-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JZRaRV+zwqD42KFeMwBg8YFVas8hHgpSY7EiP1MNbP2+DAO9Mn3/G2h+SOJAhDt2 TzeyVjfYvCJVV5uuVf06Uw== 0001047469-99-010521.txt : 19990322 0001047469-99-010521.hdr.sgml : 19990322 ACCESSION NUMBER: 0001047469-99-010521 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990319 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NETWORK SIX INC CENTRAL INDEX KEY: 0000726714 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 050366090 STATE OF INCORPORATION: RI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21038 FILM NUMBER: 99568997 BUSINESS ADDRESS: STREET 1: 475 KILVERT ST CITY: WARWICK STATE: RI ZIP: 02886 BUSINESS PHONE: 4017329000 MAIL ADDRESS: STREET 1: 475 KILVERT STREET CITY: WARWICK STATE: RI ZIP: 02886 10-K 1 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, 1998 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. [X] The aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant as of February 26, 1999 (computed by reference to the closing price of such stock on The NASDAQ SmallCap Market) was $3,900,800. As of February 26, 1999, there were 780,160 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 1999 Annual Meeting of Stockholders Part III NETWORK SIX, INC. Form 10-K TABLE OF CONTENTS
ITEM PAGE Part I 1 Business........................................................................................... 3 2 Properties......................................................................................... 10 3 Legal Proceedings.................................................................................. 10 4 Submission of Matters to a Vote of Security Holders................................................ 12 Part II 5 Market for Registrant's Common Equity and Related Stockholder Matters.............................. 13 6 Selected Financial Data............................................................................ 13 7 Management's Discussion and Analysis of Financial Condition and Results of Operation........................................................................... 14 8 Financial Statements and Supplementary Data........................................................ 23 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure........................................................................... 23 Part III 10 Directors and Executive Officers of the Registrant................................................. 23 11 Executive Compensation............................................................................. 23 12 Security Ownership of Certain Beneficial Owners and Management..................................... 24 13 Certain Relationships and Related Transactions..................................................... 24 Part IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.................................... 24 Signatures......................................................................................... 27
2 PART I ITEM 1. BUSINESS. GENERAL Network Six, Inc. is a systems integrator and provider of software, information technology consulting and network services to government and industry. Incorporated in 1976 under the name National E-F-T, Inc., the Company has historically focused on providing its services to state government human services agencies. In 1998, substantial portions of its revenues were derived from contracts with such agencies. The Company today also targets its marketing activities to many government agencies other than human service agencies, as well as higher education and network services. 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. 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; 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. 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 HUMAN SERVICES AGENCY MARKET State government 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, must maintain extensive records, and they are being required to increase the capacity and enhance the capabilities of their information systems as 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 obsolete and have limited data interfacing capabilities. Moreover, the states often require 3 them to do more with less. 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 previous welfare programs of AFDC and Jobs Opportunities and Basic Skills (JOBS) program which have been combined into the TANF (Temporary Assistance to Needy Families) and together with the food stamp program; (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 that 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 that state CSE systems, in order to receive federal funding, to meet certain federal functional requirements covering case initiation, case management, database linkage, financial management, enforcement, security, privacy, and reporting. Welfare reform has had a major impact on CSE systems as well. Welfare reform mandated: (i) changes to 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) new interstate case processing; and (iv) modification 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 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 and are part of the cost of operating an automated food stamp program. 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. 4 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 were and are generally 50%. Also 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. OTHER 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 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, 1998:
Projected End Date Program FFP% Of Current FFP% - ------- ---- --------------- Temporary Aid to Needy Families Varies* None* Food Stamps 50% None CSE 66%-90% September 30, 1999** Medicaid 50% None Medicaid/Managed Care 50-90% Varies by program component Child Welfare 50%-75% None Other Human Services Systems Varies Varies by program component
* 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 the U.S. Congress. 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 5 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, 1998 relating to the Company's significant contracts with state agencies since December 1994:
State Program Area Project Contract Date Status - ----- ------------ ------- ------------- ------ U.S. Virgin Islands CSE Transfer system December 1994 In process Idaho CSE Support services May 1995 Completed Rhode Island TANF/CSE Support services July 1995 In process Rhode Island Dept. of Health Develop new system May 1996 In process Maine Child Welfare Transfer system April 1997 Completed MACWIS warranty phase Maine Child Welfare Support services April 1998 In process MACWIS
CONTRACT PROCESS. Because most human services agency contracts involve federal funding, they originate with a federally required Advanced Planning Document (APD) submitted by the 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 $50,000 and $150,000, 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 as between technically acceptable proposals. Contract award generally occurs approximately 12 months after issuance of the RFP. 6 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 - managing the system. As a result, the services provided in performing a contract are not technically complex, but 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 24 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 information systems currently being installed have a useful technological life of approximately five years and that the systems require revisions every year to keep up with changing legislation, regulation, and its needs. TERMINATION. As with government contracts generally, the Company's contracts with state human services agencies may be terminated upon relatively short notice, 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. HIGHER EDUCATION The Company has included Higher Education as a market focus. At a local university, the Company is working on a number of initiatives that fall under the Strategic IT Planning umbrella. In addition to assisting the university in building a comprehensive Strategic IT Plan, the Company has been working on components of this plan, including Administrative Department Assessments, Administrative Systems Planning, and Year 2000 planning and remediation. The Company views its relationship with this customer as a true partnership and looks forward to continued successes in helping them meet their goals 7 and objectives. The Company is working to expand the education client base. The education market is ever evolving and is demanding more and more IT resources. The Company can help these institutions meet their needs for new and existing systems initiatives. Our qualifications as a successful systems integrator, with seasoned IT professionals from a variety of disciplines, allows us to offer real value to this market. Our success is a reflection of the value we can offer, and we will continue to pursue opportunities for market sector growth. NETWORK SERVICES The Company's network services practice continues to grow. Since 1997, the Company has added many new accounts including private sector companies, cities, towns, and local colleges. In addition, the Company provides network services for current Company customers as well as for the Company offices. Highlights of 1998 projects include work for several municipalities and higher education customers as well as private and non-profit sector customers. During 1998, the Company planned and implemented a Windows NT WAN/LAN for a non-profit center involving two primary locations made up of a total of five buildings. Work on the project included hardware and software procurement and installation, as well as electronic messaging, Internet access, remote dial-in access, anti-virus, system back-up and support services. The Company also planned and implemented Windows NT wide-area and local-area networks for different municipalities. Work included hardware and software procurement and installation, as well as the installation of the Microsoft Exchange messaging System. The Company has also done work for several area colleges and universities. It conducted a high-level assessment of a university's network infrastructure as part of a larger consulting project. The infrastructure assessment involved a review of the university's Help Desk services, infrastructure documentation, disaster recovery plan, network security, system procedures and MIS organizational structure. The review concluded with a report on the findings and recommendations for improvements. The Company was also selected by another college to provide desktop PC configuration and troubleshooting services. The project involved the configuration of over 350 new Dell computers for use in administrative and academic areas. The Company has also provided network support to several private sector companies. The projects include migrating an existing Novell NetWare LAN to a Windows NT network, providing help desk support, and other network services. COMPETITION The Company operates in a highly competitive market. The Company's competitors for state human services agency contracts include firms such as Andersen Consulting, Unisys, DRC, American Management Systems, BDM International (now part of TRW) and Deloitte & Touche. These competitors have substantially greater financial, technical, and marketing resources than those of the Company. 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, flexibility and price. 8 With respect to other State agencies, non-profits and private sector, there are numerous companies that provide software and system development and information technology services. None, however, dominates the market. The network services market is relatively young and has many companies competing for various business opportunities. 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/contingent upon state or federal funding. The Company does not believe that contracts for work outstanding at any particular time provide a meaningful indication of future revenue. At December 31, 1998, the Company had the following contracts to provide services which, if fully performed, would result in the revenues shown:
Contract Contract Revenues Backlog Contract Title Amount(1) Earned Thru 12/31/98 as of 12/31/98(2) -------------- ----------- -------------------- ----------------- Rhode Island CSE $ 1,859,426 $ 1,701,523 $ 157,903 Rhode Island Support 5,307,043 2,828,601 2,478,442 U.S. Virgin Islands 5,879,074 5,533,718 345,356 Rhode Island Dept. of Health 2,008,788 1,729,665 279,123 Maine Child Welfare (MACWIS) (3) 9,346,858 8,369,380 977,478 MIM Corporation (4) 1,311,897 1,188,327 123,570 Others 157,600 129,514 28,086 ------------- ------------------- ----------------- Totals $ 25,870,686 $ 21,480,728 $ 4,389,958 ------------- ------------------- ----------------- ------------- ------------------- -----------------
(1) Contract amounts for certain of 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, 1998 will be realized by the end of 1999. 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. (3) This includes both the transfer and support services contracts. (4) The Company has been doing time and materials consulting for MIM Corporation since January 1998. The Company entered into a one-year support contract with them in March 1999. 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. 9 As of December 31, 1998, 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 $186,000 that expires on October 31, 2000. The Company also leases 3,600 square feet in Augusta, Maine to support project activities. This lease expires June 30, 1999. The Company believes that these offices are adequate for its current and near term needs. ITEM 3. LEGAL PROCEEDINGS In June 1995, the Company began negotiating a significant amendment to its contract for a child support enforcement ("CSE") system with the State of Hawaii (the State) when it determined that the total estimated cost to complete the system would be significantly greater than expected. In March 1996, the Company received final State and federal government approval for this contract amendment totaling $4.4 million. As a result of numerous in-depth reviews of this contract amendment, management determined that remaining contract costs would exceed the contract value by $440,000, and therefore, accrued this loss in December 1995. In June 1996 the Company announced a new subcontract agreement with Complete Business Solutions, Inc ("CBSI") to expand CBSI's role in the Hawaii CSE contract. CBSI, at the request of Hawaii, was contracted to lead a detailed review of the current system under development. Hawaii, in turn, agreed to pay CBSI $1.2 million from the Company's remaining contract budget when various milestones were achieved. The Company had a significant role in the detailed review and had hoped that its results would facilitate the resolution of open contractual scope issues. On September 13, 1996, the State of Hawaii terminated its contract with the Company, effective September 23, 1996, claiming that the Company had failed to fulfill its obligations under the contract. In response, the Company also terminated the contract with the State effective September 23, 1996. The Hawaii contract, originally estimated to be a $20.7 million contract, was increased to $25.2 million by the State and the Company in February 1996, and was the Company's largest contract at the time. Prior to termination, approximately $16.5 million of costs had been incurred towards completion of the contract, and $11 million had been billed and substantially paid. On November 12, 1996 the State of Hawaii filed a lawsuit in the Circuit Court of the First Circuit of the State of Hawaii against the Company and Aetna Casualty and Surety and Federal Insurance Company for damages due to breach of contract (the "Hawaii litigation"). Aetna Casualty and Surety and Federal Insurance Company provided the $10.3 million performance bond on the Company's contract with the State of Hawaii to develop and install the State's child support enforcement system. The suit alleges the Company failed to meet contractual deadlines, provided late, incomplete and/or unsuitable deliverables, materially breached the contract by never completing the design, the application programming, and the system test and systems implementation. The State is seeking an unspecified amount for general damages, consequential and special damages, liquidated damages, attorneys' fees, reimbursement for the cost of the suit and interest costs that the court deems just and proper. 10 The Company vigorously denies the State's allegation and, on January 23, 1997, filed a counter claim against the State alleging that the State has breached the contract. The Company is seeking $70 million in damages and is alleging that the State fraudulently induced the Company into designing and building a system having capabilities and features far beyond the scope of the Company's contract. The fraudulent inducement was in the form of withholding payments, improper rejection of work that satisfied the requirements of the contract and verbal and written abuse of the Company's employees and management. In addition, Unisys, a vendor providing equipment under the Company's Hawaii contract, submitted a $896,000 claim against the $10.3 million performance bond. In February of 1997, the State released all but $1.1 million of the performance bond; the remainder is intended to cover amounts payable to Unisys and other subcontractors. In April of 1997, after a detailed review of their records and discussions with the Company, Unisys agreed to lower their claim to $859,602 and Aetna Casualty and Surety paid that claim. Lockheed Martin IMS (Lockheed), who guaranteed the performance bond, reimbursed Aetna for that claim. In December 1997, the Company reached an agreement with Lockheed to repay the $859,602 over a five-year period. On December 13, 1996 CBSI filed a lawsuit in the Superior Court of the State of Rhode Island for $517,503, which the Company had previously accrued, plus interest, costs and attorney's fees. The Company disputes the $517,503 owned to CBSI and filed a counterclaim against CBSI on January 13, 1997 alleging, among other things, that CBSI failed to complete its duties required under the subcontract with the Company in a timely manner, improperly engaged in negotiations with the State of Hawaii to complete the project, hired and attempted to hire employees of the Company in violation of its subcontract agreement with the Company and obtained and utilized confidential information and proprietary intellectual property inappropriately. Also, the Company alleges that CBSI owes the Company $482,750 as of December 31, 1996 for which the Company has not established a reserve for uncollectibility. On February 3, 1997, the Company filed a third-party complaint ("TPC") as part of the Hawaii litigation against MAXIMUS Corporation ("MAXIMUS") and CBSI. MAXIMUS has been the State of Hawaii's contract supervisor and advisor since the inception of the Hawaii project. The allegations the Company has made against CBSI in this TPC are substantially similar to the allegations made against CBSI in the Company's counterclaim to CBSI's December 13, 1996 lawsuit brought against the Company in Rhode Island. The Company alleged, moreover, that MAXIMUS is liable to the Company on grounds that: (i) the Company was an intended third party beneficiary under the contract between the MAXIMUS and Hawaii; (ii) MAXIMUS tortuously interfered in the contract between the Company and Hawaii; (iii) MAXIMUS negligently breached duties to the Company, and (iv) MAXIMUS aided and abetted Hawaii in Hawaii's breach of contract. The Company's complaint seeks $70 million in damages. In connection with the Hawaii litigation the Company was ordered to assign all Hawaii related leases to the State. One of the lessors has sued the Company for failure to pay. The Company believes it was released of all responsibility on the lease per the court order. Management believes that the Company's claims against the State, MAXIMUS and CBSI have substantial merit and will vigorously pursue these claims. There is substantial uncertainty, however, inherent in all litigation. If the Company were not to prevail in its suit with the State, such a result could have a material adverse financial effect on the Company and could jeopardize the Company's ability to 11 continue with its present listing on The NASDAQ SmallCap Market. Management of the Company and its attorneys are unable to predict with any certainty the ultimate outcome of this litigation, although it is their belief that a unfavorable outcome is unlikely. At December 31, 1998, the Company had unbilled work-in-process and related receivables from the State and CBSI of approximately $3.46 million, which is slightly less than stockholders' equity of approximately $3.8 million, for which no allowance for uncollectibility has been recorded. The Company has not accrued for any potential liability to the State, which may result from this litigation. In addition, the Company has not accrued for any legal expense to be incurred in connection with this litigation, which could be significant. Due to the significant uncertainty created by these events, the Company ceased recognition of revenue on the Hawaii contract in 1996. An adjustment of $1.8 million was recorded in the fourth quarter to reverse revenue of $1 million, $400 thousand and $400 thousand previously in the first, second and third quarters, respectively. In addition, 1996 costs incurred related to the Hawaii contract of $1.96 million have been charged to expense. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 12 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. The following table sets forth the high and low sales prices of the Company's Common Stock as reported on The NASDAQ National Market prior to October 29, 1998 thereafter on the NASDAQ SmallCap Market.
HIGH LOW 1998 First Quarter $ 5.38 $ 2.75 Second Quarter 6.00 3.38 Third Quarter 9.75 3.19 Fourth Quarter 5.25 2.94 1997 First Quarter $ 2.88 $ 0.88 Second Quarter 2.13 1.25 Third Quarter 3.00 1.75 Fourth Quarter 3.88 2.25
As of December 31, 1998 there were 302 holders of record of the Common Stock, representing approximately 391 beneficial owners. The last reported sale price for the Common Stock, as reported on The NASDAQ SmallCap Market on February 26, 1999 was $5.00 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 required to be paid 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, 1998 are derived from the Company's audited financial statements. 13 INCOME STATEMENT DATA:
YEAR ENDED DECEMBER 31, 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Contract revenue earned $ 10,399,979 $ 11,460,437 $ 7,344,380 $ 20,985,012 $ 21,210,878 Cost of revenue earned 6,418,678 8,620,097 7,359,649 19,299,944 13,768,838 ------------ ------------ ----------- ------------ ------------ Gross profit (loss) 3,981,301 2,840,340 1,685,068 7,442,040 (15,269) Selling, general and administrative expense 2,260,418 2,071,294 2,240,073 4,369,260 3,700,789 Research & development expense 185,235 - - - - Restructuring expense (119,436) 537,221 - - - Income (loss) from operations 1,720,883 769,046 (2,135,906) (3,406,648) 3,741,251 Income (loss) before income taxes 1,674,006 534,950 (2,533,368) (3,792,521) 3,574,612 Net income (loss) 1,061,006 406,950 (1,758,345) (2,427,440) 2,109,020 Net income (loss) per share Basic 0.96 0.25 (2.71) (3.68) 2.79 Diluted 0.96 0.25 (2.71) (3.68) 2.39 Shares used in computing net income (loss) per share Basic 758,547 729,927 719,317 709,841 689,587 Diluted 758,547 729,927 719,317 709,841 883,184
BALANCE SHEET DATA:
YEAR ENDED DECEMBER 31, 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- Working capital $ 1,416,200 $ 22,117 $(1,073,671) $(2,075,339) $ 6,266,622 Hawaii contract receivables* 3,459,382 3,459,382 3,571,824 5,711,022 3,691,048 Total assets 8,700,782 9,292,103 8,273,564 14,945,273 11,930,399 Long-term obligations 1,156,812 1,422,725 235,479 254,393 158,038 Total stockholders' equity 3,808,883 2,955,420 2,748,777 4,644,494 6,914,434
* See Note 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 conditions 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. 14 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 results and regulatory and state funding changes could cause results to differ materially from any that may be expected. In particular, adverse decisions in on-going material litigation could have a material adverse effect on the Company's financial condition and operating results. See Item 3 - Legal Proceedings. 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 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 human services agencies. Commencing in 1998, the Company began targeting its marketing efforts at other state government agencies as well as non-for-profit organizations and the private commercial sector. In January 1998 the Company announced a new $1.5 million line of credit (See "Liquidity and Capital Resources") and the change of its independent auditors from KPMG LLP to Sansiveri, Kimball & McNamee L.L.P. The Company also announced an extension of the child support enforcement contract with the U.S. Virgin Islands and a contract to assist MIM Corporation with the development of a pharmaceutical benefits management system. On October 29, 1998 the Company's stock was transferred from the NASDAQ National Market and moved to The NASDAQ SmallCap Market. The Company received comments on January 30, 1998 from the Securities and Exchange Commission regarding the timing of revenue recognition with regard to the Company's contract with the State of Hawaii during 1996 and whether an allowance should be taken by the Company against the contract receivable relating to that contract ($3,459,382 at December 31, 1998). The Company believes that, although the outcome of the Company's litigation with the State of Hawaii is uncertain (see Item 3 - Legal Proceedings), it is likely to prevail in the Hawaii litigation and therefore the Company is not required to take an allowance against that receivable. In April 1998 the Company announced the extension of its contract with the State of Rhode Island, Department of Human Services, to support the InRHODES system. The contract has been extended through June 30, 1999. The contract extension is valued at approximately $2.8 million. InRHODES is a comprehensive computer system that integrates data and functions for the Family Independence Program, Food Stamps, Child Support Enforcement, Medicaid Eligibility and General Public Assistance programs. 15 In May 1998, the Company announced a three-month support contract with the State of Maine, Department of Human Services, for the child welfare system known as MACWIS that the Company recently developed and implemented followed by a one-year support contract valued at $1.8 million. The $1.8 million contract was signed in June 1998 and subsequently increased to $1.9 million. In May 1998 director Dana Gaebe decided not to run for re-election to the Board of Directors. The Company wishes to thank Mr. Gaebe for his twenty-two years of service as a Board member. In September 1998, the Company announced it had entered into a $250,000 term loan with the Business Development Corporation of Rhode Island and a $250,000 term loan with the Small Business Loan Fund Corporation, a subsidiary of the Rhode Island Economic Development Corporation. See Liquidity and Capital Resources. In December 1998, the Company announced that Mr. Ralph O. Cot, formally an executive with Commercial Union, a global insurance provider, had joined the Board of Directors. In January 1999, the Company announced that the State of Rhode Island, Department of Administration, had increased its contract with the Company for an additional $2.5 million for enhancing the State's InRHODES computer system. This brings the total value of the Company's support contract with the State of Rhode Island for InRHODES-related work to $5.3 million. In February 1999 the Company announced that Dr. Samara H. Navarro, formally Deputy Commissioner, Department of Children and Families, State of Florida, joined the Company as Vice President of Governmental Services. YEAR 2000 DISCLOSURE The Year 2000 issue concerns the inability of information systems, primarily computer software programs, to recognize properly and process date sensitive information subsequent to December 31, 1999. The Company has committed resources (approximately $50,000) over the past six months to improve its information systems ("IS project"). The Company has used this IS project as an opportunity to evaluate its state of readiness, estimate expected costs and identify and quantify risks associated with any potential year 2000 issues. State of Readiness: In evaluating the Company's exposure to the year 2000 issue, management first identified those systems that were critical to the ongoing business of the Company and that would require significant manual intervention should those systems be unable to process dates correctly following December 31, 1999. These systems were the Company's internal time tracking system and internal administrative system. Once these systems were identified, the following steps were identified as those that would be required to be taken to ascertain the Company's state of readiness: I. Obtaining letters from software and hardware vendors concerning the ability of their products to properly process dates after December 31, 1999; II. Testing the operating systems of all hardware used in the Company, and internal administration systems to determine if dates after December 31, 1999 can be processed correctly; III. Surveying other parties who provide or process information in electronic format to the 16 Company as to their state of readiness and ability to process dates after December 31, 1999; and IV. Testing the identified information systems to confirm that they will properly recognize and process dates after December 31, 1999. The Company anticipates completion of Step I - Step IV above for all material software and hardware by the end of June 1999. Any software or hardware determined to be noncompliant will be modified, repaired or replaced. The Company estimates the costs of such modifications, repairs and replacements to be $100,000 at this time. Costs: As noted above, the Company spent approximately $50,000 over the past six months to improve its information systems. In addition, the Company anticipates that it will spend approximately $50,000 over the next 12 months to further improve its information systems. Risks: Effective August 4, 1998, the Securities and Exchange Commission issued Release No. 33-7558 (the "Release") in an effort to provide further guidance to reporting companies concerning disclosure of the year 2000 issue. In this Release, the Commission required that registrants include in its year 2000 disclosure a reasonable description of its "most reasonably likely worst case scenario." Based on the Company's assessment and the results of remediation performed to date as described above, the Company believes that all problems related to the year 2000 will be addressed on a timely basis so that the Company will experience little or no disruption in its business immediately following December 31, 1999. However, if unforeseen difficulties arise, or if compliance testing is delayed or necessary remediation efforts are not accomplished in accordance with the Company's plans described above, the Company anticipates that its "most reasonably likely worst case scenario" (as required to be described by the Release) is that some percentage of the Company's time tracking related to contract labor costs would need to be processed manually for some limited period of time. In addition, the Company anticipates that all businesses (regardless of their state of readiness), including the Company, will encounter some minimal level of disruption in its business (e.g., phone and fax systems, alarm systems, etc.) as a result of the year 2000 issue. However, the Company does not believe that it will incur any material expenses or suffer any significant loss of revenues in connection with such minimal disruptions. Contingency Plans: As discussed above, in the event of the occurrence of the "most reasonably likely worst case scenario" the Company could hire an appropriate level of temporary staff to manually assist with the time tracking process. Forward Looking Statements: Certain information set forth above regarding the year 2000 issue and the Company's plans to address those problems are forward looking statements under the Securities Act and the Exchange Act. See the second paragraph of Management's Discussion and Analysis of Financial Condition and Results of Operations for a discussion of forward-looking statements and related risks and uncertainties. In addition, certain factors particular to the year 2000 issue could cause actual results to differ materially 17 from those contained in the forward looking statements, including, without limitation: failure to identify critical information systems which experience failures, delays and errors in the compliance and remediation efforts described above, unexpected failures by key vendors, software providers or business partners to be year 2000 compliant or the inability to repair critical information systems. In any such event, the Company's results of operations and financial condition could be adversely affected. In addition, the failure to be year 2000 compliant of third parties outside of our control such as electric utilities or financial institutions could adversely effect the Company's results of operations and financial condition. 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, --------------------------------- 1998 1997 1996 1995 ---- ---- ---- ---- Contract revenue earned 100.0% 100.0% 100.0% 100.0% Cost of revenue earned 61.7% 75.2% 100.2% 92.0% Gross profit 38.3% 24.8% -0.2% 8.0% Selling and administrative expenses 21.7% 18.1% 30.5% 20.8% Research and development expense 0.0% 0.0% 0.0% 0.9% Restructuring 0.0% 0.0% -1.6% 2.6% Income before income taxes 16.1% 4.7% -34.5% -18.1% Net income (loss) 10.2% 3.6% -23.9% -11.6%
