-----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, OHs3A5RDgg/CT34OiO+aRaWzx1/KmtBQjc7P+0fHPZUqrHnrWATz6ff9fZiAFBMo R/v/nessy4g6ba5hMFYkPg== /in/edgar/work/0000950147-00-001533/0000950147-00-001533.txt : 20001006 0000950147-00-001533.hdr.sgml : 20001006 ACCESSION NUMBER: 0000950147-00-001533 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20000630 FILED AS OF DATE: 20001005 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NETWORK CONNECTION INC CENTRAL INDEX KEY: 0000932088 STANDARD INDUSTRIAL CLASSIFICATION: [3576 ] IRS NUMBER: 581712432 STATE OF INCORPORATION: GA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 001-13760 FILM NUMBER: 735517 BUSINESS ADDRESS: STREET 1: 222 NORTH 44TH STREET CITY: PHOENIX STATE: AZ ZIP: 85034 BUSINESS PHONE: 6022008900 MAIL ADDRESS: STREET 1: 222 NORTH 44TH STREET CITY: PHOENIX STATE: AZ ZIP: 85034 10KSB 1 0001.txt FORM 10-KSB FOR THE YEAR ENDED 6/30/00 ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended June 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 1-13760 THE NETWORK CONNECTION, INC. (Name of Small Business Issuer in Its Charter) GEORGIA 58-1712432 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 1811 CHESTNUT STREET, SUITE 110 PHILADELPHIA, PENNSYLVANIA 19103 (Address of Principal Executive Offices) (215) 832-1046 (Issuer's Telephone Number, Including Area Code) Securities registered under Section 12(b) of the Exchange Act: Name of Each Exchange Title of Each Class on Which Registered ------------------- ------------------- Common Stock, $0.001 par value per share The Nasdaq SmallCap Market Securities registered under Section 12(g) of the Exchange Act: None Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes [X] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ ] Issuer's revenues for its most recent fiscal year: $7,091,660 As of September 25, 2000, the number of shares of Common Stock outstanding was 19,973,117 and the aggregate market value of such Common Stock (based on the closing sales price of the Common Stock on such date as reported by the Nasdaq SmallCap Market) held by non-affiliates was approximately $20,226,221. Transitional Small Business Disclosure Format: Yes [ ] No [X] ================================================================================ DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates information by reference from portions of TNCi's definitive proxy statement for its 2000 Annual Meeting of Shareholders scheduled to be held on Thursday, November 16, 2000 (the "Proxy Statement"). With the exception of those portions which are expressly incorporated by reference, the Proxy Statement is not deemed filed as a part of this Annual Report. REFERENCES AND FORWARD-LOOKING STATEMENTS References made in this Annual Report on Form 10-KSB to "TNCi," the "Company" or the "Registrant" refer to The Network Connection, Inc. and its subsidiary. AirView, Cheetah, Cheetah Workgroup, CruiseView, EduView, InnView, M2, M2V, Quad-Cheetah, T.R.A.C., The Network Connection, TNX, TrainView, TransPORTAL, Triumph, the TNCi logo are trademarks of TNCi. This Annual Report on Form 10-KSB contains forward-looking statements. In some cases, readers can identify forward-looking statements by terminology such as "may," "will," "should," "could," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," or "continue." These statements involve known and unknown risks, uncertainties and other factors that may cause TNCi's actual results, performance, or achievements to be materially different from those stated herein. Although management of TNCi believes the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, performance, or achievements. Factors that could cause actual results to differ materially include, but are not limited to, the risks detailed below and included from time to time in the Company's other SEC reports and press releases, copies of which are available from the Company upon request. The Company assumes no obligation to update any forward-looking statements contained herein. THE NETWORK CONNECTION, INC. ANNUAL REPORT ON FORM 10-KSB TABLE OF CONTENTS Page ---- PART I.........................................................................2 ITEM 1 - DESCRIPTION OF BUSINESS............................................2 ITEM 2 - DESCRIPTION OF PROPERTY...........................................10 ITEM 3 - LEGAL PROCEEDINGS.................................................11 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............12 PART II.......................................................................13 ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..........13 ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS or plan OF OPERATION.........13 ITEM 7 - FINANCIAL STATEMENTS..............................................24 ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..........................................24 PART III......................................................................25 ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.................25 ITEM 10 - EXECUTIVE COMPENSATION............................................25 ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....25 ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................25 ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K..................................25 PART I ITEM 1 - DESCRIPTION OF BUSINESS GENERAL The Network Connection is a pioneer in bringing broadband, all-digital entertainment and information solutions to the "away-from-home" marketplace. Our solutions are designed to deliver customized interactive services such as digital movies, video-on-demand, e-commerce, Internet/Intranet access, laptop connectivity, video-based training, advertising, Internet protocol (IP) IP telephony, and other IP-based services. Our platform is based on the same standards that power the Internet today, providing the ability to scale and expand our solutions along with industry advancements. Each installation is based on the same advanced system architecture, allowing us to easily upgrade and expand the services available over time. We are a leader in developing and deploying these all-digital solutions, and our technology has been selected and installed in hotels, cruise ships, educational facilities, and in a railway simulator car in Europe. We have had the following recent developments: * EXECUTIVE MANAGEMENT - In March 2000, we announced the appointment of a new executive management team, including Robert S. Pringle, President and Chief Operating Officer, Dr. Jay R. Rosan, Executive Vice President, and Richard E. Genzer, Chief Technology Officer. These well-regarded Internet executives have broad experience in building branded Internet portals, creating successful e-commerce solutions, and aggregating information and entertainment content. * SYSTEM DEPLOYMENT - In September 2000, we announced a relationship with Comdisco (NYSE:CDO), enhancing our capability to manage system installation, monitoring and deployment on a global basis. * CONTENT DIVISION - In March 2000, we formed a new division to focus on creating long-term business models for content, commerce, community and connectivity. This division will create an enhanced away-from-home experience where people can access and customize content and data. Richard Gallagher was hired in August 2000 to lead this division. * HOTEL & HOSPITALITY DIVISION - Our technology is currently installed in approximately 800 guest rooms, and we have signed contracts to install the technology in over 2,000 additional guest rooms for a total contractual base of 2,500 guest rooms. Our InnView(TM) system has been well received in the marketplace, and we expect our progress in this marketplace to continue to accelerate given our initial successful implementations. * CRUISE SHIP DIVISION - We have developed an enhanced version of our CruiseView technology platform, increasing its performance and capabilities, and are in advanced discussions with several major cruise companies about installing this interactive system, including Carnival. We have terminated our prior contract with Carnival Cruise Lines, through a mutual release which allows us to retain our equipment and retain approximately $1.6 million in cash advances. We continue to operate our CruiseView(TM)system on one 1,040-cabin Carnival ship while we negotiate the terms of a potential forward-looking agreement to deploy our latest CruiseView(TM)solution. * EDUCATION & CORPORATE TRAINING DIVISION - In September 1999, we completed delivery and installation of 195 Cheetah video servers to Georgia schools in connection with the Georgia Metropolitan Regional Education Services Agency (MRESA) Net 2000 project. We received payment of $5.4 million in connection with the project. We have developed a national network of leading technology integrators for the educational marketplace, and have submitted several significant proposals for new business in this area. 2 * PASSENGER RAIL DIVISION - In September 1999, we hired Stephen J. Ollier to lead the division. We have submitted pricing proposals to two of the world's largest train operators for new and retrofit installations of TrainView systems. We launched our new PROJECTRAINBOW(TM) showroom and demonstration system in June in the United Kingdom. We have entered into advanced discussions with leading railway operators in the United Kingdom to outfit our system on their fleets. Guest Services available through our CruiseView and InnView Systems include: * on-demand films, short video features and music videos; * free-to-guest television programs; * concierge information and reservations; * in-room guest messaging and bulletin boards; and * in-room folio review, express check-out and guest surveys. Eventually, we also plan to include the following guest services through our systems: * high-speed access to the World Wide Web and e-mail; * voice-over IP (i.e., long distance telephone calls over the Internet); * e-commerce services, such as interactive shopping; * interactive games and casino-style gambling where permitted by law; and * interactive advertising and promotion of customer events, shops and restaurants. BUSINESS STRATEGY Our primary objective is to be a leading provider of broadband solutions for the away-from-home marketplace. To this end, we have developed the following strategies: * DEPLOY, OWN, AND OPERATE BROADBAND NETWORKS ACROSS MULTIPLE SEGMENTS OF THE AWAY-FROM-HOME MARKETPLACE. We provide both infrastructure and programming, retaining the long-term rights to deliver services over our broadband networks. Our business model balances shared up-front capital investment with shared long-term revenue streams. * BE RECOGNIZED AS A TOTAL SOLUTION PROVIDER. We will continue to develop our content division, which will acquire, package and monitor a broad range of compelling multimedia content tailored to appeal to the typical end-users in each of our market segments. We believe this is necessary so that we can be viewed by our customers not as a system infrastructure provider, but rather as a total solution provider. * LEVERAGE OUR CORE TECHNOLOGY ACROSS MARKET SEGMENTS. We will pursue new markets and applications for our systems, products and technologies. * NURTURE KEY BUSINESS PARTNERS AND STRATEGIC ALLIANCES. We will nurture our existing business relationships, and develop new ones with partners who have strong national and international presences. We will use these business relationships to further penetrate our targeted markets. * DEVELOP OUR NEWLY CREATED DIVISIONS AND PENETRATE FURTHER THE MARKETS THEY SERVE. We will continue to invest in our newly created divisions and staff them with the skilled professionals 3 necessary to effectively and efficiently maximize order generation for our systems, products and services in the markets they serve. * INVEST IN OUR CORE COMPETENCIES. We will continue to attract and retain highly skilled professionals in these critical disciplines: industry specific marketing and sales; multimedia content development, acquisition and management; systems and software engineering; supplier management; finance; contracts administration; and program management applied to large-scale systems. PRODUCTS AND SERVICES TECHNOLOGY The hardware for our interactive systems consists of high speed Cheetah servers, multiple disk drives, networking infrastructure, set-top personal computers, and televisions or other electronic displays that serve as monitors for our systems. Our TransPORTAL system software is based on standardized Web browser component technology. Our systems provide a variety of informative, entertainment and interactive content which may be accessed and viewed on demand. Our systems are 100% digital and offer our customers flexibility in adding new content to the system, as well as the ability to customize and brand their marketing vision via the "look and feel" of the underlying graphical user interface. Dual, fault-tolerant Cheetah servers serve as the heart of our systems. One Cheetah server operates as the local area network backbone and can provide up to 100 megabit connectivity to each user on the system. The scaleable architecture of our server is based on Intel processors and Microsoft operating systems. Our systems interface with a variety of color flat panel computer monitors and television displays. The design for our interactive information and entertainment systems are proprietary to us, as are our Cheetah video servers and TransPORTAL software tools. However, other hardware and components used in our systems are predominantly commercial, off-the-shelf hardware, based on non-proprietary or open-system computer and IP network standards. We believe that this use of available commercial hardware allows us to outsource component product manufacturing to suppliers without compromising overall product quality and reliability. We believe that it also allows us to focus our operations resources on supplier management, final assembly and testing. Each of our video servers can scale to serve up to 300 simultaneous users. We can install multiple video servers where required. TURNKEY INTERACTIVE INFORMATION AND ENTERTAINMENT SYSTEMS We currently market three customized turnkey systems. Each of these systems is built on our Cheetah servers and TransPORTAL software package. We customize the content available through our systems to provide the best total solution for our respective market purchasers: * TrainView is our newest system solution. We anticipate that our TrainView system will provide interactive entertainment and other content to be determined in conjunction with future customers, if any. We have developed a TrainView prototype, which we are currently marketing to train operators in Europe and Asia. * InnView is our system solution for the hotel and time-share market. Generally, we expect to provide interactive and entertainment content for use by the hotel guests. The system is also designed to provide Internet access over the television, voice over IP, and concierge and other guest services. Some of the content can be available free of charge, some can be advertising supported, and some can be available on a pay-per-use basis. We will share revenues from advertising and pay-per-use with the hotels on a negotiated percentage basis. * CruiseView is our system solution for the cruise ship market. The system is designed to provide information, entertainment, gaming, shore excursions and free-to-guest services. The system is also 4 designed to provide Internet access over the television, voice over IP, and concierge and other guest services. Some of the content can be available free of charge, some can be advertising supported, and some can be available on a pay-per-use basis. We will share revenues from advertising and pay-per-use with the cruise lines on a negotiated percentage basis. SERVER SALES Our current business strategy is to offer and sell complete, turnkey interactive information and entertainment systems. However, a substantial portion of our revenues generated since June 30, 1999 have come from the sale of our Cheetah video servers which have been part of a system designed and installed by others. Although we will continue to offer and sell the servers as stand-alone, high-end, video servers, we are endeavoring to be known as a total system solution provider in the education market as well as in the other markets we serve. CONTENT We obtain the content which we show on our systems in several different ways. Movies are obtained by licensing products from industry suppliers. Other content is purchased or licensed from other providers. We expect to expand all of our systems to include additional content and features, such as Internet access, on-line shopping and local entertainment guides. We are currently developing our content division which will oversee this development. Our content division is also looking to provide a total solution system for the education and corporate training markets. OUR HISTORY We were incorporated in Georgia in 1986. Our common stock is listed on the Nasdaq SmallCap Market under the ticker symbol "TNCX." Our primary focus under prior management from inception to 1995 was providing video products and services to the educational market. After an initial public offering in 1995, prior management began to market interactive information and entertainment systems to the commercial airline and passenger cruise ship industries. Our AirView product was installed on two Fairlines Airlines aircraft. In addition, the in-flight entertainment system developed by the Interactive Entertainment Division we acquired from Global Technologies was installed on 19 Swissair aircraft, two Debonair Airlines aircraft and three Alitalia aircraft. The heavily regulated nature of the airline market prohibitively increased our costs. Fairlines filed for bankruptcy protection and we were never able to collect the amounts owed to us. These facts, together with the Swissair litigation, led us and Global Technologies to stop pursuing this market in 1998. See "Risk Factors - We are a defendant in a multi-district, mass tort class action lawsuit." In addition, prior management entered into agreements with Carnival Cruise Lines and Star Cruises to install our systems on several of their cruise ships. Operational problems on the Star cruise ship led Star to cancel its agreement, and we were unable to recover our investment. Prior management also negotiated a fixed price agreement with Carnival Cruise Lines and installed a system on one Carnival ship. We have terminated the Carnival agreement, through a mutual release which allows us to retain our equipment and recognize revenue of $1.4 million for the sale of networking equipment aboard the ships. We continue to operate our CruiseView(TM) system on one 1,040-cabin Carnival ship while we negotiate the terms of a potential forward-looking agreement to deploy our latest CruiseView(TM) solution. Early in 1999, prior management's inability to collect receivables and other administrative problems left us struggling financially and in need of capital. In May 1999, Global Technologies, Ltd., a Delaware corporation listed on the Nasdaq National Market under the ticker symbol "GTLL," acquired majority control of us by exchanging the assets of its Interactive Entertainment Division 5 and approximately $4.25 million in cash for 1,055,745 shares of our common stock and 2,945,400 shares of our Series D Convertible Preferred Stock. This transaction gave Global Technologies ownership of approximately 60% of our then outstanding common equity on a fully diluted basis. Through a series of additional transactions, Global Technologies acquired additional shares of our common stock and shares of our Series B Convertible Preferred Stock so that, on a fully converted basis, it now owns approximately 79% of our outstanding common equity. The transaction brought together synergistic technologies, and the engineering and program management capabilities of two companies experienced in the field of developing, manufacturing, marketing and installing interactive information and entertainment systems. In connection with the acquisition, Global Technologies elected a new board of directors, which put in place our current management team. The board of directors was re-elected, with the exception that Robert Pringle was elected to take the place of Morris Aaron, at the 2000 annual meeting of shareholders on May 11, 2000. OUR DIVISIONS AND MARKETS Under new management, we have identified four primary markets for our products and services. We believe these markets represent opportunities to achieve substantial market share and profitability. These markets are: (1) hotels and time-share properties, (2) cruise ships, (3) educational institutions and corporate training, and (4) long-haul passenger trains. In an effort to capitalize on opportunities in these markets, we have formed separate sales and marketing divisions, and have recently hired experienced executives to lead each of the four divisions. HOTELS AND TIME-SHARE PROPERTIES We have begun to market our products and services to "land-based" hotels and time-share properties in North America. In addition, we are in the process of developing sales and marketing strategies for hotels and time-share properties in Europe, Asia and South America. We call the system we market to the hotel and time-share market "InnView." Initially, we are focusing our efforts on hotels with 100 or more rooms. We formed our Hotel & Hospitality Division in December 1999. Management believes there are approximately 3.6 million rooms in the domestic hotel market, approximately 1.9 million of which do not have in-room information and entertainment systems. Management also believes there are almost 0.5 million time-share properties which also do not have installed information and entertainment systems. Of the unserved hotel rooms, we estimate that approximately 0.8 million would meet the economic criteria for installation of our InnView systems. In addition, we estimate that contracts covering approximately 1.7 million domestic hotel rooms currently served by a competitor's system will come up for renewal over the next five years. Since forming this division, we have retained several national and international sales executives. To date, we have entered into agreements for our InnView system for over 2,800 guest rooms, and have live, operational installations in over 800 rooms. Generally, we expect our InnView systems to become operational within four months after entering into an agreement with a particular hotel. We have not installed InnView in any time-share properties. We provide the systems at no cost to the hotel in exchange for a revenue share agreement in which we retain the majority of such revenues or we share in the up-front installation costs and share the revenues on a commensurate basis. PASSENGER RAIL There are currently 11 operators of long-haul passenger trains in the world. We believe that each of these operators are potential customers for our TrainView system over the next several years. The fleets operated by these companies contain an aggregate of almost one million seats that could be fitted with our TrainView systems. However, to date, no trains have been fitted with information or entertainment systems. 6 In September 1999, we formed a Passenger Rail Division to promote our interactive information and entertainment systems for installation at individual seats on long-haul and cross-country passenger trains in the U.S., European and Asian markets. This system is called "TrainView." We announced the appointment of Stephen J. Ollier, the former General Manager of ALSTOM Railway Maintenance Services, Ltd., as President of the division. We believe that Mr. Ollier is uniquely qualified for the position, offering both the technical and industry experience we believe necessary to bring TrainView to the international rail market. In May 1999, ALSTOM Transport Ltd., a unit of ALSTOM SA, which is one of the largest train manufacturers in the world, contracted with us to engineer TrainView into ALSTOM's high-speed train design. We were paid in connection with the contract but expect no further business from ALSTOM because we have become aware that ALSTOM is in the process of creating a subsidiary to compete with us in the passenger rail market. Under the direction of Mr. Ollier, we have submitted pricing proposals to two train operators in the United Kingdom for installation of TrainView systems. To date, we have not installed TrainView on any passenger train. CRUISE SHIPS Management estimates that there are currently more than 70 cruise ships in revenue service with 500 or more guest cabins. We estimate that the current construction schedules for ships of this size show more than 30 new ships entering service between now and the end of 2004. In total, we estimate the market to host over 10 million passenger cruises annually, the vast majority of which are hosted by one of a handful of leading cruise operators. We believe that only about ten ships to date have had interactive entertainment and information systems installed. Historically, the cruise line industry has not embraced the installation of interactive systems in individual cabins like their hotel counterparts. The major reason for this reluctance is not related to a lack of demand. Only recently has the technology of interactive guest systems progressed to levels that enable them to profitably and logistically contribute to cruise line profits and the vacation experience. In fact, the most significant hurdles have been adapting the system to the compact configuration and harsh environment of cruise ships, while maintaining adequate levels of price and performance. We have had over a year's experience with our systems aboard Carnival Cruise Lines, and have recently developed an enhanced version of our CruiseView technology platform, increasing its performance and capabilities. We are in advanced discussions with several major cruise companies about installing this interactive system, including Carnival. EDUCATION AND CORPORATE TRAINING We continue to manufacture our Cheetah family of multimedia servers for the interactive education and corporate training markets. Sales of servers have historically been a core business of ours, with over 2,000 Cheetah video servers sold worldwide. In August 1999, we sold multimedia servers in connection with the first phase of the Georgia school system's Net 2000 project. We supplied our Cheetah video servers as the central backbone of 193 Georgia schools' multimedia networks. Two other Cheetah servers were delivered in connection with the order and installed at the Georgia schools' network operating center. Using our servers, students and teachers are able to access, on-demand, hundreds of hours of digitally stored multimedia content, access the Internet and build interactive courses. The total value of orders received under the program to date is $5.4 million. We believe that this installation is the largest of its kind in the country and that it may well be a model for the expansion of this type of program. Our sales to MRESA were limited to our Cheetah video servers. In the future, we hope to be able to sell entire interactive systems, which we call "EduView," to school related purchasers. In 1999, the Federal government instituted the E-Rate Program, which has a primary goal of bringing the Internet and various forms of multimedia content directly to elementary and secondary classrooms. The program makes $2.25 billion available to schools to obtain the technology necessary to achieve this goal. To obtain these funds, a school district must make application and pay a portion of the equipment cost. A significant amount of the funding for our delivery of 195 Cheetah video servers to Georgia schools in connection with the Georgia MRESA Net 2000 project came from the E-Rate Program. We formed our Education & Corporate Training Division in December 1999 to promote our interactive products and services to educational institutions and corporate training departments. In addition, we hired James D. Oots and Farley Barge as leaders of this division. This team brings to us a great deal of experience in the corporate training and education markets. 7 ACQUISITION, PACKAGING AND MONITORING OF BROADBAND, MULTIMEDIA CONTENT In an effort to capitalize on what we believe to be the advantages of our system architecture and technology, we are developing a division to acquire, package and monitor a broad range of compelling multimedia content tailored to appeal to the typical end-users in each of our market segments. We believe that the provision of compelling content through our systems will encourage user interaction with the system, which, in turn, should maximize pay-for-use revenue generation for us and for our vertical market partners. We believe that our content division will be integral to our success. The revenue generated from content can be long-term and should span the life-cycle of our systems. In addition, because it is generally industry practice in the markets we serve to share the cost of system hardware, and in the hotel market to provide the hardware free of charge, content revenue will be an essential revenue source. OUR SALES, MARKETING AND DISTRIBUTION We currently market our systems, products and services worldwide through the efforts of our sales people in each operating division. We also plan to market our systems through value-added resellers, distributors and alliance partners. System installation and on-site customer support are provided through internal customer engineering personnel and may, in the future, be provided through the efforts of value-added resellers and alliance partners. The sales arrangements for our systems depends upon various factors, such as the size and type of hotel, time-share property, ship or train, and the system features and other requested customization. There is generally a long sales-cycle for our systems because of the need to design the system configuration for the particular environment in which the system will be installed, test each installed system and to negotiate any necessary agreements with other providers. The sales cycle is also dependent upon a number of factors beyond our control, such as the financial condition of the customer, safety and maintenance concerns, regulatory issues, and purchasing patterns of particular operators and the industry generally. This is expected to result in long and unpredictable buying patterns for our systems. OUR COMPETITION We face substantial competition in each of our markets. Some general factors that we believe will influence whether we succeed include: * the ability to deliver total system solutions for our customers, including, in particular, content acquisition and management; * system quality, reliability and performance; * product hardware and software that can easily be upgraded during the product life cycle; * market-driven pricing of our systems, products and services, and * the ability to deliver new sources of revenue generation for our customers. There are three major providers of interactive guest services systems in the hotel and hospitality market. On Command Corporation (NASDAQ:ONCO) has the greatest market share with approximately one million rooms, followed by LodgeNet Entertainment Corporation (NASDAQ:LNET) with approximately 780,000 rooms, and Quadriga. On Command and LodgeNet focus their sales and marketing efforts on North American properties, whereas Quadriga markets its products primarily to European hotels and to a much lesser extent Middle Eastern and African hotels. All of these competitors employ a technology that is different from ours. We believe our systems designs are superior to those of our competitors because the scalability of our servers permits us to provide the content at each site such that all selections are always available. By contrast, our competitors are sometimes required to omit movie titles which are temporarily unavailable because the number of copies of those titles at the site are all in use. In addition, we believe that our system designs are superior based on the content and features offered, such as Internet connectivity and voice-over IP that can 8 be made available through the systems. Our two primary competitors in the cruise ship market are Allin Interactive (NASDAQ:ALLN) and Siemens. We estimate that Allin currently has two installed systems on two cruise ships with Royal Caribbean, while Siemens has a system installed on one. Although we have an opportunity to be first-to-market in providing train operators with interactive multimedia information and entertainment system solutions, SmartWorld, a UK-based company, has announced its intention to develop and offer a limited video-on-demand system for the passenger rail market. Matsushita, a leading provider of in-flight entertainment systems in the long-haul commercial airplane market, is considering an entry into this market. In addition, we are aware that ALSTOM and Adtranz are creating subsidiaries in an effort to compete in this market. Our Cheetah video servers apply hardware control of video streaming to achieve high-integrity, MPEG-2 quality images and pause, fast-forward, and rewind capabilities. These servers are scaleable to provide up to 300 simultaneous video streams. Competitor video server products in this market, such as are provided by Dell, Gateway, Silicon Graphics, Compaq and Hewlett Packard, are high-speed, general-purpose servers, with software control of limited video streams (typically less than 10 to 15). nCube has high end video servers which may also compete with us. All of these companies have greater financial, technical and marketing resources than we do. Moreover, our competitors have developed goodwill and name recognition among the hospitality operators whom we call on to solicit sales, and also among end users who have grown accustomed to their offerings. In addition, we expect that to the extent that the market for our systems, services and products develops, competition will intensify and new competitors will enter our designated target markets. We may not be able to compete successfully against existing and new competitors as the market for our systems, products and services evolves and the level of competition increases. A failure to compete successfully against existing and new competitors would have a materially adverse effect on our business and results of operations. OUR OPERATIONS AND MANUFACTURING Contract manufacturers assemble our proprietary systems in the United States. Final assembly, integration, burn-in and functional testing are conducted at our facilities in Phoenix, Arizona or at supplier or customer locations. We obtain electronic components and finished sub-assemblies for our system components "off-the-shelf" from a number of qualified suppliers. We have established a testing protocol in an effort to ensure that components and sub-assemblies meet our specifications and standards before final assembly and integration. We have elected to procure off-the-shelf component parts and sub-assemblies from suppliers in an effort to ensure better quality control and pricing. To date, we have experienced some interruptions in the supply of component parts and sub-assemblies due to the lack of availability of certain electronic components, and are identifying additional qualified suppliers. The inability of our current suppliers to provide component parts to us, coupled with our inability to find alternative sources, would adversely affect our operations. RESEARCH AND DEVELOPMENT The market for our systems and products is characterized by rapid technological change and evolving industry standards, and it is highly competitive with respect to timely product innovation. The introduction of products embodying new technology and the emergence of new industry standards can render existing products obsolete and unmarketable. We believe that our future success will depend upon our ability to develop, manufacture and market new systems and products, as well as enhancements to existing systems and products on a cost-effective and timely basis. The system architecture for our interactive information and entertainment systems has been designed to permit hardware and software upgrades over time. Moreover, we believe that the current architecture presents no known limits on a customer's ability to offer compelling content to the user in a rapid and reliable manner. Therefore, a major focus of our research and development efforts is to reduce the cost of network and client hardware and to enhance the core software of the system to permit even easier integration of new content. 