UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
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 333-12091
INTER*ACT SYSTEMS, INCORPORATED
(Exact name of registrant as specified in its charter)
NORTH CAROLINA 56-1817510
- -------------------------------------------------------------- ----------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
14 WESTPORT AVENUE
NORWALK, CONNECTICUT 06851
- -------------------------------------------------------------- ----------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (203) 750-0300
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date. As of May 14, 1998 the
registrant had 7,728,555 shares of common stock outstanding.
INDEX
PAGE
----
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 1998 (unaudited) and December 31, 1997 ......... 1
Consolidated Statements of Income for the three-month period ended
March 31, 1998 (unaudited) and March 31, 1997 (unaudited) ......................... 2
Consolidated Statements of Cash Flows for the three-month period ended
March 31, 1998 (unaudited) and March 31, 1997 (unaudited) ......................... 3
Notes to Consolidated Financial Statements ............................................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ..... 6
Part II - Other Information
Item 1. Legal Proceedings ........................................................................10
Item 4. Submission of Matters to a Vote of Security Holders ......................................10
Item 6. Exhibits and Reports on Form 8-K .........................................................10
Signatures .........................................................................................12
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
INTER*ACT SYSTEMS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
1998 1997
---------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents .................................................. $ 31,266 $ 45,211
Receivables, net of allowance for doubtful accounts of $30
at March 31, 1998 and December 31, 1997, respectively .................. 678 813
Other current assets ....................................................... 2,946 3,067
-------- --------
Total current assets ................................................... 34,890 49,091
Property, plant and equipment, net ............................................. 27,062 26,900
Bond issuance costs, net of accumulated amortization of $758 and
$633 at March 31, 1998 and December 31, 1997, respectively ................. 3,177 3,302
Patents, licenses and trademarks, net of accumulated amortization of
$169 and $95 at March 31, 1998 and December 31, 1997, respectively ......... 1,703 1,687
Other noncurrent assets ........................................................ 43 43
-------- --------
Total assets ........................................................... $ 66,875 $ 81,023
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable ........................................................... $ 3,467 $ 3,204
Accrued expenses ........................................................... 5,220 6,870
Deferred revenue ........................................................... 408 539
-------- --------
Total current liabilities .............................................. 9,095 10,613
Long-term debt, net of discount ................................................ 96,107 91,406
-------- --------
Total liabilities ...................................................... 105,202 102,019
-------- --------
Common stock purchase warrants ................................................. 27,436 27,436
-------- --------
Stockholder's equity (deficit):
Preferred stock, no par value, authorized 5,000,000 shares; none outstanding -- --
Common stock, no par value, authorized 20,000,000 shares; 7,728,555 shares
issued and outstanding at March 31, 1998 and
December 31, 1997, respectively ........................................ 28,251 28,251
Additional paid-in capital ................................................. 768 768
Deferred compensation ...................................................... (531) (570)
Cumulative translation adjustments ......................................... (19) (14)
Accumulated deficit ........................................................ (94,232) (76,867)
-------- --------
Total stockholders' equity (deficit) ................................... (65,763) (48,432)
-------- --------
Total liabilities and stockholders' equity (deficit) ................... $ 66,875 $ 81,023
======== ========
See Notes to Consolidated Financial Statements
1
INTER*ACT SYSTEMS, INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
---------------------------
MARCH 31, MARCH 31,
1998 1997
----------- -----------
(UNAUDITED) (UNAUDITED)
Gross sales ...................................... $ 695 $ 304
Less: Retailer reimbursements ............... (412) (186)
-------- -------
Net sales ............................. 283 118
-------- -------
Operating expenses:
Direct costs ................................ 2,282 1,075
Selling, general and administrative expenses 9,568 3,418
Depreciation and amortization of intangibles 1,475 631
-------- -------
Total operating expenses ............... 13,325 5,124
-------- -------
Operating loss ................................... (13,042) (5,006)
-------- -------
Other income (expense)
Interest income ............................. 510 1,125
Interest expense ............................ (4,833) (4,117)
-------- -------
Total other income (expense) ........... (4,323) (2,992)