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Contract revenue earned decreased $1,060,457, or 9%, from $11,460,437 in the year ended December 31, 1997 to $10,399,980 in the year ended December 31, 1998 primarily due to the completion of the Idaho Child Support Enforcement project in March 1997, and the substantial completion of the Rhode Island Department of Health system (KidsNet) and the Maine Automated Child Welfare Information System (MACWIS) projects. This decrease was offset by increased work on the Rhode Island Department of Human Services contract due to welfare reform, commencement of the MIM Corporation project, and increased business for the Company's Network Services Division. Cost of revenue earned, consisting of direct employee labor, direct contract expense and subcontracting expense, decreased $2,201,419, or 26%, from $8,620,097 in 1997 to $6,418,678 in 1998. 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 $1,140,961 from $2,840,340 in 1997 to $3,981,301 in 1998. Gross profit, as a percentage of revenue was 25% for 1997 and 38% for 1998. This was primarily because of the Company's improved margins on the Maine MACWIS support project over the Maine MACWIS project. Selling, general and administrative expenses increased $189,124, or 9%, from $2,071,294 in 1997 to $2,260,418 in 1998 primarily due to an increase in marketing and related expenses. On a percentage basis, SG&A expenses increased from 18% in 1997 to 22% in 1998, as a percentage of 18 contract revenue earned. Interest expense decreased $140,716 or 53% from $266,030 in 1997 to $125,314 in 1998 due to a lower level of borrowing. As a result of the foregoing, income before income taxes was $1,674,006 in 1998, an increase of $1,139,056 from $534,950 in 1997. Income before income taxes, as a percentage of contract revenue earned increased from 5% in 1997 to 16% in 1998. Net income of $1,061,006 in 1998 represents an increase of $654,056, or 161%, from $406,950 in 1997. As a percentage of contract revenue earned, net income increased from 4% in 1997 to 10% in 1998. The Company's effective tax rate was 24% for 1997 and 37% for 1998. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 Contract revenue earned increased $4,116,057, or 56%, from $7,344,380 in the year ended December 31, 1996 to $11,460,437 in the year ended December 31, 1997 primarily due to the commencement of the Maine Automated Child Welfare Information System (MACWIS) and additional work on the Rhode Island support contract in response to federal welfare reform legislation. This increase was offset in part by the substantial completion of the Idaho and the Virgin Islands Child Support Enforcement (CSE) projects and the West Virginia support project. Cost of revenue earned, consisting of direct employee labor, direct contract expense and subcontracting expense, increased $1,260,448, or 17%, from $7,359,649 in 1996 to $8,620,097 in 1997. This was a consequence of an increased level of effort needed to support the higher level of business. Gross profit increased $2,855,609 from a loss of $15,269 in 1996 to $2,840,340 in 1997. Gross profit as a percentage of revenue was (0.2%) for 1996 and 25% for 1997. The Company's expected lower margin on the Maine MACWIS project, where the Company's subcontractor is playing a significant role, was offset by higher margins on the welfare reform work on the Rhode Island support project. Selling, general and administrative expenses decreased $168,779, or 8%, from $2,240,073 in 1996 to $2,071,294 in 1997 primarily due to a reduction of expense to support the Company's marketing and proposal efforts. On a percentage basis, SG&A expenses decreased from 31% in 1996 to 18% in 1997, as a percentage of contract revenue earned, primarily as a consequence of the Company's efforts to reduce expenses and increase revenues. Interest expense decreased $169,895 or 39% from $435,925 in 1996 to $266,030 due to a lower level of borrowing. As a result of the foregoing, income before income taxes was $534,950 in 1997, an increase of $3,068,318 from a loss of $2,533,368 in 1996. Income before income taxes, as a percentage of contract revenue earned increased from a loss of 34% in 1996 to 5% in 1997. Net income of $406,950 in 1997 represents an increase of $2,165,295 from a net loss of $1,758,345 in 1996. As a percentage of contract revenue earned net income increased from a loss of 24% in 1996 to income of 4% in 1997. The Company's effective tax rate was 31% for 1996 and 24% for 1997. 19 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 expects to continue and expand this practice prospectively as well as to pursue more time and material contracts than it has historically pursued. Time and materials contracts generally do not require performance bonds and almost always involve less risk to deliver what the customer requires. 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. Prospectively, the Company expects to tighten up this timetable, thereby reducing the requirement for additional working capital. 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 $1,066,014, $1,854,052 and $2,230,504 in the years ended December 31, 1998, 1997, and 1996 respectively. Fluctuations in net cash provided by operating activities are primarily the result of changes in net income, accounts receivable and income tax receivable, accounts payable and costs and estimated earnings in excess of billings on contracts due to differences in contract milestones and payment dates. On April 30, 1997 the Company signed a term loan (the "Loan") with its bank which required the Company to reduce its outstanding borrowings under the Loan from $1.8 million to the following limits: October 15, 1997 - $1,500,000, November 15, 1997 - $1,200,000 and December 15, 1997 - $900,000. The interest rate on the Loan was 16%, with the difference between 16% and prime plus 2% payable at maturity, which was January 31, 1998. There were also a number of provisions for accelerated payment to reduce the Loan balance, such as paying the bank 50% of any contract holdbacks or income tax refunds. In addition, the Company agreed to provide the bank with warrants to purchase 50,487 unregistered shares of the Company's Common Stock at $1.75 per share, exercisable immediately with an expiration date of April 30, 2002, and agreed to provide the bank 15% of any recovery received from its litigation in Hawaii. The warrants and the bank's right to a percentage of any recovery would terminate if the Company paid down the Loan completely or raised $1 million of equity capital prior to maturity. The Company's obligations under the Loan were secured by substantially all of the assets of the Company. The Loan also provided that the Company not pay any dividends on its capital stock without the consent of the bank. On January 26, 1998 the Loan was paid in full. As of December 31, 1997, the balance was $1,160,000. The warrants and the bank's right to a percentage of any Hawaii recovery were returned to the Company. On December 31, 1997 the Company signed a $1.5 million line of credit with a commercial lender (the "Line of Credit"). Accounts receivable from four of the Company's contracts secure the new Line of Credit. The Company can borrow up to 80% of the aggregate invoice amounts and is required to repay any borrowings within 90 days. The interest rate is prime plus five percent on balances below $1 million and prime plus one and one half percent on balances over $1 million. The Line of Credit also carries a six- percent annual service fee on borrowed balances. At December 31, 1998 the Line of Credit had an outstanding balance of zero. 20 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. 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 noncurrent assets on the accompanying balance sheet. The Company believes that cash flow generated by operations will be sufficient to fund continuing operations through the end of 1999. This assumes, however, that there are no materially adverse decisions rendered in the ongoing litigation with Hawaii, MAXIMUS and CBSI. See Item 3 - Legal Proceedings. The Company believes that inflation has not had a material impact on its results of operations to date. RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive Income" which established standards for reporting and displaying of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This statement requires that an enterprise classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the equity section of the balance sheet. This statement is effective for fiscal years beginning after December 15, 1997and had no effect on the Company's financial statements for 1997 and 1998. In June 1997, Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information" was issued. This statement requires the use of the "management approach" model for segment reporting. The management approach model is founded upon the way the Company's management organizes segments within the Company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, management structure, or other parameters which management uses to organize a company. The Company is required to adopt this new standard for the year ended December 31, 1998; however, such standard had no effect on the Company's financial statements for 1997 and 1998. In February 1998, Statement of Financial Accounting Standards No, 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" was issued. This statement standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on changes in the benefit calculation, and eliminates certain disclosures that are no longer considered useful. This statement effectively revised guidance previously provided by Statement of Financial Accounting Standards Nos., 87,88 and 106. The Company is required to adopt the new standard for the year ended December 31, 1998; however, such standard had no effect on the Company's financial statements for 1998. 21 In June 1998, Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" was issued. This statement establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that entities recognize all derivatives as both assets and liabilities in the statement of financial position and measure those instruments at fair value. This standard is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. 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. 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 22 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-26 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. On January 6, 1998, the Company engaged the firm of Sansiveri, Kimball & McNamee, L.L.P. ("SKM"), as its auditors. Before the engagement, neither the Company nor anyone on its behalf (i) consulted with the newly engaged accountant regarding the application of accounting principles to a specific completed or contemplated transaction or the type of audit opinion that might be rendered on the Company's financial statements, or (ii) had been provided with advice that was an important factor considered by the Company in reaching a decision as to an accounting, auditing or financial reporting issue. The decision to engage SKM was approved by the Audit Committee of the Board of Directors of the Company. On January 6, 1998, the Company terminated, with the concurrence of its Audit Committee, its relationship with its auditors KPMG LLP ("KPMG"). KPMG included in its Independent Auditors' reports dated March 28, 1997 and April 1, 1996 a statement that the accompanying financial statements had been prepared assuming that the Company will continue as a going concern. In addition, during the audit of the Company's financial statements for the year ended December 31, 1996, KPMG concluded that approximately $1.8 million of revenue recognized on the Company's contract with the State of Hawaii during the first three quarters of 1996 should not have been recognized and should have been reversed in the respective quarters. The Company believes that the revenue was properly and correctly recognized and that there is no reason that it should have known under applicable accounting standards that the revenue should not have been recognized at the time. Moreover, when the Company had reason to know that revenue under the contract should not be recognized because of changed conditions, such revenue was reversed in the fourth quarter of 1996 and for the year ended December 31, 1996. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS. The Company currently intends to include the information required by Item 10 for its 1999 Annual Meeting Proxy Statement ("1999 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 1999 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. 23 The Company currently intends to include information required by Item 12 in the Company's 1999 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 1999 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-26 of this report: Independent Auditors' Report of Sansiveri, Kimball & McNamee L.L.P. Independent Auditors' Report of KPMG LLP Balance Sheets as of December 31, 1998 and 1997 Statements of Operations for the Years Ended December 31, 1998, 1997, and 1996 Statements of Stockholders' Equity for the Years Ended December 31, 1998, 1997, and 1996 Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 Notes to Financial Statements (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 (incorporated by reference from the Company's Form 10, File No. 0-21038) 3.2 Bylaws of the Company as amended (incorporated by reference 24 from the Company's Form 10, File No. 0-21038) 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 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 (incorporated by reference from the Company's Form 10-K, exhibit 10.18, for the fiscal year ended December 31, 1993) 10.7 Contract dated November 10, 1994, between the Company and the Government of the Virgin Islands re CSE transfer system (incorporated by reference from the Company's Form 10-K, exhibit 10.21, for the fiscal year ended December 31, 1994) 10.8 Non-employee Director Stock Option Plan (incorporated by reference from the Company's Form 10-K, exhibit 10.12, for the fiscal year ended December 31, 1996) 10.9 Contract dated May 1996 between the Company and the State of Rhode Island Department of Health re RICAP system (incorporated by reference from the Company's Form 10-K, exhibit 10.13, for the fiscal year ended December 31, 1996) 10.10 Contract dated July 1996 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 10.14, for the fiscal year ended December 31, 1996) 10.11 Contract dated May 1996 between the Company and Complete Business Solutions, Inc. re walk through agreement (incorporated by reference from the Company's Form 10-K, exhibit 10.15, for the fiscal year ended December 31, 1996) 10.12 Employment Agreement between the Company and Mr. 25 Kenneth C. Kirsch dated January 1, 1997 (incorporated by reference from the Company's Form 10-K, exhibit 10.16, for the fiscal year ended December 31, 1996) 10.13 Credit Agreement dated December 31, 1997 between the Company and Prinvest Financial Corporation (incorporated by reference from the Company's Form 10-K, exhibit 10.17, for the fiscal year ended December 31, 1997) 10.14 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) 10.15 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 ended December 31, 1997) 10.16 Credit Agreement dated September 23, 1998 between the Company and Small Business Loan Fund Corporation, a subsidiary of the Rhode Island Economic Development Corporation 10.17 Credit Agreement dated September 23, 1998 between the Company and Business Development Corporation of Rhode Island 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. 23.2 Consent of KPMG LLP (B) REPORTS ON FORM 8-K. A current report on Form 8-K, dated December 1, 1998 was filed by the Company and included the press release dated December 1, 1998 announcing Ralph H. Cote as a new member of the Board of Directors. A current report on Form 8-K, dated November 2, 1998 was filed by the Company and included the press release dated October 29, 1998 announcing the Company's listing on the NASDAQ SmallCap Market. A current report on Form 8-K, dated October 28, 1998 was filed by the Company and included the press release dated October 26, 1998, announcing the Company's results for the quarter ended September 30, 1998. A Statement of Operations (without notes) for the quarters ended September 30, 1998 and, 1997 was included with the filing. A balance sheet as of September 30, 1998 and December 31, 1997 was also included with the filing. 26 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 18th day of March 1999. 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 /s/ KENNETH C. KIRSCH Chairman of the Board, President, March 18, 1999 - ------------------------ and Chief Executive Officer (Principal Kenneth C. Kirsch Executive Officer) /s/ DOROTHY M. CIPOLLA Chief Financial Officer, and March 18, 1999 - ------------------------ Treasurer (Principal Financial Dorothy M. Cipolla and Accounting Officer) /s/ RALPH H. COTE Director March 18, 1999 - ------------------------ Ralph H. Cote /s/ NICHOLAS R. SUPRON Director March 18, 1999 - ------------------------ Nicholas R. Supron /s/ CLIFTON C. DUTTON Director March 18, 1999 - ------------------------ Clifton C. Dutton
27 INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Page ---- Independent Auditors' Report of Sansiveri, Kimball & McNamee L.L.P. F-2 Independent Auditors' Report of KPMG LLP F-3 Balance Sheets as of December 31, 1998 and 1997 F-4-5 Statements of Operations for the Years Ended December 31, 1998, 1997, and 1996 F-6 Statements of Stockholders' Equity for the Years Ended December 31, 1998, 1997, and 1996 F-7 Statements of Cash Flows for the Years Ended December 31, 1998, 1997, and 1996 F-8-9 Notes to Financial Statements F-10
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, 1998 and 1997 and the related statements of operations, stockholders' equity and cash flows for the years ended December 31, 1998 and 1997. 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. The financial statements of Network Six, Inc. as of December 31, 1996 were audited by other auditors, whose report dated March 28, 1997 on those statements included an explanatory paragraph that described significant uncertainties as to the Company's ability to continue as a going concern. 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, 1998 and 1997, and the results of its operations and its cash flows for the years then ended, in conformity with generally accepted accounting principles. As discussed more fully in Note 12 to the financial statements, in 1996 the State of Hawaii terminated a significant system implementation contract with the Company and filed a lawsuit against the Company seeking an unspecified amount for damages due to alleged breach of contract, including alleged failure to complete the design, application programming, system test, and system implementation. In January 1997, the Company filed a counterclaim alleging that the State had fraudulently induced the Company into designing and building a system having capabilities and features beyond the scope of the contract. At December 31, 1998 and 1997, the Company had unbilled work-in-progress and related receivables from the State of Hawaii of approximately $3.5 million. Also, the Company is involved in other litigation related to the Hawaii contract as discussed in Note 12. Sansiveri, Kimball & McNamee, L.L.P. /s/ Sansiveri, Kimball & McNamee, L.L.P. Providence, Rhode Island February 19, 1999 F-2 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Network Six, Inc.: We have audited the accompanying statements of operations, stockholders' equity and cash flows of Network Six, Inc. for the year ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Network Six, Inc. for the year period ended December 31, 1996, in conformity with generally accepted accounting principles. The accompanying 1996 financial statements have been prepared assuming that the company will continue as a going concern. As discussed more fully in note 12 to the financial statements, in 1996 the State of Hawaii terminated a significant system implementation contract with the Company and filed a lawsuit against the Company seeking an unspecified amount for damages due to alleged breach of contract, including alleged failure to complete the design, application programming, system test and system implementation. In January 1997, the Company filed a counterclaim alleging that the State had fraudulently induced the Company into designing and building a system having capabilities and features beyond the scope of the contract. Management of the Company and its attorneys are unable to predict with any certainty the ultimate outcome of this litigation, including the probability that this litigation will have a material adverse impact on the Company's financial position. At December 31, 1996, the Company had unbilled work-in-process and related receivables from the State of Hawaii of approximately $3.5 million, which exceeded the Company's stockholders' equity of approximately $2.7 million, for which no allowance for uncollectability had been recorded. Additionally, the Company has not accrued for any liability to the State which may result from this litigation. Also the Company is involved in other litigation related to the Hawaii contract as discussed in note 12, had suffered recurring losses and its bank financing agreement has expired. These circumstances raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding these uncertainties are also described in note 12. The 1996 financial statements do not include any adjustments that might result from the outcome of these uncertainties. KPMG LLP /s/ KPMG LLP Providence, Rhode Island March 28, 1997 F-3 NETWORK SIX, INC. Balance Sheets December 31, 1998 and 1997
ASSETS (NOTE 4) 1998 1997 - --------------- ----------------- ------------------ Current assets: Cash and cash equivalents $ 1,442,035 $ 1,291,924 Contract receivables, less allowance for doubtful accounts of $69,175 in 1998 and $50,000 in 1997 (note 2) 1,966,788 2,011,379 Costs and estimated earnings in excess of billings on contracts (note 3) 1,220,253 1,388,515 Other assets 112,433 244,257 ----------------- ------------------ Total current assets 4,741,509 4,936,075 ----------------- ------------------ Property and equipment (note 5): Computers and equipment 590,527 506,484 Furniture and fixtures 163,532 167,558 Leasehold improvements 20,191 20,191 ----------------- ------------------ 774,250 694,233 Less: accumulated depreciation and amortization 602,033 627,146 ----------------- ------------------ Net property and equipment 172,217 67,087 Deferred taxes (note 6) 37,097 391,475 Contract receivables and costs in excess of billings on Hawaii contract (notes 2, 3 and 12) 3,459,382 3,459,382 Other assets 290,577 438,084 ----------------- ------------------ Total assets $ 8,700,782 $ 9,292,103 ----------------- ------------------ ----------------- ------------------ (continued -1)
F-4 NETWORK SIX, INC. Balance Sheets, continued December 31, 1998 and 1997
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997 - ------------------------------------ -------------- --------------- Current liabilities: Notes payable to bank (note 4) $ - $ 1,160,000 Current installment of obligations under capital leases (note 5) 89,483 82,690 Current portion of long-term debt: Vendors (note 7) 200,000 163,871 Others (note 4) 91,997 - Accounts payable 58,456 188,377 Accrued salaries and benefits 579,320 449,133 Accrued subcontractor expense 24,950 1,352,393 Other accrued expenses 320,982 342,465 Billings in excess of costs and estimated earnings on contracts (note 3) 341,572 155,754 Income taxes payable (note 6) 780,066 13,338 Deferred taxes (note 6) 42,491 545,869 Preferred stock dividends payable 795,992 460,068 -------------- --------------- Total current liabilities 3,325,309 4,913,958 -------------- --------------- Obligations under capital leases, excluding current installments (note 5) 38,090 104,003 Long-term debt, less current portion: Vendors (note 7) 542,239 742,239 Others (note 4) 409,778 - Hawaii Payable (note 12) 576,483 576,483 -------------- --------------- Total Liabilities 4,891,899 6,336,683 -------------- --------------- Commitments (notes 5, 9 and 12) Other information (notes 10 and 11) 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 1998 and 1997; 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 764,663 shares in 1998 and 734,294 in 1997 76,466 73,429 Additional paid-in capital 1,796,284 1,670,939 Retained earnings (accumulated deficit) (299,541) (1,024,622) -------------- --------------- Total stockholders' equity 3,808,883 2,955,420 -------------- --------------- Total Liabilities and Stockholders' Equity $8,700,782 $ 9,292,103 -------------- --------------- -------------- ---------------
See accompanying notes to financial statements. (concluded -2) F-5 NETWORK SIX, INC. Statements of Operations Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 ----------------- ----------------- ----------------- Contract revenue earned (note 10) $ 10,399,979 $ 11,460,437 $ 7,344,380 Cost of revenue earned 6,418,678 8,620,097 7,359,649 ----------------- ----------------- ----------------- Gross profit (loss) 3,981,301 2,840,340 (15,269) Selling, general and administrative expenses 2,260,418 2,071,294 2,240,073 Restructuring (note 11) (119,436) - - ----------------- ----------------- ----------------- Income (loss) from operations 1,720,883 769,046 (2,135,906) Other deductions (income) Interest expense 125,314 266,030 435,925 Interest earned (78,437) (31,934) (38,463) ----------------- ----------------- ----------------- Income (loss) before income taxes 1,674,006 534,950 (2,533,368) Income taxes (note 6) 613,000 128,000 (775,023) ----------------- ----------------- ----------------- Net income (loss) $ 1,061,006 $ 406,950 $(1,758,345) ----------------- ----------------- ----------------- ----------------- ----------------- ----------------- Net income (loss) per share: Basic $ 0.96 $ 0.25 $ (2.71) ----------------- ----------------- ----------------- ----------------- ----------------- ----------------- Diluted $ 0.96 $ 0.25 $ (2.71) ----------------- ----------------- ----------------- ----------------- ----------------- ----------------- Shares used in computing net income per share: Basic 758,547 729,927 719,317 ----------------- ----------------- ----------------- ----------------- ----------------- ----------------- Diluted 758,547 729,927 719,317 ----------------- ----------------- ----------------- ----------------- ----------------- ----------------- Preferred dividends declared $ 335,925 $ 225,307 $ 187,500 ----------------- ----------------- ----------------- ----------------- ----------------- -----------------
See accompanying notes to financial statements. F-6 NETWORK SIX, INC. Statements of Stockholders' Equity Years Ended December 31, 1998, 1997 and 1996
Series A Retained Convertible Additional Earnings Total Preferred Common Paid-in (Accumulated Treasury Stockholders' Stock Stock Capital Deficit) Stock Equity -------------------------------------------------------------------------------------- Balance at December 31, 1995 $ 2,235,674 $ 71,517 $ 1,603,770 $ 739,580 $ (6,047) $ 4,644,494 Net Loss (1,758,345) (1,758,345) Dividends declared on preferred stock 7.5%/share (187,500) (187,500) Shares Issued in connection with exercise of options 4,900 shares 490 37,485 37,975 Shares Issued in connection with employee stock purchase plan 1,120 shares 112 12,041 12,153 -------------------------------------------------------------------------------------- Balance at December 31, 1996 2,235,674 72,119 1,653,296 (1,206,265) (6,047) 2,748,777 Net Income 406,950 406,950 Dividends declared on preferred stock 7.5%/share (Q1-Q3); 13.5% (Q4) (225,307) (225,307) Sale of 4,998 treasury shares 6,047 6,047 Sale of 13,102 shares of common stock 1,310 17,643 18,953 -------------------------------------------------------------------------------------- Balance at December 31, 1997 2,235,674 73,429 1,670,939 (1,024,622) - 2,955,420 Net Income 1,061,006 1,061,006 Dividends declared on preferred stock 7.5%/share (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 ------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------
See accompanying notes to financial statements. F-7 NETWORK SIX, INC. Statements of Cash Flows Years ended December 31, 1998, 1997 and 1996
1998 1997 1996 ---- ---- ---- Net Income (loss) $1,061,006 $ 406,950 $ (1,758,345) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 47,415 82,010 337,460 Provision for doubtful accounts 19,175 (47,856) 47,856 Loss on sale/disposal of fixed assets 6,518 9,023 60,487 Provision for deferred taxes (149,000) 75,000 (394,862) Accrued financing fee 20,000 - - Forgiveness of note payable to vendor (50,036) - - Changes in operating assets and liabilities: Contract receivables 25,416 (434,765) (100,059) Cost and estimated earnings in excess of billings on contracts 168,262 476,423 1,348,138 Income taxes receivable - 516,046 1,231,778 Other current assets 131,824 (85,281) 105,186 Due from officer - - 63,779 Other noncurrent assets 181,548 (261,785) 256,547 Long term amounts due from Hawaii - 112,442 2,139,198 Accounts payable (129,921) (1,543,955) 35,333 Accrued salaries and benefits 130,187 (21,634) 28,104 Accrued subcontractor exp. (1,327,443) 1,330,149 (399,613) Other notes payable - 698,593 207,517 Hawaii payable - 576,483 - Other accrued expenses (21,483) (165,729) (110,675) Accrued restructuring - (5,383) (512,297) Billings in excess of costs and estimated earnings on contracts 185,818 123,983 (355,028) Income taxes payable 766,728 13,338 - ---------------- ---------------- ----------------- Net cash provided by operating activities 1,066,014 1,854,052 2,230,504 ---------------- ---------------- -----------------
F-8 NETWORK SIX, INC. Statements of Cash Flows, Continued Years ended December 31, 1998, 1997 and 1996
1998 1997 1996 ---- ---- ---- Cash flows from investing activities: Proceeds from sale of assets $ - $ 1,948 $ 32,811 Capital expenditures (156,299) (21,552) (10,277) ---------------- ---------------- ----------------- Net cash provided by (used in) investing activities (156,299) (19,604) 22,534 ---------------- ---------------- ----------------- Cash flows from financing activities: Principal payments on capital lease obligations (59,120) (55,105) (181,235) Net proceeds (payments) from note payable to bank (1,160,000) (640,000) (3,200,000) Proceeds from long-term debt 500,000 - - Payments on long-term debt (132,060) - - Proceeds from issuance of common stock 91,576 18,593 50,126 Proceeds from sales of treasury stock - 6,047 - ---------------- ---------------- ----------------- Net cash used in financing activities (759,604) (670,105) (3,331,109) ---------------- ---------------- ----------------- Net increase (decrease) in cash 150,111 1,164,343 (1,078,071) Cash at beginning of year 1,291,924 127,581 1,205,652 ---------------- ---------------- ----------------- Cash at end of year $ 1,442,035 $ 1,291,924 $ 127,581 ---------------- ---------------- ----------------- ---------------- ---------------- ----------------- Supplemental cash flow information: Cash (received) paid during the year for: Income taxes $ (4,788) $ (467,781) $(2,086,198) ---------------- ---------------- ----------------- ---------------- ---------------- ----------------- Interest $ 89,030 $ 222,376 $ 399,182 ---------------- ---------------- ----------------- ---------------- ---------------- -----------------
