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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________
FORM 10-KSB
[X] Annual Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 1998
-- or --
[ ] Transition Report under Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from to
____________
Interactive Objects, Inc.
Name of small business issuer as specified in its charter
0-25373
Commission File Number
<TABLE>
<S> <C>
State of Washington 87-0434226
State or Other Jurisdiction of I.R.S. Employer Identification Number
Incorporation or Organization
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217 Pine Street, Suite 800
Seattle, Washington 98101
Address of Principal Executive Offices
(206) 464-1008
Issuer Telephone Number
____________
Securities registered under Section 12(b) of the Exchange Act:
Common Stock, $.01 par value
Securities registered under Section 12(g) of the Exchange Act:
[None]
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [ ] No [X]
Check if disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. Yes [X] No [ ]
The registrant's revenues for its most recent fiscal year were $2,122,846.
As of March 23, 1999, there were 14,708,927 shares of the Registrant's common
stock issued and outstanding and the aggregate market value of such common stock
held by non-affiliates was approximately $13,334,920 based on the average of the
bid ($1-17/32) and ask ($1-5/8) prices on that date of $1.578.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
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PART I
ITEM 1: DESCRIPTION OF BUSINESS
The following discussion contains forward-looking statements regarding the
Company, its business, prospects and results of operations that are subject to
risks and uncertainties posed by many factors and events that could cause the
Company's actual business, prospects and results of operations to differ
materially from those that may be anticipated by such forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed herein as well as those discussed under the captions
"Risk Factors" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" as well as those discussed elsewhere in this Report.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date of this report. The Company
undertakes no obligation to revise any forward-looking statements in order to
reflect events or circumstances that may subsequently arise. Readers are urged
to carefully review and consider the various disclosures made by the Company in
this report and in the Company's other reports filed with the Securities and
Exchange Commission that attempt to advise interested parties of the risks and
factors that may affect the Company's business.
The Company
Interactive Objects designs, develops and markets modular software
components. Additionally, the Company, through its consulting services group,
provides sophisticated software business solutions designed to facilitate
integrating medium- to large-scale businesses with the Internet.
The Company's products are designed for use primarily on the Microsoft
suite of visual programming languages including Visual Basic(R), Visual C++(R)
and Visual FoxPro(R) and are marketed to corporate and professional developers
for use in a variety of environments, including multi-tier client-server,
intranet, extranet and Internet environments. The Company's products are
reusable, modular software components designed to work across multiple operating
platforms. As a result, corporate and professional developers are able to focus
on the core functionality of the applications they are developing--designing and
constructing their applications more efficiently. The Company released two
components in the first quarter of 1998 and released a suite of four additional
components in October 1998.
The Company has historically derived a substantially all of its revenue
from its consulting services group. The consulting services group specializes in
sophisticated software business solutions which involve intranet, extranet and
Internet environments. In addition to providing sophisticated business solutions
to enterprise companies, Interactive Objects' consultants provide much of the
Company's research and development input for creating new and innovative
products. In 1998, substantially all of the Company's revenues were the result
of contracts awarded to its consulting group. These contracts provided the
Company valuable insight into the technology hurdles confronting medium and
large companies.
The Company's business strategy is focused on broadening its product
development by productizing the business solutions the Company's consultants
have designed or identified while performing consulting services. These products
are "application frameworks," sets or suites of reusable software components
architected to facilitate scaleable application development designed to solve a
specific business problem. By assembling its base components together with the
business objects generated from its consulting projects in a framework
architecture, the Company can address the sophisticated business solution
requirements of medium to large size organizations.
While continuing to invest its engineering and development resources in
expanding its library of development tools and components, the Company believes
that by assembling objects within an application framework, the resulting
solutions will have greater market potential than that of individual component
sales. The move from developer solutions to business solutions represents a
natural evolution for the Company. The Company believes that its core
capabilities are application architecture through its consulting group and
reusable component development by its product development team. See "RISK
FACTORS--Uncertainties Regarding Market Acceptance of the Company's Products;
New Product Introductions."
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Industry Background
Increasing Dependence on Software. Businesses are increasingly relying on
information systems as a strategic resource and as a way of differentiating
themselves from their competitors. A sophisticated enterprise-wide information
system can allow a company to take advantage of new markets before a competitor,
reduce operating expenses, and increase ties with suppliers and customers.
Business solutions incorporating Internet and intranet technologies can be
particularly effective in extending the information system outside the bounds of
a company, creating even more opportunities. Of all the pieces that make up an
information system, software plays a critical role. Therefore, as businesses
become more dependent on their information systems, their dependence on software
increases. In addition, original equipment manufacturers ("OEMs") and
independent software vendors ("ISVs") are increasingly dependent on the
development of software to provide critical functionality and product
differentiation.
Need for Improved Software Development Technologies and Methods. Software
development technologies and methods have not kept pace with the increasing
reliance on software systems. In fact, the intricacies of modern software
systems have tended to make the software development process longer, more
complicated and increasingly error prone. For example, many businesses are
implementing client-server applications that must be scalable (capable of
growing to support additional users) enough to handle hundreds or thousands of
users, yet flexible enough to meet continually changing business requirements.
Businesses implementing enterprise-wide information systems face a particularly
difficult challenge in developing software for the distributed, heterogeneous
environments that these systems typically demand. In addition, businesses
recognize that not only are these software systems expensive to develop, they
can also be expensive to maintain.
Organizations have taken an initial step in addressing the complexity and
cost of today's software systems by breaking software applications into
functional segments to be developed by separate teams of programmers. However,
traditional software development methodologies often produce unnecessary and
complex interdependencies among functional software segments. The resulting
software is typically difficult to develop and test, as well as expensive to
modify and maintain.
Adoption of Object-Oriented Technologies. To address the difficulties of
developing and maintaining complex software systems, organizations are
increasingly adopting object-oriented technologies and development
methodologies. Object-oriented programming allows software to be written in
terms of objects that are used as building blocks to model real-world objects
and systems. Objects, sometimes referred to as components, are self-contained
units that encapsulate a collection of data and related procedures. Although
objects may be internally complex, they are designed to have simple interfaces
that allow programmers to develop and change objects independently without
affecting other segments of the software system. The generalized, self-
contained nature of well-designed objects allows them to be reused within a
single software system and in subsequent applications. To a large extent,
developing software applications then becomes a matter of assembling new and
existing objects, rather than writing entire programs from scratch, resulting in
significantly reduced development times and improved software quality. In
addition, because the internal details of each object are relatively insulated
from the rest of the system, objects can be tested, modified and maintained
independently.
As object-oriented technologies have been adopted over the last several
years, Microsoft's Visual Programming Languages (primarily Visual C++(R) and
Visual Basic(R)) have emerged as the de facto standard computer languages for
object-oriented software development. Java(R) by Sun Microsystem, Inc., another
object-oriented programming language that is similar to C++(R), is gaining
popularity with the growth of the Internet and intranet environments.
Need for Reusable Third-Party Software Components. While objects or
components are easy to use once built, developing reusable, well-designed
components can be extremely difficult and time consuming. Many technical details
must be addressed, including support for various platforms, graphical user
interfaces, databases and networking protocols. As a result, object-oriented
software development can be improved significantly through the use of pre-built,
industry-standard objects ("components"). Software components are typically sold
as a "class library," a group of up to 100 related object types ("classes").
Organizations seek to improve quality and time-to-market by purchasing pre-
written components from independent vendors to handle fundamental operations
ranging from simple functions such as date handling to more complex functions
such as network communications. Using off-the-shelf components for such tasks
allows developers to focus on the core functionality of the systems they are
developing. For example, using a standard component for database connectivity
allows a developers to develop an
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application without regard to the low-level details of programming to any
particular database while allowing the freedom to switch between different
database vendors. In addition, commercially available software components
typically are more thoroughly tested and provide more complete functionality
than parts developed in-house. The Company believes that the use of third-party
software components will enable organizations to develop robust software
applications more rapidly, at lower cost and with more functionality than
applications using only internally developed components.
Benefits of Implementing Application Framework Technology. As the
complexity of applications developed to solve specific business problems
increase, developers have looked to expand upon the concept of reusable
component architecture to capture the benefits this process facilitates. As a
result, the concept of application frameworks has evolved. Application
frameworks are a set or suite of reusable components architected and assembled
in such a way as to facilitate scaleable application development designed to
solve a specific business problem. As such, application frameworks represent a
reusable, easily modifiable environment where application development of a
robust business solution becomes an assembly process, built on the substantial
reuse of common, well-tested components or business objects.
In theory, application frameworks represent a development methodology where
up to 80 percent of an application or business solution under development can be
based on reusable software. As a result, application frameworks pledge to
shorten development cycles, reduce skill requirements, and cut the costs
associated with custom development of software-based business solutions. Unlike
traditional "middleware" solutions that only address low-level application
programming interface (API) integration and data transformation, application
frameworks extend upward to the business process layer allowing developers to
develop robust business solutions in less time than traditional programming
practices provide.
Interactive Objects' Solutions
In addition to providing high-level consulting services to major
corporations, Interactive Objects designs, develops and markets reusable,
modular software components.