9 If we are unable, for technological or other reasons, to develop new systems and products in a timely manner in response to changes in the industry, or if systems and products or system and product enhancements that we develop do not achieve market acceptance, our business will be materially adversely affected. There can be no assurance that technical or other difficulties in the future will not delay the introduction of new systems, products or enhancements. PROTECTING OUR INTELLECTUAL PROPERTY We rely on a combination of trade secret and other intellectual property law, nondisclosure agreements with most of our employees and other protective measures to establish and protect our proprietary rights in our systems and products. We believe that because of the rapid pace of technological change in the open systems networking industry, legal protection of our proprietary information is less significant to our competitive position than factors such as our strategy, the knowledge, ability and experience of our personnel, new system and product development and enhancement, market recognition and ongoing product maintenance and support. Without legal protection, however, it may be possible for third parties to copy aspects of our systems and products or technology, or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect proprietary rights in products and technology to the same extent as do the laws of the United States. Although we continue to implement protective measures and intend to defend our proprietary rights vigorously, we give no assurance that these efforts will be successful. Our failure or inability to effectively protect our proprietary rights could have an adverse affect on our business. EMPLOYEES We employ 77 full-time staff at our various locations and sales offices and we are adding skilled personnel in the following fields: content procurement and development; software, systems and hardware engineering; program management; contracts administration; supplier management; customer engineering; and sales and marketing. We have formed separate vertical sales and marketing divisions for each of our four target markets. These divisions are anchored by the recent hiring of experienced executives from within each of these markets. We anticipate that these executives will be able to leverage our core technology in broadband, multimedia content distribution and IP network solutions to increase sales of our systems, products and services. We have recognized the need to create an additional internal operating division to provide our customers with the personalized programming necessary to bring users a broad range of content options. We are in the process of hiring personnel to anchor this new division. WARRANTIES The Company provides a warranty regarding its products for periods ranging from one to three years, depending on the requirements of customers. To date, the Company has not experienced significant claims under warranties, and its ability to meet the full demands of having a significant number of units sold to customers who require such service has not been tested. The Company also passes through to end users the warranties that it receives from vendors on any separate hardware, software or component parts that it sells independently of full systems. ITEM 2 - DESCRIPTION OF PROPERTY We lease the following facilities, which we believe are adequate and suitable for current operations: * approximately 3,500 square feet of office space located at 1811 Chestnut Street, Philadelphia, Pennsylvania used for executive and administrative purposes; * approximately 17,000 square feet of office and production space located at 222 North 44th Street, Phoenix, Arizona; 10 * approximately 16,000 square feet of office space in Conshohocken, Pennsylvania to be used for administrative purposes and our content operations; and * approximately 1,000 square feet of space in Derby, England where our Passenger Rail Division is headquartered. ITEM 3 - LEGAL PROCEEDINGS Swissair/MDL-1269, IN REGARDS TO AN AIR CRASH NEAR PEGGY'S COVE, NOVA SCOTIA. This multi-district litigation, which is being overseen by the United States District Court for the Eastern Division of Pennsylvania, relates to the crash of Swissair Flight No. 111 on September 2, 1998. The Swissair MD-11 aircraft involved in the crash was equipped with an entertainment network system that had been sold to Swissair by Global's predecessor company, Interactive Flight Technologies, Inc. Estates of the victims of the crash have filed lawsuits throughout the United States against Swissair, Boeing, Dupont and various other parties, including Global and TNCi, which has been named in some of the lawsuits filed on a successor liability theory. TNCi and Global deny all liability for the crash. TNCi and Global are being defended by our aviation insurer. On September 1, 1999, SAir Group invited the Company to participate in a conciliation hearing before the Justice of the Peace in Kloten, Switzerland, which is the customary manner in which civil litigation is initiated in Switzerland. The document informing us of the proceeding states that the request has been filed in connection with the crash of Swissair Flight 111 primarily in order to avoid the expiration of any applicable statutes of limitations and to reserve the right to pursue further claims. The document states that the relief sought is "possibly the equivalent of CHF 342,000,000 - in a currency to be designated by the court; each plus 5% interest with effect from September 3, 1998; legal costs and a participation to the legal fees (of the plaintiff) to be paid by the defendant." BRYAN R. CARR V. THE NETWORK CONNECTION, INC. AND GLOBAL TECHNOLOGIES, LTD., Superior Court of Georgia, Civil Action No. 99-CV-1307. Bryan R. Carr, TNCi's former Chief Operating and Financial Officer and a former Director, filed a claim on November 24, 1999 alleging a breach of his employment agreement with TNCi. Mr. Carr claims that he is entitled to the present value of his base salary through October 31, 2001, a share of any "bonus pool," the value of his stock options and accrued vacation time. TNCi and Global filed a motion to compel arbitration of the claims pursuant to an arbitration provision in the employment agreement and to stay the State Court action pending the arbitration proceeding. The Company's motion was granted on August 9, 2000. As of this date, Mr. Carr has not filed an arbitration claim against TNCi or Global, but on September 20, 2000, Mr. Carr sent a letter to the Company stating his demands in hopes of settlement. A suit captioned LODGENET ENTERTAINMENT CORPORATION V. THE NETWORK CONNECTION, INC. was filed April 5, 2000 in the Circuit Court for the Second Judicial Circuit of the State of South Dakota. The action arose out of TNCi's hiring of Theodore P. Racz, a former LodgeNet Entertainment Corporation employee, as its Senior Vice President of the Hotels & Hospitality division. LodgeNet alleged tortious interference with contract and tortious interference with business relationships. LodgeNet sought to prohibit Mr. Racz from being employed by TNCi, as well as damages, and fees and costs. This case was voluntarily dismissed without prejudice by LodgeNet because there was no jurisdiction in South Dakota. A suit captioned AVNET, INC. V. THE NETWORK CONNECTION, INC., was filed May 17, 2000 in Maricopa County Superior Court, CV2000-009416. The suit relates to invoices for inventory purchased by TNCi in late 1998 and early 1999. Avnet, Inc. seeks payment of the invoices, interest and legal fees. TNCi has not paid for the inventory purchased primarily for the following reasons: (i) the inventory purchased did not meet specifications and thus was not accepted by TNCi's customer, and (ii) TNCi is currently pursuing a separate warranty claim against Avnet regarding certain other inventory purchased from Avnet. The Company is subject to other lawsuits and claims arising in the ordinary course of its business. In the Company's opinion, as of June 30, 2000, the effect of such matters will not have a material adverse effect on the Company's results of operations and financial position. 11 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 11, 2000 at an Annual Meeting of Shareholders, the following matters were submitted to a vote of security holders: 1. To elect four (4) directors to hold office as follows: M. Moshe Porat and Stephen Schachman to hold office until the 2001 Annual Meeting; Robert Pringle to hold office until the 2002 Annual Meeting; and Irwin L. Gross to hold office until 2003 Annual Meeting; and 2. To ratify the selection of KPMG LLP as auditors of the Company for the fiscal year ending June 30, 2000. VOTES ABSTENTION AND AGAINST OR BROKER MATTER VOTES FOR WITHHELD NON-VOTES ------ --------- -------- --------- Proposal #1 - M. Moshe Porat 11,365,642 7,700 0 - Stephen Schachman 11,365,642 7,700 0 - Robert Pringle 11,365,642 7,700 0 - Irwin L. Gross 11,365,642 7,700 0 Proposal #2 11,365,642 7,700 600 12 PART II ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is listed on The NASDAQ SmallCap Market. The following table shows the high and low bid prices in dollars per share for the last two years as reported by NASDAQ. YEAR ENDED JUNE 30, 1999 LOW HIGH ------------------------ --- ---- First Quarter $ 1.813 $ 4.938 Second Quarter $ 2.000 $ 4.125 Third Quarter $ 2.125 $ 3.938 Fourth Quarter $ 1.375 $ 3.375 YEAR ENDED JUNE 30, 2000 LOW HIGH ------------------------ --- ---- First Quarter $ 1.250 $ 2.906 Second Quarter $ 1.438 $ 7.000 Third Quarter $ 5.375 $ 13.375 Fourth Quarter $ 2.875 $ 8.719 As of September 25, 2000, there were approximately 100 record holders of the Company's Common Stock, but the Company believes that there are approximately 2,200 beneficial shareholders, based upon broker requests for distribution. DIVIDEND POLICY Holders of the Company's Common Stock are entitled to receive dividends only when declared by the Company's Board of Directors. Other than prior to September 22, 1994 when the Company made distributions to shareholders as an S corporation, dividends have never been declared or paid and the Company does not plan to make any dividend payments in the foreseeable future. Instead the Company will reinvest in the expansion and development of our business. If the Board of Directors decides to declare a dividend in the future, the decision will be based on our earnings, financial condition, cash requirements, and any other factors they deem relevant. ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ TOGETHER WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES INCLUDED IN ANOTHER PART OF THIS ANNUAL REPORT AND WHICH ARE DEEMED TO BE INCORPORATED INTO THIS SECTION. THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THOSE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING BUT NOT LIMITED TO, THOSE SET FORTH UNDER AND INCLUDED IN OTHER PORTIONS OF THIS ANNUAL REPORT. SEE "FORWARD-LOOKING STATEMENTS" ON PAGE 22. BACKGROUND AND BASIS OF PRESENTATION We design, manufacture, install and maintain advanced, high-performance computer servers and interactive, broad-band information and entertainment systems. We also procure and provide the content available through the systems. These all-digital systems deliver an on-demand, multimedia experience via high-speed, high-performance Internet Protocol (IP) networks. These systems are designed to provide users access to information, entertainment and a wide array of service options, such as shopping for goods and services, computer games, access to the World Wide Web and on-line gambling, where permitted by applicable law. The targeted markets for our products are hotels and time-share properties, cruise ships, educational institutions and corporate training, and passenger trains. On May 18, 1999, we obtained substantially all of the assets and certain liabilities of the Interactive Entertainment Division of Global Technologies, Ltd. (formerly known as Interactive Flight Technologies, Inc.) and $4,250,000 in 13 cash in exchange for 1,055,745 shares of our common stock and 2,495,400 shares of our Series D Convertible Preferred Stock. For accounting purposes, this acquisition is treated as a reverse merger. Global Technologies is deemed to have acquired us. As a result, we are treated as the successor to the historical operations of the Interactive Entertainment Division and our financial statements, which have been reported to the SEC on Forms 10-KSB and 10-QSB, among others, have been replaced with those of the Interactive Entertainment Division. We will continue to file as a SEC registrant and continue to report under the name The Network Connection, Inc. We changed our fiscal year-end from December 31 to June 30. Accordingly, the eight-month period resulting from this change - November 1, 1999 through June 30, 1999 - is referred to in this report as the "transition period." For accounting purposes, the date of the acquisition of the Interactive Entertainment Division was May 1, 1999. The financial statements as of and for the year ended October 31, 1998 reflect the historical results of the Interactive Entertainment Division as previously included in Global Technologies' consolidated financial statements. Included in the financial statements for the eight months ended June 30, 1999 are the historical results of the Interactive Entertainment Division through April 30, 1999, and the results of the post-transaction company for the two months ended June 30, 1999. All consolidated financial statements from July 1, 1999 forward reflect the results of the post-transaction company. As of June 30, 2000, we were a 79% owned subsidiary of Global Technologies, whose ownership was represented by 1,500 shares of our Series B 8% Convertible Preferred Stock, 2.5 million shares of our Series D Preferred Stock and approximately 8.1 million shares of our common stock. In addition, pursuant to the terms of the acquisition of Global Technologies' Interactive Entertainment Division, Global Technologies is entitled to receive 270,081 additional shares of the Company's Common Stock on account of claims that arose during the one-year period following the acquisition. Our consolidated financial statements are prepared using generally accepted accounting principles applicable to a going concern which contemplate the realization of assets and liquidation of liabilities in the normal course of business. We have incurred net losses from operations for two of the last three periods, had an accumulated deficit at June 30, 2000 as a result of efforts to build our customer base and develop our operations. Management believes that our current cash balances, the $5 million credit facility with Global Technologies (of which approximately $2.7 million remained available as of September 29, 2000), and currently available external sources of financing will not be sufficient to meet our currently anticipated cash requirements for operations for the next 12 months. A substantial portion of our accounts payable are past due and many suppliers have imposed cash on delivery terms. We are in discussions with private equity sources which, if transactions are consumated, together with the Global Technologies credit facility and currently available external sources of financing, should provide sufficient short-term funding. Our inability to draw on the credit facility with Global Technologies, to obtain funds pursuant to the currently available external sources of financing, or not complete certain private placement transactions, would have a material adverse effect on our operating results, financial condition and ability to continue as a going concern. 14 Global Technologies does not currently have sufficient cash for us to borrow under the credit facility and no assurance can be given that currently available external sources of financing will have the resources necessary to meet its commitments as we draw down from time to time pursuant to our private equity line, or that any other financings will be consumated. Additionally, any increase in our growth rate, shortfalls in anticipated revenues, increase in anticipated expenses, or significant acquisition or expansion opportunities could have a material adverse effect on our liquidity and capital resources and would require us to raise additional capital from public or private equity or debt sources in order to finance operating losses, anticipated growth, and contemplated capital expenditures and expansions. We have significant expansion plans which we intend to fund with the facilities discussed above; however, if there is any delay in consumating these facilities, we will not engage in such expansion until adequate capital sources have been arranged. If such sources of financing are insufficient or unavailable, we will be required to modify our growth and operating plans or scale back operations to the extent of unanticipated opportunities, such as acquisitions of complementary businesses or the development of new products, or otherwise respond to unanticipated competitive pressures. There can be no assurance that we will be able to raise any such capital on terms acceptable to us or at all. We expect to continue to focus on developing and expanding our enhanced broadband information and entertainment systems while continuing to expand our current operation's market penetration. Accordingly, we expect that our capital expenditures and cost of revenues and depreciation and amortization expenses will continue to increase significantly, all of which could have a negative impact on short-term operating results. In addition, we may change our strategy to respond to a changing competitive environment. There can be no assurance that growth in our revenue or market penetration will continue, that our expansion efforts will be profitable, or that we will be able to achieve or sustain profitability or positive cash flow. Further, we will require substantial financing to continue as a going concern, accomplish any significant acquisition or merger transaction, and provide for working capital to operate our current and proposed expanded operations until profitability is achieved, if ever. RESULTS OF OPERATIONS In August 1999, our fiscal year-end was changed from December 31 to June 30. Our financial statements included in this Annual Report on Form 10-KSB contain the results from operations for our fiscal year ended October 31, 1998, for the eight-month Transition Period ended June 30, 1999 and for our fiscal year ended June 30, 2000. For purposes of this management's discussion and analysis, for comparative purposes only, we will refer to the pro forma unaudited results of operations for the twelve-month period ended June 30, 1999. In some instances, where we compare results for the pro forma unaudited twelve months ended June 30, 1999 with the fiscal year ended October 31, 1998, please note that there is a four-month overlap between such periods. The pro forma unaudited results of operations for the twelve months ended June 30, 1999 and audited year ended June 30, 2000 are as follows: 15 TWELVE MONTHS YEAR ENDED ENDED JUNE 30, 2000 JUNE 30, 1999 (AUDITED) (PRO FORMA UNAUDITED) ------------ --------------------- Revenues: Equipment sales $ 6,983,787 $ 980,533 Service income 107,873 411,677 ------------ ----------- Total revenues 7,091,660 1,392,210 Cost of equipment sales 4,867,519 1,801,037 Cost of service income 61,978 736 General and administrative expenses 9,827,804 9,881,556 Reversal of warranty, maintenance and commission accruals -- (7,151,393) Provision for doubtful accounts -- 28,648 Non-cash compensation expense 1,005,232 -- Special charges 2,156,205 331,590 Amortization of intangibles 912,553 74,981 ------------ ----------- Total operating expense 18,831,291 4,967,155 ------------ ----------- Operating loss (11,739,631) (3,574,945) Other income (expense): Interest expense (4,602,183) (86,373) Interest income 109,001 154,629 Other expense (19,386) (567,307) Cumulative dividend on preferred stock (120,000) (30,667) ------------ ----------- Net loss available to common shareholders $(16,372,199) $(4,104,663) ============ =========== REVENUES Revenue for the year ended June 30, 2000 was $7,091,660, an increase of $5,699,450 (or 409%) compared to revenue of $1,392,210 (unaudited) for the twelve months ended June 30, 1999. Equipment sales of $6,983,787 for the year ended June 30, 2000 are comprised principally of approximately $5.4 million generated from the sale of 195 of the Company's Cheetah(R) video servers in connection with the Georgia Metropolitan Regional Education Services Agency ("MRESA") Net 2000 project and approximately $1.4 million related to network equipment installed onboard two Carnival ships. (See Liquidity and Capital Resources for a discussion of Carnival Settlement Agreement.) Service income of $107,873 for the year ended June 30, 2000 is comprised principally of $48,046 provided by the Company's share of revenue generated by the Cruise View system on two Carnival ships and $59,827 generated from design services provided to ALSTOM Transport Ltd. ("Alstom"). The Company provided these services to Alstom, but expects no further business from Alstom as they plan to create a subsidiary that would compete with the Company in the passenger rail market. Equipment sales of $980,533 (unaudited) for the twelve months ended June 30, 1999 are comprised principally of $875,957 (unaudited) generated from payments received from Swissair for one of four entertainment networks billed per the April 1998 contract with Swissair and $89,028 (unaudited) generated from the sale of spare parts needed for the entertainment networks installed previously on three Swissair aircraft. Service income of $411,677 (unaudited) for the twelve months ended June 30, 1999 was principally generated from programming services provided to Swissair, representing the Company's share of gaming profits generated by the Swissair systems and revenue earned under the Swissair extended warranty contract. There will be no further revenue under the Swissair agreement. Revenue for the twelve months ended June 30, 1999 was $1,392,210, a decrease of $17,424,752 (or 93%) compared to revenue of $18,816,962 for the year ended October 31, 1998. Equipment sales of $980,533 (unaudited) for the twelve months ended June 30, 1999 are comprised principally of $875,957 (unaudited) generated from payments received from Swissair for one of four entertainment networks billed per the April 1998 contract with Swissair and $89,028 16 (unaudited) generated from the sale of spare parts needed for the entertainment networks installed previously on three Swissair aircraft. Service income of $411,677 (unaudited) for the twelve months ended June 30, 1999 was principally generated from programming services provided to Swissair, representing the Company's share of gaming profits generated by the Swissair systems and revenue earned under the Swissair extended warranty contract. Equipment sales of $18,038,619 for the year ended October 31, 1998 was generated as a result of installations completed by the Company under the initial Swissair program on ten business class and eighteen first class planes. Service income of $778,343 for the year ended October 31, 1998 was principally generated from programming services provided to Swissair, the Company's share of gaming profits generated by the Swissair systems and revenue earned under the Swissair extended warranty Letter of Intent. COST OF SALES Cost of equipment sales for the year ended June 30, 2000 were $4,867,519, an increase of $3,066,482 (or 170%) compared to cost of equipment sales of $1,801,037 (unaudited) for the twelve months ended June 30, 1999. Cost of equipment sales in the current year is principally comprised of approximately $3.4 million of material costs and estimated warranty costs for the 195 video servers for the Georgia schools project and approximately $1.4 million of material costs related to network equipment onboard two Carnival ships. Cost of equipment sales of $1,801,037 (unaudited) for the twelve months ended June 30, 1999 is comprised principally of material costs for four Swissair Entertainment Networks. Cost of service income of $61,978 for the year ended June 30, 2000 is principally attributable to video content costs. Cost of service income for the twelve months ended June 30, 1999 is related to programming services provided to Swissair. Cost of equipment sales for the twelve months ended June 30, 1999 was $1,801,037 (unaudited), a decrease of $13,722,245 (or 88%) compared to $15,523,282 for the fiscal year ended October 31, 1998. Cost of equipment sales of $1,801,037 (unaudited) for the year ended June 30, 1999 is comprised principally of material costs for four Swissair Entertainment Networks. Cost of equipment sales of $15,523,282 for fiscal 1998 includes materials, installation and maintenance costs, as well as estimated one-year warranty costs and costs of upgrades to the Swissair Entertainment Networks that the Company was contractually committed to providing to Swissair. GENERAL AND ADMINISTRATIVE COSTS General and administrative expenses for the year ended June 30, 2000 were $9,827,804, a decrease of $53,752 (or 1%) compared to expenses of $9,881,556 (unaudited) for the twelve months ended June 30, 1999. The decrease in expenses in the current fiscal year can be principally attributed to a $3.1 million (unaudited) severance payment recorded in the twelve months ended June 30, 1999 for three former executives of the former IED as well as a $1.6 million (unaudited) write-off in the twelve months ended June 30, 1999 of certain consulting agreements determined to have no future value, offset in fiscal 2000 by an increase in payroll and benefit costs generated by an approximate 180% increase in personnel, increases in depreciation expense, the addition of the Company's Philadelphia office and expenses incurred by the Company's UK subsidiary. Significant components of general and administrative expenses include payroll costs and legal and professional fees. General and administrative expenses for the twelve months ended June 30, 1999 were $9,881,556 (unaudited), an increase of $861,684 (or 10%) compared to expenses of $9,019,872 for the year ended October 31, 1998. Significant components of general and administrative expenses include costs of consulting agreements, legal and professional fees, and corporate insurance costs. RESEARCH AND DEVELOPMENT EXPENSES There were no research and development expenses in the year ended June 30, 2000. There were no research and development expenses for the twelve months ended June 30, 1999 (unaudited), compared to $1,092,316 for the year ended October 31, 1998. The decrease in expenses in 1999 from 1998 reflects the Company's decision not to develop the next generation of the Inflight Entertainment Network and the resulting reduction in staff and professional fees. We expect a substantial increase in research and development costs in future periods as we continue to develop new technologies and product features. 17 REVERSAL OF WARRANTY, MAINTENANCE AND COMMISSION ACCRUALS For the twelve months ended June 30, 1999 the Company recorded warranty, maintenance, commission and support cost accrual adjustments of $5,117,704 (unaudited), $504,409 (unaudited), $303,321 (unaudited) and $1,225,959 (unaudited), respectively. Such adjustments to prior period estimates, which totaled $7,151,393 (unaudited), resulted from an evaluation of specific contractual obligations related to Swissair and discussions between the new management of the Company and other parties related to such contracts. Based on the results of the Company's findings during fiscal 1999, such accruals were no longer considered necessary. NON-CASH COMPENSATION EXPENSE Non-cash compensation expense of $1,005,232 for the year ended June 30, 2000 is comprised of an $85,000 expense for a former employee as part of a severance package, charges of $132,821 for modifications of stock option awards for two former employees and charges totaling $787,411 related to the issuance of Common Stock purchase warrants and Common Stock for financial advisory services. PROVISION FOR DOUBTFUL ACCOUNTS There were no provisions for doubtful accounts for the year ended June 30, 2000 compared to $28,648 (unaudited) for the twelve months ended June 30, 1999. The provisions in the previous fiscal year resulted from entertainment programming services provided to Swissair for which the Company has not been paid. Provisions for doubtful accounts for the twelve months ended June 30, 1999 were $28,648 (unaudited), compared to zero for the year ended October 31, 1998. Twelve months ended June 30, 1999 provisions resulted from entertainment programming services provided to Swissair. SPECIAL CHARGES Special charges for the year ended June 30, 2000 were $2,156,205 compared to $331,590 (unaudited) for the previous twelve month period. Fiscal 2000 special charges are principally comprised of costs associated with two Carnival ships resulting from the write-off of certain inventory, refurbishment of equipment and estimated de-installation obligations. See discussion of Carnival in "Liquidity and Capital Resources" below. Special charges for the twelve month period ended June 30, 1999 are comprised of $521,590 (unaudited) in assets written off related to Swissair, offset by the recovery of $190,000 (unaudited) that was recognized during the quarter ended September 30, 1998 as a result of a reduction in the number of entertainment networks installed in Swissair aircraft requiring maintenance. Special charges for the twelve months ended June 30, 1999 were $331,590 (unaudited), compared to $400,024 for the year ended October 31, 1998. Special charges for the year ended June 30, 1999 are comprised of $521,590 (unaudited) in assets written off related to Swissair, offset by the recovery of $190,000 (unaudited) that was recognized during the quarter ended September 30, 1998 as a result of a reduction in the number of entertainment networks installed in Swissair aircraft requiring maintenance. Special charges in fiscal 1998 primarily resulted from equipment write-offs of $1,006,532. The write-offs were for excess computers, furniture and other equipment that the Company was not utilizing in its operations. The equipment write-offs were partly offset by a recovery of special charges expensed in fiscal 1997. During fiscal 1998, a recovery of $190,000 was recognized as a special charge credit as a result of a reduction in the number of Entertainment Networks requiring maintenance. The Company also recognized a recovery of $416,508 related to Swissair's decision to not develop the system for the front row in the economy sections of its aircraft. AMORTIZATION OF INTANGIBLES Amortization expense for the year ended June 30, 2000 was $912,553, an increase of $837,572 (or 1,117%) compared to amortization expense of $74,981 (unaudited) for the twelve months ended June 30, 1999. The increase in intangible amortization in the current fiscal year is due to goodwill amortization recorded during the year which resulted from the May 1999 18 acquisition transaction described above. Effective May 1, 2000, we revised our estimate of the remaining useful life of goodwill from ten years to five years as a result of economic events which occured during the period. Had the Company assumed a five-year life for goodwill amortization at the Transition date, additional expense of approximately $593,000 would have been recorded for the year-ended June 30, 2000, and approximately $712,000 for each of the remaining years. Amortization expense was $74,981 (unaudited) for the twelve months ended June 30, 1999, compared to zero for the year ended October 31, 1998. INTEREST EXPENSE Interest expense for the year ended June 30, 2000 was $4,602,183 compared to $86,373 (unaudited) for the twelve months ended June 30, 1999. Interest expense for the current fiscal year can be attributed principally to non-cash expenses related to a beneficial conversion attributed to the revolving credit facility with Global, whereas interest expense for the previous fiscal year can be attributed to long-term debt obligations as well as capital leases for furniture which expired in September 1999. Interest expense was $86,373 (unaudited) for the twelve months ended June 30, 1999 compared to $11,954 for the year ended October 31, 1998. The twelve month 1999 expense can be attributed principally to long-term debt obligations, whereas the fiscal 1998 expense is attributable to the Company's capital leases for furniture that expire in September 1999. INTEREST INCOME Interest income for the year ended June 30, 2000 was $109,001 compared to $154,629 (unaudited) for the twelve months ended June 30, 1999. Interest income for the current fiscal year was principally generated from short-term investments of working capital, whereas interest income for the previous fiscal year is principally attributed to Swissair extended warranty billings. Interest income for the twelve months ended June 30, 1999 was $154,629 (unaudited) compared to $53,465 for the year ended October 31, 