See accompanying notes to financial statements. F-9 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 (1) Summary of Significant Accounting Policies (a) Description of Business Network Six, Inc. (the "Company"), formerly Network Solutions, Inc., 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. More recently, the Company has expanded its customer base to include private sector, non-profit and other organizations. (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 F-10 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 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. (c) Cash and cash equivalents Cash and cash equivalents include investments with an original maturity of three months or less. (d) Other Assets Other assets consist of employee receivables both current and long-term portions, 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 F-11 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 equivalents include stock options and warrants. For 1998, 1997 and 1996, 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. (h) Costs of Modifying Software The costs of modifying the Company's software for year 2000 compliance are charges 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 only as they are incurred. (j) Financial Instruments Financial Instruments consist of cash, contract accounts receivable, leases receivable, accounts payable, lease obligations, and notes payable. The carrying value of these financial instruments approximate their fair value, except for the financial instruments related to the Hawaii contract for which fair value cannot be determined due to the circumstances discussed in note 12. (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, the ultimate collectability on the Hawaii contract receivables and estimated costs to complete under the percentage of completion method of accounting. Actual results could differ from those estimates. (l) Reclassifications Certain 1996 balances have been reclassified to conform to the 1997 presentation. (m) Recent Accounting Pronouncements In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive Income" which established standards for reporting and displaying of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This statement requires that an enterprise classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the equity section of the balance sheet. This statement is effective for fiscal years beginning after December 15, 1997 and had no effect on the Company's financial statements for 1997 and 1998. In June 1997, Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information" was issued. This statement requires the use of the F-12 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 "management approach" model for segment reporting. The management approach model is founded upon the way the Company's management organizes segments within the Company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, management structure, or other parameters which management uses to organize a company. The Company is required to adopt this new standard for the year ended December 31, 1998; however, such standard had no effect on the Company's financial statements for 1997 and 1998. In February 1998, Statement of Financial Accounting Standards No, 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" was issued. This statement standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on changes in the benefit calculation, and eliminates certain disclosures that are no longer considered useful. This statement effectively revised guidance previously provided by Statement of Financial Accounting Standards Nos., 87,88 and 106. The Company is required to adopt the new standard for the year ended December 31, 1998; however, such standard had no effect on the Company's financial statements for 1998. In June 1998, Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" was issued. This statement establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that entities recognize all derivatives as either assets and liabilities in the statement of financial position and measure those instruments at fair value. This standard is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. (2) Contract Receivables
Contract receivables at December 31 consist of: 1998 1997 ---- ---- Time and materials and completed fixed price contracts $ 816,338 $ 476,552 Fixed price contracts in progress 1,219,625 1,584,827 ---------------- --------------- 2,035,963 2,061,379 Less allowance for doubtful accounts 69,175 50,000 ---------------- --------------- $1,966,788 $2,011,379 ---------------- --------------- ---------------- ---------------
At December 31, 1998 and 1997, $534,300 was receivable from the State of Hawaii ("Hawaii") and CBSI, a subcontractor to the Company on the Hawaii contract. This amount has been reclassified to a long-term asset and is included in contract receivables and costs in excess of billings on Hawaii contract due to the litigation discussed in note 12. F-13 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 (3) Costs and Estimated Earnings on Contracts
Costs and estimated earnings on contracts at December 31 consist of: 1998 1997 ---- ---- Beginning balance $ 1,232,761 $ 1,833,168 Costs incurred 6,418,678 8,620,097 Estimated Earnings 3,981,301 2,840,340 ------------------ ----------------- 11,632,740 13,293,605 Less billings 10,754,059 12,060,844 ------------------ ----------------- $ 878,681 $ 1,232,761 ------------------ ----------------- ------------------ ----------------- Included in the accompanying balance sheets under the following captions: 1998 1997 ---- ---- Costs and estimated earnings in excess of billings on contracts $ 1,220,253 $ 1,388,515 Billings in excess of costs and estimated earnings on contracts (341,572) (155,754) ------------------ ----------------- $ 878,681 $ 1,232,761 ------------------ ----------------- ------------------ -----------------
Costs and estimated earnings on contracts at December 31, 1998 and 1997 are expected to be billed and collected within one year. At December 31, 1998 and 1997, $2,925,082 was related to the Hawaii contract. This amount has been reclassified to long term assets due to the litigation discussed in note 12 and is included in contract receivables and costs in excess of billings on Hawaii contract. (4) Notes Payable - Secured On April 30, 1997 the Company signed a term loan (the "Loan") with its bank which required the Company to reduce its outstanding borrowings under the Loan from $1.8 million to the following limits: October 15, 1997 - $1,500,000, November 15, 1997 - $1,200,000 and December 15, 1997 - $900,000. The interest rate on the Loan was 16%, with the difference between 16% and prime plus 2% payable at maturity, which was January 31, 1998. There were also a number of provisions for accelerated payment to reduce the loan balance, such as paying the bank 50% of any contract holdbacks or income tax refunds. In addition, the Company agreed to provide the bank with a warrant to purchase 50,487 unregistered shares of the Company's Common Stock at $1.75 per share, exercisable immediately with an expiration date of April 30, 2002, and agreed to provide the bank 15% of any recovery received from its litigation in Hawaii. The warrant and the bank's right to a percentage of any recovery terminate if the Company pays down the Loan completely or raises $1 million of equity capital prior to maturity. The Company's obligations under the Loan were secured by substantially all of the assets of the Company. The Loan also provided that the Company not pay any dividends on its capital stock without the consent of the bank. On January 26, 1998 the Loan was paid in full and the warrants and the rights to a percentage of any Hawaii recovery were returned to the Company. F-14 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 On December 31, 1997 the Company signed a $1.5 million line of credit with a commercial lender. Receivables from four of the Company's contracts secure the new line of credit. The Company can borrow up to 80% of the invoice amount on a ninety-day promissory note. The interest rate is prime plus five percent on balances below $1 million and prime plus one and one half percent on balances over $1 million. The line also carries a six- percent annual service fee. The prime rate was 7.75% at December 31, 1998. 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. The BDC was also issued five-year warrants to purchase 11,500 shares of the 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 noncurrent assets on the accompanying balance sheet. Scheduled maturities of secured long-term debt, including annual deferred fee, as of December 31, 1998 are as follows: 1999 $ 91,997 2000 101,164 2001 105,746 2002 110,782 2003 92,086 ---------------- $ 501,775 ---------------- ----------------
(5) Leases The Company leases office space and equipment under several operating and capital leases expiring at various times through 2000. Rent expense including utilities for the years ended December 31, 1998, 1997 and 1996 was approximately $192,000, $186,000 and $431,000, respectively. Rental obligations as of December 31, 1998 for the remainder of the lease terms are as follows: F-15 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996
Capital Leases Operating Leases 1999 $ 112,736 $ 182,600 2000 36,469 138,700 ------------------ ----------------- Total lease payments 149,205 $ 321,300 ----------------- ----------------- Amount representing interest 21,632 ------------------ Net present value of payments 127,573 Less current portion 89,483 ------------------ Long term portion $ 38,090 ------------------ ------------------
During 1995, the Company leased various computer equipment from its vendors, then in turn leased those assets to two of its customers. The Company's lease obligation is included above. The lease to the customers is accounted for as a sales type lease. Consequently, the Company recognized a gross profit of approximately $2,200, $5,300 and $2,500, respectively for 1998, 1997 and 1996. Over the life of these leases the Company will recognize approximately $107,000 of lease interest income. Approximately $12,200, $18,500 and $31,500 of lease interest income was recognized in 1998, 1997 and 1996, respectively, and is included in contract revenue in the statement of operations. Future minimum lease payments to be received are as follows: 1999 $ 164,659 2000 26,366 ----------------- 191,025 Amount representing interest 56,938 ----------------- Net present value of payments 134,087 Less current portion 97,243 ----------------- Long term portion $ 36,844 ----------------- -----------------
Approximately $73,700 of the net present value of payments is related to the Hawaii contract and had been reclassified to contract receivables and costs in excess of billings on Hawaii contract, the remainder is classified in other assets. (6) Income Taxes The components of income tax expense (benefit) for the years ended December 31, are as follows: F-16 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996
1998 1997 1996 ---- ---- ---- Current taxes: Federal $599,000 $ 36,000 $(380,161) State 163,000 17,000 - -------------- -------------- --------------- Sub total 762,000 53,000 (380,161) -------------- -------------- --------------- Deferred taxes: Federal (119,000) 53,000 (314,651) State (30,000) 22,000 (80,211) -------------- -------------- --------------- Sub total (149,000) 75,000 (394,862) -------------- -------------- --------------- Total $613,000 $128,000 $(775,023) -------------- -------------- --------------- -------------- -------------- ---------------
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:
1998 1997 1996 ---- ---- ---- Computed "expected" tax expense (benefit) $569,162 $181,883 $(861,345) Increase in income tax expense (benefit) resulting from state and local taxes, net of federal income tax benefit 93,744 25,740 (52,939) Change in beginning of the year balance of the valuation allowance for deferred tax asset, allocated to income tax expense (50,000) (84,000) 134,000 Other, net 94 4,377 5,261 -------------- -------------- --------------- Total income tax expense (benefit) $613,000 $128,000 $(775,023) -------------- -------------- --------------- -------------- -------------- --------------- Effective tax rate (%) 37 24 (31) -------------- -------------- --------------- -------------- -------------- ---------------
Deferred tax assets and liabilities at December 31 are comprised of the following: F-17 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996
1998 1997 ---- ---- Deferred tax assets: Accounts receivable, principally due to allowance for doubtful accounts $ 27,396 $ 19,640 Deferred compensation 61,592 77,805 Unamortized retainage, due to change in tax reporting - 24,409 Property, plant and equipment depreciation 13,017 35,451 Non-deductible loss on contract 81,012 80,350 Vacation expense 58,295 35,997 Contingent liability 202,030 200,380 Health insurance - 1,268 Stock bonus 31,580 16,940 Loan facility fee 9,901 - -------------- --------------- Total gross deferred tax assets 484,823 492,240 Less valuation allowance - 50,000 -------------- --------------- Net deferred tax asset 484,823 442,240 -------------- --------------- Deferred tax liability: Retainage, due to deferral for tax reporting $490,217 $ 596,634 -------------- --------------- Net deferred tax liability $ 5,394 $ 154,394 -------------- --------------- -------------- ---------------
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 recognition of deferred tax assets as of December 31, 1998 and 1997 is supported by the fact that the Company has sufficient reversals of temporary differences to support the recognition of the deferred tax assets. (7) Notes Payable - Vendors On December 12, 1996 the Company restructured a $218,901 account payable with CPL Worldgroup ("CPL") to an eighteen month unsecured note payable. CPL was a subcontractor to the Company, and continued to provide services to the Company. The note carried a 9.25% interest, with monthly payments of $13,071, due on the first of the month, through June of 1998. If all note payments were made on time and all future invoices were paid within thirty days, $50,036 of the balance would be forgiven. All payments were made when due and the note was paid off in February of 1998. 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 F-18 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 Hawaii contract. The note is payable to Lockheed and carries an initial interest rate of five percent through 1998, six percent during 1999, seven and one half percent in 2000 and nine percent during 2001, with such interest to be paid monthly. Principal payments are to be made annually as follows: December 1998 - $100,000, December 1999 - $200,000, December 2000 - $200,000 and December 2001 - $342,239. Under certain conditions, the Company is obligated to pay Lockheed the remaining principal balance within 15 days of receipt of funds if the Company settles or wins its litigation against the State of Hawaii. The note has a discount provision for early payment. (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 them 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. So 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 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 are 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 becomes 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 F-19 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 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, 1998 were $795,992, which equals $1.11 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. At December 31, 1998 all of these warrants remain outstanding and are exercisable until 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, 1998 all of these warrants remain outstanding and are exercisable until November 23, 2003. Warrants to purchase 50,487 shares of the Company's Common Stock at an exercise price of $1.75 per share were authorized and issued in 1997 to the Company's principal lender at that time. On January 26, 1998, however, these warrants were returned to the Company, per the terms of the Loan agreement with the Company's principal lender. 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. At December 31, 1998 all of these warrants remain outstanding and are exercisable until September 20, 2003. (c) Stock Option Plan The Company's Board of Directors and stockholders adopted the Company's Incentive Stock Option Plan (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 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. F-20 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 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.
1998 1997 ---- ---- Net income (loss): As Reported $ 1,061,006 $ 406,950 Pro Forma 904,264 376,570 Net income (loss) per share: As Reported $ 0.96 $ 0.25 Pro Forma 0.75 0.18
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 1998 and 1997, respectively; no dividend yield; expected volatility of 85.2% and 86.8%; risk-free interest rate of 4.9% and 6.1%; and expected lives of five years. The weighted-average fair market value of options granted during 1998 and 1997 was $2.56 and $1.13, respectively. A summary of the status of the Company's stock option plan as of December 31, 1998, 1997 and 1996 and changes during the years on those dates is presented below:
1998 1997 1996 -------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Shares Exercise Shares Exercise Shares Exercise Price Price Price ------------------------------------ ------------------------------ ---------------------------- Outstanding at beginning of year 136,225 $ 1.64 $ 1.71 41,281 $ 28.62 92,850 Granted 131,410 152,550 4.32 3.65 71,600 1.58 Cancelled (81,950) 15.76 - - - - Exercised (6,275) (4,900) 7.75 2.05 - - Forfeited (8,920) (28,225) (14,131) 24.93 2.59 1.71 Outstanding at ---------------- --------------- ------------- end of year 252,440 136,225 92,850 1.71 - 1.64 ---------------- --------------- ------------- ---------------- --------------- ------------- Exercisable at year end 80,750 55,700 1.86 1.88 46,392 1.82 ---------------- --------------- ------------- ---------------- --------------- -------------
F-21 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 The following table summarizes information about the Company's stock options, considered compensation under SFAS 123, outstanding at December 31, 1998:
Options Outstanding Options Exercisable ------------------------------------- ------------------------ Number Weighted Avg. Number Outstanding Remaining Exercisable Exercise Price At Dec 31, 1998 Contractual Life At Dec 31, 1998 - -------------- --------------- ---------------- --------------- $1.125 6,250 18,750 8.1 1.500 25,483 37,600 8.5 1.750 15,517 44,050 8.3 2.000 26,000 26,000 8.0 3.000 2,500 48,290 9.5 3.125 18,750 9.2 - 3.750 2,500 2,500 9.9 4.000 4,000 9.4 - 4.125 2,500 2,500 9.5 4.500 50,000 9.1 - ------------------ ------------ 252,440 80,750 ------------------ ------------ ------------------ ------------
At December 31, 1998, 1997, and 1996, common shares reserved for issuance under these plans were 275,000, 200,000 and 125,000, respectively. At December 31, 1998, 1997 and 1996, common shares available under the Non-Employee Director Option Plan were 50,000, 25,000 and 25,000, respectively. Each director will be awarded 2,500 options, each year in January, for a maximum of 10,000 options per director. (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, 1998, 1997 and 1996. 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. 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 F-22 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 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 1998, 1997 and 1996 the Company had the following sales from customers whose individual sales exceeded 10% of the Company's total sales:
1998 1997 1996 ---- ---- ---- Rhode Island DHS $ 5,361,955 $ 4,222,923 $ 2,399,170 Maine Dept of Human Services 2,651,893 5,721,103 - MIM Corporation 1,188,327 - - Virgin Islands - - 1,026,195 RI Dept of Health - - 927,372 ------------------ ----------------- ----------------- $ 9,202,175 $ 9,944,026 $ 4,352,737 ------------------ ----------------- ----------------- ------------------ ----------------- -----------------
(11) Restructuring In December 1995 as a result in the decrease in the Company's backlog, management approved a plan of reorganization of the Company in an effort to reduce expenses and operate more efficiently while still maintaining a firm commitment to deliver high quality services. Under the plan, the Company targeted a reduction in work force of approximately 30 to 35 positions through an involuntary separation plan. These positions were from the technical, administrative and middle management levels. Estimated salaries, related payroll taxes and other costs associated with these reductions amounted to approximately $537,000, of which approximately $20,000 was paid in 1995, and has been included as a restructure charge in the accompanying statement of operations for 1995. In 1996, 42 positions were eliminated and the Company renegotiated the facilities lease and returned unneeded space to the landlord. Approximately $119,000 has been included as a reversal of a restructure charge in the accompanying statement of operations for 1996. (12) Litigation In June 1993, the Company entered into a fixed price contract with the State of Hawaii (the State) for the transfer of a Child Support Enforcement System to the State of Hawaii. In June 1995, the Company began negotiating a significant amendment to its contract with the State when it determined that the total estimated cost to complete the system would be significantly greater than expected. In the first quarter of 1996, the Company received final state and federal approval for this contract amendment totaling an incremental $4.4 million. However, at December 31, 1995, as a result of in-depth reviews of this contract, management determined that contract costs continued to increase and expected to realize a gross loss on the entire contract of approximately $440,000, which was recorded in December 1995. F-23 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 While at December 31, 1995 management of the Company believed that the actual costs to complete this contract would be within its latest cost estimates, due to uncertainties inherent in the estimation process and in the Company's latest negotiations to reach a final definitive plan for the completion of the contract, it was management's position that these estimates could need further revision. In 1996, the Company continued in its attempts to negotiate a final definitive plan with the State and at the end of the first quarter of 1996, it furloughed substantially all of its technical employees in Hawaii while it continued its negotiations on site with key management and administrative personnel. In conjunction with these negotiations, the State requested that the Company hire Complete Business Solutions, Inc. (CBSI) to conduct a detailed review of the system to facilitate the resolution of open contractual scope issues. On September 13, 1996, the State of Hawaii terminated its contract with the Company, and therefore CBSI's contract was automatically terminated effective September 23, 1996, claiming that the Company had failed to fulfill its obligations under the contract. In response, the Company also terminated the contract with the State effective September 23, 1996. On November 12, 1996, the State filed a lawsuit against the Company and its bonding companies, Aetna Casualty and Surety (Aetna) and Federal Insurance Company for damages due to breach of contract. The suit alleges that the Company failed to meet contractual deadlines, provided late, incomplete and/or unsuitable deliverables, and materially breached the contract by never completing the design, the application programming, the system test, and systems implementation. The State is seeking an unspecified amount for general damages, consequential and special damages, liquidated damages, attorneys' fees, reimbursement for the cost of lawsuit and interest costs that the court deems just and proper. In late 1996, Unisys, a vendor providing equipment to the Company on the Hawaii contract, submitted an $896,000 claim against the $10.3 million performance bond posted on behalf of Hawaii to ensure the Company's performance on the contract. On December 13, 1996, Complete Business Solutions, Inc. (CBSI), a subcontractor on the Hawaii contract, filed a lawsuit against the Company in the Superior Court of the State of Rhode Island for $517,503 which the Company has accrued, plus interest, costs and attorney's fees. The Company disputes the $517,503 owed to CBSI and filed a counterclaim against CBSI on January 13, 1997 alleging, among other things, that CBSI failed to complete its duties required under the subcontract with the Company related to the detailed review of the system in a timely manner, improperly engaged in negotiations with the State of Hawaii to complete the project, hired and attempted to hire employees of the Company in violation of its subcontract agreement with the Company and obtained and utilized confidential information inappropriately. Also, the Company alleges that CBSI owes the Company $482,750 as of December 31, 1996 for which the Company has not established a reserve for uncollectibility. In February 1997, the State of Hawaii released Aetna from all but $1.1 million of the performance bond. In addition, Hawaii hired Lockheed/Martin IMS, the guarantor of the Aetna bond, to complete the system, incorporating changes to comply with the recent welfare reform legislation, for approximately $19 million. On January 23, 1997, the Company filed a counterclaim against the State alleging that the State had F-24 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 fraudulently induced the Company into designing and building a system having capabilities and extraordinary features far beyond the scope of the contract and industry standards. The Company is seeking damages of $70 million together with prejudgment interest, costs and attorneys' fees. On February 3, 1997, the Company filed a third-party complaint ("TPC") in the Hawaii litigation against MAXIMUS Corporation ("MAXIMUS") and CBSI. MAXIMUS has been the State of Hawaii's supervisor and advisor on the contract since the inception of the Hawaii project. The allegations the Company has made against CBSI in this TPC are substantially similar to the allegations made against CBSI in the Company's counterclaim to CBSI's December 13, 1996 lawsuit brought against the Company in Rhode Island. The Company alleged, moreover, that MAXIMUS is liable to the Company on grounds that: (i) the Company was an intended third party beneficiary under the contract between MAXIMUS and Hawaii; (ii) MAXIMUS tortuously interfered in the contract between the Company and Hawaii; (iii) MAXIMUS negligently breached duties to the Company and (iv) MAXIMUS aided and abetted Hawaii in Hawaii's breach of contract. The Company's complaint seeks $70 million in damages. In connection with the Hawaii litigation the Company was ordered to assign all Hawaii related leases the to State. One of the lessors has sued the Company for failure to pay. The Company believes it was released of all responsibility on the lease per the court order. Management of the Company and its attorneys are unable to predict with any certainty the ultimate outcome of this litigation, although it is their belief that an unfavorable outcome is unlikely. If the Company is unable to prevail in its suit with the State such a result could have a material adverse financial effect on the Company and could jeopardize the Company's ability to continue with its present listing on The NASDAQ SmallCap Market. At December 31,1998, the Company had unbilled work-in-process and related receivables from the State and CBSI of approximately $3.5 million, which is slightly less than stockholders' equity of approximately $3.8 million, for which no allowance for uncollectibility has been recorded. The Company has not accrued for any potential liability to the State, which may result from this litigation. In addition, the Company has not accrued for any legal expenses to be incurred in connection with this litigation, which could be significant. Due to the significant uncertainty created by these events, the Company ceased recognition of revenue on the Hawaii contract in 1996. An adjustment of $1.8 million was recorded in the fourth quarter to reverse revenue of $1 million, $400 thousand and $400 thousand previously recorded in the first, second and third quarters, respectively. In addition, 1996 costs incurred related to the Hawaii contract of $1.96 million have been charged to expense. F-25 NETWORK SIX, INC. Notes to Financial Statements December 31, 1998, 1997 and 1996 (13) Quarterly Financial Data (unaudited) The following is a summary of quarterly results from operations:
Quarter 1998: First Second Third Fourth Contract revenue earned $ 2,221,618 $ 3,253,696 $ 2,662,603 $2,262,062 Gross profit 774,962 1,095,167 1,127,215 983,957 Net income 140,465 309,798 298,136 312,607 Earnings per share 0.08 0.30 0.28 0.30 Weight average shares outstanding 749,503 756,176 763,880 764,630 1997: Contract revenue earned $ 1,414,186 $ 3,431,835 $ 3,572,313 $3,042,103 Gross profit 441,045 838,487 806,762 754,046 Net income (loss) (132,187) 242,797 116,690 179,650 Earnings (loss) per share (0.24) 0.27 0.09 0.13 Weight average shares outstanding 721,192 729,927 734,294 734,294