Software Consulting Services
Specializing in Internet-based technologies and protocols, the Company's
consultants target primarily large enterprise-caliber companies. Through its
object-oriented, standards-based architectures, the Company provides
sophisticated solutions and interfaces connecting enterprise corporations to
relevant communities of interest their distributors, their salesforce, their
employees, clients and business partners. With their thorough understanding of
re-useable, modular application architecture, the Company's consultants deliver
enterprise business solutions that bridge the gap between legacy information and
today's cutting-edge Web technology. In addition to providing sophisticated IS
solutions to enterprise companies, Interactive Objects' consultants serve as
part of the Company's research and development arm identifying and defining new
and innovative products that may ultimately be sold by the Company. Emphasizing
collaboration, coordination and communication, the Company is a premium service
provider of complex business solutions for large corporations such as SAFECO,
Eddie Bauer and Microsoft. See "RISK FACTORS--Concentration of Customers;
Limited Marketing Experience."
Because Internet development expertise is in demand, many companies find
they simply don't have the resources in house to tackle particularly challenging
applications. In these cases, the Company's consultants provide the technical
guidance on a project basis and solve the complex problems presented to them. By
working directly with companies, the Company's consultants see first-hand the
problems confronting corporate IS departments. That, in turn, gives Interactive
Objects a competitive advantage in creating the tools to solve that problem. The
customized tools created by the Company's consultants to solve a particular
problem today may become Company products in the future. See "RISK FACTORS--
Dependence on Consulting Engagements for Product Research and Development and
Market Research."
The Company's consultants focus on providing solutions leveraging
Interactive Objects core area of expertise integrating the enterprise with the
Internet. The Company's most recent consulting agreement related to the design
of an enterprise-wide information automation system that will enable SAFECO's
nationwide network of over 8,000 independent agents to create and process
insurance applications over the Internet. The suite of software components and
business objects resulting from this partnership are expected to increase the
efficiencies of
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SAFECO's claim and policy processing while reducing the cost of SAFECO's remote
agent support activities. See "RISK FACTORS--Concentration of Customers; Limited
Marketing Experience."
Cognizant of the competitive nature in the professional IS services arena,
the Company, in an effort to provide the highest level of flexibility and
responsiveness for its clients and to limit the growth of its employee base,
assembles teams of independent programmers for each project based on the
individual requirements of that project. Utilizing this business model, the
Company can limit the risks inherent in assembling large teams of low-level
programmers while maintaining management of the project and the ability to
provide the highest level of service. See "RISK FACTORS--Recruiting and
Retaining Technical Personnel."
Interactive Objects believes that its consulting services provide many
opportunities and benefits to the Company, including:
Market Research -- By working directly with large corporations, Interactive
Objects gains timely insight into the needs of the information services market.
The Company analyzes and utilizes this market research information to identify
opportunities for the development of new components. The Company believes that
consulting projects will not only enable the Company to further develop its core
expertise while keeping apprised of the needs of the market, but will also
foster a competitive advantage for the Company since this market research is not
an added expense to the Company. See "RISK FACTORS-- Dependence on Consulting
Engagements for Product Research and Development and Market Research."
Development -- The customized tools created to solve business problems on
the consulting engagement can be further developed to become products marketed
by Interactive Objects. See "RISK FACTORS--Uncertainties Regarding Market
Acceptance of the Company's Products; New Product Introductions."
Product Exposure The solutions implemented to business problems
encountered on a particular consulting engagement may require the use of
existing Interactive Objects' products, resulting in increased awareness and
exposure to the Company, its products, and personnel. See "RISK FACTORS--
Concentration of Customers; Limited Marketing Experience."
Reusable Software Components
Improved Software Quality. Interactive Objects' products improve software
quality by providing professional developers with reliable, reusable software
components and application frameworks. The use of the Company's products result
in reduced development times for applications that are easier to maintain and
contain less untested code, resulting in fewer bugs and higher quality. See
"RISK FACTORS--Uncertainties Regarding Market Acceptance of the Company's
Products; New Product Introductions."
Accelerated Development Time. By incorporating the Company's pre-
programmed, pre-tested, reusable software components within their applications,
developers can produce more reliable software solutions in less time.
Responsive to Developers. The method of bundling multiple components has
become an industry standard. However, the Company believes that in many
instances, components with little to no commonality are bundled together as a
class library. Interactive Objects offers its components on an individual basis
versus pre-bundled allowing the developer to pick and choose according to his or
her needs. The Company believes this method is a competitive advantage as it
empowers customers to determine their needs rather than the vendor.
Increased Focus on Critical Functionality. The Company's products
encapsulate fundamental operations within reusable software components, allowing
developers to focus on defining and creating the critical business logic within
applications rather than the mundane routines that an application needs to
request and carry out lower-level services.
Reduced Maintenance Cost. The Company's products are designed to reduce
overall maintenance and support costs over the life of an application. Use of
the Company's products help developers program flexible, modular applications
that are easier to update, modify and refine. See "RISK FACTORS--Rapid
Technological Change."
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The Interactive Objects Strategy
Interactive Objects' objective is to be a leading provider of modular
software components, application frameworks and Internet, intranet and extranet
business software solutions. The Company intends to achieve this objective by:
Expanding upon its Consulting Services to Enterprise-level Corporations.
Leveraging its key technological expertise in Internet, intranet and extranet
business solutions, the Company intends to invest in expanding its
infrastructure and personnel base to facilitate a more aggressive sales
initiative targeting medium to large companies. See "RISK FACTORS--Evolving
Markets and Standards" and "--Rapid Technological Change."
Continuing to Develop Modular Software Components that are both Reusable
and Robust. The Company intends to continue to develop reliable modular software
components designed to facilitate accelerated application development of robust
business solutions for the professional and corporate developer. See "RISK
FACTORS--Dependence on Growth of Internet/Intranet/Extranet Software
Applications."
Leveraging Consulting Relationships to Develop Application Frameworks. By
leveraging the intellectual properties resulting from certain of its consulting
relationships and its software components, the Company intends to develop
application frameworks for the corporate IS and enterprise business community.
See "RISK FACTORS--Dependence on Consulting Engagements for Product Research and
Development and Market Research."
Expanding its Sales and Distribution Network. While it has historically
relied on Web-based electronic software distribution, the Company has recently
expanded its sales and distribution capabilities through distribution
relationships with Digital River, Inc. and Earth Web, Inc. The Company intends
to expand its sales activity further through a variety of activities including
establishing and building a network of resellers and integrators to support the
Company's enterprise initiatives, growing its internal sales organization to
facilitate dealing directly with Fortune 2000 companies, and encouraging the
establishment of co-marketing relationships with leading OEMs, ISVs and VARs.
See "RISK FACTORS--Limited Product Distribution."
Performing Strategic Acquisitions. The Company continually evaluates
potential acquisitions of complementary businesses, products and technologies,
that among other things, could expand the breadth and depth of its products and
organization. See "RISK FACTORS--Competition" and "--Risks Associated with
Potential Acquisitions."
Interactive Objects' Products and Services
Interactive Objects designs, develops and markets modular software
components. Additionally, the Company, through its consulting services group,
provides sophisticated software business solutions designed to facilitate
integrating medium- to large-scale businesses with the Internet.
Products
Visual Gateway Interface ("VGI"), the Company's first product released in
the first quarter of 1998, is a fully integrated, object-oriented Microsoft-
based development tool allowing users develop true server-independent Web- based
applications able to run on any NT Web server without relying on, or learning, a
new scripting language. VGI was created to solve a problem Web programmers
consistently encounter--the fact that different gateways and Web servers support
different scripting languages and/or protocol specifications. As a result,
visual programmers were required to learn and use multiple tool sets to create
separate versions of the same application for deployment across the different
servers. VGI provides a familiar, standards-based interface that visual
programmers can use to create a single version of a Web application that runs on
all popular Web servers without needing to learn and use the Web server specific
scripting language (e.g., VBScript, JavaScript, Perl, etc.). This tool enables
visual programmers to concentrate on the development and enhancement of the Web
application itself rather than on the protocols necessary to run them. By
simplifying the method for integrating standard Web protocols into the
developer's native visual application environment, VGI provides an easy-to-use
framework for creating and migrating visual applications to the Web. VGI retails
for $149.00. Sales of VGI, to date, have been insignificant.
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Visual Mail Interface ("VMI"). The VMI product suite is a series of four
reusable, object-oriented components that let developers create and implement a
variety of electronic mail applications without having to learn specific e- mail
protocols. The Company released VMI in October 1998. Both componentized and
reusable, VMI allows for the easy assimilation of e-mail capabilities into
existing or new applications from either the client or server side. From
requisition and form routing, to automatic response mechanisms, VMI lets
developers quickly and easily add innovative e-mail functionality to their
applications. All the VMI components come pre-tested, ensuring the highest level
of reliability and stability available. Designed for COM-compliant development
environments including Visual Basic(R), Visual C++(R), Visual J++(R) and
Delphi(R), VMI supports the leading Internet and communication protocols: POP3,
SMTP, MIME and UUencode. The Company plans to release the VMI product line the
fourth quarter of 1998. The Company intends to market VMI both as a suite and as
individual components. VMI individual components retail for $149.00 to $199.00
and the product suite retails for $499.00.
Products Under Development
Application Frameworks. Leveraging its core competencies and its consulting
relationships, the Company plans to release its first application framework in
1999. These application frameworks will represent a set of reusable objects
architected and assembled in such a way as to facilitate scaleable application
development that solves a specific business problem. As the Company's products,
specifically its application framework solutions, become more complex, customers
increasingly require greater professional assistance in the design, development
and deployment of these business solutions within their individual
organizations. As a result of the complexity and robustness of its application
framework technology, the Company expects that application framework pricing
will be significantly in excess of prices charged for its components. See "RISK
FACTORS--Uncertainties Regarding Market Acceptance of the Company's Products;
New Product Introductions" and "--Dependence on Growth of
Internet/Intranet/Extranet Software Applications."