1998. Fiscal 1999 and fiscal 1998 interest income is principally attributed to Swissair extended warranty billings. OTHER INCOME (EXPENSE) Other expense for the year ended June 30, 2000 was $19,386. This is comprised of income resulting from the sale of equipment, offset by expense resulting from a loss on the buyout of a capital lease for furniture, losses incurred on the sale of two buildings located in Georgia and a loss incurred on the buyout of a vehicle lease. Other expense for the twelve months ended June 30, 1999 was $567,307 (unaudited), resulting from furniture and equipment write-offs in October 1998. Other income of $10,179 for the year ended October 31, 1998 represents proceeds from the sale of scrapped inventory. LIQUIDITY AND CAPITAL RESOURCES We expect to use a significant amount of cash in the next twelve months. Cash will be used primarily to repay existing vendors, finance anticipated operating losses resulting from efforts to build a customer base and develop operations, and to make capital expenditures required for sales of our systems. Our consolidated financial statements are prepared using generally accepted accounting principles applicable to a going concern which contemplate the realization of assets and liquidation of liabilities in the normal course of business. We have incurred net losses from operations for two of the last three periods, had an accumulated deficit at June 30, 2000 as a result of efforts to build our customer base and develop our operations. Management believes that our 19 current cash balances, the $5 million credit facility with Global Technologies (of which approximately $2.7 million remains available as of September 29, 2000), and currently available external sources of financing will not be sufficient to meet our currently anticipated cash requirements for operations for the next 12 months. A substantial portion of our accounts payable are past due and many suppliers have imposed cash on delivery terms. We are in discussions with private equity sources which, if transactions are consumated, together with the Global Technologies credit facility and currently available external sources of financing, should provide sufficient short-term funding. Our inability to draw on the credit facility with Global Technologies, to obtain funds pursuant to the currently available external sources of financing, or not complete certain private placement transactions, would have a material adverse effect on our operating results, financial condition and ability to continue as a going concern. Global Technologies does not currently have sufficient cash for us to borrow under the credit facility and no assurance can be given that currently available external sources of financing will have the resources necessary to meet its commitments as we draw down from time to time pursuant to our private equity line, or that any other financings will be consumated. Additionally, any increase in our growth rate, shortfalls in anticipated revenues, increases in anticipated expenses, or significant acquisition or expansion opportunities could have a material adverse effect on our liquidity and capital resources and would require us to raise additional capital from public or private equity or debt sources in order to finance operating losses, anticipated growth, and contemplated capital expenditures and expansions. We have significant expansion plans which we intend to fund with the facilities discussed above; however, if there is any delay in the anticipated closing of these facilities or any shortfall, we will not engage in such expansion until adequate capital sources have been arranged. If such sources of financing are insufficient or unavailable, we will be required to modify our growth and operating plans or scale back operations to the extent of unanticipated opportunities, such as acquisitions of complementary businesses or the development of new products, or otherwise respond to unanticipated competitive pressures. There can be no assurance that we will be able to raise any such capital on terms acceptable to us or at all. We expect to continue to focus on developing and expanding our enhanced broadband information and entertainment systems while continuing to expand our current operation's market penetration. Accordingly, we expect that our capital expenditures and cost of revenues and depreciation and amortization expenses will continue to increase significantly, all of which could have a negative impact on short-term operating results. In addition, we may change our strategy to respond to a changing competitive environment. There can be no assurance that growth in our revenue or market penetration will continue, that our expansion efforts will be profitable, or that we will be able to achieve or sustain profitability or positive cash flow. Further, we will require substantial financing to continue as a going concern, accomplish any significant acquisition or merger transaction, and provide for working capital to operate our current and proposed expanded operations until profitability is achieved, if ever. We are currently using our working capital to finance equipment purchases and other expenses associated with the delivery and installation of our products, and general and administrative costs. Prior to June 30, 1999, our primary source of funding had been through contributed capital from Global Technologies. In August 1999, we received an order for $5.4 million for the manufacture, delivery and installation of 195 of our Cheetah(R) multimedia video servers in connection with the Georgia MRESA Net 2000 project; and a service order under an agreement with Carnival for installation of a second CruiseView(TM) system. In addition, as of the date of 20 this report, we have received orders for the installation of our InnView(TM) system in eleven hotels within the United States. We have received the full payment of $5.4 million in connection with the Net 2000 project. We received payments from Carnival for the two ships (see Notes to Consolidated Financial Statements, Note 20). Working capital will continue to decrease as we continue to invest in equipment for orders under the agreements with the hotel orders, invest in business development, and invest in additional equipment to the extent we are successful in generating additional orders for sales of our systems, which are longer term by nature. During the year ended June 30, 2000, we used $4,755,647 of cash for operating activities, an increase of $1,657,700 from the $3,097,947 of cash used for the Transition Period ended June 30, 1999. The cash utilized in operations during the year ended June 30, 2000 resulted primarily from the net loss, partially offset by increases in accounts payable, non-cash interest and special charges. The cash utilized in operations during the Transition Period ended June 30, 1999 resulted primarily from reversal of warranty, maintenance and commission accruals and an increase in accounts payable, partially offset by increases in inventory and deferred revenue. Cash flows used in investing activities were $2,397,851 during the year ended June 30, 2000, an increase of $2,091,839 from the $306,012 of cash used for the Transition Period ended June 30, 1999. The increase in cash used resulted primarily from the purchase of equipment used for installations of our system into hotel properties, partially offset by sale of investment securities in the quarter ended December 31, 1999 and proceeds from the sale of two buildings held for sale (one in the first quarter, and one in the second quarter). During the year ended June 30, 2000, cash provided by financing activities was $4,990,241 a decrease of $1,150,876 from the $6,141,117 of cash provided for the Transition Period ended June 30, 1999. The decrease in cash provided in the current fiscal year resulted primarily from borrowings under the credit facility with Global Technologies, advances received from a related party, as well as advances under an equity purchase agreement, offset by payments made on notes payable. Prior to the acquisition of the Interactive Entertainment Division, we entered into a secured promissory note with Global Technologies in the principal amount of $750,000, bearing interest at a rate of 9.5% per annum, and a related security agreement granting Global Technologies a security interest in our assets. This promissory note was converted into 886,000 shares of our Common Stock by Global Technologies in December 1999. In July and August 1999, Global Technologies purchased all of our Series A and E notes and the Series D notes, respectively, from the holders of such notes. Concurrent with such purchase by Global Technologies, we executed several allonges to the promissory note which cancelled such Series Notes and rolled the principal balance, plus accrued but unpaid interest, penalties and redemption premiums on the Series Notes into the principal balance of the promissory note. Subsequent to May 18, 1999, Global Technologies had also advanced working capital to us in the form of intercompany advances. In August 1999, we executed an allonge to the promissory note which rolled the intercompany advances into the principal balance of the promissory note and granted Global Technologies the ability to convert the promissory note directly into shares of our common stock as an administrative convenience. On August 24, 1999, the board of directors of Global Technologies approved the conversion of the promissory note into shares of our common stock. Such conversion, to the extent it exceeded approximately one million shares of our common stock on August 24, 1999, was contingent upon receiving shareholder approval to increase our authorized share capital. This increase in authorized share capital was subsequently approved on September 17, 1999 at the Special Meeting of our shareholders. Accordingly, in December 1999, we issued to Global Technologies 4,802,377 shares of our common stock based on the conversion date of August 24, 1999. 21 On August 24, 1999, the board of directors of Global Technologies approved a $5 million secured revolving credit facility by and between Global Technologies and us. This credit facility provides that we may borrow up to $5 million for working capital and general corporate purposes at the prime rate of interest plus 3%. The credit facility matures in September 2001. We paid an origination fee of $50,000 to Global Technologies and will pay an unused line fee of 0.5% per annum. The credit facility is secured by all of our assets and is convertible, at Global Technologies' option, into shares of our common stock at a price equal to the lesser of 66.7% of the trailing five-day average share price of the preceding 20 days, $1.50 per share, or any lesser amount at which common stock has been issued to third parties. Pursuant to Nasdaq rules, Global Technologies may not convert borrowings under the credit facility into shares of our common stock in excess of 19.99% of the number of shares of common stock outstanding on August 24, 1999, without shareholder approval. As of June 30, 2000, $2,350,000 was outstanding under the credit facility. As of June 30, 2000, Global Technologies did not have sufficient cash for us to borrow the full $5 million under the credit facility. Should we be unable to borrow funds under the credit facility, it could result in a material adverse effect on our operating results and financial condition. In September 1999, we sold one of our two buildings in Alpharetta, Georgia. The net proceeds from the sale, plus cash of approximately $80,000 was used by us to repay a note payable due April 19, 2001 in the principal amount of $470,000. The sale of the second building occurred in November 1999. The net proceeds of approximately $367,000 from sale were used to retire a note payable due 2009 in the principal amount of $217,000. In September 1998, the Company entered into a Turnkey Agreement (the "Carnival Agreement") with Carnival Corporation ("Carnival") for the purchase, installation and maintenance of its advanced cabin entertainment and management system for the cruise industry ("CruiseView(TM)") on a minimum of one Carnival Cruise Lines ship. During the four-year period commencing on the date of the Carnival Agreement, Carnival had the right to designate an unspecified number of additional ships for the installation of CruiseView(TM). The cost per cabin for CruiseView(TM) purchase and installation on each ship was provided for in the Carnival Agreement. In December 1998, Carnival ordered the installation of CruiseView(TM) on one Carnival Cruise Lines "Fantasy" class ship which has been in operational use since August 1999. In August 1999, Carnival ordered the installation of CruiseView(TM) on one Carnival Cruise Lines "Destiny" class ship which was in operational use from October 1999 through March 2000. Under the terms of the agreement, the Company was to receive payment for 50% of the sales price of the system in installments through commencement of operation of the system. Recovery of the remaining sales price of the system was to be achieved through the receipt of the Company's 50% share of net profits, as defined in the Carnival Agreement, generated by the system over future periods. The terms of the Carnival Agreement provided that Carnival may return the CruiseView(TM) system within the acceptance period, as defined in the Carnival Agreement, or for breach of warranty. The acceptance period for the Fantasy and Destiny class ships were twelve months and three months, respectively, from completion of installation and testing, which occurred in February 1999 and October 1999, respectively. The initial warranty period for these systems was three years. As of March 31, 2000, the Company had recorded deferred revenue of approximately $2.1 million related to the two Carnival ships. Beginning in the quarter ended March 31, 2000, the Company had experienced costs in excess of those recoverable under the Carnival Agreement. Given these costs, and ongoing technical issues, the Company notified Carnival of its desire to renegotiate the Carnival Agreement. During these discussions, Carnival notified the Company in a letter dated April 24, 2000 that it sought to terminate the Carnival Agreement and sought to assert certain remedies thereunder. On September 25, 2000, the Company entered into a Master Settlement Agreement and Mutual Release with Carnival (the "Settlement Agreement"). The Settlement Agreement specifies that the Company and Carnival agree: (i) To terminate the Carnival Agreement; (ii) to negotiate in good faith to enter into a New Agreement; (iii) that the Company will issue to Carnival a one-year convertible note payable in the principal amount of $550,000; (iv) to mutually release each party from any prior claims; and (v) the Company shall retain ownership of any and all equipment (other than wiring and switching equipment installed for networking purposes which Carnival purchased and paid in full pursuant to the Carnival Agreement) installed on any Carnival ship. 22 Based on the above, the Company recorded revenue of $1.4 million for the value of networking equipment purchased by Carnival, cost of revenue in an equal amount by applying the cost recovery method of accounting and special charges of approximately $2.1 million resulting from the Settlement Agreement. The Company recorded a special charge reflecting the write-off of: (i) all remaining inventory associated with Carnival as substantial uncertainty exists regarding its realizability (approximately $2.1 million); (ii) all costs associated with the deinstallation and removal of equipment from the two ships (approximately $85,000) and (iii) all costs associated with the refurbishment of certain equipment such that the equipment may be re-deployed to other customers ($174,000). Special charges were offset by the reversal of deferred revenue of $190,000 which the Company was not required to return to Carnival, and warranty accruals for which the Company has no continuing obligation. Pursuant to the Settlement Agreement, the Company and Carnival continued discussions with respect to a New Agreement which would cover the installation of the Company's latest CruiseView(TM) technology on the "Fantasy" class ship discussed above, and contractual terms more favorable to the Company than the Carnival Agreement, including a longer-term and multiple ship arrangement. The Company believes its new technology improves the Company's ability to create multiple new content and commerce-based revenue streams, and to establish a business relationship providing appropriate returns to each partner. However, while the Company is optimistic about the discussions, there is no assurance that the Company will be successful in reaching a mutually satisfactory resolution of the Carnival Agreement and in securing a new, more favorable long-term contract with Carnival. Notwithstanding the above, the Company continues to operate its CruiseView(TM) system aboard one Carnival Fantasy class ship on a month-to-month basis and will continue to do so as long as the economics are beneficial to the Company and Carnival. INFLATION AND SEASONALITY We do not believe that we are significantly impacted by inflation. Our operations are not seasonal in nature, except to extent fluctuations in quarterly operating results occur due to the cyclical nature of government funding to be obtained in connection with education programs. RISKS ASSOCIATED WITH YEAR 2000 In prior periods, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed the remediation and testing of its critical computer dependent systems. Through June 30, 2000, the Company has experienced no significant disruptions in critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of our suppliers and vendors throughout the year 2000. FORWARD-LOOKING INFORMATION This Report contains certain forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The cautionary statements made in this Report should be read as being applicable to all related forward-looking statements wherever they appear in this Report. Forward-looking statements, by their very nature, include risks and uncertainties. Accordingly, the Company's actual results could differ materially from those discussed herein. A wide variety of factors could cause or contribute to such differences and could adversely impact revenues, profitability, cash flows and capital needs. Such factors, many of which are beyond the control of the Company, include the following: the Company's success in obtaining new contracts; the volume and type of work orders that are received under such contracts; the accuracy of the cost estimates for the projects; the Company's ability to complete its projects on time and within budget; levels of, and ability to, collect accounts receivable; availability of trained personnel and utilization of the Company's capacity to complete work; competition and competitive pressures on pricing; and economic conditions in the United States and in other regions served by the Company. 23 NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivatives and Similar Financial Instruments and for Hedging Activities", to establish accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. This new standard, as amended by related SFAS Nos. 137 and 138, will be effective for the Company for its fiscal year ending June 30, 2001. We are currently evaluating the impact of SFAS No. 133. In March 2000, the Financial Accounting Standards Board issued FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation (an interpretation of APB 25). This interpretation clarifies the application of APB No. 25 by clarifying the definition of an employee, the determination of non-compensatory plans and the effect of modifications to stock options. This interpretation is effective July 1, 2000 and is not expected to have a material effect on the Company's consolidated financial statements. ITEM 7 - FINANCIAL STATEMENTS The financial statements and schedules are included herewith commencing on page F-1. ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There are no items or circumstances to be disclosed under this Item 8. 24 PART III ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT The information required by Item 9 of Form 10-KSB with respect to identification of directors is incorporated by reference from the information contained in the sections captioned "Election of Directors" "Management" and "Compliance with Section 16(a) of the Exchange Act" in TNCi's definitive Proxy Statement for the Annual Meeting of Stockholders to be held November 16, 2000 (the "Proxy Statement"), a copy of which will be filed with the Securities and Exchange Commission before the meeting date. ITEM 10 - EXECUTIVE COMPENSATION The information required by Item 10 of Form 10-KSB is incorporated by reference from the information contained in the section captioned "Executive Compensation and Other Matters" in the Proxy Statement. ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 11 of Form 10-KSB is incorporated by reference from the information contained in the section captioned "General Information" in the Proxy Statement. ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by Item 12 of Form 10-KSB is incorporated by reference from the information contained in the section captioned "Certain Relationships and Related Transactions" in the Proxy Statement. ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS The following Exhibits are filed as part of this Annual Report on Form 10-KSB pursuant to Rule 601 of Regulation S-B.
Exhibit Number Description Reference - ------ ----------- --------- 2.1 Asset Purchase and Sale Agreement with Interactive Flight Technologies, Inc. (Global Technologies) dated April 29, 1999 (1) 2.2 First Amendment to Asset Purchase and Sale Agreement, dated April 29, 1999 (1) 3.1.1 Second Amended and Restated Articles of Incorporation (2) 3.1.2 Articles of Amendment to the Articles of Incorporation (re: Series A Preferred) (3) 3.1.3 Articles of Amendment to the Articles of Incorporation (re: Series B Preferred) (4) 3.1.4 Articles of Amendment to the Articles of Incorporation (re: elimination of Series A preferred) (5) 3.1.5 Articles of Amendment to the Articles of Incorporation (re: Amendment to Series B Preferred) (6) 3.1.6 Articles of Amendment to the Articles of Incorporation (re: Series C Preferred) (6) 3.1.7 Articles of Amendment to the Articles of Incorporation (re: Series D Preferred) (7) 3.1.8 Articles of Amendment to the Second Amended and Restated Articles of Incorporation (re: increase of authorized shares) (8) 3.1.9 Articles of Amendment to the Second Amended and Restated Articles of Incorporation (re: increase in shares of Series C Preferred) (8) 3.1.10 Articles of Amendment to the Articles of Incorporation (re: Series E Preferred) 3.2 Amended and Restated Bylaws (2)
25
Exhibit Number Description Reference - ------ ----------- --------- 10.1 Employment Agreement, dated October 31, 1998, by and between the corporation and Wilbur L. Riner (4) 10.2 Addendum and Modification to Employment Agreement, dated May 14, 1999, by and between the corporation and Wilbur L. Riner (7) 10.3 Employment Agreement, dated October 31, 1998, by and between the corporation and James E. Riner (4) 10.4 Addendum and Modification to Employment Agreement, dated May 14, 1999, by and between the corporation and James E. Riner (7) 10.5 Employment Agreement, dated October 31, 1998, by and between the corporation and Bryan R. Carr (4) 10.6 Employment Agreement, effective June 11, 1999, by and between the corporation and Frank Gomer (7) 10.7 Separation Agreement and Release of All Claims , effective April 12, 2000, by and between the corporation and Frank Gomer (5) 10.8 Employment Agreement, effective June 11, 1999, by and between the corporation and Morris C. Aaron (7) 10.9 1994 Employee Stock Option Plan, including form of Stock Option Agreement (9) 10.10 1995 Stock Option Plan for Non-Employee Directors (10) 10.11 Securities Purchase Agreement dated as of October 23, 1998, between the Shaar Fund Ltd. and the corporation (11) 10.12 Registration Rights Agreement dated as of October 23, 1998, between Shaar and the corporation (11) 10.13 Warrant Agreement dated October 23, 1998, between Shaar and the corporation (11) 10.14 Securities Purchase Agreement dated as of December 28, 1998, between Cache Capital and the corporation (4) 10.15 Registration Rights Agreement dated as of December 28, 1998, between Cache Capital and the corporation (4) 10.16 Service Agreement between The Network Connection and Stephen J. Ollier (12) 10.17 Secured Promissory Note, dated January 25, 1999, made in favor of Interactive Flight Technologies, Inc. (6) 10.18 First Allonge to Secured Promissory Note, dated May 10, 1999, made in favor of Interactive Flight Technologies, Inc. (6) 10.19 Second Allonge to Secured Promissory Note, dated May 10, 1999, made in favor of Interactive Flight Technologies, Inc. (6) 10.20 Third Allonge to Secured Promissory Note, dated May 10, 1999, made in favor of Interactive Flight Technologies, Inc. (6) 10.21 Fourth Allonge to Secured Promissory Note, dated May 10, 1999, made in favor of Interactive Flight Technologies, Inc. (6) 10.22 Amendment No. 1 to Registration Rights Agreement, dated May 10, 1999, between the corporation and Interactive Flight Technologies, Inc. (6) 10.23 Fifth Allonge to Secured Promissory Note, dated July 16, 1999, made in favor of Interactive Flight Technologies, Inc. (7) 10.24 Sixth Allonge to Secured Promissory Note, dated August 9, 1999, made in favor of Interactive Flight Technologies, Inc. (7) 10.25 Seventh Allonge to Secured Promissory Note, dated August 24, 1999, made in favor of Interactive Flight Technologies, Inc. (7) 10.26 Revolving Credit Note in the aggregate amount of $5,000,000 in favor of Interactive Flight Technologies, Inc. (7) 10.27 Agreement between Carnival Corporation and The Network Connection (12) 10.28 Master Settlement Agreement and Mutual Release (Carnival Corporation) * 10.29 Convertible Note (Carnival Corporation) * 10.30 Agreement between Embassy Suites and The Network Connection (12) 10.31 Agreement between Radisson Resort and The Network Connection (12) 10.32 Amended and Restated Seventh Allonge to Secured Promissory Note, dated December 10, 1999. (5) 10.33 Employment Agreement between Robert Pringle and the corporation, dated March 6, 2000. (13) 10.34 Employment Agreement between Jay Rosan and the corporation, dated March 6, 2000. (13)
26
Exhibit Number Description Reference - ------ ----------- --------- 10.35 Employment Agreement between Richard Genzer and the corporation, dated March 6, 2000. (13) 10.36 Option Agreement between Robert Pringle and the corporation, dated March 6, 2000. (13) 10.37 Option Agreement between Jay Rosan and the corporation, dated March 6, 2000. (13) 10.38 Option Agreement between Richard Genzer and the corporation, dated March 6, 2000. (13) 10.39 Registration Rights Agreement between the corporation and Robert Pringle, Jay Rosan and Richard Genzer, dated March 6, 2000. (13) 10.40 Agreement between Brisbane Lodging LP DBA Radisson Hotel San Francisco Airport at Sierra Point and the corporation. (13) 10.41 Master Facility Agreement by and between the corporation and Fusion Capital Fund II, LLC dated as of June 1, 2000. (14) 16.1 Letter on Change in Certifying Accountant (12) 21.1 Schedule of Subsidiaries * 23.1 Consent of KPMG LLP * 27 Financial Data Schedule *
- ---------- * Filed herewith. (1) Incorporated by reference, filed as an exhibit with The Network Connection's Current Report on Form 8-K on May 18, 1999. (2) Incorporated by reference, filed as an exhibit with The Network Connection's Current Report on Form 8-K on June 21, 1996. (3) Incorporated by reference, filed as an exhibit with The Network Connection's Current Report on Form 8-K on June 9, 1998. (4) Incorporated by reference, filed as an exhibit with The Network Connection's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1998 on April 15, 1999. (5) Incorporated by reference, filed as an exhibit with The Network Connection's registration statement on Form SB-2 on February 23, 2000. SEC File No. 333-30980. (6) Incorporated by reference, filed as an exhibit with the Network Connection's Quarterly Report on Form 10-QSB for the fiscal quarter ended March 31, 1999. (7) Incorporated by reference, filed as an exhibit with The Network Connection's Annual Report on Form 10-KSB for the fiscal year ended June 30, 1999 on October 14, 1999. (8) Incorporated by reference, filed as an exhibit with The Network Connection's Quarterly Report 10-QSB for the quarter ended September 30, 1999 on November 17, 1999. (9) Incorporated by reference, filed as an exhibit with The Network Connection's registration statement on Form SB-2 on October 26, 1994. SEC File No. 33-85654. (10) Incorporated by reference, filed as an exhibit with The Network Connection's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1995. (11) Incorporated by reference, filed as an exhibit with the corporation's Quarterly Report on Form 10-QSB for the fiscal quarter ended September 30, 1998 on November 16, 1998. (12) Incorporated by reference to the respective exhibits filed with The Network Connection's Quarterly Report on Form 10-QSB for the fiscal quarter ended December 31, 1999 on February 14, 2000. (13) Incorporated by reference, filed as an exhibit with the corporation's Quarterly Report on Form 10-QSB for the fiscal quarter ended March 31, 2000 on May 15, 2000. (14) Incorporated by reference, filed as an exhibit with The Network Connection's Amendment No. 1 to its registration statement on Form SB-2 on June 7, 2000. SEC File No. 333-30980. (b) CURRENT REPORTS ON FORM 8-K None. 27 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, thereunto duly authorized. THE NETWORK CONNECTION, INC. Dated: October 5, 2000 By: /s/ IRWIN L. GROSS ------------------------------------ Irwin L. Gross, Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /s/ IRWIN L. GROSS Chairman of the Board October 5, 2000 - ---------------------------- Irwin L. Gross /s/ MORRIS C. AARON Executive Vice President October 5, 2000 - ---------------------------- and Chief Financial Officer Morris C. Aaron /s/ ROBERT PRINGLE President, Chief Operating October 5, 2000 - ---------------------------- Officer and Director Robert Pringle /s/ STEPHEN SCHACHMAN Director October 5, 2000 - ---------------------------- Stephen Schachman /s/ M. MOSHE PORAT Director October 5, 2000 - ---------------------------- M. Moshe Porat 26 THE NETWORK CONNECTION, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page ---- Independent Auditors' Report.................................................F-2 Consolidated Balance Sheets as of June 30, 2000 and 1999.....................F-3 Consolidated Statements of Operations for the Year Ended June 30, 2000, the Transition Period Ended June 30, 1999 and the Year Ended October 31, 1998........................................F-4 Consolidated Statements of Cash Flows for the Year Ended June 30, 2000, the Transition Period Ended June 30, 1999 and the Year Ended October 31, 1998........................................F-5 Consolidated Statements of Stockholders' Equity (Deficiency) and Comprehensive Income for the Year Ended June 30, 2000, the Transition Period Ended June 30, 1999 and the Year Ended October 31, 1998...........................................................F-6 Notes to Consolidated Financial Statements...................................F-7 F-1 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors The Network Connection, Inc.: We have audited the accompanying consolidated balance sheets of The Network Connection, Inc. and Subsidiary (the Company) as of June 30, 2000 and 1999 and the related consolidated statements of operations, stockholders' equity (deficiency) and comprehensive income and cash flows for the year ended June 30, 2000, the Transition Period ended June 30, 1999 and the year ended October 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the financial position of The Network Connection, Inc. and Subsidiary at June 30, 2000 and 1999 and the results of its operations and its cash flows for the year ended June 30, 2000, the Transition Period ended June 30, 1999 and the year ended October 31, 1998, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that The Network Connection, Inc. and Subsidiary will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has incurred net losses from operations and has a working capital deficiency and an accumulated deficit that raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ KPMG LLP Phoenix, Arizona September 27, 2000 F-2 THE NETWORK CONNECTION, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
JUNE 30, JUNE 30, Assets 2000 1999 ------------ ------------ Current assets: Cash and cash equivalents $ 579,721 $ 2,751,506 Restricted cash 475,915 446,679 Investment securities -- 302,589 Accounts receivable 55,951 75,792 Notes receivable from related parties -- 98,932 Inventories -- 1,400,000 Prepaid expenses 336,721 169,429 Assets held for sale -- 800,000 Due from affiliate 73,607 -- Other current assets 74,566 173,999 ------------ ------------ Total current assets 1,596,481 6,218,926 Note receivable from related party 117,612 75,000 Property and equipment, net 3,810,649 1,338,580 Intangibles, net 6,697,955 7,119,806 Other assets 1,246,002 150 ------------ ------------ Total assets $ 13,468,699 $ 14,752,462 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,338,943 $ 1,681,771 Accrued liabilities 2,924,797 2,209,682 Deferred revenue -- 365,851 Accrued product warranties 141,796 -- Dividends payable 140,000 -- Notes payable 4,744 24,391 Notes payable to related parties 800,000 68,836 ------------ ------------ Total current liabilities 8,350,280 4,350,531 Notes payable -- 3,467,045 Notes payable to related parties 2,350,000 1,647,692 ------------ ------------ Total liabilities 10,700,280 9,465,268 ------------ ------------ Commitments and contingencies Stockholders' equity: Series B preferred stock par value $0.01 per share, 1,500 shares designated, issued and outstanding 15 15 Series C preferred stock par value $0.01 per share, 1,600 shares designated; zero and 800 issued and outstanding, respectively -- 8 Series D preferred stock par value $0.01 per share, 2,495,400 designated, issued and outstanding 24,954 24,954 Common stock par value $0.001 per share, 40,000,000 shares authorized; 14,460,212 and 6,339,076 issued and outstanding, respectively 14,460 6,339 Additional paid-in capital 102,053,251 88,316,945 Accumulated other comprehensive income: Loss on foreign currency translation (11,521) -- Net unrealized loss on investment securities -- (526) Accumulated deficit (99,312,740) (83,060,541) ------------ ------------ Total stockholders' equity 2,768,419 5,287,194 ------------ ------------ Total liabilities and stockholders' equity $ 13,468,699 $ 14,752,462 ============ ============
