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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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(Mark One)
[x] Quarterly report pursuant to section 13 of 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended June 30, 1997
[ ] Transition report pursuant to section 13 of 15(d) of the Securities Exchange
Act of 1934 for the transition period from _____________ to ____________
Commission File No. 0-21038
NETWORK SIX, INC.
(Exact name of registrant as specified in its charter)
Rhode Island 05-036-6090
(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 June 30, 1997, there were 734,294 shares of the registrant's Common Stock,
$.10 par value, outstanding.
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PART 1 - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETWORK SIX, INC.
Condensed Balance Sheets
June 30, 1997 Dec. 31, 1996
------------- -------------
(unaudited)
ASSETS
- ------
Current assets:
Cash....................................... $ 386,887 $ 127,581
Contract receivables, less allowance for
doubtful accounts of $50,000 at
June 30, 1997 and $97,856 December 31,
1996..................................... 3,059,929 1,528,757
Costs and estimated earnings in excess of
billings on contracts.................... 615,978 1,864,939
Income taxes receivable.................... 130,010 516,046
Other assets............................... 173,141 158,976
---------- ----------
Total current assets..................... 4,365,945 4,196,299
---------- ----------
Property and equipment
Computers and equipment.................... 626,562 620,042
Furniture and fixtures..................... 182,142 194,878
Leasehold improvements..................... 20,191 20,191
---------- ----------
828,895 835,111
Less: accumulated depreciation and
amortization........................ 726,351 696,596
---------- ----------
Net property and equipment............ 102,544 138,515
Deferred taxes............................... 247,629 190,624
Contract receivables and costs in excess of
billings on Hawaii contract................ 3,459,382 3,571,824
Other assets................................. 686,574 176,302
---------- ----------
$8,862,074 $8,273,564
========== ==========
2
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current installment of obligations under
capital leases........................... $ 70,646 $ 70,190
Notes payable to bank...................... 1,800,000 1,800,000
Trade accounts payable..................... 1,554,258 1,732,332
Accrued salaries and benefits.............. 260,371 470,767
Accrued subcontractor expense.............. 1,149,462 22,244
Accrued restructuring...................... 0 5,383
Note payable - short term.................. 137,530 143,646
Other accrued expenses..................... 459,280 508,194
Billings in excess of costs and estimated
earnings on contracts.................... 57,975 31,771
Deferred taxes............................. 113,513 270,021
Preferred stock dividends payable.......... 327,739 234,760
---------- ----------
Total current liabilities................ 5,930,774 5,289,308
---------- ----------
Obligations under capital leases, excluding
current installments....................... 139,891 171,608
Note payable - long term..................... 0 63,871
---------- ----------
Total Liabilities........................ 6,070,665 5,524,787
---------- ----------
Stockholders' equity:
Series A convertible preferred stock,
$3.50 par value. Authorized 857,142.85
shares; issued and outstanding 714,285.71
shares at June 30, 1997 and December 31,
1996; 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 734,294 shares
at June 30, 1997 and 721,192 at
December 31, 1996........................ 73,429 72,119
Additional paid-in capital................. 1,670,939 1,653,296
Retained earnings (accumulated deficit).... (1,188,633) (1,206,265)
Treasury stock, 3,748 common shares at
December 31, 1996 at cost................ 0 (6,047)
---------- ----------
Total stockholders' equity............... 2,791,409 2,748,777
---------- ----------
Total Liabilities & Stockholder's Equity. $8,862,074 $8,273,564
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3
NETWORK SIX, INC.