F-26 EX-10.16 2 EXHIBIT-10.16 EXHIBIT-10.16 SMALL BUSINESS LOAN FUND CORPORATION LOAN AGREEMENT This Loan Agreement is entered into by and among SMALL BUSINESS LOAN FUND CORPORATION, a governmental agency and public instrumentality of the State of Rhode Island having a principal place of business located at One West Exchange Street, Providence, Rhode Island 02903 (the "Lender"), and NETWORK SIX, INC., a Rhode Island Corporation having its chief executive office at 475 Kilvert Street, Warwick, Rhode Island 02886 (the "Borrower") in connection with Borrower's Two Hundred Fifty Thousand Dollar ($250,000.00) loan (the "Loan") from Lender of even date herewith. Section 1. Recitals. 1.1 Borrower has this day executed and delivered to Lender a Promissory Note in the original principal amount of Two Hundred Fifty Thousand Dollars ($250,000.00) evidencing the Loan (the "Note"); 1.2 The Note is secured or supported, inter alia, by: (a) a Security Agreement of even date herewith between Borrower and Lender with respect to the personal property described therein (the "Security Agreement") the Note and all such other documents being sometimes hereinafter collectively referred to as the "Loan Documents". Section 2. Agreement Borrower and Lender make this Agreement in order to provide financing for the purposes described in Section 4.1 hereof, and Lender agrees to make the Loan upon and subject to all the terms and conditions set forth herein and in the Loan Documents. Section 3. Representations and Warranties Borrower hereby represents and warrants to Lender, which representations and warranties shall survive the making of the Loan: 3.1 That Borrower (if Borrower is a corporation) is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Rhode Island and has all requisite power and authority to own all of its properties and assets and to carry on its business as it is now being conducted and has full power and authority to place mortgages and liens upon its assets subject to the liens referenced in Exhibit A which is attached hereto and incorporated herein by reference ("Senior Liens") and to borrow funds secured thereby; 3.2 That Borrower is duly qualified and/or registered to do business and in good standing in all jurisdictions where such qualifications or registration is required, including, without limitation, the State of Rhode Island, if the state of Borrower's incorporation or creation is other than Rhode Island; 3.3 That the execution and delivery of the Loan Documents to which Borrower is a signatory and the consummation of the transactions contemplated thereby do not violate any provisions of Borrower's Articles of Incorporation, bylaws, or partnership agreement, as the case may be, or any provision of, or result in the acceleration of any obligation of Borrower under, any deed of trust or mortgage, lien, lease, agreement, instrument, arbitration award, judgment or decree to which Borrower is a party or by which Borrower is bound, and with respect to which Borrower has not obtained a written waiver, and do not violate or conflict with any other restriction of any kind or character to which Borrower is subject; 3.4 That the Loan is being made to Borrower in furtherance of legitimate purposes of Borrower and all actions required by law, by Borrower's Articles of Incorporation, bylaws, partnership agreement or otherwise, to authorize execution and delivery of the Loan Documents to which Borrower is a signatory or signatories thereof on behalf of Borrower have been taken, and that such Loan Documents constitute the valid and binding obligations of Borrower, enforceable in accordance with their respective terms. 3.5 That there are no actions, suits or proceedings pending or, to the knowledge of Borrower, threatened against or affecting Borrower, or the properties or other assets of Borrower before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which if determined adversely to Borrower would have a material adverse effect on the financial condition, properties or operations of Borrower other than as heretofore disclosed to the Lender; 3.6 That neither Borrower nor any corporation, partnership, or other legal entity in which Borrower is a principal is now in default of any of their obligations and agreements, and no condition exists, which, with the passage of time or giving of notice or both, would constitute such a default, other than as heretofore disclosed to the Lender. Section 4. Covenants and Agreements 4.1 The proceeds of the Loan shall be used solely for hire additional highly trained network specialists (4-6) to expand current marketing efforts and modify computer programs to accommodate year 2000 and that Borrower shall, if requested by Lender, provide to Lender documentation in form reasonably satisfactory to Lender showing that the proceeds of the Loan were so used. 4.2 Borrower shall maintain or cause to be maintained hazard, liability and other insurance policies as required by the Loan Documents. 2 4.3 Borrower shall deliver to Lender within ninety (90) days of the close of Borrower's fiscal year, the consolidated and consolidating financial statements of Borrower, including, without limitation, a balance sheet and income statement, prepared on a review basis by a firm of independent public accountants selected by Borrower and approved by Lender. Borrower shall also deliver to Lender (i) within forty five (45) days of the close of each of Borrower's fiscal quarters, financial statements including, without limitation, a balance statement, and income statement certified to by Borrower's president or chief financial officer for the fiscal year to date; (ii) such other information bearing on the financial condition of Borrower and its business operations as Lender may reasonably request; and (iii) annual employment reports in form satisfactory to Lender detailing the number of employees of Borrower, the change in such number over the course of the applicable year and the average wages of such employees. 4.4 Borrower shall cause to be provided to Lender such financial information with respect to any person now or hereafter liable absolutely or contingently, for the whole or part of the indebtedness evidenced by the Note (an "Other Liable Party") including, without limitation, any guarantor(s) thereof, as Lender shall reasonably request, including, without limitation, the information required of Borrower by Section 4.3 above. 4.5 Borrower shall maintain its principal office and operating facilities within the State of Rhode Island. 4.6 Borrower shall maintain at its principal operating facilities located at 475 Kilvert Street, Warwick, Rhode Island 02886, all assets utilized in connection with the operation of its business, except as specifically permitted by an instrument in writing executed by Lender or except in the ordinary course of business. 4.7 The Loan Documents shall be duly executed or shall be caused to be duly executed by the Borrower and every Other Liable Party, together with such additional supporting documents as Lender or its counsel may now or hereafter request. 4.8 Borrower will promptly notify Lender of any condition or event which constitutes, or would constitute with the passage of time or giving of notice or both, an Event of Default under the Note or any of the other Loan Documents, and promptly inform Lender of any events or changes in the financial condition of Borrower or any Other Liable Party occurring since the date of the last financial statements of Borrower or such Other Liable Party delivered to Lender, which individually or cumulatively when viewed in light of prior financial statements of Borrower or such Other Liable Party delivered to Lender, may result in a material adverse change in the financial condition of Borrower or such Other Liable Party. 4.9 Borrower shall, annually before January 31, provide the Lender an employment report compassing states goals with results obtained. 3 4.10 The Borrower shall not, without prior written consent of the Lender, sell the Borrower or substantially all of the assets thereof. 4.11 The Borrower shall not, without the prior written consent of the Lender, move or transfer any of the Borrower's business or its assets out of the State of Rhode Island unless in the ordinary course of business. Section 5. Additional Representations, Warranties and Covenants of Borrower 5.1 The Borrower is now in compliance with, and will at all times comply with (i) Title VI of the Civil Rights Act of 1964, as amended; and (ii) R.I.G.L. ss.28-6.1-1, as amended; 5.2 Borrower is now in compliance with, and will at all times comply with all applicable federal, state and local laws, regulations and ordinances relating to environmental matters, hazardous waste and hazardous materials of any kind and will obtain all necessary permits and certificates for all environmental requirements. 5.3 That the Loan will not result, directly or indirectly, in the permanent relocation of jobs from one labor area to another. 5.4 Borrower shall obtain Flood Hazard Insurance when reasonably required by Lender or by applicable law. 5.5 Borrower will insure access for the handicapped if the project financed in whole or in part by the Loan involves construction with respect to facilities to which the public will have access. 5.6 Borrower will whenever possible, and in good faith, give consideration for employment to the long-term underemployed and unemployed residing in the Rhode Island area for any qualified Rhode Island positions. 5.7 Borrower shall undertake Affirmative Action Programs designed to eliminate patterns and practices of discrimination. 5.8 Borrower further covenants and agrees that if requested by Lender, Borrower will present evidence of Borrower's compliance with any of the provisions of this Section 5. Section 6. Miscellaneous 6.1 The law governing this Agreement shall be the substantive law of Rhode Island determined without resort to the state's conflict of law rules. 4 6.2 All rights of Lender hereunder shall inure to the benefit of its successors and assigns, and all obligations of Borrower hereunder shall bind its, his, her or their successors and assigns. 6.3 Lender shall not be deemed to have waived or amended any of its rights or remedies under any of the Loan Documents except by written instrument duly executed by a duly authorized officer of Lender. IN WITNESS WHEREOF, the Borrower and Lender have executed this Agreement or caused this Agreement to be executed by their duly authorized representatives on this 21st day of September, 1998. WITNESS: LENDER: SMALL BUSINESS LOAN FUND CORPORATION /s/ [ILLEGIBLE] By: /s/ [ILLEGIBLE] - --------------------------- ---------------------------- Its: Administrator BORROWER: NETWORK SIX, INC. /s/ [ILLEGIBLE] By: /s/ Dorothy M. Cipolla - --------------------------- ---------------------------- Its: Treasurer 5 EXHIBIT A Senior Liens shall include: 1. Any and all liens resulting from a loan agreement entered into between PrinVest Financial Corp., a New Jersey corporation, and the Borrower hereof dated December 31, 1997 any successor bank or institutional lender for financing to be used by the Borrower in conjunction with its day to day business operations, which financing is or may be secured by Borrower's grant of a first position security interest in all accounts receivable and work in progress of the Borrower. 2. Any and all equipment leases presently existing and any other equipment leases entered into by the Borrower after the date hereof. 3. An assignment of certain litigation proceeds by Borrower to Lockhead Martin IMS Corporation dated December 24, 1997. 4. A financing arrangement between the Borrower and Unisys Corporation relating to a contract between Borrower and the State of Maine dated April 11, 997 which is identified as the "Maine Automated Child Welfare Information System Contract" and evidenced by financing statement 665667 and 665719 filed with the Rhode Island Secretary of State. 6 SMALL BUSINESS LOAN FUND CORPORATION PROMISSORY NOTE $250,000.00 September 21, 1998 Providence, Rhode Island FOR VALUE RECEIVED, NETWORK SIX, INC., a Rhode Island corporation, having a principal place of business located at 475 Kilvert Street, Warwick, Rhode Island 02886 (hereinafter referred to as "Maker"), jointly and severally, if more than one, promises to pay to the order of SMALL BUSINESS LOAN FUND CORPORATION, a governmental agency and public instrumentality of the State of Rhode Island having a principal place of business located at One West Exchange Street, Providence, Rhode Island 02903 (hereinafter referred to as "Payee"), the principal sum of Two Hundred Fifty Thousand Dollars ($250,000.00), payable at the times hereinafter specified, together with interest, in arrears, from the date hereof on the unpaid principal balance from time to time outstanding and on all unpaid installments of interest, whether before or after the maturity of or default under this note, at the rate of nine and one half percent (9.50%) per annum. All interest payable hereunder shall be computed on the basis of the actual number of days elapsed using a three hundred sixty (360) day year. Principal and interest hereunder shall be payable in 59 consecutive equal monthly installments of $5,250.47 each, commencing on the 21st day of October, 1998 and continuing on the same day of each month thereafter through and including the 21st day of August, 2003, and in one (1) final installment of the entire unpaid balance of principal and interest on the 21st day of September, 2003. The entire principal balance, together with all unpaid interest, fees, expenses and other charges, if not sooner paid, shall in any event be paid on September 21, 2003. All sums payable hereunder are payable in lawful money of the United States of America and in immediately available funds at the above stated office of Payee or such other place or places as Payee, its successors or assigns (hereinafter sometimes the "Holder") may designate in writing. This note may be prepaid at any time, in whole or in part, without penalty or premium, provided that Maker gives to the Holder not less than ten (10) days prior written notice thereof. All such partial payments, if applied to principal pursuant to the terms of this Note, shall be applied against installments of principal in the inverse order of their maturity. All sums paid under this note shall be applied first to any interest, fees, expenses and other charges then due and unpaid, in such order as the Holder shall determine, with the remaining balance, if any, to be applied to unpaid principal. Whenever a day on which payment of interest and/or principal required to be made hereunder falls on a Saturday, Sunday or public holiday, such payment shall be due on the next following normal business day, and where time is extended for the payment of principal by virtue of the due date thereof falling on a Saturday, Sunday or public holiday, such extended time shall be included in the computation of interest. This note is referred to in a certain Loan Agreement (the "Agreement") between Maker and Payee of even date herewith and is in all respects subject to the provisions thereof. This note is secured or supported by inter alia (check appropriate box or boxes) |X| a Security Agreement between Maker and Payee of even date herewith, granting a security interest in personal property described therein; all of which documents, agreements and instruments listed above are hereinafter collectively referred to as the "Security Instruments". Payee and any successor Holder may assign, transfer or negotiate this note and any security for the performance of Maker's obligations hereunder, and in such event all the provisions of this note and the Security Instruments shall inure to the benefit of and may be exercised by or on behalf of the successor Holder, and all payments of principal and of interest due and to become due under this note after the date of such assignment shall not thereafter be subject to any defense, counterclaim or set-off which Maker may have against any prior Holder. The occurrence of any one or more of the following events will constitute an Event of Default hereunder: 1. Nonpayment of any installment of principal and/or interest due under this note when it shall become due and payable (no prior demand therefor being necessary) and such nonpayment shall have continued for more than ten (10) days. 2. Nonpayment of any other sum payable under the Agreement, this note, any of the Security Instruments or any other documents, instruments or agreements ("Other Documents") now or hereafter securing this note or executed by Maker or any other person, corporation or other entity now or hereafter liable, absolutely or contingently, for the whole or any part of the indebtedness evidenced by this note, including, without limitation, any guarantor(s) hereof (an "Other Liable Party") in 2 connection herewith, and such nonpayment shall have continued for more than ten (10) days after written notice thereof by Holder to Maker. 3. Nonperformance or nonobservance of any of the other covenants, agreements, or conditions of the Agreement, any of the Security Instruments or any of the Other Documents after the expiration of applicable grace periods, if any, and such nonperformance or nonobservance shall have continued for more than thirty (30) days after written notice thereof by Holder to Maker. 4. The occurrence of any "Event of Default" under the Agreement, any of the Security Instruments or any of the Other Documents, or the occurrence of any event or condition which would entitle Holder to exercise any of its remedies under the Agreement, any of the Security Instruments or any of the Other Documents. 5. The cancellation, lapse or termination of any insurance coverage required to be maintained by Maker under the Agreement, any of the Security Instruments or any of the Other Documents which is not reinstated or replaced during applicable grace periods. 6. Any real or personal property, mortgaged, pledged or otherwise given to secure this note or any portion thereof or any interest therein is conveyed, voluntarily encumbered or otherwise transferred in any way without the prior written consent of Holder, except as may be specifically provided or described in the Agreement or the Security Instruments. 7. Breach of or the proving false or misleading, in any material respect, of any representation or warranty now or hereafter made to any Holder by, on behalf of, or for the benefit of Maker, or contained in: (a) the Agreement; (b) any of the Security Instruments or Other Documents; (c) this note; or (d) any loan application, statement, financial statement, certificate or other document, agreement or instrument furnished, signed or executed in connection herewith by the Maker or, on behalf of or for the benefit of the Maker at the request of Maker. 8. The occurrence of any "event of default" under any document, agreement or instrument now or hereafter (a) evidencing or securing any other obligation or indebtedness of Maker or any Other Liable Party, to Holder now existing or hereafter arising or (b) evidencing any obligation or other indebtedness secured in whole or in part by any or all of the real or personal property covered by any of the Security Instruments, or the nonpayment, nonperformance or nonobservance of any of the covenants, 3 agreements or conditions of any such documents, agreements or instruments, which nonpayment, nonperformance or nonobservance shall have continued beyond the expiration of any applicable grace or notice period and the occurrence of any event or condition which would entitle the obligee of or under any such documents, agreements or instruments to exercise any of its default remedies thereunder. 9. Nonpayment of any indebtedness in excess of Fifty Thousand Dollars ($50,000.00) of the Maker or any Other Liable Party (other than this note or the other indebtedness referred to in the preceding paragraph) if the effect of such nonpayment is to accelerate the maturity of such indebtedness or to permit the holder thereof to cause such indebtedness to become due prior to the stated maturity thereof. 10. (a) (i) The insolvency or inability of Maker or any Other Liable Party to pay his or its debts as they mature; (ii) the appointment of a receiver, trustee, custodian or other fiduciary for, or for any of the property of, Maker or any Other Liable Party; (iii) the making of an assignment for the benefit of creditors, or the making of or entering into a trust mortgage or deed or other instrument of similar import for the benefit of creditors, by Maker or any Other Liable Party; or (iv) the convening of a meeting of the creditors, or the selection of a committee representing the creditors of Maker or any Other Liable Party; or (b) The filing by Maker or any Other Liable Party of a petition, complaint, motion or other pleading seeking any relief under any receivership, insolvency, or debtor relief law, or seeking any readjustment of indebtedness, reorganization, composition, extension or any similar type of relief, or the filing of a petition, complaint, or motion under any chapter of the federal bankruptcy code, 11 U.S.C. ss.101 et seq., as the same now exists or may hereafter by amended (the "Bankruptcy Code"); or (c) The filing against Maker or any Other Liable Party of a petition, complaint, motion or other pleading seeking any relief under any receivership, insolvency, or debtor relief law, or under any chapter of the Bankruptcy Code, or seeking any readjustment of indebtedness, reorganization, composition, extension or any similar type of relief, or the entry of any order for relief under any chapter of the Bankruptcy Code; provided, however, that if Maker shall immediately notify Holder in writing of the filing of any such petition, complaint, motion or other pleading against Maker or, any Other Liable Party, and shall provide evidence satisfactory to Holder that Maker or such Other Liable Party, as the case may be, has in good faith and within ten (10) days after the filing of any such petition, complaint, motion or other pleading filed an answer thereto contesting same, then there shall be no Event of Default under this subparagraph (c) until the earliest of (i) the entry of an order for relief or a judgment under any proceedings referred to in this subparagraph (c), (ii) the appointment of a receiver, trustee, custodian or other fiduciary in any such proceeding, or (iii) the expiration of a period of thirty (30) days, at the end of which such petition, complaint, motion or other pleading remains undismissed; or 4 (d) The entry of any judgment in excess of Fifty Thousand Dollars ($50,000.00) against, or the attachment or garnishment of any of the property, goods or credits of Maker or any Other Liable Party which remains unpaid, unstayed, undismissed or unbonded for a period of sixty (60) days (excluding any judgment in the Hawaii litigation); or if any foreclosure is commenced (by judicial proceedings, by publication of notice pursuant to a power of sale or otherwise) against Maker under any mortgage, deed of trust or security agreement granted by Maker and is not dismissed or terminated within thirty (30) days after such commencement. 11. The dissolution, liquidation or termination of existence of Maker or any Other Liable Party or a sale of all or substantially all of the assets of Maker or any Other Liable Party out of the ordinary course of business. 12. Any material adverse change in the financial condition of, or any act or omission of Maker or any Other Liable Party, which leads Holder reasonably to believe that performance of any of the covenants, agreements, or conditions of the Loan Agreement, this note, the Security Instruments or any Other Document, is or may be substantially impaired. 13. If Maker fails to notify Holder in writing within ten (10) days of the occurrence of any event or condition of which Maker is aware which constitutes an Event of Default, or which with the passage of time or giving of notice or both would constitute an Event of Default, and together with such notice, furnish a written statement to Holder which shall set forth the details of any action Maker proposes to take with respect thereto. 14. If Maker is a corporation, the merger or consolidation with any corporation by Maker, without the written consent of the Holder. Upon the occurrence of any Event of Default, this note, at the option of the Holder, shall become immediately due and payable without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived by Maker and by every Other Liable Party. The Holder's failure to exercise such option shall not constitute a waiver of the right to exercise it at any other time. Irrespective of the exercise or nonexercise of the foregoing option, in the event that any payment herein provided for shall become overdue for more than five (5) days a "late charge" of five percent (5%) of the overdue payment shall become immediately due and payable to the Holder as liquidated damages for failure to make prompt payment, and the same shall be secured by the Security Instruments. No renewal or extension granted, or any indulgence shown to, or any release of, or any dealings between the Holder and any other person, corporation, or entity now or hereafter interested in this note or in the property securing this note, whether as owner, encumbrancer, grantor, or otherwise, shall discharge, extend or in any way affect the obligations of Maker or any Other Liable Party hereunder. 5 Maker shall remain primarily liable on this note and the Security Instruments given to secure the same until full payment, unaffected by any alienation of all or any part of the property securing this note, by any agreement or transaction between any Holder and any alienee as to payment of principal, interest or other monies, by any forbearance or extension of time, guaranty or assumption by others, or by any other matter, as to all of which notice is hereby waived by Maker. Maker will pay the reasonable legal and other fees and expenses of the Holder reasonably incurred in connection with or incidental to (i) the negotiation, closing and administration of the loan evidenced by this note, and (ii) the enforcement of any of the obligations of Maker or any Other Liable Party or rights of the Holder under this note, the Security Instruments or any other agreement, document or instrument now or hereafter executed in connection herewith, by litigation or otherwise; and all such fees and expenses shall be indebtedness under this note and shall be secured by the Security Instruments. All provisions of this note, the Agreement and the Security Instruments are expressly subject to the condition that in no event, whether by reason of acceleration of maturity of the indebtedness evidenced hereby or otherwise, shall the amount paid or agreed to be paid to Payee hereunder and deemed interest under applicable law exceed the maximum rate of interest on the unpaid principal balance of this note allowed by applicable law (the "Maximum Allowable Rate"), which shall mean the law in effect on the date of this note, except that if there is a change in such law which results in a higher Maximum Allowable Rate being applicable to this note, then this note shall be governed by such amended law from and after its effective date. In the event that fulfillment of any provision of this note, the Agreement or any of the Security Instruments results in the interest rate hereunder being in excess of the Maximum Allowable Rate, the obligation to be fulfilled shall automatically be reduced to eliminate such excess. If, notwithstanding the foregoing, Payee or any successor Holder receives an amount which under applicable law would cause the interest rate hereunder to exceed the Maximum Allowable Rate, the portion thereof which would excessive shall automatically be applied to and be deemed a prepayment of the unpaid principal balance of this note and not a payment of interest. All obligations of Maker hereunder are the joint and several obligations of all persons or entities executing this note, and all references to Maker herein shall be deemed to refer to all of them, each of them and any of them. This note may not be modified or terminated orally. This note has been executed and delivered in Rhode Island and for all purposes shall be enforced and construed in accordance with the substantive law of the State of Rhode Island, without resort to Rhode Island's conflict of laws rules. 6 IN WITNESS WHEREOF, Maker has executed this note or caused this note to be executed by its duly authorized representatives, under seal, on the date first written above. Witnessed by: NETWORK SIX, INC. /s/ [ILLEGIBLE] By: /s/ Dorothy M. Cipolla - ---------------------------- ------------------------------- Treasurer 7 SMALL BUSINESS LOAN FUND CORPORATION SECURITY AGREEMENT THIS AGREEMENT is made this 21st day of September, 1998, by and between NETWORK SIX, INC., a Rhode Island corporation having its chief executive office and principal place of business at 475 Kilvert Street, Warwick, Rhode Island 02886 (hereinafter referred to as "Debtor"), and SMALL BUSINESS LOAN FUND CORPORATION, a governmental agency and public instrumentality of the State of Rhode Island having a principal place of business at One West Exchange Street, Providence, Rhode Island 02903 (hereinafter referred to as "Secured Party"). For good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties agree as follows: Section 1. Definitions 1.1 "Accounts Receivable" includes all accounts, contract rights, notes, drafts, acceptances, and all forms of obligations and receivables now or hereafter owed or belonging to Debtor for Inventory sold or for services rendered, all guaranties and security therefor, all right, title and interest of Debtor in the Inventory which gave rise thereto, including the right of stoppage in transit, and all rights of the Debtor, earned or yet to be earned under contracts to sell Inventory and/or other goods or to render services. 1.2 "Inventory" includes all inventory, including, all goods, merchandise, raw materials, work in process, finished goods, supplies, materials used or consumed in connection with the production thereof, and other tangible personal property now owned or hereafter acquired by Debtor and held for sale or lease or furnished or to be furnished under contracts of service or used or consumed in the business of Debtor as well as contracts and contract rights with respect thereto, documents representing the same, and the proceeds thereof. 1.3 "Equipment" includes all machinery, equipment, furniture and fixtures now owned or hereafter acquired by Debtor and all spare and replacement parts and tools therefore, (including, without limiting the generality of the foregoing, all equipment listed on any schedule attached hereto). 1.4 "Intangible Property" includes all instruments, documents of title, warehouse receipts, bills of lading, policies and certificates of insurance, securities, chattel paper, deposits, cash, patents, trademarks, copyrights, trade secrets, income tax refunds, proceeds of insurance, contract rights, choses in action, books and records (wherever located and in whatever form they are evidenced or stored), general intangibles and all other property now or hereafter owned by Debtor or in which it may have an interest, including without limitation, all of the Debtor's right, title and interest in and to any litigation proceeds payable to Debtor from the State of Hawaii or otherwise in connection with the Debtor's contract with the State of Hawaii for the Development and Implementation of a Statewide Comprehensive Automated Child Support System. 1.5 "Licenses" includes all municipal, state and federal licenses and permits on which Debtor is named or in which Debtor has an interest. 1.6 "Senior Liens" include any and all liens listed on Exhibit A which is attached hereto and incorporated herein by reference. Section 2. Security Interest 2.1 Debtor hereby grants to Secured Party subject to all Senior Liens and any equipment leases of the Debtor (" Equipment Leases"), a second position security interest in, a general lien upon and a right of offset against all of the following property (the "Collateral"), now owned or hereafter acquired by Debtor: |X| all Accounts Receivable; check if |X| all Inventory; applicable |X| all Equipment; |X| all Intangible Property; |X| all Licenses; and any and all additions and accessions to and substitutions for and proceeds (including, without limitation, insurance proceeds) and products of the foregoing. 2.2 The security interest granted hereby is to secure payment and performance of all Obligations at any time owing by Debtor to Secured Party. The term "Obligations" as used in this Security Agreement means and includes all loans, advances, debts, liabilities, obligationsand covenants owing by Debtor to Secured Party of every kind and description (whether or not evidenced by any note or other instrument and whether or not for the payment of money), direct or indirect, (whether as principal debtor, guarantor, or otherwise), absolute or contingent, due or to become due, now existing or hereafter arising, including, without limitation, the payment of the promissory note (the "Note") of the Debtor of even date herewith in the principal amount of Two Hundred Fifty Thousand Dollars ($250,000.00), and the payment and performance by Debtor of all additional obligations contained or referred to in the Note, in this Agreement, or in any other document, instrument, or agreement securing the Note or the loan evidenced thereby or executed in connection with the Note or the loan evidenced thereby, any debt, liability or obligation owing from Debtor to others which Secured Party may have obtained by assignment or otherwise, and further including, without limitation, all interest, reasonable fees, charges, attorneys' fees, court costs and expenses of whatever kind incident to the collection of the Obligations and the enforcement and protection of the security interest created hereby, all future advances and interest thereon made by Secured Party for taxes, levies, insurance and repairs to or maintenance of the Collateral, all other monies heretofore or hereafter advanced by Secured Party to or for the account of Debtor at the option of the Secured Party, and all other present or future 2 liabilities and indebtedness of Debtor to Secured Party of any nature whatsoever, liquidated or unliquidated, absolute or contingent and any extensions or renewals thereof. Section 3. Representations and Warranties Debtor represents and warrants as follows: 3.1 Debtor has the power and authority to own the Collateral, subject to any and all Senior Liens, to enter into and perform this Agreement and any other document, instrument or agreement delivered in connection herewith and to incur the Obligations. 3.2 Debtor has not acquired any of the stock or assets of any other person or entity nor been the surviving entity in a merger, except as follows: Acquisitions: -------------------------------------------------------------------------- -------------------------------------------------------------------------- Mergers: -------------------------------------------------------------------------- -------------------------------------------------------------------------- 3.3 Debtor utilizes no trade names in the conduct of its business, except as follows: Trade Names -------------------------------------------------------------------------- -------------------------------------------------------------------------- 3.4 Debtor has filed all federal, state and local tax returns and other reports it is required to file and has paid all taxes, assessments and other governmental charges now due and payable. Section 4. Representations, Warranties and Covenants Debtor represents, warrants and covenants as follows: 4.1 Except for the security interest granted hereby, and except for Senior Liens, Debtor has, and in the case of after-acquired Collateral, will have good and marketable title to the Collateral free from any adverse lien, security interest or encumbrance; and that Debtor will defend the Collateral against all claims and demands of all persons at any time claiming the same or any interest therein. 