entertainment Division and our financial
statements, which have been reported to the SEC on Forms 10-KSB and 10-QSB,
among others, have been replaced with those of the Interactive Entertainment
Division. We will continue to file as a SEC registrant and continue to report
under the name The Network Connection, Inc.
In August 1999, we changed our fiscal year-end from December 31 to June 30.
Accordingly, the eight-month period resulting from this change -- November 1,
1999 through June 30, 1999 -- is referred to in this report as the "transition
period."
For accounting purposes, the date of the acquisition of the Interactive
Entertainment Division was May 1, 1999. The financial statements as of and for
the years ended October 31, 1998 and October 31, 1997, respectively, and the
three months and nine months ended March 31, 1999, respectively, reflect the
historical results of the Interactive Entertainment Division as previously
included in Global Technologies' consolidated financial statements. Included in
the financial statements for the eight months ended June 30, 1999 are the
historical results of the Interactive Entertainment Division through April 30,
1999, and the results of the post-transaction company for the two months ended
June 30, 1999.
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As of March 31, 2000, we were an 80% owned subsidiary of Global
Technologies, whose ownership was represented by 1,500 shares of our Series B 8%
Convertible Preferred Stock, 2,495,000 shares of our Series D Preferred Stock
and approximately 6.8 million shares of our common stock. In addition, pursuant
to the terms of the acquisition of Global Technologies' Interactive
Entertainment Division, Global Technologies may be entitled to receive
additional equity on account of claims arising during the one-year period
following the acquisition. Global Technologies has notified us and we are
currently trying to assess how much they may be entitled to.
RESULTS OF OPERATIONS
REVENUES. Revenue for the quarter ended March 31, 2000 was $590 and was
generated from the sale of server equipment. Revenue for the nine months ended
March 31, 2000 was $5,657,736, an increase of $5,179,671 (or 1,083%) compared to
revenue of $478,065 for the corresponding period of the previous fiscal year. We
deferred revenue of approximately $2.1 million in connection with the Carnival
agreement pending the outcome of current contract negotiations. Equipment sales
during the nine months ended March 31, 2000 are comprised principally of
approximately $5.4 million generated from the sale of 195 of the Company's
Cheetah(R) video servers in connection with the Georgia Metropolitan Regional
Education Services Agency ("MRESA") Net 2000. Service income of $59,827 for the
nine months ended March 31, 2000 was generated from system design services
provided to ALSTOM Transport LTD. We provided these services to ALSTOM, but
expect no further business from ALSTOM, as it plans to create a subsidiary that
would compete with us in the passenger rail market. Equipment sales of $89,028
during the nine-month period ended March 31, 1999 were generated from the sale
of spare parts needed for the entertainment networks installed previously on
three Swissair aircraft. Service income of $389,037 for the nine-month period
ended March 31, 1999, was principally generated from programming services
provided to Swissair, representing our share of gaming profits generated by the
Swissair systems and revenue earned under the Swissair extended warranty
contract. There will be no further revenue under the Swissair agreement.
COST OF SALES. Cost of equipment sales for the three-month period ended
March 31, 2000 was $225,669 and was comprised principally of the excess costs
over expected revenue related to Carnival. Cost of service income for the
current period was $21,189 attributable to video content costs. Cost of
equipment sales for the nine months ended March 31, 2000 was $3,680,584, and was
principally comprised of material costs and estimated warranty costs for the 195
video servers for the Georgia schools project, as well as the excess of costs
over expected revenue related to Carnival. Cost of equipment sales of $283,714
for the corresponding period ended March 31, 1999 was comprised of material,
installation and maintenance costs, as well as estimated warranty costs and
costs of upgrades to the entertainment networks installed in Swissair aircraft.
GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
quarter ended March 31, 2000 were $2,103,517 an increase of $1,174,917 (or 127%)
compared to expenses of $928,600 for the corresponding quarter of the previous
fiscal year. General and administrative expenses for the nine months ended March
31, 2000 were $4,678,325, a decrease of $2,269,493 (or 33%) compared to expenses
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of $6,947,818 for the corresponding period of the previous fiscal year.
Significant components attributable to the increase in the current quarter
include the addition of our Philadelphia office, expenses incurred by our UK
subsidiary and an increase in payroll and benefit costs generated by a 60%
increase in personnel in the current quarter. The decrease in expenses during
the nine-months ended March 31, 2000 compared to the corresponding period of the
previous fiscal year is principally attributed to a $3.1 million severance
payment recorded September 1998 for three former executives of the former
Interactive Entertainment Division, offset partially by the increase in expenses
in the current period. Significant components of general and administrative
expenses include payroll costs and legal and professional fees.
NON-CASH COMPENSATION. Non-cash compensation expense of $238,429 in the
three-month period ended March 31, 2000 is related to the issuance of warrants
and stock in exchange for services. Non-cash compensation expense of $545,311
for the nine-month period ended March 31, 2000 is comprised of an $85,000
expense for a former employee as part of a severance package as well as $460,311
of expense related to the issuance of warrants and stock in exchange for
services.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense for
the quarter ended March 31, 2000 was $332,511, an increase of $271,990 (or 449%)
compared to depreciation and amortization expense of $60,521 for the
corresponding period in the previous fiscal year. Depreciation and amortization
expense for the quarter ended March 31, 2000 are comprised of property, plant
and equipment depreciation of $139,279 and intangible amortization of $193,232.
Depreciation and amortization expense for the corresponding period ended March
31, 1999 was comprised of property, plant and equipment depreciation of $60,521.
There was no intangible amortization expense for the 1999 period. The increase
in depreciation expense in the current quarter can be attributed to fixed assets
acquired during May 1999 as a result of the merger and an increase in fixed
asset purchases in the current period. Depreciation and amortization expense for
the nine months ended March 31, 2000 was $972,528, an increase of $528,908 (or
119%) compared to depreciation and amortization expense of $443,620 for the
corresponding period ended March 31, 1999. Depreciation and amortization expense
for the nine months ended March 31, 2000 is comprised of property, plant and
equipment depreciation of $404,641 and intangible amortization of $567,887.
Depreciation and amortization expense for the corresponding period ended March
31, 1999 is comprised of property, plant and equipment depreciation of $443,620.
There was no intangible amortization for the 1999 period. The decrease in
property, plant and equipment depreciation in the current nine-month period is a
result of equipment write-offs of $1,006,532 during October 1998, substantially
offset by the depreciation of assets acquired during May 1999 as a result of the
merger as well as the increase in fixed asset purchases in the current period.
SPECIAL CHARGES. Special charges for the nine months ended March 31, 2000
were zero compared to a credit of $190,000 during the corresponding period ended
March 31, 1999. A recovery of $190,000 was recognized during September 1998 as a
result of a reduction in the number of entertainment networks installed in
Swissair aircraft requiring maintenance.
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PROVISION FOR DOUBTFUL ACCOUNTS. There were no provisions for doubtful
accounts for the three and nine months ended March 31, 2000 compared to $28,647
for the corresponding periods of the previous fiscal year. The provisions in the
previous fiscal year resulted from entertainment programming services provided
to Swissair for which we have not been paid.
INTEREST EXPENSE. Interest expense for the quarter ended March 31, 2000 was
$11,331 compared to $1,358 for the corresponding period ended March 31, 1999.
Interest expense for the nine months ended March 31, 2000 was $150,839 compared
to $5,614 for the corresponding period ended March 31, 1999. Interest expense
for the three-month period of the current fiscal year can be attributed to the
cost of cash borrowed against the revolving credit facility with Global
Technologies. Interest expense for the nine-month period of the current fiscal
year can be attributed principally to our prior long-term debt obligations,
whereas interest expense for the corresponding period of the previous fiscal
year is attributable to our capital leases for furniture which expired in
September 1999.
INTEREST INCOME. Interest income was $13,354 and $90,728 for the three and
nine months ended March 31, 2000 compared to $39,529 and $118,188 for the three
and nine months ended March 31, 1999, respectively. Interest income for the
three and nine-month period ended March 31, 2000 was principally generated from
short-term investments of working capital, whereas interest income for the
corresponding period ended March 31, 1999 is principally attributable to
Swissair extended warranty billings.
OTHER EXPENSE. Other expense of $15,911 and $24,741 for the three and nine
months ended March 31, 2000, respectively, represent a loss on the buyout of a
capital lease for furniture, losses incurred on the sale of two buildings
located in Alpharetta, Georgia and a loss incurred on the buyout of a vehicle
lease. Other expense of $567,317 for the nine-month period ended March 31, 1999
resulted from furniture and equipment write-offs of $1,006,532 during October
1998, partially offset by the recovery of furniture and equipment written off in
fiscal 1997.
TRANSITION PERIOD ENDED JUNE 30, 1999 AND YEARS ENDED OCTOBER 31, 1997
AND OCTOBER 31, 1998.
REVENUES. Revenue were $11,100,709 for the year ended October 31, 1997,
$18,816,962 for the year ended October 31, 1998 and $958,607 for the transition
period ended June 30, 1999. Revenues consisted principally of equipment sales,
service income and our share of gaming profits. The decline in revenue is the
primarily the result of a lack of new customer orders. In fiscal year 1997, we
completed installations under the Swissair program in nine business class
aircraft and one first class aircraft. In fiscal year 1998 we completed
installations in ten such business class aircraft and eighteen first class
aircraft. These aircraft installations represented the last nine such
installations we performed. For the transition period, equipment sales were
generated on only one of four entertainment networks installed and billed to
Swissair. Service income followed a similar pattern. Service income was $575,881
for the year ended October 31, 1997, $778,343 for the year ended October 31,
1998 and $82,650 for the transition period. Service income was principally
generated from programming services provided to Swissair, services relating to
the initial entertainment system design for Alstom Transport and system upgrades
provided to the Georgia schools.
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COST OF EQUIPMENT SALES AND SERVICE. Cost of equipment sales were
$24,878,460 for the year ended October 31, 1997, $15,537,071 for the year ended
October 31, 1998 and $1,517,803 for the transition period ended June 30, 1999.
The decrease in cost of equipment sales in fiscal year 1998 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 our
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 our redesign of the
tray table utilized in the entertainment networks for the economy section of an
aircraft. The decrease is also attributable to reductions in maintenance costs
and estimated one-year warranty costs as the reliability of the entertainment
networks improved. Additionally, we recognized a reduction in installation costs
from our subcontractor during fiscal 1998. We do not expect to realize such
decreases in the future.
PROVISION FOR DOUBTFUL ACCOUNTS. Provisions for doubtful accounts were
$216,820 for the year ended October 31, 1997, zero for the year ended October
31, 1998 and $28,648 for the transition period ended June 30, 1999. Such
provisions result from one-time write-offs on account of entertainment
programming services provided to a previous customer in 1997 and Swissair in the
transition period. For the year ended October 31, 1997, we recovered $1,064,284
on account of an accounts receivable under a customer agreement which was
reserved for during the fourth quarter of our fiscal year ended October 31,
1996.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses were
$7,821,640 for the year ended October 31, 1997, $1,092,316 for the year ended
October 31, 1998 and zero for the transition period ended June 30, 1999. The
decreases reflect our decision not to develop the next generation of the
entertainment network and the resulting reduction in staff and professional
fees. We do not plan to continue our research and development in the in-flight
entertainment business beyond those efforts that are required contractually by
the Swissair agreement. The Swissair agreement requires us to provide specific
upgrades to the entertainment network, however, we have ceased development of
these upgrades as a result of Swissair's breach of its agreement and do not plan
to develop any further upgrades.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
were $12,574,223 for the year ended October 31, 1997, $9,019,872 for the year
ended October 31, 1998 and $3,703,633 for the transition period ended June 30,
1999. General and administrative expenses include principally costs of
consulting agreements, legal and professional fees, corporate insurance costs
and legal fees related to the acquisition of the Interactive Entertainment
Division from Global Technologies. General and administrative expenses have
decreased primarily because of reductions in staff in administrative areas,
including production, marketing and program management. As of May 29, 1998, we
terminated almost all sales and marketing efforts related to the Interactive
Entertainment Division. The decrease in general and administrative expenses
during fiscal year 1998 was partly offset by the payment of $3,053,642 in
severance to three former executives. The decrease in general and administrative
expenses in the transition period were offset by a 1999 accrual of approximately
$1.6 million to write-off certain consulting agreements determined to have no
future value.
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WARRANTY AND SUPPORT EXPENSES. For the transition period ended June 30,
1999, we recorded warranty, maintenance, commission and support cost accrual
adjustments of $5,117,704, $504,409, $303,321 and $1,225,959, respectively. Such
adjustments to prior period estimates, which totaled $7,151,393, resulted from
an evaluation of specific contractual obligations and discussions between our
new management team and other parties related to such contracts. Based on the
results of our findings during fiscal 1999, such accruals were no longer
considered necessary.
SPECIAL CHARGES. Special charges were $19,649,765 for the year ended
October 31, 1997, $400,024 for the year ended October 31, 1998 and $521,590 for
the transition period ended June 30, 1999. Special charges in fiscal year 1998
primarily resulted from write-offs of $1,006,532 for excess computers, furniture
and other equipment of which we are in the process of disposing. These equipment
write-offs were partly offset by a recovery of special charges expensed in
fiscal 1997. In fiscal year 1998, we recognized a recovery of $190,000 as a
special charge credit as a result of a reduction in the number of entertainment
networks requiring maintenance and 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
installation of entertainment networks on three Swissair aircraft and
installations required by the Debonair agreement. 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, in fiscal year
1997, we 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 our future operations.
INTEREST. Interest income was zero for the year ended October 31, 1997,
$53,465 for the year ended October 31, 1998 and $77,682 for the transition
period ended June 30, 1999. Interest income during these periods was due
principally to Swissair extended warranty billings. Interest expense was $13,423
for the year ended October 31, 1997, $11,954 for the year ended October 31, 1998
and $83,029 for the transition period ended June 30, 1999. Interest expense
during these periods was due principally to long-term debt obligations and
capital leases for furniture that expired in September 1999.
LIQUIDITY AND CAPITAL RESOURCES
We are currently using our working capital to finance inventory purchases
and other expenses associated with the delivery and installation of our
products, and general and administrative costs.
Prior to June 30, 1999, our primary source of funding had been through
contributed capital from Global Technologies. In August 1999, we received an
order for $5.3 million for the manufacture, delivery and installation of 195 of
our Cheetah(R) multimedia video servers in connection with the Georgia MRESA Net
2000 project; and a service order under an agreement with Carnival for
installation of a second CruiseView(TM) system. In addition, as of the date of
this prospectus, we have received orders for the installation of our InnView(TM)
system in two hotels in California, one hotel in Arizona and one hotel in
Indiana. We have received the full payment of $5.3 million in connection with
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the Net 2000 project. We received payments from Carnival for the two ships
currently under contract, which have been recorded as deferred revenue (the
aggregate amount of which is $2.1 million as of March 31, 2000) (See Notes to
Condensed Consolidated Financial Statements, Notes 7(b) and 8, on pages F-30 and
F-31). Working capital will continue to decrease as we continue to invest in
inventory for orders under the agreement with Carnival and the four hotel
orders, invest in business development and invest in additional inventory to the
extent we are successful in generating additional orders for sales of our
systems, which are longer term by nature.
During the nine months ended March 31, 2000, we used $3,794,972 of cash for
operating activities, a decrease of $3,991,096 from the $7,786,068 of cash used
for the corresponding period of 1999. The cash utilized in operations during the
nine months ended March 31, 2000 resulted primarily from the net loss, increases
in inventory related to installations of InnView(TM) and CruiseView(TM), as well
as decreases in accrued liabilities, partially offset by increases in deferred
revenue related to the Carnival agreement, increases in accounts payable
resulting from inventory purchases and accrued product warranties related to the
Carnival agreement.
Cash flows provided by investing activities were $745,989 during the nine
months ended March 31, 2000. The increase in cash resulted primarily from the
sale of investment securities in the quarter ended December 31, 1999 and
proceeds from the sale of two buildings held for sale (one in the first quarter,
and one in the second quarter), offset by purchases of property and equipment in
the first and third quarter.
During the nine months ended March 31, 2000, cash provided by financing
activities of $557,077 resulted primarily from borrowings under the credit
facility with Global Technologies, payments made by an affiliate and from
exercise of employee stock options, as well as payments made on notes payable
and in the purchase of outstanding warrants.
In October 1999, a note payable in the principle amount of $400,000 due
September 5, 1999 was converted into 200,000 shares of our common stock.
Prior to the acquisition of the Interactive Entertainment Division, we
entered into a secured promissory note with Global Technologies in the principal
amount of $750,000, bearing interest at a rate of 9.5% per annum, and a related
security agreement granting Global Technologies a security interest in its
assets. This promissory note is convertible into shares of our Series C 8%
Convertible Preferred Stock at the discretion of Global Technologies. The note
had an original maturity of May 14, 1999, but has been extended until September
2001.
In July and August 1999, Global Technologies purchased all of our Series A
and E notes and the Series D notes, respectively, from the holders of such
notes. Concurrent with such purchase by Global Technologies, we executed several
allonges to the promissory note which cancelled such Series Notes and rolled the
principal balance, plus accrued but unpaid interest, penalties and redemption
premiums on the Series Notes into the principal balance of the promissory note.
Subsequent to May 18, 1999, Global Technologies had also advanced working
capital to us in the form of intercompany advances. In August 1999, we executed
an allonge to the promissory note which rolled the intercompany advances into
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the principal balance of the promissory note and granted Global Technologies the
ability to convert the promissory note directly into shares of our common stock
as an administrative convenience.
On August 24, 1999, the board of directors of Global Technologies approved
the conversion of the promissory note into shares of our common stock. Such
conversion, to the extent it exceeded approximately one million shares of our
common stock on August 24, 1999, was contingent upon receiving shareholder
approval to increase our authorized share capital. This increase in authorized
share capital was subsequently approved on September 17, 1999 at the September
17, 1999 Special Meeting of our shareholders. Accordingly, in December 1999, we
issued to Global Technologies 4,802,377 shares of our common stock based on the
conversion date of August 24, 1999. Separately from the promissory note, we
issued 886,140 shares of our common stock to Global Technologies upon conversion
of our Series C 8% Convertible Preferred Stock held by it.
