SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ x ] Quarterly report pursuant to section 13 of 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 1999
[ ] Transition report pursuant to section 13 of 15(d) of the Securities
Exchange Act of 1934 for the transition
period from to
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Commission File No. 0-21038
NETWORK SIX, INC.
(Exact name of registrant as specified in its charter)
Rhode Island 05-0366090
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
475 Kilvert Street, Warwick, Rhode Island 02886
(Address of principal executive offices, including zip code)
(401) 732-9000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
------ -----
As of September 30, 1999, there were 792,881 shares of the registrant's Common
Stock, $.10 par value, outstanding.
PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETWORK SIX, INC.
Condensed Balance Sheets
ASSETS
- ------ Sept. 30, 1999 Dec. 31, 1998
------------------ -----------------
Current assets: (unaudited)
Cash and cash equivalents $2,534,719 $1,442,035
Contract receivables, less allowance for doubtful
accounts of $50,000 at September 30, 1999 and
$69,175 December 31, 1998 1,558,083 1,966,788
Costs and estimated earnings in excess of billings
on contracts 816,352 1,220,253
Refundable taxes on income (note 3) 686,000 --
Other current assets 127,820 112,433
---------- ----------
Total current assets 5,722,974 4,741,509
---------- ----------
Property and equipment
Computers and equipment 618,021 590,527
Furniture and fixtures 162,606 163,532
Leasehold improvements 20,191 20,191
---------- ----------
800,818 774,250
Less: accumulated depreciation and amortization 587,574 602,033
---------- ----------
Net property and equipment 213,244 172,217
Deferred taxes 417,401 37,097
Contract receivables and costs in excess of billings
on Hawaii contract -- 3,459,382
Other assets 86,906 290,577
---------- ----------
Total assets $6,440,525 $8,700,782
---------- ----------
---------- ----------
Sept. 30, 1999 Dec. 31, 1998
----------------- -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY (unaudited)
Current liabilities:
Current installment of obligations under capital leases $ 7,227 $ 89,483
Current portion of long-term debt:
Vendors 100,000 200,000
Others 340,918 91,997
Accounts payable 80,645 58,456
Accrued salaries and benefits 573,266 579,320
Accrued subcontractor expense 24,153 24,950
Other accrued expenses 74,726 320,982
Billings in excess of costs and estimated earnings on contracts 328,478 341,572
Income taxes payable -- 780,066
Deferred taxes 42,491 42,491
Preferred stock dividends payable 1,035,975 795,992
----------------- -----------------
Total current liabilities 2,607,879 3,325,309
----------------- -----------------
Obligations under capital leases, excluding current installments -- 38,090
Long-term debt, less current portion:
Vendors 642,239 542,239
Others 837,234 409,778
Hawaii Payable -- 576,483
----------------- -----------------
Total Liabilities 4,087,352 4,891,899
----------------- -----------------
Stockholders' equity:
Series A convertible preferred stock, $3.50 par value. Authorized
857,142.85 shares; issued and outstanding 714,285.71 shares at
September 30, 1999 and December 31, 1998; liquidation of $3.50 per
share plus unpaid and accumulated dividends 2,235,674 2,235,674
Common stock, $.10 par value. Authorized
4,000,000 shares; issued 792,881 shares at
September 30, 1999 and 764,663 at December 31, 1998 79,288 76,466
Additional paid-in capital 1,886,294 1,796,284
Treasury stock, recorded at cost,
591 shares at September 30, 1999 (3,245) --
Accumulated deficit (1,844,838) (299,541)
----------------- -----------------
Total stockholders' equity 2,353,173 3,808,883
----------------- -----------------
Total Liabilities & Stockholders' Equity $ 6,440,525 $8,700,782
================= =================
NETWORK SIX, INC.