-------- -------
Net loss ......................................... $(17,365) $(7,998)
======== =======
Per share information:
Net loss per common share:
Basic ....................................... $ (2.25) $ (1.04)
======== =======
Diluted ..................................... $ (2.25) $ (1.04)
======== =======
Common shares used in computing per share amounts
Basic ....................................... 7,729 7,669
======== =======
Diluted ..................................... 7,729 7,669
======== =======
See Notes to Consolidated Financial Statements
2
INTER*ACT SYSTEMS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
---------------------------
MARCH 31, MARCH 31,
1998 1997
----------- -----------
(UNAUDITED) (UNAUDITED)
Cash flows from operating activities:
Net loss ................................................... $(17,365) $ (7,998)
Items not affecting cash:
Depreciation and amortization of intangible assets .... 1,475 631
Loss on disposal of assets ............................ 270 --
Non-cash interest on discounted bonds ................. 4,826 4,101
Other items, net ...................................... 39 (254)
Changes in working capital:
Receivables ........................................... 135 72
Accounts payable and accrued expenses ................. (1,387) 3,835
Other current assets .................................. 121 91
Deferred revenues ..................................... (131) 426
-------- --------
Net cash (used in) provided by operating activities (12,017) 904
-------- --------
Cash flows from investing activities:
Expenditures for property, plant and equipment ........ (1,833) (6,006)
Patent acquisition costs .............................. (90) --
Other investments ..................................... -- (301)
-------- --------
Net cash used in investing activities ............ (1,923) (6,307)
-------- --------
Foreign exchange effects on cash and cash equivalents ........... (5) --
-------- --------
Net decrease in cash and cash equivalents ....................... (13,945) (5,403)
Cash and cash equivalents at beginning of period ................ 45,211 88,306
-------- --------
Cash and cash equivalents at end of period ...................... $ 31,266 $ 82,903
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest.................................................... $ -- $ --
======== ========
See Notes to Consolidated Financial Statements
3
INTER*ACT SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND MARCH 31, 1997
1. BUSINESS DESCRIPTION
Inter*Act Systems, Incorporated ("Inter*Act" or the "Company") is one of
the nation's largest in-store operators of customer-interActive electronic
marketing systems. The Company's patented technologies enable consumer products
manufacturers ("Manufacturers") and supermarket retailers ("Retailers") to offer
shopper-specific purchase incentives and messages to customers moments before
shopping begins. The Company's proprietary system, called the Inter*Act Loyalty
Network'tm' ("ILN"), utilizes patented, multimedia touch-screen terminals, or
Smart Kiosks'tm', located in the entrance area of retail grocery stores. These
terminals are connected to each store's point-of-sale scanning system, which
allows the electronic promotions to be immediately redeemed at the check-out.
This fully automated process virtually eliminates misredemption and fraud
associated with paper coupons, estimated by industry sources to cost
manufacturers hundreds of millions of dollars per year. As of March 31, 1998,
the Company had 2,142 terminals installed in 1,388 stores across 17 divisions of
six grocery chains compared to 1,001 terminals in 570 stores across 7 divisions
of four chains as of March 31, 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Preparation
The accompanying interim financial statements as of March 31, 1998 and
for the three-month period ended March 31, 1998 and March 31, 1997 are
unaudited; however, in the opinion of management, all adjustments, which consist
of normal recurring accruals, necessary for a fair presentation of the financial
position and results of operations from such interim periods, are included. The
results of operations for the interim periods presented are not necessarily
indicative of results to be expected for an entire year. For further information
refer to the consolidated financial statements and notes thereto included in the
Company's annual report on Form 10-K for the year ended December 31, 1997.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
Net income (loss) per share
Effective December 31, 1997, the Company adopted SFAS No. 128, "Earnings
Per Share". In accordance with SFAS No. 128, net loss per common share amounts
("basic EPS") were computed by dividing net loss by the weighted average number
of common shares outstanding and contingently issuable shares (which satisfy
certain conditions) and excluded any potential dilution. Net loss per common
share amounts -- assuming dilution ("diluted EPS") were computed by reflecting
potential dilution from the exercise of stock options and warrants. SFAS No. 128
requires the presentation of both basic EPS and diluted EPS on the face of the
income statement. Net loss per share amounts for the same prior-year periods
have been restated to conform with the provisions of SFAS No. 128; however, the
result of that restatement was not material. In all periods presented, the
impact of stock options and warrants was anti-dilutive.
Comprehensive Income
During the quarter ended March 31, 1998, the Company adopted SFAS No.