On August 24, 1999, the board of directors of Global Technologies approved
a $5 million secured revolving credit facility by and between Global
Technologies and us. This credit facility provides that we may borrow up to $5
million for working capital and general corporate purposes at the prime rate of
interest plus 3%. The credit facility matures in September 2001. We paid an
origination fee of $50,000 to Global Technologies and will pay an unused line
fee of 0.5% per annum. The credit facility is secured by all of our assets and
is convertible, at Global Technologies' option, into shares of our common stock
at a price equal to the lesser of 66.7% of the trailing five-day average share
price of the preceding 20 days, $1.50 per share, or any lesser amount at which
common stock has been issued to third parties. Pursuant to Nasdaq rules, Global
Technologies may not convert borrowings under the credit facility into shares of
our common stock in excess of 19.99% of the number of shares of common stock
outstanding on August 24, 1999, without shareholder approval. As of March 31,
2000, $1,080,000 was outstanding under the credit facility. As of March 31,
2000, Global Technologies did not have sufficient cash for us to borrow the full
$5 million under the credit facility. Should we be unable to borrow funds under
the credit facility, it could result in a material adverse effect on our
operating results and financial condition.
In September 1999, we sold one of our two buildings in Alpharetta, Georgia.
The net proceeds from the sale, plus cash of approximately $80,000 was used by
us to repay a note payable due April 19, 2001 in the principal amount of
$470,000. The sale of the second building occurred in November 1999. The net
proceeds of approximately $367,000 from sale were used to retire a note payable
due 2009 in the principal amount of $217,000.
The terms of the Carnival agreement provide that Carnival may return the
CruiseView(TM) system within the acceptance period, as defined in the Carnival
agreement, or for breach of warranty. The acceptance period for the Fantasy and
Destiny class ships are twelve months and three months, respectively, from
completion of installation and testing which occurred in February 1999 and
October 1999, respectively. The initial warranty period for these systems is
three years. As of March 31, 2000, we had recorded deferred revenue of
approximately $2.1 million related to the two Carnival ships. (See Notes to
Condensed Consolidated Financial Statements, Notes 7(b) and 8, on pages F-30 and
F-31).
32
<PAGE>
In the quarter ended March 31, 2000, we concluded that the cost of building
and installing CruiseView(TM) systems on the existing two Carnival ships
pursuant to the Carnival agreement has exceeded the revenue that can be earned
in connection therewith. Accordingly, we have recorded an expense of $208,146 in
the period ended March 31, 2000, reflecting the excess of cost over expected
revenue. Carnival's continuing to exercise its option for building and
installing CruiseView(TM) on additional ships under the agreement may prove
unprofitable, and therefore have a negative effect on our working capital. We
are currently endeavoring to renegotiate the terms of the agreement with
Carnival.
Although we signed a letter of intent in January 2000 to obtain net loan
proceeds of $5.8 million, we were unable to reach agreement on certain material
terms of the proposed transaction with the prospective lender. Consequently, we
did not pursue this financing. However, we continue to pursue additional
financing.
We expect to use a significant amount of cash in the next 12 months. Cash
will be used primarily to finance anticipated operating losses, increases in
inventories and accounts receivable, and to make capital expenditures required
for sales of our systems. While we believe that our current cash balances, the
$5 million credit facility with Global Technologies (of which approximately $1.6
million remains available as of June 2, 2000), and the Fusion financing will be
sufficient to meet our currently anticipated cash requirements for operations
for at least the next 12 months, our inability to draw on the credit facility
with Global Technologies or to obtain funds pursuant to the Fusion financing
could have a material adverse effect on our operating results and financial
condition. Global Technologies does not currently have sufficient cash for us to
borrow under the credit facility and no assurance can be given that Fusion will
have the resources necessary to meet its commitments as we draw down from time
to time pursuant to our private equity line. For more information on the Fusion
financing, please refer to "The Fusion Transaction" on page 36.
We are also currently negotiating equipment financing to fund the cost of
our systems which are expected to be installed at customer locations. Our
inability to secure such financing could have a material adverse effect on our
operating results and financial condition.
INFLATION AND SEASONALITY
We do not believe that we are significantly impacted by inflation. Our
operations are not seasonal in nature, except to extent fluctuations in
quarterly operating results occur due to the cyclical nature of government
funding obtained in connection with education programs with which we may become
involved, if any. We are not currently involved with any such program and give
no assurance that we will be in the future.
YEAR 2000
Many currently installed computer systems and software products were coded
to accept only two digit year entries in the date code field. Consequently,
subsequent to December 31, 1999, many of these systems became subject to failure
or malfunction. Although we are not aware of any material Year 2000 issues at
this time, Year 2000 problems may occur or be made known to us in the future.
Year 2000 issues may possibly affect software solutions developed by us or
33
<PAGE>
third-party software incorporated into our solutions. We generally do not
guarantee that the software licensed from third-parties by our clients is Year
2000 compliant, but we sometimes do warrant that the solutions developed by us
are Year 2000 compliant.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which establishes standards for the accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts, and hedging activities. This statement generally
requires recognition of gains and losses on hedging instruments, based on
changes in fair value or the earnings effect of forecasted transactions. As
issued, SFAS No. 133 is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities--Deferral of the
Effective Date of FASB Statement No. 133--An Amendment of FASB Statement No.
133," which deferred the effective date of SFAS No. 133 until June 15, 2000. We
are currently evaluating the impact of SFAS No. 133.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain Transactions involving Stock
Compensation (an interpretation of APB Opinion No. 25). This interpretation
provides guidance regarding the application of APB Opinion 25 to Stock
Compensation involving employees. This interpretation is effective July 1, 2000
and is not expected to have a material effect on our consolidated financial
statements.
THE FUSION TRANSACTION
GENERAL
On June 1, 2000 we executed a master facility agreement with Fusion Capital
Fund II, LLC pursuant to which on June 16, 2000 Fusion Capital entered into an
equity purchase agreement with us with an aggregate available amount of
$12,000,000. The date we entered into the equity purchase agreement is referred
to as the "closing date." Under the master facility agreement, the equity
purchase agreement grants Fusion Capital the right to purchase from us shares of
common stock up to $12,000,000 at a price equal to the lesser of (1) $8.00 or
(2) a price based upon the future performance of the common stock, in each case
without any fixed discount to the market price.
PURCHASE OF SHARES UNDER THE EQUITY PURCHASE AGREEMENT
GENERAL. Under the equity purchase agreement Fusion Capital will purchase
shares of our common stock by "converting" a specified dollar amount of the
outstanding available amount into common stock. Subject to the limits on
conversion and the termination rights described below, each month during the
twelve-month term of the equity purchase agreement Fusion Capital will have the
right to convert up to $1.0 million of the available amount of the equity
purchase agreement, plus any amounts for any prior month that have not yet been
converted, into shares of our common stock at the applicable conversion price.
34
<PAGE>
After the end of such term, Fusion Capital may convert the entire remaining
available amount of the applicable conversion price. The conversion price per
share is equal to the lesser of:
* the lowest sale price of our common stock on the day of submission of
a conversion notice by Fusion Capital; or
* the average of any two closing bid prices of our common stock selected
by Fusion Capital during the 12 consecutive trading days prior to the
submission of a conversion notice by Fusion Capital; or
* $8.00.
The following table sets forth the number of shares of our common stock
that would be issuable to Fusion Capital upon conversion of the equity purchase
agreement at varying conversion prices:
<TABLE>
<CAPTION>
Number of Shares to be Issued Percent of Our
Upon a Full Conversion of the Common Stock Outstanding
Assumed Conversion Price Equity Purchase Agreement (1) as of June 16, 2000 (1)
------------------------ ----------------------------- ------------------------
<S> <C> <C>
$2.50 4,800,000(3) 26.65%
$3.28(2) 3,657,143(3) 21.68%
$4.00 3,000,000(3) 18.51%
$5.00 2,400,000 15.37%
$8.00(4) 1,500,000 10.20%
</TABLE>
----------
(1) Percentages are based upon 13,211,479 shares of our common stock
outstanding as of June 16, 2000, which includes the 300,000 shares issued
on the date hereof to Fusion Capital as a commitment fee, plus the
applicable number of conversion shares which would be issued. Note, no
issuance of common stock would be permitted in violation of Nasdaq listing
requirements.
(2) The conversion price on June 16, 2000.
(3) We estimate that we will issue no more than 2,560,000 shares to Fusion
Capital upon conversion of the equity purchase agreement and the issuance
of shares as a commitment fee, all of which are included in this offering.
If more than 2,560,000 shares are issuable to Fusion Capital, we have the
right and presently intend, to terminate the equity purchase agreement
without any payment to or liability to Fusion Capital.
(4) The fixed conversion price.
OUR RIGHT TO PREVENT CONVERSIONS. If the closing sale price of our common
stock is below $8.00 on any trading day, we will have the unconditional right to
suspend conversions upon three trading days notice until the earlier of (1) our
revocation of such suspension and (2) when the sale price of our common stock is
above $8.00.
OUR MANDATORY CONVERSION RIGHTS. If the closing sale price of our common
stock on each of the five trading days immediately prior to the first trading
day of any monthly period is at least $3.20 and no event of default under the
equity purchase agreement has occurred and is continuing, we will have the right
to require that Fusion Capital convert all or a portion of the available amount
of the equity purchase agreement during the next two monthly periods. We may
revoke, in our sole discretion, upon three trading days' notice, our written
request with respect to any conversions in excess of the amount that Fusion
Capital is otherwise permitted to convert.
35
<PAGE>
LIMITATION ON ISSUANCES. Notwithstanding the foregoing, no conversion of
the equity purchase agreement will be permitted if it would result in Fusion
Capital or its affiliates beneficially owning more than 4.99% of our then
aggregate outstanding common stock immediately after the proposed conversion. In
addition, no conversion of the equity purchase agreement, including shares
issued for Fusion Capital's commitment fee, will be permitted if it would result
in a violation of Nasdaq listing regulations.
OUR TERMINATION RIGHTS
If the closing sale price of our common stock is below $8.00 for any 10
consecutive trading days, then we may elect upon three trading days notice to
terminate the equity purchase agreement without any liability or payment to
Fusion Capital.
ADJUSTMENT TO CONVERSION PRICE
The conversion price of the equity purchase agreement will be adjusted for
any reorganization, recapitalization, non-cash dividend, stock split or other
similar transaction.
MAJOR TRANSACTION
The following types of transactions are each referred to as "Major
Transactions":
* the consolidation, merger or other business combination with another
entity;
* any transaction which could involve a fair value of $5,000,000 or more
in a single transaction or a series of related transactions;
* the issuance of debt or equity securities in a single transaction or a
series of related transactions involving the receipt by us of proceeds
of $5,000,000 or more; or
* a purchase, tender or exchange offer made to the holders of 50% of the
outstanding shares of common stock
If we enter into a Major Transaction, then we may not terminate the equity
purchase agreement until 30 trading days after public announcement of the Major
Transaction. If we publicly announce a Major Transaction within 30 trading days
after terminating the equity purchase agreement, then we must pay to Fusion
Capital the amount, if any that, the average of the closing sale price of our
common stock for the ten trading days following either the public announcement
or the completion, as selected by Fusion Capital, of the Major Transaction
exceeds the conversion price determined as of the date that the agreement is
terminated multiplied by the number of shares of our common stock issuable upon
conversion of the available amount on such date.
36
<PAGE>
NO SHORT-SELLING OR HEDGING BY FUSION CAPITAL
Fusion Capital has agreed that neither it nor its affiliates will engage in
any direct or indirect short-selling or hedging of our common stock during any
time prior to the termination of the master facility agreement except in
connection with a simultaneous conversion pursuant to the equity purchase
agreement.
EVENTS OF DEFAULT
Generally, Fusion Capital may terminate the equity purchase agreement
without any liability or payment to us upon the occurrence of any of the
following events of default:
* if for any reason the shares offered by this prospectus cannot be sold
pursuant to this prospectus for a period of 10 consecutive trading
days or for more than an aggregate of 30 trading days in any 365-day
period;
* suspension by The Nasdaq SmallCap Market of our common stock from
trading for a period of 10 consecutive trading days or for more than
an aggregate of 30 trading days in any 365-day period;
* our failure to satisfy any listing criteria of our principal
securities exchange or market for a period of 10 consecutive trading
days or for more than an aggregate of 45 trading days in any 365-day
period;
* (1) notice from us or our transfer agent to the effect that either of
us intends not to comply with a proper request for conversion of the
available amount under the equity purchase agreement into shares of
common stock or (2) our failure to confirm to the transfer agent
Fusion Capital's conversion notice or (3) the failure of the transfer
agent to issue shares of our common stock upon delivery of a
conversion notice;
* any issuance of our common stock upon a conversion which would violate
Nasdaq listing requirements;
* any breach of the representations or warranties or covenants contained
in the master facility agreement or any related agreements which has
or which could have a material adverse effect on us or the value of
the equity purchase agreement, subject to a cure period of 10 trading
days for a curable breach of covenant;
* a default of any of our payment obligations in excess of $1 million;
or
* our participation in insolvency or bankruptcy proceedings by or
against us.
Notwithstanding the foregoing, Fusion Capital has agreed that no Event of
Default shall be declared by Fusion Capital under the equity purchase agreement
37
<PAGE>
from our failure to meet the requirements of the Principal Market until 40
Trading Days after we receive written notice thereof from the Principal Market.
ADDITIONAL SHARES ISSUED TO FUSION CAPITAL
Under the terms of the master facility agreement, Fusion Capital receives
additional shares of our common stock as a commitment fee in two tranches as
follows:
* initially, on the closing date, Fusion received 300,000 shares of our
common stock, calculated as the number of shares equal to $960,000
divided by the lower of (1) $4.2875, the average of the closing sale
price of our common stock for the five consecutive trading days
immediately preceding the trading day that is two trading days prior
to the closing date, and (2) $3.20, the average of the closing sale
price of our common stock for the five consecutive trading days
immediately preceding the date of the master facility agreement; and
* upon (i) our receipt of at least $8,000,100 pursuant to conversions
under the equity purchase agreement or (ii) at any time prior to the
end of the eighth monthly period after the closing date of the equity
purchase agreement, so long as we have received at least $6 million
pursuant to conversions under the equity purchase agreement at an
average conversion price of either (x) $4.00 or (y) an average of
$3.00 for the first four monthly periods and $5.00 for the next four
monthly periods, at the option of Fusion Capital, then the number of
shares equal to $480,000 divided by the lower of (1) $4.2875, the
average of the closing sale price of our common stock for the five
consecutive trading days immediately preceding the trading day that is
two trading days prior to the closing date, and (2) $3.20, the average
of the closing sale price of our common stock for the five consecutive
trading days immediately preceding the date of the master facility
agreement.
On the closing date for the equity purchase agreement on June 16, 2000,
Fusion Capital received an aggregate of 300,000 shares of our common stock as a
commitment fee under the initial tranche. Unless an event of default occurs,
these shares must be held by Fusion Capital until the master facility agreement
or equity purchase agreement has been terminated. Fusion Capital may also
transfer these shares to its affiliates or pledge them in connection with a
margin account. In addition, should the master facility agreement be terminated
on account of a failure to close, we will generally be obligated to issue a
portion of or the entire commitment fee, depending on the circumstances, to
Fusion Capital.
NO VARIABLE PRICED FINANCINGS
So long as this financing is in effect, we have agreed not to issue, or
enter into any agreement with respect to the issuance of, any variable priced
equity or variable priced equity-like securities unless we have obtained Fusion
Capital's prior written consent.
HOLDINGS OF FUSION CAPITAL UPON TERMINATION OF THIS OFFERING
Because Fusion Capital may sell all, some or none of the common stock
offered by this prospectus, no estimate can be given as to the amount of common
stock that will be held by Fusion Capital upon termination of the offering.
38
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of The Network Connection, Inc., and
their ages are as follows:
Name Age Position
Irwin L. Gross 56 Chairman of the Board of Directors and
Chief Executive Officer
Robert Pringle 39 Director, President and Chief Operating Officer
Morris C. Aaron 36 Executive Vice President, Chief Financial
Officer and Secretary
M. Moshe Porat (1)(2) 52 Director
Stephen Schachman (1)(2) 55 Director
Jay R. Rosan 55 Executive Vice President
Richard E. Genzer 38 Chief Technology Officer
----------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
IRWIN L. GROSS has been the Chairman of the Board of Directors and Chief
Executive Officer of The Network Connection since May 18, 1999. Mr. Gross was
reelected to the board of directors in May 2000 and will serve until the 2003
annual meeting of shareholders. He is also Chairman of the Board of Directors
and Chief Executive Officer of Global Technologies, Ltd., a publicly held
company listed on the Nasdaq National Market. Global Technologies is a
technology incubator that invests in, develops and manages emerging growth
companies focused on e-commerce, networking solutions, telecommunications and
gaming. Mr. Gross also currently sits on the board of directors of U.S. Wireless
Corporation, a publicly held company listed on the Nasdaq National Market. Mr.
Gross is a founder of Rare Medium, Inc., a publicly held company listed on the
Nasdaq National Market, and was Chairman of the Board of Directors of Rare
Medium from 1984 to 1998. In addition, Mr. Gross served as the Chief Executive
Officer of Engelhard/ICC, a joint venture between Rare Medium and Engelhard. Mr.
Gross has served as a consultant to, investor in and director of, numerous
publicly held and private companies, and serves on the board of directors of
several charitable organizations. Mr. Gross has a Bachelor of Science degree in
Accounting from Temple University and a Juris Doctor degree from Villanova
University.