3 4.2 All warranties, representations, statements and other information furnished to Secured Party by Debtor or on behalf of Debtor at the Debtor's request, are and will be when the same are made or furnished by Debtor accurate and complete in all material respects. 4.3 The chief executive office of Debtor is as stated above, and Debtor will not change such chief executive office without thirty (30) days prior written notice to Secured Party. 4.4 The Collateral is and will be kept at Debtor's address listed above, and that Debtor will not remove any of the Collateral from said location without the prior written consent of Secured Party, except Inventory, sold in the ordinary course of business. 4.5 Except as indicated in Section 4.1 above, no financing statement, tax lien or other lien, claim or encumbrance covering any of the Collateral or any proceeds thereof is on file in any public office, and that at the request of Secured Party, Debtor will join with Secured Party in executing one or more financing statements pursuant to the Uniform Commercial Code in form satisfactory to Secured Party and will pay the cost of filing the same in all public offices wherever filing is deemed by Secured Party to be necessary or desirable; and Debtor hereby irrevocably constitutes and appoints any officer of Secured Party. Debtor's attorney-in-fact to execute and file in the name and on behalf of Debtor such financing statement or statements in the event Debtor refuses or fails to do so, provided that the Secured Party shall subordinate the same to all Senior Liens. 4.6 Debtor will not sell, pledge, hypothecate, encumber, assign, or offer to sell or otherwise transfer the Collateral or any interest therein after the date hereof without the prior written consent of Secured Party, except in the ordinary course of business, and except that the Debtor may at any time refinance Senior Lien with PrinVest to obtain new financing as provided on Exhibit A as a Senior Lien for which the Debtor may give a first priority security interest Accounts Receivables and work in progess without the prior written consent of Secured Party. A sale in the ordinary course of business does not include, inter alia, a transfer in partial or total satisfaction of a debt. Lender agrees to subordinate its interest in the accounts receivable and work in progress to any such bank or institutional Lender. 4.7 Debtor shall maintain insurance at all times with respect to the Collateral against loss by fire (including so-called extended coverage), theft, and such other casualties as Secured Party may require in a sum not less than the replacement cost of the Collateral, In addition Debtor will have and maintain, in such form and with such companies and in such amounts as shall be reasonably satisfactory to Secured Party, insurance against such other losses as may be reasonably required by Secured Party or as are customarily maintained by similar businesses operating in similar localities and under similar conditions as Debtor, including by way of illustration and not of limitation, flood, public liability, personal property, theft, workmens' compensation and collision insurance. Each and every policy of insurance (except workman's compensation) shall insure Secured Party's interest regardless of any breach or violation by Debtor of any warranties, declarations or conditions contained in such policies. All policies of such insurance shall be in such form as shall be reasonably satisfactory to Secured Party, shall be made payable in case of loss to Secured Party, shall provide that the same may not be altered or cancelled by the insurer except after thirty (30) days prior written notice to 4 Secured Party, and such certificates as Secured Party may from time to time request, shall be delivered to Secured Party, to be held as collateral security for the Obligations. Debtor shall have free choice of agent and insurer through or by which such insurance is to be placed or written provided said insurer is authorized to write such insurance in the State in which the Collateral is located, as a licensed resident agent in said state, and has, at all times while this Agreement is in effect, a general policy-holder's rating of A or A+ in Best's latest rating guide. If any proceeds under any insurance policies are paid to Secured Party while any Obligations are outstanding, Secured Party shall, unless Event of Default has occurred and is continuing, pay over such proceeds to Debtor for the purpose of replacing the lost, damaged, or destroyed Collateral with respect to which such proceeds are paid. Upon an Event of Default, payment may be made to Debtor at the option of the Secured Party or shall be applied to Debtor's Obligations. Upon Event of Default, Secured Party, in its discretion, may act as attorney for Debtor in obtaining, adjusting, settling, and cancelling such insurance. If Debtor fails to procure or maintain such insurance, Secured Party shall have the right, but not the obligation, to effect such insurance, in which event Debtor shall repay to Secured Party the cost thereof immediately upon demand, and until repaid these amounts shall be added to the unpaid principal balance of the Note, shall bear interest at rate of interest set forth in the Note and together with such interest shall be secured by this Agreement and by any other agreements securing the Note. 4.8 Except as indicated in Section 4.1 above, the Collateral is now in good order and repair, and that Debtor will keep the Collateral in good order and repair and free from any adverse lien, security interest and encumbrance (except Senior Liens) and will not waste or destroy the Collateral or operate or use the Collateral in violation of any statute or ordinance. 4.9 Debtor will pay promptly when due all taxes and assessments upon the Collateral or for its use or operation or upon any note or notes evidencing the Obligations. 4.10 Debtor will permit Secured Party, through its authorized attorneys, accountants and representatives, to inspect and examine the Collateral and/or books, accounts, records, ledgers and assets of every kind and description of Debtor with respect to the Collateral at all reasonable times upon reasonable notice, and to make copies and extracts from such books, accounts, records and ledgers. 4.11 Debtor will, at all times and from time to time at the request of Secured Party, do, make, and execute and deliver all such additional and further acts, things, deeds, assurances and instruments as Secured Party reasonably deems necessary or appropriate to more completely perfect or maintain perfected its security interest in the Collateral subject to Senior Liens and/or to otherwise further vest in and assure to Secured Party its rights hereunder and in or to the Collateral and the proceeds and products thereof. 4.12 Debtor hereby authorizes Secured Party to file financing and continuation statements with respect to the Collateral in accordance herewith without the signature of Debtor whenever lawful. 5 4.13 If all or any portion of the Collateral is a motor vehicle or vehicles otherwise subject to any certificate of title law, Debtor will cause the interest of Secured Party to be noted thereon, and Secured Party, to the extent permitted by law, shall hold the original Certificate of Title until payment in full of the Obligations. Section 5. Discharge of Liens At its option, Secured Party may discharge taxes, liens, or security interests or other encumbrances at any time levied or placed on the Collateral, and may pay for the maintenance and preservation of the Collateral. Any payment made or expense incurred by Secured Party pursuant to this provision shall be repaid to Secured Party immediately upon demand and until repaid, these amounts shall be added to the unpaid principal balance of the Note, shall bear interest at the rate of interest set forth in the Note together with such interest shall be secured by this Agreement and by any other documents, instruments or agreements now or hereafter securing the Note. Section 6. Possession by Debtor Until the occurrence of an Event of Default hereunder, Debtor may have possession of the Collateral and use it in any lawful manner not inconsistent with (i) any policy of insurance thereon, (ii) this Agreement or (iii) the Loan Agreement of even date herewith between Secured Party and Debtor. Section 7. Events of Default Debtor shall be in default under this Agreement upon the occurrence of any of the following "Events of Default": 1. Default in the payment of any amounts due under the Note, whether at the due date thereof after applicable grace periods or by acceleration or otherwise, no prior demand therefor being necessary, such non-payment having continued for ten (10) days; 2. Default in the payment when due of any other Obligations, such Default continuing beyond any applicable grace period, such Default having continued for ten (10) days after written notice thereof by Secured Party to Debtor; 3. Nonperformance or nonobservance of any of the covenants, agreements or conditions of this Agreement, and such nonperformance or nonobservance shall have continued for more than thirty (30) days after written notice except as otherwise provided herein; ; 4. The proving false of any material representation or warranty contained herein or in any other document, instrument or agreement now or hereafter entered into between Debtor and Secured Party or given by or on behalf of Debtor to Secured Party; 5. Substantial loss, theft, damage or destruction of the Collateral not covered by insurance; or 6. The occurrence of an "Event of Default" as defined in the Note. Section 8. Remedies Upon the occurrence of an Event of Default and at any time thereafter Secured Party may while such default continues declare all Obligations secured hereby immediately due and payable without presentment, demand, protest or other notice of any kind, and all of which expressly 6 waived. Secured Party in addition to such other rights and remedies as are or may be set forth in this Agreement or in any other document, agreement or instrument between Debtor and Secured Party or in the Note, may exercise and shall have the rights and remedies of a secured party under the Uniform Commercial Code in effect in Rhode Island at the time of such default. Without limiting the generality of the foregoing, Secured Party may require Debtor to assemble the Collateral and make it available to Secured Party at a place designated by Secured Party. Secured Party will give Debtor notice of the time and place of any public sale thereof or the time at which any private sale or any other intended disposition thereof is to be made. The requirements of notice shall be met if such notice is mailed, postage prepaid, to Debtor at its address set forth or other address Debtor provides the Secured Party in writing above at least ten (10) days before the time of the sale or disposition. Debtor shall pay to Secured Party on demand any and all expenses including all reasonable attorneys' fees and legal expenses incurred or paid by Secured Party in protecting or enforcing its rights, powers and remedies hereunder or under any other document, instrument or agreement between Debtor and Secured Party or the Note, or in any way connected with any proceeding or action by whomsoever initiated concerning the protection or enforcement of such rights, powers and remedies by Secured Party. Debtor understands and agrees that Secured Party may exercise its rights hereunder without giving Debtor any opportunity for a hearing to be held before Secured Party, through judicial process or otherwise, may take possession of the Collateral upon the occurrence of an Event of Default and Debtor expressly waives the right, if any, to such prior hearing. Section 9. Accounts Receivable Only upon the Event of Default and while such default continues, and subject to all rights of Senior Liens in the Collateral: 9.1 If all or any portion of the Collateral is Accounts Receivable, Debtor hereby irrevocably appoints Secured Party and any other person whom Secured Party may from time to time designate, with full power and authority, acting in its own name or in the name of the Debtor; 9.1.1 to endorse Debtor's name on any checks, notes, acceptances, money orders, drafts or other forms of payment or security that may come into Secured Party's possession; to sign Debtor's name on any invoice or bill of lading relating to any Accounts Receivable, on drafts against customers; on schedules and assignments of Accounts Receivable, on notice of assignment, financing statements, and other public records, on verifications of accounts and on notices to customers; to notify the post office authorities to change the address for delivery of Debtor's mail to an address designated by Secured Party; to receive, open and dispose of all mail addressed to Debtor; to send requests for verification of Accounts Receivable to customers of account debtors; and to do all things necessary to carry out this Agreement; 9.1.2 to obtain from any computer or other billing agency or service any and all information relating to the Accounts Receivable, including without limiting the generality of the 7 foregoing, copies of all trial balances, aging reports, summary reports, and lists containing the names and addresses of account debtors; 9.13 to insert in any mailing being made by Debtor or on behalf of Debtor to account debtors, such notices, letters, flyers or other notifications or insertions as Secured Party may desire; and 9.1.4 to notify account debtors, or to require Debtor to notify account debtors, that the Accounts Receivable have been assigned to, and are payable directly to Secured Party. 9.2 Debtor hereby ratifies and approves all acts of such attorney and agrees that neither Secured Party nor any other such attorney shall be liable for any acts or omissions nor for any error of judgment or mistake of fact or law. This power, being coupled with an interest, is irrevocable so long as any Accounts Receivable assigned to Secured Party or in which Secured Party has a security interest remain unpaid or until the Obligations have been fully satisfied. 9.3 As long as Secured Party does not request that any of the account debtors on the Accounts Receivable be notified of the assignment thereof to Secured Party, Debtor shall make collections on the Accounts Receivable. After notification of account debtors pursuant to Section 9.1.4 above, if Debtor receives any payments from account debtors, Debtor shall hold the proceeds received in trust for Secured Party without commingling the same with other funds of Debtor, and turn over such proceeds to Secured Party in the exact form in which they are received. If any of said collections include checks, drafts or other payments payable to Debtor, they shall be duly endorsed by Debtor. Secured Party being authorized to endorse in the name of Debtor any instruments delivered to Secured Party unendorsed. All proceeds so received by Secured Party shall be applied by Secured Party to the payment of the Obligations in such order as Secured Party shall determine in its discretion. Section 10. Miscellaneous 10. 1 The captions in this Agreement are for convenience and reference only and do not define, limit or describe the scope of the provisions hereof. 10.2 The provisions of this Agreement may not be modified or terminated orally. Secured Party shall not be deemed to have waived or amended any of its rights or remedies hereunder unless such waiver or amendment be in writing and signed by it. No delay or omission on the part of the Secured Party in exercising any such right or remedy shall operate as a waiver of such right or remedy or any other right or remedy. A waiver on any one occasion shall not be construed as a bar to or a waiver of the same right or remedy on any future occasion. 10.3 The rights and remedies provided the Secured Party in this Agreement and in any other document, instrument or agreement between the parties hereto shall be cumulative and shall be in addition to and not in derogation of any rights or remedies provided Secured Party in any such other document, instrument or agreement or under applicable law or otherwise. 8 10.4 All rights of Secured Party hereunder shall inure to the benefit of its successors and assigns; and all Obligations of Debtor hereunder shall bind its heirs, executors, administrators, successors and assigns. 10.5 Every word herein purporting to the neuter gender only shall extend to and include males and females and every word herein importing the singular number only shall be construed to extend to and include the plural number also. 10.6 In the event any term or provision of this Agreement or the application thereof to any person or circumstance shall, to any extent, be held invalid or unenforceable, the remainder of this Agreement or the application of such term or provision to persons or circumstances other than those to which it is held invalid or unenforceable, shall be valid and enforceable to the fullest extent permitted by law. 10.7 The law governing this Agreement shall be the substantive law of the State of Rhode Island determined without resort to the state's conflict-of-laws rules. Notwithstanding any of the foregoing provisions, this Agreement shall at all times be subordinate to any Senior Liens Debtor has in effect as of the date of this Agreement or enters into after the date of this Agreement, including the refinancing of the PrinVest Lien listed on Exhibit A. IN WITNESS WHEREOF, Debtor and Secured Party have executed this Security Agreement, under seal, on the day and year first above written. WITNESS: DEBTOR: NETWORK SIX, INC. /s/ [ILLEGIBLE] By: /s/ Dorothy M. Cipolla - ---------------------------- ------------------------------- Treasurer SECURED PARTY: SMALL BUSINESS LOAN FUND CORPORATION /s/ [ILLEGIBLE] By: /s/ [ILLEGIBLE] - ---------------------------- ------------------------------- Administrator 9 EXHIBIT A Senior Liens shall include: 1. Any and all liens resulting from a loan agreement entered into between PrinVest Financial Corp., a New Jersey corporation, and the Maker hereof dated December 31, 1997 any successor bank or institutional lender for financing to be used by the Borrower in conjunction with its day to day business operations, which financing is or may be secured by Borrower's grant of a first position security interest in all accounts receivable and work in progress of the Borrower. 2. Any and all equipment leases presently existing and any other equipment leases entered into by the Borrower after the date hereof. 3. An assignment of certain litigation proceeds by Borrower to Lockhead Martin IMS Corporation dated December 24, 1997. 4. A financing arrangement between the Borrower and Unisys Corporation relating to a contract between Borrower and the State of Maine dated April 11, 997 which is identified as the "Maine Automated Child Welfare Information System Contract" and evidenced by financing statement 665667 and 665719 filed with the Rhode Island Secretary of State. 10 4.2 All warranties, representations, statements and other information furnished to Secured Party by Debtor or on behalf of Debtor at the Debtor's request, are and will be when the same are made or furnished by Debtor accurate and complete in all material respects. 4.3 The chief executive office of Debtor is as stated above, and Debtor will not change such chief executive office without thirty (30) days prior written notice to Secured Party. 4.4 The Collateral is and will be kept at Debtor's address listed above, and that Debtor will not remove any of the Collateral from said location without the prior written consent of Secured Party, except Inventory, sold in the ordinary course of business. 4.5 Except as indicated in Section 4.1 above, no financing statement, tax lien or other lien, claim or encumbrance covering any of the Collateral or any proceeds thereof is on file in any public office, and that at the request of Secured Party, Debtor will join with Secured Party in executing one or more financing statements pursuant to the Uniform Commercial Code in form satisfactory to Secured Party and will pay the cost of filing the same in all public offices wherever filing is deemed by Secured Party to be necessary or desirable; and Debtor hereby irrevocably constitutes and appoints any officer of Secured Party, Debtor's attorney-in-fact to execute and file in the name and on behalf of Debtor such financing statement or statements in the event Debtor refuses or fails to do so, provided that the Secured Party shall subordinate the same to all Senior Liens. 4.6 Debtor will not sell, pledge, hypothecate, encumber, assign, or offer to sell or otherwise transfer the Collateral or any interest therein after the date hereof without the prior written consent of Secured Party, except in the ordinary course of business, and except that the Debtor may at any time refinance Senior Lien with PrinVest to obtain new financing as provided on Exhibit A as a Senior Lien for which the Debtor may give a first priority security interest Accounts Receivables and work in progess without the prior written consent of Secured Party. A sale in the ordinary course of business does not include, inter alia a transfer in partial or total satisfaction of a debt. Lender agrees to subordinate its intent in the accounts receivable and work in progress to any such bank or institutional Lender. 4.7 Debtor shall maintain insurance at all times with respect to the Collateral loss by fire (including so-called extended coverage), theft, and such other casualties as Secured Party may require in a sum not less than the replacement cost of the Collateral. In addition Debtor will have and maintain, in such form and with such companies and in such amounts as shall be reasonably satisfactory to Secured Party, insurance against such other losses as may be reasonably required by Secured Party or as are customarily maintained by similar businesses operating in similar localities and under similar conditions as Debtor, including by way of illustration and not of limitation, flood, public liability, personal property, theft, workmens' compensation and collision insurance. Each and every policy of insurance (except workman's compensation) shall insure Secured Party's interest regardless of any breach or violation by Debtor of any warranties, declarations or conditions contained in such policies. All policies of such insurance shall be in such form as shall be reasonably satisfactory to Secured Party, shall be made payable in case of loss to Secured Party, shall provide that the same may not be altered or cancelled by the insurer except after thirty (30) days prior written notice to 4 Secured Party, and such certificates as Secured Party may from time to time request, shall be delivered to Secured Party, to be held as collateral security for the Obligations. Debtor shall have free choice of agent and insurer through or by which such insurance is to be placed or written provided said insurer is authorized to write such insurance in the State in which the Collateral is located, as a licensed resident agent in said state, and has, at all times while this Agreement is in effect, a general policy-holder's rating of A or A+ in Best's latest rating guide. If any proceeds under any insurance policies are paid to Secured Party while any Obligations are outstanding, Secured Party shall, unless Event of Default has occurred and is continuing, pay over such proceeds to Debtor for the purpose of replacing the lost, damaged, or destroyed Collateral with respect to which such proceeds are paid. Upon an Event of Default, payment may be made to Debtor at the option of the Secured Party or shall be applied to Debtor's Obligation. Upon Event of Default, Secured Party, in its discretion, may act as attorney for Debtor in obtaining, adjusting, settling, and cancelling such insurance. If Debtor fails to procure or maintain such insurance, Secured Party shall have the right, but not the obligation, to effect such insurance, in which event Debtor shall repay to Secured Party the cost thereof immediately upon demand, and until repaid these amounts shall be added to the unpaid principal balance of the Note, shall bear interest at rate of interest set forth in the Note and together with such interest shall be secured by this Agreement and by any other agreements securing the Note. 4.8 Except as indicated in Section 4.1 above, the Collateral is now in good order and repair, and that Debtor will keep the Collateral in good order and repair and free from any adverse lien, security interest and encumbrance (except Senior Liens) and will not waste or destroy the Collateral or operate or use the Collateral in violation of any statute or ordinance. 4.9 Debtor will pay promptly when due all taxes and assessments upon the Collateral or for its use or operation or upon any note or notes evidencing the Obligations. 4.10 Debtor will permit Secured Party, through its authorized attorneys, accountants and representatives, to inspect and examine the Collateral and/or books, accounts, records, ledgers and assets of every kind and description of Debtor with respect to the Collateral at all reasonable times upon reasonable notice, and to make copies and extracts from such books, accounts, records and ledgers. 4.11 Debtor will, at all times and from time to time at the request of Secured Party, do, make, and execute and deliver all such additional and further acts, things, deeds, assurances and instruments as Secured Party reasonably deems necessary or appropriate to more completely perfect or maintain perfected its security interest in the Collateral subject to Senior Liens and/or to otherwise further vest in and assure to Secured Party its rights hereunder and in or to the Collateral and the proceeds and products thereof. 4.12 Debtor hereby authorizes Secured Party to file financing and continuation statements with respect to the Collateral in accordance herewith without the signature of Debtor whenever lawful. 5 EXHIBIT A Senior Liens shall include: 1. Any and all liens resulting from a loan agreement entered into between PrinVest Financial Corp., a New Jersey corporation, and the Maker hereof dated December 31, 1997 any successor bank or institutional lender for financing to be used by the Borrower in conjunction with its day to day business operations, which financing is or may be secured by Borrower's grant of a first position security interest in all accounts receivable and work in progress of the Borrower. 2. Any and all equipment leases presently existing and any other equipment leases entered into by the Borrower after the date hereof. 3. An assignment of certain litigation proceeds by Borrower to Lockhead Martin IMS Corporation dated December 24, 1997. 4. A financing arrangement between the Borrower and Unisys Corporation relating to a contract between Borrower and the State of Maine dated April 11, 997 which is identified as the "Maine Automated Child Welfare Information System Contract" and evidenced by financing statement 665667 and 665719 filed with the Rhode Island Secretary of State. 10 NETWORK SIX, INC. CERTIFICATE OF SECRETARY I, Dorothy M. Cipolla, do hereby certify that I am the duly elected, qualified and acting Secretary of Network Six, Inc. (the "Corporation"), a Rhode Island corporation, and that the resolutions set forth in this certificate were adopted by the written consent of all of the Board of Directors of the Corporation dated September 21, 1998: RESOLVED: That the Corporation is hereby authorized to borrow from Small Business Loan Fund Corporation of Rhode Island (the "Lender") the aggregate principal amount of up to Two Hundred Fifty Thousand Dollars ($250,000.00) and, in connection therewith, to execute, deliver and perform a term loan agreement between the Corporation and Lender pursuant to which the Lender will lend to the Corporation up to Two Hundred and Fifty Thousand Dollars ($250,000.00) (the "Loan Agreement"), a Two Hundred Fifty Thousand Dollar ($250,000.00) Term Promissory Note (the "Note"), and a Security Agreement securing repayment of the same (the "Security Agreement"). RESOLVED: That the President or Treasurer of the Corporation be, and each of them acting alone hereby is authorized to execute in the name and deliver on behalf of the Corporation one or more counterparts of the Loan Agreement, the Note, and the Security Agreement, to be in form and substance as may be approved by the officer executing the same, his or her execution thereof to be deemed conclusive evidence of such approval and of his or her authority hereunder. RESOLVED: That the several officers of the Corporation be and each of them acting alone hereby is authorized to execute such instruments and take such other actions in the name and on behalf of the Corporation as they or any one of them may deem necessary or appropriate to carry out the terms of the Loan Agreement, the Note, and the Security Agreement, including without limitation, the execution, acknowledgment and delivery of any and all agreements, certificates, instruments and other documents as they or any one of them shall deem necessary or appropriate. And I do hereby certify that the following are the officers of the Corporation and that they have been elected to serve in the capacities set forth opposite their names until such time as their successors have been duly elected and qualified: Kenneth C. Kirsch - President Donna J. Guido - Vice President Dorothy M. Cipolla - Secretary and Treasurer IN WITNESS WHEREOF, I have executed this Certificate of Secretary on the 21st day of September, 1998. /s/ Dorothy M. Cipolla ------------------------------ Secretary CERTIFICATE OF SECRETARY OF NETWORK SIX, INC. The undersigned, being the duly elected Secretary of Network Six, Inc., a Rhode Island corporation (the "Corporation"), hereby certifies that the copy of the by-laws of the Corporation attached hereto as Exhibit A is a true and accurate copy of said by-laws as of this date, the originals being kept with the Corporation's minutes in the offices of Gaebe & Kezirian, 128 Dorrance Street, Providence, RI 02903. IN WITNESS WHEREOF, the undersigned has set her hand this 21 day of September, 1998. /s/ Dorothy M. Cipolla ------------------------------ Dorothy M. Cipolla, Secretary INTERCREDITOR AGREEMENT BETWEEN BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND AND SMALL BUSINESS LOAN FUND CORPORATION Agreement entered into this 21st day of September, 1998, by and between Business Development Company of Rhode Island, a Rhode Island corporation with its office at 40 Westminster Street, Suite 702, Providence, Rhode Island 02903 ("BDC") and Small Business Loan Fund Corporation, a Rhode Island governmental instrumentality with an office at One West Exchange Street, Providence, Rhode Island 02903 ("SBLFC") WITNESSETH: WHEREAS, NETWORK SIX, INC., a Rhode Island corporation with offices at 475 Kilvert Street, Warwick, Rhode Island 02886 ("Borrower"), has obtained term loan financing in the original principal sum of $250,000 from BDC ("BDC Term Loan"), such BDC Term Loan to be secured by a lien interest in all of the Borrower's presently owned and hereafter acquired fixtures, tangible and intangible personal property (the "Collateral"); and WHEREAS, the Borrower has obtained financing in the original aggregate principal amount of $250,000 from SBLFC (the "SBLFC Loan"), such SBLFC Loan to be secured by a lien interest in all of the Collateral; and WHEREAS, BDC and SBLFC agree that it is in their best interest to enter into an Intercreditor Agreement governing their relationship; NOW, THEREFORE, in consideration of the foregoing and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: 1. Consent to Grant of Security Interest. SBLFC consents to the granting by the Borrower to BDC of a security interest in and to all the Collateral and the proceeds thereof, as security for the BDC Term Loan. BDC consents to the granting by the Borrower to SBLFC of a security interest in and to all the Collateral and the proceeds thereof, as security for the SBLFC Loan. 2. Pari Passu. In consideration of the premises, BDC and SBLFC hereby agree that BDC's security interest in the Collateral and products and proceeds thereof, shall be and hereby is pari passu with the security position for the SBLFC Loan. 3. Primary Debt. BDC and SBLFC agree that each of their security documents and any amendments thereto will not, at any time, secure an amount greater than the Primary Debt. For purposes of this Agreement, the term "Primary Debt" shall mean: (a) with respect to BDC, the amount of the BDC Term Loan, plus: (i) accrued and unpaid interest on and fees related to the BDC Term Loan; (ii) amounts advanced by BDC on behalf of the Borrower for taxes, insurance, maintenance or repairs relating to the Collateral; and (iii) other costs incurred by BDC, including but not limited to attorneys' fees, in protecting or realizing upon its liens or security interest 2 under the documents, instruments, agreements, or other writings evidencing or securing the BDC Term Loan; and (b) with respect to SBLFC, the amount of the SBLFC Loan plus (i) accrued and unpaid interest on and fees related to the SBLFC Loan; (ii) amounts advanced by SBLFC on behalf of the Borrower for taxes, insurance, maintenance or repairs relating to the Collateral; and (iii) other costs incurred by SBLFC, including but not limited to attorneys' fees, in protecting or realizing upon its liens or security interest under the documents, instruments, agreements, or other writing evidencing or securing the SBLFC Loan. 4. Relative Priorities. BDC and SBLFC agree that despite their respective secured positions concerning the Collateral, they wish to establish, as between them, and only between them, the order of priority as to the application of proceeds realized from any disposition of any secured party, or otherwise, of the Collateral. BDC and SBLFC agree that such proceeds shall be applied on a pari passu basis based upon the then outstanding respective amounts of the BDC Primary Debt and the SBLFC Primary Debt. Each of the parties hereto shall execute such instruments including, without limitation, those forms commonly referred to as "UCC-1" and/or "UCC-3" with respect to the priorities described and established in Paragraph 4, above, as the other reasonably may request from time to time. 5. Exchange of Notices. Each of the parties shall provide 3 the other with a copy of any notices of demand or default given the Borrower and shall provide the other with written notice of any acceleration in each event as and when effected or made by that party; provided, however, the failure to provide such notice shall not have adverse effect upon such demand, default, and/or acceleration. 