Condensed Statements of Income
(Unaudited)
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED 9/30/99 ENDED 9/30/98 ENDED 9/30/99 ENDED 9/30/98
------------- ------------- ------------- -------------
Contract revenue earned $ 2,575,192 $ 2,662,603 $ 7,813,958 $ 8,137,916
Cost of revenue earned 1,632,648 1,535,388 4,772,396 5,140,572
----------- ----------- ----------- -----------
Gross profit 942,544 1,127,215 3,041,562 2,997,344
Selling, general & administrative expenses 655,048 617,290 2,011,408 1,737,581
Litigation settlement (note 3) -- -- 3,176,665 --
----------- ----------- ----------- -----------
Income (loss) from operations 287,496 509,925 (2,146,511) 1,259,763
Other deductions (income)
Interest expense 60,147 14,573 119,512 54,289
Interest earned (26,426) (10,336) (58,124) (63,377)
----------- ----------- ----------- -----------
Income (loss) before income taxes 253,775 505,688 (2,207,899) 1,268,851
Income taxes 104,048 207,552 (902,584) 520,452
----------- ----------- ----------- -----------
Net income (loss) $ 149,727 $ 298,136 $(1,305,315) $ 748,399
=========== =========== =========== ===========
Net income (loss) per share:
Basic $ 0.09 $ 0.28 $ (1.97) $ 0.66
=========== =========== =========== ===========
Diluted $ 0.09 $ 0.28 $ (1.97) $ 0.66
=========== =========== =========== ===========
Shares used in computing net income (loss) per share:
Basic 792,881 763,880 785,476 756,519
=========== =========== =========== ===========
Diluted 792,881 763,880 785,476 756,519
=========== =========== =========== ===========
Preferred dividends declared $ 81,918 $ 85,068 $ 239,983 $ 252,431
=========== =========== =========== ===========
NETWORK SIX, INC.
Condensed Statements of Cash Flow
(Unaudited)
Nine months Nine months
ended ended
9/30/99 9/30/98
------- -------
Cash flows from operating activities:
Net income (loss) $(1,305,315) $ 748,399
Adjustment to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 62,109 31,774
Provision for doubtful accounts (19,175) --
Loss on sale/disposal of fixed assets 704 6,518
Proceeds from CBSI settlement 300,000 --
Payments on Hawaii settlement (250,000) --
Deferred taxes (380,304) --
Changes in operating assets and liabilities:
Contract receivables 427,880 491,252
Cost and estimated earnings
in excess of billings on contracts 403,901 (70,294)
Refundable taxes on income (686,000) --
Other current assets (15,387) 124,361
Long term amounts due from Hawaii 3,459,382 --
Other assets 195,033 90,943
Accounts payable 22,189 (81,820)
Accrued salaries and benefits (6,054) 91,074
Accrued subcontractor exp (797) (1,172,291)
Debt owed on Hawaii settlement 950,000 --
Hawaii payable (576,483) --
Other accrued expenses (246,256) 114,017
Billings in excess of costs
and estimated earnings on contracts (13,094) (31,280)
Income taxes payable (780,066) 525,240
----------- -----------
Net cash provided by operating activities 1,542,267 867,893
----------- -----------
Nine months Nine months
ended ended
9/30/99 9/30/98
------------ ------------
Cash flows from investing activities:
Proceeds from Sale/Disposal of Capital Assets 350 --
Capital expenditures (95,551) (84,904)
----------- -----------
Net cash used in investing activities (95,201) (84,904)
----------- -----------
Cash flows from financing activities:
Principal payments on capital lease obligations (120,346) (43,738)
Payments on long term debt (323,623) --
Net payments on note payable to bank -- (1,160,000)
Net proceeds on other notes payable -- 456,129
Purchases of treasury stock (3,245) --
Proceeds from issuance of common stock 92,832 127,082
----------- -----------
Net cash used in financing activities (354,382) (620,527)
----------- -----------
Net increase in cash and equivalents 1,092,684 162,462
Cash and cash equivalents at beginning of period 1,442,035 1,291,924
----------- -----------
Cash and cash equivalents at end of period $ 2,534,719 $ 1,454,386
=========== ===========
Supplemental cash flow information:
Cash paid during the period for:
Income taxes $ 943,786 $ (4,788)
Interest 73,341 54,289
=========== ===========
NETWORK SIX, INC.
Notes to Financial Statements
September 30, 1999
(unaudited)
(1) Basis of Presentation
The interim financial statements have been prepared without audit,
pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC). Certain information and footnote disclosures, normally
included in financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted pursuant
to SEC rules and regulations; nevertheless, management believes that the
disclosures herein are adequate to make the information presented not
misleading. These financial statements should be read in conjunction
with the financial statements and notes thereto included in the Form 10K
and Proxy Statement. In the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary to present
fairly the financial position of the Company as of September 30, 1999,
and the statements of income and cash flows for the nine month periods
ended September 30, 1999 and 1998, have been included herein. The
results of operations for the interim periods are not necessarily
indicative of the results for the full years.