ROBERT PRINGLE has served as President and Chief Operating Officer of the
Company since March 5, 2000. He is also a director, having been elected at the
2000 annual meeting of shareholders on May 11, 2000 and will serve until the
2002 annual meeting of shareholders. Before his employment with the Company, Mr.
Pringle served as President and Chief Operating Officer for InteliHealth, Inc.
from September 1997 to October 1999. Prior thereto, Mr. Pringle was Vice
President for InteliHealth, Inc., a subsidiary of Reuters, from January 1996 to
September 1997. Prior thereto, Mr. Pringle was Vice President for Reality
Online, Inc. from September 1994 to January 1996. Mr. Pringle has a Bachelor of
Science in Economics degree from the Wharton School at the University of
Pennsylvania, a Bachelor of Applied Science from the Moore School of Electrical
Engineering at the University of Pennsylvania, and a Masters in Business
Administration from the University of Chicago Graduate School of Business.
39
<PAGE>
MORRIS C. AARON has been Executive Vice President and Chief Financial
Officer of The Network Connection since May 18, 1999. From May 1999 to May 2000,
Mr. Aaron also served as a member of our board of directors. From September 1998
to December 1999, Mr. Aaron served as Senior Vice-President and Chief Financial
Officer of Global Technologies. From January 1996 to September 1998, Mr. Aaron
was the Chief Financial Officer and Treasurer of Employee Solutions, Inc., a
publicly held company listed on the Nasdaq National Market. From 1986 to 1996,
Mr. Aaron was with the firm of Arthur Andersen, LLP in the corporate finance and
corporate restructuring group. Mr. Aaron holds a Bachelors Degree in Accounting
from Pennsylvania State University, an M.B.A. from Columbia University and is a
Certified Public Accountant in the State of New York.
M. MOSHE PORAT has been a director of The Network Connection since May 18,
1999. Mr. Porat was reelected to the board of directors in May 2000 and will
serve until the 2001 annual meeting of shareholders. Dr. Porat is also a
director of Global Technologies. Since September 1996, Dr. Porat has served as
the Dean of the School of Business and Management at Temple University. From
1988 to 1996 he was Chairman of the Risk Management, Insurance and Actuarial
Science Department at Temple University. Dr. Porat received his undergraduate
degree in economics and statistics (with distinction) from Tel Aviv University
and his M.B.A. (MAGNA CUM LAUDE) from the Recanati Graduate School of Management
at Tel Aviv University, and he completed his doctoral work at Temple University.
Dr. Porat is the Chairholder of the Joseph E. Boettner Professorship in Risk
Management and Insurance and has won several other awards in the insurance
field. He holds the CPCU professional designation, and is a member of ARIA
(American 25 Risk and Insurance Association), IIS (International Insurance
Society), RIMS (Risk and Insurance Management Society) and the Society of CPCU.
Dr. Porat has authored several monographs on captive insurance companies and
their use in risk management, and has published numerous articles on captive
insurance companies, self- insurance and other financial and risk topics.
STEPHEN SCHACHMAN has been a director of The Network Connection since May
18, 1999. Mr. Schachman was reelected to the board of directors in May 2000 and
will serve until the 2001 annual meeting of shareholders. Mr. Schachman is also
a director of Global Technologies. Since 1995, Mr. Schachman has been the owner
of his own consulting firm, Public Affairs Management, which is located in the
suburban Philadelphia area. From 1992 to 1995, Mr. Schachman was an executive
officer and consultant to Penn Fuel Gas Company, a supplier of natural gas
products. Prior thereto, he was an attorney with the Philadelphia law firm
Dilworth, Paxson, Kalish & Kaufman. Mr. Schachman was also an Executive Vice
President of Bell Atlantic Mobile Systems and prior thereto, President of the
Philadelphia Gas Works, the largest municipally owned gas company in the United
States. Mr. Schachman has a Bachelor of Arts degree from the University of
Pennsylvania and Juris Doctor degree from the Georgetown University Law School.
JAY R. ROSAN has served as Executive Vice President of the Company since
March 6, 2000. Prior to that he served as Executive Vice President of
InteliHealth, a leading consumer health information web company, from August 1,
1998. He also was on the board of directors of InteliHealth. Prior to that he
was the Senior Vice President and Corporate Medical Director for Aetna US
40
<PAGE>
Healthcare from June 16, 1996 to August 1, 1998. Prior to June 16, 1996 he was
the cofounder and Executive Vice President of InteliHealth from June, 1995.
RICHARD E. GENZER has served as Chief Technology Officer of the Company
since March 6, 2000. Before his employment with the Company, Mr. Genzer served
as Chief Technology Officer for InteliHealth, Inc. from April 1996 to November
1999. Prior thereto, Mr. Genzer was Vice President of Engineering for Reality
Online, Inc. from 1989 to February 1996. Prior thereto, Mr. Genzer was an
electrical engineer with the US Department of Defense from 1983 to 1989.
All executive officers serve at the discretion of the board of directors.
There are no family relationships between any of the directors or executive
officers of The Network Connection.
DIRECTOR COMPENSATION
Each of our non-employee directors is paid $1,000 for attendance in person
at each meeting of the board of directors and $500 for participation in each
telephonic Board meeting. In addition, each non-employee director receives $500
for attendance at each meeting of a Board Committee of which he is a member. In
addition, we reimburse directors for their out-of-pocket expenses incurred in
connection with their service on the board of directors. On June 11, 1999, Mr.
Schachman and Dr. Porat were each granted a non-qualified option under the 1995
Stock Option Plan for Non-Employee Directors to acquire 30,000 shares of our
common stock at an exercise price of $2.25 per share, the fair market value per
share on the date of grant. All options granted to non-employee directors vest
in equal annual installments beginning June 11, 2000 and ending June 11, 2002.
EXECUTIVE COMPENSATION
The following table sets forth certain information for the transition
period ended June 30, 1999 and our last three completed fiscal years ended
December 31, 1998, 1997 and 1996, with respect to compensation we paid or
accrued to each person who served as our Chief Executive Officer during such
period, our other executive officers who were serving as such at June 30, 1999
and whose combined salary and bonus exceeded $100,000, and one other highly
compensated officer who was not serving as an executive officer at June 30,
1999.
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<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long-Term
Compensation/
Annual Compensation Awards
------------------------------- -----------
Securities
Other Annual Underlying
Name and Principal Position Year Salary ($) Compensation ($) Options (#)
--------------------------- ---- ---------- ---------------- -----------
<S> <C> <C> <C> <C>
Irwin L. Gross 1999 -- -- --
Chairman of the Board and Chief 1998 -- -- --
Executive Officer (1) 1997 -- -- --
1996 -- -- --
Frank E. Gomer 1999 21,348 -- 50,000
President and Chief Operating 1998 -- -- --
Officer (1) (6) 1997 -- -- --
1996 -- -- --
Morris C. Aaron 1999 14,884 -- 50,000
Executive Vice President and Chief 1998 -- -- --
Financial Officer (1) (2) 1997 -- -- --
1996 -- -- --
Wilbur L. Riner, Sr. 1999 104,000 3,600 (4) 25,000
Executive Vice President - Business 1998 156,000 22,900 (4) 100,000
Development (1) 1997 104,322 23,400 (4) 100,000
1996 101,414 24,375 (4) 20,000
James E. Riner 1999 94,031 (3) 2,400 (4) 10,000
Vice President - Engineering 1998 91,790 3,600 (4) 25,000
1997 86,790 3,600 (4) 25,000
Bryan R. Carr 1999 70,000 2,800 (4) --
Vice President - Finance and Chief 1998 120,000 15,301 (4) 50,000
Financial Officer (5) 1997 101,667 30,171 (4) 80,000
1996 95,625 18,888 99,000
</TABLE>
----------
(1) Global Technologies acquired control of The Network Connection on May 18,
1999. Prior to the acquisition, Wilbur L. Riner, Sr. served as our
Chairman, President and Chief Executive Officer and Bryan R. Carr served as
our Vice President - Finance and Chief Financial Officer. In connection
with the acquisition, on May 18, 1999, Irwin L. Gross replaced Wilbur L.
Riner, Sr. as our Chairman and Chief Executive Officer and Frank E. Gomer
became our President and Chief Operating Officer. Wilbur L. Riner, Sr.
remained with us as Executive Vice President - Business Development until
December 31, 1999, when his employment with us terminated in accordance
with a separation and release agreement. Also in connection with the
acquisition, on May 18, 1999, Morris C. Aaron became our Executive Vice
President and Chief Financial Officer.
(2) Until December 15, 1999 (the date on which Global Technologies hired its
new Chief Financial Officer, Patrick J. Fodale), Morris C. Aaron also
served as Chief Financial Officer of Global Technologies and devoted
approximately 40% of his time to Global Technologies. Mr. Aaron received
approximately 40% of his compensation from Global Technologies until the
hire of Mr. Fodale.
(3) Includes approximately $14,000 for moving expenses.
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<PAGE>
(4) Consists of the following:
Automobile
Name Year Allowance ($) Commissions ($) Total ($)
---- ---- ------------- --------------- ---------
Wilbur L. Riner, Sr. 1999 3,600 -- 3,600
1998 5,400 17,500 22,900
1997 5,400 18,000 23,400
1996 5,625 18,750 24,375
James E. Riner 1999 2,400 -- 2,400
1998 3,600 -- 3,600
1997 3,600 -- 3,600
Bryan R. Carr 1999 2,800 -- 2,800
1998 4,800 10,501 15,301
1997 5,000 25,171 30,171
1996 4,800 14,088 18,888
(5) Mr. Carr's employment with us was terminated on May 31, 1999.
(6) Dr. Gomer is currently a consultant for the Company. At the end of the
transition period ended June 30, 1999 and until March 6, 2000, Dr. Gomer
was our President and Chief Operating Officer. On March 6, 2000, Robert
Pringle was hired as our President and Chief Operating Officer.
During fiscal years 1998 and 1997, Wilbur L. Riner, Sr. and Bryan R. Carr
provided, from time to time, significant assistance to our sales and marketing
staff in effecting sales of our products, for which sales they received
commission compensation.
OPTION GRANTS
(INDIVIDUAL GRANTS)
The following tables set forth certain information with respect to
individual grants of stock options made to the named executive officers during
the eight-month transition period ended June 30, 1999 and the fiscal year ended
October 31, 1998:
Percentage of
Number of Total Options
Securities Granted to Exercise
Underlying Employees in or Base Expiration
Name Options(#) Fiscal Year(%) Price($)(1) Date
---- ---------- -------------- ----------- ----------
Irwin L. Gross (5) -- -- -- --
Frank E. Gomer (2) 50,000 14.50 2.25 6/11/09
Morris C. Aaron (2) 50,000 14.50 2.25 6/11/09
Wilbur L. Riner, Sr. (3) 25,000 7.25 2.25 6/11/09
James E. Riner (4) 10,000 2.90 2.25 6/11/09
Bryan R. Carr -- -- -- --
----------
(1) Represents the closing price of our common stock on the grant date of June
11, 1999.
(2) These qualified options vest as follows: 10,000 on each of June 11, 1999,
June 11, 2000, June 11, 2001, June 11, 2002 and June 11, 2003. Subsequent
to the transition period ended June 30, 1999, Dr. Gomer has ceased to be
employed by us, and 30,000 of these options have since been canceled. For
more information, please refer to "Employment Arrangements" below.
(3) These qualified options vest as follows: 12,500 on each of June 11, 2000
and June 11, 2001.
(4) These qualified options vest as follows: 2,500 on each of June 11, 2000,
June 11, 2001, June 11, 2002, June 11, 2003 and June 11, 2004.
(5) On November 10, 1999, the Compensation Committee of the board of directors
recommended option grants to purchase up to 500,000 shares of the Company's
Common Stock to Mr. Irwin L. Gross, Chairman and Chief Executive Officer of
The Network Connection. Such recommendation was adopted and approved by the
board of directors on November 29, 1999. One quarter of these options
vested immediately and one quarter vest over three years. The remainder
vest on the sixth anniversary of the date of grant, subject to acceleration
to a three-year schedule in the event certain performance milestones are
achieved. The exercise price of the options is $2.00, the closing market
price of the Company's Common Stock on November 10, 1999. The options
expire in November 2009.
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<PAGE>
AGGREGATED OPTION EXERCISES
AND OPTION VALUES AS OF JUNE 30, 1999
The following table sets forth certain information with respect to the
exercise of stock options by each of the named executive officers during the
transition period ended June 30, 1999 and the fiscal year ended October 31,
1998, and the value of unexercised options as of the end of the transition
period:
Number of Securities Value of Unexercised
Underlying Unexercised Options In-The-Money Options at
at Fiscal Year End(#) Fiscal Year End($)(1)(2)
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
Irwin L. Gross -- -- -- --
Frank E. Gomer 10,000 40,000 -- --
Morris C. Aaron 10,000 40,000 -- --
Wilbur L. Riner, Sr. -- 40,000 -- --
James E. Riner 12,500 54,348 3,125 --
Bryan R. Carr -- -- -- --
----------
(1) Market value of underlying securities at fiscal year-end minus exercise
price multiplied by the number of shares.
(2) If no value is indicated, these options did not have an exercise price less
than the closing bid price per share of our common stock on the Nasdaq
SmallCap Market at June 30, 1999.
EMPLOYMENT ARRANGEMENTS
Wilbur L. Riner, Sr. served as Executive Vice President - Business
Development pursuant to the terms of an employment agreement that would have
terminated on May 18, 2001, had we not entered into a separation and release
agreement with Mr. Riner providing for his termination on December 31, 1999.
Pursuant to his employment agreement, Mr. Riner received a minimum annual base
salary of $156,000 per year. The employment agreement provided for a severance
payment in the event we terminated Mr. Riner's employment other than for "cause"
as defined in the agreement. The severance payment amount was to be equal to the
lesser of Mr. Riner's base annual salary or his base salary for the remaining
term of the agreement. The employment agreement also provided that we may pay
other incentive compensation as may be set by the board of directors from time
to time and for such other fringe benefits as are paid to our other executive
officers.
On December 2, 1999, we entered into a separation and release agreement
with Mr. Riner and his spouse pursuant to which Mr. Riner resigned all positions
with us as of December 31, 1999. In exchange, we paid Mr. Riner a lump-sum
payment equal to two months base salary (offset in part by certain indebtedness
owed to us), and acknowledged certain option exercise rights belonging to him
and his spouse and the right of his spouse to sell certain restricted shares of
our common stock. Each of Mr. Riner and his spouse provided a full release to us
with respect to any potential claims arising prior to the date of the agreement.
Pursuant to the agreement, both Mr. Riner and his spouse entered into customary
non-compete covenants with us, and Mr. Riner acknowledged his obligations of
confidentiality under a non-disclosure agreement that he entered into with us
previously.
James E. Riner serves as Vice President - Engineering pursuant to the terms
of an employment agreement that terminates on October 31, 2001. Mr. Riner
receives a minimum annual base salary of $140,000 per year. The employment
agreement provides for a severance payment in the event that we terminate Mr.
44
<PAGE>
Riner's employment other than for "cause" as defined in the agreement. The
severance payment amount would be equal to the lesser of his base annual salary
or his base salary for the remaining term of the agreement. The employment
agreement also provides that we may pay other incentive compensation as may be
set by the board of directors from time to time and for such other fringe
benefits as are paid to our other executive officers.
Bryan Carr served as Vice President - Finance, Treasurer, Chief Financial
Officer and Chief Operating Officer until May 1999, pursuant to the terms of an
employment agreement providing for a minimum annual base salary of $120,000 per
year and for commissions of .5% for net sales that exceed $500,000 in any
calendar month. The employment agreement also provided 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 our business and/or assets, and any
event that 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 provided that we may pay other incentive compensation
as may be set by the board of directors from time to time and for such other
fringe benefits as are paid to our other executive officers. Mr. Carr's
employment was terminated on May 31, 1999. He received no severance payment in
connection with the termination and we do not believe any additional amounts are
due to Mr. Carr under the agreement. We are currently engaged in litigation with
Mr. Carr regarding his termination and intends to defend its position
vigorously. See "Legal Proceedings."
Frank E. Gomer served as President and Chief Operating Officer at the end
of the transition period ended June 30, 1999, and most recently as President of
our systems group, pursuant to the terms of an employment agreement that by its
terms would have terminated on June 10, 2001. Dr. Gomer received a minimum
annual base salary of $215,000. Beginning June 11, 1999 and ending June 11,
2003, Dr. Gomer also received 50,000 10-year options under our employee stock
option plan, which vest in increments of 10,000 options per year pursuant to the
terms and conditions of the employment agreement. The employment agreement also
provided for a severance payment in the event that Dr. Gomer was terminated
other than for "cause" as defined in the employment agreement. The severance
payment was to be equal to two times the remaining balance of his base salary
for the remainder of the then current term. The employment agreement also
provided for a payment in the event we terminated Dr. Gomer due to a termination
of our business as defined in the employment agreement or upon termination
without cause following a change in control. In either such event, Dr. Gomer was
to receive an amount equal to two times his remaining base salary for the then
current term, but not less than his annual base salary for one year. The
employment agreement also provides that we may pay other incentive compensation
as may be set by the board of directors from time to time and for such other
fringe benefits as are paid to our other executive officers. Such fringe
benefits take the form of medical and dental coverage and an automobile
allowance of $500 per month. On April 12, 2000, we and Dr. Gomer entered into a
Separation Agreement and Release of All Claims. The agreement provides that Dr.
Gomer's employment with us terminated on April 12, 2000, that he will receive
one year's severance and benefits, and an additional payment of $28,500 in
return for serving as a consultant to us on certain matters, cancellation of
substantially all of his unvested options, and a release of all claims against
us. Under the terms of the agreement, Dr. Gomer has agreed to customary
non-solicitation, non-competition and confidentiality obligations.