6. Exercise of Rights. BDC and SBLFC hereby agree: (a) Each party shall upon request of the other party provide financial and/or audit information that has been obtained from the Borrower, directly or indirectly, unless prohibited by applicable law. (b) The within Agreement is intended to reflect and restate the relative priorities and rights of the parties hereto, and is not intended to amend or modify any of the provisions of the instruments executed in connection with the loan arrangements between either BDC or SBLFC and the Borrower. 7. Insurance Proceeds. The respective rights and priorities of the parties in and to any proceeds realized on account of any insured loss to all or any portion of the Borrower's assets are the same as the priorities set forth in Paragraph 4. above. Subject to the foregoing, in the event of any insured loss, the parties shall agree concerning their respective interest in the insurance proceeds arising therefrom, shall cooperate concerning the adjustment and collection of such loss, and shall cooperate concerning the 4 collection of any check, draft, or other item which represents such insurance proceeds and the distribution of such proceeds amongst the parties. 8. Duration. This Agreement and all obligations hereunder or with respect hereto, of the Borrower, BDC and SBLFC shall continue in full force and effect until payment in full of the SBLFC Loan. 9. Notices. Notices and other correspondence concerning the within Agreement shall be given to the following addresses, each of which may be changed upon seven (7) days prior written notice to all others by certified mail, return receipt requested: If to SBLFC: Small Business Loan Fund Corporation One West Exchange Street Providence, RI 02903 Attention: John F. Sheehan If to BDC: Business Development Company of Rhode Island 40 Westminster Street, Suite 702 Providence, RI 02903 Attention: Peter C. Dorsey, Jr. Vice President 10. Independent Parties. BDC and SBLFC each acknowledge that the other party maintains and manages its own independent relationship with the Borrower and that neither BDC nor SBLFC is the agent of any other party. 5 IN WITNESS WHEREOF, the parties have executed the within Agreement on the date first above written. BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND ("BDC") By: /s/ [ILLEGIBLE] ---------------------------------- Title: President ------------------------------- SMALL BUSINESS LOAN FUND CORPORATION By: /s/ [ILLEGIBLE] ---------------------------------- Title: Administrator ------------------------------- Borrower hereby consents to the terms of the above Agreement and specifically consents to the provisions contained in Paragraph 6(a) and 6(b). NETWORK SIX, INC. ("Borrower") By: /s/ Dorothy M. Cipolla ---------------------------------------- Title: TREASURER ------------------------------------- 6 EX-10.17 3 EXHIBIT-10.17 EXHIBIT-10.17 TERM LOAN AGREEMENT AGREEMENT made this 21st day of September, 1998, by and between BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND, a Rhode Island corporation with its principal place of business at 40 Westminster Street, Suite 702, Providence, Rhode Island 02903 (the "Lender"), and NETWORK SIX, INC., a Rhode Island corporation with its principal address at 475 Kilvert Street, Warwick, Rhode Island 02886 (the "Borrower"). I. GENERAL TERMS Section 1.01. Loan: The Borrower agrees to borrow from the Lender the principal sum of up to Two Hundred Fifty Thousand Dollars ($250,000) on a term basis (the "Loan"), and the Lender has agreed to make the Loan to the Borrower, subject to all the terms and conditions of this Agreement. Section 1.02. Note: The Loan shall be evidenced by the Borrower's $250,000 Term Promissory Note (the "Note") in the form attached hereto as Exhibit A, which Note is hereby incorporated herein by reference and made a part hereof. Section 1.03. Prepayment. Subject to the provisions hereof, the Borrower may prepay the principal of the Note, in whole at any time, or in part, as long as any prepayment is equal to at least 5% of any outstanding principal balance from time to time, and tendered on any principal payment date upon not less than ten (10) business days prior written notice to the Lender. Each such notice shall specify the prepayment date and the principal amount of the Note to be prepaid. If prepayment is made on the Note at any time between the date hereof and five (5) years from the date hereof, the prepayment penalty shall be equal to five percent (5%) of the prepaid amount. All prepayments shall be applied to the payment of installments of principal of the Note in the inverse order of maturity thereof. Each prepayment shall be accompanied by the interest accrued on the principal amount so prepaid through the date of prepayment. Section 1.04. Use of Proceeds: The proceeds of the Loan shall be used to hire additional marketing staff, purchase computer equipment and software, and provide working capital. Loan proceeds shall not be used for any other purpose including the financing of legal expenses. Section 1.05. Security for the Note: The Note and the Borrower's obligations thereunder shall be secured by: (a) a second (behind only a senior lender's lien on accounts receivable and work-in-process and other senior liens set forth on Exhibit C hereto) priority security interest (shared on a pari passu basis with the Small Business Loan Fund Corp. ("SBLFC")) in all of the tangible and intangible personal property of the Borrower pursuant to the terms of a Security Agreement of even date (the "Security Agreement"); (b) reserved. All agreements and instruments described in this Section 1.05, together with any and all other agreements and instruments heretofore or hereafter securing the Note, are sometimes hereinafter 2 referred to collectively as the "Security Documents" and individually as a "Security Document". Section 1.06. Loan Commitment Deferred Fee: The Borrower, subject to the terms and conditions of this Agreement and of the Note, shall pay to the Lender a loan commitment deferred fee of Twenty-Five Thousand Dollars ($25,000) (the "Deferred Fee") in five (5) consecutive annual payments, each in the sum of Five Thousand Dollars ($5,000), beginning on the 1st day of September, 1999, and payable on the same day of each successive year or the next business day thereafter, with a final payment being due and payable on September 1, 2003; provided, however, that if the Borrower prepays the principal of the Note in whole at any time, then the Deferred Fee shall be due and payable immediately upon such prepayment. Further, the Borrower agrees that the Deferred Fee, if not paid when due, shall bear interest at the rate provided for in the Note on the entire unpaid balance of the Deferred Fee, and shall in all events be secured by the lien of the Security Agreement. II. REPRESENTATIONS AND WARRANTIES The Borrower represents and warrants to the Lender (which representations and warranties shall survive the delivery of the Note and the making of the Loan) that: Section 2.01. The Borrower has heretofore furnished to the Lender a balance sheet of the Borrower and profit and loss and surplus statements of the Borrower for its most recently completed fiscal year or other period then ended, together with supporting schedules, all prepared by certified public accountants, together with supporting 3 schedules, prepared by the Borrower. Said balance sheet and statements have been prepared in accordance with generally accepted principles of accounting ("GAAP") applied on a basis consistent with that of preceding periods and are complete and correct and fairly present the financial condition of the Borrower as at said dates, and the results of its operations for the year or other period ended on said dates. To the best of the Borrower's knowledge and belief, the Borrower has no contingent obligations, liabilities for taxes or unusual forward or long-term commitments except as in the foregoing financial statements specifically mentioned. Since the date(s) of said financial statements, there has been no material adverse change in the financial condition of the Borrower, nor any material decrease in sales or order backlog, and since that date no dividends or other distributions on common stock have been paid or made to the stockholders of the Borrower except as may be otherwise stated in a letter of the Borrower to the Lender dated the date of this Agreement and acknowledged in writing by the Lender. Section 2.02. The Borrower (a) is duly organized, validly existing and in good standing under the laws of its state of incorporation, (b) has the corporate power and authority to own its properties and to carry on business as now being conducted and is qualified to do business in every jurisdiction where to Borrower's knowledge such qualification is necessary and (c) has the corporate power to execute and deliver, and perform its obligations under this Agreement, the Note and the Security Documents. 4 Section 2.03. The execution and delivery and performance by the Borrower of its obligations under this Agreement, the Note and each of the Security Documents have been duly authorized by all requisite corporate action and will not violate any provision of law, any order of any court or other agency of government, the corporate charter or by-laws of the Borrower or any indenture, agreement or other instrument to which it is a party, or by which it is bound, or be in conflict with, result in a breach of, or constitute (with due notice or lapse of time or both) a default under, or except as may be provided by this Agreement, result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of the property or assets of the Borrower pursuant to, any such indenture, agreement or instrument. The Borrower is not required to obtain any consent, approval or authorization from, or to file any declaration or statement with, any governmental instrumentality or other agency in connection with or as a condition to the execution, delivery or performance of this Agreement, the Note or the Security Documents. Section 2.04. Except as previously disclosed in writing to Lender, there is no action, suit or proceeding at law or in equity or by or before any governmental instrumentality or other agency now pending or, to the knowledge of the Borrower, threatened against or affecting the Borrower which, if adversely determined, would have a material adverse effect on the business, operations, properties, assets or condition, financial or otherwise, of the Borrower. 5 Section 2.05. The Borrower is not a party to any agreement or instrument or subject to any charter or other corporate restriction materially adversely affecting its business, properties or assets, operations or conditions, financial or otherwise, other than has been previously disclosed to the Lender. The Borrower is not in default in the performance, observance or fulfillment of any of the obligations, covenants or conditions contained in any agreement or instrument to which it is a party, other than as previously disclosed in writing to the Lender. Section 2.06. The Borrower has good title to all of its properties and assets, free and clear of all mortgages, security interests, restrictions, liens and encumbrances of any kind, except liens permitted hereunder and restrictions, easements and minor irregularities in title which do not and will not materially interfere with the occupation, use and enjoyment by the Borrower of such properties and assets in the normal course of its business as presently conducted or materially impair the value of such properties and assets for the purpose of such business. Section 2.07. Any borrowings made by the Borrower under this Agreement do not and will not render the Borrower insolvent; the Borrower is not contemplating either the filing of a petition by it under any state or federal bankruptcy or insolvency laws or the liquidating of all or a major portion of its property, and the Borrower has no knowledge of any person contemplating the filing of any such petition against it, including the properties and assets 6 reflected in the financial statements referred to in Section 2.01 hereof. Section 2.08. No statement of fact made by or on behalf of the Borrower in this Agreement or in any certificate or schedule furnished to the Lender pursuant hereto, contains any untrue statement of a material fact or omits to state any material fact necessary to make statements contained therein or herein not misleading. There is no fact presently known to the Borrower which has not been disclosed to the Lender which materially affects adversely, nor as far as the Borrower can foresee, will materially affect adversely the property, business, operations or condition (financial or otherwise) of the Borrower. Section 2.09. The Borrower is not an "investment company", or a company "controlled" by an "investment company", as such terms are defined in the Investment Company Act of 1940, as amended. Section 2.10. The Borrower has filed all federal, state and local tax returns required to be filed and has paid or made adequate provision for the payment of all federal, state and local taxes, charges and assessments. Section 2.11. The Borrower does not have a pension, profit sharing or other similar plan providing for a program of deferred compensation to any employee except as set forth in a separate letter to the Lender of even date herewith and acknowledged by the Lender in writing. With respect to such plan(s), if any, Borrower covenants and agrees to cause to be paid when due all amounts necessary to fund in accordance with its terms all such plan(s) and will take no action 7 which could result in liability to the Pension Benefit Guaranty Corporation, or any of its successors or assigns, or to the entity which provides funds for such plan(s). III. CONDITIONS OF MAKING THE LOAN The obligation of the Lender to make the Loan hereunder is subject to the following conditions precedent: Section 3.01. The representations and warranties set forth in Article II hereof shall be true and correct on and as of the date hereof and the date the Loan is made. Section 3.02. The Borrower shall have executed and delivered to the Lender, upon the execution of this Agreement, the following: (a) The Note. (b) The Security Documents, together with any other documents required by the terms thereof. (c) A certificate of the Secretary or Assistant Secretary of the Borrower certifying to the votes of the Borrower's Board of Directors authorizing the execution and delivery of this Agreement, the Note and the Security Documents. (d) A certificate of the Secretary or Assistant Secretary of the Borrower which shall certify the name of the officer of the Borrower authorized to sign this Agreement, the Note, the Security Documents and any other documents or certificates to be delivered pursuant to this Agreement by the Borrower or its designated officer, 8 together with the true signatures of such officer. The Lender may conclusively rely on such certificate until it shall receive a further certificate of the Secretary or an Assistant Secretary of the Borrower cancelling or amending the prior certificate and submitting the signatures of the officers named in such further certificate. (e) Certificates of the Secretary of State and the Division of Taxation or other equivalent authorities, dated reasonably near the date of the Loan, of the state of incorporation or organization of the Borrower stating that the Borrower is duly incorporated and in good standing in such state and has filed all annual reports and has paid all franchise and other taxes required to be filed or paid to the date of such certificate. A letter from the Borrower's certified public accountants may be substituted for the certificate of the Division of Taxation. (f) The financial statements of the Borrower as set forth in Section 2.01 hereof. (g) The Borrower shall have issued to the Lender a warrant to purchase up to 11,500 shares of the common stock of the Borrower at the price per share equal to the average market price per share at the opening of trading for the five (5) days prior to the date hereof, which warrant shall be exercisable in whole or in part upon written notice to the Borrower on a date or dates as set forth therein. The warrant shall be substantially in form attached hereto as Exhibit D. 9 (h) Proof of insurance obtained by the Borrower on the collateral described in Section 1.05 hereof in an amount reasonably satisfactory to the Lender and which shall name the Lender as mortgagee, loss payee and an additional insured party as its interests may appear and provide for not less than thirty (30) days' advance notice to the Lender of cancellation or nonrenewal thereof. (i) Such other supporting documents and certificates as the Lender or its special counsel may request. Section 3.03. The Lender shall have received the favorable written opinion of Gaebe & Kezirian, counsel for the Borrower, dated the date of the Loan, reasonably satisfactory to the Lender and its counsel in scope and substance. Section 3.04. All legal matters incident to the transactions hereby contemplated shall be satisfactory to counsel for the Lender. Section 3.05. No event of default as specified in Article VI hereof, nor any event which upon notice or lapse of time or both would constitute such an event of default, shall have occurred and be continuing. Section 3.06. The Borrower shall contemporaneously close on a $250,000 term loan from SBLFC on terms reasonably satisfactory to the Lender. 10 IV. AFFIRMATIVE COVENANTS The Borrower covenants and agrees that, from the date hereof and until payment in full of the principal of, and interest on, the Note and any other indebtedness of the Borrower to the Lender, whether now existing or arising hereafter, the Borrower will: Section 4.01. (a) Do or cause to be done all things necessary to preserve, renew and keep in full force and effect its corporate existence, rights, licenses, permits and franchises and comply with all laws and regulations applicable to it; at all times maintain, preserve and protect all franchises and trade names and preserve all the remainder of its property used or useful in the conduct of its business and keep the same in good repair, working order and condition, and from time to time, make, or cause to be made, all needful and proper repairs, renewals, replacements, betterments and improvements thereto, so that the business carried on in connection therewith may be properly and advantageously conducted at all times; and keep its insurable properties adequately insured at all times, by financially sound and reputable insurers, to such extent and against such risks, including fire and other risks insured against by extended coverage, and maintain liability and such other insurance as is customarily maintained by companies engaged in similar businesses. (b) Comply with all applicable laws and regulations, whether now in effect or hereafter enacted or promulgated by any governmental authority having jurisdiction in the premises. Section 4.02. Pay and discharge or cause to be paid and discharged all taxes, assessments and governmental charges or levies 11 imposed upon it or upon its respective income and profits or upon any of its property, real, personal or mixed, or upon any part thereof, before the same shall become in default, as well as all lawful claims for labor, materials and supplies or otherwise, which, if unpaid, might become a lien or charge upon such properties or any part thereof; provided that the Borrower shall not be required to pay and discharge or cause to be paid and discharged any such tax, assessment, charge, levy or claim so long as the validity thereof shall be contested in good faith by appropriate proceedings and it shall have set aside on its books adequate reserves with respect to any such tax, assessment, charge, levy or claim, so contested; and provided, further, that payment with respect to any such tax, assessment, charge, levy or claim shall be made before any of its property shall be seized or sold in satisfaction thereof. Section 4.03. Give prompt written notice to the Lender of any proceedings instituted against it by or in any Federal or state court or before any commission or other regulatory body, whether Federal, state or local, which, if adversely determined, would have a material adverse effect upon its business, operations, properties, assets, or condition, financial or otherwise. Section 4.04. Furnish to the Lender: (a) Within one hundred twenty (120) days of the end of each fiscal year, balance sheets and statements of income and surplus, together with supporting schedules, audited by independent certified public accountants selected by the Borrower and acceptable to the Lender, showing the 12 financial condition of the Borrower at the close of such fiscal year, the results of operations during such year and containing a statement to the effect that such accountants have examined the provisions of the Agreement and that, based on information which has been provided by the Borrower to such accountants, none of the events of default, as specified in Article VI hereof, nor any event which upon notice or lapse of time or both would constitute such an event of default, has occurred. Such statements shall be accompanied by a qualified, going concern opinion of such accountants stating that such statements have been prepared in accordance with GAAP and disclose all contingent liabilities of Borrower. (b) Within sixty (60) days after the end of each quarter, balance sheets and statements of income and surplus, together with supporting schedules, together with agings reports of accounts receivable and accounts payable, prepared by the Borrower in accordance with GAAP and certified by its chief financial officer, such balance sheets to be as of the close of such quarter and such statements of income and surplus to be for the period from the beginning of the then current fiscal year to the end of such quarter, in each case subject to year-end adjustments. (c) Concurrently with the delivery of all financial statements required by Section 4.04 (a) and (b), a certificate in the form attached hereto as Exhibit B by the 13 President or chief financial officer of the Borrower calculating the financial covenants and certifying as to the fact that he has examined the provisions of this Agreement and that none of the Events of Default, as specified in Article VI hereof, nor any event which upon notice or lapse of time, or both, would constitute such an Event of Default, has occurred and is continuing. (d) Within thirty (30) days of the end of each fiscal year, an annual forecasted financial statement (prepared on a month-by-month basis) prepared by the Borrower and satisfactory to the Lender in form and substance. (e) Promptly, from time to time such other information regarding its operations, assets, business, affairs and financial condition, as the Lender may reasonably request. Section 4.05. Permit agents or representatives of the Lender, at Borrower's expense, and at reasonable times and upon reasonable notice, to inspect its books and records and to make abstracts or reproductions thereof. Section 4.06. Promptly advise the Lender of any material adverse change in its condition, financial or otherwise, or of the occurrence of any Event of Default by the Borrower of the type described in Article VI hereof, or of the occurrence of any event which upon notice or lapse of time or both would constitute such an Event of Default. 14 Section 4.07. Maintain a standard system of accounting in accordance with GAAP. Section 4.08. Maintain at all times a "Cash Flow to Debt Service Coverage Ratio" which is defined as (i) earnings (after all legal expenses) before interest and taxes ("EBIT"); plus (ii) depreciation and amortization, each to the extent accrued in the relevant accounting period and actually deducted in determining EBIT; minus (iii) taxes actually paid (and not merely accrued), dividends actually paid (and not merely accrued) and unfinanced capital expenditures; all divided by interest expense on all indebtedness plus required principal payments of both long term debt and capital leases for the relevant accounting period, which when determined in accordance with GAAP shall be not less than 1.25 to 1.00. Section 4.09. Reserved. Section 4.10. (a) In the event of any discharge, spill, leakage or release of hazardous material affecting the Borrower's premises located at 475 Kilvert Street, Warwick, Rhode Island (the "Real Property"), in violation of any applicable law, whether or not the same originates or emanates from the Real Property or any contiguous real estate onto the Real Property, prior to or while this Loan is outstanding ("Release"), Borrower agrees to contain, remove or mitigate the same on the Real Property immediately and in accordance with all Federal, state or local laws, regulations, orders or directives. (b) The Borrower will dispose of or cause to be disposed of any hazardous material used on the Real Property in strict compliance with all applicable Federal, state or local laws and regulations. 15 (c) Borrower will give Lender prompt written notice (i) of any threatened or actual notice of any violation given by any Federal state or local agency or department relating to hazardous material (1) on the Real Property, or (2) being generated by the Borrower in violation of any applicable law, or (ii) upon learning of the presence of hazardous material on or contiguous to the Real Property in violation of any applicable law. Borrower will take prompt action for the containment of such hazardous material on and the removal of such hazardous material from the Real Property (except for hazardous material found and stored on the Real Property in accordance with applicable law) in accordance with all applicable laws, orders and regulations. (d) Borrower shall indemnify Lender and hold Lender harmless from and against all loss, liability, damage and expenses, including reasonable attorney's fees suffered or incurred by Lender with respect to any Release or any violation of the warranties, representations or covenants in this Section 4.10 hereof, whether as successor in interest to Borrower or otherwise. V. NEGATIVE COVENANTS The Borrower covenants and agrees that, until payment in full of the principal of, and interest on, the Note and any other indebtedness of the Borrower to the Lender, whether now existing or arising hereafter, unless the Lender shall otherwise consent in writing, it will not hereafter, directly or indirectly: Section 5.01. Incur, create, assume, become or be liable in any manner with respect to, or permit to exist, any indebtedness or liability, except: (a) indebtedness to the Lender; 16 (b) indebtedness with respect to trade obligations and other normal accruals in the ordinary course of business not yet due and payable, or with respect to which it is contesting in good faith the amount or validity thereof by appropriate proceedings, and then only to the extent it has set aside on its books adequate reserves therefor; and (c) indebtedness to Lockheed Martin IMS Corporation pursuant to that certain Settlement Agreement and Assignment dated in or around December, 1997, and to one (1) bank or institutional lender (including but not limited to Prinvest Financial Corp.) for financing to be used by the Borrower in conjunction with its day to day business operations, which financing is or may be secured by Borrower's grant of a first position security interest in all of the accounts receivable and work in process of the Borrower. Lender agrees to subordinate its interest in the accounts receivable and work in process of the borrower to any such bank or institutional lender, provided that there shall be no more than one (1) such lender at any time and provided further that nothing herewith will require Lender to subordinate its interest in any collateral other than accounts receivable and work in process of Borrower; and (d) indebtedness to SBLFC. Section 5.02. Create, incur, assume or suffer to exist any mortgage, pledge, lien, charge or other encumbrance of any nature whatsoever on any of its assets, now or hereafter owned, other than: 17 (a) liens securing the payment of taxes, either not yet due or the validity of which is being contested in good faith by appropriate proceedings, and as to which it shall have set aside on its books adequate reserves; (b) deposits under worker's compensation, unemployment insurance and social security laws, or to secure the performance of bids, tenders, contracts (other than for the repayment of borrowed money) or leases, or to secure statutory obligations or surety or appeal bonds, or to secure indemnity, performance or other similar bonds in the ordinary course of business; (c) liens imposed by law, such as carriers', warehousemen's or mechanics' liens, incurred by it in good faith in the ordinary course of business, and liens arising out of a judgment or award (other than in the pending litigation in and against the State of Hawaii in the event that such judgment or award is less than or equal to $750,000 (the "Hawaii Litigation")) against it with respect to which it shall currently be prosecuting an appeal, a stay of execution pending such appeal having been secured; (d) liens in favor of the Lender; (e) liens existing on the date hereof and described in Exhibit C attached hereto and made a part hereof, or replacement liens as set forth in Section 5.01(c) hereof; (f) liens fully subordinated to Lender; and (g) liens in favor of SBLFC. 