Consulting Services
Specializing in Internet-based technologies and protocols, the Company's
consultants target primarily large enterprise-caliber companies. Through its
object-oriented, standards-based architectures, the Company provides
sophisticated solutions and interfaces connecting enterprise corporations to
relevant communities of interest--their distributors, their sales force, their
employees, clients and business partners. With their thorough understanding of
re-useable, modular application architecture, the Company's consultants deliver
enterprise business solutions that bridge the gap between legacy information and
today's cutting-edge Web technology. Emphasizing collaboration, coordination and
communication, the Company is a premium service provider of complex business
solutions for large corporations such as SAFECO, Eddie Bauer and Microsoft.
Product Development
Interactive Objects approaches product development as an organized
development effort utilizing individual product teams. These teams are designed
to be small, focused, and efficient. Each team consists of a project manager,
and a number of software designers, documentation writers and test engineers.
The teams work on a six to nine month development cycle, with each team focusing
on a particular component or set of related components during a development
period. The Company's product development plan includes the release of a suite
of 4 components in October 1998. The Company currently has two product
development teams and will add additional teams if product sales warrant.
Additionally, the Company maintains information on freelancers, independent
developers/programmers, and 3rd party development organizations the Company
could contract with, and outsource projects to, in an effort to help facilitate
the Company's development plans, in the event internal resources are
insufficient to accomplish the specific project. See "RISK FACTORS--Recruiting
and Retaining Technical Personnel."
The Company believes that quality is a competitive factor in the software
component market. In as much, the Company emphasizes quality assurance as a
fundamental element within its development process. Each product development
team is staffed with a test engineer whose purpose is to develop test scripts
for the respective components and to conduct unit testing. In addition,
Interactive Objects has contracted with a third-party laboratory, ST Labs Inc.,
one of the nation's leading providers of software testing and quality assurance
support services, for functionality, stress, and scalability testing. The
Company believes that with its commitment to thoroughly testing
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its products, the Company will engender developer confidence in the reliability
of all products Interactive Objects brings to market. See "RISK FACTORS--
Software Defects and Liability Claims."
Sales, Distribution and Support
The Company distributes its products through Digital River, Inc. and its
network of over 500 reseller sites. The Company also has a distribution
relationship with Developer.com and Developer Direct, on-line distribution
channels that target professional software developers. The Company seeks to
increase awareness of its products, to provide customer and technical support
and to encourage dialogue regarding its products by maintaining a World Wide Web
site. Interactive Objects' current sales and support strategy for its software
components relies almost exclusively on the Internet and electronic software
distribution. A visitor to the Company's Web site can download products for a
free time-limited trial period (15 to 30-days in length) letting potential users
become aware of the features and benefits of the respective product. At the end
of the trial period, the user must purchase the product or it will automatically
expire. To purchase the product, the user must enter credit card information to
facilitate the sale.
The Company believes that the electronic channel is an important source of
information and support for IT professionals. By utilizing the Web and ESD as
its principal means of distribution for its components, the Company believes it
has taken the most direct and effective route to its target market, the
professional software developers a group that tends to spend significant time on
the Web. This marketing strategy enables the Company to eliminate most of the
manufacturing, distribution and inventory costs traditionally associated with
selling software. See "RISK FACTORS--Limited Product Distribution."
Another advantage to the Company's Web-based ESD is increased
responsiveness to market changes. This strategy allows the Company to provide
instantaneous changes to its product line without recalling outdated or unsold
product. The Company can also quickly respond to market pressures and can adjust
the price of a product depending on market demand. In addition, the Company has
the flexibility to dynamically package its products in a variety of
configurations versus being tied to the rigid packaging requirements standard
distribution channels require. The Company provides both volume discounts and
corporate licenses encouraging mass distribution of its products. See "RISK
FACTORS-- Uncertainties Regarding Component Product Positioning" and "--Rapid
Technological Change."
As the Company expands its activities into the application frameworks
arena, the Company will move beyond the Web-centric sales and distribution model
it has employed for its components. Historically, the Company has not had a
large enterprise or national accounts sales force. Establishing and building a
channel of resellers and integrators to support the Company's overall strategic
sales and marketing activities as it expands into its enterprise initiative will
be a priority for the Company. Accordingly, the Company is currently recruiting
seasoned sales professionals in an effort to expand its direct sales department.
These individuals will serve as the primary sales mechanism necessary to
communicate the strengths of the Company to the targeted audience-- enterprise
organizations.
The Company also provides support through its Web site. By providing
support electronically, the Company believes that it is often able to identify
and solve customer problems more rapidly.
Marketing
Interactive Objects' promotion activities focus on two objectives: generate
and raise awareness to the Company and its products, and increase the number of
visits and resulting sales from its Web site. Advertising and promotional
efforts are focused on these goals. Using controlled circulation publications
such as Visual Basic Programmer's Journal and Microsoft Interactive Developer,
Interactive Objects has implemented a plan targeting professional software
developers through print advertising for its component product lines.
Interactive Objects has also pursued Web advertising. Banner ads have been
placed on www.microsoft.com, one of the highest trafficked sites on the Web. The
Company believes this to be an effective form of advertising since it leverages
the visibility a high traffic site like Microsoft's provides, while enabling
customers to hyperlink directly to the Company's Web site. See "RISK FACTORS--
Competition."
As the Company expands its activities to the application framework market,
its marketing activities will also expand. Direct mail supported by
telemarketing, reseller channel development and training, third-party
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partnerships with other independent software vendors will all be explored as the
Company's strategy evolves. The Company's commitment to establishing these
relationships is demonstrated through its participation in Microsoft's Software
Developers Network Independent Software Vendor Program, as well as being named a
charter member of Wall Data's Cyberprise(R) Consulting Partner Program. See
"RISK FACTORS--Concentration of Customers; Limited Marketing Experience."
Media and analyst relations will remain a core component to the Company's
promotional campaign. The Company believes that press coverage of the Company is
a cost-efficient way to increase visibility and establish credibility.
Interactive Objects has already received positive coverage in Web Techniques,
The Seattle Times, The Seattle Post-Intelligencer, Washington CEO magazine,
Puget Sound Business Journal, Business Week, and CNET's electronic magazine,
AnchorDesk. Interactive Objects intends to continue to invest in this channel
through press/analyst tours with the objective of generating further interest
and visibility in industry, general business and regional publications.
Interactive Objects' promotional activities include maintaining a presence
in the industry by promoting itself at selective trade shows. Trade shows give
Interactive Objects the opportunity to enhance its image as the corporate
developer's advocate, establish business relationships with OEMs and VARs, meet
with industry analysts and press as well as research the market and the
competitors. The Company's commitment to tradeshows was immediately recognized
at VBITS'98 San Francisco (March 1998)--the Company's first show appearance--
where Interactive Objects was awarded "Best of Show" for its marketing
activities and booth design.
Acquisitions
The software industry has experienced and is expected to continue to
experience a significant amount of consolidation. While the Company expects that
it will grow internally, the Company continually evaluates potential
acquisitions of complementary businesses, products and technologies, that among
other things, could expand the breadth and depths of its products and
organization. See "RISK FACTORS--Risks Associated with Potential Acquisitions."
Competition
The market for software consulting and contract development/software system
design services is extremely competitive. The principal competitive factors in
this market are thoroughness and ingenuity of solution proposed and
responsiveness to client proposal requests, and to a lessor degree, reputation
and price. Many of the Company's competitors in the consulting arena have
substantially greater financial, management, marketing and technical resources
than the Company. There can be no assurance that the Company will be able to
compete successfully against current and future competition, and the failure to
do so would have a material adverse effect upon the Company's business,
operating results and financial condition. See "RISK FACTORS--Concentration of
Customers; Limited Marketing Experience" and "--Competition."
The market for the Company's products is intensely competitive, subject to
rapid change, and significantly affected by new product introductions and
related marketing activities of industry participants. The Company's products
are targeted at the emerging market for re-usable business objects and software
components specific to Internet-related applications. Sales in the component
industry is not currently dominated by any one company. International Data
Corporation in its 1998 Worldwide Markets and Trends Report on Internet Tools,
reports that, with the exception of Oracle Corporation at 16, no programmer
development tool vendor has over 5.1 percent of the worldwide market share. See
"RISK FACTORS--Rapid Technological Change."
Direct competitors of the Company's reusable software components include
Progress Software Corporation (Crescent division) and Sheridan Software Systems,
Inc. Both produce components that are targeted directly at visual developers and
both were early leaders in the visual component market.
The Company believes that the principal competitive factors in this market
to be: product quality, flexibility, performance, functionality and features,
use of standards-based technology, quality of support and service, company
reputation and price. While price is less significant than other factors for
corporate customers, price can be a significant factor for individual
developers.
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According to International Data Corporation in its 1998 Worldwide Markets
and Trends Report on Internet Tools, the Windows component market share
(developer tools produced to support Microsoft's Windows 95(R), Windows 98(R)
and Windows NT(R)) is expected to double in the next five years, from 22.3 in
1997 to 42.5 in 2002. The Company believes that by containing its development
efforts to Windows-based solutions, that it will be well positioned to take
advantage of this anticipated growth.