(2) Under the requirements in Statement of Financial Accounting Standards
(SFAS) No. 128 for calculating basic earnings per share, the dilutive
effect of stock options and warrants are excluded.
(3) Litigation Settlement
On May 11, 1999 the Company announced it had entered into a settlement
agreement with the State of Hawaii and Complete Business Solutions, Inc.
("CBSI"). See Item 1 - Legal Proceedings. Prior to the settlement, the
Company had assets related to the Hawaii project of $3.46 million and
liabilities of $856,000. After tax considerations are taken into effect,
the settlement will result in a reduction of net assets of $1.87
million. The effect of the settlement on net income for the nine months
ended September 30, 1999 was as follows:
Write off of contract receivables and costs in excess of
billings on Hawaii contract ($3,459,382)
Present value of litigation settlement (868,957)
Payment received from CBSI 300,000
Hawaii payable 576,483
Capital leases, short and long term portion 57,994
Other accrued expenses 217,197
-----------
Effect on income before income taxes ($3,176,665)
Tax effect 1,302,433
-----------
Effect on net income ($1,874,232)
===========
It is anticipated the Company will carry back the 1999 net operating loss
to the 1998 tax year with proceeds expected to be received during 2000. The
balance will be available for carry forward.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements reflecting the
Company's expectations or beliefs concerning future events that could materially
affect Company performance in the future. All forward-looking statements are
subject to the risks and uncertainties inherent with predictions and forecasts.
They are necessarily speculative statements, and unforeseen factors, such as
competitive pressures, litigation results and regulatory and state funding
changes could cause results to differ materially from any that may be expected.
In particular, adverse decisions in on-going material litigation could have a
material adverse effect on the Company's financial condition and operating
results. Actual results and events may therefore differ significantly from those
discussed in forward-looking statements. Moreover, forward-looking statements
are made in the context of information available as of the date stated, and the
Company undertakes no obligation to update or revise such statements to reflect
new circumstances or unanticipated events as they occur.
GENERAL
In July 1999, the Company announced that the State of Maine had
extended the Company's contract to support and enhance the MACWIS child welfare
system for another year. The value of the contract is approximately $2.6
million.
On October 29, 1999 the Company and MAXIMUS Corporation ("MAXIMUS")
entered into a settlement agreement whereby the Company released MAXIMUS from
all claims and potential claims in relation to the Hawaii contract and vice
versa in exchange for a payment to the Company of $50,000. The check was
received in November 1999. See Item 1 Legal Proceedings.
YEAR 2000 DISCLOSURE
The Year 2000 issue concerns the inability of information systems,
primarily computer software programs, to recognize properly and process date
sensitive information subsequent to December 31, 1999. The Company has committed
resources (approximately $80,900) over the past year to improve its information
systems ("IS project"). The Company has used this IS project as an opportunity
to evaluate its state of readiness, estimate expected costs and identify and
quantify risks associated with any potential year 2000 issues.
State of Readiness:
In evaluating the Company's exposure to the year 2000 issue, management
first identified those systems that were critical to the ongoing business of the
Company and that would require significant manual intervention should those
systems be unable to process dates correctly following December 31, 1999. These
systems were the Company's internal time tracking system and internal
administrative system. Once these systems were identified, management identified
and agreed to undertake the following steps to ascertain the Company's state of
readiness:
I. Obtaining letters from software and hardware vendors
concerning the ability of their products to properly process
dates after December 31, 1999;
II. Testing the operating systems of all hardware used in the
Company, and internal administration systems to determine if
dates after December 31, 1999 can be processed correctly;
III. Surveying other parties who provide or process information in
electronic format to the Company as to their state of
readiness and ability to process dates after December 31,
1999; and
IV. Testing the identified information systems to confirm that
they will properly recognize and process dates after December
31, 1999.
The Company completed Steps I - Step IV above for all material software
and hardware in September of 1999. Any software or hardware determined to be
noncompliant was modified, repaired or replaced.
Costs:
As noted above, the Company spent approximately $80,900 over the past
year to improve its information systems.