See accompanying notes to consolidated financial statements. F-3 THE NETWORK CONNECTION, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
TRANSITION YEAR ENDED PERIOD ENDED YEAR ENDED JUNE 30, JUNE 30, OCTOBER 31, 2000 1999 1998 ------------ ------------ ------------ Revenue: Equipment sales $ 6,983,787 $ 875,957 $ 18,038,619 Service income 107,873 82,650 778,343 ------------ ------------ ------------ 7,091,660 958,607 18,816,962 ------------ ------------ ------------ Costs and expenses: Cost of equipment sales 4,867,519 1,517,323 15,523,282 Cost of service income 61,978 480 13,789 General and administrative expenses 9,827,804 3,628,652 9,019,872 Research and development expenses -- -- 1,092,316 Reversal of warranty, maintenance & commission accruals -- (7,151,393) -- Non cash compensation expense 1,005,232 -- -- Provision for doubtful accounts -- 28,648 -- Special charges 2,156,205 521,590 400,024 Amortization of intangibles 912,553 74,981 -- ------------ ------------ ------------ 18,831,291 (1,379,719) 26,049,283 ------------ ------------ ------------ Operating income (loss) (11,739,631) 2,338,326 (7,232,321) Other: Interest expense (4,602,183) (83,029) (11,954) Interest income 109,001 77,682 53,465 Other income (expense) (19,386) 11,226 10,179 ------------ ------------ ------------ Net income (loss) (16,252,199) 2,344,205 (7,180,631) Cumulative dividend on preferred stock (120,000) (30,667) -- ------------ ------------ ------------ Net income (loss) available to common stockholders $(16,372,199) $ 2,313,538 $ (7,180,631) ============ ============ ============ Basic net income (loss) per common share $ (1.71) $ 0.97 $ (6.80) ============ ============ ============ Weighted average number of shares outstanding 9,600,322 2,387,223 1,055,745 ============ ============ ============ Diluted net income (loss) per common share $ (1.71) $ 0.13 $ (6.80) ============ ============ ============ Weighted average number of common and dilutive shares outstanding 9,600,322 18,543,707 1,055,745 ============ ============ ============
See accompanying notes to consolidated financial statements. F-4 THE NETWORK CONNECTION, INC. STATEMENT OF CASH FLOWS
TRANSITION YEAR ENDED PERIOD ENDED YEAR ENDED JUNE 30, JUNE 30, OCTOBER 31, 2000 1999 1998 ------------ ----------- ----------- Cash flows from operating activities: Net income (loss) $(16,252,199) $ 2,313,538 $(7,180,631) Adjustments to reconcile net income (loss) to net cash: Depreciation and amortization 1,458,038 342,544 1,205,361 Change in inventory valuation -- (892,010) -- Special charges 2,156,205 521,590 400,024 Non cash interest 4,336,743 -- -- Reversal of warranty, maintenance and commission accruals -- (7,151,393) -- Loss on sale of assets held for sale 37,893 -- -- Loss on disposal of assets 44,300 -- -- Non cash compensation expense 1,005,232 -- -- Changes in net assets and liabilities, net of effect of Transaction: Decrease (increase) in accounts receivable 19,841 (482,344) 4,523,470 Decrease (increase) in inventories (957,625) 1,897,437 5,105,334 Decrease (increase) in prepaid expenses (24,955) (116,717) 47,428 Increase in due from affiliate (73,607) -- -- Decrease in other current assets 38,141 78,134 247,549 Increase in other assets (31,250) -- (411,042) (Decrease) increase in accounts payable 2,817,583 (1,449,333) (4,933,431) (Decrease) increase in accrued liabilities 153,983 702,559 (1,758,210) (Decrease) increase in deferred revenue 374,234 1,138,048 (1,930,882) Increase in accrued product warranties 141,796 -- 758,321 ------------ ----------- ----------- Net cash used in operating activities $ (4,755,647) $(3,097,947) $(3,926,709) ------------ ----------- ----------- Cash flows from investing activities: Purchases of investment securities -- (302,589) -- Sale of investment securities 303,115 -- -- Purchases of property and equipment (3,479,808) (18,243) (36,008) Proceeds from sale of equipment 3,590 -- 3,620 Proceeds from sale of assets held for sale 762,107 -- -- Cash acquired in Transaction -- 23,997 -- Increase in restricted cash (29,236) (9,177) (437,502) Repayments on notes receivable 42,381 -- -- ------------ ----------- ----------- Net cash used in investing activities $ (2,397,851) $ (306,012) $ (469,890) ------------ ----------- ----------- Cash flows from financing activities: Payments on notes payable (787,840) (58,450) (80,753) Borrowings under revolving credit facility 4,200,000 -- -- Advances from related parties 1,138,044 -- -- Advances under equity purchase agreement 500,000 -- -- Re-purchase of outstanding warrants (296,040) -- -- Advances from parent -- 805,616 -- Capital contribution -- 5,391,951 4,427,544 Employee stock option exercises 236,077 2,000 -- ------------ ----------- ----------- Net cash provided by financing activities $ 4,990,241 $ 6,141,117 $ 4,346,791 ------------ ----------- ----------- Effect of exchange rate on cash and cash equivalents (8,528) -- -- ------------ ----------- ----------- Net increase (decrease) in cash and cash equivalents (2,171,785) 2,737,158 (49,808) Cash and cash equivalents at beginning of year 2,751,506 14,348 64,156 ------------ ----------- ----------- Cash and cash equivalents at end of year $ 579,721 $ 2,751,506 $ 14,348 ============ =========== ===========
See accompanying notes to financial statements. F-5 THE NETWORK CONNECTION, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY) AND COMPREHENSIVE INCOME Year Ended June 30, 2000, Transition Period Ended June 30, 1999 and Year Ended October 31, 1998
SERIES B SERIES C SERIES D COMMON PAID-IN PREFERRED PREFERRED PREFERRED STOCK CAPITAL --------- --------- --------- ----- ------- Balance as of October 31, 1997 $ -- $ -- $ -- $ -- $ -- Contributed capital -- -- -- -- -- Net loss -- -- -- -- -- ---- ---- ------- ------- ------------ Balance as of October 31, 1998 $ -- $ -- $ -- $ -- $ -- Contributed capital -- -- -- -- -- Contribution of advances to capital -- -- -- -- 85,010,410 Issuance of stock 15 8 24,954 6,338 3,304,536 Exercise of stock options -- -- -- 1 1,999 Comprehensive income (loss): Unrealized loss on available for sale securities -- -- -- -- -- Net income -- -- -- -- -- Total comprehensive income -- -- -- -- -- ---- ---- ------- ------- ------------ Balance as of June 30, 1999 $ 15 $ 8 $24,954 $ 6,339 $ 88,316,945 Issuance of stock for services -- -- -- 106 312,970 Exercise of stock options -- -- -- 112 235,965 Dividends payable to affiliate -- -- -- -- (140,000) Conversion of Promissory Note -- -- -- 4,802 4,471,246 Conversion of Series C Stock -- (8) -- 886 (878) Partial conversion of Facility -- -- -- 1,233 1,848,766 Conversion of note payable -- -- -- 200 399,800 Purchase of outstanding warrants -- -- -- -- (296,036) Advance under equity purchase agreement -- -- -- -- 447,544 Net issuance of commitment shares associated with equity purchase agreement -- -- -- 315 605,818 Beneficial conversion on Facility -- -- -- -- 4,200,000 Cashless exercise of outstanding warrants -- -- -- 467 (467) Non-cash compensation and issuance of warrants for services -- -- -- -- 853,910 Issuance of warrants to related party in connection with financing -- -- -- -- 797,668 Comprehensive loss: Loss on foreign currency translation -- -- -- -- Change in unrealized loss on avilable for sale securities -- -- -- -- Net loss -- -- -- -- Total comprehensive loss -- -- -- -- -- ---- ---- ------- ------- ------------ Balance as of June 30, 2000 $ 15 $ -- $24,954 $14,460 $102,053,251 ==== ==== ======= ======= ============ ACCUMULATED OTHER ADDITIONAL CONTRIBUTED ACCUMULATED TOTAL CAPITAL IN EXCESS COMPREHENSIVE (DEFICIT) STOCKHOLDERS' OF PAR VALUE INCOME INCOME EQUITY (DEFICIENCY) ------------ ------ ------ ------------------- Balance as of October 31, 1997 $ 75,190,915 $ -- $(78,193,448) $ (3,002,533) Contributed capital 4,427,544 -- -- 4,427,544 Net loss -- -- (7,180,631) (7,180,631) ------------ -------- ------------ ------------ Balance as of October 31, 1998 $ 79,618,459 $ -- $(85,374,079) $ (5,755,620) Contributed capital 5,391,951 -- -- 5,391,951 Contribution of advances to capital (85,010,410) -- -- -- Issuance of stock -- -- -- 3,335,851 Exercise of stock options -- -- -- 2,000 Comprehensive income (loss): Unrealized loss on available for sale securities -- (526) -- -- Net income -- -- 2,313,538 -- Total comprehensive income -- -- -- 2,313,012 ------------ -------- ------------ ------------ Balance as of June 30, 1999 $ -- $ (526) $(83,060,541) $ 5,287,194 Issuance of stock for services -- -- -- 313,076 Exercise of stock options -- -- -- 236,077 Dividends payable to affiliate -- -- -- (140,000) Conversion of Promissory Note -- -- -- 4,476,048 Conversion of Series C Stock -- -- -- -- Partial conversion of Facility -- -- -- 1,849,999 Conversion of note payable -- -- -- 400,000 Purchase of outstanding warrants -- -- -- (296,036) Advance under equity purchase agreement -- -- -- 447,544 Net issuance of commitment shares associated with equity purchase agreement -- -- -- 606,133 Beneficial conversion on Facility -- -- -- 4,200,000 Cashless exercise of outstanding warrants -- -- -- -- Non-cash compensation and issuance of warrants for services -- -- -- 853,910 Issuance of warrants to related party in connection with financing -- -- -- 797,668 Comprehensive loss: Loss on foreign currency translation -- (11,521) -- -- Change in unrealized loss on avilable for sale securities -- 526 -- -- Net loss -- -- (16,252,199) -- Total comprehensive loss -- -- -- (16,263,194) ------------ -------- ------------ ------------ Balance as of June 30, 2000 $ -- $(11,521) $(99,312,740) $ 2,768,419 ============ ======== ============ ============
See accompanying notes to consolidated financial statements. F-6 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (a) DESCRIPTION OF BUSINESS The Network Connection, Inc. and Subsidiary (the "Company" or "TNCi") was incorporated on December 30, 1986. The Company designs, manufactures, installs and maintains advanced, high-end, high-performance computer servers and interactive, broad-band information and entertainment systems, and procures and provides the content available through the systems. These all-digital systems deliver an on-demand multimedia experience via high-speed, high-performance Internet Protocol (IP) networks. These systems are designed to provide users access to information, entertainment and a wide array of service options, such as shopping for goods and services, computer games, access to the World Wide Web and on-line gambling where permitted by applicable law. The service options available are customized for each installation and generally vary depending on the environment in which each system is installed. Our targeted markets for these systems are hotels and time-share properties, cruise ships, educational institutions and corporate training, and passenger trains. (b) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of The Network Connection, Inc. and its wholly-owned UK subsidiary, TNCi UK Limited. All significant intercompany accounts and transactions have been eliminated in consolidation. (c) BASIS OF PRESENTATION On May 18, 1999, Global Technologies, Ltd. (formerly known as Interactive Flight Technologies, Inc.) ("Global") received from the Company 1,055,745 shares of its common stock and 2,495,400 shares of its Series D Convertible Preferred Stock in exchange for $4,250,000 in cash and substantially all the assets and certain liabilities of Global's Interactive Entertainment Division ("IED"), as defined in the Asset Purchase and Sale Agreement dated April 30, 1999, as amended (the "Transaction"). The Transaction has been accounted for as a reverse merger whereby, for accounting purposes, Global is considered the accounting acquiror, and although the legal capital structure carries forward, and the Company is treated as the successor to the historical operations of IED. Accordingly, the historical financial statements of the Company, which previously have been reported to the Securities and Exchange Commission ("SEC") on Forms 10-KSB, 10-QSB, among others, as of and for all periods through March 31, 1999, will be replaced with those of IED. The Company will continue to file as a SEC registrant and continue to report under the name The Network Connection, Inc. The financial statements as of and for the year ended October 31, 1998 reflect the historical results of Global's IED as previously included in Global's consolidated financial statements. Included in the results of operations for the eight months ended June 30, 1999 are the historical results of Global's IED through April 30, 1999, and the results of the post Transaction company for the two months ended June 30, 1999. The Transaction date for accounting purposes is May 1, 1999. Contributed capital reflects the cash consideration paid by Global to the Company in the Transaction in addition to funding of IED historical operations. Global will continue to report as a separate SEC registrant, owning the shares of the Company as described above. As of June 30, 1999, the Company is a majority owned subsidiary of Global whose ownership, through a combination of the Transaction described above and Global's purchase of Series B 8 % preferred stock of the Company and 110,000 shares of the Company's common stock from third party investors, approximates 78% of the Company on an if-converted common stock basis. (See Note 17). As of June 30, 2000, Global's ownership in the Company increased to 79% as a result of continued investment on the part of Global, offset by additional third party investment and exercise of warrants and stock options. The historical financial statements of the Company up to the date of the Transaction as previously reported will no longer be included in future filings of the Company. F-7 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED (d) USE OF ESTIMATES The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Additionally, such estimates and assumptions affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. (e) CHANGE IN FISCAL YEAR-END As of June 30, 1999, the Company changed its fiscal year-end from December 31 to June 30. The Transition Period resulting from the change in fiscal year-end is measured from IED's former fiscal year-end of October 31. Accordingly, the eight-month period resulting from this change, November 1, 1998 through June 30, 1999, is referred to as the "Transition Period." (f) CASH EQUIVALENTS The Company considers all highly liquid investments with original maturities at the date of purchase of three months or less to be cash equivalents. (g) INVESTMENT SECURITIES Investment securities consisted of debt securities with a maturity greater than three months at the time of purchase. In accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115") the debt securities are classified as available-for-sale and carried at fair value, based on quoted market prices. The net unrealized gains or losses on these investments are reported in stockholders' equity. The specific identification method is used to compute the realized gains and losses on the debt securities. (h) INVENTORIES Inventories consisting principally of entertainment network components are stated at the lower of cost (first-in, first-out method) or market. As of June 30, 1999, inventories consisted of $1.4 million of finished goods. (i) INTANGIBLES Intangibles consist of goodwill and trademarks. Goodwill represents the excess of the purchase price over the fair value of the net assets acquired and is amortized over five years using the straight-line method. Effective May 1, 2000, the Company revised its estimate of the remaining useful life of its goodwill from ten years to five years as a result of economic events which occurred during the period. (See Note 22(e)). Goodwill amortization expense was $896,287, $73,986 and $0 in the year ended June 30, 2000, the Transition period ended June 30, 1999 and the year ended October 31, 1998, respectively. Had the Company assumed a five-year life for goodwill amortization at the Transition date, additional expense of approximately $593,000 (unaudited) would have been recorded for the year-ended June 30, 2000, and approximately $712,000 (unaudited) for each of the remaining years. Trademarks are stated at fair market value at the date of acquisition and are amortized over ten years using the straight-line method. The Company continually evaluates whether events and circumstances have occurred that indicate the remaining estimated useful lives of intangibles may warrant revision or that the remaining balances may not be recoverable. When factors indicate that the assets should be evaluated for possible impairment, the Company uses an estimate of the undiscounted net cash flows over the remaining life of the assets in measuring whether the asset is recoverable. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized to reduce the carrying value of the intangible to its estimated fair value. F-8 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED (j) PROPERTY AND EQUIPMENT Property and equipment are stated at the lower of cost or net realizable value. Depreciation and amortization expense is calculated using the straight-line method over the estimated useful lives of the assets ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of the underlying lease term or asset life. Guest pay interactive systems consist of equipment and related costs of installation. Construction in progress consists of purchased and manufactured parts of partially installed guest pay interactive systems. (k) REVENUE RECOGNITION The Company's revenue derived from sales and installation of equipment is recognized upon installation and acceptance by the customer. Fees derived from servicing installed systems are recognized when earned, according to the terms of the service contract. Revenue pursuant to contracts that provide for revenue sharing with customers and/or others is recognized in the period the services are purchased by the systems' end users (i.e., a hotel guest). Revenue earned pursuant to extended warranty agreements is recognized ratably over the warranty period. (l) DEFERRED REVENUE Deferred revenue represents cash received on advance billings of equipment sales as allowed under installation and extended warranty contracts. (m) RESEARCH AND DEVELOPMENT Research and development costs are expensed as incurred except for development costs required by a customer contract. Development costs incurred pursuant to contractual obligations are allocated to deliverable units. These development costs are expensed as cost of equipment sales upon installation of the complete product and acceptance by the customer. (n) WARRANTY COSTS The Company provides, by a current charge to income, an amount it estimates will be needed to cover future warranty obligations for products sold with an initial warranty period. Revenue and expenses under extended warranty agreements are recognized ratably over the term of the extended warranty. (o) IMPAIRMENT OF LONG-LIVED ASSETS The Company evaluates the potential impairment of long-lived assets in accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized to reduce the carrying value of the asset to its estimated fair value. (p) INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (q) NET INCOME (LOSS) PER SHARE Basic net income (loss) per share is computed by dividing net income (loss) available to common stockholders, by the weighted average number of common F-9 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED shares outstanding for the period. Diluted net income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income (loss) of the Company. (r) STOCK-BASED COMPENSATION In accordance with the provisions of Accounting Principals Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), the Company measures stock-based compensation expense as the excess of the market price at the grant date over the amount the employee must pay for the stock. The Company's policy is to generally grant stock options at fair market value at the date of grant; accordingly, no compensation expense is recognized. Statement of Financial Accounting Standards (SFAS No. 123 "Accounting for Stock Based Compensation") established accounting and disclosure requirements using a fair value based method of accounting for stock based employee compensation plans. As permitted, the Company has elected to adopt the pro forma disclosure provisions only of SFAS No. 123. (s) RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivatives and Similar Financial Instruments and for Hedging Activities", to establish accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. This new standard, as amended by related SFAS Nos. 137 and 138, will be effective for the Company for its fiscal year ending June 30, 2001. We are currently evaluating the impact of SFAS No. 133. In March 2000, the Financial Accounting Standards Board issued FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation (an interpretation of APB 25). This interpretation clarifies the application of APB No. 25 by clarifying the definition of an employee, the determination of non-compensatory plans and the effect of modifications to stock options. This interpretation is effective July 1, 2000 and is not expected to have a material effect on the Company's consolidated financial statements. (t) FOREIGN CURRENCY TRANSLATION The consolidated financial statements of the Company's United Kingdom subsidiary are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation". Assets and liabilities of the subsidiary are translated into U.S. dollars at current exchange rates. Income and expense items are translated at the average exchange rate for the year. The resulting translation adjustments are recorded directly as a separate component of stockholders' equity. All transaction gains or losses are recorded in the statement of operations. (u) RECLASSIFICATIONS Certain reclassifications have been made to the 1999 consolidated financial statements to conform to the 2000 presentation. (v) COMPREHENSIVE INCOME The Company reports comprehensive income and its components in its full set of financial statements in accordance with SFAS No. 130, "Reporting Comprehensive Income". Comprehensive income consists of net income and foreign currency translations, net of taxes and is presented in the consolidated statement of stockholders, equity and comprehensive income; it does not affect the Company's financial position or results of operations. (w) FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107 "Disclosure about Fair Value of Financial Instruments" requires that the Company disclose estimated fair values for its financial instruments. The following summary presents a description of the methodologies and assumptions used to determine such amounts. Fair value estimates are made at a specific point in time and are based on relevant market information and information about the financial instrument; they are subjective in nature and involve uncertainties, matters of judgment and, therefore, cannot be determined with precision. These estimates do not reflect any premium or discount that could result from offering for sale, at one time, the Company's entire holdings of a particular instrument. Changes in assumptions could significantly affect these estimates. Since the fair value is estimated as of June 30, 2000, the amounts that will actually be realized or paid at settlement or maturity of the instruments could be significantly different. The carrying amount of cash, cash equivalents and restricted cash approximates fair value because their maturity is generally less than three months. The carrying amount of accounts receivable, accounts payable and accrued liabilities approximate fair value as they are expected to be collected or paid within ninety days of year-end. The fair value of notes receivable and notes payable approximate the terms in the marketplace at which they could be replaced. Therefore, the fair value approximates the carrying value of these financial instruments. (2) FINANCIAL CONDITION AND LIQUIDITY The Company's consolidated financial statements are prepared using generally accepted accounting principles applicable to a going concern which F-10 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED contemplate the realization of assets and liquidation of liabilities in the normal course of business. The Company, which has incurred net losses from operations for two of the last three periods, has an accumulated deficit at June 30, 2000 as a result of efforts to build its customer base and develop its operations. Management believes that our current cash balances, the $5 million credit facility with Global Technologies (of which approximately $2.7 million remains available as of September 29, 2000), and currently available external sources of financing will not be sufficient to meet our currently anticipated cash requirements for operations for the next 12 months. A substantial portion of the Company's accounts payable are past due and many suppliers have imposed cash on delivery terms. The Company is in discussions with private equity sources which, if transactions are consumated, together with the Global Technologies credit facility and currently available external sources of financing, should provide sufficient short-term funding. Our inability to draw on the credit facility with Global Technologies, to obtain funds pursuant to the currently available external sources of financing, or not complete certain private placement transactions, would have a material adverse effect on our operating results, financial condition and ability to continue as a going concern. Global Technologies does not currently have sufficient cash for us to borrow under the credit facility and no assurance can be given that currently available external sources of financing will have the resources necessary to meet its commitments as we draw down from time to time pursuant to our private equity line, or that other financings will be consumated. Additionally, any increases in the Company's growth rate, shortfalls in anticipated revenues, increases in anticipated expenses, or significant acquisition or expansion opportunities could have a material adverse effect on the Company's liquidity and capital resources and would require the Company to raise additional capital from public or private equity or debt sources in order to finance operating losses, anticipated growth, and contemplated capital expenditures and expansions. The Company has significant expansion plans which it intends to fund with the facilities discussed above; however, if there is any delay in the anticipated closing of these facilities or any shortfall, the Company will not engage in such expansion until adequate capital sources have been arranged. If such sources of financing are insufficient or unavailable, the Company will be required to modify its growth and operating plans or scale back operations to the extent of unanticipated opportunities, such as acquisitions of complementary businesses or the development of new products, or otherwise respond to unanticipated competitive pressures. There can be no assurance that the Company will be able to raise any such capital on terms acceptable to the Company or at all. The Company expects to continue to focus on developing and expanding its enhanced broadband information and entertainment systems while continuing to expand its current operation's market penetration. Accordingly, the Company expects that its capital expenditures and cost of revenues and depreciation and amortization expenses will continue to increase significantly, all of which could have a negative impact on short-term operating results. In addition, the Company may change its strategy to respond to a changing competitive environment. There can be no assurance that growth in the Company's revenue or market penetration will continue, that its expansion efforts will be profitable, or that the Company will be able to achieve or sustain profitability or positive cash flow. Further, the Company will require substantial financing to continue as a going concern, accomplish any significant acquisition or merger transaction, and provide for working capital to operate its current and proposed expanded operations until profitability is achieved, if ever. (3) ACQUISITION The Transaction has been accounted for by the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed based upon estimated fair values at the date of acquisition as follows: F-11 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED Purchase Price: Cash $ 4,250,000 Net liabilities of IED contributed (4,012,430) ----------- Total $ 237,570 =========== Assets acquired and liabilities assumed: Historical book value of net liabilities $(2,457,723) Fair value adjustments: Inventory (1,280,847) Property and equipment (1,246,145) Other assets (430,567) Liabilities (672,506) ----------- Total fair value of liabilities assumed $(6,087,788) Excess of fair value of TNCi Series B Preferred Stock and Series C Preferred Stock over its recorded value $(1,501,000) Purchase of Common Stock of TNCi (254,658) =========== Excess of purchase price over fair value of net liabilities assumed (goodwill) $ 7,605,876 =========== The excess of fair value of TNC Series B Preferred Stock and Series C Preferred Stock is the result of Global's acquisition of such shares based on the fair value of the Global Series A Preferred Stock amounting to $4,080,000, less $980,000 (net of $50,000 of legal fees) cash received and the historical value of $1,549,000 of the Series B Preferred Stock. Purchase of 110,000 shares of Common Stock of TNCi from a third party was valued based on the cash consideration paid by Global for the shares. On May 9, 2000, pursuant to the indemnification provisions of the Asset Purchase and Sale Agreement, Global notified the Company of several violations of representation and warranties contained in the Agreement, including undisclosed liabilities. Accordingly, previously recognized fixed assets and unrecorded liabilities were recorded with an adjustment to goodwill of $490,702. The Company will issue an additional 270,081 shares to Global in consideration of the indemnification provisions. (4) RESTRICTED CASH At June 30, 2000 and 1999, the Company held restricted cash of $475,915 and $446,679, respectively, in a trust fund for payments which may be required under a severance agreement with one former executive of Global. (See Note 17.) (5) INVESTMENT SECURITIES A summary of investment securities by major security type at June 30, 1999 follows: F-12 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED GROSS GROSS UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR COST GAINS LOSSES VALUE ---- ----- ------ ----- Available-for-sale: Corporate debt securities $303,115 $167 $(693) $302,589 ======== ==== ===== ======== (6) ASSETS HELD FOR SALE In connection with the acquisition of TNCi, the Company relocated corporate offices and production capabilities of TNCi to its Phoenix, Arizona offices. Accordingly, as of June 30, 1999, certain assets were recorded at their net realizable value and classified as assets held for sale. In September 1999, TNCi sold one of its two buildings in Alpharetta, Georgia. The net proceeds of approximately $390,000 from the sale, plus additional cash of approximately $80,000, was used by the Company to repay a note payable due April 2001, in the principal amount of $470,000. The sale of the second building occurred in November 1999. The net proceeds of approximately $367,000 from the sale were used to retire a note payable due 2009 in the principal amount of $220,508. (7) PROPERTY AND EQUIPMENT A summary of property and equipment follows: JUNE 30, JUNE 30, 2000 1999 ----------- ----------- Leasehold improvements $ 199,143 $ 24,117 Purchased software 188,476 149,703 Furniture 160,648 163,609 Equipment 1,831,563 1,684,180 Guest pay interactive systems: Installed 467,885 -- Construction in progress: System components 967,215 -- Work in progress 1,009,907 -- ----------- ----------- 4,824,837 2,021,609 Less: accumulated depreciation and amortization (1,014,188) (683,029) ----------- ----------- Property and equipment, net $ 3,810,649 $ 1,338,580 =========== =========== (8) INTANGIBLES A summary of intangibles follows: JUNE 30, JUNE 30, 2000 1999 ----------- ----------- Goodwill $ 7,605,876 $ 7,115,174 Trademarks 79,613 79,613 ----------- ----------- 7,685,489 7,194,787 Accumulated amortization (987,534) (74,981) ----------- ----------- $ 6,697,955 $ 7,119,806 =========== =========== F-13 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED (9) ACCRUED LIABILITIES A summary of accrued liabilities follows: JUNE 30, JUNE 30, 2000 1999 ---------- ---------- Due to related parties (See Note 17) $1,419,716 $1,891,123 Other accrued expenses 1,505,081 318,559 ---------- ---------- Accrued liabilities $2,924,797 $2,209,682 ========== ========== (10) NOTES PAYABLE TO RELATED PARTIES In May and June 2000, The Gross Charitable Unit Trust and The Gross Charitable Annuity Trust (together the "Trusts"), advanced a total of $800,000 to the Company for working capital purposes. An additional $250,000 was advanced to the Company in July 2000. On September 12, 2000, the advances were converted into two promissory notes, each in the amount of $525,000, issued to each Trust by the Company. The notes mature on December 31, 2000 and bear interest at 9%. The Trusts are controlled by the Company's Chairman and Chief Executive Officer, Irwin L. Gross. (See Note 17 - Related Party Transactions and Note 22 (c).) As of June 30, 1999, the Company had notes payable in the amount of $68,836 to related parties with interest payable at approximately 5% per annum. These notes became due and payable upon achievement of certain operational goals which were achieved during the fiscal year ended June 30, 2000, and accordingly paid in full. On August 24, 1999, the Board of Directors of Global approved a $5 million secured revolving credit facility by and between Global and the Company (the "Facility"). The Facility provides that the Company may borrow up to $5 million for working capital and general corporate purposes at the prime rate of interest (9.5% at June 30, 2000) plus 3%. The Facility matures in September 2001. The Company paid an origination fee of $50,000 to Global and will pay an unused line fee of 0.5% per annum. The Facility is secured by all of the assets of the Company and is convertible, at any time at Global's option, into shares of the Company's Series C Stock or Common Stock at a price equal to the lesser of 66.7% of the closing bid price for the trading day immediately preceding the Conversion Date, $1.50 per share or any lesser amount at which Common Stock has been issued to third parties. Pursuant to Nasdaq rules, Global may not convert borrowings under the Facility into shares of Common Stock in excess of 19.99% of the number of shares of Common Stock outstanding on August 24, 1999 without shareholder approval. On June 29, 2000, Global exercised its right to convert $1,850,000 of the balance outstanding under the Facility into 1,233,333 shares of the Company's Common Stock. As of June 30, 2000, $2,350,000 was outstanding under the Facility. The Company's revolving credit facility is considered a convertible debt security with a nondetachable conversion feature. The conversion rate of the Facility is measured each time the Company borrows or repays amounts under the Facility ("Commitment Date"). If the market price of the Company's common stock at the Commitment Date is greater than the Conversion Price, the advance is considered to be in-the-money and is considered to have an embedded beneficial conversion feature. EITF 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios" requires that embedded beneficial conversion features present in convertible securities should be valued separately. The Company's borrowings under the Facility during the year ended June 30, 2000 and related beneficial conversion features resulted in a charge to earnings of $4.2 million of which $1,080,000 relates to the quarter ended March 31, 2000, and $3.1 million relates to the quarter ended June 30, 2000, and is recorded in interest expense. Had the Company identified this beneficial conversion feature of $1,080,000 (unaudited) as of March 31, 2000, the net loss of the Company for the three-month period ended March 31, 2000 would have increased from $(3.0) million (unaudited) to $(4.0) million (unaudited) and basic and diluted net loss per share would have increased from $(.24) (unaudited) to $(.33) (unaudited). The net loss of the Company for the nine-month period ended March 31, 2000 would have increased from $(4.4) F-14 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED million (unaudited) to $(5.5) million (unaudited) and basic and diluted net loss per share increased from $(.52) (unaudited) to $(.65) (unaudited). Prior to the Transaction, the Company entered into a secured promissory note with Global in the principal amount of $750,000, bearing interest at a rate of 9.5% per annum, and a related security agreement granting Global a security interest in its assets (the "Promissory Note"). The Promissory Note was convertible into shares of the Company's Series C Stock on the same terms and conditions as the Facility described above, at the discretion of Global. Global has also advanced approximately $898,000 to the Company in the form of intercompany advances. As of June 30, 1999, $1,647,692 was outstanding under these arrangements. (11) NOTES PAYABLE Notes payable consists of the following:
JUNE 30, JUNE 30, 2000 1999 ---------- ---------- Series A, D & E Notes (see below) -- 2,386,048 Note payable due September 5, 1999, interest at 7%, convertible to Common Stock at the option of the Company (see below) -- 400,000 Note payable due in varying installments through 2009, interest at prime (8.25% at June 30, 1999) plus 2%, collateralized by certain commercial property and personally guaranteed by two shareholders (see below) -- 220,508 Note payable due in varying installments through December 2000, interest at 6.9%, collateralized by a vehicle 4,744 10,308 Note payable due and payable April 19, 2001, interest 16% payable monthly, collateralized by certain commercial property (see below) -- 470,000 Note payable due in varying installments through 2000, interest at 11%, collateralized by a vehicle -- 4,572 ---------- ---------- 4,744 3,491,436 Less current portion 4,744 24,391 ---------- ---------- $ 0 $3,467,045 ========== ==========
(a) SERIES NOTES The Series A, D and E Notes ("Series Notes") were issued by the Company in 1998 prior to the Transaction. The Series Notes all had original maturities of approximately 135 days with interest at approximately 7% to 8% per annum. The Company could choose to repay such Notes in cash subject to a payment charge equal to approximately 7% of the face amount of the Note or the Company could elect to convert the Series Notes into preferred stock of the Company which is convertible into common stock. In July and August 1999, Global purchased all of the Series Notes from the holders of such notes. Concurrent with such purchase by Global, the Company executed several allonges to the Promissory Note which cancelled such Series Notes and rolled the principal balance, plus accrued but unpaid interest, penalties and redemption premiums on the Series Notes into the principal balance of the Promissory Note. Subsequent to May 18, 1999, Global had also advanced working capital to the Company in the form of intercompany advances. In August 1999, the Company executed an allonge to the Promissory Note which rolled the intercompany advances into the principal balance of the Promissory Note and granted Global the ability to convert the Promissory Note directly into shares of the Company's Common Stock, without first converting to Series C Stock, as an administrative convenience. F-15 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED On August 24, 1999, the Board of Directors of Global approved the conversion of the Promissory Note into shares of the Company's Common Stock. Such conversion, to the extent it exceeded approximately one million shares of the Company's Common Stock on August 24, 1999, was contingent upon receiving shareholder approval to increase the authorized share capital of the Company. This increase in authorized share capital was subsequently approved at the September 17, 1999 Special Meeting of the Company's shareholders. Accordingly, in December 1999, the Company issued to Global 4,802,377 shares of its Common Stock based on the conversion date of August 24, 1999. (b) OTHER NOTES PAYABLE In September 1999, the Company sold one of its two buildings in Alpharetta, Georgia. The net proceeds of approximately $390,000 from the sale, plus additional cash of approximately $80,000, was used by the Company to repay a note payable due April 2001, in the principal amount of $470,000. The sale of the second building occurred in November 1999. The net proceeds of approximately $367,000 from the sale were used to retire the note payable due 2009 in the principal amount of $217,000. In October 1999, a note payable in the principle amount of $400,000 due September 5, 1999 was converted into 200,000 shares of the Company's Common Stock. (12) NET INCOME (LOSS) PER SHARE For the Transition Period, basic weighted average number of shares outstanding includes 1,055,745 common shares held by Global for the full period and approximately 5.3 million shares (the shares issued and outstanding prior to the Transaction) for two months. Diluted weighted average number of shares outstanding for the Transition Period include 1,055,745 common shares and 15,097,170 potential dilutive securities resulting from the Series D Convertible Preferred Stock for the entire Transition Period (both issued to Global in connection with the Transaction); plus 5,278,737 common shares outstanding prior to the merger, and 1,133,120 common stock equivalents related to the Convertible Promissory Note, Series A, D and E Convertible Notes, Series B 8% Convertible Preferred Stock, Series C 8% Convertible Preferred Stock and options each weighted for the two months ended June 30, 1999. Basic and diluted weighted average number of shares outstanding for the year ended October 31, 1998 included 1,055,745 shares of the Company's common stock, representing 100% of the Company's capital stock which was all owned by Global. No effect was given to common stock equivalents in either year in the computation of diluted loss per share for the years ended June 30, 2000 and October 31, 1998 as their effect would have been anti-dilutive. F-16 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
TRANSITION YEAR ENDED YEAR ENDED PERIOD ENDED OCTOBER 31, JUNE 30, 2000 JUNE 30, 1999 1998 ------------- ------------- ------------ Net income (loss) $ (16,252,199) $ 2,344,205 $ (7,180,631) Less: preferred stock dividends (120,000) (30,667) -- ------------- ------------ ------------ Income (loss) available to common stockholders $ (16,372,199) $ 2,313,538 $ (7,180,631) ============= ============ ============ Basic EPS - weighted average shares outstanding 9,600,322 2,387,223 1,055,745 ============= ============ ============ Basic net income (loss) per share $ (1.71) $ 0.97 $ (6.80) ============= ============ ============ Basic EPS - weighted average shares outstanding 9,600,322 2,387,223 1,055,745 Effect of dilutive securities: Stock Purchase Options - common stock -- 82,033 -- Convertible preferred stock -- 15,570,814 -- Convertible debt -- 503,638 -- ------------- ------------ ------------ Dilutive EPS - weighted average shares outstanding 9,600,322 18,543,708 1,055,745 Net income (loss) $ (16,372,199) $ 2,344,205 $ (7,180,631) ------------- ------------ ------------ Diluted net income (loss) per share $ (1.71) $ 0.13 $ (6.80) ============= ============ ============ Common stock equivalents not included in dilutive EPS since antidilutive - Convertible preferred stock 16,273,641 -- 15,097,170 ============= ============ ============ - Convertible debt 1,566,667 -- -- ============= ============ ============ - Stock options and warrants 4,026,348 -- -- ============= ============ ============
(13) STOCK OPTION PLANS Under the Company's 1994 Employee Stock Option Plan (the "Plan"), as amended, the Company has reserved an aggregate of 1,200,000 shares of Common Stock for issuance under the Plan. Options granted under the Plan are for periods not to exceed ten years. Under the Plan, incentive and non-qualified stock options may be granted. All option grants under the Plan are subject to the terms and conditions established by the Plan and the Stock Option Committee of the Board of Directors. Options must be granted at not less than 100% of fair value for incentive options and not less than 85% of fair value of non-qualified options of the stock as of the date of grant and generally are exerciseable in increments of 25% each year subject to continued employment with the Company. Options generally expire five to ten years from the date of grant. Options canceled represent the unexercised options of former employees, returned to the option pool in accordance with the terms of the Plan upon departure from the Company. The Board of Directors may terminate the Plan at any time at their discretion. During the year ended June 30, 2000, 687,500 stock options with up to a four-year vesting period were granted at exercise prices ranging from $2.00 to $11.50. On August 16, 1995, the Company adopted the 1995 Stock Option Plan For Non-Employee Directors (the "Directors Plan") and reserved 100,000 shares of unissued common stock for issuance to all non-employee directors of the Company. The Directors Plan is administered by a committee appointed by the Board of Directors consisting of directors who are not eligible to participate in the Directors Plan. Pursuant to the Directors Plan, directors who are not employees of the Company may receive for their services, on the date first elected as a member of the Board and on each anniversary thereafter, if they continue to serve on the Board of Directors, an automatically granted option to acquire 5,000 shares of the Company's common stock at its fair market value on the date of grant; such options become exercisable in two equal annual installments if the individual continues at that time to serve as a director, and once exercisable remain so until the fifth anniversary of the date of grant. Other grants may be made at the discretion of the Board of Directors from time to time. During fiscal 2000, there were no options granted. F-17 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED During the year ended June 30, 2000, the Company granted options pursuant to separate plans as described below. The total number of stock options granted pursuant to separate plans during the year ended June 30, 2000 was 2,350,000. In November 1999, the Compensation Committee of the Board of Directors of the Company recommended option grants to purchase up to 500,000 shares of the Company's Common Stock to Mr. Irwin L. Gross, Chairman and Chief Executive Officer of the Company outside of the plans described above. Such recommendation was accepted and approved by the Board of Directors. One quarter of these options vested immediately and one quarter vest in equal annual installments over three years. The remaining half vest on the sixth anniversary of the date of grant, subject to acceleration to a three-year vesting schedule in the event certain performance milestones are achieved. Exercise price of the options is equal to the closing market price of the Company's Common Stock on the day of grant. The options expire in October 2009. On March 6, 2000, the Company granted options to purchase up to 800,000 shares of the Company's Common Stock to Mr. Robert Pringle, President and Chief Operating Officer of the Company outside of the plans described above. One fifth of these options vest on June 6, 2000, with the remainder vesting in four equal annual installments beginning March 6, 2001. Exercise price of the options is equal to the closing market price of the Company's Common Stock on the day prior to grant, and the options expire on March 6, 2010. On March 6, 2000, the Company granted options to purchase up to 800,000 shares of the Company's Common Stock to Dr. Jay Rosan, an Executive Vice President of the Company outside of the plans described above. One fifth of these options vest on June 6, 2000, with the remainder vesting in four equal annual installments beginning March 6, 2001. Exercise price of the options is equal to the closing market price of the Company's Common Stock on the day prior to grant, and the options expire on March 6, 2010. On March 6, 2000, the Company granted options to purchase up to 250,000 shares of the Company's Common Stock to Mr. Richard Genzer, Chief Technology Officer of the Company outside of the plans described above. One fifth of these options vest on June 6, 2000, with the remainder vesting in four equal annual installments beginning March 6, 2001. Exercise price of the options is equal to the closing market price of the Company's Common Stock on the day prior to grant, and the options expire on March 6, 2010. A summary of the aforementioned stock option activity follows:
YEAR ENDED TRANSITION PERIOD ENDED JUNE 30, 2000 JUNE 30, 1999 ---------------------- --------------------- WEIGHTED WEIGHTED NUMBER AVERAGE NUMBER AVERAGE OF EXERCISE OF EXERCISE SHARES PRICE SHARES PRICE ---------- -------- -------- -------- Balance at the beginning of year 719,978 $ 3.09 676,478 $ 5.00 Granted 3,037,500 6.97 345,348 2.25 Exercised (111,823) 2.11 (20,000) 3.84 Forfeited (392,307) 4.03 (281,848) 4.75 --------- -------- Balance at the end of year 3,253,348 6.65 719,978 3.09 ========= ======== Exercisable at the end of year 568,337 6.66 331,731 4.29 ========= ======== Weighted-average fair value of options granted during the year $ 6.56 $ 1.66 ========= ========
In accordance with the provisions of APB 25, the Company measures stock-based compensation expense as the excess of the market price at the grant date over the amount the employee must pay for the stock. The Company's policy is to generally grant stock options at fair market value at the date of grant, so no compensation expense is recognized. As permitted, the Company has elected to adopt the disclosure provisions only of SFAS No. 123. Had compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been reduced (increased) to the pro forma amounts indicated below: F-18 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED TRANSITION PERIOD YEAR ENDED ENDED JUNE 30, 2000 JUNE 30, 1999 ------------- ------------- Net income (loss) available to common stockholders: As reported $ (16,372,199) $ 2,313,538 ============= =========== Pro forma $ (22,578,107) $ 2,018,009 ============= =========== Basic net income (loss) per share: As reported $ (1.71) $ 0.97 ============= =========== Pro forma $ (2.35) $ 0.85 ============= =========== Diluted net income (loss) per share: As reported $ (1.71) $ 0.13 ============= =========== Pro forma $ (2.35) $ 0.11 ============= =========== Pro forma net income (loss) reflect only options granted during the year ended 2000 and the Transition Period ended 1999. There were no options granted related to IED for the year ended October 31, 1998. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income (loss) amount presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to November 1995 are not considered under SFAS No. 123. For purposes of the SFAS No. 123 pro forma net income (loss) and net income (loss) per share calculations, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the year ended June 30, 2000 and the Transition Period ended June 30, 1999: TRANSITION PERIOD YEAR ENDED ENDED JUNE 30, 2000 JUNE 30, 1999 ------------- ------------- Dividend yield 0% 0% Expected volatility 165.87% 58.76% Risk free interest rate 6.02% 5.67% Expected lives (years) 5.0 10.0 The following table summarizes the status of outstanding stock options as of June 30, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------------- ----------------------------- WEIGHTED AVERAGE RANGE OF NUMBER OF REMAINING WEIGHTED NUMBER OF WEIGHTED EXERCISE OPTIONS CONTRACTUAL AVERAGE OPTIONS AVERAGE PRICES OUTSTANDING LIFE (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE - -------------- ----------- ------------ -------------- ----------- -------------- $2.00 - $ 2.25 258,848 8.20 $2.23 73,337 $2.25 2.31 - 4.97 913,000 8.93 2.90 125,000 2.31 5.13 - 5.88 92,000 9.59 5.62 -- -- 6.50 - 8.72 54,500 9.60 7.70 -- -- 9.00 - 11.50 1,935,000 9.67 9.04 370,000 9.00 --------- ------- Total 3,253,348 568,337 ========= =======
F-19 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED (14) BENEFIT PLAN On June 1, 1999 a formal termination of the Company's 401(k) plan was initiated. The formal termination is expected to be completed in October 2000. The 401(k) plan of parent company Global was amended June 1, 1999 to include employees of the Company. Global has adopted a defined contribution benefit plan that complies with section 401(k) of the Internal Revenue Code and provides for discretionary company contribution. Employees who complete three months of service are eligible to participate in the Plan. Global did not make any contributions to the Plan for the year ended June 30, 2000, the Transition Period ended June 30, 1999, nor the year ended October 31, 1998. (15) STOCKHOLDERS' EQUITY PREFERRED STOCK Series B 8% Convertible Preferred Stock ("Series B Stock"); stated value $1,000 per share and liquidation value of 120% of stated value. The Holder of Series B Stock is entitled to an annual cumulative dividend of $80 per share payable quarterly in cash or Common Stock. Cumulative unpaid dividends at June 30, 2000 total $140,000. Each share of Series B Stock is convertible into Common Stock at a price equal to the lowest of: a) 75% of the Average Price of Common Stock, as defined, or b) 75% of the Average Price of Common Stock, as defined calculated as if April 29, 1999 were the conversion date. The Series B Stock has no voting rights. Global owns 100% of the issued and outstanding Series B Stock. There were 1,500 shares of Series B Convertible Preferred Stock outstanding at June 30, 2000. Series C 8% Convertible Preferred Stock ("Series C Stock"); stated value $1,000 per share and liquidation value of 120% of stated value. The Holder of Series C Stock is entitled to an annual cumulative dividend of $80 per share payable quarterly in cash or Common Stock. Each share of Series C Stock is convertible into Common Stock at a price equal to the lowest of: a) $2.6875 per share, or b) 66.67% of the Average Price, as defined, or c) at the lowest rate the Company issues equity securities, as defined. The Series C Stock generally has no voting rights. On August 24, 1999, Global notified the Company of its intent to convert such shares into Common Stock contingent upon receiving shareholder approval to increase the authorized share capital of the Company. The increase in authorized share capital was subsequently approved at the September 17, 1999 Special Meeting of the Company's shareholders. Accordingly, in December 1999, the Company issued 886,000 shares of its Common Stock to Global upon conversion of all the Series C stock held by Global. Series D Convertible Preferred Stock ("Series D Stock"); stated value $10 per share and liquidation value of 120% of stated value. The Holder of Series D Stock is entitled to an annual dividend as and when declared by the Board of Directors of the Company. The Series D Stock generally has no voting rights. The Series D Stock is convertible into the Company's Common Stock at a conversion rate of 6.05 Common shares for each share of Series D Stock. COMMON STOCK At June 30, 2000, there are authorized 40,000,000 shares of Common Stock, par value $0.001 per share. The holders of Common Stock are entitled to one vote for each share held of record on all matters submitted to a vote of the shareholders. On June 1, 2000, the Company executed a master facility agreement with Fusion Capital Fund II, LLC ("Fusion") pursuant to which Fusion agreed to enter into an equity purchase agreement with an aggregate available amount of $12,000,000. Under the master facility agreement, the equity purchase agreement grants Fusion the right to purchase up to $12,000,000 of the Company's Common Stock at a price equal to the lesser of (1) $8.00 per share or (2) a price based on the future performance of the common stock, in each case without any fixed discount to the market price. Under the agreement, Fusion has the right to convert up to $1.0 million of the available amount of the purchase equity agreement each month, plus any prior month amounts that have not yet been converted, into shares of the Company's Common Stock at the conversion price. F-20 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED The Company has certain rights to prevent conversion or to require mandatory conversion. At no time would Fusion be permitted to beneficially own more than 4.99% of the then aggregate outstanding common stock. Additionally, Fusion received 300,000 shares of the Company's Common Stock as a commitment fee. The shares were valued at $1,021,860, and $468,183 had been netted against proceeds received as of June 30, 2000. As of June 30, 2000, Fusion purchased from the Company an aggregate of 15,400 shares of common stock at an average price of $3.41 per share and provided an advance, repayable in common shares, of $448,000. In December 1999 and January 2000, the Company issued 29,500 and 10,000 shares of common stock respectively, to third parties for investor relation services to be provided over a twelve month period. WARRANTS The following table summarizes warrant activity for the year ended June 30, 2000, the Transition Period ended June 30, 1999 and the year ended October 31, 1998: Outstanding as of October 31, 1997 -- Issued in connection with consulting services 334,700 Issued in connection with Series B Preferred Stock 162,500 Issued in connection with Series A Notes 189,025 Issued in connection with Series D Notes 70,000 -------------- Outstanding as of October 31, 1998 756,225 Issued in connection with Series E Notes 132,500 Issued in connection with Series F Notes 187,000 Issued in connection with Promissory Notes 290,000 -------------- Outstanding as of June 30, 1999 1,365,725 Issued in connection with consulting services 150,000 Exercised during the year (678,225) Repurchased during year (64,500) -------------- Outstanding as of June 30, 2000 773,000 ============== Exercise Price $ 2.41 - 10.00 ============== During the year ended June 30, 2000, the Company issued 150,000 Common Stock purchase warrants, resulting in 773,000 warrants outstanding at June 30, 2000. Each warrant represents the right to purchase one share of the Company's Common Stock at exercise prices ranging from $2.41 to $10.00 per share, until such warrants expire beginning August 12, 2001 through December 23, 2004. In December 1999, the Company issued common stock purchase warrants to purchase 25,000 shares of the Company's Common Stock at $6.50 per share to Emden Consulting Corp. in exchange for advisory services. The exercise period of the warrants expires in December 2004. Non-cash expense of $144,868 was recorded in the fiscal year ended June 30, 2000. In December 1999, the Company issued common stock purchase warrants to purchase 25,000 shares of the Company's Common Stock at $6.50 per share to Waterton Group LLC in exchange for advisory services. The exercise period of the warrants expires in December 2004. Non-cash expense of $144,868 was recorded in the fiscal year ended June 30, 2000. In December 1999, the Company issued common stock purchase warrants to purchase 100,000 shares of the Company's Common Stock at prices ranging from $6 to $10 per share to Continental Capital & Equity Corp. in exchange for public relations and financial advisory services. The warrants were to vest over a period of 270 days and expire in February 2002. Non-cash expense of $350,269 was recorded in the fiscal year ended June 30, 2000. On March 13, 2000, the Company issued 236,081 shares of its Common Stock in connection with the cashless exercise of common stock purchase warrants held by the former holders of the Company's Series A and E notes. The warrants exercised represented warrants to purchase 311,525 shares of the Company's Common Stock. F-21 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED Additionally, on March 13, 2000, the Company issued 123,382 shares of its Common Stock in connection with the cashless exercise of common stock purchase warrants previously issued in connection with the Company's Series F notes. The warrants exercised represented warrants to purchase 182,000 shares of the Company's Common Stock. In March 2000, the Company repurchased for cash 64,500 Common Stock purchase warrants for $296,000. The warrants were issued prior to the May 1999 Transaction. The repurchase was recorded as a reduction to additional paid-in capital. In May 2000, the Company issued 107,433 shares of its Common Stock in connection with the cashless exercise of Common Stock purchase warrants issued in January and May 1998 in connection with financial advisory services. No services have been provided to the Company since the Transaction Date. The warrants exercised represented warrants to purchase 184,700 shares of the Company's Common Stock. (16) INCOME TAXES Income taxes (benefit) differed from the amounts computed by applying the U.S. Federal corporate income tax rate of 34% to net income (loss) as a result of the following:
TRANSITION YEAR ENDED PERIOD ENDED YEAR ENDED JUNE 30, 2000 JUNE 30, 1999 OCTOBER 31, 1998 ------------- ------------- ---------------- Computed expected tax (benefit) $(5,525,746) $ 786,603 $(2,441,415) Change in federal valuation allowance 3,976,710 (983,188) 2,100,322 Nondeductible expense 1,549,036 16,320 416,498 Other -- 180,265 (75,405) ----------- --------- ----------- $ -- $ -- $ -- =========== ========= ===========
The tax effects of temporary differences that give rise to significant portions of the net deferred tax asset are presented below: TRANSITION PERIOD YEAR ENDED ENDED JUNE 30, 2000 JUNE 30, 1999 ------------- ------------- Deferred tax assets: Net operating loss carryforward $ 11,416,005 $ 5,443,825 Property and equipment 1,145,301 972,785 Allowance for bad debts -- 1,517,277 Provision for inventory valuation 3,607,166 3,142,092 Accrued liabilities 876,320 770,859 Deferred revenue -- 146,699 Other -- 262,589 ------------ ------------ 17,044,792 12,256,126 Less valuation allowance (17,044,792) (12,256,126) ------------ ------------ Net deferred tax asset $ -- $ -- ============ ============ In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company believes sufficient uncertainty exists regarding the realization of the tax assets such that a full valuation allowance is appropriate. As of June 30, 2000, the Company has a net operating loss (NOL) carryforward for federal income tax purposes of approximately $28,752,372, which begins to expire in 2009. The Company likely underwent a change in ownership in accordance with Internal Revenue Code Section 382, the effect of which has not yet been determined by the Company. This change F-22 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED would effect the timing of the utilization of the NOL, as well as the amount of the NOL which may ultimately be utilized, though it is not expected to materially effect the amount of the NOL carryforward. (17) RELATED PARTY TRANSACTIONS Prior to the Transaction, TNCi entered into the Promissory Note with Global in the principal amount of $750,000, bearing interest at a rate of 9.5% per annum, and a related security agreement granting Global a security interest in its assets. In July and August 1999, Global purchased all of the Series A and E notes and the Series D notes issued by TNCi (collectively, the "Series Notes"), respectively from the holders of such notes. Concurrent with such purchases, TNCi executed allonges to the Promissory Note, which cancelled the Series Notes and rolled the principal balance, plus accrued interest, penalties and redemption premiums of the Series Notes into the principal balance of the Promissory Note. In August 1999, TNCi executed another allonge to the Promissory Note which rolled approximately $1.2 million of prior intercompany advances from Global into the Promissory Note and granted Global the ability to convert the Promissory Note directly into shares of TNCi's Common Stock as an administrative convenience. On August 24, 1999, the Board of Directors of Global approved the conversion of the Promissory Note into approximately 4.8 million shares of TNCi's Common Stock. Such conversion was contingent upon receiving shareholder approval to increase the authorized share capital of TNCi. This increase in authorized share capital was approved on September 17, 1999, and the shares were subsequently issued in December 1999 based as on the August 24, 1999 conversion date. On August 24, 1999, the Company's Board of Directors approved a $5,000,000 secured revolving credit facility by and between TNCi and Global (the "Facility"). The Facility provides that TNCi may borrow up to $5,000,000 for working capital and general corporate purposes at the Prime Rate of interest (9.5% at June 30, 2000) plus 3%. The Facility matures in September 2001. TNCi paid an origination fee of $50,000 to Global and will pay an unused line fee of 0.5% per annum. The Facility is secured by all of the assets of TNCi and is convertible into shares of TNCi's Common Stock. During the year ended June 30, 2000, TNCi had net borrowings of $4.2 million under the Facility. On June 28, 2000 the Board of Directors approved the conversion of $1,850,000 of the Facility into 1,233,333 shares of TNCi Common Stock. At June 30, 2000 the balance on the Facility was $2,350,000. During the year ended June 30, 2000, the Company incurred interest expense of $112,375 to Global. TNCi provides certain administrative services to Global, including accounting, payroll and human resources under an arrangement in which Global pays TNCi through an intercompany account. Through June 30, 2000, these services amounted to $175,889. As of June 30, 2000, Global owed to the Company $73,607 which is the net result of various intercompany transactions which includes the aforementioned charge. The Company's Chief Executive Officer is a principal of Ocean Castle Investments, LLC ("Ocean Castle") which maintains administrative offices for the Company's Chief Executive Officer and certain other employees of Global. During the year ended October 31, 1998, Ocean Castle executed consulting agreements with two principal stockholders of Global. The rights and obligations of Ocean Castle under the agreements were assumed by the Company in connection with the Transaction. The consulting agreements require payments aggregating $1,000,000 to each of the consultants through December 2003 in exchange for advisory services. Each of the consultants also received stock options to purchase 50,000 shares of Class A Common Stock of Global at an exercise price of $3.00. As of June 30, 1999, the Company determined that the consulting agreements had no future value due to the Company's shift away from in-flight entertainment into alternative markets such as leisure cruise and passenger rail transport. Only limited services were provided in 1999, no services were provided in 2000, and no future services will be utilized. Accordingly, the Company recorded a charge to general and administrative expenses in the Transition Period of $1.6 million representing the balance due under such contracts. In August 2000, Global, on behalf of TNCi, settled the outstanding obligation with the principle stockholders of Global for Common Stock of Global. The Company will issue to Global 411,146 shares of its Common Stock as reimbursement to Global for such settlement. In May and June 2000, The Gross Charitable Unit Trust and The Gross Charitable Annuity Trusts (together the "Trusts"), advanced a total of $800,000 to the Company for working capital purposes. An additional $250,000 was advanced to the Company in July 2000. On September 12, 2000, the advances were converted into two promissory notes, each in the amount of $525,000, issued to each Trust F-23 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED by the Company. The notes mature on December 31, 2000 and bear interest at 9%. The Trusts are controlled by the Company's Chairman and Chief Executive Officer, Irwin L. Gross. In August 1999, the Company executed a separation and release agreement with a shareholder and former officer of the Company, pursuant to which the Company paid approximately $85,000 in the form of 66,667 unregistered shares of the Company's common stock. In June 1999, the Company loaned to a vice president, $75,000 for the purpose of assisting in a corporate relocation to the Company's headquarters in Phoenix, Arizona. The Company also added other outstanding advances to the principal amount of the rate in the amount of $42,000. Such loan is secured by assets of the employee. The note matures in August 2009 and bears an interest rate of approximately 5%. Global had an Intellectual Property License and Support Services Agreement (the "License Agreement") for certain technology with FortuNet, Inc. ("FortuNet"). FortuNet is owned by a principal stockholder and former director of Global. The License Agreement provides for an annual license fee of $100,000 commencing in October 1994 and continuing through November 2002. The Company paid FortuNet $100,000 during each of the years ended October 31, 1998 and 1997. As of October 31, 1998, the remaining commitment of $400,000 is included in accrued liabilities on the balance