Condensed Statements of Income
(Unaudited)
THREE MONTHS THREE MONTHS SIX MONTHS SIX MONTHS
ENDED 06/30/97 ENDED 06/30/96 ENDED 06/30/97 ENDED 06/30/96
-------------- -------------- -------------- --------------
Contract revenue earned................................ $3,431,835 $2,579,934 $4,846,020 $6,266,763
Cost of revenue earned................................. 2,593,348 1,826,237 3,566,488 4,346,651
---------- ---------- ---------- ----------
Gross profit....................................... 838,487 753,697 1,279,532 1,920,112
Selling, general, & administrative expenses............ 472,987 462,073 999,318 1,171,553
---------- ---------- ---------- ----------
Income from operations............................. 365,500 291,624 280,214 748,559
Other deductions (income)
Interest Expense................................... 61,979 120,328 112,636 221,328
Interest Earned.................................... (4,797) (19,655) (8,554) (60,333)
---------- ---------- ---------- ----------
Income before income taxes......................... 308,318 190,951 176,132 587,564
Income taxes........................................... 65,521 78,290 65,521 242,332
---------- ---------- ---------- ----------
NET INCOME............................................. $ 242,797 $ 112,661 $ 110,611 $ 345,232
---------- ---------- ---------- ----------
Per share information:
Net income used in fully diluted calculation....... 242,797 112,661 110,611 345,232
Less preferred dividend............................ 46,747 46,747 92,979 92,980
---------- ---------- ---------- ----------
Net income used in primary per share
calculation................................ 196,050 65,914 17,631 252,252
---------- ---------- ---------- ----------
Net income per share:
Primary:
Net income..................................... $ 0.27 $ 0.09 $ 0.02 $ 0.35
---------- ---------- ---------- ----------
Fully diluted:
Net income..................................... $ 0.26 $ 0.12 $ 0.12 $ 0.38
---------- ---------- ---------- ----------
Shares used in computing net income per share:
Primary............................................ 738,553 728,153 733,836 720,071
Fully Diluted...................................... 926,043 906,880 916,867 898,724
4
NETWORK SIX, INC.
Condensed Statements of Cash Flow
(Unaudited)
Six months Six months
ended ended
6/30/97 6/30/96
----------- -----------
Cash Flows from operating activities:
Net income................................................ $ 110,611 $ 345,232
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization......................... 46,454 176,098
Provision for doubtful accounts....................... (47,856) --
Loss on sale/disposal of fixed assets................. 3,212 --
Increase in contract receivables...................... (1,483,315) (225,210)
(Increase) decrease in other current assets........... (14,165) 65,116
Decrease in costs and estimated earnings in
excess of billings.................................. 1,248,960 231,063
Decrease in income taxes receivable................... 386,036 559,869
Increase (decrease) in billings in excess of costs
and estimated earnings on contracts................. 26,203 (351,687)
(Increase) decrease in long term receivables.......... (115,867) 190,838
Increase (decrease) in trade accounts payable......... (178,074) 353,536
Decrease in accrued salaries and benefits............. (210,396) (122,001)
Increase(decrease) on accrued subcontractor
expenses............................................ 1,127,218 (167,014)
Decrease in other notes payable....................... (69,987) --
Decrease in accrued restructuring..................... (5,383) (289,222)
Decrease in other accrued expenses.................... (48,914) (314,580)
Increase (decrease) in other assets................... (394,407) 155,242
Decrease from Long Term Amounts Due from
Hawaii.............................................. 112,443 303,970
Increase (decrease) in due from officer............... (57,005) 46,801
Decrease in deferred tax assets....................... -- 34,405
Decrease in deferred tax liability.................... (156,508) (60,117)
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Net cash provided by operating activities............. 279,260 777,097
----------- -----------
Cash flows from investment activities:
Cash proceeds from sale/disposal of capital assets...... 1,525 --
Capital expenditures.................................... (15,219) (2,310)
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Net cash used in investing activities................. (13,694) (2,310)
----------- -----------
Cash flows from financing activities:
Proceeds from the issuance of common stock.............. 18,954 50,254
Proceeds from the sale of treasury stock................ 6,047 --
Payments on notes payable to bank....................... -- (1,320,000)
Principal payments on capital lease obligations......... (31,261) (78,871)
----------- -----------
Net cash used in financing activities................. (6,260) (1,348,617)
----------- -----------
Net increase (decrease) in cash........................... 259,306 (573,830)
Cash at beginning of the period........................... 127,581 1,205,652
----------- -----------
Cash at end of period..................................... $ 386,887 $ 631,822
Supplemental cash flow information:
Cash paid (received) during the year for:
Income taxes.......................................... $ (107,003) $ 81,000
Interest.............................................. 110,026 237,471
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5
NETWORK SIX, INC.
Notes to Financial Statements
June 30, 1997
(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 June 30, 1997, and the statements of income and cash
flows for the six month periods ended June 30, 1997 and 1996, have been
included herein. The results of operations for the interim periods are not
necessarily indicative of the results for the full years.
(2) Reclassifications
Certain 1996 balances have been reclassified to conform to the 1997
presentation.
