10-K 1 a2039931z10-k.txt 10-K -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 COMMISSION FILE NUMBER 0-21038 ------------------------ NETWORK SIX, INC. (Exact name of registrant as specified in its charter) RHODE ISLAND 05-0366090 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 475 KILVERT STREET WARWICK, RHODE ISLAND 02886 (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (401) 732-9000 ------------------------ Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.10 PAR VALUE ------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES /X/ NO / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant as of February 28, 2001 (computed by reference to the closing price of such stock on The NASDAQ SmallCap Market) was $2,193,017. As of February 28, 2001, there were 825,684 shares of the registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED -------- ------------------ Portions of the registrant's definitive Proxy Statement regarding the 2000 Annual Meeting of Stockholders Part III
-------------------------------------------------------------------------------- -------------------------------------------------------------------------------- NETWORK SIX, INC. FORM 10-K TABLE OF CONTENTS
ITEM PAGE ---- -------- PART I 1 Business.................................................... 3 2 Properties.................................................. 8 3 Legal Proceedings........................................... 8 4 Submission of Matters to a Vote of Security Holders......... 8 PART II 5 Market for Registrant's Common Equity and Related Stockholder Matters....................................... 8 6 Selected Financial Data..................................... 9 7 Management's Discussion and Analysis of Financial Condition and Results of Operation.................................... 10 8 Financial Statements and Supplementary Data................. 14 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.................................. 15 PART III 10 Directors and Executive Officers of the Registrant.......... 15 11 Executive Compensation...................................... 15 12 Security Ownership of Certain Beneficial Owners and Management................................................ 15 13 Certain Relationships and Related Transactions.............. 15 PART IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................................. 15 Signatures.................................................. 18
2 PART I ITEM 1. BUSINESS. GENERAL Network Six, Inc. (the "Company") is a full service provider of information technology solutions that enable its customers to operate more efficiently and effectively. The Company's services include e-commerce planning and implementation, technology consulting, applications development and support and network design and implementation. Incorporated in 1976 under the name National E-F-T, Inc., the Company has historically focused on providing its services to state governments, particularly health and human services agencies. Although the Company has targeted additional markets (such as higher education, health care and network services), the Company derived substantially all of its revenues in 2000 from contracts with state government health and human service agencies. The Company is incorporated under the laws of Rhode Island, and its principal executive offices are located at 475 Kilvert Street, Warwick, Rhode Island 02886, telephone number (401) 732-9000. THE INFORMATION TECHNOLOGY INDUSTRY Rapid improvements in the price and performance of computer and communications equipment in the last 20 years, coupled with the growth of sophisticated, powerful software, have resulted in a substantial increase in the number of organizations that use computer-based information systems and in the scope and complexity of such systems. The proliferation of both products and suppliers of products has not only expanded the scope of tasks that can be performed by information systems, but it has also increased the complexity of such systems. Information systems typically include computer hardware (mainframe, minicomputers, and workstations), software (both custom and packaged), and communications equipment (routers, servers, etc.). Effective operation of information systems depends not only on having proper equipment and software, but also on having well-trained and skilled personnel. The pace and magnitude of technological change have been so great that it has been difficult for in-house data processing staffs to remain abreast of developments. As a result, business and government organizations increasingly retain third-party vendors employing skilled information technology professionals to define, develop, and install complex custom information systems and to provide applications software and comprehensive solutions to their information systems needs. Business and government organizations are also turning to third-party vendors to provide information technology services in order to reduce their investments in technology and personnel. STATE GOVERNMENT HEALTH AND HUMAN SERVICES AGENCIES State government health and human services agencies are among the organizations that most need the services of outside providers of information technology services to upgrade and maintain their computer based information systems. They have large and burdensome caseloads and must maintain extensive records. At the same time, they are required to increase the capacity and enhance the capabilities of their information systems. The federal government, which in most cases provides a substantial portion of the funding of the programs states administer (see chart below), requires detailed, standardized reporting of program data, elimination of errors, and more responsive management. Yet the information systems of many such agencies are antiquated and have limited data interfacing and reporting capabilities. As the role of state governments and "block grant" funding has increased, states have also asked that their own unique requirements be incorporated into these systems. 3 The federal government assists the states by providing financial assistance for information systems in five major areas: (i) the Child Support Enforcement (CSE) program; (ii) the Temporary Assistance to Needy Families (TANF) program (a combination of the AFDC, foodstamp and Jobs Opportunities and Basic Skills (JOBS) programs; (iii) the Medicaid and experimental managed care programs; (iv) the Child Welfare program; and (v) other programs, including Electronic Benefit Transfer (EBT), automated program policy systems, and out sourcing and privatization of human services agency functions. The U.S. Department of Health and Human Services (HHS) administers these programs at the federal level, with the exception of the food stamp program which is administered by the Food Nutrition Service of the U.S. Department of Agriculture (USDA). CHILD SUPPORT ENFORCEMENT. The federal government established the Child Support Enforcement (CSE) program in 1975 in response to the increasing failure of many parents to provide financial support to their children. The CSE program is intended to help strengthen families and reduce dependence on government assistance by requiring parents to support their children rather than the government. State governments generally must locate absent parents, establish paternity if necessary, obtain judicial support orders, and collect the support payments required by those orders. The Child Support Enforcement Amendments of 1984 require that state CSE systems, in order to receive federal funding, meet certain federal functional requirements covering case initiation, case management, database linkage, financial management, enforcement, security, privacy, and reporting. The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 ("Welfare Reform") has had a major impact on CSE systems as well. Welfare Reform: (i) changed the way collections are distributed; (ii) added a Federal Case Registry (FCR), which is a central repository for child support cases and participants from all states; (iii) added new interstate case processing; and (iv) modified to federal reporting requirements. TANF. The automated information system requirements of two distinct federal-state programs--AFDC and Food Stamps--are usually combined at the state level, previously under the name FAMIS or "Family Assistance Management Information System." Welfare Reform has changed the name of the program to TANF (Temporary Assistance to Needy Families). Welfare Reform has established time limits for assistance and has made the need for education, training, job placement, and other supportive services, such as child care and transportation, especially important. The Food Stamp Program is designed to improve the nutrition of low-income households and is also administered by state welfare agencies under the supervision of USDA. Benefits are generally provided in the form of food stamp coupons and are funded by the federal government, which reimburses part of the cost of establishing an automated system. MEDICAID AND MANAGED CARE. Medicaid is a federal-state matching entitlement program providing reimbursement for the cost of medical care to low-income individuals who are aged, blind, disabled, or members of families with dependent children, and to certain other pregnant women and children. Within broad federal guidelines, each state designs and administers its own program. Eligibility systems and claims processing systems are automated by states to handle this program, which is typically the largest line item in a state budget. Federal assistance is also available on a waiver basis for managed care experiments for Medicaid recipients and similar populations. CHILD WELFARE. In November 1993 Congress created a funding authority for Statewide Automated Child Welfare Information Systems (SACWIS) that provided federal funds at a 75% rate for the creation of information systems for fiscal years 1994, 1995, 1996 and 1997. Funding levels for 1998 and beyond are generally 50%. In December 1993, the Administration for Children and Families of HHS published the final rules for the implementation of the section of the Social Security Act of 1935 that requires the collection of adoption and foster care data. 4 OTHER HEALTH AND HUMAN SERVICES PROGRAMS. State human services agencies have initiated a number of additional programs, some of which have involved the use of federal funds. These programs include: (i) communications kiosks and voice response systems to inform and educate citizens about human services programs and to answer specific inquiries; (ii) privatization and out sourcing of various human services functions such as child support collections; (iii) automated policy systems to eliminate the volumes of federal and state regulations that must be referred to by social workers; (iv) Electronic Benefit Transfer (EBT) systems that involve the transfer of food stamp and other benefits and payments via electronic networks that may utilize debit cards or smart cards in conjunction with automated teller machines or point of sale devices. FEDERAL FUNDING. Federal Financial Participation (FFP) is the term used for federal funds provided to states to assist in delivering human services or for establishing automated systems to assist in such delivery. From time to time Congress will increase FFP percentages for a limited time in an attempt to motivate states to automate or upgrade certain systems. The following is a table of FFP percentages for state system automation by selected program as of December 31, 2000:
PROJECTED END DATE PROGRAM FFP% OF CURRENT FFP% ------- ----------- -------------------------------------- CSE................................... 66%-80% None** Temporary Assistance to Needy Families None* (TANF).............................. Varies* Food Stamps........................... 50% None Medicaid/Managed Care................. 50-90% Varies by program component Medicaid.............................. 50% None Child Welfare......................... 50%-75% None Other Health and Human Services Varies by program component Systems............................. Varies
------------------------ * States receive block grants and are permitted to use federal funds within their discretion. ** Declines to 66%, except for certain welfare reform initiatives, which would be eligible for 80% FFP. The FFP percentages shown above are subject to change at any time by federal law. CONTRACTS AND SERVICES PROVIDED The Company's contracts with state agencies have covered four basic types of projects: (i) the transfer of an entire automated information system currently in use by another state, which may involve the development of substantial modifications to that system and installation of the modified system; (ii) the development of an entirely new system; (iii) the development and installation of enhancements to an agency's existing system; and (iv) the provision of support services with respect to an existing system. The following table sets forth information as of December 31, 2000 relating to the Company's significant contracts with state agencies since December 1998:
STATE PROGRAM AREA PROJECT CONTRACT DATE STATUS ----- ------------------ ------------------ ------------- ------------------ Maine................ Child Welfare Support services April 1998 In process Rhode Island......... TANF/CSE Support services July 1999 In process Rhode Island......... Child Welfare Support services February 2000 In process
CONTRACT PROCESS. Because most health and human services agency contracts involve federal funding, they originate with a federally required Advanced Planning Document (APD) submitted by the 5 state agency to the federal government for approval. The federal government reviews APDs to ensure that the system proposed by the agency incorporates minimum functional requirements and will otherwise meet federal, state, and user needs in a cost effective manner. Following approval of the APD, the state agency prepares a request for proposals (RFP) from private industry for software services and for equipment, or hardware, by which the system will operate. Each RFP, which is also subject to approval by the federal government, is usually divided into two parts, one soliciting technical proposals and the other soliciting price proposals. There may be separate RFP's for hardware and software or the RFP may be a "bundled" bid that includes both hardware and software. RFPs essentially define the procuring agency's functional requirements, and proposals submitted in response thereto by the Company and its competitors are extensive, detailed descriptions of the manner in which the system proposed would satisfy those requirements and the experience and qualifications of those who would design and implement the system. The Company's cost of preparing such proposals ranges between $10,000 and $100,000, and the Company has submitted proposals both as a prime contractor and as a subcontractor to others. Contracts are usually awarded on the basis of a combination of technical considerations and price, although price can be the determinative factor between technically acceptable proposals. SERVICES. The Company's contracts with state agencies are usually fixed price agreements, except for support services which are generally time and materials contracts, and typically involve most or all of the following services provided by the Company: - customizing and modifying an existing system to be transferred or designing a new system; - writing computer programs; - installing the system; - converting data from computer or manual files; - testing the system; - training personnel to operate the system; - providing computers and related equipment; and - maintaining the system. As a result, the services the Company provides in performing a contract vary in terms of technical complexity. Moreover, they require emphasis on carefully defining the needs of the staffs of the agencies that administer the programs involved and adapting existing technology to satisfy those needs. Change orders and enhancements under existing contracts are also usually performed on a fixed-price basis and may result in substantial additions to the base contract price. Contract performance generally occurs over a period of 12 to 36 months. FEDERAL CERTIFICATION. When system development and installation are complete, the contracting state agency is generally required to obtain federal certification that the system meets federal requirements. There are generally no fixed time requirements for obtaining certification, and certification of the systems installed by the Company has generally been received between 6 and 12 months following completion of installation. Many state agencies require the contractor to provide a performance bond, ranging from 10% to 50% of the contract price, to be released upon completion of the warranty period or upon certification. Total-systems contracts also often provide for a warranty period following completion of the contract. Following certification of a newly installed system, it is not unusual for state agencies to contract for support services. Services provided under support contracts are usually paid for on the basis of an hourly rate plus expenses with an overall limitation. The Company estimates that automated 6 information systems currently being installed have a useful technological life of approximately five to ten years and that the systems require revisions and upgrades almost every year to keep up with changing technology, legislation and regulations. TERMINATION. As with government contracts generally, the Company's contracts with state agencies may be terminated upon relatively short notice, often with no obligation upon the agency other than to reimburse the Company for its costs of performance through the date of termination. Such contracts also generally impose substantial penalties for default, such as failure to obtain federal certification of the completed system. COMPETITION The Company operates in a highly competitive market. The Company's competitors for significant state health and human services agency contracts include firms such as Accenture (formerly Andersen Consulting), Unisys, Dynamics Research Corporation, American Management Systems, Covansys (formerly Complete Business Solutions, Inc.), Keane, TRW, MAXIMUS, and Deloitte & Touche LLP. These competitors have substantially greater financial, technical, and marketing resources than those of the Company. A number of smaller companies also compete for smaller state government contracts. These companies vary by state. The Company believes, however, that no single contractor is dominant in its market and that the primary competitive factors are reputation, capability and resources, experience with similar systems, quality and reliability of service, proposed solution, flexibility and price. BACKLOG Substantially all of the Company's revenues are derived from work to be performed under contracts of expected duration exceeding one year. Such contracts may be terminated on relatively short notice and may be subject to or are contingent upon state or federal funding. At December 31, 2000, the Company had the following contracts to provide services which, if fully performed, would result in the revenues shown:
AMOUNT RECOGNIZED AS CONTRACT CONTRACT REVENUES BACKLOG CONTRACT TITLE AMOUNT(1) EARNED THRU 12/31/00 AS OF 12/31/00(2) -------------- ----------- -------------------- ----------------- Rhode Island Support (InRHODES)................ $ 7,023,312 $3,181,575 $3,841,737 Maine Child Welfare (MACWIS)................... 1,795,190 695,397 1,099,793 Rhode Island Support (RICHIST)................. 1,495,000 1,342,599 152,401 ----------- ---------- ---------- Totals......................................... $10,313,502 $5,219,571 $5,093,931 =========== ========== ==========
------------------------ (1) Contract amounts for the above contracts have been adjusted to reflect change orders for enhancements or additional functionality. (2) The Company expects that substantially all of its backlog at December 31, 2000 will be realized by the end of 2001. There can be no assurance, however, that the Company will ultimately realize all of these revenues from such contracts. See Note 10 to Financial Statements regarding concentration of revenue. EMPLOYEES The Company believes that its future success will depend in large part upon its continued ability to hire and retain qualified technical and project management personnel. There can be no assurance that the Company will be successful in attracting and retaining sufficient numbers of qualified personnel to conduct its business in the future. 7 As of December 31, 2000, the Company had approximately 100 employees. None of the Company's employees is represented by a labor union. The Company believes its relations with its employees are excellent. ITEM 2. PROPERTIES. The Company's principal offices are located in Warwick, Rhode Island, approximately 12 miles from Providence. The Company leases approximately 9,500 square feet of office space at this location under a lease with an average annual cost including utilities of approximately $200,500 that expires in October 2003. The Company also leases 3,600 square feet in Augusta, Maine to support project activities. This lease expires in June 2001. The Company believes that these offices are adequate for its current and near term needs. ITEM 3. LEGAL PROCEEDINGS As of December 31, 2000, the Company was not involved in any litigation. On November 12, 1996, the State of Hawaii filed a lawsuit against the Company and Aetna Casualty and Surety and Federal Insurance Company for damages due to an alleged breach of a child support enforcement ("CSE") contract between the Company and the State of Hawaii. The Company denied the State's allegation and filed a counter-clam alleging the State breached the contract. In addition, on December 13, 1996, Covansys filed a lawsuit against the Company seeking damages relating to Covansys subcontract with the Company to the Hawaii CSE contract. The Company disputed Covansys claims and filed a number of counterclaims. On February 3, 1997, the Company filed a third-party complaint against MAXIMUS Corporation, Hawaii's contract supervisor and advisor on the Hawaii CSE contract, alleging, among other things, that MAXIMUS tortiously interfered in that contract. On May 11, 1999, the Company reached a settlement agreement to end its lawsuits with the State of Hawaii and Covansys. Per the settlement, the Company agreed to pay the State of Hawaii $1 million over four years and received $300,000 from Covansys. As of the date of this filing, the Company has paid $500,000 to the State of Hawaii. The settlement resulted in a one-time charge to pre-tax earnings during the quarter ended June 30, 1999 of $3.1 million ($1.9 after-tax) which included the write-off of Hawaii related receivables, work in process and liabilities. On October 29, 1999, MAXIMUS agreed to pay the Company $50,000 in exchange for dismissal of the Company's third-party complaint. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock is traded on The NASDAQ SmallCap Market under the symbol "NWSS." Prior to August 2, 1993, the Common Stock was traded in the over-the-counter market under the same symbol. 8 The following table sets forth the high and low sales prices of the Company's Common Stock as reported on the NASDAQ SmallCap Market.