Morris C. Aaron serves as Executive Vice President and Chief Financial
Officer pursuant to the terms of an employment agreement that terminates on June
10, 2001. Mr. Aaron receives a minimum annual base salary of $215,000. Beginning
June 11, 1999 and ending June 11, 2003, Mr. Aaron also received 50,000 10-year
options under our employee stock option plan, which vest in increments of 10,000
options per year pursuant to the terms of the employment agreement. The
employment agreement provides for a severance payment in the event that we
terminate Mr. Aaron other than for "cause" as defined in the employment
agreement. The severance payment would be equal to two times the remaining
balance of his base salary for the remainder of the then current term. The
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<PAGE>
employment agreement also provides a payment in the event we terminate Mr. Aaron
due to a termination of our business as defined in the employment agreement. In
the event of the termination of our business, Mr. Aaron would receive an amount
equal to two times his remaining base salary for the then current term, but not
less than his annual base salary for one year. The employment agreement also
provides that we may pay other incentive compensation as may be set by the board
of directors from time to time and for such other fringe benefits as are paid to
our other executive officers. Such fringe benefits take the form of medical and
dental coverage and an automobile allowance of $500 per month.
Until December 15, 1999, the date on which Global Technologies hired its
new Chief Financial Officer, Patrick J. Fodale, Mr. Aaron also served as Chief
Financial Officer of Global Technologies and devoted approximately 40% of his
time to Global Technologies. Mr. Aaron received approximately 40% of his
compensation from Global Technologies until Mr. Fodale's hire.
REPORT ON REPRICING OF OPTIONS
On June 11, 1999, we cancelled existing options to purchase 20,000 shares
of our common stock previously granted to Wilbur L. Riner, Sr. at an exercise
price of $8.75 per share. We repriced these options and granted Mr. Riner
incentive stock options to purchase 20,000 shares of our common stock at an
exercise price of $2.25 per share, half of which vest on the first anniversary
of the date of grant and half of which vest on the second anniversary of the
date of grant. We repriced these options in connection with Global Technologies'
acquisition of us to provide additional incentive to Mr. Riner.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below sets forth the following information, as of May 15, 2000:
* beneficial ownership of our common stock by each person known by us to
own more than 5% of our common stock; and
* beneficial ownership of each class of our equity securities, and the
equity securities of Global Technologies, by each of our executive
officers and directors, and by all of our executive officers and
directors as a group.
<TABLE>
<CAPTION>
The Network Connection Global Technologies
Common Stock Class A Common Stock
-------------------------------- -------------------------------
Name and Address Number of Shares Percent of Number of Shares Percent of
of Beneficial Owner (1) Beneficially Owned Class (2) Beneficially Owned Class (3)
----------------------- ------------------ --------- ------------------ ---------
<S> <C> <C> <C> <C>
Irwin L. Gross 338,667 (4) 2.6% 2,283,108 (5) 21.0%
Morris C. Aaron 20,000 (6) * 24,148 (7) *
Frank E. Gomer 20,000 (8) * 6,592 (9) *
Wilbur L. Riner, Sr. -- (10) -- -- --
M. Moshe Porat 10,000 (11) * 405,000 (12) 3.9%
Stephen Schachman 10,000 (13) * 26,400 (14) *
Robert Pringle 160,000 (15) 1.2 -- --
Global Technologies, Ltd. 23,437,903 (16) 79.5% -- --
All directors and executive
as a group (7 persons) 558,667 (17) 4.2% 2,745,248 (18) 25.13%
</TABLE>
----------
* Less than 1%
46
<PAGE>
(1) Except as otherwise indicated, the address of each beneficial owner is c/o
The Network Connection, Inc., 1811 Chestnut Street, Suite 120,
Philadelphia, PA 19103.
(2) Based on 12,911,479 shares of common stock outstanding.
(3) Based on 10,498,488 shares of Class A Common Stock outstanding.
(4) Includes 125,000 shares issuable upon the exercise of options exercisable
within 60 days, and 213,667 shares beneficially owned by Mr. Gross directly
and indirectly through various entities.
(5) Includes 375,000 shares issuable upon the exercise of options exercisable
within 60 days, and 50,949 shares owned by trusts for the benefit of Mr.
Gross' children as to which Mr. Gross disclaims beneficial ownership.
(6) Represents 20,000 shares issuable to Mr. Aaron upon exercise of options
exercisable within 60 days. Mr. Aaron's address is 222 North 44th Street
Phoenix, AZ 85034.
(7) Includes 15,000 shares issuable upon the exercise of options exercisable
within 60 days.
(8) Represents 20,000 shares issuable upon the exercise of options exercisable
within 60 days. 10,000 of these options will be held in escrow until April
12, 2001 in accordance with the terms of Dr. Gomer's Separation Agreement
and Release of All Claims. Dr. Gomer's address is 222 North 44th Street
Phoenix, AZ 85034.
(9) Includes 3,592 shares issuable upon the exercise of options exercisable
within 60 days.
(10) Does not include 420,120 shares owned by Barbara Riner, Mr. Riner's wife.
Mr. Riner has disclaimed all beneficial interest in the shares held by his
wife. Mr. Riner's address is 1324 Union Hill Road, Alpharetta, GA 30201.
(11) Includes 10,000 shares issuable upon the exercise of options exercisable
within 60 days.
(12) Includes 15,000 shares issuable upon the exercise of options exercisable
within 60 days, and 375,000 shares over which Mr. Porat retains voting
power pursuant to a certain proxy agreement.
(13) Includes 10,000 shares issuable upon the exercise of options exercisable
within 60 days.
(14) Includes 15,000 shares issuable upon the exercise of options exercisable
within 60 days.
(15) Includes 160,000 shares issuable upon the exercise of options exercisable
within 60 days.
(16) Includes 1,176,471 shares of common stock issuable upon conversion of
shares of Series B 8% Convertible Preferred Stock, 15,097,170 shares of
common stock issuable upon conversion of our Series D Convertible Preferred
Stock and 310,000 shares of common stock issuable upon exercise of
warrants.
(17) See footnotes 4, 6, 11, 13 and 15.
(18) See footnotes 5, 7, 9, 12 and 14.
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<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Our Chief Executive Officer is a principal of Ocean Castle Partners, LLC
which maintains administrative offices for our Chief Executive Officer and
certain other employees of Global Technologies. During the year ended October
31, 1998, Ocean Castle executed consulting agreements with two shareholders of
Global Technologies, Don Goldman and Yuri Itkis. We assumed the rights and
obligations of Ocean Castle under the agreements in connection with Global
Technologies' acquisition of its interest in our 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 of
Global Technologies at an exercise price of $4.50. As of June 30, 1999, we
determined that the consulting agreements had no future value due to our shift
away from in-flight entertainment and into alternative markets. Only limited
services were provided in 1999 and no future services will be utilized.
Accordingly, we recorded a charge to general and administrative expenses in the
eight-month transition period ended June 30, 1999 of $1.6 million representing
the balance due under such contracts.
In August 1999, we executed a separation and release agreement with Barbara
Riner, a shareholder and former officer, pursuant to which we paid approximately
$85,000 in the form of unregistered shares of our common stock.
In June 1999, we loaned $75,000 to James Riner, one of our vice presidents
for the purpose of assisting in a corporate relocation to our headquarters in
Phoenix, Arizona. The loan is secured by assets of the employee. The note
matures in August 2009 and bears an interest rate of approximately 6%.
Global Technologies was party to an intellectual property license and
support services agreement for certain technology with FortuNet, Inc. FortuNet
is owned by Yuri Itkis, a shareholder of Global Technologies and previous
director of Global Technologies. The license agreement provides for an annual
license fee of $100,000 commencing in October 1994 and continuing through
November 2002. We assumed this liability in connection with Global Technologies'
acquisition of its interest in our company. We paid FortuNet $100,000 during
each of the years ended October 31, 1998 and 1997. In the second half of 1999 we
reached agreement with FortuNet with respect to a termination of this agreement
and paid FortuNet $100,000 plus legal fees. During the transition period ended
June 30, 1999, we revised our estimated accrual to $200,000, which is included
in accrued liabilities at June 30, 1999.
During the year ended October 31, 1998, Global Technologies extended by one
year a consulting agreement with Steve Fieldman, one of its former vice
presidents pursuant to which Global Technologies will pay $55,000 for services
received during the period November 1999 through October 2000. We have assumed
the liability for the consulting agreement in connection with Global
Technologies' acquisition of its interest in our company in the amount of
approximately $45,250, which is included in accrued liabilities at December 31,
1999.
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<PAGE>
During the year ended October 31, 1998, Global Technologies executed
severance and consulting agreements with three of its former officers, pursuant
to which Global Technologies paid the former officers and set aside restricted
funds in the amounts of $3,053,642 and $735,000, respectively. The consulting
agreements all expire by September 1999. Payments totaling $735,000 have been
made from restricted cash through September 1999. Expenses associated with these
agreements were charged to general and administrative expenses in the year ended
October 31, 1998.
During the year ended October 31, 1996, Global Technologies executed
severance agreements with three former officers pursuant to which it will pay
severance of $752,500 over a three-year period. As of June 30, 1999 and October
31, 1998, $18,000 and $55,000 remained to be paid under these agreements. Such
liabilities were assumed by us in connection with our acquisition of Global
Technologies' Interactive Entertainment Division in May 1999.
We have agreed to reimburse B.H.G. Flight, LLC ("BHG") for costs and
expenses associated with our use for corporate purposes of an airplane owned by
BHG. Irwin L. Gross, our Chairman of the Board and Chief Executive Officer, owns
a 50% interest in BHG. To date, we have incurred approximately $43,800 for such
costs and expenses.
Global Technologies owns a controlling interest in our company. See
"Security Ownership of Certain Beneficial Owners and Management." Global
Technologies generally acquired its interest in our company on May 18, 1999. See
"Management's Discussions and Analysis of Financial Conditions and Results of
Operation." See also the description of the $5 million line of credit with
Global Technologies on page 33.
DESCRIPTION OF SECURITIES
OUR COMMON STOCK
We have authorized 40,000,000 shares of our common stock, par value $0.001
per share. The holders of our common stock are entitled to one vote for each
share held of record on all matters submitted to a vote of the shareholders.
Subject to preferences that may be applicable to any shares of preferred stock
issued in the future, holders of common stock are entitled to receive ratably
such dividends as may be declared by the board of directors out of funds legally
available therefor. In the event of our liquidation, dissolution or winding up,
holders of common stock are entitled to share ratably in all assets remaining
after payment of liabilities and the liquidation preference of any then
outstanding preferred stock. Holders of common stock have no preemptive rights
and no right to convert their common stock into any other securities. There are
no redemption or sinking fund provisions applicable to the common stock. All
outstanding shares of common stock are, and all shares of common stock to be
outstanding upon completion of the offering contemplated hereby, will be fully
paid and nonassessable.
OUR PREFERRED STOCK
We have authorized 2,500,000 shares of preferred stock. Shares of preferred
stock may be issued without shareholder approval. The board of directors is
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<PAGE>
authorized to issue such shares in one or more series and to fix the rights,
preferences, privileges, qualifications, limitations and restrictions thereof,
including dividend rights and rates, conversion rights, voting rights, terms of
redemption, redemption prices, liquidation preferences and the number of shares
constituting any series or the designation of such series, without any vote or
action by the shareholders. Any preferred stock to be issued could rank prior to
our common stock with respect to dividend rights and rights on liquidation. Our
board of directors, without shareholder approval, may issue preferred stock with
voting and conversion rights which could adversely affect the voting power of
holders of common stock and discourage, delay or prevent a change in control of
The Network Connection.
We currently have 1,500 shares of Series B 8% convertible preferred stock
outstanding. The Series B preferred stock has a stated value of $1,000 per share
and a liquidation value of 120% of the stated value. The holders of the Series B
preferred stock are entitled to an annual cumulative dividend of $80 per share,
payable quarterly in cash or common stock. Cumulative unpaid dividends at June
30, 1999 totaled $20,000. Each share of Series B preferred stock is convertible
into common stock at a price equal to the lowest of: (a) 75% of the average
price of the common stock or (b) 75% of the average price of the common stock,
calculated as if April 29, 1999 were the conversion date. The Series B
convertible preferred stock has no voting rights. Global Technologies owns 100%
of the issued and outstanding Series B 8% Convertible Preferred Stock.
We currently have 2,495,400 shares of Series D convertible preferred stock
outstanding. The Series D convertible preferred stock has a stated value of $10
per share and a liquidation value of 120% of the stated value. The holders of
the Series D preferred stock are entitled to an annual dividend as and when
declared by our board of directors. Each share of the Series D convertible
preferred stock is convertible into 6.05 shares of common stock. The Series D
convertible preferred stock has six votes per share. Global Technologies owns
100% of the issued and outstanding Series D convertible preferred stock.
OUR TRANSFER AGENT
Continental Stock Transfer & Trust Company, New York, New York, serves as
transfer agent for the shares of common stock.
50
<PAGE>
SELLING SECURITY HOLDERS
The following table sets forth for each selling shareholder (i) the name of
the selling shareholder, (ii) the number of shares of our common stock owned by
the selling shareholder before the offering (in some cases, as noted in the
footnotes to the table, some or all shares underlie warrants held by the selling
shareholder), (iii) the number of shares of our common stock offered by the
selling shareholder under this prospectus, (iv) the number of shares of our
common stock that will be owned by the selling shareholder assuming that all
shares of our common stock registered hereby on that shareholder's behalf are
sold, and (v) the percentage of our outstanding shares of common stock that
those remaining shares will represent. Each of the selling shareholders is a
party to an agreement by which we agreed to register their shares of our common
stock. Registration of these shares enables the selling shareholders to sell the
shares from time to time in any manner described in "Plan of Distribution"
below, but does not necessarily mean that the selling shareholders will sell all
or any of the shares.
<TABLE>
<CAPTION>
Number of Number of Percentage of
Shares Shares Common Stock
Beneficially Beneficially Beneficially
Owned Before Number of Owned After Owned After
Name of Selling Shareholder Offering Shares Offered Offering Offering
--------------------------- -------- -------------- -------- --------
<S> <C> <C> <C> <C>
Fusion Capital Fund II, LLC (1) 2,560,000 2,560,000 -- --
Goodbody International 107,433 107,433 -- --
Continental Capital & Equity Corp. (2) 129,500 129,500 -- --
Emden Consulting Corp. (3) 25,000 25,000 -- --
Waterton Group LLC (4) 25,000 25,000 -- --
</TABLE>
----------
(1) Includes an estimated 450,000 shares to be issued as a commitment fee, of
which 300,000 shares have been issued in connection with the execution of
an equity purchase agreement, and an estimated 2,110,000 shares which are
issuable upon conversion of the equity purchase agreement which has a
principal amount of $12,000,000. The equity purchase agreement provides
that Fusion Capital may not beneficially own in excess of 4.99% of our
outstanding common stock. See "The Fusion Transaction" on page 36.
(2) Continental Capital & Equity Corp. owns 29,500 shares of common stock and
warrants exercisable for 100,000 shares of common stock. The exercise
prices payable under the warrants range from $6.00 to $10.00.
(3) Emden Consulting Corp. owns warrants exercisable for 25,000 shares of
common stock at an exercise price of $6.50.
(4) Waterton Group LLC owns warrants exercisable for 25,000 shares of common
stock at an exercise price of $6.50.
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<PAGE>
PLAN OF DISTRIBUTION
The selling shareholders or their respective pledgees, donees, transferees
or other successors-in-interest:
* may sell shares of common stock offered hereby by delivery of this
prospectus from time to time in one or more transactions (which may
involve block transactions) on the Nasdaq SmallCap Market or on such
other market on which the common stock may from time to time be
trading;
* may sell the shares offered hereby in privately negotiated
transactions, may sell shares of common stock short and (if such short
sales were effected pursuant hereto and a copy of this prospectus
delivered therewith) deliver the shares offered hereby to close out
such transactions;
* may engage in the sale of such shares through equity-swaps or the
purchase or sale of options; and/or
* may pledge the shares offered hereby to a broker or dealer or other
financial institution, and upon default, the broker or dealer may
effect sales of the pledged shares by delivery of this prospectus or
as otherwise described herein or any combination thereof.
The sale price to the public may be the market price for common stock
prevailing at the time of sale, a price related to such prevailing market price,
at negotiated prices or such other price as the selling shareholders determine
from time to time. The shares offered hereby may also be sold pursuant to Rule
144 under the Securities Act without delivery of this prospectus. The selling
shareholders shall have the sole discretion not to accept any purchase offer or
make any sale of shares if they deem the purchase price to be unsatisfactory at
any particular time. There can be no assurance that all or any part of the
shares offered hereby will be sold by the selling shareholders.
The selling shareholders or their respective pledgees, donees, transferees
or other successors-in-interest may also sell the shares directly to market
makers acting as principals and/or broker-dealers acting as agents for
themselves or their customers. These broker-dealers may receive compensation in
the form of discounts, concessions or commissions from the selling shareholders
and/or the purchasers of shares for whom the broker-dealers may act as agents or
to whom they sell as principal, or both (which compensation as to a particular
broker-dealer might be in excess of customary commissions). Market makers and
block purchasers purchasing the shares will do so for their own account and at
their own risk. It is possible that a selling shareholder will attempt to sell
shares of common stock in block transactions to market makers or other
purchasers at a price per share which may be below the then market price.
The selling shareholders, alternatively, may sell all or any part of the
shares offered hereby through an underwriter. No selling shareholder has entered
into any agreement with a prospective underwriter and there is no assurance that
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<PAGE>
any such agreement will be entered into. If a selling shareholder enters into
such an agreement or agreements, the relevant details will be set forth in a
supplement or revisions to this prospectus. To the extent required, we will
amend or supplement this prospectus to disclose material arrangements regarding
the plan of distribution.
Fusion Capital is an "underwriter" within the meaning of Section 2(11) of
the Securities Act of 1933. The other selling shareholders may be deemed to be
"underwriters" within the meaning of Section 2(11) of the Securities Act .