6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
In April the Company signed a new bank agreement providing for a secured
$1.8 million nine month term loan. The loan agreement requires $300,000 pay
downs in each of October, November and December 1997. See "Liquidity and Capital
Resources".
In May the State of Rhode Island, Department of Human Services, extended
its support contract with the Company for another year, through June 30, 1998.
The Company's current contract would have expired on June 30, 1997. The contract
extension is valued at approximately $2.7 million.
Results of Operations - Six Months Ended June 30, 1997 Compared to 1996
Contract revenue decreased $1,420,742 or 23% from $6,266,763 for the six
months ended June 30, 1996 to $4,846,020 for the six months ended June 30, 1997
primarily due to the substantial completion of the Idaho and the Virgin Islands
Child Support Enforcement (CSE) projects. Last year's figures also included
$1.4 million from the now terminated Hawaii CSE project. This reduction was
offset in part by additional work on the Rhode Island support contract related
to welfare reform and the commencement of the Maine Automated Child Welfare
Information System (MACWIS) in April.
Cost of revenue earned, consisting of direct employee labor, direct
contract expense and subcontracting expense, decreased $780,163 or 18% from
$4,346,651 for the six months ended June 30, 1996 to $3,566,488 for the six
months ended June 30, 1997. This was a consequence of a decreased level of
effort needed to support the lower level of business.
Gross profit decreased $640,580 or 33% from $1,920,112 for the six months
ended June 30, 1996 to $1,279,532 for the six months ended June 30, 1997. Gross
profit as a percentage of revenue earned decreased from 30.6% for the six months
ended June 30, 1996 to 26.4% for the six months ended June 30, 1997. The
decrease in gross profit margin is primarily due to an expected lower margin on
the Maine MACWIS project where the Company's subcontractor is playing a
significant role.
Selling, general and administrative (SG&A) expenses decreased $172,235 or
15% from $1,171,553 for the six months ended June 30, 1996 to $999,318 for the
six months ended June 30, 1997 primarily due to reduction of personnel and
expenses due to the lower level of business. On a percentage basis, SG&A
expenses increased to 21% of revenue from 19% primarily as a consequence of
higher legal fees associated with: (1) the Company's Hawaii-related litigation;
(2) finalizing the Maine contract; and (3) the negotiation of a new bank
agreement. See Part II - Other
7
Information, Item 1 - Legal Proceedings.
Interest expense decreased to $112,636 from $221,328 due to a lower level
of borrowing.
As a result, income before income taxes decreased $411,432, or 70% from
$587,564 for the six months ended June 30, 1996 to $176,132 for the six months
ended June 30, 1997. Income taxes decreased to $65,521, or 37% of pre tax
income, from $242,332, or 41% of pre tax income, due to a lower effective tax
rate and lower income before taxes.
Net income decreased $234,621, or 68%, from $345,232 for the six months
ended June 30, 1996 to $110,611 for the six months ended June 30, 1997.
Results of Operations - Three Months Ended June 30, 1997 Compared to 1996
Contract revenue increased $851,901 or 33% from $2,579,934 for the three
months ended June 30, 1996 to $3,431,835 for the three months ended June 30,
1997 primarily due to the commencement of the Maine MACWIS project and the
additional work on the Rhode Island support project related to welfare reform.
Cost of revenue earned, consisting of direct employee labor, direct
contract expense and subcontracting expense, increased $767,111 or 42% from
$1,826,237 for the three months ended June 30, 1996 to $2,593,348 for the three
months ended June 30, 1997 due to the increased level of effort needed to
support the higher level of business.
Gross profit increased $84,790 or 11% from $753,697 for the three months
ended June 30, 1996 to $838,487 for the three months ended June 30, 1997. Gross
profit as a percentage of revenue earned decreased from 29.2% for the three
months ended June 30, 1996 to 24.4% for the three months ended June 30, 1997.
The decrease in gross profit margins is primarily due to an expected lower
margin on the Maine MACWIS contract, where the Company's subcontractor is
playing a significant role.
SG&A expenses increased $10,914 or 2% from $462,073 for the three months
ended June 30, 1996 to $472,987 for the three months ended June 30, 1997
primarily as a consequence of higher legal fees associated with: (1) the
Company's Hawaii-related litigation; (2) finalizing the Maine contract; and (3)
the negotiation of a new bank agreement. See Part II - Other Information, Item 1
- - Legal Proceedings. On a percentage of revenue basis, SG&A expenses decreased
to 14% from 18%.