In the application framework product area, the competition the Company
faces is not easily identified. As an emerging market, it is difficult to
project which companies may be the most effective competitors and, as the market
matures, the Company believes it is inevitable that strong competitors will
surface. Until that time, the Company is confronted by a myriad of competitors
including Mortice Kern Systems Inc., Neuron Data, Inc. and Usoft Corporation.
Indirect competitors include many of the independent information system
consulting organizations which may have distributed component technology
expertise.
Many of these direct and indirect competitors have longer operating
histories, more resources (financial, technical, and marketing), greater name
recognition and larger installed base of customers than the Company. As a
result, these competitors may be able to respond more quickly to new or emerging
technologies and changes in customer requirements, or devote greater resources
to the development, promotion and sale of their products than the Company. The
Company believes that its product positioning, including its planned offering of
individual, non-bundled components, as well as complete application frameworks,
and its dedication to high quality, reliable products will enable it to gain
competitive advantage in the market. In addition, the Company's business objects
are designed to interact smoothly with established software systems. With
components specifically developed for use with Microsoft, the Company intends to
partner with these companies to bundle the components with theirs, or sell them
in conjunction. The Company's products are also developed using standards-based
object technologies enabling them to run on multiple platforms and with multiple
programming languages.
The Company also faces competition from systems integrators and internal
development efforts. Some systems integrators possess industry-specific
expertise that may enable them to offer a single vendor solution where they
already have a reputation among potential customers. There can be no assurance
that these third parties, some of which have significantly greater resources
than the Company, will not market competitive software products in the future.
It is also possible that new competitors or alliances among competitors will
emerge and rapidly acquire significant market share. The Company also expects
that competition will increase as a result of software industry consolidation.
Increased competition may result in price reductions, reduced gross margins and
loss of market share, any of which could materially and adversely affect the
Company's business, operating results and financial condition. There can be no
assurance that the Company will be able to compete successfully against current
and future competitors or that competitive pressures faced by the Company will
not materially and adversely affect its business, financial condition and
results of operations. See "RISK FACTORS--Uncertainties Regarding Market
Acceptance of the Company's Products; New Product Introductions" and
"--Competition."
Intellectual Property and Other Proprietary Rights
The Company relies primarily on a combination of copyright, trademark and
trade secret laws, confidentiality procedures and contractual provisions to
protect its proprietary rights. The Company also believes that factors such as
the technological and creative skills of its personnel, new product
developments, frequent product enhancements, name recognition and reliable
product maintenance are essential to establishing and maintaining a
technological leadership position. The Company seeks to protect its software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection. The Company believes its current
intellectual property rights are sufficient to carry on its business as
currently conducted. Despite the Company's efforts to protect its proprietary
rights, unauthorized parties may attempt to copy aspects of the Company's
products or to obtain and use information that the Company regards as
proprietary. Policing unauthorized use of the Company's products is difficult,
and while the Company is unable to determine the extent to which piracy of its
software products exists, software piracy can be expected to be a persistent
problem. In addition, the laws of some foreign countries do not protect the
Company's proprietary rights as fully as do the laws of the United States. There
can be no assurance that the Company's means of protecting its proprietary
rights in the United States or abroad will be adequate or that competition will
not independently develop similar technology. See "RISK FACTORS--Proprietary
Rights; Risks of Infringement."
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The Company is not aware that it is infringing any proprietary rights of
third parties. There can be no assurance, however, that third parties will not
claim infringement by the Company of their intellectual property rights. The
Company expects that software product developers will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
industry segment grows and the functionality of products in different industry
segments overlaps. Any such claims, with or without merit, could be time
consuming to defend, result in costly litigation, divert management's attention
and resources, cause product shipment delays, or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company, if at all. In
the event of a successful claim of product infringement against the Company and
failure or inability of the Company to license the infringed or similar
technology, the Company's business, operating results and financial condition
would be materially and adversely affected.
Employees
As of March 23, 1999, the Company had a total of nine employees, all of
whom were based in the Seattle, Washington area. Of the total, six were in
product development and consulting services, one was engaged in sales and
marketing and two were in administration and finance. The Company's future
success depends in significant part upon the continued service of its key
technical and senior management personnel and its continuing ability to attract
and retain highly qualified technical and managerial personnel. Competition for
highly qualified personnel is intense and there can be no assurance that the
Company will be able to retain its key managerial and technical employees or
that it will be able to attract and retain additional highly qualified technical
and managerial personnel in the future. None of the Company's employees is
represented by a labor union. The Company has not experienced any work stoppages
and considers its relations with its employees to be good. See "RISK FACTORS--
Recruiting and Retaining Technical Personnel" and "--Reliance on Management and
Key Personnel; Changes in Management."
Risk Factors
In addition to the other information in this Report, the following risk
factors should be considered carefully in evaluating the Company and its
business. This registration statement may contain forward-looking statements
that involve risks and uncertainties. When used in this registration statement,
the words "anticipate," "believe," "effect," "estimate," "expect" and similar
expressions as they relate to the Company or its management are intended to
identify such forward-looking statements. The Company's actual results,
performance or achievements could differ materially from the results expressed
in or implied by these forward-looking statements. Factors that might cause
such differences include, but are not limited to, those discussed in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" as well as those discussed elsewhere in this Report.
Limited Operating History; No Profitable Operations. The Company was
founded in 1995 and has had insignificant operating results until 1997. The
Company has experienced losses since incorporation and there can be no assurance
that the Company will become profitable in the near future or at all. The
Company experienced losses of $(4,146,000) and $(1,682,266) for the years ended
December 31, 1998 and December 31, 1997, respectively. The losses for the years
ended December 31, 1998 and December 31, 1997 include a non-recurring non-cash
compensation expenses for securities issued in exchange for services. The
Company's ability to achieve revenue growth and profitability are substantially
dependent upon its ability to successfully grow and expand its consulting
division, the success of the Company's software component and application
framework strategies, and upon its ability to successfully complete and
introduce new products. There can be no assurance that the Company will be able
to successfully accomplish the foregoing or to achieve or maintain profitability
in future periods. The Company believes that its existing capital resources will
enable it to fund its operations, without additional capital, through 1999. If
the Company determines to seek additional capital through the issuance of
additional shares of capital stock, such issuance could result in dilution to
the holders of the Company's Common Stock. There can be no assurance that the
Company will be able to obtain such capital on acceptable terms or at all.
Concentration of Customers; Limited Marketing Experience. The Company's
consulting group architects, designs and implements Web-based software systems
to address Internet, intranet and/or extranet communication and integration
needs of medium to large corporations in the Pacific Northwest. Since 1995, the
Company has performed consulting services primarily for SAFECO Insurance
Companies of America, Inc. ("SAFECO") and to a lesser degree for Eddie Bauer
Incorporated ("Eddie Bauer"), and Microsoft. For 1997 and the first nine months
of 1998, revenues resulting from the Company's relationship with SAFECO
accounted for substantially all of the Company's revenues. The Company's most
recent project with SAFECO involved developing an enterprise-wide,
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Internet-based information automation system. The Company's relationship with
SAFECO ended on July 31, 1998. There can be no assurance that the Company will
be able to market its consulting services successfully to similarly positioned
organizations in the future. If the Company is unsuccessful in marketing its
consulting services this would have a material adverse effect on the Company's
financial condition and results of operations. In addition much of the Company's
research and development for creating new and innovative products, as well as
further development of the Company's application frameworks, may be delayed,
which would adversely affect the Company's financial condition and results of
operation.
Uncertainties Regarding Market Acceptance of the Company's Products; New
Product Introductions. The Company's future revenues will depend substantially
on its ability to successfully design and market new and innovative products
that appeal to developers using Microsoft's visual development programming
languages, including Microsoft's Visual Basic(R), Visual C++(R), Visual
FoxPro(R) ("Microsoft Visual Programming Languages"). The Company's current
product line adheres to Microsoft's COM (component object model) standard, which
competes with the Object Modeling Group's CORBA (common object request broker
architecture) standard. There can be no assurances that sales of the Company's
current or future products will meet the Company's expectations, due to various
factors. The Company may introduce products later to market than expected or
later to market than competitors' introductions, or competitors may introduce
competitive products at lower prices. The acceptance of the Company's products
are dependent in part on the continued adoption of the Internet as the new
computing paradigm, and the continued growth of Microsoft's visual development
environment and languages. For example, if Object Modeling Group's CORBA
standard grows in popularity, reliance and demand for COM-based products could
decline dramatically. This in turn would adversely affect the Company's
financial condition and its results of operation would be materially and
adversely affected.
Periodically, the Company expects to make announcements regarding new
product releases and product updates. Such announcements are made for the
purpose of providing customers with a general idea of the expected availability
of products for planning purposes, and are based upon estimates and are not a
prediction of the exact availability date for such products. Some new products
are based on technology from third parties, and the Company has limited control
over whether and when these technologies may be enhanced. The failure or delay
in enhancements of technology from third parties could have a material adverse
effect on the Company's ability to develop and enhance its products. Due to the
inherent uncertainties of software development, it is likely that such
situations will occur from time to time in the future. Moreover, the loss of key
employees may increase the risk of delays in product availability from
timeframes originally anticipated. Consequently, announcements regarding the
Company's expectations of when products may ship should not be considered a
prediction by the Company that the products will ship in any particular quarter
or otherwise be relied upon by investors as a basis for predicting the Company's
results for any future period. Delays in the shipment of such products and
product enhancements will have a material adverse impact on the Company. Without
the introduction of such new products, the Company's products may become
technologically outdated, and as a result the Company's business, operating
results and financial condition could be materially adversely affected. There
can be no assurance that the future development and marketing efforts by the
Company will be successful.