Therefore, Fusion Capital and any other selling shareholder that may be deemed
to be an underwriter will be subject to prospectus delivery requirements under
the Securities Act. Any broker-dealers who act in connection with the sale of
the shares hereunder may be deemed to be "underwriters" within the meaning of
the Securities Act, and any commissions they receive and proceeds of any sale of
the shares may be deemed to be underwriting discounts and commissions under the
Securities Act.
To comply with the securities laws of certain jurisdictions, the shares
offered by this prospectus may need to be offered or sold in such jurisdictions
only through registered or licensed brokers or dealers. Under applicable rules
and regulations promulgated under the Exchange Act, any person engaged in a
distribution of the shares of common stock covered by this prospectus may be
limited in its ability to engage in market activities with respect to such
shares. The selling shareholders, for example, will be subject to the applicable
provisions of the Exchange Act and the rules and regulations promulgated
thereunder, including, without limitation, Regulation M, which provisions may
restrict certain activities of the selling shareholders and limit the timing of
purchases and sales of any shares of common stock by the selling shareholders.
Furthermore, under Regulation M, persons engaged in a distribution of securities
are prohibited from simultaneously engaging in market making and certain other
activities with respect to such securities for a specified period of time prior
to the commencement of such distributions, subject to specified exceptions or
exemptions. The foregoing may affect the marketability of the shares offered by
this prospectus.
We have agreed to pay certain expenses of the offering and issuance of the
shares of common stock covered by this prospectus, including the printing, legal
and accounting expenses we incur and the registration and filing fees imposed by
the Commission and the Nasdaq SmallCap Market. Certain of the selling
shareholders will be indemnified by us against certain civil liabilities,
including certain liabilities under the Securities Act, or will be entitled to
contribution in connection therewith. We will be indemnified by certain of the
selling shareholders against certain civil liabilities, including certain
liabilities under the Securities Act, or will be entitled to contribution in
connection therewith.
Upon a sale of common stock pursuant to this registration statement of
which this prospectus forms a part, the common stock will be freely tradable in
the hands of persons other than our affiliates. We will not pay brokerage
commissions or taxes associated with sales by the selling shareholders.
FUSION CAPITAL AND ITS AFFILIATES HAVE AGREED NOT TO ENGAGE IN ANY DIRECT
OR INDIRECT SHORT SELLING OR HEDGING OF OUR COMMON STOCK DURING THE TERM OF THE
EQUITY PURCHASE AGREEMENT.
This offering will terminate on the earlier of (1) the date on which the
shares are eligible for resale without restrictions in accordance with Rule
144(k) under the Securities Act or (2) the date on which all shares offered by
this prospectus have been sold by the selling shareholders.
53
<PAGE>
DISCLOSURE OF THE SEC'S POSITION ON
INDEMNIFICATION
FOR SECURITIES ACT LIABILITIES
Our articles of incorporation and bylaws provide that we will indemnify our
directors, officers, employees and agents to the fullest extent permitted by
Georgia law. Specifically, our articles of incorporation eliminate the personal
liability of directors to us or our shareholders for monetary damages for breach
of fiduciary duty as a director; provided, however, that such elimination of the
personal liability of a director to us does not apply for any liability for:
* any appropriation, in violation of his duties, of any business
opportunity of ours,
* acts or omissions which involve intentional misconduct or a knowing
violation of law,
* actions prohibited under Section 14-2-832 of the Georgia Business
Corporation Code (I.E., liabilities imposed upon directors who vote
for or assent to the unlawful payment of dividends, unlawful payment
of dividends, unlawful repurchases or redemption of stock, unlawful
distribution of our assets to the shareholders without the prior
payment or discharge of our debts or obligations, or unlawful making
or guaranteeing of loans to directors), or
* any transaction from which the director derived an improper personal
benefit.
We intend to enter into indemnity agreements with each of our directors and
executive officers to indemnify them against expenses and losses incurred for
claims brought against them in their capacities as directors or executive
officers. We maintain directors' and officers' liability insurance.
These provisions do not affect, however, a director's or officer's
responsibilities under any other laws, such as the federal securities laws.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and control persons of The Network
Connection pursuant to the foregoing provisions, or otherwise, we have been
advised that in the opinion of the SEC, such indemnification is against public
policy as expressed in the Securities Act of 1933, and is, therefore,
unenforceable.
There is no pending litigation or proceeding involving a director or
officer as to which indemnification is being sought. We are not aware of any
pending or threatened litigation that may result in claims for indemnification
by any director or officer. See, however, "Legal Proceedings," which discusses
the Carr case. Mr. Carr was previously a director and officer of our company.
54
<PAGE>
EXPERTS
Our financial statements dated as of June 30, 1999 and October 31, 1998,
and for the transition period ended June 30, 1999 and each of the years in the
two year period ended October 31, 1998 have been included in this prospectus in
reliance upon the report of KPMG LLP, independent certified public accountants,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing.
CHANGE IN INDEPENDENT ACCOUNTANTS.
On May 18, 1999 we acquired the Interactive Entertainment Division of
Global Technologies. This transaction was treated as a reverse acquisition of us
by Global Technologies. As a result of this reverse acquisition, our board of
directors determined to terminate its engagement of PricewaterhouseCoopers, LLP
as independent accountants, effective as of July 30, 1999.
None of the reports of PricewaterhouseCoopers on our financial statements
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
our ability to continue as a going concern.
There were no disagreements with PricewaterhouseCoopers, 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, would have caused it to make
reference to the subject matter of the disagreement in connection with its
report.
PricewaterhouseCoopers did not note any reportable conditions for the
period ended December 31, 1998. PricewaterhouseCoopers has not been engaged nor
has it performed any audit procedures subsequent to their audit of the December
31, 1998 financial statements and up to the date of its termination.
We engaged the firm of KPMG LLP, effective July 30, 1999, to audit our
financial statements commencing with the financial statements to be included in
our transition report on Form 10-KSB for the transition period ended June 30,
1999.
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us
by Mesirov Gelman Jaffe Cramer & Jamieson, LLP, Philadelphia, Pennsylvania.
55
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, proxy statements and other
information with the Commission. You may read and copy any such documents that
we have filed. You may do so at the Commission's public reference room, Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. These
documents are also available at the following Regional Office: 7 World Trade
Center, Suite 1300, New York, New York 10048. Please call the Commission at
1-800-SEC-0330 for further information on the public reference rooms.
Our SEC filings are also available to the public on the Commission's web
site at http://www.sec.gov. Our web site can be found at http://www.tncx.com.
56
<PAGE>
THE NETWORK CONNECTION, INC.
INDEX TO FINANCIAL STATEMENTS
Page
----
ANNUAL FINANCIAL STATEMENTS:
Independent Auditors' Report.............................................. F-2
Balance Sheets as of June 30, 1999 and October 31, 1998................... F-3
Statements of Operations for the Transition Period Ended June 30, 1999
and the Years Ended October 31, 1998 and 1997............................ F-4
Statements of Cash Flows for the Transition Period Ended June 30, 1999
and the Years Ended October 31, 1998 and 1997............................ F-5
Statements of Stockholders' Equity (Deficiency) and Comprehensive Income
for the Transition Period Ended June 30, 1999 and the Years Ended
October 31, 1998 and 1997................................................ F-6
Notes to Financial Statements............................................. F-7
INTERIM FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets as of March 31, 2000
(unaudited) and June 30, 1999 (audited).................................. F-24
Condensed Consolidated Statement of Operations for the Three Months
and Nine Months Ended March 31, 2000 and 1999 (unaudited)................ F-25
Condensed Consolidated Statement of Cash Flows for the Nine Months
Ended March 31, 2000 and 1999 (unaudited)................................ F-26
Notes to Condensed Consolidated Financial Statements...................... F-27
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
The Network Connection, Inc.:
We have audited the accompanying balance sheets of The Network Connection, Inc.
as of June 30, 1999 and October 31, 1998 and the related statements of
operations, changes in stockholders' equity (deficiency) and comprehensive
income and cash flows for the Transition Period ended June 30, 1999 and each of
the years in the two year period ended October 31, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above, present fairly, in
all material respects, the financial position of The Network Connection, Inc. at
June 30, 1999 and October 31, 1998 and 1997 and the results of its operations
and its cash flows for the Transition Period ended June 30, 1999 and each of the
years in the two year period ended October 31, 1998, in conformity with
generally accepted accounting principles.
/s/ KPMG LLP
Phoenix, Arizona
October 12, 1999
F-2
<PAGE>
THE NETWORK CONNECTION, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, OCTOBER 31,
ASSETS 1999 1998
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 2,751,506 $ 14,348
Restricted cash 446,679 437,502
Investment securities 302,589 --
Accounts receivable, net 75,792 1,130,648
Notes receivable from related parties 98,932 --
Inventories, net 1,400,000 1,005,427
Prepaid expenses 169,429 44,695
Assets held for sale 800,000 --
Other current assets 173,999 270,225
------------ ------------
Total current assets 6,218,926 2,902,845
Note receivable from related party 75,000 --
Property and equipment, net 1,338,580 780,035
Intangibles, net 7,119,806 --
Other assets 150 555,150
------------ ------------
Total assets $ 14,752,462 $ 4,238,030
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 1,681,771 $ 891,242
Accrued liabilities 2,209,682 3,280,378
Deferred revenue 365,851 453,022
Accrued product warranties -- 5,369,008
Current maturities of long-term debt 24,391 --
Notes payable to related parties 68,836 --
------------ ------------
Total current liabilities 4,350,531 9,993,650
Notes payable 3,467,045 --
Due to affiliate 1,647,692 --
------------ ------------
Total liabilities 9,465,268 9,993,650
------------ ------------
Commitments and contingencies
Stockholders' equity (deficiency):
Series B preferred stock par value $0.01 per share,
1,500 shares authorized, issued and outstanding 15 --
Series C preferred stock par value $0.01 per share,
1,600 shares authorized; 800 shares issued and outstanding 8 --
Series D preferred stock par value $0.01 per share,
2,495,400 authorized, issued and outstanding 24,954 --
Common stock par value $0.001 per share, 10,000,000 shares
authorized; 6,339,076 issued and outstanding 6,339 --
Additional paid-in capital 88,316,945 --
Contributed capital in excess of par value -- 79,618,459
Accumulated other comprehensive income:
Net unrealized loss on investment securities (526) --
Accumulated deficit (83,060,541) (85,374,079)
------------ ------------
Total stockholders' equity (deficiency) 5,287,194 (5,755,620)
------------ ------------
Total liabilities and stockholders' equity (deficiency) $ 14,752,462 $ 4,238,030
============ ============
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
TRANSITION
PERIOD ENDED
JUNE 30, YEAR ENDED OCTOBER 31,
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Revenue:
Equipment sales $ 875,957 $ 18,038,619 $ 10,524,828
Service income 82,650 778,343 575,881
------------ ------------ ------------
958,607 18,816,962 11,100,709
------------ ------------ ------------
Costs and expenses:
Cost of equipment sales 1,517,323 15,523,282 24,646,334
Cost of service income 480 13,789 232,126
Provision for doubtful accounts 28,648 -- 216,820
Research and development expenses -- 1,092,316 7,821,640
General and administrative expenses 3,703,633 9,019,872 12,574,223
Special charges 521,590 400,024 19,649,765
Reversal of warranty, maintenance and
commission accruals (7,151,393) -- --
Bad debt recoveries -- -- (1,064,284)
------------ ------------ ------------
(1,379,719) 26,049,283 64,076,624
------------ ------------ ------------
Operating income (loss) 2,338,326 (7,232,321) (52,975,915)
Other:
Interest expense (83,029) (11,954) (13,423)
Interest income 77,682 53,465 --
Other income (expense) 11,226 10,179 (203,649)
------------ ------------ ------------
Net income (loss) 2,344,205 (7,180,631) (53,192,987)
Cumulative dividend on preferred stock (30,667) -- --
------------ ------------ ------------
Net income (loss) attributable to common stockholders $ 2,313,538 $ (7,180,631) $(53,192,987)
============ ============ ============
Basic net income (loss) per common share $ 0.97 $ (6.80) $ (50.38)
============ ============ ============
Weighted average number of shares outstanding 2,387,223 1,055,745 1,055,745
============ ============ ============
Diluted net income (loss) per common share $ 0.13 $ (6.80) $ (50.38)
============ ============ ============
Weighted average number of common and
dilutive shares outstanding 18,543,707 1,055,745 1,055,745
============ ============ ============
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
TRANSITION
PERIOD ENDED
JUNE 30, YEAR ENDED OCTOBER 31,
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 2,313,538 $ (7,180,631) $(53,192,987)
Adjustments to reconcile net income (loss) to net cash:
Depreciation and amortization 342,544 1,205,361 1,815,779
Change in inventory valuation allowance (892,010) -- 8,297,933
Special charges 521,590 400,024 19,649,765
Reversal of warranty, maintenance and commission accruals (7,151,393) -- --
Loss on disposal of equipment -- -- 203,649
Non cash compensation expense -- -- 480,749
Changes in net assets and liabilities, net of effect
of Transaction:
Decrease (increase) in accounts receivable (482,344) 4,523,470 (5,754,771)
Decrease (increase) in inventories 1,897,437 5,105,334 (12,563,721)
Decrease (increase) in prepaid expenses (116,717) 47,428 183,394
Decrease in other current assets 78,134 247,549 --
Increase in other assets -- (411,042) --
(Decrease) increase in accounts payable (1,449,333) (4,933,431) 1,673,893
(Decrease) increase in accrued liabilities 702,559 (1,758,210) (584,655)
(Decrease) increase in deferred revenue 1,138,048 (1,930,882) 2,383,904
Increase in accrued product warranties -- 758,321 836,667
------------ ------------ ------------
Net cash used in operating activities $ (3,097,947) $ (3,926,709) $(36,570,401)
Cash flows from investing activities:
Purchases of investment securities (302,589) -- --
Purchases of property and equipment (18,243) (36,008) (10,341,561)
Proceeds from sale of equipment -- 3,620 --
Cash acquired in Transaction 23,997 -- --
Increase in restricted cash (9,177) (437,502) --
------------ ------------ ------------
Net cash used in investing activities $ (306,012) $ (469,890) $(10,341,561)
Cash flows from financing activities:
Payments on notes payable (58,450) (80,753) (53,085)
Advances from parent 805,616 -- --
Contributed capital 5,391,951 4,427,544 47,029,203
Proceeds from issuance of stock 2,000 -- --
------------ ------------ ------------
Net cash provided by financing activities $ 6,141,117 $ 4,346,791 $ 46,976,118
Net increase (decrease) in cash and cash equivalents 2,737,158 (49,808) 64,156
Cash and cash equivalents at beginning of year 14,348 64,156 --
------------ ------------ ------------
Cash and cash equivalents at end of year $ 2,751,506 $ 14,348 $ 64,156
============ ============ ============
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
THE NETWORK CONNECTION, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY) AND COMPREHENSIVE INCOME
TRANSITION PERIOD ENDED JUNE 30, 1999 YEARS ENDED OCTOBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ADDITIONAL
SERIES B SERIES C SERIES D COMMON PAID-IN
PREFERRED PREFERRED PREFERRED STOCK CAPITAL
--------- --------- ---------- ------ ------------
<S> <C> <C> <C> <C> <C>
Balance as of October 31, 1996 $ -- $ -- $ -- $ -- $ --
Contributed capital -- -- -- -- --
Net loss -- -- -- -- --
------ ------ ---------- ------ ------------
Balance as of October 31, 1997 $ -- $ -- $ -- $ -- $ --
Contributed capital -- -- -- -- --
Net loss -- -- -- -- --
------ ------ ---------- ------ ------------
Balance as of October 31, 1998 $ -- $ -- $ -- $ -- $ --
Contributed capital -- -- -- -- --
Contribution of advances to capital -- -- -- -- 85,010,410
Issuance of stock 15 8 24,954 6,338 3,304,536
Exercise of stock options -- -- -- 1 1,999
Comprehensive income (loss):
Unrealized loss on available for
sale securities -- -- -- -- --
Net income -- -- -- -- --
Total comprehensive income -- -- -- -- --
------ ------ ---------- ------ ------------
Balance as of June 30, 1999 $ 15 $ 8 $ 24,954 $6,339 $ 88,316,945
====== ====== ========== ====== ============
ACCUMULATED
OTHER ACCUMULATED TOTAL
CONTRIBUTED COMPREHENSIVE (DEFICIT) STOCKHOLDERS'
CAPITAL INCOME EARNINGS EQUITY
----------- ------------ ------------ -----------
Balance as of October 31, 1996 $ 28,161,712 $ -- $(25,000,461) $ 3,161,251
Contributed capital 47,029,203 -- -- 47,029,203
Net loss -- -- (53,192,987) (53,192,987)
----------- ------------ ------------ -----------
Balance as of October 31, 1997 $ 75,190,915 $ -- $(78,193,448) $(3,002,533)
Contributed capital 4,427,544 -- -- 4,427,544
Net loss -- -- (7,180,631) (7,180,631)
----------- ------------ ------------ -----------
Balance as of October 31, 1998 $ 79,618,459 $ -- $(85,374,079) $(5,755,620)
Contributed capital 5,391,951 -- -- 5,391,951
Contribution of advances to capital (85,010,410) -- -- --
Issuance of stock -- -- -- 3,335,851
Exercise of stock options -- -- -- 2,000
Comprehensive income (loss):
Unrealized loss on available for
sale securities -- (526) -- --
Net income -- -- 2,313,538 --
Total comprehensive income -- -- -- 2,313,012
----------- ------------ ------------ -----------
Balance as of June 30, 1999 $ -- $ (526) $(83,060,541) $ 5,287,194
=========== ============ ============ ===========
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE>
THE NETWORK CONNECTION, INC.
NOTES TO FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(a) DESCRIPTION OF BUSINESS
The Network Connection, Inc. (the "Company" or "TNCi") is engaged in
the development, manufacturing and marketing of computer-based
entertainment and data networks, which provides users access to
information, entertainment and a wide array of service options, such
as movies, shopping for goods and services, computer games, access the
World Wide Web and gambling, where permitted by applicable law. The
Company's primary markets for its products are cruise ships, passenger
trains, schools and corporate training. Secondary markets include
business jets and hotel operators, among others.