Risks:
Effective August 4, 1998, the Securities and Exchange Commission issued
Release No. 33-7558 (the "Release") in an effort to provide further guidance to
reporting companies concerning disclosure of the year 2000 issue. In this
Release, the Commission required that registrants include in its year 2000
disclosure a reasonable description of its "most reasonably likely worst case
scenario." Based on the Company's assessment and the results of remediation
performed to date as described above, the Company believes that all problems
related to the year 2000 have been addressed and that the Company will
experience little or no disruption in its business immediately following
December 31, 1999. However, if unforeseen difficulties arise, the Company
anticipates that its "most reasonably likely worst case scenario" (as required
to be described by the Release) is that some percentage of the Company's time
tracking related to contract labor costs would need to be processed manually for
some limited period of time. In addition, the Company anticipates that all
businesses (regardless of their state of readiness), including the Company, will
encounter some minimal level of disruption in its business (e.g., phone and fax
systems, alarm systems, etc.) as a result of the year 2000 issue. However, the
Company does not believe that it will incur any material expenses or suffer any
significant loss of revenues in connection with such minimal disruptions.
Contingency Plans:
As discussed above, in the event of the occurrence of the "most
reasonably likely worst case scenario" the Company could hire an appropriate
level of temporary staff to manually assist with the time tracking process.
Forward Looking Statements:
Certain information set forth above regarding the year 2000 issue and
the Company's plans to address those problems are forward looking statements
under the Securities Act and the Exchange Act. See the second paragraph of
Management's Discussion and Analysis of Financial Condition and Results of
Operations for a discussion of forward-looking statements and related risks and
uncertainties. In addition, certain factors particular to the year 2000 issue
could cause actual results to differ materially from those contained in the
forward looking statements, including, without limitation: failure to identify
critical information systems which experience failures, delays and errors in the
compliance and remediation efforts described above, unexpected failures by key
vendors, software providers or business partners to be year 2000 compliant or
the inability to repair critical information systems. In any such event, the
Company's results of operations and financial condition could be adversely
affected. In addition, the failure to be year 2000 compliant of third parties
outside of our control such as electric utilities or financial institutions
could adversely effect the Company's results of operations and financial
condition.
The Company has conducted a comprehensive review of its internal
computer systems to identify the systems that could be affected by the "Year
2000" issue and has implemented a plan to resolve the issue. The Year 2000
problem is the result of computer programs being written using two digits rather
than four to define the applicable year. Any of the Company's programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
that the year 2000. This could result in a major system failure or
miscalculations. The Company presently believes that the Year 2000 problem will
not pose significant operational problems for the Company's computer systems as
so modified and converted.
Results of Operations - Nine Months Ended September 30, 1999 Compared to 1998
Contract revenue decreased $323,958 or 4% from $8,137,916 in the nine
months ended September 30, 1998 to $7,813,958 in the nine months ended September
30, 1999 primarily due to the completion of the development and implementation
of the Maine Child Welfare Information Systems (MACWIS) project in April 1998.
This was partially offset by increased revenues on information technology
consulting and systems development activities with commercial customers and
higher education institutions.
Cost of revenue earned, consisting of direct employee labor, direct
contract expense and subcontracting expense, decreased $368,176 or 7% from
$5,140,572 in the nine months ended September 30, 1998 to $4,772,396 in the nine
months ended September 30, 1999 due to a reduction in information technology
subcontractor cost as a result of the completion of the MACWIS project.
Gross profit increased $44,218 or 1%, from $2,997,344 for the nine
months ended September 30, 1998 to $3,041,562 for the nine months ended
September 30, 1999. Gross profit as a percentage of revenue earned increased
from 37% for the nine months ended September 30, 1998 to 39% for the nine months
ended September 30, 1999. The increase in gross profit percentage is due to
higher margins on new projects commencing in the first half of 1999.
Selling, general and administrative (SG&A) expenses increased $273,827
or 16% from $1,737,581 in the nine months ended September 30, 1998 to $2,011,408
in the nine months ended September 30, 1999 due to an increase in marketing and
business development staff and related activities. On a percentage of revenues
basis, SG&A expenses increased from 21% to 26%.
The effect of the litigation settlement before taxes consisting of (1)
the write off of Hawaii related receivables, work in process and liabilities,
(2) the present value of the payment due to Hawaii and (3) a $300,000 payment
from CBSI is $3,176,665. See Item 1 - Legal Proceedings and Note 3 in Notes to
Financial Statements.
Interest expense increased $65,223 to $119,512, or 120%, from $54,289
due to a higher level of borrowings under the Company's two term loans. See
Liquidity and Capital Resources.