HIGH LOW -------- -------- 2000 First Quarter.................. $4.75 $3.00 Second Quarter................. 4.66 2.56 Third Quarter.................. 4.22 2.63 Fourth Quarter................. 3.00 1.19 1999 First Quarter.................. $6.25 $3.25 Second Quarter................. 6.50 3.38 Third Quarter.................. 6.75 3.50 Fourth Quarter................. 5.19 3.13
As of December 31, 2000 there were 286 holders of record of the Common Stock. The last reported sale price for the Common Stock, as reported on The NASDAQ SmallCap Market on February 28, 2001 was $2.66 per share. DIVIDEND POLICY The Company has not paid any dividends on its Common Stock since its formation. It presently intends to retain its earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. The Company's Articles of Incorporation prohibit the payment of dividends on the Common Stock if dividends on the Company's Series A Convertible Preferred Stock are in arrears, which they are. ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data are qualified by reference to, and should be read in conjunction with, the Company's Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operation" contained elsewhere in or incorporated by reference in this Form 10-K. The selected financial data for each of the five years in the period ended December 31, 2000 are derived from the Company's audited financial statements. 9 INCOME STATEMENT DATA:
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------- 2000 1999 1998 1997 1996 ----------- ----------- ----------- ----------- ----------- Contract revenue earned....... $11,008,158 $10,225,676 $10,399,979 $11,460,437 $ 7,344,380 Cost of revenue earned........ 7,157,821 6,178,286 6,418,678 8,620,097 7,359,649 ----------- ----------- ----------- ----------- ----------- Gross profit (loss)........... 3,850,337 4,047,390 3,981,301 2,840,340 (15,269) Selling, general and administrative expense...... 2,778,360 2,920,352 2,260,418 2,071,294 2,240,073 Restructuring expense......... -- -- -- (119,436) Litigation settlement......... 3,126,665 Income (loss) from operations.................. 1,071,977 (1,999,627) 1,720,883 769,046 (2,135,906) Income (loss) before income taxes....................... 1,106,868 (2,064,615) 1,674,006 534,950 (2,533,368) Net income (loss)............. 653,868 (1,221,615) 1,061,006 406,950 (1,758,345) Net income (loss) per share Basic....................... 0.37 (1.96) 0.96 0.25 (2.71) Diluted..................... 0.37 (1.96) 0.96 0.25 (2.71) Shares used in computing net income (loss) per share Basic....................... 805,809 787,638 758,547 729,927 719,317 Diluted..................... 805,809 787,638 758,547 729,927 719,317
BALANCE SHEET DATA:
YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 2000 1999 1998 1997 1996 ---------- ---------- ---------- ---------- ----------- Working capital................... $3,245,933 $2,853,369 $1,416,200 $ 22,117 $(1,073,671) Hawaii contract receivables*...... -- -- 3,459,382 3,459,382 3,571,824 Total assets...................... 5,995,478 6,160,188 8,700,782 9,292,103 8,273,564 Long-term obligations............. 858,857 1,317,875 1,566,590 1,422,725 235,479 Total stockholders' equity........ 2,676,741 2,330,945 3,808,883 2,955,420 2,748,777
------------------------ * See Notes 11 and 12 in the notes to the financial statements. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. The following analysis of the financial condition and results of operations of the Company should be read in conjunction with the Company's Financial Statements and Notes thereto included elsewhere in or incorporated by reference in this Form 10-K. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This report contains forward-looking statements reflecting the Company's expectations or beliefs concerning future events that could materially affect Company performance in the future. All forward-looking statements are subject to the risks and uncertainties inherent with predictions and forecasts. They are necessarily speculative statements, and unforeseen factors, such as competitive pressures, litigation and regulatory and state funding changes could cause results to differ materially from any that may be expected. Actual results and events may therefore differ significantly from those discussed in forward-looking statements. Moreover, forward-looking statements are made in the context of 10 information available as of the date stated, and the Company undertakes no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. GENERAL The Company was incorporated in 1976 as National E-F-T, Inc. Initially the Company provided consulting services with respect to electronic funds transfer and electronic data interchange systems. In 1983 the Company changed its name to Network Solutions, Inc. and on February 1, 1994 to Network Six, Inc. By 1983, the Company had changed its focus to that of a regional provider of systems development and contract computer programming services. Since 1988, the Company has focused its efforts on providing its services to state government health and human services agencies. Commencing in 1998, the Company began targeting its marketing efforts at other state government agencies as well as non-profit organizations and the private commercial sector. However, the Company recently announced that it intends to focus on its core business of providing IT solutions to state governments. In March 2000, the Company announced that three non-employee Directors of the Board resigned. The three, Ralph A. Cote, Nicholas R. Supron and Peter C. Wallace, all cited personal reasons as well as philosophical differences with the Company's Chairman, President and CEO, Kenneth C. Kirsch. None of them expressed any objection to any action of the Company or the Board. The Company also announced that Donna J. Guido, Vice President of Information Systems for the Company, and Henry N. Huta, President/CEO of BIW Tamaqua Cable were elected to the Board of Directors. In March 2000, the Company announced that Edward J. Braks, Chief Financial Officer and Chair of the Management Committee of Paul Arpin Van Lines was elected to the Board. The Company further announced that Owen S. Crihfield and Thomas J. Berardino, both Managing Directors of Saugatuck Capital Company, had joined the Board of Directors. In July 2000, the Company announced that the State of Maine had extended the Company's contract to support and enhance the MACWIS child welfare system for another year. The value of the contract is approximately $1.7 million. In September 2000, the Company announced that the State of Rhode Island, Department of Administration, had extended the Company's contract to support and enhance the State's InRHODES computer system for another year. The value of the contract is approximately $5.5 million. In October 2000, the Company announced that the State of Rhode Island had extended the Company's contract to support and enhance the RICHIST child welfare system for another year, commencing in February 2001. The value of the contract is approximately $1.6 million. RESULTS OF OPERATIONS The following table sets forth for the years indicated, information derived from the Company's Financial Statements expressed as a percentage of the Company's contract revenue earned:
YEAR ENDED DECEMBER 31, -------------------------------------------------- 2000 1999 1998 1997 -------- -------- -------- -------- Contract revenue earned..................... 100.0% 100.0% 100.0% 100.0% Cost of revenue earned...................... 65.0% 60.4% 61.7% 75.2% Gross profit................................ 35.0% 39.6% 38.3% 24.8% Selling and administrative expenses......... 25.2% 28.6% 21.7% 18.1% Income before income taxes.................. 10.1% (20.2)% 16.1% 4.7% Net income (loss)........................... 5.9% (11.9)% 10.2% 3.6%
11 YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 Contract revenue earned increased $782,482, or 8%, from $10,225,676 in the year ended December 31, 1999 to $11,008,158 in the year ended December 31, 2000. This was primarily due to the addition of the State of Rhode Island Department of Children, Youth and Families maintenance and support contract known as RICHIST in February, 2000. This increase was partially offset by lower contract revenue from certain private sector accounts. Cost of revenue earned, consisting of direct employee labor, direct contract expense and subcontracting expense, increased $979,535, or 16%, from $6,178,286 in 1999 to $7,157,821 in 2000 due to increased contract revenues and startup costs associated with the RICHIST contract. Gross profit decreased $197,053 from $4,047,390 in 1999 to $3,850,337 in 2000. Gross profit, as a percentage of revenue, was 40% for 1999 and 35% for 2000. The decrease in gross profit percentage is due to higher costs relating to the RICHIST contract. Selling, general and administrative expenses ("SG&A") decreased $141,992, or 5%, from $2,920,352 in 1999 to $2,778,360 in 2000 primarily due to lower staffing and lower bad debt expenses. Interest expense decreased $24,033, or 16%, from $153,765 in 1999 to $129,732 in 2000 due to a reduction in long-term debt. As a result of the foregoing, income before income taxes was $1,106,868 in 2000, an increase of $3,171,483 from a loss before taxes of $2,064,615 in 1999. Net income increased $1,875,483 in 2000 from a loss of $1,221,615 in 1999 to net income of $653,868 in 2000. YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998 Contract revenue earned decreased $174,303, or 2%, from $10,399,979 in the year ended December 31, 1998 to $10,225,676 in the year ended December 31, 1999. This was primarily due to the completion of the Maine Automated Child Welfare Information System (MACWIS), lower maintenance and support services at MIM Corporation, and the completion of a contract with GTECH Corporation. This decrease was offset by increased revenues from the installation of a web-based application and related work in support of a "Performance Based Transcript" system for a local university. Cost of revenue earned, consisting of direct employee labor, direct contract expense and subcontracting expense, decreased $240,392, or 4%, from $6,418,678 in 1998 to $6,178,286 in 1999. This was primarily due to a lower reliance on subcontractor labor, which is generally at a higher cost than the Company's internal staff. Gross profit increased $66,089 from $3,981,301 in 1998 to $4,047,390 in 1999. Gross profit, as a percentage of revenue, was 38% for 1998 and 40% for 1999. This was primarily because of the Company's improved margins on the Maine MACWIS support project compared to the initial Maine MACWIS development and implementation project which included substantial subcontract labor. Selling, general and administrative expenses increased $659,934, or 29%, from $2,260,418 in 1998 to $2,920,352 in 1999 primarily due to an increase in marketing and business development staff and related activities. On a percentage of contract revenue earned, SG&A expenses increased from 22% in 1998 to 29% in 1999. The effect of the litigation settlement in 1999 before taxes consisting of (1) the write off of Hawaii related receivables, work in process and liabilities, (2) the present value of the payment due to Hawaii, (3) a $300,000 payment from CBSI and (4) a $50,000 payment from MAXIMUS is $3,126,665. See Item 3--Legal Proceedings and Notes 11 and 12 in Notes to Financial Statements. 