(b) BASIS OF PRESENTATION
On May 18, 1999, Global Technologies, Ltd. (formerly known as
Interactive Flight Technologies, Inc.) ("GTL") received from 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 GTL's
Interactive Entertainment Division ("IED"), as defined in the Asset
Purchase and Sale Agreement dated April 30, 1999, as amended (the
"Transaction"). The Transaction has been accounted for as a reverse
merger whereby, for accounting purposes, GTL is considered the
accounting acquiror, and although the legal capital structure carries
forward, 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 IED.
The Company will continue to file as a SEC registrant and continue to
report under the name The Network Connection, Inc. The financial
statements as of and for the years ended October 31, 1998 and 1997
reflect the historical results of GTL's IED as previously included in
GTL's consolidated financial statements. Included in the results of
operations for the eight months ended June 30, 1999 are the historical
results of GTL's IED through April 30, 1999, and the results of the
post Transaction company for the two months ended June 30, 1999. The
Transaction date for accounting purposes is May 1, 1999. Contributed
capital reflects the cash consideration paid by GTL to the Company in
the Transaction in addition to funding of IED historical operations.
GTL will continue to report as a separate SEC registrant, owning the
shares of the Company as described above. As of June 30, 1999, the
Company is a majority owned subsidiary of GTL whose ownership, through
a combination of the Transaction described above and GTL's purchase of
Series B 8 % preferred stock of the Company and 110,000 shares of the
Company's common stock from third party investors, approximates 78% of
the Company on an if-converted common stock basis (See note 15.) The
historical financial statements of the Company up to the date of the
Transaction as previously reported will no longer be included in
future filings of the Company.
(c) CHANGE IN FISCAL YEAR-END
The Company has changed its fiscal year-end from December 31 to June
30. The Transition Period resulting from the change in fiscal year-end
is measured from IED's former fiscal year-end of October 31.
Accordingly, the eight-month period resulting from this change,
November 1, 1998 through June 30, 1999, is referred to as the
"Transition Period."
F-7
<PAGE>
(d) 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.
(e) 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.
(f) RESTRICTED CASH
At June 30, 1999 and October 31, 1998, the Company held restricted
cash of $446,679 and $437,502, respectively, in a trust fund for
payments which may be required under severance agreements with one
former executive of GTL. (See note 15.)
(g) 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. 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.
(h) INVENTORIES
Inventories consisting principally of entertainment network components
are stated at the lower of cost (first-in, first-out method) or
market.
(i) GOODWILL
The Company classifies as goodwill the excess of the purchase price
over the fair value of the net assets acquired and is amortized over
ten years using the straight line method.
(j) 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.
(k) 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 systems is recognized when earned,
according to the terms of the service contract. Revenue pursuant to
contracts that provide for revenue sharing with customers and/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. Revenue earned pursuant to extended warranty agreements is
recognized ratably over the warranty period.
F-8
<PAGE>
(l) DEFERRED REVENUE
Deferred revenue represents cash received on advance billings of
equipment sales as allowed under installation and extended warranty
contracts.
(m) 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
deliverable units. These development costs are expensed as cost of
goods sold upon installation of the complete product and acceptance by
the customer.
(n) 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.
(o) 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.
(p) 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.
(q) INCOME (LOSS) PER SHARE
During fiscal 1998, the Company adopted Financial Accounting Standards
Board (FASB) SFAS No. 128, "Earnings per Share" (SFAS No. 128). Income
(loss) per share for all prior periods have been restated to conform
to the provisions of SFAS 128. Basic income (loss) per share is
computed by dividing income (loss) attributable to common
stockholders, by the weighted average number of common shares
outstanding for the period. Diluted income (loss) per share reflects
the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into
common stock or resulted in the issuance of common stock that then
shared in the income (loss) of the Company. In calculating net loss
per common share for 1998 and 1997, $15.1 million and $15.1 million,
respectively, common stock equivalent shares consisting of convertible
preferred stock issued to GTL in connection with the Transaction have
been excluded because their inclusion would have been anti-dilutive.
F-9
<PAGE>
(r) 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 11.)
(s) In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which
establishes standards for the accounting and reporting for derivative
instruments, including certain derivative instruments embedded in
other contracts, and hedging activities. This statement generally
requires recognition of gains and losses on hedging instruments, based
on changes in fair value or the earnings effect of forecasted
transactions. As issued, SFAS No. 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999. In June
1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133--An Amendment of FASB Statement No. 133," which
deferred the effective date of SFAS No. 133 until June 15, 2000. We
are currently evaluating the impact of SFAS No. 133.
On January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for
reporting and presentation of comprehensive income and its components
in a full set of financial statements. Comprehensive income consists
of net income and unrealized gains and losses on investment securities
net of taxes and is presented in the consolidated statements of
stockholders' equity (deficiency) and comprehensive income; it does
not affect the Company's financial position or results of operations.
On January 1, 1998, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131
supersedes SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise" replacing the "industry segment" approach with
the "management" approach. The management approach designates the
internal organization that is used by management for making operating
decisions and assessing performance as the source of the Company's
reportable segments. SFAS No. 131 also requires disclosure about
products and services, geographical areas, and major customers. The
adoption of SFAS No. 131 does not affect results of operations or
financial position but does affect the disclosure of segment
information.
F-10
<PAGE>
(2) ACQUISITION
The Transaction has been accounted for by the purchase method of accounting
and, accordingly, the purchase price has been allocated to the assets
acquired and the liabilities assumed based upon estimated fair values at
the date of acquisition as follows:
Purchase price:
Cash $ 4,250,000
Net liabilities of IED contributed (4,012,430)
-----------
Total $ 237,570
===========
Assets acquired and liabilities assumed:
Historical book value of net liabilities $(2,457,723)
Fair value adjustments:
Inventory (1,280,847)
Property and equipment (806,873)
Other assets (368,255)
Liabilities (681,390)
-----------
Total fair value of liabilities assumed $(5,597,086)
Excess of fair value of TNCi Series B Preferred Stock
and Series C Preferred Stock over its recorded value $(1,501,000)
Purchase of Common Stock of TNCi (254,658)
===========
Excess of purchase price over fair value of net
liabilities assumed (goodwill) $ 7,115,174
===========
The excess of fair value of TNC Series B Preferred Stock and Series C
Preferred Stock is the result of GTL's acquisition of such shares based on
the fair value of the GTL Series A Preferred Stock amounting to $4,080,000,
less $1,030,000 cash received and the historical value of $1,549,000 of the
Series B Preferred Stock.
Purchase of 110,000 shares of Common Stock of TNCi from a third party was
valued based on the cash consideration paid by GTL for the shares.
(3) INVESTMENT SECURITIES
A summary of investment securities by major security type at June 30, 1999
is as follows:
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -----
JUNE 30, 1999
Available-for-sale:
Corporate debt securities $303,115 $167 $(693) $302,589
======== ==== ===== ========
As of June 30, 1999 all maturities are less than one year.
F-11
<PAGE>
(4) INVENTORIES
Inventories consist of the following:
JUNE 30, OCTOBER 31,
1999 1998
----------- -----------
Raw materials $ 2,398,973 $ 2,192,442
Work in process 1,405,372 3,439,888
Finished goods 5,433,250 4,102,702
----------- -----------
9,237,595 9,735,032
Less: inventory valuation allowance (7,837,595) (8,729,605)
----------- -----------
$ 1,400,000 $ 1,005,427
=========== ===========
(5) ASSETS HELD FOR SALE
In connection with the Transaction, the Company relocated its corporate
offices and production capabilities to its Phoenix, Arizona offices.
Accordingly, as of June 30, 1999 the decision to sell the Georgia property
was made and the assets were recorded at their net realizable value and
classified as assets held for sale.
(6) PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
JUNE 30, OCTOBER 31,
1999 1998
----------- -----------
Leasehold improvements $ 24,117 $ 237,551
Purchased software 149,703 149,703
Furniture 163,609 138,609
Equipment 1,684,180 903,873
----------- -----------
2,021,609 1,429,736
Less: accumulated depreciation (683,029) (649,701)
----------- -----------
$ 1,338,580 $ 780,035
=========== ===========
During the year ended October 31, 1998, the Company recorded equipment
write-offs of $1,006,531 which are included in special charges on the
statement of operations. The write-offs are principally related to excess
computers, furniture and other equipment that the Company is not utilizing.
(7) INTANGIBLES
Intangibles consist of the following:
JUNE 30,
1999
-----------
Goodwill $ 7,115,174
Other intangibles 79,613
-----------
7,194,787
Accumulated amortization (74,981)
-----------
$ 7,119,806
===========
F-12
<PAGE>
(8) ACCRUED LIABILITIES
Accrued liabilities consist of the following:
JUNE 30, OCTOBER 31,
1999 1998
---------- ----------
Accrued development and support costs $ -- $1,845,915
Accrued maintenance costs -- 402,418
Due to related parties (see note 15) 1,891,123 455,000
Other accrued expenses 318,559 577,045
---------- ----------
Accrued liabilities $2,209,682 $3,280,378
========== ==========
(9) NOTES PAYABLE AND DUE TO AFFILATE
Notes Payable consists of the following:
JUNE 30,
1999
----------
Series A, D and E Notes (see below) $2,386,048
Note payable due September 5, 1999, interest at 7%,
convertible to preferred stock at the option of the
Company 400,000
Note payable due in varying installments through 2009,
interest at prime (8.25% at June 30, 1999) plus 2%,
collateralized by certain commercial property and
personally guaranteed by two stockholders 220,508
Note payable due in varying installments through 2000,
interest at 6.9%, collateralized by a vehicle 10,308
Note payable due and payable April 19, 2001, interest at
16% payable monthly, collateralized by certain
commercial property 470,000
Note payable due in varying installments through 2000,
interest at 11%, collateralized by a vehicle 4,572
----------
3,491,436
Less current portion 24,391
----------
$3,467,045
==========
Aggregate maturities of notes payable as of June 30, 1999 are as follows:
2000 $ 24,391
2001 890,491
2002 2,403,402
2003 19,126
2004 21,078
Thereafter 132,948
----------
$3,491,436
==========
F-13
<PAGE>
The Series A, D and E Notes ("Series Notes") were issued by the Company in
1998 prior to the Transaction. The Series Notes all had original maturities
of approximately 135 days with interest at approximately 7% to 8% per
annum. The Company could choose to repay such Notes in cash subject to a
payment charge equal to approximately 7% of the face amount of the Note or
the Company could elect to convert the Series Notes into preferred stock of
the Company which is convertible into common stock at various discounts to
market ranging from 15% to 25%. The Company was in default on the Series
Notes on June 30, 1999. (See note 20.)
The note payable due September 5, 1999 was in default at June 30, 1999.
Subsequent to year-end, the note was converted into 200,000 shares of the
Company's common stock. Therefore, the note payable has been classified as
long-term at June 30, 1999.
Prior to the Transaction, the Company entered into a Secured Promissory
Note with GTL in the principal amount of $750,000, bearing interest at a
rate of 9.5% per annum, and a related security agreement granting GTL a
security interest in its assets (the "Promissory Note"). The Promissory
Note is convertible into shares of the Company's Series C 8% preferred
stock at the discretion of GTL.
GTL has also advanced approximately $898,000 to the Company in the form of
intercompany advances. Both the Promissory Note and the advances have been
classified as due to affiliate in the balance sheet as of June 30, 1999.
(See note 20.)
Notes payable in the amount of $68,836 to related parties with interest
payable at approximately 5% per annum become due and payable upon
achievement of certain operational goals.
(10) INCOME (LOSS) PER SHARE
Basic and diluted weighted average number of shares outstanding for the two
years ended October 31, 1998 and 1997, included 1,055,745 shares of the
Company's common stock, representing 100% of the Company's capital stock
which was all owned by GTL. No effect was given to common stock equivalents
in the computation of diluted loss per share as their effect would have
been anti-dilutive.
For the Transition Period, basic weighted average number of shares
outstanding includes 1,055,745 common shares held by GTL for the full
period and approximately 5.3 million shares (the shares issued and
outstanding prior to the Transaction) for two months. Diluted weighted
average number of shares outstanding for the Transition Period include
1,055,745 common shares and 15,097,170 potential dilutive securities
resulting from the Series D Convertible Preferred Stock for the entire
Transition Period (both issued to GTL in connection with the Transaction);
plus 5,278,737 common shares outstanding prior to the merger, and 1,133,120
common stock equivalents related to the Convertible Promissory Note, Series
A, D and E Convertible Notes, Series B 8% Convertible Preferred Stock,
Series C 8% Convertible Preferred Stock and options each weighted for the
two months ended June 30, 1999.
F-14
<PAGE>
<TABLE>
<CAPTION>
TRANSITION
PERIOD ENDED
JUNE 30, YEAR ENDED OCTOBER 31,
1999 1998 1997
------------ ----------- ------------
<S> <C> <C> <C>
Net income (loss) $ 2,344,205 $(7,180,631) $(53,192,987)
Less: preferred stock dividends (30,667) -- --
------------ ----------- ------------
Income (loss) available to common
stockholders $ 2,313,538 $(7,180,631) $(53,192,987)
============ =========== ============
Basic EPS - weighted average shares
outstanding 2,387,223 1,055,745 1,055,745
============ =========== ============
Basic income (loss) per share $ 0.97 $ (6.80) $ (50.38)
============ =========== ============
Basic EPS - weighted average shares
outstanding 2,387,223 1,055,745 1,055,745
Effect of dilutive securities:
Stock Purchase Options - common stock 82,033 -- --
Convertible preferred stock 15,570,814 -- --
Convertible debt 503,638 -- --
------------ ----------- ------------
Dilutive EPS - weighted average shares
outstanding 18,543,708 1,055,745 1,055,745
Net income (loss) $ 2,344,205 $(7,180,631) $(53,192,987)
------------ ----------- ------------
Diluted income (loss) per share $ 0.13 $ (6.80) $ (50.38)
============ =========== ============
</TABLE>
(11) STOCK OPTION PLANS
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 to ten 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 fiscal 1999, 285,348 stock options with up to a four-year vesting
period were granted at exercise prices ranging from $2.25 to $3.125.
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 fiscal 1999,
60,000 options were granted.
F-15
<PAGE>
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 earnings and net
earnings per share on a pro forma basis would be as indicated below:
TRANSITION PERIOD
ENDED
JUNE 30, 1999
-----------------
Net earnings:
As reported $2,313,538
==========
Pro forma $2,018,009
==========
Basic net earnings per share:
As reported $ 0.97
==========
Pro forma $ 0.85
==========
Diluted net earnings per share:
As reported $ 0.13
==========
Pro forma $ 0.11
==========
Pro forma net earnings reflect only options granted during the Transition
Period and in each of the fiscal years ended 1998, 1997 and 1996. There
were no options granted related to IED for the years ended October 31, 1998
and 1997. Therefore, the full impact of calculating compensation cost for
stock options under SFAS No. 123 is not reflected in the pro forma net
earnings amount 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.
For purposes of the SFAS No. 123 pro forma net earnings and net earnings
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 1999:
TRANSITION PERIOD
ENDED
JUNE 30, 1999
-----------------
Dividend yield 0%
Expected volatility 58.76%
Risk free interest rate 5.67%
Expected lives (years) 10.0
F-16
<PAGE>
Activity related to the stock option plans is summarized below:
TRANSITION PERIOD ENDED
JUNE 30, 1999
--------------------
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
--------- --------
Balance at the beginning of year 676,478 $5.00
Granted 345,348 2.25
Exercised (20,000) 3.84
Forfeited (281,848) 4.75
--------
Balance at the end of year 719,978 3.09
========
Exercisable at the end of year 331,731 4.29
========
Weighted-average fair value of options
granted during the year $ 1.66
========
The following table summarizes the status of outstanding stock options as
of June 30, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ---------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
RANGE OF OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE
EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
--------------- ----------- ------------ -------- ----------- --------
$2.00 - $2.25 528,096 7.68 $2.16 159,848 $2.04
$2.50 - $4.17 51,383 7.04 3.41 31,383 3.60
$6.48 - $7.25 85,750 4.02 6.59 85,750 6.59
$7.50 - $9.82 54,750 8.07 7.63 54,750 7.63
======= =======
719,978 331,731
======= =======
(12) BENEFIT PLAN
On June 1, 1999 a formal termination of the Company's 401(k) plan was
initiated. The 401(K) plan of parent company GTL was amended June 1, 1999
to include employees of the Company.
GTL has adopted a defined contribution benefit plan that complies with
section 401(k) of the Internal Revenue Code and provides for discretionary
company contribution. Employees who complete three months of service are
eligible to participate in the Plan.
(13) STOCKHOLDERS' EQUITY
PREFERRED STOCK
Series B 8% Convertible Preferred Stock ("Series B Stock"); stated value
$1,000 per share and liquidation value of 120% of stated value. The Holder
of Series B Stock is entitled to an annual cumulative dividend of $80 per
share payable quarterly in cash or Common Stock. Cumulative unpaid
dividends at June 30, 1999 total $20,000. Each share of Series B Stock is
convertible into Common Stock at a price equal to the lowest of: a) 75% of
the Average Price of Common Stock, as defined, or b) 75% of the Average
Price of Common Stock, as defined calculated as if April 29, 1999 were the
conversion date. The Series B Stock has no voting rights. GTL owns 100% of
the issued and outstanding Series B Stock.