As a result, income before income taxes decreased $3,476,750 from
$1,268,851 for the nine months
ended September 30, 1998 to a loss of $2,207,899 for the nine months ended
September 30, 1999.
Net income decreased $2,053,714 from $748,399 for the nine months ended
September 30, 1998 to a loss of $1,305,315 for the nine months ended September
30, 1999.
Results of Operations - Three Months Ended September 30, 1999 Compared to 1998
Contract revenue decreased $87,411 or 3%, from $2,662,603 in the three
months ended September 30, 1998 to $2,575,192 in the three months ended
September 30, 1999 primarily due to the completion of several software
development implementation projects.
Cost of revenue earned, consisting of direct employee labor, direct
contract expense and subcontracting expense, increased $97,260, or 6%, from
$1,535,388 in the three months ended September 30, 1998 to $1,632,648 in the
three months ended September 30, 1999 due to training and related costs
associated with upgrading technical skills.
Gross profit decreased $184,671, or 16%, from $1,127,215 for the three
months ended September 30, 1998 to $942,544 for the three months ended September
30, 1999. Gross profit as a percentage of revenue earned decreased from 42% for
the three months ended September 30, 1998 to 37% for the three months ended
September 30, 1999. The decrease in gross profit as a percentage of revenue is
due largely to the increased training provided to the Company's technical staff
during the third quarter of 1999.
Selling, general and administrative (SG&A) expenses increased $37,758
or 6% from $617,290 in the three months ended September 30, 1998 to $655,047 in
the three months ended September 30, 1999 due to an increase in sales, marketing
and business development staff and related expenses. On a percentage of revenues
basis, SG&A expenses increased from 23% to 26%.
Interest expense increased $45,574 to $60,147, or 313%, from $14,573
due to a higher level of borrowings on the Company's two term loans. See
Liquidity and Capital Resources.
As a result, income before income taxes decreased $251,913 from
$505,688 for the three months ended September 30, 1998 to $253,775 for the three
months ended September 30, 1999.
Net income decreased $148,409 from $298,136 for the three months ended
September 30, 1998 to $149,727 for the three months ended September 30, 1999.
LIQUIDITY AND CAPITAL RESOURCES
In order to finance bid preparation costs and to obtain sufficient
collateral to support performance bonds required by some customers, the Company
has, in the past, entered into joint ventures with other firms with greater
financial resources when bidding for contracts. The Company expects to continue
and expand this practice prospectively as well as to pursue more time and
material contracts than it has historically pursued. Time and materials
contracts generally do not require performance bonds and almost always involve
less risk to deliver what the customer requires.
The Company has historically not received its first contract progress
payments until approximately three to six months after contract award, which
itself was as much as 12 months after proposal preparation
commences. The Company was therefore required to fund substantial costs well
before the receipt of related income, including marketing and proposal costs and
the cost of a performance bond. Prospectively, the Company expects to tighten up
this timetable, thereby reducing the requirement for additional working capital.
The Company has funded its operations through cash flows from
operations, bank borrowings, borrowings from venture partners, and private
placements of equity securities. Net cash provided by operating activities was
$1,542,267 and $867,893 in the nine months ended September 30, 1999 and 1998
respectively. Fluctuations in net cash provided by operating activities are
primarily the result of changes in net income, accounts receivable and
refundable taxes on income, legal settlements, accounts payable and costs and
estimated earnings in excess of billings on contracts due to differences in
contract milestones and payment dates.
The Company has a $1.5 million line of credit with a commercial lender
(the "Line of Credit"). Accounts receivable from three of the Company's
contracts secure the Line of Credit. The Company can borrow up to 80% of the
aggregate invoice amounts and is required to repay any borrowings within 90
days. The interest rate is prime plus five percent on balances below $1 million
and prime plus one and one half percent on balances over $1 million. The Line of
Credit also carries a six percent annual service fee on borrowed balances. At
September 30, 1999 the Line of Credit had an outstanding balance of zero.
On September 21, 1998 the Company entered into two five-year term
loans, each for $250,000. One lender was the Small Business Loan Fund
Corporation, ("SBLFC"), a subsidiary of the Rhode Island Economic Development
Corporation. The other lender was the Business Development Corporation of Rhode
Island ("BDC"). The SBLFC loan carries an annual interest rate of 9.5% and must
be repaid over five years. The BDC loan carries an annual interest rate of
10.25%, and an annual deferred fee of $5,000, and must be paid back over five
years. Both term loans are secured by substantially all the assets of the
Company. The BDC was also issued five-year warrants to purchase 11,500
unregistered shares of the Company's Common Stock at a price of $4.50 per share.