sheet. The Company assumed this liability in connection with the Transaction. In September 1999, the Company agreed to a termination of this agreement and paid FortuNet $100,000 plus legal fees. During the Transition Period ended June 30, 1999, the Company had revised its estimated accrual to $200,000 which is included in accrued liabilities at June 30, 1999. During the year ended June 30, 2000, actual costs associated with this settlement were $43,150 less than the estimate. Accordingly, the Company reversed the liability and reduced administrative expense. During the year ended October 31, 1998, Global extended by one year a consulting agreement with a former officer of Global pursuant to which Global will pay $55,000 for services received during the period November 1999 through October 2000. The Company assumed the liability for the consulting agreement in connection with the Transaction in the amount of $55,000 which is included in accrued liabilities at June 30, 1999. As of June 30, 2000, $18,000 remained to be paid. During the year ended October 31, 1998, Global executed severance and consulting agreements with three former officers, pursuant to which Global paid the former officers and set aside restricted funds in the amounts of $3,053,642 and $735,000, respectively. The consulting agreements all expired by September 1999. Payments totaling $735,000 were made from restricted cash of Global through September 1999. Expenses associated with these agreements were charged to general and administrative expenses in the year ended October 31, 1998. During the year ended October 31, 1996, Global executed severance agreements with three former officers pursuant to which the Company will pay severance of $752,500 over a three-year period. As of June 30, 2000 and 1999, zero and $18,000 remained to be paid under these agreements. Such liabilities were assumed by the Company in connection with the Transaction. The Company has agreed to reimburse B.H.G. Flight, LLC ("BHG") for costs and expenses associated with the Company's use for corporate purposes of an airplane owned by BHG. Irwin L. Gross, Chairman of the Board and Chief Executive Officer, owns a 50% interest in BHG. To date, the Company has incurred approximately $44,000 for such costs and expenses. (18) COMMITMENTS AND CONTINGENCIES (a) LITIGATION Swissair/MDL-1269, IN REGARDS TO AN AIR CRASH NEAR PEGGY'S COVE, NOVA SCOTIA. This multi-district litigation, which is being overseen by the United States District Court for the Eastern Division of Pennsylvania, relates to the crash of Swissair Flight No. 111 on September 2, 1998. The Swissair MD-11 aircraft involved in the crash was equipped with an entertainment network system that had been sold to Swissair by Global's predecessor company, Interactive F-24 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED Flight Technologies, Inc. Estates of the victims of the crash have filed lawsuits throughout the United States against Swissair, Boeing, Dupont and various other parties, including Global and TNCi, which has been named in some of the lawsuits filed on a successor liability theory. TNCi and Global deny all liability for the crash. TNCi and Global are being defended by our aviation insurer. On September 1, 1999, SAir Group invited the Company to participate in a conciliation hearing before the Justice of the Peace in Kloten, Switzerland, which is the customary manner in which civil litigation is initiated in Switzerland. The document informing us of the proceeding states that the request has been filed in connection with the crash of Swissair Flight 111 primarily in order to avoid the expiration of any applicable statutes of limitations and to reserve the right to pursue further claims. The document states that the relief sought is "possibly the equivalent of CHF 342,000,000 - in a currency to be designated by the court; each plus 5% interest with effect from September 3, 1998; legal costs and a participation to the legal fees (of the plaintiff) to be paid by the defendant." BRYAN R. CARR V. THE NETWORK CONNECTION, INC. AND GLOBAL TECHNOLOGIES, LTD., Superior Court of Georgia, Civil Action No. 99-CV-1307. Bryan R. Carr, TNCi's former Chief Operating and Financial Officer and a former Director, filed a claim on November 24, 1999 alleging a breach of his employment agreement with TNCi. Mr. Carr claims that he is entitled to the present value of his base salary through October 31, 2001, a share of any "bonus pool," the value of his stock options and accrued vacation time. TNCi and we filed a motion to compel arbitration of the claims pursuant to an arbitration provision in the employment agreement and to stay the State Court action pending the arbitration proceeding. The Company's motion was granted on August 9, 2000. As of this date, Mr. Carr has not filed an arbitration claim against TNCi or Global, but on September 20, 2000, Mr. Carr sent a letter to the Company stating his demands in hopes of settlement. A suit captioned AVNET, INC. V. THE NETWORK CONNECTION, INC., was filed May 17, 2000 in Maricopa County Superior Court, CV2000-009416. The suit relates to invoices for inventory purchased by TNCi in late 1998 and early 1999. Avnet, Inc. seeks payment of the invoices, interest and legal fees. TNCi has not paid for the inventory purchased primarily for the following reasons: (i) the inventory purchased did not meet specifications and thus was not accepted by TNCi's customer, and (ii) TNCi is currently pursuing a separate warranty claim against Avnet regarding certain other inventory purchased from Avnet. The Company is subject to other lawsuits and claims arising in the ordinary course of its business. In the Company's opinion, as of June 30, 2000, the effect of such matters will not have a material adverse effect on the Company's results of operations and financial position. (b) LEASE OBLIGATIONS The Company leases office space and equipment under operating leases which expire at various dates through August 2005. The future minimum lease commitments under these leases are as follows: YEARS ENDING JUNE 30, TOTAL --------------------- ----------- 2001 $ 566,689 2002 626,215 2003 519,362 2004 519,362 2005 502,721 ----------- Total minimum lease payments $ 2,734,349 =========== F-25 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED Rental expense under operating leases totaled $175,042, $292,042 and $944,932 for the fiscal year ended June 30, 2000, for the Transition Period ended June 30, 1999 and the fiscal year ended October 31, 1998 , respectively. (19) SPECIAL CHARGES AND REVERSAL OF WARRANTY, MAINTENANCE AND COMMISSION ACCRUALS Global had previously entered into sales contracts with three airlines, Schweizerische Luftverkehr AG ("Swissair"), Debonair Airways, Ltd. ("Debonair") and Alitalia Airlines, S.p.A. ("Alitalia") for the manufacture and installation of its in-flight entertainment network, and to provide hardware and software upgrades, as defined in the agreements. In connection with the Transaction, the Company assumed all rights and obligations of the above contracts. Pursuant to the October 1997 agreement with Swissair, Swissair purchased shipsets for the first and business class sections of sixteen aircraft for an average of $1.7 million per aircraft. Included in the purchase price was material, installation, maintenance through September 1998, one-year warranty and upgrade costs for the sixteen aircraft. As of October 31, 1998, the Company had completed installations of the entertainment network on all of these aircraft. The agreement also required the Company to install the entertainment network in the first, business and economy class sections of three additional aircraft, at no charge to Swissair. The Company was responsible for all costs including entertainment network components, installation and maintenance through September 1998 for the three aircraft. As of October 31, 1998, the Company had completed installations of the entertainment network on all of these aircraft and title to each of these three shipsets had been transferred to Swissair. During the fiscal year ended October 31, 1998, the Company recognized a recovery of special charges of $606,508 which resulted from a reduction in the number of entertainment networks requiring maintenance in the economy class sections of the Swissair aircraft and a reduction in development expenses. In April 1998 and October 1998, the Company entered into additional contracts with Swissair. The first letter of intent related to a $4.7 million order for first and business class installations on four Swissair MD-11 aircraft that were being added to the Swissair fleet. Swissair had made payments of $1,450,000 on the $4.7 million order through February 1999. No payments have been received since February. The second contract was to extend the warranty on all installed systems for a second and third year at a price of $3,975,000. Through February 1999, the Company had been paid $707,500 under this contract. No subsequent payments have been received from Swissair. On October 29, 1998, the Company was notified by Swissair of its decision to deactivate the entertainment networks on all Swissair aircraft. However, by April 1999, discussions between the Company and Swissair regarding outstanding financial matters related to current accounts receivable, inventory, purchase commitments and extended warranty obligations, as well as planning discussions for an October 1999 reactivation ceased to be productive. On May 6, 1999, Global filed a lawsuit against Swissair in the United States District Court for the District of Arizona seeking damages for Swissair's failure to honor its obligations for payment and reactivation of the Company's Entertainment Network. The Swissair agreements are not assignable to third parties under the terms of such agreements. However, in connection with the Transaction, Global has agreed to pay to the Company any net proceeds, if any, received from Swissair as a result of the above litigation or otherwise. Further, the Company, as a subcontractor to Global, will assume any operational responsibilities of the Swissair agreement in the event that such requirement arises. The Company has not assumed any liabilities or obligations arising out of the crash of Swissair Flight No. 111. As a result of the above events, management concluded that its only source of future payment, if any, will be through the litigation process. In addition, with the deactivation of the entertainment system and Swissair's breach of its agreements with Global, the Company believes it will not be called upon by Swissair to perform any ongoing warranty, maintenance or development services. Swissair's actions have rendered the Company's accounts receivable, inventory and deposits worthless as of June 30, 1999. Accordingly, for the Transition Period, the Company has recognized revenue on equipment sales to the extent of cash received of $876,000; charged off inventory to cost of equipment sales in the amount of $1,517,000; wrote off deposits of $655,000 to special charges; and reversed all warranty and maintenance accruals totaling $5,164,000. F-26 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED Pursuant to an agreement with Debonair, the Company was to manufacture, install, operate, and maintain the entertainment network on six Debonair aircraft for a period of eight years from installation. In February 1998, the Company and Debonair signed a Termination Agreement. Pursuant to the Termination Agreement, Debonair removed the entertainment network from its aircraft and the Company paid Debonair $134,235 as full and final settlement of all of its obligations with Debonair. In connection with these agreements with Swissair and Debonair and the absence of any new entertainment network orders, the Company recorded property and equipment write-downs of $1,006,532 during fiscal 1998, which are included in special charges on the consolidated statement of operations. Pursuant to an agreement with Alitalia, the Company delivered five first generation shipsets for installation on Alitalia aircraft during fiscal 1996. Subsequently, Alitalia notified the Company that it did not intend to continue operation of the shipsets, and the Company indicated that it will not support the shipsets. For the Transition Period ended June 30, 1999, the Company recorded warranty, maintenance and commission accrual adjustments of $5,117,704, $1,730,368 and $303,321, respectively, related to the Swissair and Alitalia matters. Such adjustments to prior period estimates, which totaled $7,151,393 resulted from an evaluation of specific contractual obligations and discussions between the new management of the Company and other parties related to such contracts. Based on the results of the Company's findings during this period, such accruals were no longer considered necessary. (20) SEGMENT INFORMATION The Company operates principally in one industry segment; development, manufacturing and marketing of computer-based entertainment and data networks. Prior to the Transition Period, the Company's principal revenues had been derived from European customers. Since the Transaction, the majority of revenues have been derived from the sale of servers and equipment in the U.S. For the year ended June 30, 2000, one customer accounted for 78% of the Company's sales. For the Transition Period ended June 30, 1999 and the year ended October 31, 1998, one different customer accounted for 91% and 98% of the Company's sales, respectively. Outstanding receivables from each of the customers were zero at June 30, 2000 and June 30, 1999. (21) SUPPLEMENTAL FINANCIAL INFORMATION Supplemental disclosure of cash flow information is as follows:
YEAR ENDED TRANSITION YEAR ENDED JUNE 30, PERIOD ENDED OCTOBER 31, 2000 JUNE 30, 1999 1998 ----------- ------------- ----------- Cash paid for interest $ 28,777 $ -- $ 11,954 =========== ==== ======== Non-cash for investing and financing activities: Issuance of warrants and stock to third parties for services and in connection with financing $ 1,166,880 $ -- $ -- Issuance of warrants to related party for collateral pledges 797,668 -- -- Conversion of Promissory Note 4,476,048 -- -- Conversion of note payable 400,000 -- -- Beneficial conversion on Facility 4,200,000 -- -- Partial conversion of Facility 1,850,000 -- -- Net Issuance of commitment shares associated with equity purchase agreement 553,677 -- --
(22) SUBSEQUENT EVENTS (a) CONVERSION OF SERIES D PREFERRED STOCK On August 2, 2000, upon receipt of notice of conversion from Global, the Company issued 5,000,000 shares of its Common Stock to Global upon conversion of 826,447 shares of the Company's Series D Preferred Stock held by Global. As of September 25, 2000, Global's ownership in the Company was 77% on an if-converted common stock basis. F-27 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED (b) ISSUANCE OF SERIES E CONVERTIBLE PREFERRED STOCK In August 2000, the Company designated 500 shares of Series E 6% Convertible Preferred Stock ("Series E Stock"); stated value $10,000 per share and liquidation value $10,000 per share plus accrued and unpaid dividends. At the option of the Holder, beginning 180 days after the date of issue, each share of Series E Stock is convertible into common stock at the lesser of $4.00 per share or the Average Market Price for common stock for the five consecutive trading days immediately preceding such date, as defined. The Company may redeem the Series E Stock at prices ranging from 110% to 120% of stated value, plus accrued dividends during the first 180 days from date of issue. The redemption premium increases at a rate of 3% per month to a maximum of 140% of stated value. On August 3, 2000, the Company entered into a subscription agreement for the sale of up to 500 shares of Series E Stock. On that date, the Company sold for net proceeds of approximately $920,000, 100 shares of its Series E Stock. (c) ISSUANCE OF NOTE PAYABLE AND WARRANTS On September 12, 2000, the Board of Directors authorized the issuance of common stock purchase warrants to purchase 311,560 shares of the Company's Common Stock which have been divided equally between two trusts controlled by Irwin L. Gross, the Chairman and Chief Executive Officer of the Company, as compensation for various working capital advances made to the Company from May 2000 through July 2000. As of June 30, 2000, advances totaled $800,000 and additional advances of $250,000 have been made subsequent to year end. On September 12, 2000, the Company's Board of Directors also approved the conversion of these advances into promissory notes from the Company. (See Note 10). The number of warrants issued for each advance was based upon the amount advanced divided by the closing market price of the Company's common stock on the date of each advance. The warrants have an exercise price based upon the closing market price of the Company's Common Stock on the date of the advance and a term of five years from such date. The fair value of the warrants issued were $797,000 of which $137,000 was recorded as a non-cash charge to interest expense in the year ended June 30, 2000. (d) INVESTMENT BY OFFICER In August 2000, an officer of the Company advanced $970,000 to the Company for working capital purposes in exchange for common stock. Final terms and conditions of this investment have not been reached, however, common stock purchase warrants of the Company will be issued in connection with this transaction. (e) CARNIVAL AGREEMENT In September 1998, the Company entered into a Turnkey Agreement (the "Carnival Agreement") with Carnival Corporation ("Carnival") for the purchase, installation and maintenance of its advanced cabin entertainment and management system for the cruise industry ("CruiseView(TM)") on a minimum of one Carnival Cruise Lines ship. During the four-year period commencing on the date of the Carnival Agreement, Carnival had the right to designate an unspecified number of additional ships for the installation of CruiseView(TM). The cost per cabin for CruiseView(TM) purchase and installation on each ship was provided for in the Carnival Agreement. In December 1998, Carnival ordered the installation of CruiseView(TM) on one Carnival Cruise Lines "Fantasy" class ship which has been in operational use since August 1999. In August 1999, Carnival ordered the installation of CruiseView(TM) on one Carnival Cruise Lines "Destiny" class ship which was in operational use from October 1999 through March 2000. Under the terms of the agreement, the Company was to receive payment for 50% of the sales price of the system in installments through commencement of operation of the system. Recovery of the remaining sales price of the system was to be achieved through the receipt of the Company's 50% share of net profits, as defined in the Carnival Agreement, generated by the system over future periods. F-28 THE NETWORK CONNECTION, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED The terms of the Carnival Agreement provided that Carnival may return the CruiseView(TM) system within the acceptance period, as defined in the Carnival Agreement, or for breach of warranty. The acceptance period for the Fantasy and Destiny class ships were twelve months and three months, respectively, from completion of installation and testing, which occurred in February 1999 and October 1999, respectively. The initial warranty period for these systems was three years. As of March 31, 2000, the Company had recorded deferred revenue of approximately $2.1 million related to the two Carnival ships. Beginning in the quarter ended March 31, 2000, the Company had experienced costs in excess of those recoverable under the Carnival Agreement. Given these costs, and ongoing technical issues, the Company notified Carnival of its desire to renegotiate the Carnival Agreement. During these discussions, Carnival notified the Company in a letter dated April 24, 2000 that it sought to terminate the Carnival Agreement and sought to assert certain remedies thereunder. On September 25, 2000, the Company entered into a Master Settlement Agreement and Mutual Release with Carnival (the "Settlement Agreement"). The Settlement Agreement specifies that the Company and Carnival agree: (i) To terminate the Carnival Agreement; (ii) to negotiate in good faith to enter into a New Agreement; (iii) that the Company will issue to Carnival a one-year convertible note payable in the principal amount of $550,000; (iv) to mutually release each party from any prior claims; and (v) the Company shall retain ownership of any and all equipment (other than wiring and switching equipment installed for networking purposes which Carnival purchased and paid in full pursuant to the Carnival Agreement) installed on any Carnival ship. Based on the above, the Company recorded revenue of $1.4 million for the value of networking equipment purchased by Carnival, cost of revenue in an equal amount by applying the cost recovery method of accounting and special charges of approximately $2.1 million resulting from the Settlement Agreement. The Company also recorded a special charge reflecting the write-off of: (i) all remaining inventory associated with Carnival as substantial uncertainty exists regarding its realizability (approximately $2.1 million); (ii) all costs associated with the deinstallation and removal of equipment from the two ships (approximately $85,000) and (iii) all costs associated with the refurbishment of certain equipment such that the equipment may be re-deployed to other customers ($174,000). Special charges were offset by the reversal of deferred revenue of $190,000 which the Company was not required to return to Carnival, and warranty accruals for which the Company has no continuing obligation. Pursuant to the Settlement Agreement, the Company and Carnival continued discussions with respect to a New Agreement which would cover the installation of the Company's latest CruiseView(TM) technology on the "Fantasy" class ship discussed above, and contractual terms more favorable to the Company than the Carnival Agreement, including a longer-term and multiple ship arrangement. The Company believes its new technology improves the Company's ability to create multiple new content and commerce-based revenue streams, and to establish a business relationship providing appropriate returns to each partner. However, while the Company is optimistic about the discussions, there is no assurance that the Company will be successful in reaching a mutually satisfactory resolution of the Carnival Agreement and in securing a new, more favorable long-term contract with Carnival. Notwithstanding the above, the Company continues to operate its CruiseView(TM) system aboard one Carnival Fantasy class ship on a month-to-month basis and will continue to do so as long as the economics are beneficial to the Company and Carnival. F-29 EX-3.1.10 2 0002.txt AMENDMENT TO ARTICLES OF INCORPORATION ARTICLES OF AMENDMENT TO THE ARTICLES OF INCORPORATION OF THE NETWORK CONNECTION, INC. These Articles of Amendment (the "Amendment") are being executed as of August 3, 2000, for the purpose of amending the Articles of Incorporation of The Network Connection, Inc. (the "Company"), pursuant to Section 14-2-602 of the Georgia Business Corporation Code. NOW THEREFORE, the undersigned hereby certifies as follows: FIRST: The name of the corporation is The Network Connection, Inc. (the "CORPORATION"). RESOLVED, that pursuant to Article V of the Articles of Incorporation of the company, there be and hereby is authorized and created a series of Preferred Stock, hereby designated as Series E Convertible Preferred Stock to consist of Five Hundred (500) shares with a par value of $.01 per share and a Stated Value of $10,000 per share (the "Stated Value"), and that the designations, preferences and relative, participating, optional or other rights of the Series E Convertible Preferred Stock (the "Series E Preferred Stock") and qualifications, limitations or restrictions thereof, shall be as follows: ARTICLE 1 DIVIDENDS The Series E Preferred Shares shall bear dividends commencing on the Issuance Date at the rate of 6% per annum based upon a 365-day year. Dividends shall be payable by the Company to the holder in cash or Common Stock registered with the u.s. Securities and Exchange Commission (the "SEC") in accordance with the requirements of Article 2(f) herein. The number of registered shares of Common Stock to be delivered pursuant to this Section shall be determined by dividing the amount of the dividend due and payable by the applicable Conversion Price. ARTICLE 2 HOLDER'S CONVERSION OF SERIES E PREFERRED SHARES A holder of Series E Preferred Shares shall have the right, at such holder's option, to convert the Series E Preferred Shares into shares of the Company's common stock, $. 001 par value per share (the "COMMON STOCK"), on the following terms and conditions: (a) CONVERSION RIGHT. Subject to the provisions of Sections 2(g) and 3(a) below, at any time or times on or after the earlier of (i) February 1, 2001 (as defined herein), (ii) 5 days after receiving a "no-review" status from the SEC in connection with a registration statement ("REGISTRATION STATEMENT") covering the resale of Common Stock issued upon conversion of the Series E Preferred Shares and required to be filed by the Company pursuant to the Registration Rights Agreement between the Company and its initial holders of Series E Preferred Shares (the "REGISTRATION RIGHTS AGREEMENT"), (iii) the date that the Registration Statement is declared effective by the SEC any holder of Series E Preferred Shares shall be entitled to convert any Series E Preferred Shares into fully paid and nonassessable shares (rounded to the nearest whole share in accordance with Section 2(h) below) of Common Stock (the "Initial Conversion Date"), at the Conversion Rate (as defined below); PROVIDED, HOWEVER, that in no event other than upon a Mandatory Conversion pursuant to Section 2(g) hereof, or upon a Triggering Event pursuant to Section 6(e) hereof, shall any holder be entitled to convert Series E Preferred Shares in excess of that number of Series E Preferred Shares which, upon giving effect to such conversion, would cause the aggregate number of shares of Common Stock beneficially owned by the holder and its affiliates to exceed 4.9% of the outstanding shares of the Common Stock following such conversion. For purposes of the foregoing proviso, the aggregate number of shares of Common Stock beneficially owned by the holder and its affiliates shall include the number of shares of Common Stock issuable upon conversion of the Series E Preferred Shares with respect to which the determination of such proviso is being made, but shall exclude the number of shares of Common Stock which would be issuable upon (i) conversion of the remaining, nonconverted Series E Preferred Shares beneficially owned by the holder and its affiliates beneficially owned by the holder and its affiliates. Except as set forth in the preceding sentence, for purposes of this paragraph, beneficial ownership shall be calculated in accordance with Section 13(d) of the Securities Exchange Act of 1934, as amended. In the event that the Company breaches any of the representations, warranties or covenants contained herein or in any agreement executed in connection herewith, the Initial Conversion Date shall be accelerated to the date of such breach. (b) CONVERSION RATE. The number of shares of Common Stock issuable upon conversion of each of the Series E Preferred Shares pursuant to Section (2)(a) shall be determined according to the following formula (the "CONVERSION RATE"); 10,000 ---------------- CONVERSION PRICE For purposes of this Certificate of Designations, the following terms shall have the following meanings: (i) "CONVERSION PRICE" means as, of any Conversion Date (as defined below), the lower of the Fixed Conversion Price and the Floating Conversion Price, each in effect as of such date, if applicable, and subject to adjustment as provided herein; (ii) "FIXED CONVERSION PRICE" means $4.00, subject to adjustment, as provided herein; (iii) "FLOATING CONVERSION PRICE" means, as of any date of determination, the amount obtained by multiplying the Conversion Percentage in effect as of such date by the Average Market Price for the Common Stock for the five (5) consecutive trading days immediately preceding such date; (iv) "CONVERSION PERCENTAGE" means 80% as adjusted as described herein; 2 (v) "AVERAGE MARKET PRICE" means, with respect to any security for any period, that price which shall be computed as the arithmetic average of the Closing Bid Prices (as defined below) for such security for each trading day in such period; (vi) "CLOSING BID PRICE" means, for any security as of any date, the last closing bid price on the Nasdaq National Market (the "NASDAQ-NM") as reported by Bloomberg Financial Markets ("BLOOMBERG"), or, if the Nasdaq-NM is not the principal trading market for such security, the last closing bid price of such security on the principal securities exchange or trading market where such security is listed or traded as reported by Bloomberg, or if the foregoing do not apply, the last closing sale price of such security in the over-the-counter market on the pink sheets or bulletin board for such security as reported by Bloomberg, or, if no closing sale price is reported for such security by Bloomberg, the last closing trade price of such security as reported by Bloomberg. If the Closing Bid Price cannot be calculated for such security on such date on any of the foregoing bases, the Closing Bid Price of such security on such date shall be the fair market value as reasonably determined in good faith by the Board of Directors of the Company (all as appropriately adjusted for any stock dividend, stock split or other similar transaction during such period); and (vii) "N" means the number of days from, but excluding, the Issuance Date through and including the Conversion Date for the Series E Preferred Shares for which conversion is being elected. (viii) "ISSUANCE DATE" means the date of issuance of any of the Series E Preferred Shares. (ix) "REGISTRATION RIGHTS AGREEMENT" means that Registration Rights Agreement by and among the Company and the holders of the Series E Preferred Shares. (c) ADJUSTMENT TO CONVERSION PRICE - REGISTRATION STATEMENT. If the Registration Statement (i) has not been filed on or before November 1, 2000 (the "FILING DEADLINE"), (ii) is not declared effective by the SEC on or before one February 1, 2001 (THE "REGISTRATION DEADLINE"), and, in either case, the Company has not paid the full amount of Late Payment Penalty by the applicable Late Penalty Due Date (each as defined in the Registration Rights Agreement), or (iii) if after the Registration Statement has been declared effective by the SEC, sales cannot be made pursuant to the Registration Statement for any period of ten (10) trading days (whether because of a failure to keep the Registration Statement effective, to disclose such information as is necessary for sales to be made pursuant to the Registration Statement, to register sufficient shares of Common Stock or otherwise), then, as partial relief for the damages to any holder by 3 reason of any such delay in or reduction of its ability to sell the underlying shares of Common Stock (which remedy shall not be exclusive of any other remedies at law or in equity), the Conversion Percentage and the Fixed Conversion Price shall be adjusted as follows: (i) CONVERSION PERCENTAGE. The Conversion Percentage in effect from time to time, with respect to the Series E Preferred Shares which may be converted as permitted by Section 2(a) hereof, shall be reduced by a number of percentage points equal to the product of (A) three (3) and (B) the sum of (I) the number of months (prorated for partial months) after the Filing Deadline or Registration Deadline, as the case maybe, and prior to the date that the relevant Registration Statement is declared effective by the SEC and (II) the number of months (prorated for partial months) that sales cannot be made as set forth in Section 2(c) above.. (For example, if the Registration Statement becomes effective one and one-half (1 1/2) months after the Scheduled Effective Date, the Conversion Percentage with respect to the Series E Preferred Shares would decrease by four and one half percent (4.5% to 75.5%) until any subsequent adjustment; if, as a further example, thereafter sales could not be made pursuant to the Registration Statement for a period of two (2) additional months, the Conversion Percentage with respect to the Series E Preferred Shares would decrease by an additional six percent (6%), for an aggregate decrease of seven percent (10.5% to 69.5%). (ii) FIXED CONVERSION PRICE. The Fixed Conversion Price in effect from time to time with respect to the Series E Preferred Shares shall be reduced by an amount equal to the product of (A) $4.00 and (B) the sum of (I) the number of months (prorated for partial months) after the Filing Deadline or Registration Deadline, as the case maybe, and prior to the date that the Registration Statement is declared effective by the SEC and (II) the number of months (prorated for partial months) that sales cannot be made as set forth in Section 2(c) above. (For example, if the Registration Statement becomes effective one and one-half (1 1/2) months after the Scheduled Effective Date, the Fixed Conversion Price with respect to the Series E Preferred Shares would be $3.82. until any subsequent adjustment; if thereafter sales could not be made pursuant to the Registration Statement for a period of two (2) additional months, the Fixed Conversion Price with respect to the Series E Preferred Shares would then be $3.58). (ii) LIMITATION ON REDUCTION OF CONVERSION PERCENTAGE. At no time shall the Conversion Percentage (i) be reduced more than 3% in any calendar month period or (ii) be less than 60%. (d) ADJUSTMENT TO CONVERSION PRICE - DILUTION AND OTHER EVENTS. In order to prevent dilution of the rights granted under this Certificate of Designations, the Conversion Price will be subject to adjustment from time to time as provided in this Section 2(d). 