18 Section 5.03. Guarantee, endorse or otherwise in anyway become or be responsible for obligations of any other person, except endorsements of negotiable instruments for collection in the ordinary course of business. Section 5.04. Sell, lease, transfer or otherwise dispose of its properties, assets, rights, licenses and franchises to any person, except in the ordinary course of its business (including the purchase and sale of repossessed equipment), or turn over the management of, or enter a management contract with respect to, such properties, assets, rights, licenses and franchises, except as otherwise permitted herein. Section 5.05. Enter into any arrangement, directly or indirectly, with any person whereby it shall sell, pledge or transfer any property, real, personal or mixed, used or useful in its business, whether now owned or hereafter acquired, and thereafter rent or lease such property other than in the ordinary course of business. Section 5.06. Except in the ordinary course of its business, purchase, invest in or otherwise acquire or hold securities, including, without limitation, capital stock and evidences of indebtedness of, or make loans or advances to, or enter into any arrangement for the purpose of providing funds or credit to, any other person, except: (a) advances to employees for business expenses or for personal needs not to exceed Five Thousand Dollars ($5,000) in the case of any one (1) employee and not to 19 exceed Twenty-Five Thousand Dollars ($25,000) in the aggregate to all such employees outstanding at one time; and (b) investments in short-term obligations of the United States. Section 5.07. Dissolve, liquidate, consolidate with or merge with, form a new business entity or otherwise acquire all or substantially all of the assets or properties of, any corporation, or make any substantial change in its executive management. Section 5.08. Engage, directly or indirectly, in a business substantially different from the business now being conducted. Section 5.09. Sell, assign, discount or dispose in any way of any accounts receivable, promissory notes or trade acceptances held by the Borrower, with or without recourse, except for collection (including endorsements) in the ordinary course of business or pursuant to financing permitted pursuant to Section 5.01(c) hereof. Section 5.10. Intentionally Omitted. Section 5.11. Maintain its principal place of business outside the State of Rhode Island. Section 5.12. Pay any dividends, or make any distribution of cash or property, or both, to holders of shares of its capital stock, whether common or preferred, or directly or indirectly, redeem, purchase or otherwise acquire for a consideration any shares of its capital stock. 20 VI. DEFAULTS In each case of happening of any of the following events (each of which is herein and in the Note sometimes called an "Event of Default"): (a) any representation or warranty made herein, or in any report, certificate, financial statement or other instrument furnished in connection with this Agreement, or the borrowing hereunder, shall prove to be false or misleading in any material respect; (b) default in the payment of any installment of the principal of, or interest on, the Note or any other indebtedness of the Borrower to the Lender for more than ten (10) days after the date when the same shall become due and payable, whether at the due date thereof or at a date fixed for prepayment or by acceleration or otherwise; (c) default in the due observance or performance of any covenant, condition or agreement contained in Articles IV or V hereof, in the Note or in any instrument granting security to the Lender for the Note and such default shall continue for twenty (20) days after notice thereof from the Lender to the Borrower; (d) default in the due observance or performance of any other covenant, condition or agreement, on the part of the Borrower to be observed or performed pursuant to the terms hereof and such default shall continue for twenty (20) days after notice thereof from the Lender to the Borrower; (e) default with respect to any evidence of indebtedness in excess of $50,000 of the Borrower (other 21 than to the Lender), if the effect of such default is to accelerate the maturity of such indebtedness or to permit the holder thereof to cause such indebtedness to become due prior to the stated maturity thereof, or if any indebtedness of the Borrower in excess of $50,000 (other than to the Lender and other than the Hawaii Litigation as set forth in Section 5.02(c) hereof) is not paid, when due and payable, including any applicable grace periods, whether at the due date thereof or a date fixed for prepayment or otherwise; (f) the Borrower shall (i) apply for or consent to the appointment of a receiver, trustee, custodian or liquidator of it or any of its property, (ii) admit in writing its inability to pay its debts as they mature, (iii) make a general assignment for the benefit of creditors, (iv) be adjudicated a bankrupt or insolvent or be the subject of an order for relief under Title 11 of the United States Code, (v) file a voluntary petition in bankruptcy, or a petition or an answer seeking reorganization or an arrangement with creditors or to take advantage of any bankruptcy, reorganization, insolvency, readjustment of debt, dissolution or liquidation law or statute, or an answer admitting the material allegations of a petition filed against it in any proceeding under any such law or if corporate action shall be taken for the purpose of effecting any of the foregoing; (g) an order, judgment or decree shall be entered, without the application, approval or consent of the Borrower by any court of competent jurisdiction, approving a 22 petition seeking reorganization of the Borrower or appointing a receiver, trustee, custodian or liquidator of the Borrower of all or a substantial part of the assets of the Borrower, and such order, judgment or decree shall continue unstayed and in effect for any period of thirty (30) days; (h) final judgment for the payment of money in excess of an aggregate of Fifty Thousand Dollars ($50,000) shall be rendered against the Borrower, and the same shall remain undischarged for a period of thirty (30) consecutive days, during which execution shall not be effectively stayed; provided, however, that such aggregate amount shall be exclusive of the pending Hawaii Litigation in which case, and for such case only, such aggregate amount shall be increased to Seven Hundred Fifty Thousand Dollars ($750,000); (i) the occurrence of any attachment of any deposits or other property of the Borrower in the hands or possession of the Lender, or the occurrence of any attachment of any other property of the Borrower, other than in the Hawaii Litigation as set forth in Section 5.02(c) hereof, in an amount exceeding Fifty Thousand Dollars ($50,000) which shall not be discharged within thirty (30) days of the date of such attachment; and (j) for any reason Kenneth Kirsch shall cease to be or function as President of the Borrower and (i) a successor is not appointed within sixty (60) days of such cessation and (ii) the Lender shall not have approved in 23 writing of such successor within ten (10) days of such appointment; then and in every such Event of Default and at any time thereafter during the continuance of such event, the Note and any and all other indebtedness of the Borrower to the Lender, shall immediately become due and payable, both as to principal and interest, without presentment, demand, protest or notice of any kind, all of which are hereby expressly waived, anything contained herein or in the Note or other evidence of such indebtedness to the contrary notwithstanding. VII. MISCELLANEOUS Section 7.01. This Agreement and all covenants, agreements, representations and warranties made herein and in the certificates delivered pursuant hereto, shall survive the making by the Lender of the Loan, the execution and delivery to the Lender of the Note, and shall continue in full force and effect so long as the Note and any other indebtedness of the Borrower to the Lender is outstanding and unpaid. Whenever in this Agreement any of the parties hereto is referred to, such reference shall be deemed to include the successors and assigns of such party; and all covenants, promises and agreements in this Agreement contained, by or on behalf of the Borrower, shall inure to the benefit of the respective successors and assigns of the Lender. Section 7.02. The Borrower will reimburse the Lender upon demand for all reasonable out-of-pocket costs, charges and expenses of the Lender (including reasonable fees and disbursements of counsel to the Lender) in connection with (i) the preparation, execution and 24 delivery of this Agreement, the Note and any security instrument securing the Note, (ii) any brokers' or finders' commissions associated with this loan transaction between the Borrower and the Lender, (iii) the making of the Loan, (iv) any amendments, modifications, consents or waivers in respect thereof and (v) any enforcement thereof. Section 7.03. This Agreement and the Note shall be construed in accordance with and governed by the laws of the State of Rhode Island. Section 7.04. No modification or waiver of any provision of this Agreement, or of the Note, nor consent to any departure by the Borrower therefrom, shall in any event be effective unless the same shall be in writing, and then such waiver or consent shall be effective only in the specific instance, and for the purpose, for which given. No notice to, or demand, on the Borrower, in any case, shall entitle the Borrower to any other or future notice or demand in the same, similar or other circumstances. Section 7.05. Neither any failure nor any delay on the part of the Lender in exercising any right, power or privilege hereunder, or under the Note, or any other instrument given as security therefor, shall operate as a waiver thereof, nor shall a single or partial exercise thereof preclude any other or future exercise, or the exercise of any other right, power or privilege. Section 7.06. All notices, requests, demands and other communications provided for hereunder shall be in writing and mailed via certified mail or Federal Express (overnight delivery) or delivered to the applicable party at the addresses indicated below. 25 If to the Lender: Business Development Company of Rhode Island 40 Westminster Street, Suite 702 Providence, RI 02903 Attention: Peter C. Dorsey, Jr., Vice President with a copy to: Richard Nadeau, Jr., Esquire NADEAU & SIMMONS, P.C. 1250 Turks Head Building Providence, RI 02903 If to the Borrower: NETWORK SIX, INC. 475 Kilvert Street Warwick, RI 02886 Attention: Kenneth Kirsch, President with a copy to: Wayne M. Kezirian, Esquire Gaebe & Kezirian 128 Dorrance Street Providence, RI 02903 or, as to each party, at such other address as shall be designated by such parties in a written notice to the other party complying as to delivery with the terms of this Section. All such notices, requests, demands and other communication shall, when mailed, be effective three (3) days after the date when deposited in the mails, addressed as aforesaid, or delivered to Federal Express for overnight delivery. Section 7.07. This Agreement shall be binding upon and inure to the benefit of the Borrower and the Lender and their respective successors and assigns, except that the Borrower shall not have the right to assign its rights hereunder or any interest herein without the prior written consent of the Lender. Section 7.08, The Borrower, to the extent that it may lawfully do so, hereby consents to the jurisdiction of the courts of the State of Rhode Island and the United States District Court for the 26 District of Rhode Island, as well as to the jurisdiction of all courts from which an appeal may be taken from such courts, for the purpose of any suit, action or other proceeding arising out of any of its obligations arising hereunder or with respect to the transactions contemplated hereby, and expressly waives any and all objections it may have as to venue in any of such courts. THE LENDER AND THE BORROWER HEREBY WAIVE TRIAL BY JURY IN ANY ACTION, PROCEEDING, CLAIM, OR COUNTERCLAIM, WHETHER IN CONTRACT OR TORT, AT LAW OR IN EQUITY, ARISING OUT OF OR IN ANY WAY RELATED TO THIS AGREEMENT, THE NOTE, THE SECURITY DOCUMENTS, OR ANY DOCUMENTS RELATED THERETO. Section 7.09. The Lender shall not be liable for any claims, demands, losses, or damages made, claimed, or suffered by the Borrower, excepting such as may arise through or could be caused by the Lender's willful or gross negligence. Section 7.10. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof or affecting the validity or enforceability of such provision in any other jurisdiction. Section 7.11. Any Article and Section headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. As used in this Agreement, the term "person" shall include any individual, corporation, partnership, joint venture, trust, or unincorporated organization, or a government or any agency or political subdivision thereof. 27 Section 7.12. The Borrower hereby grants to the Lender permission to use the fact of the Lender's making the Loan and the amount of the Loan in the Lender's advertising and other public relations, provided that the Lender shall not make public the specific terms of the Loan, including but not limited to the terms of Article VI(h). IN WITNESS WHEREOF, the Lender and the Borrower have caused this Agreement to be duly executed by their duly authorized officers, all as of the day and year first above written. WITNESS: BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND /s/ [ILLEGIBLE] By: /s/ Gurrett B. Hunter - -------------------------------- ------------------------------- Title: President ---------------------------- WITNESS: NETWORK SIX, INC. /s/ [ILLEGIBLE] By: /s/ Dorothy M. Cipolla - -------------------------------- ------------------------------- Title: Treasurer ---------------------------- 28 EXHIBIT A $250,000 Promissory Note TERM PROMISSORY NOTE $250,000.00 Providence, Rhode Island September 21, 1998 FOR VALUE RECEIVED, NETWORK SIX, INC., a Rhode Island corporation with its principal office at 475 Kilvert Street, Warwick, Rhode Island 02886 (herein called the "Maker"), hereby promises to pay to the order of BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND, a Rhode Island corporation (herein called the "Payee"), at its office located at 40 Westminster Street, Suite 702, Providence, Rhode Island 02903, the principal sum of Two Hundred Fifty Thousand and 00/100 Dollars ($250,000.00), with interest at the effective rate of ten and one-quarter percent (10.25%) per annum (the "Interest Rate"). Principal payments shall be made in fifty-nine (59) consecutive monthly payments ("Installments") in the sum of Four Thousand One Hundred Sixty-Seven and 00/100 Dollars ($4,167.00), beginning on the 1st day of November, 1998, and payable on the same day of each successive month or the next business day, and with a sixtieth (60th) Installment being equal to the remaining unpaid principal plus accrued interest being due and payable on October 1, 2003. Interest on the unpaid principal balance shall be payable monthly, beginning on the 1st day of November, 1998, and continuing on the same day of each successive month or the next business day thereafter if such day is not a business day until the principal has been repaid in full. Each monthly Installment shall be applied first to the payment of accrued interest owing to the date received and the remainder to the reduction of principal. Monthly Installments shall be automatically debited on each due date from the Maker's operating checking account with the bank or financial institution with which the Maker maintains its accounts. Interest shall be calculated and payable whether before or after maturity of this Note. Interest shall be calculated on the basis of a year consisting of three hundred sixty (360) days counting the actual number of days elapsed. All past due Installments, or any portion thereof, not paid when due, if permitted by law, shall bear interest from such due date at the Interest Rate plus three hundred (300) basis points per annum ("Default Rate"). During the existence of any Event of Default, as defined in the hereinbelow referenced Loan Agreement, and after acceleration of this Note by the holder hereof, the entire unpaid balance of principal and interest of this Note shall bear interest at the Default Rate. If the Maker fails to pay any Installment due hereunder when such Installment is due and payable, whether at the due date thereof or due to acceleration or otherwise, a late fee equal to five percent (5.0%) of the overdue payment shall be immediately due and payable with respect to each late Installment by the Maker to the Payee hereunder. This Note is the "Note" referred to in that certain Term Loan Agreement of even date herewith between the Payee and the Maker (the "Loan Agreement") and is subject to optional prepayments and to acceleration of the maturity hereof, all as provided in said Loan Agreement, which is hereby incorporated by reference herein and made a 2 part hereof. This Note, including but not limited to amounts owed pursuant to the principal balance and interest, is secured, inter alia, by certain "Security Documents" referred to in said Loan Agreement, and is entitled to the benefits thereof. In case an Event of Default, as defined in said Loan Agreement, shall occur and be continuing, this Note, including the principal balance and all interest accrued hereon and thereon, shall at the option of the holder of this Note become due and payable in the manner and with the effect provided in said Loan Agreement. In the event that the holder of this Note shall exercise or endeavor to exercise any of its remedies hereunder or under said Loan Agreement or any agreements securing this Note, the Maker shall pay all reasonable costs and expenses incurred in connection therewith, including without limitation, reasonable attorneys' fees, and the holder hereof may take judgment for all such amounts in addition to all other sums due hereunder. The Maker hereby waives presentment, dishonor, protest and demand, diligence, notice of protest, demand and of dishonor, and any other notice otherwise required to be given under the law in connection with the delivery, acceptance, performance, default, enforcement or collection of this Note, and expressly agrees that this Note or any payment hereunder may be extended or subordinated, by forbearance or otherwise, from time to time, without in any way affecting the liability of the Maker. No consent or waiver by the holder hereof with respect to any action or failure to act which, without such consent or waiver, would constitute a breach of any 3 provision of this Note, shall be valid and binding unless in writing and signed by both the Maker and the holder hereof. All agreements between the Maker and the Payee are hereby expressly limited so that in no contingency or event whatsoever whether by reason of acceleration of maturity of the indebtedness evidenced hereby or otherwise shall the amount paid or agreed to be paid to the Payee for the use, forbearance or detention of the indebtedness evidenced hereby exceed the maximum permissible interest rate under applicable law. As used herein, the term "applicable law" shall mean the law in effect as of the date hereof, provided, however, that in the event there is a change in the law which results in a higher permissible rate of interest, then this Note shall be governed by such new law as of its effective date. If, from any circumstance whatsoever, fulfillment of any provision hereof or of the Loan Agreement or of any agreements securing this Note at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by law, then ipso facto, the obligation to be fulfilled shall be reduced to the limit of such validity, and if from any circumstance the Payee should ever receive as interest an amount which would exceed the highest lawful rate, such amount which would be excessive interest shall be applied to the reduction of the principal balance evidenced hereby and not to the payment of interest. This provision shall control every other provision of all agreements between the Maker and the Payee. This Note shall be construed in accordance with and governed by the laws of the State of Rhode Island, except to the extent that such laws are superseded by Federal enactments. 4 THE MAKER HEREBY WAIVES TRIAL BY JURY IN ANY ACTION, PROCEEDING, CLAIM, OR COUNTERCLAIM, WHETHER IN CONTRACT OR TORT, AT LAW OR IN EQUITY, ARISING OUT OF OR IN ANY WAY RELATED TO THIS NOTE. IN WITNESS WHEREOF, the Maker has caused this Note to be executed by its duly authorized officer as of the day and year first above written. NETWORK SIX, INC. By: ------------------------------- Title: ---------------------------- 5 EXHIBIT B Certificate as to No Events of Default Business Development Company of Rhode Island 40 Westminster Street, Suite 702 Providence, Rhode Island 02903 Re: Compliance Certificate required by Section 4.04 of Loan Agreement by and between Business Development Company of Rhode Island and NETWORK SIX, INC. (the "Agreement") Gentlemen: This certificate is submitted by the undersigned pursuant to Section 4.04 of the Agreement. Capitalized terms used herein have the same meaning as in the Agreement. The undersigned has calculated the financial covenants set forth in Article IV as follows: Debt Service Coverage Ratio _______ to 1.00 The undersigned hereby certifies that the balance sheet and statement of income and surplus as of ( ) are true, accurate and complete. The undersigned further certifies that he has examined the financial statements delivered in connection herewith and the provisions of the Agreement, and that as of the date hereof no Event of Default, nor any event which upon notice or lapse of time, or both, would constitute an Event of Default, has occurred and is continuing. NETWORK SIX, INC. By: ------------------------------- Title: ---------------------------- EXHIBIT C Liens Existing as of the Date Hereof 1. Liens set forth on the UCC-11 Search Report attached hereto and incorporated by reference herein. 2. Lockheed Martin IMS Corporation pursuant to that certain Settlement Agreement and Assignment dated in or around December, 1997. 3. Small Business Loan Fund Corporation (to be created as of the date hereof). EXHIBIT "A" COLLATERAL DESCRIPTION In the account, contract rights, rights to payment, intangibles, and cash and non-cash proceeds including but not limited to instruments, documents, chattel paper, warrants and any other indicia of payment in respect to the Debtor's contract dated on or about April 1, 1997 with the State of Maine and identified as the "Maine Automated Child Welfare Information System Contract For Special Services" or "MACWIS." EXHIBIT "A" COLLATERAL DESCRIPTION A purchase money security interest in all inventory of goods obtained by Debtor from Unisys Corporation ("Unisys") including Unisys and third party computer products for the Debtor's contract dated on or about April 1, 1997 with the State of Maine which is identified as the "Maine Automated Child Welfare Information System Contract for Special Services" or "MACWIS," and all cash or non-cash proceeds therefrom. SCHEDULE "A" CONTINUATION OF DESCRIPTION OF COLLATERAL PAGE UCC-1 FILING STATEMENT FORM FOR Rhode Island This Financing Statement covers the following types or items of property of Debtor, whether now owned or hereafter acquired; all Accounts and accounts receivable listed in Schedule 1 of a certain Financing end Security Agreement dated on or about 1997 by and between PrinVest Financial Corp ("PrinVest") and Network Six, Inc. (attached hereto), as may be amended from time to time, or as relate to Accounts due pursuant to contracts or purchase orders subsequently assigned to PrinVest, the proceeds thereof presently existing or hereafter arising, all interest of the Debtor in said Accounts, accounts receivable and/or proceeds thereof, and all books and records pertaining thereto. Capitalized terms used herein shall have the meanings given them in the Uniform Commercial Code. PURSUANT TO AN AGREEMENT BETWEEN DEBTOR AND SECURED PARTY, DEBTOR HAS AGREED NOT TO FURTHER ENCUMBER THE COLLATERAL DESCRIBED ABOVE. DEBTOR: Network Six, Inc. 475 Kilvert Street Warwick, RI 02886 /s/ Kenneth C. Kirsch 12/31/97 - ----------------------------------------------------- Debtor's Signature Date Kenneth C. Kirsch President & CEO - ----------------------------------------------------- Print Name and Title SECURED PARTY: PrinVest Financial Corp 3 Princess Rad Lawrenceville, NJ 08648 /s/ Robert W. Vera Jr. 12-31-97 - ----------------------------------------------------- Secured Party's Signature Date Robert W. Vera Jr. - ----------------------------------------------------- Print Name and Title EXHIBIT D Warrant WARRANT TO PURCHASE COMMON STOCK OF NETWORK SIX, INC. This is to certify that, FOR VALUE RECEIVED, Business Development Company of Rhode Island, a Rhode Island corporation, ("Holder"), is entitled to purchase, subject to the provisions of this Warrant, from Network Six, Inc., a Rhode Island corporation ("Company"), 11,500 shares ("Warrant Shares") of common stock, par value 10 cents per share, of the Company ("Common Stock") at a price per share equal to Four and 50/100 Dollars ($4.50) (the "Exercise Price"), at any time from the date a loan agreement is entered into by and between the Holder and the Company for a Two Hundred Fifty Thousand Dollar ($250,000.00) term loan through but not later than 5:00 p.m. Providence, Rhode Island Time, on the 20th day of September, 2003. (1) EXERCISE OF WARRANT. This Warrant may be exercised in whole or in part at any time or from time to time until it expires by presentation and surrender hereof to the Company at its principal office at 475 Kilvert Street, Warwick, Rhode Island, with the Purchase Form annexed hereto duly executed and accompanied by payment of the Exercise Price for the number of shares specified in such form. If this Warrant should be exercised in part only, the Company shall, upon surrender of this Warrant for cancellation, execute and deliver a new Warrant evidencing the rights of the Holder thereof to purchase the balance of the shares purchasable thereunder. Upon receipt by the Company of this Warrant at its office in proper form for exercise, the Holder shall be deemed to be the holder of record of the shares of Common Stock issuable upon such exercise, notwithstanding that the stock transfer books of the Company shall then be closed or that certificates representing such shares of Common Stock shall not then be actually delivered to the Holder. (2) RESERVATION OF SHARES. The Company hereby agrees that at all times until expiration of this Warrant there shall be reserved for issuance and/or delivery upon exercise of this Warrant such number of shares of its Common Stock as shall be required for issuance and delivery upon exercise of this Warrant. (3) FRACTIONAL SHARES. No fractional shares may be issued upon the exercise of this Warrant. (4) EXCHANGE OR LOSS OF WARRANT. This Warrant is exchangeable, without expense, at the option of the Holder, upon presentation and surrender hereof to the Company for other warrants of different denominations entitling the holder thereof to purchase in the aggregate the same number of shares of Common Stock purchasable hereunder. The term "Warrant" as used herein includes any Warrants into which this Warrant may be divided or exchanged. Upon receipt by the Company of evidence satisfactory to it of the loss, theft, destruction or mutilation of this Warrant, and of reasonably satisfactory indemnification, and upon surrender and cancellation of this Warrant, if mutilated, the Company will execute and deliver a new Warrant of like tenor and date. (5) RIGHTS OF THE HOLDER. The Holder shall not, by virtue hereof, be entitled to any rights of a shareholder in the Company, either at law or equity, and the rights of the Holder are limited to those expressed in the Warrant and are not enforceable against the Company except to the extent set forth herein. (6) ANTI-DILUTION RIGHTS. The number of Warrant Shares and/or the Exercise Price shall be automatically adjusted to give effect to any and all stock dividends or stock splits. Whenever the number of Warrant Shares or the Exercise Price shall be adjusted as required by the provisions of this Warrant, the Company shall forthwith file in the custody of its Secretary or an Assistant Secretary at its principal office an officer's certificate showing the adjusted number of Warrant Shares and Exercise Price determined as herein provided, setting forth in reasonable detail the facts requiring such adjustment, including a statement of the number of additional shares of Common Stock, if any, and such other facts as shall be necessary to show the reason for and the manner of computing such adjustment. Each such officer's certificate shall be made available at all reasonable times for inspection by the Holder and the Company shall, forthwith after each such adjustment, mail a copy by certified mail of such certificate to the Holder. (7) RESTRICTIONS ON TRANSFER. All stock certificates issued pursuant to any exercise of this Warrant shall bear the following restrictive legend: THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR ANY STATE SECURITIES LAWS, AND MAY NOT BE TRANSFERRED UNTIL (i) A REGISTRATION STATEMENT UNDER THE ACT AND REGISTRATION OR QUALIFICATION FOR SALE UNDER APPROPRIATE STATE SECURITIES LAWS SHALL BECOME EFFECTIVE WITH RESPECT THERETO, OR (ii) RECEIPT OF AN OPINION OF COUNSEL TO THE COMPANY OR OTHER COUNSEL REASONABLY ACCEPTABLE TO THE COMPANY TO THE EFFECT THAT REGISTRATION OR QUALIFICATION UNDER THE ACT AND APPROPRIATE STATE SECURITIES LAWS ARE NOT REQUIRED IN CONNECTION WITH SUCH PROPOSED TRANSFER. (8) EXPIRATION DATE. This Warrant shall expire and shall be returned to the Company and shall be and become null and void at 5:00 P.M. Providence, Rhode Island Time, on the 20th day of September, 2003. (10) GOVERNING LAW. This Warrant shall be governed by and construed in accordance with the laws of the State of Rhode Island (without giving effect to the conflict of law principles thereof). Any suit, action or proceeding relating to this 2 Warrant shall be brought in Rhode Island state courts or Federal courts sitting in Rhode Island. NETWORK SIX, INC. By: /s/ Dorothy M. Cipolla ---------------------------- Treasurer Dated: Attest: /s/ Dorothy M. Cipolla - ------------------------------ Secretary 3 PURCHASE FORM Dated ________________________ The undersigned hereby irrevocably elects to exercise the within Warrant to the extent of purchasing _________________ shares of Common Stock and hereby makes payment of________________ in payment of the actual exercise price thereof. ________________ INSTRUCTIONS FOR STOCK TRANSFER AGENT Name____________________________________________________________________________ (Please typewrite or print in block letters) Address_________________________________________________________________________ SS# or Federal I.D.