Interest expense decreased $67,349 to $61,979, or 52%, from $129,328 due to
a lower level of borrowing.
As a result, income before income taxes increased $117,367, or 61% from
$190,951 for the three months ended June 30, 1996 to $308,318 for the three
months ended June 30, 1997. However, income taxes decreased 16% to $65,521 from
$78,290. The Company had reported a loss before taxes of $132,186 in the first
quarter without recording any tax benefit for the loss. Such benefit has been
effectively taken in the second quarter resulting in an effective tax rate for
the quarter of 21%.
8
Net income increased $130,136 or 116% from $112,661 for the three months
ended June 30, 1996 to $242,797 for the three months ended June 30, 1997.
Liquidity and Capital Resources
In order to finance bid preparation costs and to obtain sufficient
collateral to support performance bonds required by some state government
agencies, 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 and to pursue more time and
material contracts. Time and materials contracts generally do not require
performance bonds and generally result in less delivery risk.
The Company historically has not received its first contract progress
payments on fixed price contracts until approximately three to six months after
contract award, which itself was as much as 12 months after proposal preparation
commences. The Company was therefore required to fund substantial costs well
before the receipt of related income, including marketing and proposal costs and
the cost of a performance bond. The Company is taking steps to tighten up this
timetable, thereby reducing the requirement for additional working capital. For
example, the Company is breaking up proposed deliverables into smaller
components which allow it to reach a payment milestone earlier than was
previously possible. The Company is also attempting to hold its customers to
their payment commitments, generally 30 days after invoicing.
The Company has funded its operations through cash flows from operations,
bank borrowings, and private placements of equity securities. Net cash provided
by operating activities was $279,260 and $777,097 in the six months ended June
30, 1997 and 1996, respectively. Fluctuations in net cash provided by operating
activities were primarily the result of changes in net income, contract and
income tax receivables, accounts payable and costs and estimated earnings in
excess of billings on contracts due to differences in contract milestones and
payment dates.
On April 30, 1997 the Company signed a new term loan (the "loan") with its
bank. The Company is required to reduce outstanding borrowings under the Loan
from $1.8 million to the following limits: October 15, 1997 - $1,500,000,
November 15, 1997 - $1,200,000 and December 15, 1997 - $900,000. The interest
rate on the Loan is 16%, with the difference between 16% and prime plus 2%
payable at maturity, which is January 31, 1998. There are also a number of
provisions for accelerated payment to reduce the loan balance, such as paying
the bank 50% of any contract holdbacks or income tax refunds. In addition, the
Company agreed to provide the bank with a warrant to purchase 50,487
unregistered shares of the Company's Common Stock at $1.75 per share,
exercisable immediately with an expiration date of April 30, 2002, and agreed to
provide the bank 15% of any recovery received from its litigation in Hawaii. The
warrants and the bank's right to a percentage of any recovery terminate if the
Company pays down the Loan completely or raises $1 million of equity capital
prior to maturity. The Company's obligations under the Loan are secured by
substantially all of the assets of the Company. The loan also provides that the
Company may not pay any dividends on its capital stock without the consent of
the bank.
Although the Company believes that cash flow generated by operations will
be sufficient to fund continuing operations through the end of 1997, this
assumes timely payments from the Company's customers, that there are no material
adverse decisions rendered in the ongoing Hawaii- related litigation and that
the Company can meet its obligations to its bank. The Company continues to seek
new equity in order to strengthen its financial flexibility.
9
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 12, 1996 the State of Hawaii filed a lawsuit in the Circuit
Court of the First Circuit of the State of Hawaii (the "State") against the
Company and Aetna Casualty and Surety and Federal Insurance Company for damages
alleging 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 enforcement system. The suit alleges the Company failed to meet
contractual deadlines, provided late, incomplete and/or unsuitable deliverables,
and materially breached the contract by never completing the design, the
application programming, and the system test and systems implementation. The
State is seeking general damages, consequential and special damages, liquidated
damages, attorneys' fees, reimbursement for the cost of the suit and interest,
and costs that the court deems just and proper all in an unspecified amount.
The Company vigorously denies the State's allegations and, on January 23,
1997 filed a counter claim against the State alleging that the State breached
the Company's contract. The Company is seeking $70 million in damages and is
alleging that the State had fraudulently induced the Company into designing and
building a system having capabilities and extraordinary features far beyond the
scope of the Company's contract and industry standards. The fraudulent
inducement was in the form of withholding payments, improper rejection of work
that satisfies 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, has 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. The Company
expects that a request for reimbursement will be forthcoming from Aetna.