4 (i) ADJUSTMENT OF FIXED CONVERSION PRICE UPON SUBDIVISION OR COMBINATION OF COMMON STOCK. If the Company at any time subdivides (by any stock split, stock dividend, recapitalization or otherwise) one or more classes of its outstanding shares of Common Stock into a greater number of shares, the Fixed Conversion Price in effect immediately prior to such subdivision will be proportionately reduced. If the Company at any time combines (by combination, reverse stock split or otherwise) one or more classes of its outstanding shares of Common Stock into a smaller number of shares, the Fixed Conversion Price in effect immediately prior to such combination will be proportionately increased. (ii) REORGANIZATION, RECLASSIFICATION, CONSOLIDATION, MERGER, OR SALE. Any recapitalization, reorganization reclassification, consolidation, merger, sale of all or substantially all of the Company's assets to another Person (as defined below) or other SIMILAR transaction which is effected in such a way that holders of Common Stock are entitled to receive (either directly or upon subsequent liquidation) stock, securities or assets with respect to or in exchange for Common Stock is referred to herein as in "Organic Change." Prior to the consummation of any Organic Change, the Company will make appropriate provision (in form and substance satisfactory to the holders of a majority of the Series E Preferred Shares then outstanding) to insure that each of the holders of the Series E Preferred Shares will thereafter have the right to acquire and receive in lieu of or in addition to (as the case may be) the shares of Common Stock immediately theretofore acquirable and receivable upon the conversion of such holder's Series E Preferred Shares, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for the number of shares of Common Stock immediately theretofore acquirable and receivable upon the conversion of such holder's Series E Preferred Shares had such Organic Change not taken place. In any such case, the Company will make appropriate provision (in form and substance satisfactory to the holders of a majority of the Series E Preferred Shares then outstanding) with respect to such holders' rights and interests to insure that the provisions of this Section 2(d) and Section 2(e) below will thereafter be applicable to the Series E Preferred Shares. The Company will not effect any such consolidation, merger or sale, unless prior to the consummation thereof the successor entity (if other than the Company) resulting from consolidation or merger or the entity purchasing such assets assumes, by written instrument (in form and substance satisfactory to the holders of a majority of the Series E Preferred Shares then outstanding), the obligation to deliver to each holder of Series E Preferred Shares such shares of stock, securities or assets as, in accordance with the foregoing provisions, such holder may be entitled to acquire. For purposes of this Agreement, "PERSON" shall mean an individual, a limited liability company, a partnership, a joint venture, a corporation, a trust, an unincorporated organization and a government or any department or agency thereof. 5 (iii) NOTICES. (A) Immediately upon any adjustment of the Conversion Price, the Company will give written notice thereof to each holder of Series E Preferred Shares, setting forth in reasonable detail and certifying the calculation of such adjustment. (B) The Company will give written notice to each holder of Series E Preferred Shares at least twenty (20) days prior to the date on which the Company closes its books or takes a record (I) with respect to any dividend or distribution upon the Common Stock, (II) with respect to any pro rata subscription offer to holders of Common Stock or (III) for determining rights to vote with respect to any Organic Change, dissolution or liquidation. (C) The Company will also give written notice to each holder of Series E Preferred Shares at least twenty (20) days prior to the date on which any Organic Change, Major Transaction (as defined below), dissolution or liquidation will take place. (e) PURCHASE RIGHTS. If at any time the Company grants, issues or sells any Options, Convertible Securities or rights to purchase stock, warrants, securities or other property pro rata to the record holders of any class of Common Stock (the "PURCHASE RIGHTS"), then the holders of Series E Preferred Shares will be entitled to acquire, upon the terms applicable to such Purchase Rights, the aggregate Purchase Rights which such holder could have acquired if such holder had held the number of shares of Common Stock acquirable upon complete conversion of the Series E Preferred Shares immediately before the date an which a record is taken for the grant issuance or sale of such Purchase Rights, or, if no such record is taken, the date as of which the record holders of Common Stock are to be determined for the grant, issue or sale of such Purchase Rights. (f) MECHANICS OF CONVERSION. Subject to the Company's inability to fully satisfy its obligations under a Conversion Notice (as defined below) as provided for in Section 5 below: (i) HOLDER'S DELIVERY REQUIREMENTS. To convert Series E Preferred Shares into full shares of Common Stock on any date (the "CONVERSION DATE"), the holder thereof shall (A) deliver or transmit by facsimile, for receipt on or prior to 11:59 p.m., Eastern Standard Time, on such date, a copy of a fully executed notice of conversion in the form attached hereto as Exhibit I (the "CONVERSION NOTICE") to the Company or its designated transfer agent (the "TRANSFER AGENT"), and (B) surrender to a common carrier for delivery to the Company as soon as practicable following such date, the original certificates representing the Series E Preferred Shares being converted (or an indemnification undertaking with respect to such shares in the case of their loss, theft or destruction) (the "PREFERRED STOCK CERTIFICATES") and the originally executed Conversion Notice. Upon such conversion by any such holders the 6% per annum premium which has accrued shall be payable hereunder shall be paid in cash or common stock (based upon the Conversion Price) at such time at the election of the Company. 6 (ii) COMPANY'S RESPONSE. Upon receipt by the Company of a facsimile copy of a Conversion Notice, the Company shall as soon as practicable send, via Facsimile, a confirmation of receipt of such Conversion Notice to such holder. Upon receipt by the Company or the Transfer Agent of the Preferred Stock Certificates to be converted pursuant to a Conversion Notice, together with the originally executed Conversion Notice, the Company or the Transfer Agent (as applicable) shall, within five (5) business days following the date of receipt, (A) issue and surrender to a common carrier for overnight delivery to the address as specified in the Conversion Notice, a certificate, registered in the name of the holder or its designee, for the number of shares of Common Stock to which the holder shall be entitled or (B) credit the aggregate number of shares of Common Stock to which the holder shall be entitled to the holder's or its designee's balance account at The Depository Trust Company and (C) pay any dividends due to holder or its designee. (iii) DISPUTE RESOLUTION. In the case of a dispute as to the determination of the Average Market Price or the arithmetic calculation of the Conversion Rate, the Company shall promptly issue to the holder the number of shares of Common Stock that is not disputed and shall submit the disputed determinations or arithmetic calculations to the holder via facsimile within three (3) business days of receipt of such holder's Conversion Notice. If such holder and the Company are unable to agree upon the determination of the Average Market Price or arithmetic calculation of the Conversion Rate within two (2) business days of such disputed determination or arithmetic calculation being submitted to the holder, then the Company shall within one (1) business day submit via facsimile (A) the disputed determination of the Average Market Price to an independent, reputable investment bank or (B) the disputed arithmetic calculation of the Conversion Rate or any dividends due and payable to its independent, outside accountant. The Company shall cause the investment bank or the accountant, as the case may be, to perform the determinations or calculations and notify the Company and the holder of the results no later than forty-eight (48) hours from the time it receives the disputed determinations or calculations. Such investment bank's or accountant's determination or calculation, as the case may be, shall be binding upon all parties absent manifest error. (iv) RECORD HOLDER. The person or persons entitled to receive the shares of Common Stock issuable upon a conversion of Series E Preferred Shares shall be treated for all purposes as the record holder or holders of such shares of Common Stock on the Conversion Date. (v) COMPANY'S FAILURE TO TIMELY CONVERT. If the Company shall fail to issue to a holder within five (5) business days following the date of receipt by the Company of the Preferred Stock Certificates to be converted pursuant to a Conversion Notice, a certificate for the number of shares of Common Stock to which such holder is entitled upon such holder's conversion of Series E Preferred Shares, in addition to all other available remedies which such holder may pursue hereunder and under the Securities Purchase Agreement between the Company and the initial holders of the Series E Preferred Shares (the "SECURITIES PURCHASE AGREEMENT") (including indemnification pursuant to Section 8 7 thereof), the Company shall pay additional damages to such holder on each day after the fifth (5th) business day following the date of receipt by the Company or the Transfer Agent of the Preferred Stock Certificates to be converted pursuant to the Conversion Notice, for which such conversion is not timely effected, an amount calculated in accordance with the following schedule: LATE PAYMENT FOR EACH PRINCIPAL AMOUNT BEING SERIES E PREFERRED NO. BUSINESS DAYS LATE SHARE CONVERTED ---------------------- --------------------- 1 $ 100 2 $ 200 3 $ 300 4 $ 400 5 $ 500 6 $ 600 7 $ 700 8 $ 800 9 $ 900 10 $1,000 (g) MANDATORY CONVERSION. If any Series E Preferred Shares remain outstanding on August 2, 2002, then all such Series E Preferred Shares shall be converted as of such date in accordance with this Section 2 as if the holders of such Series E Preferred Shares had given the Conversion Notice on August 2, 2002, and the Conversion Date had been fixed as of August 2, 2002, for all purposes of this Section 2, and all holders of Series E Preferred Shares shall thereupon and with two (2) business days thereafter surrender all Preferred Stock Certificates, duly endorsed for cancellation, to the Company. No person shall thereafter have any rights in respect of Series E Preferred Shares, except the right to receive shares of Common Stock on conversion thereof as provided in this Section 2. (h) FRACTIONAL SHARES. The Company shall not issue any fraction of a share of Common Stock upon any conversion. All shares of Common Stock (including fractions thereof) issuable upon conversion of more than one share of the Series E Preferred Shares by a holder thereof shall be aggregated for purposes of determining whether the conversion would result in the issuance of a fraction of a share of Common Stock. If, after the aforementioned aggregation, the issuance would result in the issuance of a fraction of it share of Common Stock, the Company shall round such fraction of a share of Common Stock up or down to the nearest whole share. ARTICLE 3 COMPANY'S RIGHT TO REDEEM AT ITS ELECTION (a) (1) Until February 1, 2001, or (2) at any time on or after February 1, 2001, as long as the Company has not breached any of the representations, warrants, and covenants contained herein or in any related agreements, the Company shall have the right, in it sole discretion, to redeem ("REDEMPTION AT 8 COMPANY'S ELECTION"), from time to time, any or all of the Series E Preferred Stock: provided (i) Company shall first provide ten (10) days advance written notice as provided in subparagraph 3(a)(ii) and (ii) that the Company shall only be entitled to redeem Series E Preferred Stock having an aggregate Stated Value (as defined below) of at least Two Hundred Fifty Thousand Dollars ($250,000); provided, however, that after February 1, 2001, the Company's right to redeem hereunder is subject to the condition that the Company is not in breach of a representation, warranty or covenant contained herein or in any related agreement. If the Company elects to redeem some, but not all, of the Series E Preferred Stock, the Company shall redeem a pro-rata amount from each Holder of the Series E Preferred Stock. (i) REDEMPTION PRICE AT COMPANY'S ELECTION. The "REDEMPTION PRICE AT COMPANY'S ELECTION" shall be calculated as (a) 110% of Stated Value for the first 90 days following the Issuance Date, (b) 120% of the Stated Value for the period beginning 90 days after the Issuance Date and ending 180 days after the Issuance Date and (c) an additional 3% shall be added to 120% of the Stated Value for each 30 day period thereafter, of the Series E Preferred Stock; provided, however that the Redemption Price at Company's Election shall in no event be greater than 140% of the Stated Value. In addition, if any time prior to August 2, 2002, the Conversion Price is equal to or less than $1.75 per share, prior to any adjustment as provided herein the Company shall have the right, in it sole discretion, to redeem from time to time, any or all of the Series E Preferred Stock at a price equal to 125% of the Stated Value: provided (i) Company shall first provide twenty four hours (24) hours advance written notice by facsimile, federal express and email as provided in subparagraph 3(a)(ii) below, and (ii) that the Company shall only be entitled to redeem Series E Preferred Stock having an aggregate Stated Value (as defined below) of at least Two Hundred and Fifty Thousand Dollars ($250,000) (the "FLOOR PRICE REDEMPTION"). If the Company elects to redeem some, but not all, of the Series E Preferred Stock, the Company shall redeem a pro-rata amount from each Holder of the Series E Preferred For purposes hereof, "STATED VALUE" shall mean the original principal amount of Preferred Stock being redeemed. (ii) MECHANICS OF REDEMPTION AT COMPANY'S ELECTION. The Company shall effect each such redemption by giving at least ten (10) days prior written notice (except that in the case of the Floor Price Redemption the Company must provide 24 hours facsimile, federal express and email notice) ("NOTICE OF REDEMPTION AT COMPANY'S ELECTION") to (A) the Holders of the Series E Preferred Stock selected for redemption at the address and facsimile number of such Holder appearing in the Company's Series E Preferred Stock register and (B) the Transfer Agent, which Notice of Redemption At Company's Election (except in the case of the Floor Price Redemption) shall be deemed to have been delivered three (3) business days after the Company's mailing (by overnight or two (2) day courier, with a copy by facsimile) of such Notice of Redemption at Company's Election. Such Notice of Redemption At Company's Election shall indicate (i) the number of shares of Series E Preferred Stock that have been selected for redemption, (ii) the date which such redemption is to become effective (the "DATE OF REDEMPTION AT COMPANY'S ELECTION") and (iii) the applicable Redemption Price At Company's Election, as defined in subsection (a)(i) above. Notwithstanding the above, except in the case of a Floor Price Redemption (where upon receipt thereof by the Holder no further conversions by the Holder, with respect thereof will be 9 permitted unless the Company fails to abide by the terms of redemption described in this Article 3), Holder may convert into Common Stock, prior to actual receipt of a Notice of Redemption at Company's Election, any Series E Preferred Stock which it is otherwise entitled to convert, including Series E Preferred Stock that has been selected for redemption at Company's election pursuant to this subsection 3(a). (b) COMPANY MUST HAVE IMMEDIATELY AVAILABLE FUNDS OR CREDIT FACILITIES. The Company shall not be entitled to send any Redemption Notice and begin the redemption procedure under Sections 3(a) unless it has: (i) the full amount of the redemption price to cash, available in a demand or other immediately available account in a bank or similar financial institution; or (ii) immediately available credit facilities, in the full amount of the redemption price with a bank or similar financial institution, or (iii) an agreement with a standby underwriter willing to purchase from the Company a sufficient number of shares of stock to provide proceeds necessary to redeem any stock that is not converted prior to redemptions; or (iv) a combination of the items set forth in (i), (ii), and (iii) above, aggregating the full amount of the redemption price. (c) PAYMENT OF REDEMPTION PRICE. Each Holder submitting Preferred Stock being redeemed under this Section 3 shall send their Series E Preferred Stock Certificates redeemed to the Company or its Transfer Agent, and the Company shall pay the applicable redemption price to that Holder within five (5) business days of the Date of Redemption at Company's Election. Failure by the Company to pay the redemption price in full when due shall result in a forfeiture and termination of the Company's redemption rights as described in this Section (3). ARTICLE 4 (a) NASDAQ COMPLIANCE. So long as the Common Stock is listed for trading on Nasdaq-SM or an exchange or quotation system with a rule substantially similar to Rule 4460(i) then, notwithstanding anything to the contrary contained herein if, at any time, the aggregate number of shares of Common Stock then issued upon conversion of the Series E Preferred Shares (including any shares of capital stock or rights to acquire shares of capital stock issued by the Corporation which are aggregated or integrated with the Common Stock issued or issuable upon conversion of the Series E Preferred Stock for purposes of such rule) equals 19.99% of the "Outstanding Common Amount" (as hereinafter defined), the Series E Preferred Stock shall, from that time forward, cease to be convertible into Common Stock in accordance with the terms hereof, unless the Corporation has obtained approval of the (i) issuance of the Common Stock upon conversion of the Series E Preferred Stock by a majority of the total votes cast on such proposal, in person or by proxy, by the holders of the then-outstanding Common Stock (not including any shares of Common Stock held by present or former holders of Series E Preferred Stock that were issued upon conversion of Series E Preferred Stock that were issued upon conversion of Series E Preferred Stock) (the "STOCKHOLDER APPROVAL"), or (ii) conversion of Series E Preferred Stock, or (iii) shall have 10 otherwise obtained permission to allow such issuances from Nasdaq in accordance with Nasdaq Rule 4460(i). If the Corporation's Common Stock is not then listed on Nasdaq or an exchange or quotation system that has a rule substantially similar to Rule 4460(i) then the limitations set forth herein shall be inapplicable and of no force and effect. For purposes of this paragraph, "OUTSTANDING COMMON AMOUNT" means (i) the number of shares of the Common Stock outstanding on the date of issuance of the Series E Preferred Stock pursuant to the Purchase Agreement plus (ii) any additional shares of Common Stock issued thereafter in respect of such shares pursuant to a stock dividend, stock split or similar event. The maximum number of shares of Common Stock issuable as a result of the 19.99% limitation set forth herein is hereinafter referred to as the "MAXIMUM SHARE AMOUNT." With respect to each holder of Series E Preferred Stock, the Maximum Share Amount shall refer to such holder's pro rata share thereof. In the event that Corporation obtains Stockholder Approval or the approval of Nasdaq, by reason of the inapplicability of the rules of Nasdaq or otherwise and concludes that it is able to increase the number of shares to be issued above the Maximum Share Amount (such increased number being the "NEW MAXIMUM SHARE AMOUNT"), the references to Maximum Share Amount, above, shall be deemed to be, instead, references to the greater New Maximum Share Amount. In the event that Stockholder Approval is obtained, there are insufficient reserved or authorized shares or a registration statement covering the additional shares of Common Stock which constitute the New Maximum Share Amount is not effective prior to the Maximum Share Amount being issued (if such registration statement is necessary to allow for the public resale of such securities), the Maximum Share Amount shall remain unchanged; provided, however, that the holders of Series E Preferred Stock may grant an extension to obtain a sufficient reserved or authorized amount of shares or of the effective date of such registration statement. ARTICLE 5 INABILITY TO FULLY CONVERT (a) HOLDER'S OPTION IF COMPANY CANNOT FULLY CONVERT. If at any time after the earlier to occur of (i) effectiveness of the Registration Statement or (ii) sixty (60) days after the Scheduled Effective Date, upon the Company's receipt of a Conversion Notice, the Company does not issue shares of Common Stock which are registered for resale under the Registration Statement within five (5) business days of the time required in accordance with Section 2(f) hereof, for any reason or for no reason, including, without limitation, because the Company (x) does not have a sufficient number of shares of Common Stock authorized and available, (y) is otherwise prohibited by applicable law or by the rules or regulations of any stock exchange, interdealer quotation system or other self-regulatory organization with jurisdiction over the Company or its Securities, including without limitation the Nasdaq-Small Cap, from issuing all of the Common Stock which is to be issued to a holder of Series E Preferred Shares pursuant to a Conversion Notice or (z) fails to have a sufficient number of shares of Common Stock registered and eligible for resale under the Registration Statement, then the Company shall issue as many shares of Common Stock as it is able to issue in accordance with such holder's Conversion Notice and pursuant to Section 2(f) above and, with respect to the unconverted Series E Preferred Shares, the holder, solely at such holder's option, can, in addition to any other remedies such holder may have hereunder, under the Securities Purchase Agreement (including indemnification under Section 8 thereof), under the Registration Rights Agreement, at law or in equity, elect to: 11 (i) require the Company to redeem from such holder those Series E Preferred Shares for which the Company is unable to issue Common Stock in accordance with such holder's Conversion Notice ("MANDATORY REDEMPTION") at a price per Series E Preferred Share (the "MANDATORY REDEMPTION PRICE") equal to the greater of (x) 130% of the Liquidation Value of such share and (y) the Redemption Rate as of such Conversion Date; (ii) if the Company's inability to fully convert Series E Preferred Shares is pursuant to Section 5(a)(z) above, require the Company to issue restricted shares of Common Stock in accordance with such holder's Conversion Notice and pursuant to Section 2(f) above; or (iii) void its Conversion Notice and retain or have returned, as the case may be, the nonconverted Series E Preferred Shares that were to be converted pursuant to such holder's Conversion Notice. (b) MECHANICS OF FULFILLING HOLDER'S ELECTION. The Company shall immediately send via facsimile to a holder of Series E Preferred Shares, upon receipt of a facsimile copy of a Conversion Notice from such holder which cannot be fully satisfied as described in Section 5(a) above, a notice of the Company's inability to fully satisfy such holder's Conversion Notice (the "INABILITY TO FULLY CONVERT NOTICE"). Such Inability to Fully Convert Notice shall indicate (i) the reason why the Company is unable to fully satisfy such holder's Conversion Notice, (ii) the number of Series E Preferred Shares which cannot be converted and (iii) the applicable Mandatory Redemption Price. Such holder must within five (5) business days of receipt of such Inability to Fully Convert Notice deliver written notice via facsimile to the Company ("NOTICE IN RESPONSE TO INABILITY TO CONVERT") of its election pursuant to Section 5(a) above. (c) PAYMENT OF REDEMPTION PRICE. If such holder shall elect to have its shares redeemed pursuant to Section 5(a) above, the Company shall pay the Mandatory Redemption Price in cash to such holder within thirty (30) days of the Company's receipt of the holder's Notice in Response to Inability to Convert. If the Company shall fail to pay the applicable Mandatory Redemption Price to such holder on a timely basis as described in this Section 5(c) (other than pursuant to a dispute as to the determination of the Closing Bid Price or the arithmetic calculation of the Redemption Rate), such unpaid amount shall bear interest at the rate of 2.5% per month (prorated for partial months) until paid in full. Until the full Mandatory Redemption Price is paid in full to such holder, such holder may void the Mandatory Redemption with respect to those Series E Preferred Shares for which the full Mandatory Redemption Price has not been paid and receive back such Series E Preferred Shares. Notwithstanding the foregoing, if the Company fails to pay the applicable Mandatory Redemption Price within such thirty (30) days time period due to a dispute as to the determination of the Closing Bid Price or the arithmetic calculation of the Redemption Rate, such dispute shall be resolved pursuant to Section 2(f)(iii) above with the term "CLOSING BID PRICE" being substituted for the term "AVERAGE MARKET PRICE" and the term, "REDEMPTION RATE" being substituted for the term "CONVERSION RATE." (d) PRO-RATA CONVERSION AND REDEMPTION. In the event the Company receives a Conversion Notice from more than one holder of Series E Preferred Shares on the same day and the Company can convert and redeem some, but not all, of the Series 12 E Preferred Shares pursuant to this Section 5, the Company shall convert and redeem from each holder of Series E Preferred Shares electing to have Series E Preferred Shares converted and redeemed at such time an amount equal to such holder's pro-rata amount (based on the number of Series E Preferred Shares held by such holder relative to the number of Series E Preferred Shares outstanding) of all Series E Preferred Shares being converted and redeemed at such time. ARTICLE 6 REISSUANCE OF CERTIFICATES In the event of a conversion or redemption pursuant to this Certificate of Designations of less than all of the Series E Preferred Shares represented by a particular Preferred Stock Certificate, the Company shall promptly cause to be issued and delivered to the holder of such Series E Preferred Shares a Preferred stock certificate representing the remaining Series E Preferred Shares which have not been so converted or redeemed. ARTICLE 7 RESERVATION OF SHARES The Company shall, so long as any of the Series E Preferred Shares are outstanding, reserve and keep available out of its authorized and unissued Common Stock, solely for the purpose of effecting the conversion of the Series E Preferred Shares, at least 150% of number of Shares of Common Stock as shall from time to time be sufficient to affect the conversion of all of the Series E Preferred Shares and Warrant Shares then outstanding. ARTICLE 8 VOTING RIGHTS Holders of Series E Preferred Shares shall have no voting rights, except as required by law, including but not limited to the Georgia General Business Corporation Code and as expressly provided in this Certificate of Designations. ARTICLE 9 LIQUIDATION, DISSOLUTION, WINDING-UP In the event of any voluntary or involuntary liquidation, dissolution, or winding up of the Company, the holders of the Series E Preferred Shares shall be entitled to receive in cash out of the assets of the Company, whether from capital or from earnings available for distribution to its stockholders (the "PREFERRED FUNDS"), before any amount shall be paid to the holders of any of the capital stock of the Company of any class junior in rank to the Series E Preferred Shares in respect of the preferences as to the distributions and payments on the liquidation, dissolution and winding up of the Company, an amount per Series E Preferred Share equal to the sum of (i) $10,000 and (ii) all accrued but unpaid dividends on such shares (such sum being referred to as the "LIQUIDATION VALUE"); provided that, if the Preferred Funds are insufficient to pay the full amount due to the holders of Series E Preferred Shares and holders of shares of other classes or series of preferred stock of the Company that are of equal rank with the Series E Preferred Shares as to payments of Preferred Funds (the "PARI PASSU SHARES"), then each holder of Series E Preferred Shares 13 and Pari Passu Shares shall receive a percentage of the Preferred Funds equal to the full amount of Preferred Funds payable to such holder as a liquidation preference, in accordance with their respective Certificate of Designations, Preferences and Rights as a percentage or the full amount of Preferred Funds payable to all holders of Series E Preferred Shares and Pari Passu Shares. The purchase or redemption by the Company of stock of any class in any manner permitted by law, shall not for the purposes hereof, be regarded as a liquidation, dissolution or winding up of the Company. Neither the consolidation or merger of the Company with or into any other Person, nor the sale or transfer by the Company of less than substantially all of its assets, shall, for the purposes hereof, be deemed to be a liquidation, dissolution or winding up of the Company. No holder of Series E Preferred Shares shall be entitled to receive any amounts with respect thereto upon any liquidation, dissolution or winding up of the Company other than the amounts provided for herein. ARTICLE 10 PREFERRED RATE All shares of Common Stock shall be of junior rank to all Series E Preferred Shares in respect to the preferences as to distributions and payments upon the liquidation, dissolution, and winding up of the Company. The rights of the shares of Common Stock shall be subject to the Preferences and relative rights of the Series E Preferred Shares. The Series E Preferred Shares shall be of greater than or pari passu with any Series of Common or Preferred Stock heretofore issued by the Company. Without the prior express written consent of the holders of not less than two-thirds (2/3) of the then outstanding Series E Preferred Shares, the Company shall not hereafter authorize or issue additional or other capital stock that is of senior rank to the Series E Preferred Shares in respect of the preferences as to distributions and payments upon the liquidation, dissolution and winding up of the Company. Without the prior express written consent of the holders of not less than two-thirds (2/3) of the then outstanding Series E Preferred Shares, the Company shall not hereafter authorize or make any amendment to the Company's Certificate of Incorporation or bylaws, or make any resolution of the board of directors with the Georgia Secretary of State containing any provisions, which would adversely affect or otherwise impair the rights or relative priority of the holders of the Series E Preferred Shares relative to the holders of the Common Stock or the holders of any other class of capital stock. In the event of the merger or consolidation of the Company with or into another corporation, the Series E Preferred Shares shall maintain their relative powers, designations, and preferences provided for herein and no merger shall result inconsistent therewith. ARTICLE 11 RESTRICTION ON REDEMPTION AND DIVIDENDS (a) RESTRICTION ON DIVIDEND. If any Series E Preferred Shares are outstanding, without the prior express written consent of the holders of not less than two-thirds (2/3) of the then outstanding Series E Preferred Shares, the Company shall not directly or indirectly declare, pay or make any dividends or other distributions upon any of the Common Stock so long as written notice thereof has been given to holders of the Series E Preferred Shares at least 30 days prior to the earlier of (a) the record date taken for or (b) the payment of any such dividend or other distribution. Notwithstanding the foregoing, this Section 10(a) shall not prohibit the Company from declaring and paying a 14 dividend in cash with respect to the Common Stock so long as the Company: (i) pays simultaneously to each holder of Series E Preferred Shares an amount in cash equal to the amount such holder would have received had all of such holder's Series E Preferred Shares been converted to Common Stock pursuant to Section 2 hereof one business day prior to the record date for any such dividend, and (ii) after giving effect to the payment of any dividend and any other payments required in connection therewith including to the holders of the Series E Preferred Shares under clause 10(a)(i) hereof, the Company has in cash or cash equivalents an amount equal to the aggregate of: (A) all of its liabilities reflected on its most recently available balance sheet, (B) the amount of any indebtedness incurred by the Company or any of its subsidiaries since its most recent balance sheet and (C) 130% of the amount payable to all holders of any shares of any class of preferred stock of the Company assuming a liquidation of the Company as the date of its most recently available balance sheet. (b) RESTRICTION ON REDEMPTION. Except as otherwise provided herein, if any Series E Preferred Shares are outstanding, without the prior express written consent of the holders of not less than two-thirds (2/3) of the then outstanding Series E Preferred Shares, the Company shall not directly or indirectly redeem, purchase or otherwise acquire from any person or entity other than from a direct or indirect wholly-owned subsidiary of the Company, or permit any subsidiary of the Company to redeem, purchase or otherwise acquire from any person or entity other than from the Company or another direct or indirect wholly-owned subsidiary of the Company, any of the Company's or any subsidiary's capital stock or other equity securities (including, without limitation, warrants, options and other rights to acquire such capital stock or other equity securities). ARTICLE 12 VOTE TO CHANGE THE TERMS OF SERIES E PREFERRED SHARES The affirmative vote at a meeting duly called for such purpose or the written consent without a meeting, of the holders of not less than two-thirds (2/3) of the then outstanding Series E Preferred Shares, shall be required for any change to this Certificate of Designations or the Company's Certificate of Incorporation which would amend, alter, change or repeal any of the powers, designations, preferences and rights of the Series E Preferred Shares. ARTICLE 13 LOST OR STOLEN CERTIFICATES Upon receipt by the Company of evidence satisfactory to the Company of the loss, theft, destruction or mutilation of any Preferred Stock Certificates representing the Series E Preferred Shares, and, in the case of loss, theft or destruction, of any indemnification undertaking by the holder to the Company and, in the case of mutilation, upon surrender and cancellation of the Preferred Stock Certificate(s), the Company shall execute and deliver new preferred stock certificate(s) of like tenor and date; provided, however, the Company shall not be obligated to re-issue preferred stock certificates if the holder contemporaneously requests the Company to convert such Series E Preferred Shares into Common Stock. 