12 Interest expense increased $28,451, or 23%, from $125,314 in 1998 to $153,765 in 1999 due to the imputed interest on the note payable to the State of Hawaii. See Item 3--Legal Proceedings. As a result of the foregoing, loss before income taxes was $2,064,615 in 1999, a decrease of $3,738,621 from income before taxes of $1,674,006 in 1998. Net income decreased $2,282,621 in 1999 from $1,061,006 in 1998 to a net loss of $1,221,615 in 1999. LIQUIDITY AND CAPITAL RESOURCES In order to finance bid preparation costs and to obtain sufficient collateral to support performance bonds required by some customers, the Company has, in the past, entered into joint ventures with other firms with greater financial resources when bidding for contracts. The Company continues to expand this practice prospectively as well as pursue more time and material contracts than it had historically pursued. Time and materials contracts generally do not require performance bonds and almost always involve less risk to meet customer requirements. The Company has historically not received its first contract progress payments until approximately three to six months after contract award, which itself was as much as 12 months after proposal preparation commences. The Company was therefore required to fund substantial costs well before the receipt of related income, including marketing and proposal costs and the cost of a performance bond. The Company has funded its operations through cash flows from operations, bank borrowings, borrowings from venture partners, and private placements of equity securities. Net cash provided by operating activities was $1,478,361, $1,584,094 and $1,066,014 in the years ended December 31, 2000, 1999, and 1998, respectively. Fluctuations in net cash provided by operating activities are primarily the result of changes in net income, accounts receivable and income tax receivable and payable, accounts payable and costs and estimated earnings in excess of billings on contracts due to differences in contract milestones and payment dates. On September 21, 1998 the Company entered into two five-year term loans, each for $250,000. One lender was the Small Business Loan Fund Corporation, ("SBLFC"), a subsidiary of the Rhode Island Economic Development Corporation. The other lender was the Business Development Corporation of Rhode Island ("BDC"). The SBLFC loan carries an annual interest rate of 9.5% and must be repaid over five years. The BDC loan carries an annual interest rate of 10.25%, and an annual deferred fee of $5,000, and must be paid back over five years. Both term loans are secured by substantially all the assets of the Company, subordinated to the revolving line of credit with the commercial bank. The BDC was also issued five-year warrants to purchase 11,500 unregistered shares of the Company's Common Stock at a price of $4.50 per share. The warrants expire on September 20, 2003. The fair value of the warrants was estimated by the Company to be $36,806 using the Black-Scholes model and is being amortized ratably over the exercise period. Such amount is included in other non-current assets on the accompanying balance sheet. On November 15, 1999, the Company entered into a revolving line of credit with a commercial bank. This $1 million revolving line of credit is secured by all of the assets of the Company. The Company can borrow up to 80% of certain qualified accounts receivable at an interest rate of prime plus 1/4%. On December 31, 2000, the revolving line of credit had an outstanding balance of zero. The Company believes that cash flow generated by operations will be sufficient to fund continuing operations through the end of 2001. The Company believes that inflation has not had a material impact on its results of operations to date. 13 RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS There are no recently issued financial accounting standards that impact the Company's financial statements. FACTORS THAT MAY AFFECT FUTURE RESULTS LABOR CONSIDERATIONS Due to the technical and labor-intensive nature of the Company's business, continued success of the Company depends largely upon the ability of management to attract and retain highly-skilled information technology professionals and project managers possessing the technical skills and experience necessary to deliver the Company's services. There is a high demand for qualified information technology professionals worldwide and they are likely to remain a limited resource for the foreseeable future. The Company has no assurance that qualified information technology professionals will continue to be available in sufficient numbers, or at wages, which will enable the Company to retain current or future employees. A material adverse effect on the Company's business, operating results, and financial condition would be expected if the Company fails to attract or retain qualified information technology professionals in sufficient numbers. TECHNOLOGICAL CONSIDERATIONS Rapid technological change, evolving industry standards, changing client preferences and new product introductions characterizes the information technology industry. The Company's success will depend in part on its ability to develop technological solutions that keep pace with changes in the industry. There can be no assurance that products or technologies developed by others will not render the Company's services noncompetitive or obsolete or that the Company will be able to keep pace with the expected continued rapid changes in technology. A failure by the Company to address these developments could have a material adverse effect on the Company's business, operating results and financial condition. YEAR 2000 CLIENT CONSIDERATIONS The Company's contracts, including year 2000 projects, often involve projects that are critical to the operations of its clients' businesses and provide benefits that may be difficult to measure. There can be no assurance that despite the Company's attempts to contractually limit its liability for damages arising from errors, mistakes, omissions or negligent acts in rendering its services, these attempts will be successful. The Company's inability to meet a client's expectations in the delivery of its services could result in a material adverse effect to the client's operations and, therefore, could potentially give rise to claims against the Company or damage the Company's reputation, detrimentally affecting its business, operating results and financial condition. The Company believes that it has successfully completed all client year 2000 projects and as of the date of this filing is not aware of any issues relating year 2000 projects undertaken by the Company on behalf of clients. LONG TERM CONTRACT CONCERNS The typical contract with a client is for a term of one to three years. Generally, there is no assurance that a client will renew its contract when it terminates. Under such contracts, clients may reduce the use of the Company's services without penalty. Failure by the Company to retain its existing clients could materially adversely effect its results of operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The information required by Item 8 is contained on pages F-2 to F-21 of this report. 14 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS. The Company currently intends to include the information required by Item 10 in the Company's 2001 Annual Meeting Proxy Statement ("2001 Proxy Statement") and such proxy statement is incorporated herein by reference. Such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the Company's fiscal year end. ITEM 11. EXECUTIVE COMPENSATION. The Company currently intends to include the information required by Item 11 in the Company's 2001 Proxy Statement and such information is incorporated herein by reference. Such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the Company's fiscal year end. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The Company currently intends to include information required by Item 12 in the Company's 2001 Proxy Statement and such information is incorporated herein by reference. Such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the Company's fiscal year end. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The Company currently intends to include information required by Item 13 in the Company's 2001 Proxy Statement and such information is incorporated herein by reference. Such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the Company's fiscal year end. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (A) (1) LIST OF FINANCIAL STATEMENTS. The following financial statements and notes thereto of the Company and Independent Auditors' Report thereon are included on pages F-2 to F-21 of this report: Independent Auditors' Report of Sansiveri, Kimball & McNamee L.L.P. Balance Sheets as of December 31, 2000 and 1999 Statements of Operations for the Years Ended December 31, 2000, 1999, and 1998 Statements of Stockholders' Equity for the Years Ended December 31, 2000, 1999, and 1998 Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998 Notes to Financial Statements 15 (2) LIST OF FINANCIAL STATEMENT SCHEDULES. All schedules have been omitted because they are either not applicable or not required, or the required information is provided in the financial statements or notes thereto. (3) LIST OF EXHIBITS. EXHIBIT NUMBER EXHIBIT 3.1 Articles of Incorporation of the Company, as amended 3.2 Bylaws of the Company, as amended 10.1 Stock Purchase Agreement dated October 29, 1992 between the Company and Saugatuck Capital Company Limited Partnership III (incorporated by reference from the Company's Form 10, exhibit 10.7, File No. 0-21038) 10.2 Registration Rights Agreement dated October 29, 1992 between the Company and Saugatuck Capital Company Limited Partnership III (incorporated by reference from the Company's Form 10, exhibit 10.8, File No. 0-21038) 10.3 Incentive Stock Option Plan (incorporated by reference from the Company's Form 10, exhibit 10.9, File No. 0-21038) 10.4 Deferred Compensation Agreement between the Company and Mr. Robert E. Radican, as amended (incorporated by reference from the Company's Form 10-K, exhibit 10.10, for the fiscal year ended December 31, 1994) 10.5 1993 Employee Stock Purchase Plan (incorporated by reference from the Company's Form 10-K, exhibit 10.12, for the fiscal year ended December 31, 1994) 10.6 1993 Incentive Stock Option Plan, as amended 10.7 Non-employee Director Stock Option Plan, as amended 10.8 Contract dated April, 1997 between the Company and the State of Maine Re: Automated child welfare system (incorporated by reference from the Company's Form 10-K, exhibit 10.18, for the fiscal year ended December 31, 1997) 10.9 Agreement dated December 29, 1997 between the Company and Lockheed Martin IMS re: note payable (incorporated by reference from the Company's Form 10-K, exhibit 10.19, for the fiscal year ending December 31, 1997) 10.10 Credit Agreement dated September 23, 1998 between the Company and Small Business Loan Fund Corporation, a subsidiary of the Rhode Island Economic Development Corporation (incorporated by reference from the Company's Form 10-K, exhibit 10.16, for the fiscal year ending December 31, 1998) 10.11 Credit Agreement dated September 23, 1998 between the Company and Business Development Corporation of Rhode Island (incorporated by reference from the Company's Form 10-K, exhibit 10.17, for the fiscal year ending December 31, 1998) 10.12 Employment Agreement between the Company and Mr. Kenneth C. Kirsch dated January 1, 1999 (incorporated by reference from the Company's Form 10-K, exhibit 10.12, for the fiscal year ended December 31, 1999) 10.13 Contract dated April 28, 1999 between then Company and Complete Business Solutions, Inc. ("CBSI") dismissing all outstanding claims between the Company and CBSI 16 (incorporated by reference from the Company's Form 10-K, exhibit 10.13, for the fiscal year ended December 31, 1999) 10.14 Contract dated May 1, 1999 between the Company and the State of Hawaii dismissing all outstanding claims between the Company and the State of Hawaii (incorporated by reference from the Company's Form 10-K, exhibit 10.14, for the fiscal year ended December 31, 1999) 10.15 Contract dated July 1, 1999 between the Company and the State of Rhode Island Department of Human Services re: support services (incorporated by reference from the Company's Form 10-K, exhibit 10.15, for the fiscal year ended December 31, 1999) 10.16 Loan Agreement dated November 15, 1999 between the Company and Fleet National Bank (incorporated by reference from the Company's Form 10-K, exhibit 10.16, for the fiscal year ended December 31, 1999) 10.17 Contract dated January 27, 2000 between the Company and the State of Rhode Island Department of Children, Youth and Families re: support services. 22.1 List of Subsidiaries (incorporated by reference from the Company's Form 10, File No. 0-21038) 23.1 Consent of Sansiveri, Kimball & McNamee L.L.P. (B) REPORTS ON FORM 8-K. A current report on Form 8-K, dated October 5, 2000 was filed by the Company and included the press release dated October 5, 2000 announcing the extension of the State of Rhode Island RICHIST support contract. A current report on Form 8-K, dated September 27, 2000 was filed by the Company and included the press release dated October 25, 2000 announcing the Company's results for the three months ended September 30, 2000. A Statement of Operations (without notes) for the quarters ended September 30, 2000, and 1999 was also included with the filing. 17 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned on the 12th day of March 2000. NETWORK SIX, INC. By: /s/ KENNETH C. KIRSCH ----------------------------------------- Kenneth C. Kirsch PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- Chairman of the Board, March 12, 2001 /s/ KENNETH C. KIRSCH President, and Chief ------------------------------------------- Executive Officer (Principal Kenneth C. Kirsch Executive Officer) Vice President of Finance and March 12, 2001 Administration, Chief /s/ JAMES J. FERRY Financial Officer, and ------------------------------------------- Treasurer (Principal James J. Ferry Financial and Accounting Officer) /s/ DONNA J. GUIDO March 12, 2001 ------------------------------------------- Vice President of Information Donna J. Guido Systems and Director /s/ HENRY N. HUTA March 12, 2001 ------------------------------------------- Director Henry N. Huta /s/ EDWARD J. BRAKS March 12, 2001 ------------------------------------------- Director Edward J. Braks /s/ OWEN S. CRIHFIELD March 12, 2001 ------------------------------------------- Director Owen S. Crihfield /s/ THOMAS J. BERARDINO March 12, 2001 ------------------------------------------- Director Thomas J. Berardino