The warrants expire on September 20, 2003. The fair value of the warrants was
estimated by the Company to be $36,806 using the Black-Scholes options pricing
model and is being amortized ratably over the exercise period. Such amount is
included in other noncurrent assets on the accompanying balance sheet.
The Company believes that cash flows generated by operations will be
sufficient to fund continuing operations through the end of 1999. The Company
believes that inflation has not had a material impact on its results of
operations to date.
PART 11 - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June 1995, the Company began negotiating a significant amendment to
its contract for a child support enforcement ("CSE") system with the State of
Hawaii ("the State") when it determined that the total estimated cost to
complete the system would be significantly greater than expected. In March 1996,
the Company received final State and federal government approval for this
contract amendment totaling $4.4 million. As a result of numerous in-depth
reviews of this contract amendment, management determined that remaining
contract costs would exceed the contract value by $440,000, and therefore,
accrued this loss in December 1995.
In June 1996 the Company announced a new subcontract agreement with
Complete Business Solutions, Inc ("CBSI") to expand CBSI's role in the Hawaii
CSE contract. CBSI, at the request of Hawaii, was contracted to lead a detailed
review of the current system under development. Hawaii, in turn, agreed to pay
CBSI $1.2 million from the Company's remaining contract budget when various
milestones were achieved. The Company had a significant role in the detailed
review and had hoped that its results would facilitate the resolution of open
contractual scope issues.
On September 13, 1996, the State of Hawaii terminated its contract with
the Company, effective September 23, 1996, claiming that the Company had failed
to fulfill its obligations under the contract. In response, the Company also
terminated the contract with the State effective September 23, 1996. The Hawaii
contract, originally estimated to be a $20.7 million contract, was increased to
$25.2 million by the State in February 1996, and was the Company's largest
contract at the time. Prior to termination, approximately $16.5 million of costs
had been incurred towards completion of the contract, and $11 million had been
billed and substantially paid.
On November 12, 1996 the State of Hawaii filed a lawsuit in the Circuit
Court of the First Circuit of the State of Hawaii against the Company and Aetna
Casualty and Surety and Federal Insurance Company for damages due to breach of
contract (the "Hawaii litigation"). Aetna Casualty and Surety and Federal
Insurance Company provided the $10.3 million performance bond on the Company's
contract with the State of Hawaii to develop and install the State's child
support enforcement system. The suit alleged that the Company failed to meet
contractual deadlines, provided late, incomplete and/or unsuitable deliverables,
materially breached the contract by never completing the design, the application
programming, and the system test and systems implementation. The State sought an
unspecified amount for general damages, consequential and special damages,
liquidated damages, attorneys' fees, reimbursement for the cost of the suit and
interest costs that the court might deem just and proper.
The Company denied the State's allegation and, on January 23, 1997,
filed a counter claim against the State alleging that the State has breached the
contract. The Company sought $70 million in damages and alleged that the State
fraudulently induced the Company into designing and building a system having
capabilities and features far beyond the scope of the Company's contract. The
fraudulent inducement was in the form of withholding payments, improper
rejection of work that satisfied the requirements of the contract and verbal and
written abuse of the Company's employees and management.
In addition, Unisys, a vendor providing equipment under the Company's
Hawaii contract, submitted a $896,000 claim against the $10.3 million
performance bond. In February of 1997, the State released all but $1.1 million
of the performance bond; the remainder is intended to cover amounts payable to
Unisys and other subcontractors. In April of 1997, after a detailed review of
their records and discussions with the Company, Unisys agreed to lower their
claim to $859,602 and Aetna Casualty and Surety paid that claim. Lockheed Martin
IMS ("Lockheed"), who guaranteed the performance bond, reimbursed Aetna for that
claim. In December 1997, the Company reached an agreement with Lockheed to repay
the $859,602 over a five-year period.