130, "Reporting Comprehensive Income," which requires companies to report all
changes in equity during a period, except
4
those resulting from investments by owners and distributions to owners, for the
period in which they are recognized. Comprehensive income is the total of net
income and all other nonowner changes in equity (or other comprehensive income)
such as unrealized gains/losses on securities classified as available-for-sale,
foreign currency translation adjustments and minimum pension liability
adjustments. Comprehensive and other comprehensive income must be reported on
the face of annual financial statements or in the case of interim reporting, in
the footnotes to the financial statements. For the quarters ended March 31, 1998
and 1997, the Company's operations did not give rise to material items
includible in comprehensive income which were not already included in net
income. Accordingly, the Company's comprehensive income is the same as its net
income for all periods presented.
3. LEGAL PROCEEDINGS
In February 1996, the Company filed suit against Catalina Marketing
Corporation ("Catalina") alleging that Catalina has infringed United States
Patent No. 4,554,446 (the "'446 Patent") under which the Company is licensee.
The Company alleges that Catalina is infringing the patent by making, using and
offering for sale devices and systems that incorporate and employ inventions
covered by the '446 Patent. The Company is seeking an injunction against
Catalina to stop further infringement of the patent, treble damages and the
costs and expenses incurred in connection with the suit. The complaint has been
amended to add additional detail, and Catalina has answered denying the
allegations, raising certain affirmative defenses, and seeking declaratory
judgment of non-infringement, invalidity or unenforceability of the `446 Patent.
In May 1997, Catalina asserted a second counterclaim alleging that the Company
is infringing a newly issued Catalina Patent U.S. Patent No. 5,612,868 (the
"'868 Patent"). The Company has answered denying the allegations, raising
affirmative defenses and seeking declaratory judgment of non-infringement,
invalidity and unenforceability of the `868 Patent. Discovery on the claims and
counterclaims is proceeding and various motions are pending before the United
States District Court in the District of Connecticut. As with any litigation,
the ultimate outcome of the suit cannot be predicted. However, the Company
intends to pursue the action vigorously.
In January 1998, Catalina Marketing International, Inc. ("Catalina
International," a subsidiary of Catalina) filed suit against the Company
alleging that the Company has infringed United States Patent No. 4,674,041 (the
"'041 Patent") which Catalina International acquired by assignment in December
1997. Catalina International alleges that the Company is infringing the '041
Patent by making, using and offering for sale devices and systems that
incorporate and employ inventions covered by the '041 Patent. Also in February
1998, Catalina International amended its complaint to join as additional parties
defendant Thermo Information Solutions, Inc. ("Thermo") and Coleman Research
Corporation ("Coleman"), who have manufactured kiosks pursuant to an agreement
with the Company. Catalina International seeks injunctive and declaratory relief
as well as unspecified money damages against all defendants, and has filed a
motion for preliminary injunction against the Company seeking to stop alleged
infringement of the '041 Patent pending trial. Various other motions are pending
in the United States District Court in the District of Connecticut, including
the Company's motion for a more definite statement. The Company intends to
defend against Catalina International's claims vigorously, and to pursue
available remedies against Catalina International. This action was recently
consolidated with the litigation involving the '446 Patent and the '868 Patent
for purposes of discovery and trial.
5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis is qualified by reference to and
should be read in conjunction with the Company's Unaudited Consolidated
Financial Statements, including the Notes thereto, included elsewhere in this
Report. This report contains certain statements regarding future operating
results and anticipated growth, the accuracy of which is subject to many risks
and uncertainties. Such trends, and their anticipated impact on the Company,
could differ materially from those discussed in this report. Operating results
for the three months ended March 31, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998 or any other
period.
The Company is one of the nation's largest in-store operators of
customer-interActive electronic marketing systems. The Company's patented
technologies enable consumer products manufacturers ("Manufacturers") and
supermarket retailers ("Retailers") to offer shopper-specific purchase
incentives and messages to customers moments before shopping begins. The
Company's proprietary system, called the Inter*Act Loyalty Network ("ILN"),
utilizes patented, multimedia touch-screen terminals, or Smart Kiosks, located
in the entrance area of retail grocery stores. These terminals are connected to
each store's point-of-sale scanning system, which allows the electronic
promotions to be immediately redeemed at check-out. This fully automated process
virtually eliminates the misredemption and fraud associated with paper coupons,
estimated by industry sources to cost Manufacturers hundreds of millions of
dollars per year.