18 INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE -------- Independent Auditors' Report of Sansiveri, Kimball & McNamee L.L.P..................................................... F-2 Balance Sheets as of December 31, 2000 and 1999............. F-3-4 Statements of Operations for the Years Ended December 31, 2000, 1999, and 1998...................................... F-5 Statements of Stockholders' Equity for the Years Ended December 31, 2000, 1999, and 1998......................... F-6 Statements of Cash Flows for the Years Ended December 31, 2000, 1999, and 1998...................................... F-7-8 Notes to Financial Statements............................... F-9
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders of Network Six, Inc.: We have audited the accompanying balance sheet of Network Six, Inc. as of December 31, 2000 and 1999 and the related statements of operations, stockholders' equity and cash flows for the years ended December 31, 2000, 1999 and 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements referred to above present fairly, in all material respects, the financial position of Network Six, Inc. at December 31, 2000 and 1999, and the results of its operations and its cash flows for the years ended December 31, 2000, 1999 and 1998, in conformity with generally accepted accounting principles. Sansiveri, Kimball & McNamee, L.L.P. /s/ Sansiveri, Kimball & McNamee, L.L.P. Providence, Rhode Island February 6, 2001 F-2 NETWORK SIX, INC. BALANCE SHEETS DECEMBER 31, 2000 AND 1999
2000 1999 ----------- ----------- ASSETS Current assets: Cash and cash equivalents................................. $ 1,650,959 $ 2,453,935 Short term investments (Note 2)........................... 1,803,387 -- Contract receivables, less allowance for doubtful accounts of $49,000 at December 31, 2000 and 1999 (Note 3)....... 1,094,142 1,561,255 Costs and estimated earnings in excess of billings on contracts (Note 4)...................................... 843,021 759,891 Refundable taxes on income................................ -- 150,640 Deferred taxes (Note 7)................................... 268,177 287,083 Other assets.............................................. 46,127 151,933 ----------- ----------- Total current assets.................................... 5,705,813 5,364,737 ----------- ----------- Property and equipment: Computers and equipment................................... 639,258 590,124 Furniture and fixtures.................................... 162,606 162,606 Leasehold improvements.................................... 20,190 20,191 ----------- ----------- 822,054 772,921 Less: accumulated depreciation and amortization............. 659,097 578,015 ----------- ----------- Net property and equipment.............................. 162,957 194,906 Deferred taxes (Note 7)..................................... 79,701 513,795 Other assets................................................ 47,007 86,750 ----------- ----------- Total assets................................................ $ 5,995,478 $ 6,160,188 =========== ===========
F-3 NETWORK SIX, INC. BALANCE SHEETS DECEMBER 31, 2000 AND 1999
2000 1999 ----------- ----------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt (Note 5): Vendors................................................. $ 100,000 $ 100,000 Others.................................................. 354,018 349,141 Accounts payable.......................................... 31,023 202,195 Accrued salaries and benefits............................. 389,158 508,193 Other accrued expenses.................................... 93,021 107,913 Billings in excess of costs and estimated earnings on contracts (Note 4)...................................... 19,048 124,458 Preferred stock dividends payable......................... 1,473,612 1,119,468 ----------- ----------- Total current liabilities............................... 2,459,880 2,511,368 ----------- ----------- Long-term debt, less current portion (Note 5): Vendors................................................. 442,239 542,239 Others.................................................. 416,618 775,636 ----------- ----------- Total Liabilities....................................... 3,318,737 3,829,243 ----------- ----------- Commitments (Notes 6 and 9) Stockholders' equity (Note 8): Series A convertible preferred stock, $3.50 par value. Authorized 857,142.85 shares; issued and outstanding 714,285.71 shares in 2000 and 1999; liquidation of $3.50 per share plus unpaid and accumulated dividends......... 2,235,674 2,235,674 Common stock, $.10 par value. Authorized 4,000,000 shares; issued and outstanding 825,684 shares in 2000 and 794,306 in 1999......................................... 82,568 79,430 Additional paid-in capital.................................. 1,947,767 1,888,652 Treasury stock, recorded at cost, 11,843 shares at December 31, 2000 and 8,081 shares at December 31, 1999............ (44,360) (28,179) Retained earnings (accumulated deficit)..................... (1,544,908) (1,844,632) ----------- ----------- Total stockholders' equity.............................. 2,676,741 2,330,945 ----------- ----------- Total Liabilities and Stockholders' Equity.............. $ 5,995,478 $ 6,160,188 =========== ===========
See accompanying notes to financial statements. F-4 NETWORK SIX, INC. STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998 ----------- ----------- ----------- Contract revenue earned (Note 10)..................... $11,008,158 $10,225,676 $10,399,979 Cost of revenue earned................................ 7,157,821 6,178,286 6,418,678 ----------- ----------- ----------- Gross profit (loss)................................. 3,850,337 4,047,390 3,981,301 Selling, general and administrative expenses.......... 2,778,360 2,920,352 2,260,418 Litigation settlement (Note 12)....................... -- 3,126,665 -- ----------- ----------- ----------- Income (loss) from operations....................... 1,071,977 (1,999,627) 1,720,883 Other deductions (income) Interest expense.................................... 129,732 153,765 125,314 Interest earned..................................... (164,623) (88,777) (78,437) ----------- ----------- ----------- Income (loss) before income taxes................. 1,106,868 (2,064,615) 1,674,006 Income taxes (Note 7)................................. 453,000 (843,000) 613,000 ----------- ----------- ----------- Net income (loss)..................................... $ 653,868 $(1,221,615) $ 1,061,006 =========== =========== =========== Net income (loss) per share: Basic................................................. $ 0.37 $ (1.96) $ 0.96 =========== =========== =========== Diluted............................................... $ 0.37 $ (1.96) $ 0.96 =========== =========== =========== Shares used in computing net income (loss) per share: Basic................................................. 805,809 787,638 758,547 =========== =========== =========== Diluted............................................... 805,809 787,638 758,547 =========== =========== =========== Preferred dividends................................... $ 354,144 $ 323,476 $ 335,925 =========== =========== ===========
See accompanying notes to financial statements. F-5 NETWORK SIX, INC. STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
SERIES A RETAINED CONVERTIBLE ADDITIONAL EARNINGS TOTAL PREFERRED COMMON PAID-IN (ACCUMULATED TREASURY STOCKHOLDERS' STOCK STOCK CAPITAL DEFICIT) STOCK EQUITY ----------- -------- ---------- ------------ -------- ------------- Balance at December 31, 1997..... $2,235,674 $73,429 $1,670,939 $(1,024,622) $ -- $ 2,955,421 Net Income....................... 1,061,006 1,061,006 Dividends on preferred stock 13.5%/ share (Q1-Q3); 13.25% (Q4)........................... (335,925) (335,925) Shares Issued in connection with exercise of options 6,275 shares......................... 628 12,223 12,851 Sale of 24,094 shares of common stock.......................... 2,409 76,316 78,725 Warrants issued with term loan... 36,806 36,806 ---------- ------- ---------- ----------- -------- ----------- Balance at December 31, 1998..... 2,235,674 76,466 1,796,284 (299,541) -- 3,808,883 Net Income (Loss)................ (1,221,615) (1,221,615) Dividends on preferred stock 12.75%/share (Q1-Q2); 13.0% (Q3); 13.25% (Q4).............. (323,476) (323,476) Shares Issued in connection with exercise of options 14,200 shares......................... 1,420 35,036 36,456 Purchase of 8,081 treasury shares......................... (28,179) (28,179) Sale of 15,443 shares of common stock.......................... 1,544 57,332 58,876 ---------- ------- ---------- ----------- -------- ----------- Balance at December 31, 1999..... 2,235,674 79,430 1,888,652 (1,844,632) (28,179) 2,330,945 Net Income....................... 653,868 653,868 Dividends on preferred stock 13.5%/ share (Q1); 14.0% (Q2); 14.5% (Q3-Q4).................. (354,144) (354,144) Shares Issued in connection with exercise of options 29,600 shares......................... 2,960 53,292 56,252 Purchase of 3,762 treasury shares......................... (16,181) (16,181) Sale of 1,778 shares of common stock.......................... 178 5,823 6,001 ---------- ------- ---------- ----------- -------- ----------- Balance at December 31, 2000..... $2,235,674 $82,568 $1,947,767 $(1,544,908) $(44,360) $ 2,676,741 ========== ======= ========== =========== ======== ===========
See accompanying notes to financial statements. F-6 NETWORK SIX, INC. STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998 ---------- ----------- ----------- Net Income (loss)....................................... $ 653,868 $(1,221,615) $ 1,061,006 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization......................... 92,091 74,237 47,415 Litigation settlement, excluding cash received........ -- 3,476,665 -- Provision for doubtful accounts....................... 83 97,760 19,175 Loss on sale/disposal of fixed assets................. 1,606 3,976 6,518 Provision for deferred taxes.......................... 453,000 (806,272) (149,000) Accrued financing fee................................. -- -- 20,000 Forgiveness of note payable to vendor................. -- -- (50,036) Changes in operating assets and liabilities: Contract receivables.................................. 467,030 307,773 25,416 Cost and estimated earnings in excess of billings on contracts........................................... (83,130) 460,362 168,262 Refundable taxes on income............................ 150,640 (150,640) -- Other current assets.................................. 105,806 (39,500) 131,824 Other noncurrent assets............................... 39,743 334,870 181,548 Accounts payable...................................... (171,172) 143,739 (129,921) Accrued salaries and benefits......................... (119,035) (71,127) 130,187 Accrued subcontractor expense......................... -- (12,107) (1,327,443) Other accrued expenses................................ (14,892) (16,847) (21,483) Billings in excess of costs and estimated earnings on contracts........................................... (105,410) (217,114) 185,818 Income taxes payable.................................. -- (780,066) 766,728 ---------- ----------- ----------- Net cash provided by operating activities........... $1,470,228 $ 1,584,094 $ 1,066,014 ---------- ----------- -----------