#____________________________________________________________ Signature________________________________________________________________ ________________ 4 TERM PROMISSORY NOTE $250,000.00 Providence, Rhode Island September 21, 1998 FOR VALUE RECEIVED, NETWORK SIX, INC., a Rhode Island corporation with its principal office at 475 Kilvert Street, Warwick, Rhode Island 02886 (herein called the "Maker"), hereby promises to pay to the order of BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND, a Rhode Island corporation (herein called the "Payee"), at its office located at 40 Westminster Street, Suite 702, Providence, Rhode Island 02903, the principal sum of Two Hundred Fifty Thousand and 00/100 Dollars ($250,000.00), with interest at the effective rate of ten and one-quarter percent (10.25%) per annum (the "Interest Rate"). Principal payments shall be made in fifty-nine (59) consecutive monthly payments ("Installments") in the sum of Four Thousand One Hundred Sixty-Seven and 00/100 Dollars ($4,167.00), beginning on the 1st day of November, 1998, and payable on the same day of each successive month or the next business day, and with a sixtieth (60th) Installment being equal to the remaining unpaid principal plus accrued interest being due and payable on October 1, 2003. Interest on the unpaid principal balance shall be payable monthly, beginning on the 1st day of November, 1998, and continuing on the same day of each successive month or the next business day thereafter if such day is not a business day until the principal has been repaid in full. Each monthly Installment shall be applied first to the payment of accrued interest owing to the date received and the remainder to the reduction of principal. Monthly Installments shall be automatically debited on each due date from the Maker's operating checking account with the bank or financial institution with which the Maker maintains its accounts. Interest shall be calculated and payable whether before or after maturity of this Note. Interest shall be calculated on the basis of a year consisting of three hundred sixty (360) days counting the actual number of days elapsed. All past due Installments, or any portion thereof, not paid when due, if permitted by law, shall bear interest from such due date at the Interest Rate plus three hundred (300) basis points per annum ("Default Rate"). During the existence of any Event of Default, as defined in the hereinbelow referenced Loan Agreement, and after acceleration of this Note by the holder hereof, the entire unpaid balance of principal and interest of this Note shall bear interest at the Default Rate. If the Maker fails to pay any Installment due hereunder when such Installment is due and payable, whether at the due date thereof or due to acceleration or otherwise, a late fee equal to five percent (5.0%) of the overdue payment shall be immediately due and payable with respect to each late Installment by the Maker to the Payee hereunder. This Note is the "Note" referred to in that certain Term Loan Agreement of even date herewith between the Payee and the Maker (the "Loan Agreement") and is subject to optional prepayments and to acceleration of the maturity hereof, all as provided in said Loan Agreement, which is hereby incorporated by reference herein and made a 2 part hereof. This Note, including but not limited to amounts owed pursuant to the principal balance and interest, is secured, inter alia, by certain "Security Documents" referred to in said Loan Agreement, and is entitled to the benefits thereof. In case an Event of Default, as defined in said Loan Agreement, shall occur and be continuing, this Note, including the principal balance and all interest accrued hereon and thereon, shall at the option of the holder of this Note become due and payable in the manner and with the effect provided in said Loan Agreement. In the event that the holder of this Note shall exercise or endeavor to exercise any of its remedies hereunder or under said Loan Agreement or any agreements securing this Note, the Maker shall pay all reasonable costs and expenses incurred in connection therewith, including without limitation, reasonable attorneys' fees, and the holder hereof may take judgment for all such amounts in addition to all other sums due hereunder. The Maker hereby waives presentment, dishonor, protest and demand, diligence, notice of protest, demand and of dishonor, and any other notice otherwise required to be given under the law in connection with the delivery, acceptance, performance, default, enforcement or collection of this Note, and expressly agrees that this Note or any payment hereunder may be extended or subordinated, by forbearance or otherwise, from time to time, without in any way affecting the liability of the Maker. No consent or waiver by the holder hereof with respect to any action or failure to act which, without such consent or waiver, would constitute a breach of any 3 provision of this Note, shall be valid and binding unless in writing and signed by both the Maker and the holder hereof. All agreements between the Maker and the Payee are hereby expressly limited so that in no contingency or event whatsoever whether by reason of acceleration of maturity of the indebtedness evidenced hereby or otherwise shall the amount paid or agreed to be paid to the Payee for the use, forbearance or detention of the indebtedness evidenced hereby exceed the maximum permissible interest rate under applicable law. As used herein, the term "applicable law" shall mean the law in effect as of the date hereof, provided, however, that in the event there is a change in the law which results in a higher permissible rate of interest, then this Note shall be governed by such new law as of its effective date. If, from any circumstance whatsoever, fulfillment of any provision hereof or of the Loan Agreement or of any agreements securing this Note at the time performance of such provision shall be due, shall involve transcending the limit of validity prescribed by law, then ipso facto, the obligation to be fulfilled shall be reduced to the limit of such validity, and if from any circumstance the Payee should ever receive as interest an amount which would exceed the highest lawful rate, such amount which would be excessive interest shall be applied to the reduction of the principal balance evidenced hereby and not to the payment of interest. This provision shall control every other provision of all agreements between the Maker and the Payee. This Note shall be construed in accordance with and governed by the laws of the State of Rhode Island, except to the extent that such laws are superseded by Federal enactments. 4 THE MAKER HEREBY WAIVES TRIAL BY JURY IN ANY ACTION, PROCEEDING, CLAIM, OR COUNTERCLAIM, WHETHER IN CONTRACT OR TORT, AT LAW OR IN EQUITY, ARISING OUT OF OR IN ANY WAY RELATED TO THIS NOTE. IN WITNESS WHEREOF, the Maker has caused this Note to be executed by its duly authorized officer as of the day and year first above written. NETWORK SIX, INC. By: _________________________________ Title:_______________________________ 5 SECURITY AGREEMENT THIS AGREEMENT made as of the 21st day of September, 1998, by and between NETWORK SIX, INC., a Rhode Island corporation (the "Debtor") and BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND, a Rhode Island corporation (the "Secured Party"). WITNESSETH THAT: WHEREAS, the Debtor and the Secured Party are parties to a certain Term Loan Agreement (the "Loan Agreement") of even date; and WHEREAS, pursuant to the Loan Agreement, the Secured Party has agreed to lend to the Debtor the principal amount of $250,000 which is to be repaid with interest in accordance with the terms of a certain Term Promissory Note of even date in the face amount of $250,000 (the "Note"); and WHEREAS, the Debtor has agreed to enter into this Security Agreement in order to induce the Secured Party, inter alia, to enter into the Loan Agreement and to make the loan(s) to be evidenced by the Note; NOW, THEREFORE, for good and valuable consideration, the receipt whereof is hereby acknowledged, the parties hereto agree as follows: Section 1. The Security Interests. (A) In order (i) to secure the due and punctual payment of the Note, (ii) to secure the performance of all the obligations of the Debtor contained herein, and in the Loan Agreement, and (iii) to secure the payment of all other future advances to the Debtor by the Secured Party and all other indebtedness, liabilities and obligations of the Debtor to the Secured Party of every kind and description, direct, indirect or contingent, now or hereafter existing, due or to become due (all of the foregoing hereinafter called the "Obligations"), the Debtor hereby grants to the Secured Party a continuing security interest in the following described fixtures and personal property (hereinafter collectively called the "Collateral"): All fixtures and all tangible and intangible personal property of the Debtor, whether now owned or hereafter acquired by the Debtor, or in which the Debtor may now have or hereafter acquire an interest, including without limitation, (a) all equipment (including all machinery, tools and furniture), inventory (including all merchandise, raw materials, work in process, finished goods and supplies), and goods, whether now owned or hereafter acquired by the Debtor, or in which the Debtor may now have or hereafter acquire an interest (the "Tangible Collateral"); (b) all accounts, accounts receivable, other receivables, contract rights, chattel paper, and general intangibles of the Debtor (including, without limitation, goodwill, patents, trademarks, tradenames, blueprints, designs, product lines and research and development), whether now owned or hereafter acquired by the Debtor, or in which the Debtor may now have or hereafter acquire an interest; (c) all instruments, documents of title, policies and certificates of insurance, securities, bank deposits, deposit accounts, checking accounts and cash now or hereafter owned by the Debtor, or in which the Debtor may now have or hereafter acquire an interest; (d) all accessions, additions or improvements to, all replacements, substitutions and parts for, and all proceeds and products 2 of, all of the foregoing; and (e) all books, records and documents relating to all of the foregoing. (B) All Collateral consisting of accounts, contract rights, chattel paper and general intangibles of the Debtor arising from the sale, delivery or provision of goods and/or services are sometimes hereinafter collectively called the "Customer Receivables". (C) The security interests granted pursuant to this Section 1 (the "Security Interests") are granted as security only and shall not subject the Secured Party to, or transfer or in any way affect or modify, any obligation or liability of the Debtor under any of the Collateral or any transaction which gave rise thereto. Section 2. Chattel Paper. Subject to the rights of senior lien holders as defined in Section 5.02 of and in Exhibit C to the Loan Agreement, and upon the occurrence of an Event of Default hereunder, the Secured Party may at any time or from time to time, at its sole discretion, require the Debtor to cause any chattel paper included in the Customer Receivables to be delivered to the Secured Party or any agent or representative designated by it, or to cause a legend referring to the Security Interests to be placed on such chattel paper and upon any ledgers or other records concerning the Customer Receivables. 3 Section 3. Filing; Further Assurances. The Debtor will, at its expense, execute, deliver, file and record (in such manner and form as the Secured Party may require), or permit the Secured Party to file and record, any financing statements, any carbon, photographic or other reproduction of a financing statement or this Security Agreement (which shall be sufficient as a financing statement hereunder), any specific assignments or other paper that may be reasonably necessary or desirable, or that the Secured Party may request, in order to create, preserve, perfect or validate any Security Interest or to enable the Secured Party to exercise and enforce its rights hereunder with respect to any of the Collateral. The Debtor hereby appoints Secured Party as Debtor's attorney-in-fact to execute in the name and behalf of Debtor such additional financing statements as Secured Party may reasonably request in order to create, preserve, perfect or validate any Security Interest. Section 4. Representations and Warranties of Debtor. The Debtor hereby represents and warrants as follows: (A) That except as permitted by the Loan Agreement, the Debtor is, or to the extent that certain of the Collateral is to be acquired after the date hereof, will be, the owner of the Collateral free from any adverse lien, security interest or encumbrance. 4 (B) That except for such financing statements as may be described on Exhibit A attached hereto and made a part hereof, no financing statement covering the Collateral is on file in any public office, other than the financing statements filed pursuant to this Security Agreement. (C) That all additional information, representations and warranties contained in Exhibit B attached hereto and made a part hereof are true, accurate and complete on the date hereof. Section 5. Covenants of Debtor. The Debtor hereby covenants and agrees as follows: (A) That the Debtor will defend the Collateral against all claims and demands of all persons at any time claiming any interest therein, excepting only the legitimate claims of senior lien holders. (B) That the Debtor will provide the Secured Party with prompt written notice of (i) any change in the executive office of the Debtor or the office where the Debtor maintains its books and records pertaining to the Customer Receivables, and (ii) the movement or location of Collateral to or at any address other than as set forth in said Exhibit B or in the ordinary course of business to any other office or work site of the Borrower. (C) That the Debtor will promptly pay any and all taxes, assessments and governmental charges upon the Collateral prior to the date penalties are attached thereto, except to the 5 extent that such taxes, assessments and charges shall be contested in good faith by the Debtor. (D) That the Debtor will immediately notify the Secured Party of any event causing a substantial loss or diminution in the value of all or any material part of the Collateral and the amount or an estimate of the amount of such loss or diminution. (E) That the Debtor will have and maintain insurance at all times with respect to the Tangible Collateral as set forth in the Loan Agreement. (F) That Debtor will not sell or offer to sell or otherwise assign, transfer or dispose of the Collateral or any interest therein, without the written consent of the Secured Party, except in the ordinary course of its business. (G) That, except for liens permitted by the Loan Agreement, the Debtor will keep the Collateral free from any adverse lien, security interest or encumbrance and in good order and repair, reasonable wear and tear excepted, and will not waste or destroy the Collateral or any part thereof. (H) Debtor will not use the Collateral in violation of any statute or ordinance. Section 6. Records Relating to Collateral. The Debtor will keep its records concerning the Collateral, including the Customer Receivables and all chattel paper included in the Customer Receivables, at its office at 475 Kilvert Street, 6 Warwick, Rhode Island, or at such other place or places of business as the Secured Party may approve in writing. The Debtor will hold and preserve such records and chattel paper and will permit representatives of the Secured Party at any time during normal business hours upon reasonable notice to examine and inspect the Collateral and to make abstracts from such records and chattel paper, and will furnish to the Secured Party such information and reports regarding the Collateral as the Secured Party may from time to time reasonably request. Section 7. Collections with Respect to Customer Receivables Subject to the rights of senior lien holders, the Debtor will, at its expense, and subject at all times to the Secured Party's right following the occurrence and during the continuation of an Event of Default to give directions and instructions: (i) endeavor to collect or cause to be collected from customers indebted on Customer Receivables, as and when due, any and all amounts, including interest, owing under or on account of each Customer Receivable; and (ii) take or cause to be taken such appropriate action to repossess goods, the sale or rental of which gave rise to any Customer Receivable, or to enforce any rights or liens under Customer Receivables, as the Debtor or the Secured Party may deem proper, and in the name of the Debtor, or the Secured Party, as the Secured Party may deem proper; 7 provided that (x) the Debtor will use its best judgment to protect the interests of the Secured Party and (y) the Debtor shall not be required under this Section 7 to take any action which would be contrary to any applicable law or court order or inconsistent with the requirements of any senior lien holder. Subject to the rights of senior lien holders, the Debtor shall, at the request of the Secured Party following the occurrence of an Event of Default, notify the account debtors of the Security Interests of the Secured Party in any of the Customer Receivables and the Secured Party may itself at any such time so notify account debtors. The Secured Party shall have full power at any time after such notice to collect, compromise, endorse, sell or otherwise deal with any or all outstanding Customer Receivables or the proceeds thereof in the name of either the Secured Party or the Debtor. In the event that, after notice to any account debtors to pay the Secured Party, Debtor receives any payment on a Customer Receivable, any such payments shall be held by Debtor in trust for Secured Party and immediately turned over to Secured Party as aforesaid. Section 8. General Authority. The Debtor hereby irrevocably appoints the Secured Party the Debtor's true and lawful attorney, with full power of substitution, in the name of the Debtor, the Secured Party or otherwise, for the sole use and benefit of the Secured Party, 8 but at the Debtor's expense, to the extent permitted by law to exercise, at any time and from time to time after any Event of Default has occurred and is continuing, all or any of the following powers with respect to all or any of the Collateral (which power shall be in addition and supplemental to any powers, rights and remedies of the Secured Party described herein): (i) to demand, sue for, collect, receive and give acquittance for any and all monies due or to become due upon or by virtue thereof, (ii) to receive, take, endorse, assign and deliver any and all checks, notes, drafts, documents and other negotiable and non-negotiable instruments and chattel paper taken or received by the Secured Party in connection therewith, (iii) to settle, compromise, compound, prosecute or defend any action or proceeding with respect thereto, (iv) to sell, transfer, assign or otherwise deal in or with the same or the proceeds or avails thereof or the related goods securing the Customer Receivables, as fully and effectually as if the Secured Party were the absolute owner thereof, (v) to extend the time of payment of any or all thereof and to make any allowance and other adjustments with reference thereto, and 9 (vi) to discharge any taxes, liens, security interests or other encumbrances at any time placed thereon; provided that the Secured Party shall give the Debtor not less then ten (10) days' prior written notice of the time and place of any sale or other intended disposition of any of the Collateral, except any Collateral which is perishable or threatens to decline speedily in value or is of the type customarily sold on a recognized market. The Secured Party and the Debtor agree that such notice constitutes "reasonable notification" within the meaning of Section 9-504(3) of the Uniform Commercial Code. Section 9. Events of Default. The Debtor shall be in default under this Security Agreement upon the occurrence of any one of the following events (herein referred to as an "Event of Default"): (a) default by the Debtor in the due observance or performance of any covenant or agreement contained herein or breach by the Debtor of any representation or warranty herein contained and such non-observance or non-performance shall have continued for more than twenty (20) days after written notice thereof by the Secured Party to the Debtor; (b) any default in the payment when due, after any applicable grace period of the principal of, or interest on, any Obligations; or (c) the occurrence of any event of default, after any applicable grace period, under the provisions of the Loan 10 Agreement or any agreements now or hereafter securing the Note. Section 10. Remedies Upon Event of Default If any Event of Default shall have occurred, the Secured Party may exercise all the rights and remedies of a Secured Party under the Uniform Commercial Code (whether or not the Uniform Commercial Code is in effect in the jurisdiction where such rights and remedies are exercised) and, in addition, the Secured Party may, without being required to give any notice, except as herein provided or as may be required by mandatory provisions of law, (i) apply the cash, if any, then held by it as Collateral in the manner specified in Section 12, and (ii) if there shall be no such cash or if such cash shall be insufficient to pay all the Obligations in full, sell the Collateral, or any part thereof, at public or private sale or at any broker's board or on any securities exchange, for cash, upon credit or for future delivery, and at such price or prices as the Secured Party may reasonably deem satisfactory. The Secured Party may require the Debtor to assemble all or any part of the Collateral and make it available to the Secured Party at a place to be designated by the Secured Party which is reasonably convenient. Any holder of an Obligation may be the purchaser of any or all of the Collateral so sold at any public sale (or, if the Collateral is of a type customarily sold in a recognized market or is of a type which is 11 the subject of widely distributed standard price quotations, at any private sale) and thereafter hold the same, absolutely, free from any right or claim of whatsoever kind. Upon any such sale the Secured Party shall have the right to deliver, assign and transfer to the purchaser thereof the Collateral so sold. Each purchaser at any such sale shall hold the Collateral so sold absolutely, free from any claim or right of whatsoever kind, including any equity or right of redemption of the Debtor. Debtor to the extent permitted by law hereby specifically waives all rights of redemption, stay or appraisal which it has or may have under any rule of law or statute now existing or hereafter adopted. At any such sale the Collateral may be sold in one lot as an entirety or in separate parcels, as the Secured Party may determine. The Secured Party shall not be obligated to make such sale pursuant to any such notice. The Secured Party may, without notice or publication, adjourn any public or private sale or cause the same to be adjourned from time to time by announcement at the time and place fixed for the sale, and such sale may be made at any time or place to which the same may be adjourned. In case of any sale of all or any part of the Collateral on credit or for future delivery, the Collateral so sold may be retained by the Secured Party until the selling price is paid by the purchaser thereof, but the Secured Party shall not incur any liability in case of the failure of such purchaser to take up and pay for the Collateral so sold and, in case of any such failure, such Collateral may again be sold upon like notice. The Secured 12 Party, instead of exercising the power of sale herein conferred upon it, may proceed by a suit or suits at law or in equity to foreclose the Security Interests and sell the Collateral, or any portion thereof, under a judgment or decree of a court or courts of competent jurisdiction. Section 11. Right of Secured Party to Use and Operate Tangible Collateral, Etc. Upon the occurrence and during the continuation of an Event of Default, to the extent permitted by law, the Secured Party shall have the right and power to take possession of all or any part of the Tangible Collateral, and to exclude the Debtor and all persons claiming under the Debtor wholly or partly therefrom, and thereafter to hold, store, and/or use, operate, manage and control the same. Upon any such taking of possession, the Secured Party may, from time to time, at the expense of the Debtor, make all such repairs, replacements, alterations, additions and improvements to and of the Tangible Collateral as the Secured Party may deem proper. In such case, the Secured Party shall have the right to manage and control the Tangible Collateral and to carry on the business and to exercise all rights and powers of the Debtor in respect thereto as the Secured Party shall deem best, including the right to enter into any and all such agreements with respect to the leasing and/or operation of the Tangible Collateral or any part thereof as the Secured Party may see fit; and the Secured Party shall be entitled to collect and receive all rents, issues, profits, fees, revenues 13 and other income of the same and every part thereof. Such rents, issues, profits, fees, revenues and other income shall be applied to pay the expenses of holding and operating the Tangible Collateral and of conducting the business thereof, and of all maintenance, repairs, replacements, alterations, additions and improvements, and to make all payments which the Secured Party may be required or may elect to make, if any, for taxes, assessments, insurance and other charges upon the Tangible Collateral or any part thereof, and all other payments which the Secured Party may be required or authorized to make under any provision of this Security Agreement (including reasonable legal costs and attorney's fees). The remainder of such rents, issues, profits, fees, revenues and other income shall be applied to the payment of the Obligations in such order or priority as the Secured Party shall determine (subject to the provisions of Section 12 hereof) and, unless otherwise provided by law or by a court of competent jurisdiction, any surplus shall be paid over to the Debtor. Section 12. Application of Collateral and Proceeds. The proceeds of any sale of, or other realization upon, all or any part of the Collateral shall be applied in the following order of priorities: (a) first, to pay the expenses of such sale or other realization, including reasonable commission to the Secured Party's agent, and any other unreimbursed expenses for which 14 the Secured Party is to be reimbursed pursuant to Section 13 as the Secured Party in its sole discretion reasonably exercised shall determine; (b) second, to the payment of the Obligations in such other manner as the Secured Party, in its sole discretion, shall determine; and (c) finally, to pay to the Debtor, or its successors or assigns, or to a court of competent jurisdiction, or as directed by a court of competent jurisdiction, and surplus then remaining from such proceeds. Section 13. Expenses: Secured Party's Lien. The Debtor will forthwith upon demand pay to the Secured Party: (i) the amount of any taxes which the Secured Party may have been required to pay by reason of the Security Interests (including any applicable transfer taxes) or to free any of the Collateral from any lien thereon, excepting senior liens and liens set forth on Exhibit C to the Loan Agreement, and (ii) the amount of any and all reasonable out-of-pocket expenses, including the reasonable fees and disbursements of its counsel and of any agents not regularly in its employ, which the Secured Party reasonably may incur in connection with (w) the preparation and administration of this Security Agreement, (x) the collection, sale or other 15 disposition of any of the Collateral, (y) the exercise by the Secured Party of any of the powers conferred upon it hereunder, or (z) any default on the Debtor's part hereunder. Section 14. Termination of Security Interests; Release of Collateral. Upon the repayment and performance in full of all the Obligations, the Security Interests shall terminate and all rights to the Collateral shall revert to the Debtor. Upon any such termination of the Security Interests or release of Collateral, the Secured Party will, at the Debtor's expense to the extent permitted by law, execute and deliver to the Debtor such documents as the Debtor shall reasonably request to evidence the termination of the Security Interests or the release of such Collateral, as the same may be. Section 15. Notices All notices, communications and distributions hereunder shall be given or made to the parties as set forth in the Loan Agreement. Section 16. Waivers, Non-Exclusive Remedies. No failure on the part of the Secured Party to exercise, and no delay in exercising, and no course of dealing with respect to, any right, power or remedy under this Security Agreement shall operate as a waiver thereof; nor shall any single or partial 16 exercise by the Secured Party of any right, power or remedy under this Security Agreement preclude any other right, power or remedy. The remedies in this Security Agreement are cumulative and are not exclusive of any other remedies provided by law. The Debtor and the Secured Party each also waives trial by jury in any action brought on or with respect to this Security Agreement. Section 17. Changes in Writing. Neither this Security Agreement nor any provision hereof may be changed, waived, discharged or terminated orally but only by a statement in writing signed by the party against which enforcement of the change, waiver, discharge or termination is sought. Section 18. Rhode Island Law; Meaning of Terms. This Security Agreement shall be construed in accordance with and governed by the laws of the State of Rhode Island, except as otherwise required by mandatory provisions of law and except to the extent that remedies provided by the laws of any State other than Rhode Island are governed by the laws of said State. Unless otherwise defined herein, or unless the context otherwise requires, all terms used herein which are defined in the Rhode Island Uniform Commercial Code have the meanings therein stated. 17 Section 19. Separability. If any provision hereof is invalid or unenforceable in any jurisdiction, the other provisions hereof shall remain in full force and effect in such jurisdiction and shall be liberally construed in favor of the Secured Party. Section 20. Headings. The headings in this Security Agreement are for the purposes of reference only and shall not limit or otherwise affect the meaning hereof. IN WITNESS WHEREOF, this Security Agreement has been executed by the parties hereto all as of the day and year first above written. NETWORK SIX, INC. ("Debtor") By: /s/ Dorothy M. Cipolla -------------------------------- Title: Treasurer ----------------------------- BUSINESS DEVELOPMENT COMPANY OF RHODE ISLAND ("Secured Party") By: /s/ Gurrett B. Hunter -------------------------------- Title: President ----------------------------- 18 Exhibit "A" to UNIFORM COMMERCIAL CODE - FINANCING STATEMENT - FORM UCC-1 Debtor Corporate Address: 475 Kilvert Street, Warwick, RI 02888 Property Location: As described below Description of Property Covered: ITEM QTY SERIAL NO. DESCRIPTION - ---- --- ---------- ------------------------------------------------------- VENDOR: Unisys EQUIPMENT LOCATION: Oahu ICSD, 1151 Punch Bowl Street, Kalanimoku, Honolulu, HI 96813 1. (01) CISCO Pre-FSP4-V.35 4-Port Interface 2. (01) CISCO CX-TRIP2 2-Port Token Ring 3. (01) CISCO 7010 Chassis and Power 4. (01) CISCO Pre-FSIP8-V.35 Interface EQUIPMENT LOCATION: Child Support Enforcement Agency, State of Hawaii, Dole Building, 680 Iwilei Road Suite 490, Honolulu, HI 96817 1. (01) Sun Sparc Station W/64MB Mem Including all attachments and accessories thereto, and all proceeds thereof, including proceeds in the form of goods, [ILLEGIBLE] chattel paper, documents, instruments, contract rights and general intangibles. Debtor: NETWORK SIX, INC. Secured Party: CELTIC LEASING CORP. ------------------------ -------------------------- Signature: /s/ Bryan Gleason Signature: /s/ Bruce W. Atkinson --------------------- ------------------------------ Name: Bryan Gleason Name: Bruce W. Atkinson -------------------------- ----------------------------------- Title: Chief Financial Officer Title: Assistant Vice President - Credit ------------------------- ---------------------------------- EXHIBIT "A" COLLATERAL DESCRIPTION In the account, contract rights, rights to payment, intangibles, and cash and non-cash proceeds including but not limited to instruments, documents, chattel paper, warrants and any other indicia of payment in respect to the Debtor's contract dated on or about April 1, 1997 with the State of Maine and identified as the "Maine Automated Child Welfare Information System Contract For Special Services" or "MACWIS." EX-23.1 4 EXHIBIT-23.1 EXHIBIT-23.1 [LETTERHEAD OF SANSIVERI, KIMBALL & MCNAMEE, L.L.P.] INDEPENDENT AUDITORS' CONSENT To the Board of Directors and Shareholders of Network Six, Inc.: We consent to the incorporation by references in the registration statement (No. 33-87208) on Form S-8 of Network Six, Inc. of our report dated February 19, 1999 relating to the balance sheet of Network Six, Inc. as of December 31, 1998 and 1997 and the related statements of operations, stockholders' equity and cash flows for the years ended December 31, 1998 and 1997 which report appears in the December 31, 1998 annual report on Form 10-K of Network Six, Inc. /s/ Sansiveri, Kimball & McNamee, L.L.P. Providence, Rhode Island February 19, 1999 EX-23.2 5 EXHIBIT-23.2 EXHIBIT-23.2 Independent Auditors' Consent The Board of Directors of Network Six, Inc.: We consent to the incorporation by reference in the registration statement (No. 33-87208) on Form S-8 of Network Six, Inc. of our report dated March 28, 1997 relating to the statements of operations, stockholders' equity and cash flows of Network Six, Inc. for the year ended December 31, 1996, which report appears in the December 31, 1998 annual report on Form 10-K of Network Six, Inc. Our report, dated March 28, 1997, contains an explanatory paragraph that states the Company became a defendant in significant litigation with the State of Hawaii (the "State") related to its system implementation contract with the State, has become a party to other litigation related to the Hawaii contract, has suffered recurring losses, and has a bank financing agreement which has expired. These circumstances raise substantial doubt about the entity's ability to continue as a going concern. The 1996 financial statements do not include any adjustments that might result from the outcome of these uncertainties. /s/ KPMG LLP Providence, Rhode Island March 16, 1999 EX-27.1 6 EXHIBIT 27.1
5 12-MOS 3-MOS DEC-31-1998 DEC-31-1998 DEC-31-1998 DEC-31-1998 1,442,035 1,442,035 0 0 2,035,963 2,035,963 69,175 69,175 0 0 4,741,509 4,741,509 774,250 774,250 602,033 602,033 8,700,782 8,700,782 3,325,309 3,325,309 0 0 73,429 73,429 0 0 2,235,674 2,235,674 1,499,780 1,499,780 8,700,782 8,700,782 10,399,979 2,262,063 10,399,979 2,262,063 6,418,678 1,278,106 8,679,096 1,800,943 (78,437) (15,060) 0 0 125,314 71,025 1,674,006 405,155 613,000 92,548 1,061,006 312,607 0 0 0 0 0 0 1,061,006 312,607 0.96 0.3 0.96 0.3
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