The Company recognizes revenue as electronic discounts are redeemed at
store cash registers. Manufacturers pay a fee to the Company for each
redemption. The fee is composed of (1) a retailer processing fee, (2) a
redemption fee and (3) the face value of the coupon. The Company, in turn,
passes through both the retailer processing fee, which is included in direct
operating expenses, and the face value of the coupon to the Retailer, while
retaining the redemption fee. The Company records as net sales the redemption
fee and the retailer processing fee paid by the Manufacturers. Certain
Manufacturers pay the Company in advance for a portion of anticipated program
expenditures, and these amounts are recorded as deferred revenue until earned
through redemptions.
Direct costs of the Company consist of such expenditures for direct
store support, paper used in the kiosks to print shopping lists and recipes,
direct marketing costs, telecommunications between the stores and the Company
and retailer processing fees. Selling, general and administration expenses
include items relating to sales and marketing, administration, non-paid
promotional expenses and royalties payable under certain patent agreements.
Non-paid promotional expenses represent consumer discounts and retailer
processing fees paid to the Retailer by the Company on promotions offered on the
ILN that are not funded by a Manufacturer contract. Manufacturer participation
in the ILN to date has been characterized by a substantial number of trial
commitments leading to increasing dollar commitments to the ILN from those
Manufacturers as the network approaches a more national footprint. Successful
trials have recently led to multi-cycle/multi-brand category contracts or
letters of intent signed in the quarter ending March 31, 1998 with Manufacturers
including, General Mills, Procter & Gamble and Pillsbury among others.
See "--Three Months Ended March 31, 1998 Compared with Three Months
Ended March 31, 1997." As the network grows and is more widely accepted by
Manufacturers, the Company believes that the need for non-paid promotions will
diminish and that revenues from Manufacturers will increase.
To date, the Company has generated minimal operating revenue, has
incurred significant losses and has experienced substantial negative cash flow
from operations. The Company's prospects must be considered in light of the
risks, expenses and difficulties frequently encountered by companies in their
early stage of development. The Company had an accumulated stockholders' deficit
of $65.8 million as of March 31, 1998, having incurred a loss of $17.4 million
during the first quarter of 1998. The Company expects to incur substantial
additional costs to install additional ILN terminals in retail supermarket
stores and to sponsor selected promotions to demonstrate the utility of the ILN
to consumers, Retailers and Manufacturers. The Company expects to incur net
losses in 1998 and may operate at a loss for the foreseeable future, and there
can be no assurance that the Company will ever be able to achieve profitability
or, if achieved, sustain such profitability.
6
THREE MONTHS ENDED MARCH 31, 1998 COMPARED WITH THREE MONTHS ENDED
MARCH 31, 1997
The Company had an installed base of 2,142 terminals in 1,388 stores as
of March 31, 1998 as compared to 1,001 terminals in 570 stores as of March 31,
1997. During the first quarter of 1998, the Company entered into contracts to
install the ILN in Weis Markets, a chain located principally in Pennsylvania,
and, through a subsidiary, in Sainsbury's, one of the largest Retailers in the
United Kingdom.
Total redemptions for the three-month period ended March 31, 1998
increased by approximately 5.0 million redemptions to 7.7 million redemptions
from 2.7 million redemptions in the comparable period in 1997. Average
redemptions/day/store increased to 72 from 66 for the period ended March 31,
1998 versus the comparable period in 1997. The Company attributes the increase
to Retailer advertising of certain promotions partially funded by Inter*Act
in their in-store fliers, which increased kiosk usage during the first quarter
of 1998.
Manufacturers promoting on the ILN system for at least one week during
the 1998 and 1997 periods increased to 41 from 23, respectively, while total
products promoted increased to 99 from 75. Net sales during the three-month
period ended March 31, 1998 increased to $283,000 from $118,000 in the 1997
period, primarily as a result of the larger installed base of ILN terminals. As
a result of successful brand trials of the ILN and the recent installation of
the ILN in major cities such as Los Angeles and Chicago, the Company entered
into more substantial contracts and letters of intent with clients including
General Mills, Procter & Gamble, Pillsbury, Campbell's and others. In addition,
upon the first quarter announcement of the Company's contract with Sainsbury's
in the United Kingdom, the Company's U.K. subsidiary has signed agreements with
several major manufacturers for trial of the ILN in the U.K., including Procter
& Gamble, Unilever, Coca Cola and Kellogg's, among others. In aggregate, these
recent commitments represent more than $6 million to fund promotion incentives
and related fees primarily in 1998 on the ILN in both the U.S. and the U.K.