F-17
<PAGE>
Series C 8% Convertible Preferred Stock ("Series C Stock"); stated value
$1,000 per share and liquidation value of 120% of stated value. The Holder
of Series C Stock is entitled to an annual cumulative dividend of $80 per
share payable quarterly in cash or Common Stock. Cumulative unpaid
dividends at June 30, 1999 total $10,667. Each share of Series C Stock is
convertible into Common Stock at a price equal to the lowest of: a) $2.6875
per share, or b) 66.67% of the Average Price, as defined, or c) at the
lowest rate the Company issues equity securities, as defined. The Series C
Stock generally has no voting rights. On August 24, 1999, GTL notified the
Company of its intent to convert such shares into Common Stock. (See note
20.) GTL owns 100% of the issued and outstanding and accumulated unpaid
dividends Series C Stock.
Series D Convertible Preferred Stock ("Series D Stock"); stated value $10
per share and liquidation value of 120% of stated value. The Holder of
Series D Stock is entitled to an annual dividend as and when declared by
the Board of Directors of the Company. Each share of Series D Stock is
convertible into 6.05 shares of the Company's Common Stock. The Series D
Stock generally has no voting rights.
COMMON STOCK
Each share of Common Stock is entitled to one vote per share.
WARRANTS
During the Transition Period, the Company issued 489,429 warrants,
resulting in 1,206,025 warrants outstanding at June 30, 1999. Each warrant
represents the right to purchase one share of the Company's Common Stock at
exercise prices ranging from $2.34 to $4.13 per share, until such warrants
expire beginning November 1, 2001 through April 1, 2004. All outstanding
warrants are exercisable as of June 30, 1999.
(14) INCOME TAXES
Income tax (benefit) differed from the amounts computed by applying the
U.S. Federal corporate income tax rate of 34% to net income (loss) as a
result of the following:
TRANSITION
PERIOD ENDED YEAR ENDED OCTOBER 31,
JUNE 30, 1999 1998 1997
------------- ---- ----
Computed expected tax (benefit) $ 786,603 $(2,441,415) $(18,085,616)
Change in valuation allowance (983,188) 2,100,322 18,066,284
Nondeductible expense 16,320 416,498 --
Other 180,265 (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:
F-18
<PAGE>
TRANSITION
PERIOD ENDED
JUNE 30, 1999
-------------
Deferred tax assets:
Net operating loss carryforward $ 5,443,825
Property and equipment 972,785
Allowance for bad debts 1,517,277
Provision for inventory valuation 3,142,092
Accrued liabilities 770,859
Deferred revenue 146,699
Other 262,589
------------
$ 12,256,126
Less valuation allowance (12,256,126)
------------
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 June 30, 1999,
the Company has a net operating loss (NOL) carryforward for federal income
tax purposes of approximately $13,977,000, which begins to expire in 2009.
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.
(15) RELATED PARTY TRANSACTIONS
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 and certain other employees of GTL.
During the year ended October 31, 1998, Ocean Castle executed consulting
agreements with two principal stockholders of GTL. The rights and
obligations of Ocean Castle under the agreements were assumed by the
Company in connection with the Transaction. 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 of GTL at an exercise price of $4.50. As of June 30, 1999, the
Company determined that the consulting agreements had no future value due
to the Company's shift away from in-flight entertainment into alternative
markets such as leisure cruise and passenger rail transport. Only limited
services were provided in 1999 and no future services will be utilized.
Accordingly, the Company recorded a charge to general and administrative
expenses in the Transition Period of $1.6 million representing the balance
due under such contracts.
In August 1999, the Company executed a separation and release agreement
with a stockholder and former officer of the Company, pursuant to which the
Company paid approximately $85,000 in the form of unregistered shares of
the Company's common stock.
In June 1999, the Company loaned to a vice president, $75,000 for the
purpose of assisting in a corporate relocation to the Company's
headquarters in Phoenix, Arizona. Such loan is secured by assets of the
employee. The note matures in August 2009 and bears an interest rate of
approximately 5%.
F-19
<PAGE>
GTL had 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 GTL. The License Agreement provides for an annual license fee
of $100,000 commencing in October 1994 and continuing through November
2002. GTL was required to pay FortuNet $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 balance sheet. The Company assumed this liability in
connection with the Transaction. Subsequent to June 30, 1999, the Company
agreed to a termination of this agreement and paid FortuNet $100,000 plus
legal fees. During the Transition Period ended June 30, 1999, the Company
had revised its estimated accrual to $200,000 which is included in accrued
liabilities at June 30, 1999.
During the year ended October 31, 1998, GTL extended by one year a
consulting agreement with a former officer of GTL pursuant to which GTL
will pay $55,000 for services received during the period November 1999
through October 2000. The Company has assumed the liability for the
consulting agreement in connection with the Transaction in the amount of
$73,000 which is included in accrued liabilities at June 30, 1999.
During the year ended October 31, 1998, GTL executed severance and
consulting agreements with three former officers, pursuant to which GTL
paid the former officers and set aside restricted funds in the amounts of
$3,053,642 and $735,000, respectively. The consulting agreements all expire
by September 1999. Payments totaling $735,000 have been and continue to be
made from restricted cash of GTL through September 1999. Expenses
associated with these agreements were charged to general and administrative
expenses in the year ended October 31, 1998.
During the year ended October 31, 1996, GTL 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 June 30, 1999 and October 31,
1998, $18,000 and $55,000 remained to be paid under these agreements. Such
liabilities were assumed by the Company in connection with the Transaction.
(16) COMMITMENTS AND CONTINGENCIES
(a) LAWSUIT
Hollingsead International, Inc. v. The Network Connection, Inc., State
Court of Forsyth County, State of Georgia, Civil Action File No. 99S0053.
Hollingsead International, Inc. ("Hollingsead") filed suit against the
Company on January 28, 1999, alleging that the Company failed to pay
invoices submitted for installation and service of audio-visual systems in
its aircraft. Hollingsead sought damages in the amount of $357,850, in
addition to interest at the rate of 18% per annum from March 2, 1998,
attorneys' fees and punitive damages. On March 29, 1999, the Company filed
a timely answer and asserted counterclaims against Hollingsead. The parties
entered into a settlement agreement on or about August 5, 1999 that
provided for the payment of $427,870 by the Company, to be paid in
installments, including interest accruing at 8.0% per annum from July 28,
1999 until the balance is paid. The Company has provided for such amount as
of May 1, 1999. The agreement also provides for Hollingsead to pay $5,399
as reimbursement for attorneys' fees. The last installment is due on or
before December 20, 1999. Under the settlement agreement, the Company will
dismiss its counterclaims with prejudice and Hollingsead will dismiss its
Complaint with prejudice upon completion of all payments by the Company.
Sigma Designs, Inc. ("Sigma") v. the Network Connection, Inc., United
States District Court, Northern District of California, San Jose Division,
Civil Action File No. 98-21149J(EAI). Sigma filed a Complaint against the
Company on December 1, 1998, alleging breach of contract and action on
account. Sigma claims that the Company failed to pay for goods that it
F-20
<PAGE>
shipped to the Company. The matter was settled by written agreement dated
January 22, 1999, contingent upon registration of the Company stock and
warrants issued to Sigma as part of such settlement and payment by the
Company of $50,000. The Company did not complete its obligations under the
terms of the original settlement agreement. On or about May 1999, the
shares of the Company issued to Sigma as a part of the settlement of the
above-referenced lawsuit were sold by Sigma to GTL, the parent company of
the Company. The lawsuit was dismissed with prejudice on July 12, 1999.
Swissair/MDL-1269, In re Air Crash near Peggy's Cove, Nova Scotia. This
multi-district litigation relates to the crash of Swissair Flight 111 on
September 2, 1998 in waters near Peggy's Cove, Nova Scotia resulting in the
death of all 229 people on board. The Swissair MD-11 aircraft involved in
the crash was equipped with an Entertainment Network System that had been
sold to Swissair by Interactive Flight Technologies, Inc. Following the
crash, investigations were conducted and continue to be conducted by
Canadian and United States agencies concerning the cause of the crash.
Estates of the victims of the crash have filed lawsuits throughout the
United States against Swissair, Boeing, Dupont and various other parties,
including Interactive Flight Technologies, Inc. TNCi was not a party to the
contract for the Entertainment Network System, but has been named in some
of the lawsuits filed by families of victims on a claim successor
liability. TNCi denies all liability for the crash. TNCi is being defended
by the aviation insurer for Interactive Flight Technologies, Inc.
Federal Express Corporation v. The Network Connection, Inc., State Court of
Forsyth County, State of Georgia, Civil Action File No. 99-V51560685. This
lawsuit was served on the Company on or about July 22, 1999 by Federal
Express Corporation. The suit alleges the Company owes Federal Express
approximately $110,000 for past services rendered. The Company intends to
defend itself vigorously.
The Company is subject to other lawsuits and claims arising in the ordinary
course of its business. In the Company's opinion, as of June 30, 1999, the
effect of such matters will not have a material adverse effect on the
Company's results of operations and financial position.
(b) LEASE OBLIGATIONS
The Company leases office space and equipment under operating leases which
expire at various dates through June 2002. The future minimum lease
commitments under these leases are as follows:
YEAR ENDING JUNE 30, 1999 OPERATING LEASES
------------------------- ----------------
2000 $120,000
2001 120,000
2002 120,000
--------
Total minimum lease payments $360,000
========
Rental expense under operating leases totaled $292,042, $944,932 and
$920,412 for the Transition Period ended June 30, 1999 and fiscal years
ended October 31, 1998 and October 31, 1997, respectively.
(c) 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") on a minimum
of one Carnival Cruise Lines ship. During the four-year period commencing
on the date of the Carnival Agreement, Carnival has the right to designate
F-21
<PAGE>
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. In
December 1998, Carnival ordered the installation of CruiseView on the
Carnival Cruise Lines "M/S Sensation," which has been in operational use,
on a test basis, since August 1999. In August 1999, Carnival ordered the
installation of CruiseView on the Carnival Cruise Lines "M/S Triumph."
The terms of the Carnival Agreement provide that Carnival may return the
CruiseView system within the Acceptance Period, as defined in the Carnival
Agreement. For the M/S Sensation, the acceptance period is 12 months. As of
June 30, 1999, the Company recorded deferred revenue of $365,851,
reflecting amounts paid by Carnival. As of June 30, 1999, the Company has
not recognized any revenue in association with the Carnival Agreement. The
Company would be required to return such funds to Carnival in the event
Carnival does not accept the system. Under the Carnival Agreement, the
Company is required to provide a performance bond or standby letter of
credit in favor of Carnival ensuring Carnival's ability to be repaid
amounts previously paid to the Company in the event Carnival determines not
to accept the system as permitted under the Carnival Agreement.
The Company has not provided a bond or letter of credit as of June 30,
1999. Should Carnival require the Company to obtain a bond or letter of
credit, the Company may be required to provide cash collateral to a
financial institution securing such obligation.
(17) SPECIAL CHARGES AND REVERSAL OF WARRANTY, MAINTENANCE AND COMMISSION
ACCRUALS
GTL had previously 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. In connection
with the Transaction, the Company assumed all rights and obligations of the
above contracts.
Pursuant to the October 1997 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 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.
In April 1998 and October 1998, the Company entered into additional
contracts with Swissair. The first letter of intent relates to 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. Swissair had
made payments of $1,450,000 on the $4.7 million order through February
1999. No payments have been received since February. The second contract
was to extend the warranty on all installed systems for a second and third
year at a price of $3,975,000. Through February 1999, the Company had been
paid $707,500 under this contract. No subsequent payments have been
received from Swissair.
F-22
<PAGE>
On October 29, 1998, the Company was notified by Swissair of its decision
to deactivate the entertainment networks on all Swissair aircraft. However,
by April 1999, discussions between the Company and Swissair regarding
outstanding financial matters related to current accounts receivable,
inventory, purchase commitments and extended warranty obligations, as well
as planning discussions for an October 1999 reactivation ceased to be
productive. On May 6, 1999, GTL filed a lawsuit against Swissair in the
United States District Court for the District of Arizona seeking damages
for Swissair's failure to honor its obligations for payment and
reactivation of the Company's Entertainment Network.
The Swissair agreements are not assignable to third parties under the terms
of such agreements. However, in connection with the Transaction, GTL has
agreed to pay to the Company any net proceeds, if any, received from
Swissair as a result of the above litigation or otherwise. Further, the
Company, as a subcontractor to GTL, will assume any operational
responsibilities of the Swissair agreement in the event that such
requirement arises. The Company has not assumed any liabilities or
obligations arising out of the crash of Swissair Flight No. 111.
As a result of the above events, management concluded that its only source
of future payment, if any, will be through the litigation process. In
addition, with the deactivation of the entertainment system and Swissair's
breach of its agreements with GTL, the Company believes it will not be
called upon by Swissair to perform any ongoing warranty, maintenance or
development services. Swissair's actions have rendered the Company's
accounts receivable, inventory and deposits worthless as of June 30, 1999.
Accordingly, the Company has recognized deferred revenue on equipment sales
to the extent of cash received of $876,000; charged off inventory to cost
of equipment sales in the amount of $1,517,000; wrote off deposits of
$655,000 to special charges; and reversed all warranty and maintenance
accruals totaling $5,164,000.
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
Termination 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 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 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.
For the Transition Period ended June 30, 1999, the Company recorded
warranty, maintenance and commission accrual adjustments of $5,117,704,
$1,730,368 and $303,321, respectively, related to the Swissair and Alitalia
matters. Such adjustments to prior period estimates, which totaled
$7,151,393 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 period, such accruals were no longer considered necessary.
F-23
<PAGE>
(18) SEGMENT INFORMATION
The Company operates principally in one industry segment; development,
manufacturing and marketing of computer-based entertainment and data
networks. Historically, the Company's principal revenues have been derived
from European customers.
For the Transition Period and fiscal years ended October 31, 1998 and 1997,
one customer accounted for approximately 91%, 98% and 95% of the Company's
sales. Outstanding receivables from this customer were zero and $1.1
million respectively at June 30, 1999 and October 31, 1998. (See note 15.)
(19) SUPPLEMENTAL FINANCIAL INFORMATION
Supplemental disclosure of cash flow information is as follows:
TRANSITION
PERIOD ENDED YEAR ENDED OCTOBER 31,
JUNE 30, 1999 1998 1997
------------- ------- --------
Cash paid for interest $ -- $11,954 $ 13,423
========= ======= ========
Noncash investing and
financing activities:
Capital lease obligations incurred $ -- $ -- $210,678
========= ======= ========
(20) SUBSEQUENT EVENTS
In July and August 1999, GTL purchased all of the Series A and E notes and
the Series D notes, respectively, from the holders of such notes.
Concurrent with such purchase by GTL, the Company executed the fifth and
sixth allonges to the Promissory Note which cancelled such Series Notes and
rolled the principal balance, plus accrued but unpaid interest, penalties
and redemption premiums on the Series Notes into the principal balance of
the Promissory Note.
On August 24, 1999, the Board of Directors of GTL approved the conversion
of the Promissory Note and outstanding advances to the Company into Series
C Stock of the Company and, the simultaneous conversion of the Series C
Stock into the Company's common stock in accordance with the designation of
the Series C Stock. Such conversion, to the extent it exceeded
approximately one million shares of the Company's common stock on August
24, 1999, was contingent upon receiving stockholder approval to increase
the authorized share capital of the Company which was subsequently approved
on September 17, 1999. Accordingly, the Company will issue to GTL
approximately 5.6 million shares of its common stock in October 1999, based
on an anticipated conversion date of August 24, 1999. Had this transaction
occurred on June 30, 1999, pro forma stockholders' equity and tangible net
worth would have been $9,320,934 (unaudited) and $2,201,128 (unaudited),
respectively.
In September 1999, the Company sold one of its two buildings in Alpharetta,
Georgia. The net proceeds from the sale, plus cash of approximately $80,000
was used by the Company to repay the Note payable due April 19, 2001. The
sale of the second building is expected to occur in November 1999 and net
proceeds are expected to be used to retire the Note payable due 2009.
On August 24, 1999, the GTL Board of Directors approved a $5 million
secured revolving credit facility by and among GTL and the Company (the
"Facility"). The Facility provides that the Company may borrow up to $5
million for working capital and general corporate purposes at the prime
rate of interest plus 3%. The Facility matures in September 2001. The
Company paid an origination fee of $50,000 to GTL and will pay an unused
line fee of 0.5% per annum. The Facility is secured by all of the assets of
the Company and is convertible, at GTL's option, into shares of the
Company's Series C stock. The Company executed the Facility on October 12,
1999.
F-24
<PAGE>
THE NETWORK CONNECTION, INC.
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
ASSETS 2000 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 258,459 $ 2,751,506
Restricted cash 463,405 446,679
Short-term investments -- 302,589
Accounts receivable 21,087 75,792
Notes receivable from related parties 53,551 98,932
Inventories, net of allowance of $7,837,595 5,010,311 1,400,000
Prepaid expenses 202,361 169,429
Assets held for sale -- 800,000
Due from affiliate 48,986 --
Other current assets 257,973 173,999
------------ ------------
Total current assets 6,316,133 6,218,926
Note receivable from related party 78,000 75,000
Property and equipment, net of accumulated depreciation
of $1,087,670 and $683,029, respectively 1,235,920 1,338,580
Intangibles, net of accumulated amortization of $630,368
and $74,981, respectively 6,767,262 7,119,806
Other assets 37,650 150
------------ ------------
Total assets $ 14,434,965 $ 14,752,462
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,778,905 $ 1,663,411
Accrued liabilities 925,336 989,342
Deferred revenue 2,108,151 365,851
Accrued product warranties 291,796 --
Dividends payable 110,000 --
Notes payable 6,190 42,751
Notes payable to related parties -- 68,836
------------ ------------
Total current liabilities 6,220,378 3,130,191
Notes payable 1,080,000 3,467,045
Other liabilities 945,765 1,220,340
Due to affiliate -- 1,647,692
------------ ------------
Total liabilities 8,246,143 9,465,268
------------ ------------
Commitments and contingencies
Stockholders' equity:
Series B preferred stock par value $0.01 per share, 1,500
shares authorized issued and outstanding 15 15
Series C preferred stock par value $0.01 per share, 1,600 shares
authorized; zero and 800 issued and outstanding, respectively -- 8
Series D preferred stock par value $0.01 per share, 2,495,400
authorized, issued and outstanding 24,954 24,954
Common stock par value $0.001 per share, 40,000,000 shares
authorized; 12,800,046 and 6,339,076 issued and
outstanding, respectively 12,801 6,339
Additional paid-in capital 93,522,223 88,316,945
Accumulated other comprehensive income:
Loss on foreign currency translation (1,141) --
Net unrealized loss on investment securities -- (526)
Accumulated deficit (87,370,030) (83,060,541)
------------ ------------
Total stockholders' equity 6,188,822 5,287,194
------------ ------------
Total liabilities and stockholders' equity $ 14,434,965 $ 14,752,462
============ ============
</TABLE>
See accompanying notes to financial statements.