F-7 NETWORK SIX, INC. STATEMENTS OF CASH FLOWS (CONTINUED) YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998 ----------- ---------- ----------- Cash flows from investing activities: Purchases of: Short-term investments.............................. $(2,848,387) -- -- Property and equipment.............................. (62,472) $ (101,925) $ (156,299) Proceeds from: Maturities of short-term investments................ 1,045,000 -- -- Sale of assets...................................... 724 1,023 -- ----------- ---------- ----------- Net cash (used in) investing activities........... (1,865,135) (100,902) (156,299) ----------- ---------- ----------- Cash flows from financing activities: Principal payments on capital lease obligations....... -- (61,447) (59,120) Net proceeds (payments) from note payable to bank..... -- -- (1,160,000) Proceeds from long-term debt.......................... -- -- 500,000 Payments on long-term debt............................ (454,141) (476,998) (132,060) Proceeds from issuance of common stock................ 62,253 95,332 91,576 Purchase of treasury stock............................ (16,181) (28,179) -- ----------- ---------- ----------- Net cash used in financing activities............. (408,069) (471,292) (759,604) ----------- ---------- ----------- Net increase (decrease) in cash....................... (802,976) 1,011,900 150,111 Cash at beginning of year............................. 2,453,935 1,442,035 1,291,924 ----------- ---------- ----------- Cash at end of year................................... $ 1,650,959 $2,453,935 $ 1,442,035 =========== ========== =========== Supplemental cash flow information: Cash (received) paid during the year for: Income taxes, net................................... $ (176,880) $ 893,977 $ (4,788) =========== ========== =========== Interest, net....................................... $ (61,253) $ 7,939 $ 89,030 =========== ========== ===========
See accompanying notes to financial statements. F-8 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) DESCRIPTION OF BUSINESS Network Six, Inc. (the "Company"), is a provider of software development and computer-related consulting services to government and industry. Founded in 1976, the Company focuses on providing its services to state government health and human services agencies. Currently, substantially all of its revenues are derived from contracts with such agencies. Services are provided under "time and materials" contracts and "fixed price" contracts. Under these contracts, which are generally awarded as a result of formal competitive-bidding processes, the Company provides a range of information technology services, consisting primarily of systems integration, system design, software development, hardware planning and procurement, and personnel training. (B) REVENUE RECOGNITION Revenues from services provided under fixed-price and modified fixed-price contracts are recognized on the percentage-of-completion method, measured by the percentage of costs incurred to date to estimated total costs for each contract. This method is used because management considers costs incurred to be the best available measure of progress on these contracts. Revenues from time and materials contracts are recognized on the basis of costs incurred during the period plus the related fee earned. Cost of revenues earned includes all direct material and labor costs and those indirect costs related to contract performance. Selling, general, and administrative costs are charged to expense as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability including those arising from contract penalty provisions and final contract settlements, may result in revisions to costs and income and are recognized in the period in which the revisions are determined. Costs and estimated earnings in excess of billings on uncompleted contracts, represents revenues recognized in excess of amounts billed. Billings in excess of costs and estimated earnings on uncompleted contracts, represents billings in excess of revenues recognized. For fixed price contracts, costs and estimated earnings are billed upon customer approval of the Company's attaining various phases of completion set forth in each contract. Retainage is billed upon customer approval on contract completion. Costs and earnings on time and material contracts are billed when time is expended and material costs are incurred. The Company also recognizes revenue from the sale of hardware to various customers. Revenue and related costs for these sales are recorded when the customer accepts delivery and installation of the hardware. In the state government systems integration industry, it is common practice to negotiate change orders to existing contracts in progress due to the custom nature of systems integration projects. In addition, such change orders generally must be submitted to the federal government for approval because a portion of state systems integration projects are federally funded. Over the years, the Company has successfully negotiated and received federal approval of numerous contract change orders. However, the frequent need for change orders in the systems integration business and the inherent uncertainties in obtaining state and federal approval of change orders is a significant risk, which could have a material impact to the Company. F-9 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 (C) CASH Cash and cash equivalents include investments with an original maturity of approximately three months or less. (D) OTHER ASSETS Other assets consist of employee receivables, lease receivables, sales tax refund receivable, prepaid insurance, and security deposits. (E) PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation on property and equipment is calculated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the asset. The estimated useful lives of property and equipment and leasehold improvements are: Leasehold improvements 30 months Computers and equipment 3 years Furniture and fixtures 5 years
When the Company determines that certain property, plant and equipment is impaired, a loss for impairment is recorded for the excess of the carrying value over the fair market value of the asset. Fair value is determined by independent appraisal, if an active market exists for the related asset. Otherwise, fair value is estimated through forecasts of expected cash flows. (F) INCOME TAXES The Company uses the asset and liability method of accounting for income taxes. 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. 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. (G) NET INCOME (LOSS) PER COMMON SHARE Basic net income (loss) per common share is computed by dividing net income (loss), after deducting dividends on Series A convertible preferred stock by the weighted average number of common shares, and in the case of diluted earnings per share assuming the conversion of the convertible preferred stock and common stock equivalents outstanding during the period. Common stock equivalents include stock options and warrants. For 2000, 1999 and 1998, the stock purchase warrants, options, and convertible preferred stock and related dividends declared have not been included in the computation of net income or loss per share, since the effect would be anti-dilutive. Therefore the numerator of the basic and diluted earnings per share calculations were the same, as was the denominator. F-10 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 (H) COSTS OF MODIFYING SOFTWARE The costs of modifying the Company's software for year 2000 compliance were charged to expense as incurred. (I) COSTS OF FAILURE TO BE YEAR 2000 COMPLIANT Any losses that may result if the Company, its suppliers, subcontractors, or customers fail to correct Year 2000 deficiencies are recorded as they are incurred. (J) FINANCIAL INSTRUMENTS Financial Instruments consist of cash, certificates of deposit, U.S. Government Securities, contract accounts receivable, leases receivable, accounts payable, lease obligations, and notes payable. The carrying value of these financial instruments approximates their fair value. (K) 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 and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the allowance for doubtful accounts on contract receivables and the recognition of revenue on fixed price contracts by the percentage of completion method. Actual results could differ from those estimates. (2) SHORT-TERM INVESTMENTS The carrying amounts and approximate fair values of certificates of deposit and U.S. government securities at December 31, 2000 are as follows:
GROSS UNREALIZED FAIR CARRYING AMOUNT LOSS VALUE --------------- ---------- ---------- Short-term investments: Certificates of deposit................. $1,502,000 $1,502,000 U.S. Government and Federal agency securities............................ 301,387 $(1,480) 299,907 ---------- ------- ---------- $1,803,387 $(1,480) $1,801,907 ========== ======= ==========
F-11 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 (3) CONTRACT RECEIVABLES Contract receivables at December 31 consist of:
2000 1999 ---------- ---------- Time and materials and completed fixed price contracts.......................................... $ 654,101 $1,012,540 Fixed price contracts in progress.................... 489,299 597,890 ---------- ---------- 1,143,400 1,610,430 Less allowance for doubtful accounts............. 49,258 49,175 ---------- ---------- $1,094,142 $1,561,255 ========== ==========
(4) COSTS AND ESTIMATED EARNINGS ON CONTRACTS Cost and estimated earnings on contracts at December 31 consist of:
2000 1999 ----------- ----------- Beginning balance.................................. $ 635,433 $ 878,681 Costs incurred..................................... 7,157,821 6,178,286 Estimated Earnings................................. 3,850,337 4,047,390 ----------- ----------- 11,643,591 11,104,357 Less billings...................................... 10,819,618 10,468,924 ----------- ----------- $ 823,973 $ 635,433 =========== ===========
Included in the accompanying balance sheets under the following captions:
2000 1999 -------- --------- Costs and estimated earnings in excess of billings on contracts............................................ $843,021 $ 759,891 Billings in excess of costs and estimated earnings on contracts............................................ (19,048) (124,458) -------- --------- $823,973 $ 635,433 ======== =========