There can be no assurance that the Company will realize the full commitments by
Manufacturers.
Operating loss for the three-month period ended March 31, 1998 was $13.0
million versus $5.0 million in the 1997 comparable period. The increased loss
was primarily due to higher employee costs, non-paid promotions, legal fees and
depreciation expense. Higher employee costs of approximately $2.4 million
represents an increase of 109 employees, from 116 employees at March 31, 1997 to
225 employees at March 31, 1998. Most of the increase in headcount represents
additional sales and field service personnel to support the increase in number
of terminals and stores installed. Non-paid promotion expense increased by $2.0
million in the 1998 three-month period, to $3.0 million from $1.0 million in the
comparable 1997 period. Legal expense, primarily costs associated with patent
litigation (not expected to extend the life of related patents and therefore,
not capitalized) increased by $600,000 over the comparable 1997 period (See Note
3 to Notes to Consolidated Financial Statements). Depreciation expense increased
by $844,000 reflecting the addition of approximately 1,141 terminals installed
in 818 stores from March 31, 1997 to March 31, 1998.
Net loss for the three-month period ended March 31, 1998 increased by
approximately $9.4 million from $8.0 million to $17.4 million primarily due to
higher operating losses of $8.0 million, higher interest expense of $716,000 and
lower interest income of $615,000. Interest expense of $4.8 million represents
non-cash interest expense on the issuance of $142 million of 14% Senior Discount
Notes on August 2, 1996 (See "--Liquidity and Capital Resources"). Interest
income of $510,000 for the first three months of 1998 declined from 1997
reflecting a decreased average cash balance during the first three months of
1998 versus the comparable period in 1997. Cash and cash equivalents at
March 31, 1998 were $31.3 million as compared to $82.9 million at
March 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
For the three-month period ended March 31, 1998, cash used in operating
activities was $12.0 million. Cash provided by operating activities was
approximately $904,000 during the three-month period ended March 31, 1997. From
inception to March 31, 1998, the Company generated minimal revenue yet incurred
expenses related to the development of its ILN technology, test marketing the
product and recruiting additional personnel. The Company has funded its
operations through private sales of debt and equity securities. From its
inception through March 31, 1998, the Company's stockholders had contributed
$27.7 million of equity to the Company of
7
which $2.0 million was originally issued as debt and subsequently converted to
equity. The Company consummated a private offering of debt securities (the
"Private Placement") on August 2, 1996 for which it received net proceeds of
approximately $90.8 million. The Private Placement consisted of 142,000 units
representing $142 million in aggregate principal amount of 14% Senior Discount
Notes Due 2003 (the "Notes") and warrants (the "Warrants") to purchase initially
an aggregate of 1,041,428 shares of common stock of the Company at $.01 per
share. As of September 30, 1997, a Qualifying Initial Public Offering (as
defined in the Notes) had not been completed and as a result thereof, the
Warrants were then adjusted to entitle respective holders to purchase an
aggregate of 1,338,918 shares of common stock at $.01 per share. Therefore, the
Company recorded additional Common Stock Purchase Warrants of $3.0 million
reflecting the valuation of the additional 297,492 shares, or 2.095 shares
issuable per warrant.
At March 31, 1998, the Company had working capital of $25.8 million,
compared to working capital of $38.5 million at December 31, 1997. Total cash
and cash equivalents at March 31, 1998 and December 31,1997 was $31.3 million
and $45.2 million, respectively. The Company's current level of indebtedness,
amounting to approximately $96.1 million, represents long-term debt resulting
from the Private Placement.
Cash used in investing activities was $1.9 million and $6.3 million in
the three months ended March 31, 1998 and March 31, 1997, respectively,
primarily related to expenditures for ILN equipment. During the three-month
period ended March 31, 1998, the Company installed 302 terminals in 240 stores.
All of the terminals used in the first quarter installation had been purchased
in the latter part of 1997. The Company expects to spend approximately $15
million on ILN equipment during 1998.