Evolving Markets and Standards. The Company's current products are designed
for use by professional software developers who primarily rely on Microsoft
Visual Programming Languages to program in a variety of environments, including
multi-tier client-server, Internet, intranet, and extranet environments.
Although the component method of programming is in its infancy, the Company
believes the market for third-party components and application frameworks
(reusable software components and business objects assembled in a framework
architecture incorporating limited business logic and/or functionality) is
expanding. As such, the Company's growth depends upon continued market
acceptance of reusable, object-oriented components and application framework
technology. Additionally, because the Company's products are based on the
Microsoft's COM and DCOM (distributed component object model) standards,
continued market acceptance of, and adherence to, these standards is critical to
the Company's future growth. In the event that the Object Modeling Group's CORBA
standard or another standard increases in market acceptance or emerges as the
market standard, reliance on and demand for COM- based products could diminish.
This would have a material adverse affect on the Company's business, operating
results and financial condition.
There can be no assurance that the object-oriented programming market in
general, or the component market in particular, will gain further acceptance in
the near future or at all. Additionally, the Company's distributed object
solutions are designed specifically for use in Web-based applications involving
the Internet, intranets and/or
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extranets. Because critical issues in the industry concerning implementing Web-
based initiatives, including security, reliability, cost, ease of use, access
and quality of service remain unresolved, the growth of applications targeting
the Internet is uncertain and difficult to predict.
The markets for the Company's products are relatively new and still
evolving, and accordingly it is difficult to assess or predict with any
assurance the size or growth rate, if any, of these markets. There can be no
assurance that markets for the Company's products will develop, or that the
Company's products will be accepted. If these markets fail to develop, develop
more slowly than expected, or attract new competitors, or if the Company's
products do not achieve market acceptance, the Company's business, operating
results and financial condition could be materially adversely affected. Even if
broader market acceptance is achieved, the reusable component market may
continue to be characterized by numerous competitors in the areas of tools,
methodology and services. In addition, in the event COM-based programming loses
market acceptance to CORBA or to another standard, or be replaced by another
programming language, the Company's business, financial condition and results of
operations could be materially and adversely affected. Because the Company's
strategy is to develop standards-based products, and these standards are
relatively new, not widely accepted and compete with other emerging standards,
to the extent that these standards are not commercially successful, this will
have a material adverse affect on the Company's business, operating results and
financial condition. Competing or alternative technologies are being, or are
likely in the future to be, promoted by current and potential competitors of the
Company, some of which have well-established relationships with current and
potential customers of the Company. Some of these current and potential
competitors have extensive knowledge of the markets served by the Company,
better name recognition and more extensive development, sales and marketing
resources than the Company. To the extent these organizations actually become
competitors to the Company, they may prove to materially and adversely affect
the Company's business, financial condition and results of operations.
Dependence on Microsoft. The Company's current products comply with
Microsoft's COM, DCOM and COM+ standards and have been designed specifically for
professional developers who utilize primarily Microsoft Visual Development
Languages and, to a lesser extent, Inprise's programming language, Delphi(R). To
the extent that Microsoft changes its visual programming languages, changes its
programming standards, withholds information regarding such changes or other
changes to its Windows(R) or Windows NT(R) operating systems, changes the manner
in which it markets its visual development languages or component standards, or
does not provide the Company with pre-release information about such changes,
the Company could be adversely impacted. Such impacts could result in the delay
of the release of the Company's products, the Company's cost of developing
products could be significantly increased, and the Company may be required to
expend significant resources to modify its marketing and sales priorities and
direction.
Limited Product Distribution. The Company's future revenues from product
sales are substantially dependent upon the Company's ability to successfully
market and sell its products. The Company currently sells its products solely by
utilizing electronic software distribution ("ESD") via its Web site. Through
December 31, 1998, Company sales of its products via its Web site have been
limited, generating insignificant revenues. Although the Company believes that
the use of the Internet for software sales and distribution will continue to
grow, the Company acknowledges the need to increase its internal sales staff,
and to market and distribute its products through resellers and integrators and
other channels in order to increase sales. There can be no assurance that the
Company will be successful in attracting and retaining such sales professionals,
or in establishing a channel of resellers and integrators. Failure to accomplish
any of these tasks could materially and adversely affect the Company's financial
condition and results of operation. In addition, the Company has entered into
distribution relationships with Digital River Inc. and Earth Web Inc., and
intends to explore additional third-party partnerships with other independent
software vendors ("ISVs") and explore co-marketing arrangements. There can be no
assurance that such relationships will increase product sales through these
channels or that the Company will be successful in entering into further
distribution relationships or that such relationships will prove beneficial to
the Company.
Uncertainties Regarding Component Product Positioning. The current standard
in the component industry is to sell bundled tools and components in a "class
library" consisting of numerous products, whereas the Company's marketing
strategy for its software components is, among other things, to sell individual
components at a lower unit cost than the bundled products. There can be no
assurances such product positioning will be accepted in the marketplace. To the
extent that the Company's non-bundled products do not achieve market acceptance,
the Company may be required to significantly reduce the individual price per
component to make the product more
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attractive, or may be required to develop additional products to offer as a
bundled library. In either event, the Company's financial performance could be
materially adversely affected.
Uncertainty of Future Operating Results; Fluctuations in Quarterly
Operating Results. As a result of the Company's limited operating history and
the emerging nature of the markets in which it competes, the Company is unable
to forecast accurately its revenues. The Company's current and future expense
levels are based largely on its product development plans and are to a large
extent fixed. Revenues from consulting engagements tend to fluctuate as
consulting contracts, which may extend over several months, are undertaken,
renewed, completed or terminated. Product revenue is difficult to forecast due
to the fact that the Company to date has not generated significant material
revenue from its individual software component sales. The Company also has not
determined what the average sales cycle, from initial evaluation to purchase,
will be for future sales. Sales and operating results generally depend on the
volume of, timing of and ability to fulfill orders received, which are difficult
to forecast. The Company may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. Accordingly, any significant
shortfall in revenues in relation to the Company's planned expenditures would
have an immediate adverse effect on the Company's business, prospects, financial
condition and results of operations. Further, as a strategic response to changes
in the competitive environment, the Company may from time to time make certain
pricing, service or marketing decisions that could have a material adverse
effect on its business, prospects, financial condition and results of
operations.
The Company may experience significant fluctuations in its quarterly
operating results due to a variety of factors, many of which are outside the
Company's control. Future operating results will depend upon many factors,
including the timing of consulting engagements and payment terms, demand for the
Company's products and services, the level of product and price competition in
the industry, the length of the Company's sales cycle, the budget cycles of the
Company's customers, the timing of new product introductions and product
enhancements, the mix of products and services sold, activities of and
acquisitions by competitors, changes in pricing policy by the Company and its
competitors, analysts' reports about the Company, its components and application
framework technology, the hiring new employees, the ability of the Company to
develop and market new products and control costs, and general economic
conditions and economic conditions specific to the Internet, on-line commerce
and the software component industry in general.
Competition. The market for software consulting and contract
development/software system design services is extremely competitive. The
principal competitive factors in this market are thoroughness and ingenuity of
solution proposed and responsiveness to client proposal requests, and to a
lessor degree, reputation and price. Many of the Company's competitors in the
consulting arena have substantially greater financial, management, marketing and
technical resources than the Company. There can be no assurance that the Company
will be able to compete successfully against current and future competition, and
the failure to do so would have a material adverse effect upon the Company's
business, operating results and financial condition.
The market for the Company's reusable software components is intensely
competitive, subject to rapid change and significantly affected by new product
introductions and other market activities of industry participants. The
Company's current products are targeted at professional software developers who
program using primarily Microsoft Visual Programming Languages. The Company's
competitors offer a variety of products and services to address this market. The
Company believes that the principal competitive factors in this market are
product quality, flexibility, performance, functionality and product features,
use of standards-based technology, quality of support and service, company
reputation and price. While price is less significant than other factors for
corporate customers, price can be a significant factor for individual
developers. Direct and indirect competitors in the component market include
Microsoft, RogueWave Software, Inc., Progress Software Corporation, KL Group,
Inc. and others, and the Company expects to face significant competition in the
future from these and other companies. Most of these competitors have longer
operating histories, significantly greater financial, technical, marketing and
other resources, name recognition and larger installed bases of customers than
the Company. Additionally, many of these current and potential competitors have
well-established relationships with potential customers of the Company, have
extensive knowledge of the markets serviced by the Company's customers, more
extensive development, sales and marketing resources and are capable of offering
single vendor solutions. As a result, the Company's competitors may be able to
respond more quickly to new or emerging technologies and changes in customer
requirements, or to devote greater resources to the development, promotion and
sale of their products than the Company. Certain competitors have been known to
license software for free to gain a competitive advantage. Such competition
could materially adversely affect the Company's ability to sell products on
terms favorable to the Company. There can be no
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assurance that the Company will be able to compete successfully against current
and future competition, and the failure to do so would have a material averse
effect upon the Company's business, operating results and financial condition.