On December 13, 1996 CBSI filed a lawsuit in the Superior Court of the
State of Rhode Island for $517,503, which the Company had previously accrued,
plus interest costs and attorney's fees. The Company disputed the $517,503 owed
to CBSI and filed a counterclaim against CBSI on January 13, 1997 alleging,
among other things, that CBSI failed to complete its duties required under the
subcontract with the Company in a timely manner, improperly engaged in
negotiations with the State of Hawaii to complete the project, hired and
attempted to hire employees of the Company in violation of its subcontract
agreement with the Company and obtained and utilized confidential information
and proprietary intellectual property inappropriately. Also, the Company alleged
that CBSI owed the Company $482,750 as of December 31, 1996 for which the
Company did not establish a reserve for uncollectibility.
On February 3, 1997, the Company filed a third-party complaint ("TPC")
as part of the Hawaii litigation against MAXIMUS Corporation ("MAXIMUS") and
CBSI. MAXIMUS had been the State of Hawaii's contract supervisor and advisor
since the inception of the Hawaii project. The allegations the Company made
against CBSI in this TPC were substantially similar to the allegations made
against CBSI in the Company's counterclaim to CBSI's December 13, 1996 lawsuit
brought against the Company in Rhode Island. The Company alleged that MAXIMUS
was liable to the Company on grounds that: (i) the Company was an intended third
party beneficiary under the contract between MAXIMUS and Hawaii; (ii) MAXIMUS
tortuously interfered in the contract between the Company and Hawaii; (iii)
MAXIMUS negligently breached duties to the Company, and (iv) MAXIMUS aided and
abetted Hawaii in Hawaii's breach of contract. The Company's complaint sought
$70 million in damages. In connection with the Hawaii litigation, the Company
was ordered to assign all Hawaii related leases to the State.
Due to the significant uncertainty created by these events, the Company
ceased recognition of revenue on the Hawaii contract in 1996. An adjustment of
$1.8 million was recorded in the fourth quarter of 1996 to reverse revenue of $1
million, $400 thousand and $400 thousand recorded previously in the first,
second and third quarters, respectively. In addition, $1.96 million of costs
incurred related to the Hawaii contract in 1996 were expensed.
On May 11, 1999 the Company reached a settlement agreement with both
the State and CBSI, which was approved by the court on July 22, 1999. All claims
of the Company, the State and CBSI were dismissed, except the Company's claims
against MAXIMUS. Per the settlement, the Company agreed to pay the State $1
million over four years as follows: June 1999 - $250,000, June 2000 - $250,000,
June 2001 - $250,000, June 2002 - $125,000 and June 2003 - $125,000. The first
payment was reduced by a $50,000 credit for the settlement of a lease obligation
on computer equipment. The equipment lessor, who had filed suit against the
Company, accepted $50,000 from the Company in full payment of that obligation.
CBSI agreed to pay the Company $300,000 immediately, which the Company has
received. Neither party to these agreements admitted any wrongdoing. To
facilitate the settlement, Lockheed agreed to modify certain aspects of a
promissory note issued to it by the Company in 1997. Lockheed agreed to extend
the note's maturity several years, to reschedule favorably certain principal
payments and to reduce the interest rate on the remaining principal, which is
$742,000 as of September 30, 1999.
On October 29, 1999 the Company and MAXIMUS entered into a settlement
agreement whereby the Company released MAXIMUS from all claims and potential
claims in relation to the Hawaii contract and vice versa exchange for a payment
to the Company of $50,000. The check was received in November 1999.
ITEM 2. CHANGE IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER MATERIALLY IMPORTANT EVENTS
None
ITEM 6. EXHIBITS AND REPORTS
(a) None
(b) The following reports on Form 8-K have been filed during the
quarter for this report is filed.
A current report on Form 8-K, dated July 6, 1999 was filed by the
Company and included the press release dated July 6, 1999, announcing
the extension of the Maine support contract.
A current report on Form 8-K, dated July 27, 1999 was filed by the
Company and included the press release dated July 26, 1999, announcing
the Company's results for the quarter ended June 30, 1999. A Statement
of Operations (without notes) for the quarters ended June 30, 1999 and
1998 was included with the filing. A Balance Sheet as of June 30, 1999
and December 31, 1998 was also included with the filing.
SIGNATURES
Pursuant to the requirements 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.
Network Six, Inc.
Date: November 5, 1999 By: /s/ Kenneth C. Kirsch
------------------------------------
Kenneth C. Kirsch
Chairman, President and
Chief Executive Officer
By: /s/ Dorothy M. Cipolla
------------------------------------
Dorothy M. Cipolla
Chief Financial Officer and Treasurer
(principal financial officer)