As of March 24, 1998, the Company terminated its three-year exclusive
terminal supply relationship with Coleman and its subsidiary Thermo
(collectively, the "Vendors"). As part of this mutual termination agreement, the
Company agreed to pay $4.5 million, in installments, to pay balances on
previously purchased ILN equipment, to acquire certain inventory and to obtain
early release from the exclusivity provision of the original contract to allow
the Company to pursue relationships with new vendors. Of this amount, $4.1
million was charged to operating expense during 1997 and approximately $400,000
related to supplies and terminal parts acquired by the Company in the agreement
and are reflected in other current assets as of December 31, 1997 and March 31,
1998. As of May 14, 1998, $2.0 million of the $4.5 million total obligation has
been paid to the Vendors as part of the mutual termination agreement. The
remainder is included in accrued expenses and will be fully paid by August 1998.
The Company continues to use the net proceeds from the Private Placement
to fund capital expenditures, working capital requirements and operating losses
incurred in connection with the increased commercialization of its ILN. The
Company intends to raise additional equity or debt capital to fund its ongoing
1998 and 1999 expansion plans. In addition, the Company has received several
multi-year equipment leasing proposals from equipment manufacturers for future
purchases of ILN equipment. There is no assurance that such additional capital
or equipment financing can be obtained. In the event that such additional
capital or equipment financing is not obtained, the Company believes that
existing cash and cash equivalents, together with reduced or delayed operating
and capital expenditures, will be sufficient to meet the Company's operating
requirements into the first quarter of 1999. Because of the Company's early
stage of development and the risks inherent in its business, there are a number
of material uncertainties that could result in shortfalls in revenue. For
example, shortfalls could occur if the Company experiences delays in
installations of the ILN such that any growth in paid redemption volume is
delayed.
If additional funds are raised through the issuance of equity
securities, the percentage ownership of the stockholders will experience
additional dilution, or such equity securities may have rights, preferences or
privileges senior to the Common Stock. If additional funds are raised through
debt financing, such financing will increase the financial leverage of the
Company and earnings would be reduced by the associated interest expense. The
Indenture related to the Exchange Notes permits the Company to incur additional
indebtedness, subject to certain limitations. There can be no assurance that
additional financing will be available when needed on terms favorable to the
Company or at all. If adequate funds are not available on acceptable terms, the
Company may be unable to continue its planned ILN installations, expand both the
number and dollar amount of Manufacturer commitments, or respond to competitive
pressures, any of which could have a material adverse effect on the Company's
results of operations and financial condition.
8
The Company is currently in the process of updating its systems to
ensure all programs are year 2000 compliant. The Company will utilize internal
and external resources to reprogram, replace and test systems for year 2000
compliance. The estimated cost of such project is estimated to be approximately
$300,000. Year 2000 compliance testing is expected to be completed no later than
December 31, 1998. The Company is also reliant on Year 2000 compliance by
Retailers with respect to the Company's Target Engine Software ("TES") ability
to process and collect data from the TES interface to each of the Retailer's
point-of-sale systems. The Company is currently working with Retailers to test
such interfaces for year 2000 compliance. There can be no assurance that a
failure by a Retailer to become Year 2000 compliant will not negatively affect
the Company with respect to that Retailer.
CAUTIONARY STATEMENT FOR PURPOSE OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
The statements contained in this report on Form 10-Q that are not
historical facts are forward-looking statements (as such term is defined in the
Private Securities Litigation Reform Act of 1995), which can be identified by
the use of forward-looking terminology such as believes, expects, may, will,
should, or anticipates or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategy that involve risks and
uncertainties. In addition, from time to time the Company or its representatives
have made or may make forward-looking statements, orally or in writing. Such
forward-looking statements may be included in, but are not limited to, various
filings made by the Company with the Securities and Exchange Commission, or
press releases or oral statements made by or with the approval of an authorized
executive officer of the Company. Forward-looking statements are based on
management's current views and assumptions and involve risks and uncertainties
that could significantly affect expected results. The Company wishes to caution
the reader that factors, such as those listed below, in some cases have affected
and could affect the Company's actual results, causing actual results to differ
materially from those in any forward-looking statement. These factors include:
(i) the Company's limited operating history, significant losses, accumulated
deficit, negative cash flow and expected future losses, (ii) the dependence of
the Company on its ability to establish, maintain and expand relationships with
Manufacturers to promote brands on the ILN (as defined herein) and the
uncertainty of market acceptance for the ILN, (iii) the uncertainty as to
whether the Company will be able to manage its growth effectively, (iv) the
early stage of the Company's products and services and technical and other
problems that the Company has experienced and may experience, (v) risks related
to the Company's substantial leverage and debt service obligations, (vi) the
Company's dependence on third parties such as those who manufacture ILN
terminals, (vii) the intensely competitive nature of the consumer product and
promotional industry, (viii) risks that the Company's rights related to patents,
proprietary information and trademarks may not adequately protect its business,
(ix) the possible inability of new management to perform their respective roles
and the possible conflicts of interest of the Company's directors, officers and
principal shareholders in certain transactions with the Company. See Part I.