Costs and estimated earnings on contracts at December 31, 2000 and 1999 are expected to be billed and collected within one year. (5) NOTES PAYABLE (A) SECURED NOTES On September 21, 1998 the Company entered into two five-year term loans, each for $250,000. One lender was the Small Business Loan Fund Corporation, ("SBLFC"), a subsidiary of the Rhode Island Economic Development Corporation. The other lender was the Business Development Corporation of Rhode Island ("BDC"). The SBLFC loan carries an annual interest rate of 9.5% and must be repaid over five years. The BDC loan carries an annual interest rate of 10.25%, and an annual deferred fee of $5,000, and must be paid back over five years. Both term loans are secured by substantially all the assets of the Company subordinated to the revolving line of credit with a commercial bank. The BDC loan contains certain covenants which the Company complied with as of December 31, 2000. The BDC was also issued five-year warrants to purchase 11,500 shares of the F-12 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 Company's common stock with a strike price of $4.50 per share. The warrants expire on September 20, 2003. The fair value of the warrants was estimated by the Company to be $36,806 using the Black-Scholes model and is being amortized ratably over the exercise period. Such amount is included in other non-current assets on the accompanying balance sheet. On November 15, 1999, the Company entered into a revolving line of credit with a commercial bank. This $1 million revolving line of credit is secured by all of the assets of the Company. The Company can borrow up to 80% of certain qualified accounts receivable at an interest rate of prime plus 1/4%. On December 31, 2000, the revolving line of credit had an outstanding balance of zero. (B) UNSECURED NOTES On December 29, 1997, the Company restructured a $842,239 account payable with Unisys to a four year unsecured note payable. After Unisys filed a claim against the Company's Hawaii- related performance bond, the bonding company paid Unisys, and then Lockheed Martin IMS Corporation ("Lockheed") reimbursed the bonding company. Lockheed had guaranteed the Company's performance bond for the Hawaii contract. The note is payable to Lockheed and carries an initial interest rate of five percent through 1998, and six percent from 1999 until December 29, 2004, with such interest to be paid monthly. Principal payments are to be made annually as follows: December 1998--$100,000, December 1999--$100,000, December 2000--$100,000, December 2001--$100,000, December 2002--$100,000, December 2003--$150,000, December 2004--$192,239. The note has a discount provision for early payment. On May 11, 1999, the Company entered into a Settlement and Mutual Release Agreement with the State of Hawaii to resolve its long standing litigation. The Company agreed to pay the State of Hawaii $1 million over four years as follows: June 1999--$250,000, June 2000--$250,000, June 2001--$250,000, June 2002--$125,000 and June 2003--$125,000. The first payment was reduced by a $50,000 credit for the settlement of a lease obligation on computer equipment. The equipment lessor, who had filed suit against the Company, accepted $50,000 from the Company in full payment of that obligation. As of December 31, 2000, the remaining principal outstanding was $500,000. Scheduled maturities of secured and unsecured long term debt as of December 31, 2000 are as follows: 2001........................................................ $ 454,019 2002........................................................ 339,379 2003........................................................ 327,238 2004........................................................ 192,239 ---------- $1,312,875 ==========
(6) LEASES The Company leases office space and equipment under several operating leases expiring at various times through 2001. Rent expense, including utilities, for the years ended December 31, 2000, 1999 and F-13 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 1998 was approximately $248,000, $216,000 and $192,000, respectively. Rental obligations as of December 31, 2000 for the remainder of the lease terms are as follows:
OPERATING LEASES ---------------- 2001.................................................. $213,828 2002.................................................. 196,703 -------- Total lease payments........................................ $410,531 ========
(7) INCOME TAXES The components of income tax expense (benefit) for the years ended December 31, are as follows:
2000 1999 1998 -------- --------- --------- Current taxes: Federal................................... $ -- $ -- $ 599,000 State..................................... -- -- 163,000 -------- --------- --------- Sub total................................... -- -- 762,000 -------- --------- --------- Deferred taxes: Federal................................... 358,000 (666,000) (119,000) State..................................... 95,000 (177,000) (30,000) -------- --------- --------- Sub total................................... 453,000 (843,000) (149,000) -------- --------- --------- Total....................................... $453,000 $(843,000) $ 613,000 ======== ========= =========
Actual income tax expense (benefit) for the years ended December 31, differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to pretax income (loss) from operations as a result of the following:
2000 1999 1998 -------- --------- -------- Computed "expected" tax expense (benefit).... $376,335 $(701,969) $569,162 Increase in income tax expense (benefit) resulting from state and local taxes, net of federal income tax benefit.............. 61,985 (115,618) 93,744 Change in beginning of the year balance of the valuation allowance for deferred tax asset, allocated to income tax expense..... -- -- (50,000) Other, net................................... 14,680 (25,413) 94 -------- --------- -------- Total income tax expense (benefit)........... $453,000 $(843,000) $613,000 ======== ========= ======== Effective tax rate (%)....................... 41 41 37 ======== ========= ========
F-14 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 Deferred tax assets and liabilities at December 31 are comprised of the following:
2000 1999 -------- -------- Deferred tax assets: Accounts receivable, principally due to allowance for doubtful accounts....................... $ 19,538 $ 19,508 Deferred compensation................................. 22,588 43,089 Loss carryforward..................................... 79,000 429,497 Property, plant and equipment depreciation............ 3,793 1,043 Hawaii settlement..................................... 166,344 247,580 Vacation expense...................................... 55,195 54,765 Stock bonus........................................... 10,748 20,146 Loan facility fee..................................... 5,950 7,933 -------- -------- Total gross deferred tax assets..................... 363,156 823,561 Deferred tax liability Retainage, due to deferral for tax reporting........ 15,278 22,683 -------- -------- Net deferred tax asset.............................. $347,878 $800,878 ======== ========
In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company believes their future taxable earnings will be sufficient to support the recognition of deferred tax assets. As of December 31, 2000, the Company has net operating losses available to offset future taxable income of approximately $230,000. Such carry forwards expire in 2019. (8) STOCKHOLDERS' EQUITY (A) PREFERRED STOCK On October 29, 1992, the Company issued 714,285.71 shares of its Series A Convertible preferred stock at its par value of $3.50 per share. Proceeds from the issuance were $2,500,000. Costs of issuance were $264,326, and were netted against the proceeds of the offering. This stock had a redemption provision, which was exercisable at the option of the shareholder for $3.50. On March 10, 1993, an amendment to the original Stock Purchase Agreement dated October 29, 1992 was signed. The effective date of the amendment was October 29, 1992 and the agreement removed the redemption option and increased the dividend rate to the preferred stockholders beginning on October 1, 1997 as noted below. In addition, the preferred shareholders have a right and option to require the Company to buy back the preferred shares at a price of $5.60 per share upon a greater than fifty percent change in the ownership of the Company's common stock. Also, the Company has the right and option, anytime after October 30, 1997, to purchase no less than all of the preferred shares at the liquidation value of $3.50 per share plus any accrued and unpaid dividends. Each share of preferred stock may be converted at any time into common stock, on a basis of four shares of preferred stock for one share of common stock and the holders of preferred stock are entitled to one vote per four shares on all matters on which stockholders are entitled to vote, including the election of Directors. As long as there are at least 238,071 shares of preferred stock outstanding, the holders thereof are entitled as a class to elect one member of the Board of Directors. The F-15 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 affirmative vote of a majority of the issued and outstanding shares of preferred stock is required: (i) for the issuance of a class of equity securities with dividend rights superior to the preferred stock; (ii) for the Company to engage in any transaction that would materially impair the rights of the preferred stock; (iii) for the Company to declare, pay or otherwise distribute any dividends except out of retained earnings of the Company; (iv) to increase or decrease the size of the Company's Board of Directors (v) or to issue Common Stock or rights to purchase common stock to officers, employees, directors or consultants of the Company if the total number of shares held by such persons would exceed 10% of the issued and outstanding shares of Common Stock after giving effect to such issuance. Until September 30, 1997, the holders of preferred stock were entitled to receive dividends at the rate of 7.5% per share per annum payable quarterly in arrears commencing on December 31, 1992. Effective October 1, 1997, the dividend rate became the prime rate of interest as of the first business day following the end of the quarter, plus five (5) percent. The Company is required to pay such dividends before any dividends may be declared or paid for any of the common stock. In the event the Company shall be in arrears in whole or in part with respect to at least three quarterly dividend payments due to holders of preferred stock, such holders voting as a class are entitled to elect two members of the Board of Directors. Accrued and unpaid dividends as of December 31, 2000 were $1,473,612, which equals $2.06 per share of outstanding preferred stock. (B) COMMON STOCK WARRANTS Warrants to purchase 3,750 shares of the Company's common stock at an exercise price ranging from $12.00-$18.00 per share were authorized and issued April 14, 1995. These warrants expired on April 14, 2000. Warrants to purchase 10,000 shares of the Company's common stock at an exercise price of $16.00 per share were authorized and issued in 1993. At December 31, 2000 all of these warrants remain outstanding and are exercisable until November 23, 2003. Warrants to purchase 11,500 shares of the Company's common stock at an exercise price of $4.50 per share were authorized and issued in 1998 to one of the Company's secured lenders. At December 31, 2000 all of these warrants remain outstanding and are exercisable until September 20, 2003. (C) STOCK OPTION PLANS The Company's Board of Directors and stockholders adopted the Company's Incentive Stock Option Plans (the "Stock Option Plans") on April 1, 1993 and April 25, 1994, respectively. Options granted under the Stock Option Plans are intended to qualify as incentive options under Section 422(a) of the Internal Revenue Code of 1986, as amended. The Board of Directors administers the Stock Option Plans. Subject to certain limitations, the Board of Directors has authority to determine the exercise prices, vesting schedules and terms of the options. The maximum term of any option outstanding is ten years. The exercise price of options granted pursuant to the Stock Option Plans may not be less than the fair market value of the Common Stock on the date of grant. The exercise price of options granted to any participants who own stock possessing more than 10% of the total combined voting power of all classes of outstanding stock of the Company must be at least equal to 110% of the fair market value of the Common Stock on the date of grant. Any options granted to such participants must expire within F-16 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000, 1999 AND 1998 ten years from the date of grant. Stock options under the Stock Option Plans are not transferable, except by estate succession. In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting and Disclosure for Stock Based Compensation," which provides for a fair value based methodology of accounting for all stock option plans. The Company applies APB Opinion 25 and related interpretations in accounting for these plans. Since options were granted at fair market value at date of grant, no compensation cost has been recognized. Had compensation cost been determined pursuant to SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been adjusted to the pro forma amounts indicated in the table below. The effects on pro forma net income (loss) obtained from applying SFAS No. 123 may not be representative of the effects on reported net income (loss) for future years.