15 ARTICLE 14 WITHHOLDING TAX OBLIGATIONS Notwithstanding anything herein to the contrary, to the extent that the Company receives advice in writing from its counsel that there is a reasonable basis to believe that the Company is required by applicable federal laws or regulations and delivers a copy of such written advice to the holders of the Series E Preferred Shares so effected, the Company may reasonably condition the making of any distribution (as such term is defined under applicable federal tax law and regulations) in respect of any Series E Preferred Share on the holder of such Series E Preferred Shares depositing with the Company an amount of cash sufficient to enable the Company to satisfy its withholding tax obligations (the "WITHHOLDING TAX") with respect to such distribution. Notwithstanding the foregoing or anything to the contrary, if any holder of the Series E Preferred Shares so effected receives advice in writing from its counsel that there is a reasonable basis to believe that the Company is not so required by applicable federal laws or regulations and delivers a copy of such written advice to the Company, the Company shall not be permitted to condition the making of any such distribution in respect of any Series E Preferred Share on the holder of such Series E Preferred Shares depositing with the Company any Withholding Tax with respect to such distribution, PROVIDED, HOWEVER, the Company may reasonably condition the making of any such distribution in respect of any Series E Preferred Share on the holder of such Series E Preferred Shares executing and delivering to the Company, at the election of the holder, either: (i) if applicable, a properly completed Internal Revenue Service Form 4224, or (a) an indemnification agreement in reasonably acceptable form, with respect to any federal tax liability, penalties and interest that may be imposed upon the Company by the Internal Revenue Service as a result of the Company's failure to withhold in connection with such distribution to such holder. If the conditions in the preceding two sentences are fully satisfied, the Company shall not be required to pay any additional damages set forth in Section 2(f)(v) of this Certificate of Designations if its failure to timely deliver any Conversion Shares results solely from the holder's failure to deposit any withholding tax hereunder or provide to the Company an executed indemnification agreement in the form reasonably satisfactory to the Company. ARTICLE 15 All other provisions of the Articles of Incorporation, as amended, shall remain in full force and effect. ARTICLE 16 Each amendment set forth above was duly approved by the Board of Directors of the Corporation with shareholder approval in accordance with the provisions of Section 14-2-821 of the Georgia Business Corporation Code on August 2, 2000. 16 IN WITNESS WHEREOF, the Company has caused this Amendment to the Certificate of Incorporation to be signed by its duly authorized officers as of the day first above written THE NETWORK CONNECTION, INC. By: /s/ Morris C. Aaron ------------------------------------- Name: Morris C. Aaron Title: Chief Financial Officer 17 EXHIBIT I THE NETWORK CONNECTION, INC. CONVERSION NOTICE Reference is made to the Article of Amendment to the Articles of Incorporation of The Network Connection, Inc. (the "ARTICLES OF AMENDMENT"). In accordance with and pursuant to the Certificate of Designations, the undersigned hereby elects to convert the number of shares of Series E Convertible Preferred Stock, $.001 par value per share (the "SERIES E PREFERRED SHARES"), of The Network Connection, Inc., a Georgia corporation (the "COMPANY"), indicated below into shares of Common Stock, $.001 par value per share (the "COMMON STOCK"), of the Company, by tendering the stock certificate(s) representing the share(s) of Series E Preferred Shares specified below as of the date specified below. The undersigned acknowledges that any sales by the undersigned of the securities issuable to the undersigned upon conversion of the Series E Preferred Shares shall be made only pursuant to (i) a registration statement effective under the Securities Act of 1933, as amended (the "ACT"), or (ii) advice of counsel that such sale is exempt from registration required by Section 5 of the Act. Date of Conversion: ------------------------------------------- Number of Series E Preferred Shares to be converted ------------------------------------------- Stock certificate no(s). of Series E Preferred Shares to be converted: ------------------------------------------- Please confirm the following information: Conversion Price: ------------------------------------------- Number of shares of Common Stock to be issued: ------------------------------------------- ------------------------------------------- Dividend Payment Due in Cash or Stock please issue the Common Stock into which the Series E Preferred Shares are being converted in the following name and to the following address: Issue to: (1) ------------------------------------------- ------------------------------------------- Facsimile Number: ------------------------------------------- Authorization: ------------------------------------------- By: --------------------------------------- Title: ------------------------------------ Dated: ----------------------------------- ACKNOWLEDGED AND AGREED: THE NETWORK CONNECTION, INC. By: -------------------------------- Name: ------------------------------ Title: ------------------------------ Date: ------------------------------ - ---------- (1) If other than to the record holder of the Series E Preferred Shares, any applicable transfer tax must be paid by the undersigned. 2 EX-10.28 3 0003.txt MASTER SETTLEMENT AGREEMENT MASTER SETTLEMENT AGREEMENT AND MUTUAL RELEASE ---------- This Master Settlement Agreement and Mutual Release (this "Agreement") is entered into this 25th day of September 2000 by and between The Network Connection, Inc., a Georgia corporation ("TNCi"), and Carnival Corporation, a Panamanian corporation ("Carnival"). WHEREAS, TNCi and Carnival have had an ongoing business relationship for the past approximately two years, which has been governed by the Turnkey Agreement dated September 14, 1998 (the "Initial Agreement"); WHEREAS, various issues have arisen out of that business relationship that have resulted in TNCi and Carnival engaging in certain negotiations regarding the continuation of their business relationship; WHEREAS, both the Company and Carnival desire to continue their business relationship and towards that end have agreed (i) to terminate the Initial Agreement; (ii) to enter into this Master Settlement Agreement and Mutual Release regarding their business relationship prior to the date hereof, the Initial Agreement and termination thereof (this "Agreement"); ; and (iii) that the Company shall issue the Note to Carnival; WHEREAS, TNCi and Carnival now wish to settle any and all disputed claims relating to their business relationship prior to the date hereof, the Initial Agreement and the termination thereof (collectively, the "Disputed Claims"), without an admission of liability against each other; and WHEREAS, capitalized terms used but not defined herein shall have the meanings ascribed thereto in the Convertible Note Subscription Agreement or Convertible Note issued in connection therewith, each of even date herewith. NOW THEREFORE, in consideration of the premises and mutual covenants contained herein, and for other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, intending to be legally bound hereby, the parties hereto agree as follows: 1. NON-ADMISSION OF LIABILITY. This Agreement represents a compromise of disputed claims. No act carried out by either party pursuant to this Agreement, including, without limitation, issuance of the Note by TNCi to Carnival, is to be construed as an admission of liability or wrongdoing by either party hereto. Any liability or wrongdoing is specifically denied by each party. 1A. TERMINATION OF INITIAL AGREEMENT. TNCi and Carnival hereby agree that the Initial Agreement shall be terminated and of no further force or effect as of the execution and delivery hereof. 2. COVENANTS. (a) ENTRY INTO NEW AGREEMENT. TNCi and Carnival hereby agree that they shall negotiate in good faith and use their best efforts to achieve within the 60-day period following the date hereof the objective of entering into a new agreement to govern a business relationship between the parties after the execution and delivery hereof (the "New Agreement"). In connection with the execution and delivery of this Agreement , TNCi shall retain ownership of any and all equipment (other than wiring and switching equipment installed for networking purposes which Carnival purchased and has paid in full pursuant to the original Agreement) installed on any Carnival ship in connection with TNCi's provision of its systems and services to Carnival under the Initial Agreement. Unless used in connection with systems and services to be provided under any New Agreement, TNCi shall remove any of such equipment from any Carnival ship, at its sole expense. (b) ISSUANCE OF NOTE. TNCi shall issue the Note to Carnival, pursuant to a Convertible Note Subscription Agreement. The Convertible Note Subscription Agreement and Note shall be in substantially the form attached hereto as Exhibit "A" (the Note is attached to the Convertible Note Subscription Agreement as Exhibit "A" thereto). (c) CARNIVAL OBLIGATIONS. Carnival represents that Carnival is responsible for payment to ABB Marine for wiring of ship and for payment to TNCi of $48,673.02, which represents the full and complete payment for TNCi's share of net profits pursuant to Schedule A of the Initial Agreement , and Carnival covenants that it shall make such payments. 3. CLOSING. Closing of the transactions set forth in paragraph 2 above shall take place at Carnival's offices in Miami, or such other place as the parties mutually agree, at 10:00 a.m. Eastern Standard Time on September 25, 2000, or at such other time as the parties mutually agree (the "Closing Date"). The Closing may also take place, if so desired and mutually agreed by the parties, by facsimile signature on the Closing Date with hard copies to be delivered by overnight courier immediately thereafter. 2 4. CONDITIONS TO CLOSING. It shall be a condition to the effectiveness of this Agreement that each of the Convertible Note Subscription Agreement and Note (collectively, the "Transaction Documents") shall be executed and delivered together with the execution and delivery of this Agreement. Neither this Agreement nor any of the Transaction Documents shall be of force or effect until such time as all three of such documents have been executed and delivered. 5. MUTUAL RELEASE. TNCi and Carnival do hereby mutually remise, release and forever discharge each other, their directors, officers, employees, shareholders, affiliates, agents, predecessors, successors, if any, and each of them, from any and all manner of claims, causes of action, actions, suits, debts, dues, accounts, bonds, covenants, contracts, agreements and demands of every nature, on account of any grounds whatsoever, in law or in equity, asserted or unasserted, known or unknown, arising directly or indirectly as a result of, in connection with or relating to the Disputed Claims, by reason of any cause, matter or thing whatsoever, from the beginning of the world to the date of these presents. The foregoing releases shall not apply to any claim arising from a breach of this Agreement. 6. SEVERABILITY. In the event that any provision or portion of this Agreement shall be determined by a Court to be invalid, illegal or unenforceable, the remaining provisions or portions of this Agreement shall continue in full force and effect, unless such severability would thwart the purpose of this Agreement. 7. INTEGRATION. Except for the Transaction Documents, this Agreement represents the only agreement between the parties in regard to the settlement of the Disputed Claims, and any amendment or modification hereof must be in writing and signed by the parties hereto. This Agreement is binding upon the parties, their successors and assigns. 8. GOVERNING LAW. This Agreement shall be construed in accordance with the laws of the State of Florida. The federal and state court courts in Philadelphia, Pennsylvania and Miami, Florida shall have exclusive jurisdiction over this instrument and the enforcement hereof. 9. CONFIDENTIALITY. The negotiations, covenants, terms and substance of this Agreement are confidential. No party shall publicize, disclose or communicate in any manner, directly or indirectly, the negotiations, covenants, terms or substance of this Agreement to any person or entity, other than their directors, officers, employees, shareholders, affiliates, agents and successors, if any, on a need-to-know basis, and provided that any of such persons to whom such disclosure is made is informed of the confidential nature of such information and instructed to maintain such confidentiality. 3 10. NO WAIVER. The waiver by any party hereto of a breach of any provision of this Agreement by the other party shall not operate or be construed as a waiver of any subsequent breach. 11. COUNTERPARTS. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 4 IN WITNESS WHEREOF, the parties hereto have executed and delivered this Agreement, effective as of the date first above written. THE NETWORK CONNECTION, INC. By: ----------------------------------------- Name: Title: CARNIVAL CORPORATION By: /s/ Brendan Corrigan ----------------------------------------- Name: Brendan Corrigan Title: Sr. Vice President Operations 5 EXHIBIT A CONVERTIBLE NOTE SUBSCRIPTION AGREEMENT Convertible Note Subscription Agreement, dated as of September 25, 2000 (this "Agreement"), by and between The Network Connection, Inc., a Georgia corporation (the "Company"), and Carnival Corporation, a Panamanian corporation (the "Subscriber"). WHEREAS, this Agreement is entered into as a condition to the effectiveness of, and pursuant to, a Master Settlement Agreement and Mutual Release (the "Master Agreement") of even date herewith; and WHEREAS, capitalized terms used but not defined herein shall have the meanings ascribed thereto in the Master Agreement or Convertible Note issued in connection herewith. NOW, THEREFORE, in consideration of the mutual covenants contained in this Agreement and for other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, the Company and the Subscriber, intending to be legally bound, hereby agree as follows: 1. PURCHASE OF UNITS. At the Closing, the Company will issue to the Subscriber a convertible note (the "Note") in the principal amount of $550,000 in the form attached as Exhibit "A" hereto that shall be convertible at any time and from time to time at the option of the Subscriber into that number of shares of common stock of the Company ("Common Stock") equal to the dividend obtained by dividing the outstanding principal amount of the Note that the Subscriber then desires to convert by the product of (A) the average of the closing prices per share of Common Stock as reported by Nasdaq for each of the five consecutive trading days ending on the day prior to the date on which the conversion is to take place and (B) 0.8. Subscriber may not convert less than $100,000 of outstanding principal balance in connection with any conversion. The mechanics of effectuating a conversion are set forth in the Note. The Note and the shares issuable on any conversion thereof are hereinafter sometimes referred to collectively as the "Securities." 2. SUBSCRIBER'S REPRESENTATIONS. Subscriber represents and warrants to the Company as follows: (a) Subscriber is acquiring the Securities solely for investment, solely for its own account and not with a view to or for the resale or distribution thereof. Subscriber is acquiring the Securities in the ordinary course of its business and does not have any agreement or understanding, directly or indirectly, with any person or entity to distribute any of such securities. (b) Subscriber understands that it may sell or otherwise transfer the Securities only if such transaction is duly registered under the Securities Act of 1933, as amended (the "Securities Act"), or otherwise only if Subscriber shall have received and delivered to Company the favorable opinion of counsel to Subscriber (which such opinion must be reasonably acceptable to Company as to its form, substance and the giver thereof) to the effect that such sale or other transfer may be made in the absence of registration under the Securities Act and registration or qualification in every applicable state. (c) Subscriber is an "accredited investor" as such term is defined in Rule 501 of Regulation D of the Securities Act. (d) Subscriber has the full right, power and authority to enter into this Agreement and will at all times have the full power and authority to perform its obligations under this Agreement. This Agreement has been duly authorized, executed and delivered by the Subscriber. This Agreement constitutes the Subscriber's valid and binding obligation, enforceable in accordance with its terms, except as may be limited by bankruptcy, insolvency, moratorium or other laws affecting creditors' rights generally, or equitable principles, whether applied in a proceeding in equity or law. 3. This Agreement may not be changed, terminated or otherwise modified, except by written agreement of the parties. This Agreement shall not be assignable by either party without the express prior written consent of the other, and, subject to this restriction, shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. This Agreement constitutes the entire agreement and understanding of the parties hereto with respect to the subject matter hereof and supersedes all prior or contemporaneous agreements, understandings, inducements or conditions, oral or written, express or implied, except for the Master Agreement. This Agreement shall be governed by the internal laws of the State of Florida. The federal and state court courts in Philadelphia, Pennsylvania and Miami, Florida shall have exclusive jurisdiction over this instrument and the enforcement hereof. This Agreement may be executed in any number of counterparts, each of which as so executed and delivered shall be an original and all of which together shall constitute one and the same instrument. 2 IN WITNESS WHEREOF, the parties hereto have caused this Convertible Note Subscription Agreement to be duly executed by their respective authorized signatories as of the date first indicated above. THE NETWORK CONNECTION, INC. By: /s/ Robert Pringle ----------------------------------------- Name: Robert Pringle Title: President and Chief Operating Officer CARNIVAL CORPORATION By: /s/ Brendan Corrigan ----------------------------------------- Name: Brendan Corrigan Title: Sr. Vice President Operations 3 EXHIBIT A CONVERTIBLE NOTE EX-10.29 4 0004.txt CONVERTIBLE NOTE THIS NOTE, ANY REPLACEMENT NOTES AND ANY SHARES OF COMMON STOCK INTO WHICH EITHER MAY BE CONVERTED (COLLECTIVELY, THE "SECURITIES") HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 AND MAY NOT BE SOLD, PLEDGED, HYPOTHECATED, OR OTHERWISE TRANSFERRED, DISPOSED OF OR OFFERED FOR SALE, IN WHOLE OR IN PART, IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT UNDER THAT ACT COVERING THE SECURITIES, OR AN OPINION OF COUNSEL OF HOLDER THAT AN EXEMPTION FROM REGISTRATION IS AVAILABLE Principal Sum: $550,000 Holder: CARNIVAL CORPORATION Address: 3655 N.W. 87TH AVENUE, MIAMI, FLORIDA 33178-2428 CONVERTIBLE NOTE (the "Note") THE NETWORK CONNECTION, INC. The Network Connection, Inc., a Georgia corporation (the "Company"), hereby promises to pay the Principal Sum to the order of Holder, its successors or permitted assigns, on the date (the "Maturity Date"), which is the first to occur of (i)one year from the date hereof or (ii) the date on which Holder gives an Acceleration Declaration (as defined in paragraph 4(b) below). This Note shall accrue interest on the outstanding principal balance (if any) prior to the Maturity Date at an annual rate of 8%. This Note shall accrue interest after the Maturity Date at the rate of 18% per annum (or, if less, the highest rate permitted by law) ("Default Interest"). Any interest due shall be calculated and payable quarterly based on the principal balance at the end of the quarter. All payments shall be made to Holder in immediately available funds at the address set forth above. 1. CONVERSION RIGHTS. (a) CONVERSIONS. The outstanding principal balance of this Note is convertible at the option of Holder at any time and from time to time, in whole or in part, into shares of common stock of Company ("Common Stock") at a price per share equal to the Conversion Price (as defined in the next sentence); provided, however, that Holder may not convert less than $100,000 of outstanding principal balance in connection with any conversion. "Conversion Price" shall equal the product of (i) the average of the closing prices per share of Common Stock as reported by Nasdaq for each of the five consecutive trading days ending on the day prior to the Conversion Date (as defined in paragraph 1(b) below) and (ii) 0.8. The Conversion Price is subject to adjustment from time to time as set forth in paragraph 2 below. (b) MECHANICS. Holder shall effect conversions by delivering to the Company a notice, together with this Note (collectively, a "Conversion Notice"). Each Conversion Notice shall specify the amount of the outstanding principal balance to be converted (which may not be less than $100,000) and the date on which such conversion is to be effected, which date may not be prior to the date the Holder delivers such Conversion Notice (the "Conversion Date"). If no Conversion Date is specified in a Conversion Notice, the Conversion Date shall be the date that a Conversion Notice is deemed delivered hereunder. Upon receipt of a Conversion Notice, the Company shall calculate the Conversion Price and the number of shares of Common Stock into which the principal balance to be converted shall convert. If such calculation results in a fraction of a share, fractional shares less than one-half shall be disregarded and fractional shares of one-half or greater shall be rounded up to the next highest whole number of shares. If the Holder is converting less than the whole of the then outstanding principal balance, or if a conversion hereunder cannot be effected in full for any reason, the Company shall deliver to Holder, together with a certificate for the number of shares of Common Stock into which the portion of the outstanding principal balance has been (or could be) converted in connection with such conversion, a new note identical in all material respects to this Note, except that the principal amount shall be equal to the principal amount outstanding immediately prior to the conversion less the amount of the then outstanding principal balance converted (a "Replacement Note"). (c) ISSUANCE OF CERTIFICATES. Promptly after each Conversion Date, the Company will deliver to the Holder (i) a certificate or certificates representing the number of shares of Common Stock being acquired upon conversion, and (ii) a Replacement Note, if necessary. 2. ADJUSTMENTS. (a) SUBDIVISION OR COMBINATION OF COMMON STOCK AND COMMON STOCK DIVIDEND. In case the Company shall at any time subdivide its outstanding shares of Common Stock into a greater number of shares or declare a dividend upon its Common Stock payable solely in shares of Common Stock, the Conversion Price in effect immediately prior to such subdivision or declaration shall be proportionately reduced. Conversely, in case the outstanding shares of Common Stock of the Company shall be combined into a smaller number of shares, the Conversion Price in effect immediately prior to such combination shall be proportionately increased. (b) NOTICE OF ADJUSTMENT. Promptly after adjustment of the Conversion Price, the Company shall give written notice thereof to the Holder. The notice shall be signed by an authorized officer of the Company and shall state the effective date of the adjustment and the Conversion Price resulting from such adjustment, setting forth in reasonable detail the method of calculation and the facts upon which such calculation is based. 2 (c) OTHER NOTICES. If at any time (i) the Company shall declare any cash dividend upon its Common Stock, (ii) the Company shall declare or make any special dividend or other distribution to the holders of its Common Stock (other than a dividend payable solely in shares of Common Stock), (iii) there shall be any reorganization or reclassification of the Company, consolidation or merger of the Company with another entity, or a sale of all or substantially all of the Company's assets to another entity, or (iv) there shall be a voluntary or involuntary dissolution, liquidation or winding-up of the Company; then, in any one or more of said cases, the Company shall give to the Holder (A) at least 10 days prior written notice of the date on which the books of the Company shall close or a record shall be taken for such dividend or other distribution or for determining rights to vote in respect of any such dissolution, liquidation or winding-up, (B) at least 10 days prior written notice of the date on which the books of the Company shall close or a record shall be taken for determining rights to vote in respect of any such reorganization, reclassification, consolidation, merger or sale, and (C) in the case of any such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding-up, at least 10 days prior written notice of the date when the same shall take place. Any notice given in accordance with clause (A) above shall also specify, in the case of any such dividend or distribution, the date on which the holders of Common Stock shall be entitled thereto. Any notice given in accordance with clause (C) above shall also specify the date on which the holders of Common Stock shall be entitled to exchange their Common Stock for securities or other property deliverable upon such reorganization, reclassification, consolidation, merger, sale, dissolution, liquidation or winding-up, as the case may be. 3. PREPAYMENT. The Company may at any time and from time to time prepay the outstanding principal balance represented by this Note, in whole or in part; provided, however, that the Company shall not be permitted to make any such prepayments in increments of less than $50,000. Any such prepayment shall be by wire transfer of immediately available funds in accordance with the wire instructions provided by Holder that are attached hereto as Exhibit "A", together with written notice to Holder advising it of such prepayment. 4. EVENTS OF DEFAULT AND ACCELERATION. (a) An "event of default" with respect to this Note shall exist if any of the following shall occur, if: (i) The Company shall breach or fail to comply with any material provision of this Note and such breach or failure to comply shall continue for ten days after written notice by Holder to the Company for a monetary default, and 30 days after written notice by Holder to the Company for a non-monetary default, or the Company shall breach or fail to comply in any material respect with the Master Settlement Agreement and Mutual Release or the Convertible Note Subscription Agreement, each of even date herewith as set forth therein. 3 (ii) A receiver, liquidator or trustee of the Company or of a substantial part of its properties shall be appointed by court order and such order shall remain in effect for more than 60 days; or the Company shall be adjudicated bankrupt or insolvent; or a substantial part of the property of the Company shall be sequestered by court order and such order shall remain in effect for more than 60 days; or a petition to reorganize the Company under any bankruptcy, reorganization or insolvency law shall be filed against the Company and shall not be dismissed within 60 days after such filing. (iii) The Company shall file a petition in voluntary bankruptcy or request reorganization under any provision of any bankruptcy, reorganization or insolvency law, or shall consent to the filing of any petition against it under any such law. (iv) The Company shall make an assignment for the benefit of its creditors, or admit in writing its inability to pay its debts generally as they become due, or consent to the appointment of a receiver, trustee or liquidator of the Company, or of all or any substantial part of its properties. (b) If an event of default referred to in paragraph 4(a) above shall occur, the Holder may at any time thereafter, in addition to Holder's other remedies, by written notice to the Company (an "Acceleration Declaration"), declare the principal amount of this Note, plus any accrued interest, Default Interest and any other amounts due hereunder to be due and payable immediately. (c) In addition to and without limitation on any other rights of the Holder under any applicable laws upon and upon any event of default, the Holder shall have the right to offset and apply any amounts owing from the Company to Holder under any agreement or obligation between Company and Holder, or any subsidiaries or affiliates thereof. 5. OTHER OBLIGATIONS. The Company shall at all times reserve for issuance on conversion of this Note the number of shares of Common Stock which are then issuable on conversion hereof. The Company covenants and agrees that all shares of Common Stock that may be issued upon conversion of this Note will, upon issuance, be duly and validly issued, fully paid and non-assessable. 6. MISCELLANEOUS. (a) All notices and other communications required or permitted to be given hereunder shall be in writing and shall be given (and shall be deemed to have been duly given upon receipt by the intended recipient thereof) by delivery in person, by telegram, by facsimile, recognized overnight courier, e-mail, or by registered or certified mail, postage prepaid, return receipt requested, addressed as follows: (i) if to the Holder, to such address as is set forth in the heading hereof or as the Holder shall furnish to the Company in accordance with this paragraph, and (ii) if to the Company, to it at its headquarters office, or to such other address as the Company shall furnish to the Holder in accordance with this paragraph. 4 (b) This Note shall be governed and construed in accordance with the laws of the State of Florida applicable to agreements made and to be performed entirely within such State. The federal and state courts in Philadelphia, Pennsylvania and Miami, Florida shall have exclusive jurisdiction over this instrument and the enforcement hereof. (c) The Company waives protest, notice of protest, presentment, dishonor, notice of dishonor and demand. (d) If any provision of this Note shall for any reason be held to be invalid or unenforceable, such invalidity or unenforceability shall not affect any other provision hereof, but this Note shall be construed as if such invalid or unenforceable provision had never been contained herein. (e) The waiver of any event of default or the failure of the Holder to exercise any right or remedy to which it may be entitled shall not be deemed a waiver of any subsequent event of default or of the Holder's right to exercise that or any other right or remedy to which the Holder is entitled. (f) The Holder of this Note shall be entitled to recover its legal and other costs of collecting on this Note, and such costs shall be deemed added to the principal amount of this Note. (g) This Note may be changed, terminated or otherwise modified only in writing executed by the party against whom such modification is sought to be enforced. (h) In addition to restrictions on transfer under federal and state securities laws, this Note shall not be transferable by either party to any third party without the prior written consent of the other party, which may be withheld for any reason whatsoever or no reason at all (i) Any notices required hereunder to the Company shall be sent to the Company's principal business address at: The Network Connection, Inc. The Belgravia 1811 Chestnut Street, Suite 110 Philadelphia, PA 19103 Attention: President 5 IN WITNESS WHEREOF, the Company has caused this Note to be duly executed on the date set forth below. Dated: September 25, 2000 THE NETWORK CONNECTION, INC. By: /s/ Robert Pringle ------------------------------- Name: Robert Pringle ----------------------------- Title: President ---------------------------- 6 EXHIBIT A WIRE INSTRUCTIONS EX-21.1 5 0005.txt SUBSIDIARIES SUBSIDIARIES TNCi UK Limited is a wholly-owned subsidiary formed in the United Kingdom. TNCi UK Limited does business as The Network Connection. Our Passenger Rail Division is operated through this subsidiary. The Network Connection, Inc., a Delaware corporation, is a wholly-owned subsidiary. This subsidiary is currently inactive. EX-23 6 0006.txt CONSENT OF KPMG, LLP INDEPENDENT AUDITORS' CONSENT The Stockholders and Board of Directors The Network Connection, Inc. and Subsidiary: We consent to incorporation by reference in the registration statements (Nos. 333-38313 and 333-38315) on Forms S-8 and (No. 333-30980) on Form SB-2 of The Network Connection, Inc. and subsidiary of our report dated September 27, 2000, relating to the consolidated balance sheets of The Network Connection, Inc. and subsidiary as of June 30, 2000 and 1999, and the related consolidated statements of operations, changes in stockholders' equity and comprehensive income and cash flows for the year ended June 30, 2000, the Transition Period ended June 30, 1999, and the year ended October 31, 1998, which report appears in the June 30, 2000, annual report on Form 10-KSB of The Network Connection, Inc. and subsidiary. Our reported dated September 27, 2000, contains an unexplanatory paragraph that states tht The Network Connection, Inc. and subsidiary has incurred net losses from operations and has a working capital deficiency and an accumulated deficit that raises substantial doubt about its ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ KPMG LLP Phoenix, Arizona October 5, 2000 EX-27 7 0007.txt FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEETS AND STATEMENTS OF OPERATIONS FOUND IN THE COMPANY'S 10-KSB FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS JUN-30-2000 JUL-01-1999 JUN-30-2000 579,721 0 55,951 0 0 1,596,481 4,824,837 1,014,188 13,468,699 8,350,280 0 0 26,969 14,460 2,728,990 13,468,699 6,983,787 7,091,660 4,867,519 18,831,291 19,386 0 4,602,183 (16,252,199) 0 (16,252,199) 0 (16,252,199) 0 (16,252,199) (1.71) (1.71)
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