On December 13, 1996, Complete Business Solutions, Inc. (CBSI), a
subcontractor to the Company on the Hawaii contract, filed a lawsuit against the
Company in the Superior Court of the State of Rhode Island for $517,503 which
the Company had previously accrued, plus interest, costs and attorney's fees.
The Company disputes the $517,503 owed to CBSI and filed a counterclaim against
CBSI on January 13, 1997 alleging, among other things, that CBSI failed to
complete its duties required under the subcontract with the Company in a timely
manner, improperly engaged in negotiations with the State of Hawaii to complete
the project, hired and attempted to hire employees of the Company in violation
of its subcontract agreement with the Company and obtained and utilized
confidential information inappropriately. Also, the Company alleges that CBSI
owes the Company $482,750 as of December 31, 1996 for which the Company has not
established a reserve for uncollectibility. CBSI filed a motion to have their
suit and the Company's counterclaim dismissed in Rhode Island and attempted to
have all matters litigated in Hawaii. That motion was denied and the litigation
is continuing in Rhode Island.
On February 3, 1997, the Company filed a third-party complaint ("TPC") in
the Hawaii litigation against MAXIMUS Corporation ("MAXIMUS") and CBSI. MAXIMUS
has been the State of Hawaii's contract supervisor and advisor since the
inception of the Hawaii project. The allegations the Company has made against
CBSI in this TPC are substantially similar to the allegations made against CBSI
in the
10
Company's counterclaim to CBSI's December 13, 1996 lawsuit brought against the
Company in Rhode Island. The Company further alleged that MAXIMUS is liable to
the Company on grounds that: (i) the Company was an intended third party
beneficiary under the contract between MAXIMUS and Hawaii; (ii) MAXIMUS
tortiously interfered in the contract between the Company and Hawaii; (iii)
MAXIMUS negligently breached duties to the Company and (iv) MAXIMUS aided and
abetted Hawaii in Hawaii's breach of contract. The Company's complaint seeks $60
million in damages. On March 27, 1997, MAXIMUS filed a motion to dismiss many of
the counts of the TPC germane to them. A hearing was held on April 17, 1997 and
the motion was denied as to all but one count. That litigation is continuing in
Hawaii.
Management believes that the Company's claims against the State, MAXIMUS
and CBSI have substantial merit and continues to pursue these claims. There is
substantial uncertainty, however, inherent in all litigation. If the Company is
unable to prevail in its suit with the State, such a result could have a
material adverse effect on the Company. Management of the Company and its
attorneys are unable to predict with any certainty the ultimate outcome of this
litigation, including the probability that this litigation will have a negative
impact on the Company or the dollar amount of the potential impact. At June 30,
1997, the Company had unbilled work-in-process and related receivables from the
State and CBSI of approximately $3.46 million, which exceeds stockholders'
equity of $2.79 million and for which no allowance for uncollectibility has been
recorded. The Company has not accrued for any potential liability to the State
which may result from this litigation. In addition, the Company has not accrued
for any legal expense to be incurred in connection with this litigation, which
could be significant.
ITEM 2. CHANGE IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders held on June 25, 1997, shareholders
voted 742,323 shares (including voting preferred stock) in favor of:
(1) The election of Dana H. Gaebe, Kenneth C. Kirsch, Nicholas R. Supron
and Clifton C. Dutton as Directors to serve until the next annual meeting of
the stockholders or until their successors are elected and qualified.
FOR AGAINST ABSTAIN NO VOTE
Dana H. Gaebe 724,989 - 0 - 17,334 153,692
Kenneth C. Kirsch 724,864 - 0 - 17,459 153,692
Nicholas R. Supron 724,764 - 0 - 17,559 153,692
Clifton C. Dutton 724,439 - 0 - 17,884 153,692
11
(2) Approval of the reservation of an additional 75,000 shares of the
Company's authorized but unissued stock for employee stock options which
may be granted under the 1993 Incentive Stock Option Plan.
FOR AGAINST ABSTAIN NO VOTE
367,925 65,907 2,834 459,349
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS
(a) None
(b) No reports on Form 8-K have been filed during the quarter for which
this report is filed.
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: August 5, 1997 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)
12