Item 7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Risk Factors" on the Form 10-K for the year ended December 31,
1997 for a more specific description of these risks.
9
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In February 1996, the Company filed suit against Catalina alleging that
Catalina has infringed the `446 Patent under which the Company is licensee. The
Company alleges that Catalina is infringing the patent by making, using and
offering for sale devices and systems that incorporate and employ inventions
covered by the '446 Patent. The Company is seeking an injunction against
Catalina to stop further infringement of the patent, treble damages and the
costs and expenses incurred in connection with the suit. The complaint has been
amended to add additional detail, and Catalina has answered denying the
allegations, raising certain affirmative defenses, and seeking declaratory
judgment of non-infringement, invalidity or unenforceability of the `446 Patent.
In May 1997, Catalina asserted a second counterclaim alleging that the Company
is infringing a newly issued Catalina Patent, the '868 Patent. The Company has
answered denying the allegations, raising affirmative defenses and seeking
declaratory judgment of non-infringement, invalidity and unenforceability of the
'868 Patent. Discovery on the claims and counterclaims is proceeding and various
motions are pending before the United States District Court in the District of
Connecticut. As with any litigation, the ultimate outcome of the suit cannot be
predicted. However, the Company intends to pursue the action vigorously.
In January 1998, Catalina International filed suit against the Company
alleging that the Company has infringed the '041 Patent which Catalina
International acquired by assignment in December 1997. Catalina International
alleges that the Company is infringing the '041 Patent by making, using and
offering for sale devices and systems that incorporate and employ inventions
covered by the '041 Patent. Also in February 1998, Catalina International
amended its complaint to join as additional parties' defendant Thermo and
Coleman, who have manufactured kiosks pursuant to an agreement with the Company.
Catalina International seeks injunctive and declaratory relief as well as
unspecified money damages against all defendants, and has filed a motion for
preliminary injunction against the Company seeking to stop alleged infringement
of the '041 Patent pending trial. Various other motions are pending in the
United States District Court in the District of Connecticut, including the
Company's motion for a more definite statement. The Company intends to defend
against Catalina International's claims vigorously, and to pursue available
remedies against Catalina International. This action was recently consolidated
with the litigation involving the '446 Patent and the '868 Patent for purposes
of discovery and trial.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NO. DESCRIPTION
*(a)(1) Articles of Incorporation of the Company, as amended, filed as Exhibit
3(a) to the Company's Registration Statement of Form S-4 (Registration
333-12091)
*3(a)(2) Articles of Amendment of the Company dated May 21, 1997 and effective
June 3, 1997.
*3(b) Amended and Restated Bylaws of the Company
*4(a) Specimen Certificate of the Company's Common Stock, filed as Exhibit
4(a) to the Company's Registration Statement of Form S-4 (Registration
333-12091)
*4(b) Indenture dated August 1, 1996, between the Company and Fleet National
Bank, as trustee, relating to $142,000,000 in principal amount of 14%
Senior Discount Notes due 2003, filed as Exhibit 4(b) to the Company's
Registration Statement of Form S-4 (Registration 333-12091)
10
*4(c) Warrant Agreement dated August 1, 1996, between the Company and Fleet
National Bank, as Warrant Agent, filed as Exhibit 10 (l) to the
Company's Annual Report on Form 10-K for the year ended September 28,
1996.
27. Financial Data Schedule.
* Incorporated by reference to the statement or report indicated.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended March
31, 1998.
11
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTER*ACT SYSTEMS, INCORPORATED
Date
By /s/ STEPHEN R. LEEOLOU May 15, 1998
------------------------------------
STEPHEN R. LEEOLOU
CHAIRMAN & CHIEF EXECUTIVE OFFICER
By /s/ RICHARD A. VINCHESI May 15, 1998
------------------------------------
RICHARD A. VINCHESI
SENIOR VICE PRESIDENT,
CHIEF OPERATING OFFICER &
CHIEF FINANCIAL OFFICER
12
STATEMENT OF DIFFERENCES
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