The Company also faces competition from other software vendors, systems
integrators and internal development efforts. Many of these competitors possess
industry-specific expertise that may enable them to offer a single vendor
solution more easily, and already have a reputation among potential customers
for offering enterprise-wide solutions for software programming needs. There can
be no assurance that these third-parties, most of whom have significantly
greater resources than the Company, will not market competitive software
business solutions in the future. It is also possible that new competitors or
alliances among competitors will emerge and rapidly acquire significant market
share. The Company also expects that competition will increase as a result of
software industry consolidation. Increased competition may result in price
reductions, reduced gross margins and loss of market share, any of which could
materially and adversely affect the Company's business, operating results and
financial condition. There can be no assurance that the Company will be able to
compete successfully against current and future competitors or that competitive
pressures faced by the Company will not materially and adversely affect its
business, financial condition and results of operations.
The advent of the Internet as a computing, communication and collaboration
platform, as well as a low-cost and efficient distribution on-line service and
electronic commerce vehicle, increases competition and creates uncertainty as to
future directions this technology will ultimately take. The Company faces
intense competition in the development and marketing of Web-based COM, DCOM and
COM+ software components and business solutions from a wide variety of
companies. There can be no assurances that the Company will be able to compete
effectively for business opportunities as they arise on the Internet, on-line
services, electronic commerce and other emerging areas.
Dependence on Consulting Engagements for Product Research and Development
and Marketing Research. The Company's strategy depends in part on its continued
ability to use its consulting engagements as a research and development
opportunity for products the Company might market in the future. The Company
generally negotiates its consulting agreements to enable the Company to retain
intellectual property rights to portions of the software being developed, while
the client retains rights to the entire program developed. If the Company is not
successful in growing its consulting business, is not able to negotiate
consulting agreements which allow the Company to retain rights to portions of
the developed software, or the needs of the Company's consulting customers do
not create opportunities for creating marketable products, the Company may be
required to expend significant amounts of resources, or contract with third-
parties, to perform research and development for new product offerings, which
could materially and adversely affect the Company's financial condition and
results of operation. The Company also utilizes its consulting services for its
marketing research. However, the needs of the Company's consulting customers may
not be representative of the needs of the professional software developer
community in general, and there can be no assurances that the Company will be
successful in obtaining sufficient information through its consulting services
to be able to develop software components and application frameworks that are
desirable to professional software developers and corporate application
programmers. To the extent that the Company's consulting services, or other
internal research or marketing methods, are insufficient for such purposes, the
Company may be required to expend significant amounts of resources, or contract
with third-parties, to obtain the necessary market research information
necessary to validate new products or the positioning the Company proposes,
which could materially and adversely affect the Company's financial condition
and results of operation.
Rapid Technological Change. To remain competitive, the Company must develop
new products, while enhancing and improving its existing products and
components. Web-centric software tools are characterized by rapid technological
change, changes in user and customer requirements and preferences, frequent new
product and service introductions embodying new technologies, and the emergence
of new industry standards and practices that could render the Company's existing
proprietary technology and systems obsolete. The Company's success will depend,
in part, on its ability to develop or license state-of-the-art technologies,
enhance its existing services, develop or acquire new services and technologies
that address the increasingly sophisticated and varied needs of its prospective
customers, and respond to technological advances and emerging industry standards
and practices on a cost-effective and timely basis. There can be no assurance
that the Company will be successful in continuing to develop and market on a
timely and cost-effective basis fully functional product enhancements or new
products that respond to technological advances by others, or that its enhanced
and new products will achieve adequate market acceptance. If the Company is
unable, for technical, legal, financial or other reasons, to anticipate or
respond
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adequately to changes in technology and customer preferences, significant delays
in product development or introduction would have a material adverse effect on
the Company's business, financial condition and results of operations.
Dependence on Growth of Internet/Intranet/Extranet Software Applications.
The Company's product strategies focus on supporting professional software
developers programming Internet, intranet and/or extranet-related applications
using any of the visual development languages available, including Microsoft's
Visual Programming Languages and Inprise Corporation's ("Inprise") Delphi(R).
Accordingly, revenues derived from the Company's products and consulting
services will depend in large part upon the rate of adoption by businesses and
end-users of the Internet, intranets, and extranets for commerce and
communications. Many of the critical issues concerning the Internet, including
security, reliability, cost, ease of use, access and quality of service, remain
unresolved at this time, hindering adoption by many enterprises and end-users.
To the extent the Internet, intranets, and in turn extranets, are not widely
used by businesses and end- users, there would be a corresponding material
adverse effect on the Company's business, operating results and financial
condition. The Company's recent entry into these markets is subject to a number
of risks, including among others, the Company's inexperience in these markets,
the new and evolving nature of these markets, the Company's need to make choices
regarding the visual development languages and standards on which to focus, the
ongoing transition of and investment of resources for this segment by the
Company, the Company's limited market credibility in this area, and the presence
of several very large and well-established businesses, as well as a number of
smaller very successful companies, already competing in this market. There can
be no assurance that sales in these markets will meet the Company's objectives,
in which case the Company's business, operating results or financial condition
could be materially adversely affected.
Reliance on Management and Key Personnel; Changes in Management. The
Company's future performance depends in significant part upon the continued
service of its key technical personnel and senior management. The loss of the
services of one or more of the Company's executive officers or key technical
personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company has entered into
employment agreements with certain of its executive officers and key personnel.
See "MANAGEMENT--Executive Compensation and Other Information-- Employment
Contracts." Generally, these agreements are for a term of one year and may be
renewed for successive one-year terms. Additionally, the Company is continually
seeking to expand the capabilities of its management team by adding new
executives or replacing current executives. In early October 1998, Ryan Smith
and John Guarino, each a former director and the Company's former chief
executive officer and senior executive vice president, respectively, resigned
from their positions with the Company, and the Company hired Matthew Schiltz as
consultant to the Company and to serve as interim chief executive officer.
Effective on October 27, 1998, the Company appointed Steve Wollach, the
Company's Chief Financial Officer and Director, to serve as the Company's
President as part of an internal reorganization being effected by the Company
and to replace Mr. Schiltz. Mr. Schiltz has agreed to continue to serve as an
advisor to the Company through June 1999. In addition, the Company hired Dale
Western as the Company's Vice President of Engineering and Development. The
Company expects that there may be additional additions to or changes in
management in the future. The cost and management time expended in expanding the
capabilities of the management team and the resulting change in management
structure could have a material adverse affect on the Company, its product
launches and business strategy and its operating results.
Control by Existing Shareholders. Approximately 49.1 percent of the
outstanding shares of Common Stock as of March 23, 1999 are owned by current and
former directors and officers of the Company or their respective affiliates.
All such shareholders, if they were to vote together, could significantly
influence the outcome of matters submitted to a vote of the Company's
shareholders, including the election of directors to the Company's Board of
Directors. In addition, pursuant to the terms of the settlement agreements
entered into by the Company with two of its founders and former officers and
directors, Ryan Smith and John Guarino, each of Messrs. Smith and Guarino has
granted to each of the Company's current directors an irrevocable proxy to vote
an aggregate of 2,580,800 shares held by Messrs. Smith and Guarino that are
subject to a transferable call option granted in favor of the Company.
Shareholders do not have the right to cumulate votes in the election of
directors and do not have preemptive rights. See "PRINCIPAL SHAREHOLDERS,"
"DESCRIPTION OF SECURITIES" and "CERTAIN TRANSACTIONS."
Software Defects and Liability Claims. Software products frequently contain
errors or defects, especially when first introduced or when new versions or
enhancements are released. There can be no assurance that, despite testing by
the Company, third-parties and potential customers, defects and errors will not
be found in current
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versions, new versions or enhancements after commercial shipments begin,
resulting in the loss of revenues, delay in market acceptance or unexpected
re-programming costs, which could have a material adverse effect upon the
Company's business, operating results and financial condition.
The Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential product
liability claims. It is possible, however, that the limitation of liability
provisions contained in the Company's license agreements may not be effective as
a result of existing or future federal, state or local laws or ordinances or
unfavorable judicial decisions. A successful product liability claim brought
against the Company could have a material adverse effect upon the Company's
business, operating results and financial condition.
Proprietary Rights, Risks of Infringement. The Company relies primarily on
a combination of copyright, trademark and trade secret laws, confidentiality
procedures and contractual provisions to protect its proprietary rights. The
Company also believes that factors such as the technological and creative skills
of its personnel, new product developments, frequent product enhancements, name
recognition and reliable product maintenance are essential to establishing and
maintaining a technological leadership position. The Company seeks to protect
its software, documentation and other written materials under trade secret and
copyright laws, which afford only limited protection. There can be no assurance
that others will not develop technologies that are similar or superior to the
Company's technology. Despite the Company's efforts to protect its proprietary
rights, unauthorized parties may attempt to copy aspects of the Company's
products or to obtain and use information that the Company regards as
proprietary. There can be no assurance that the Company's means of protecting
its proprietary rights in the United States or abroad will be adequate or that
competition will not independently develop similar technology.
The Company is not aware that it is infringing any proprietary rights of
third parties. There can be no assurance, however, that third parties will not
claim infringement by the Company of their intellectual property rights. The
Company expects that software product developers will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
industry segment grows and the functionality of products in different industry
segments overlaps. Any such claims, with or without merit, could be
time-consuming to defend, result in costly litigation, divert management's
attention and resources, cause product shipment delays or require the Company to
enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, if at all. In the event of a successful claim of product infringement
against the Company and failure or inability of the Company to license the
infringed or similar technology, the Company's business, financial condition and
results of operations would be materially and adversely affected.