2000 1999 -------- ----------- Net income (loss): As Reported $653,868 $(1,221,615) Pro Forma 583,255 (1,299,742) Net income (loss) per As Reported $ 0.37 $ (1.96) share: Pro Forma 0.28 (2.06)
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2000 and 1999, respectively; no dividend yield; expected volatility of 77.3% and 81.9%; risk-free interest rate of 5.4% and 5.1%; and expected lives of five years. The weighted-average fair market value of options granted during 2000 and 1999 was $1.60 and $2.70, respectively. F-17 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (8) STOCKHOLDERS' EQUITY (CONTINUED) A summary of the status of the Company's stock option plans as of December 31, 2000, 1999 and 1998 and changes during the years on those dates is presented below:
2000 1999 1998 ------------------- ------------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE -------- -------- -------- -------- -------- -------- Outstanding at beginning of year....... 215,285 $2.57 252,440 $2.66 136,225 $1.64 Granted................................ 75,000 2.39 53,000 3.93 131,410 3.65 Cancelled.............................. -- -- -- -- -- -- Exercised.............................. (29,600) 1.90 (14,200) 2.57 (6,275) 2.05 Forfeited.............................. (40,230) 4.00 (75,955) 3.80 (8,920) 2.59 ------- ------- ------- Outstanding at end of year............. 220,455 2.34 215,285 2.57 252,440 2.66 ======= ======= ======= Exercisable at year end................ 135,328 -- 113,379 2.04 80,750 1.88 ======= ======= =======
The following table summarizes information about the Company's stock options, considered compensation under SFAS 123, outstanding at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------- ------------------- NUMBER WEIGHTED AVG NUMBER OUTSTANDING REMAINING EXERCISABLE EXERCISE PRICE AT DEC 31, 2000 CONTRACTUAL LIFE AT DEC 31, 2000 -------------- ---------------- ---------------- ------------------- $1.500.......................................... 29,450 5.9 29,450 1.594.......................................... 51,000 10.0 -- 1.750.......................................... 32,750 6.3 32,750 2.000.......................................... 21,125 5.9 21,125 3.000.......................................... 38,880 7.4 24,253 3.125.......................................... 18,750 7.1 12,500 3.188.......................................... 2,500 7.9 1,250 3.250.......................................... 6,000 8.9 1,500 4.125.......................................... 10,000 8.6 2,500 4.625.......................................... 7,500 9.2 7,500 4.688.......................................... 2,500 9.2 2,500 ------- ------- 220,455 135,328 ======= =======
At December 31, 2000, 1999, and 1998, common shares reserved for issuance under the Company's Incentive Stock Option plan was 275,000, 275,000 and 275,000, respectively. At December 31, 2000, 1999 and 1998, common shares available under the Non-Employee Director Option Plan were 50,000 for each of the years. Each director will be awarded 2,500 options, each year in January, for a maximum of 10,000 options per Director. F-18 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (9) COMMITMENTS The Company has a profit sharing plan under which all full-time employees with at least one year of service with the Company are eligible to participate. The Board of Directors administers the profit sharing plan and establishes the formula for each year's distributions. Distributions for each calendar year are made in the following year to eligible employees who were employed for the full previous calendar year. There was no profit sharing plan expense for the years ended December 31, 2000, 1999 and 1998. The Company sponsors a 401(k) Plan Trust in which all employees are eligible to participate. Participants can contribute up to 15% of total compensation subject to the annual Internal Revenue Service dollar limitation. Effective January 1, 1999 the Company elected to match 50% of employee contributions, up to 3% of each employee's annual total compensation. Company matching contributions vest ratably over 5 years. The Company's matching contributions totaled approximately $70,000 for the year ended December 31, 2000. Pursuant to a consulting agreement and a deferred compensation agreement with the former Chairman, the Company agreed to pay $48,000 per year for a fixed number of consulting hours, and also fund $60,000 per year to a non-qualified deferred compensation plan. The original term for the consulting agreement was seven years and eight years for the deferred compensation agreement. Effective September 1995, the consulting agreement was amended to eliminate the required consulting payments of $48,000 per year. The payments to the deferred compensation agreement will remain at $60,000 per year through the end of 2001. Accordingly, in the third quarter of 1995, the Company was required to record a liability and a related expense of approximately $245,000 for the present value of the deferred compensation payments, which will be paid at $5,000 per month through the end of 2001. (10) CONCENTRATION OF REVENUE During 2000, 1999 and 1998 the Company had the following sales from customers whose individual sales exceeded 10% of the Company's total sales:
2000 1999 1998 ----------- ---------- ---------- Rhode Island DHS........................................ $ 6,153,693 $5,617,033 $5,361,955 Maine Dept of Human Services............................ 2,293,745 2,111,323 2,651,893 Rhode Island DCYF....................................... 1,472,244 MIM Corporation......................................... 266,103 798,926 1,188,327 ----------- ---------- ---------- $10,185,785 $8,527,282 $9,202,175 =========== ========== ==========
(11) LITIGATION As of December 31, 2000, the Company was not involved in any litigation. On November 12, 1996, the State of Hawaii filed a lawsuit against the Company and Aetna Casualty and Surety and Federal Insurance Company for damages due to an alleged breach of a child support enforcement ("CSE") contract between the Company and the State of Hawaii. The Company denied the State's allegation and filed a counter-claim alleging the State of Hawaii breached the contract. In addition, on December 13, 1996, Covansys (formerly known as Complete Business F-19 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (11) LITIGATION (CONTINUED) Solutions, Inc.) filed a lawsuit against the Company seeking damages relating to Covansys subcontract with the Company to the Hawaii CSE contract. The Company disputed Covansys claims and filed a number of counterclaims. On February 3, 1997, the Company filed a third-party complaint against MAXIMUS Corporation, Hawaii's contract supervisor and advisor on the Hawaii CSE contract, alleging, among other things, that MAXIMUS tortiously interfered in that contract. On May 11, 1999, the Company reached a settlement agreement to end its lawsuits with the State of Hawaii and Covansys. Per the settlement, the Company agreed to pay the State of Hawaii $1 million over four years and received $300,000 from Covansys. As of the date of this filing, the Company has paid $500,000 to the State of Hawaii. The settlement resulted in a one-time charge to pre-tax earnings during the period ending June 30, 1999 of $3.1 million ($1.9 after-tax) which included the write-off of Hawaii related receivables, work in process and liabilities. On October 29, 1999, MAXIMUS agreed to pay the Company $50,000 in exchange for dismissal of the Company's third-party complaint. (12) LITIGATION SETTLEMENT On May 11, 1999 the Company announced it had entered into a settlement agreement with the State of Hawaii and Covansys. See Note 11--Litigation. Prior to the settlement, the Company had assets related to the Hawaii project of $3.46 million and liabilities of $856,000. After tax considerations are taken into effect, the settlement will result in a reduction of net assets of $1.85 million. The effect of the settlement on net income for the twelve months ended December 31, 1999 was as follows: Write off of contract receivables and costs in excess of billings on Hawaii contract............................... $(3,459,382) Present value of litigation settlement...................... (868,957) Payment received from CBSI.................................. 300,000 Payment received from MAXIMUS............................... 50,000 Hawaii payable.............................................. 576,483 Capital leases, short and long term portion................. 57,994 Other accrued expenses...................................... 217,197 ----------- Decrease in income before income taxes...................... (3,126,665) Income tax effect........................................... 1,281,933 ----------- Decrease in net income...................................... $(1,844,732) ===========
F-20 NETWORK SIX, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2000, 1999 AND 1998 (13) QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of quarterly results from operations:
QUARTER ------------------------------------------------- FIRST SECOND THIRD FOURTH ---------- ---------- ---------- ---------- 2000: Contract revenue earned....................... $2,856,038 $3,004,373 $2,619,519 $2,528,228 Gross profit.................................. 1,072,509 1,044,660 859,958 873,210 Net income.................................... 200,384 137,074 100,779 215,631 Earnings per share............................ 0.15 0.06 0.01 0.15 Weighted average shares outstanding........... 795,725 819,284 825,584 813,841 1999: Contract revenue earned....................... $2,688,400 $2,550,370 $2,575,192 $2,411,718 Gross profit.................................. 1,113,878 985,142 942,544 1,005,828 Net income (loss)............................. 257,198 (1,712,238) 149,727 83,700 Earnings (loss) per share..................... 0.23 (2.27) 0.09 0.00 Weighted average shares outstanding........... 774,975 788,573 792,881 794,123
F-21