F-25
<PAGE>
THE NETWORK CONNECTION, INC.
Condensed Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three months ended March 31, Nine months ended March 31,
------------------------------ ------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Equipment sales $ 590 $ -- $ 5,597,909 $ 89,028
Service income -- -- 59,827 389,037
------------ ------------ ------------ ------------
590 -- 5,657,736 478,065
------------ ------------ ------------ ------------
Costs and expenses:
Cost of equipment sales 225,669 -- 3,680,584 283,714
Cost of service income 21,189 -- 36,292 736
General and administrative expenses 2,103,517 928,600 4,678,325 6,947,818
Non cash compensation expense 238,429 -- 545,311 --
Provision for doubtful accounts -- -- -- 28,647
Special charges -- -- -- (190,000)
Depreciation and amortization expense 332,511 60,521 972,528 443,620
------------ ------------ ------------ ------------
2,921,315 989,121 9,913,040 7,514,535
------------ ------------ ------------ ------------
Operating loss (2,920,725) (989,121) (4,255,304) (7,036,470)
Other:
Interest expense (11,331) (1,358) (150,839) (5,614)
Interest income 13,354 39,529 90,728 118,188
Other expense (15,911) -- (24,741) (567,317)
------------ ------------ ------------ ------------
Net loss (2,934,613) (950,950) (4,340,156) (7,491,213)
Cumulative dividend on preferred stock (30,000) -- (90,000) --
------------ ------------ ------------ ------------
Net loss attributable to common stockholders $ (2,964,613) $ (950,950) $ (4,430,156) $ (7,491,213)
============ ============ ============ ============
Basic and diluted net loss per common share $ (0.24) $ (0.90) $ (0.52) $ (7.10)
============ ============ ============ ============
Weighted average number of shares
outstanding, basic and diluted 12,432,543 1,055,475 8,476,461 1,055,475
============ ============ ============ ============
</TABLE>
See accompanying notes to financial statements.
F-26
<PAGE>
THE NETWORK CONNECTION, INC.
Condensed Statement of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
NINE NINE
MONTHS ENDED MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(4,340,156) $(7,491,213)
Adjustments to reconcile net loss to net cash:
Depreciation and amortization 972,528 443,620
Special charges -- (190,000)
Loss on sale of assets held for sale 37,893 --
Loss on disposal of equipment -- 1,006,523
Non cash compensation expense 545,311 --
Changes in net assets and liabilities, net of
effect of acquisition:
Increase (decrease) in accounts receivable 54,705 (717,550)
Payments due from affiliate (48,986) --
(Increase) decrease in inventories (3,610,311) 86,643
(Increase) decrease in prepaid expenses (32,932) 175,286
(Increase) decrease in other current assets (83,974) 293,919
(Increase) decrease in other assets (43,750) 66,695
Increase (decrease) in accounts payable 916,910 (877,794)
Decrease in accrued liabilities (196,208) (1,056,702)
Increase in deferred revenue 1,742,300 1,900,518
Increase (decrease) in accrued product warranties 291,698 (1,426,013)
----------- -----------
Net cash used in operating activities $(3,794,972) $(7,786,068)
----------- -----------
Cash flows from investing activities:
Purchases of investment securities (542) --
Sale of investment securities 303,131 --
Purchases of property and equipment (305,571) (31,346)
Proceeds from sale of equipment 3,590 13,216
Proceeds from sale of assets held for sale 762,107 --
Increase in restricted cash (16,726) (442,282)
----------- -----------
Net cash provided by (used in) investing activities $ 745,989 $ (460,412)
----------- -----------
Cash flows from financing activities:
Payments on notes payable (785,364) --
Payments received on notes receivable 42,381 --
Borrowings under revolving credit facility 1,080,000 --
Payments from affilate 289,017 --
Re-purchase of outstanding warrants (296,036) --
Capital contribution -- 8,312,363
Employee stock option exercises 227,079 --
Payments on capital lease obligations -- (63,910)
----------- -----------
Net cash provided by financing activities $ 557,077 $ 8,248,453
----------- -----------
Effect of exchange rate on cash and cash equivalents (1,141) --
----------- -----------
Net increase (decrease) in cash and cash equivalents (2,493,047) 1,973
Cash and cash equivalents at beginning of period 2,751,506 111,418
----------- -----------
Cash and cash equivalents at end of period $ 258,459 $ 113,391
=========== ===========
</TABLE>
See accompanying notes to financial statements.
F-27
<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 financial statements and
notes thereto for the eight-month transition period ended June 30, 1999,
included in the Company's Transition Report on Form 10-KSB.
The results of operations for the three months and nine months ended
March 31, 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, 1999 balance sheet to conform with the March 31, 2000
presentation.
On May 18, 1999, Global Technologies, Ltd. ("Global") received from 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 Global's Interactive
Entertainment Division ("IED"), as defined in the Asset Purchase and Sale
Agreement dated April 30, 1999, as amended (the "Transaction"). The Transaction
has been accounted for as a reverse merger whereby, for accounting purposes,
Global is considered the accounting acquiror, and although the legal capital
structure carries forward, 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, and 10-QSB, among others, as of and
for all periods through March 31, 1999, will be replaced with those of IED.
The financial statements as of and for the three months and nine months
ended March 31, 1999, reflect the historical results of Global's IED as
previously included in Global's consolidated financial statements. The
Transaction date for accounting purposes was May 1, 1999. As of March 31, 2000,
the Company is an 80% owned subsidiary of Global, whose ownership is represented
by 1,500 shares of the Company's Series B 8% Convertible Preferred Stock,
2,495,400 shares of the Company's Series D Convertible Preferred Stock and
approximately 6.8 million shares of the Company's Common Stock. The historical
financial statements of the Company up to the date of the Transaction as
previously reported will no longer be included in future filings of the Company.
F-28
<PAGE>
(2) 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.
(3) NOTES PAYABLE
Prior to the Transaction, the Company entered into a Secured Promissory
Note with Global in the principal amount of $750,000, bearing interest at a rate
of 9.5% per annum, and a related security agreement granting Global a security
interest in its assets (the "Promissory Note"). The Promissory Note was
convertible into shares of the Company's Series C 8% Convertible Preferred Stock
("Series C Stock") at the discretion of Global. The Note had an original
maturity of May 14, 1999, but had been extended until September 2001.
In July and August 1999, Global purchased all of the Series A and E
notes and the Series D notes of the Company, respectively, from the holders of
such notes (the "Series Notes"). Concurrent with such purchase by Global, the
Company executed several allonges to the Promissory Note which cancelled such
Series Notes and rolled the principal balance, plus accrued but unpaid interest,
penalties and redemption premiums on the Series Notes into the principal balance
of the Promissory Note. Subsequent to May 18, 1999, Global had also advanced
working capital to the Company in the form of intercompany advances. In August
1999, the Company executed an allonge to the Promissory Note which rolled the
intercompany advances into the principal balance of the Promissory Note and
granted Global the ability to convert the Promissory Note directly into shares
of the Company's Common Stock, without first converting to Series C Stock, as an
administrative convenience.
On August 24, 1999, the Board of Directors of Global approved the
conversion of the Promissory Note into shares of the Company's Common Stock.
Such conversion, to the extent it exceeded approximately one million shares of
the Company's Common Stock on August 24, 1999, was contingent upon receiving
shareholder approval to increase the authorized share capital of the Company.
This increase in authorized share capital was subsequently approved at the
September 17, 1999 Special Meeting of the Company's shareholders. Accordingly,
in December 1999, the Company issued to Global 4,802,377 shares of its Common
Stock based on the conversion date of August 24, 1999. Separately from the
Promissory Note, in December 1999, the Company issued 886,140 shares of its
Common Stock to Global upon conversion of the Series C Stock held by Global.
Also on August 24, 1999, the Global Board of Directors approved a $5
million secured revolving credit facility by and between Global and the Company
(the "Facility"). The Facility provides that the Company may borrow up to $5
million for working capital and general corporate purposes at the prime rate of
interest plus 3%. The Facility matures in September 2001. The Company paid an
origination fee of $50,000 to Global and will pay an unused line fee of 0.5% per
annum. The Facility is secured by all of the assets of the Company and is
convertible, at Global's option, into shares of the Company's Common Stock at a
price equal to the lesser of 66.7% of the trailing five-day average share price
of the preceding 20 days, $1.50 per share or any lesser amount at which Common
Stock has been issued to third parties. Pursuant to Nasdaq rules, Global may not
convert borrowings under the Facility into shares of Common Stock in excess of
19.99% of the number of shares of Common Stock outstanding on August 24, 1999
without shareholder approval. As of March 31, 2000, $1,080,000 was outstanding
under the Facility.
F-29
<PAGE>
In September 1999, the Company sold one of its two buildings in
Alpharetta, Georgia. The net proceeds from the sale, plus cash of approximately
$80,000 was used by the Company to repay a Note payable due April 19, 2001 in
the principal amount of $470,000. The sale of the second building occurred in
November 1999. The net proceeds of approximately $367,000 from the sale were
used to retire a Note payable due 2009 in the principal amount of $217,000.
In October 1999, a note payable in the principle amount of $400,000 due
September 5, 1999 was converted into 200,000 shares of the Company's Common
Stock.
(4) WARRANTS
In December 1999, the Company issued common stock purchase warrants to
purchase 25,000 shares of the Company's Common Stock at $6.50 per share to Emden
Consulting Corp. in exchange for advisory services. The exercise period of the
warrants expires in December 2004. Non-cash compensation expense of $110,941 was
recorded in the quarter ended December 31, 1999.
In December 1999, the Company issued common stock purchase warrants to
purchase 25,000 shares of the Company's Common Stock at $6.50 per share to
Waterton Group LLC in exchange for advisory services. The exercise period of the
warrants expires in December 2004. Non-cash compensation expense of $110,941 was
recorded in the quarter ended December 31, 1999.
In December 1999, the Company issued common stock purchase warrants to
purchase 100,000 shares of the Company's Common Stock at prices ranging from $6
to $10 per share to Continental Capital & Equity Corp. in exchange for public
relations and financial advisory services. The warrants vest over a period of
270 days and expire in February 2002. Non-cash compensation expense of $151,286
was recognized in the three months ended March 31, 2000 and additional non-cash
compensation expense may be recognized, under variable plan accounting, over the
remaining nine months of the agreement.
On March 13, 2000, the Company issued 236,080 shares of stock in
connection with the cashless exercise of common stock purchase warrants held by
the former holders of the Company's Series A and E notes. The warrants exercised
represented warrants to purchase 311,525 shares of the Company's Common Stock.
(5) OPTION GRANTS
In November 1999, the Compensation Committee of the Board of Directors
of the Company recommended option grants to purchase up to 500,000 shares of the
Company's Common Stock to Mr. Irwin L. Gross, Chairman and Chief Executive
Officer of the Company. Such recommendation was accepted and approved by the
Board of Directors. One quarter of these options vested immediately and one
quarter vest in equal annual installments over three years. The remainder vest
on the sixth anniversary of the date of grant, subject to acceleration to a
three-year vesting schedule in the event certain performance milestones are
achieved. Exercise price of the options is equal to the closing market price of
the Company's Common Stock on the day of grant, and the options expire in
October 2009.
On March 6, 2000, the Company granted options to purchase up to 800,000
shares of the Company's Common Stock to Mr. Robert Pringle, President and Chief
Operating Officer of the Company. One fifth of these options vest on June 6,
2000, with the remainder vesting in four equal annual installments beginning
March 6, 2001. Exercise price of the options is equal to the closing market
price of the Company's Common Stock on the day prior to grant, and the options
expire on March 6, 2010.
On March 6, 2000, the Company granted options to purchase up to 800,000
shares of the Company's Common Stock to Dr. Jay Rosan, an Executive Vice
President of the Company. One fifth of these options vest on June 6, 2000, with
the remainder vesting in four equal annual installments beginning March 6, 2001.
Exercise price of the options is equal to the closing market price of the
Company's Common Stock on the day prior to grant, and the options expire on
March 6, 2010.
F-30
<PAGE>
On March 6, 2000, the Company granted options to purchase up to 250,000
shares of the Company's Common Stock to Mr. Richard Genzer, Chief Technology
Officer of the Company. One fifth of these options vest on June 6, 2000, with
the remainder vesting in four equal annual installments beginning March 6, 2001.
Exercise price of the options is equal to the closing market price of the
Company's Common Stock on the day prior to grant, and the options expire on
March 6, 2010.
(6) SEGMENT INFORMATION
For the nine months ended March 31, 2000 and 1999, respectively, the
Company operated principally in one industry segment; development, manufacturing
and marketing of computer-based entertainment and data networks. Historically,
the Company's principal revenues have been derived from European customers.
For the nine months ended March 31, 2000 and 1999, respectively, one
customer accounted for approximately 97% and a separate customer accounted for
almost 100% of the Company's sales. Outstanding receivables from these customers
were $0 and $4,188,712 respectively, at March 31, 2000 and March 31, 1999.
(7) COMMITMENTS AND CONTINGENCIES
(a) LAWSUITS
SWISSAIR/MDL-1269, IN RE 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 District 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 Technologies, Ltd. ("Global" formerly known as 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. TNCi has been named in some of the
lawsuits filed on a successor liability theory. TNCi denies all liability for
the crash. TNCi is being defended by the aviation insurer for Global.
FEDERAL EXPRESS CORPORATION V. THE NETWORK CONNECTION, INC., State
Court of Forsyth County, State of Georgia, Civil Action File No. 99-SC-0053.
This lawsuit was served on the Company on or about July 22, 1999 by Federal
Express Corporation and relates to charges incurred by prior management. The
suit alleged the Company owes Federal Express approximately $110,000 for past
services rendered. The Company has settled this matter for $75,000, with $25,000
having been paid on execution of the settlement agreement on March 3, 2000,
$10,000 having been paid on each of April 1, 2000 and May 1, 2000 and three
additional payments of $10,000 to be paid on each of June 1, 2000, July 1, 2000
and August 1, 2000.
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, the
Company'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. 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. The Company is currently defending the
claim.
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 arises out of the
Company's hiring of Theodore P. Racz, a former LodgeNet Entertainment
Corporation ("LodgeNet") employee, as its Senior Vice President of the Hotels &
Hospitality division. LodgeNet is alleging tortious interference with contract
and tortious interference with business relationships. LodgeNet is seeking to
prohibit Mr. Racz from being employed by the Company, as well as seeking
damages, fees and costs.
The Company may be subject to other lawsuits and claims arising in the
ordinary course of its business. In the Company's opinion, as of March 31, 2000,
the effect of such matters are not expected to have a material adverse effect on
the Company's results of operations and financial position.
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(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. 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(TM). The cost per cabin for
CruiseView(TM) purchase and installation on each ship is provided for in the
Carnival Agreement. 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 has been in operational use since October 1999. Under the terms of the
agreement, the Company receives payment for 50% of the sales price of the system
in installments through commencement of operation of the system. Recovery of the
remaining sales price of the system is to be achieved through the receipt of the
Company's 50% share of net profits, as defined in the Carnival Agreement,
generated by the system over future periods.
The terms of the Carnival Agreement provide that Carnival may return
the CruiseView(TM) system within the acceptance period, as defined in the
Carnival Agreement, or for breach of warranty. The acceptance period for the
Fantasy and Destiny class ships are twelve months and three months,
respectively, from completion of installation and testing, which occurred in
February 1999 and October 1999, respectively. The initial warranty period for
these systems is three years. As of March 31, 2000, the Company had recorded
deferred revenue of approximately $2.1 million related to the two Carnival
ships.
In the quarter ended March 31, 2000, the Company concluded that the
cost of building and installing CruiseView(TM) systems on the existing two
Carnival ships pursuant to the Carnival Agreement has exceeded the revenue that
can be earned in connection therewith. Accordingly, the Company has recorded an
expense of $208,146 in the period ended March 31, 2000 reflecting the excess of
cost over expected revenue. Carnival's continuing to exercise its option for
building and installing CruiseView(TM) on additional ships under the agreement
may prove unprofitable and therefore have a negative effect on the Company's
working capital. The Company is currently endeavoring to renegotiate the terms
of the agreement with Carnival. (See "Note 8 - Subsequent Event").
NOTE (8) SUBSEQUENT EVENT
Since the installation of the CruiseView(TM) system on two Carnival
cruise ships, and beginning in the quarter ended March 31, 2000, the Company has
experienced costs in excess of those recoverable under the Carnival Agreement.
Given these costs, and ongoing technical issues, the Company notified Carnival
of its desire to renegotiate the Carnival Agreement. During these discussions,
Carnival notified the Company in a letter dated April 24, 2000 that it sought to
terminate the Carnival Agreement and sought to assert certain remedies
thereunder. The Company and Carnival are in discussions seeking to resolve
issues under the Carnival Agreement regarding recovery of amounts paid to the
Company (recorded as deferred revenue), the Company's recovery of its inventory
costs, potential warranty/de-installation obligations and other matters.
Concurrently, the Company and Carnival are in 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. However, while the Company is
optimistic about the discussions, there is no assurance that the Company will be
successful in reaching a mutually satisfactory resolution of the Carnival
Agreement and in securing a new, more favorable long term contract with
Carnival.
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