Risks Associated with Potential Acquisitions. As a part of the Company's
business strategy, the Company intends to review acquisition prospects that
would complement the Company's consulting services or existing product
offerings, augment the Company's market coverage or enhance its technological
capabilities, or that may otherwise offer growth opportunities. The Company
continually evaluates potential acquisitions of complementary businesses,
products and technologies, that among other things, could expand the breadth and
depth of its products and organization. Any future acquisition by the Company
could result in potentially dilutive issuances of equity securities, the
incurrence of debt, contingent liabilities and/or amortization expenses related
to goodwill and other intangible assets, any of which could materially adversely
affect the Company's operating results and/or the market price of the Common
Stock. Acquisitions entail numerous risks, including difficulties in the
assimilation of acquired operations, technologies and products, diversion of
management's attention to other business concerns, risks of entering markets in
which the Company has no or limited prior experience and potential loss of key
employees of acquired organizations. Shareholders do not generally have rights
to approve any such acquisitions other than as required by Washington Corporate
law. No assurance can be given as to the ability of the Company to successfully
integrate any businesses, products, technologies or personnel that might be
acquired in the future, and the failure of the Company to do so could have a
material adverse effect on the Company's business, financial condition and
operating results.
Year 2000 Issues. Many companies are currently expending significant
resources in order to address the "Year 2000" issue. Expenditures to address the
Year 2000 issue often involve the modification of legacy and other existing
software systems rather than the development of new systems. Because of the size
of such expenditures, companies may defer or cancel other new software
development projects for which such companies might otherwise have purchased
products from the Company or engaged the Company for consulting. Any reductions
in revenues to
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<PAGE>
the Company resulting from other companies focus on the Year 2000 issue could
have a material adverse effect on the Company's business, results of operations
and financial condition.
The Company has commenced a review of its internal information systems. The
objective of the review is to address necessary code changes, testing and
implementation with the objective of taking corrective action based on the
results of such review. In addition, the Company could be materially and
adversely affected by costs or complications relating to code changes, testing
and implementation for its own systems or similar issues faced by its
distributors, suppliers, customers, vendors and the financial service
organizations with which the Company interacts. At this time, the Company has
not yet determined the cost related to achieving Year 2000 compliance.
The Year 2000 issue could affect the products that the Company sells. The
Company has reviewed its current products and believes that its products are
Year 2000 compliant. However, to the extent that the Company's products prove to
be non-compliant, or in the event of any dispute with any customer regarding
whether the Company's products are compliant, the Company's business, results of
operations and financial condition could be materially and adversely affected.
Recruiting and Retaining Technical Personnel. The success of the Company
depends in large part upon the ability of the Company to recruit and retain
highly skilled software engineers and programmers, both as employees and as
independent contractors. The Company's consulting division relies primarily on
independent contractors and subcontractors to perform services in connection
with its consulting engagements. If the Company is unsuccessful in obtaining
skilled independent contractors and subcontractors for its consulting
engagements, the Company may be unable to perform the contracts on a timely
basis and may be unable to bid for contracts which it cannot perform with
employees. Additionally, the Company believes that the technological and
creative skills of its personnel are essential to establishing and maintaining a
leadership position, particularly in light of the fact that its intellectual
property, once sold to the public market, is easily replicated. The competition
for such personnel is intense, and there can be no assurance that the Company
will be successful in retaining or recruiting such personnel. In seeking
qualified personnel, the Company is required to compete with companies having
greater financial and other resources than the Company. In addition, the Company
has had to, and may continue to be required to, increase substantially the
compensation, bonuses, stock options or other fringe benefits offered to
employees in order to attract and retain such personnel. Effective in November,
1998, the Company reorganized and reduced its employee base. Such reorganization
may also make recruiting new talented employees more difficult and costly. The
additional costs that may be incurred in retaining or attracting new personnel
may have a material adverse affect on the Company, its product launches and its
operating results.
No Dividends. The Company does not intend to declare any dividends on the
Common Stock in the foreseeable future.
Anti-takeover Effect of Certain Provisions of Articles of Incorporation.
The Company's Articles of Incorporation authorize the Board of Directors to
issue up to 10,000,000 shares of preferred stock and to determine the price,
rights, preferences, privileges and restrictions, including voting rights, of
those shares without any further vote or action by the shareholders. The rights
of the holders of Common Stock will be subject to, and may be adversely affected
by, the rights of the holders of any preferred stock that may be issued in the
future. The issuance of preferred stock may have the effect of delaying,
deferring or preventing a change in control of the Company without further
action by the shareholders and may adversely affect the voting and other rights
of the holders of Common Stock. The Company has no present plans to issue shares
of preferred stock. Further, certain provisions of the Company's Articles of
Incorporation and Bylaws and provisions of Washington law, including the
presence of a staggered Board of Directors, could delay or make more difficult a
merger, tender offer or proxy contest involving the Company. See "DESCRIPTION OF
CAPITAL STOCK."
Possible Adverse Effect of Outstanding Warrants and Options. There are
currently approximately 978,401 shares of Common Stock reserved for issuance
upon the exercise of certain stock purchase warrants granted by the Company (at
a weighted average exercise price of approximately $3.01 per share), and an
aggregate of 2,000,000 shares of Common Stock reserved for issuance upon
exercise of options that may be granted under the Company's 1998 Stock Option
Plan. As of March 23, 1999 the Company had granted stock options to purchase up
to an aggregate of 1,648,750 shares of Common Stock at a weighted average
exercise price of approximately $1.40 per share. In connection with the
Company's recent restructuring, which included a reduction in the number of
employees, the Company repriced all outstanding stock options held by continuing
employees and directors to
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<PAGE>
$1.406 per share, the last trade price of the Common Stock on November 4, 1998.
To the extent that any outstanding warrants or options are exercised, holders of
Common Stock will be diluted. In addition, any sales in the public market of the
shares underlying such warrants or options may adversely affect prevailing
market prices for the Common Stock and may adversely affect the Company's
ability to obtain additional equity financing. See "DESCRIPTION OF SECURITIES."
Shares Eligible for Future Sale. As of March 23, 1999, there are 14,708,927
shares of Common Stock outstanding, of which 1,946,617 shares have been
registered for resale on the Company's Registration Statement on Form SB-2 (file
no. 333-62345) as declared effective by the Commission on February 12, 1999 (the
"Registration Statement") and 5,165,526 shares that are freely tradable without
restriction or further registration under the Securities Act. In addition, the
Registration Statement also registered for resale up to 978,401 shares of Common
Stock underlying certain outstanding stock purchase warrants. The Company has
not granted any registration rights with regard to any additional shares of
Common Stock. All of the remaining 7,596,784 shares of Common Stock outstanding
are "restricted securities," as that term is defined under Rule 144 promulgated
under the Securities Act and will become eligible for sale, pursuant to Rule 144
commencing on various dates in 1999. No prediction can be made as to the
effect, if any, that sales of shares of Common Stock or even the availability of
such shares for sale will have on the market prices prevailing from time to
time. The possibility that substantial amounts of Common Stock may be sold in
the public market may adversely affect the prevailing market price for the
Common Stock and could impair the Company's ability to raise capital through the
sale of its equity securities. See "SHARES ELIGIBLE FOR FUTURE SALE."
Extreme Volatility of Stock Price. Like other software and high technology
companies, the market price of the Company's Common Stock has been and may
continue to be extremely volatile. Since the Common Stock began listing on the
OTC Bulletin Board in September 1997, the bid price of the Common Stock has
ranged from a high of $9.94 to a low of $0.9375. Factors such as quarterly
fluctuations in the Company's results of operations, the announcement of
technological innovations or the introduction of new products by the Company or
its competitors, and general conditions in the computer software and hardware
industries may have a significant impact on the market price of the Common
Stock. In addition, the stock market in general has experienced extreme price
and volume fluctuations that have affected the market price for many companies
in industries similar or related to that of the Company and that have been
unrelated to the operating performance of these companies. These market
fluctuations may materially and adversely affect the market price of the Common
Stock.
No Assurance of Public Market; Failure to Gain Listing on The Nasdaq
SmallCap Market; Risks Relating to Low-Priced Stocks. The Common Stock is
currently traded on the OTC Bulletin Board. There can be no assurance that a
regular trading market will develop or be sustained after the date of this
Prospectus. At such time that the Company meet the initial listing requirements,
the Company intends to apply for listing on The Nasdaq SmallCap Market
("NASDAQ"). The minimum listing requirements to qualify for listing on NASDAQ
include generally either $4 million in net tangible assets (total assets,
excluding goodwill, less total liabilities), $750,000 in net income or $50
million in market capitalization, and a $5 million market value of the public
float. In addition, initial listing also requires three market makers and a
minimum bid price of $4.00 per share. In order to continue to be listed on
NASDAQ, the Company must maintain either $2 million in net tangible assets or
$500,000 in net income, and a $4 million market value of its public float. As of
the date of this Report, the Company does not satisfy the initial listing
requirements for listing on NASDAQ. If the Company is not able to apply for
listing on NASDAQ or is not accepted for listing on NASDAQ, the Common Stock
will continue to be traded on the OTC Bulletin Board. In addition, if the
Company is subsequently listed on NASDAQ and fails to meet the maintenance
criteria, the Company's securities would be delisted from NASDAQ, and trading,
if any, in the Company's securities would thereafter be conducted on the OTC
Bulletin Board. For as long as the Common Stock is traded on the OTC Bulletin
Board, an investor may find it more difficult to dispose of, or to obtain
accurate quotations as to the market value of, the Common Stock than if it were
listed on NASDAQ.
For as long as the Common Stock is traded on the OTC Bulletin Board and the
trading price of the Common Stock is below $5.00 per share, trading in such
securities will be subject to the requirements of certain "penny stock" rules
promulgated under the Exchange Act. These rules require additional disclosure to
investors by broker-dealers in connection with any trades involving a stock
defined as a penny stock (generally, any non-NASDAQ equity security that has a
market price of less than $5.00 per share, subject to certain exceptions). Such
rules require that, prior to any penny stock transaction, the broker-dealer
deliver to the investor a disclosure statement explaining the penny stock market
and the associated risks with the market. The rules also impose sales
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<PAGE>
practice requirements on broker-dealers who sell penny stocks to persons other
than to established customers or accredited investors (generally institutions).
For these types of transactions, the broker-dealer must make a special
suitability determination for the purchaser and have received the purchaser's
written consent to the transaction prior to sale. The additional burdens imposed
upon broker-dealers by such requirements may discourage broker-dealers from
effecting transactions in the Company's securities, which could severely limit
the market price and liquidity of such securities and the ability of purchasers
to sell any of the Shares acquired in this offering in the secondary market.
ITEM 2. PROPERTY
In November 1998 the Company consolidated its corporate headquarters in
Seattle, Washington, where it leases approximately 8,141 square feet of office
space in the Olympic Tower Building in Seattle, Washington. The Company has also
sublet certain of its Seattle office space to unaffiliated third parties. The
Company believes that its existing facilities will be adequate through fiscal
1999 and that sufficient additional space will be available as needed thereafter
on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently in negotiations and expects to enter into
mediation and/or arbitration with Jay Paulson, a former officer and significant
shareholder of the Company, in connection with certain severance and other
matters related to his employment with the Company. In addition, the Company
has been served with a complaint filed by Mr. Paulson in King County Superior
Court in the State of Washington on November 18, 1998 (case no. 98-2-27751-1SEA)
for declaratory and injunctive relief and unspecified damages in connection with
a requested transfer of restricted securities held by Mr. Paulson. The Company
believes it has taken appropriate action and intends to vigorously defend this
lawsuit.
In addition, the Company recently entered into settlement agreements with
Ryan Smith and John Guarino, two of the Company's founders, former officers and
directors and significant shareholders of the Company, in connection with
certain matters related to their employment with the Company. See "CERTAIN
TRANSACTIONS."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year-ended December 31, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock is traded on the OTC Bulletin Board under the symbol
"OBJX". on March 23, 1999, the closing bid and asked prices of the Common Stock
as reported on the OTC Bulletin Board were $1-17/32 and $1-5/8, respectively,
and the Common Stock was held of record by approximately 261 persons on such
date (excluding holders of shares issuable upon exercise of outstanding stock
options and warrants). The Common Stock first began trading on the otc bulletin
board under the "OBJX" trading symbol on September 25, 1997. The table below
sets forth, for the calendar quarters indicated since the date that the Common
Stock began trading, the high and low bid prices for the Common Stock as
reported by the OTC bulletin board. These prices reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not represent actual
transactions.
<TABLE>
<CAPTION>
INTERACTIVE OBJECTS, INC.
COMMON STOCK
High Low
----- -----
<S> <C> <C> <C>
1997 First Quarter................................. -- --
Second Quarter................................ -- --
Third Quarter (beginning September 25, 1997)..$2.50 $1.88
Fourth Quarter................................ 2.66 1.88
</TABLE>
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<TABLE>
<S> <C> <C> <C>
1998 First Quarter................................. 4.50 1.88
Second Quarter................................ 9.94 3.84
Third Quarter (through August 21, 1998)....... 4.72 1.41
Fourth Quarter................................ 1.94 0.91
1999 First Quarter (through March 23, 1999)........$1.88 $0.94
</TABLE>
At March 23, 1999 there were 14,708,927 shares of Common Stock outstanding.
No cash dividends have been paid on the capital stock of the Company and no
dividends are currently contemplated by management. There are no restrictions
on the payment of dividends.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Financial
Statements and accompanying notes and the other financial information appearing
elsewhere in this Report.
The following discussion contains forward-looking statements regarding the
Company, its business, prospects and results of operations that are subject to
risks and uncertainties posed by many factors and events that could cause the
Company's actual business, prospects and results of operations to differ
materially from those that may be anticipated by such forward-looking
statements. Factors that might cause such a difference include, but are not
limited to, those discussed herein as well as those discussed under the captions
"Risk Factors" and "Business" as well as those discussed elsewhere in this
Report. Readers are cautioned not to place undue reliance on these forward-
looking statements, which speak only as of the date of this Report. Readers are
urged to carefully review and consider the various disclosures made by the
Company in this Prospectus that attempt to advise interested parties of the
risks and factors that may affect the Company's business.
Overview
The Company was incorporated in the State of Washington in October 1995 and
operated under the name Neoteric Media, Inc., d/b/a Interactive Objects, until
August 1997. In August 1997, pursuant to the terms of an acquisition agreement
with Asia Pacific Chemical Engineering Corp., a publicly-held Utah corporation
with nominal assets and liabilities, Neoteric Media entered into a business
combination with APEC. In the Neoteric Acquisition, the shareholders of Neoteric
Media exchanged their stock for a majority of the then-outstanding common stock
of APEC and Neoteric Media became a wholly-owned subsidiary of APEC (which
changed its name to Interactive Objects). For accounting purposes, the Neoteric
Acquisition was accounted for as a reverse purchase, with Interactive Objects as
the continuing entity. The Company's audited financial statements include, since
August 1997, the results of APEC operations, which were insignificant. See Note
1 of Notes to Financial Statements. The Company's unaudited pro forma results of
operations as if the APEC transaction had occurred on January 1, 1996 are
included in Note 1 of Notes to Financial Statements. The Company had
insignificant operations in 1996 and most of 1997.
Through December 31, 1998, substantially all of the Company's revenues have
been derived from its software consulting services. To date, the Company has
provided consulting services primarily for SAFECO, and has performed consulting
services on smaller projects for other corporations, including Microsoft and
Eddie Bauer. While the Company expects that revenue from its consulting services
will grow in the future, it also believes that over the long term, revenues from
its recently released and future products will become a larger percentage of
total sales. As of July 31, 1998, the Company's consulting relationship with
SAFECO concluded and the Company does not currently expect any future revenues
from SAFECO. On July 31, 1998, the Company's latest contract with SAFECO, the
fourth in a series of contracts granted by SAFECO for various phases in the
development of an Internet-based automation program for SAFECO's insurance
agents, expired by its terms and SAFECO took over management of the project. The
Company performed consulting services for SAFECO covering approximately one year
and during such period revenues from SAFECO consulting represented substantially
all of the Company's total revenue. With the conclusion of its relationship with
SAFECO, the Company expects that consulting revenue will
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<PAGE>
decrease for the second half of 1998. See "RISK FACTORS-- Concentration of
Customers; Limited Marketing Experience" and "--Uncertainty of Future Operating
Results; Fluctuations in Quarterly Operating Results."
In the first quarter of 1998, the Company released two software component
products and acquired a Novell-based software component product. Subsequent to
such acquisition, the Company decided to focus exclusively on Microsoft-based
software component products. The Company also released a suite of four
components in October 1998. The Company has until recently marketed its products
solely through the Internet. Revenue from product sales has been insignificant
to date, and there can be no assurance that the Company will be successful in
marketing its products. As a result of low product sales, in 1999 the Company
has been focusing more attention on development and licensing of its
intellectual property, building strategic partnerships and enhancing its
software consulting group and expects that revenues from such activities will
continue to represent a significant percentage of the Company's total revenues.
Effective in early November 1998, the Company announced a Company-wide
restructuring plan. As part of this plan, the Company reduced its employee base
from 23 to 13 employees, most of whom were first-level supervisors and
administrative staff. In addition, the Company promoted Steve Wollach, the
Company's Chief Financial Officer and Director, to serve as the Company's
President to replace Matthew Schiltz, a consultant hired by the Company in
October 1998 to serve as the Company's interim chief executive officer in
connection with the resignation of Ryan Smith, the former Chief Executive
Officer of the Company. Mr. Schiltz has agreed to continue to serve as an
advisor to the Company and its Board of Directors through June 1999. In
addition, the Company also hired Dale Western as the Company's Vice President of
Engineering and Development. In connection with the Company's restructuring
plan, the Company included a provision for up to $310,000 for severance and
settlement payments in connection with the resignations of Ryan Smith and John
Guarino from their positions as officers and directors of the Company.
Subsequent to 1998 year end, the Company settled all disputes with Messrs. Smith
and Guarino. See "CERTAIN TRANSACTIONS." Also in connection with the
restructuring plan, the Company repriced all outstanding stock options held by
current Company employees and directors to $1.406 per share, the closing trading
price of the Common Stock on the OTC Bulletin Board on November 4, 1998.
Results of Operations for Years Ended December 31, 1998 and 1997
Gross Revenue. Gross revenue for the years ended December 31, 1998 and 1997
was approximately $2,123,000 and $366,000 respectively. During the year-ended
December 31, 1998, substantially all of the Company's revenue was generated by
its software consulting services. The Company released its first product in the
first quarter of 1998, did not make any product sales prior to January 1, 1998
and has had insignificant product sales through 1998. The 580% increase in
gross revenue is attributable primarily to the Company's software consulting
agreement with SAFECO, which accounted for substantially all of the Company's
revenue in the year-ended December 31, 1998. During the year-ended December 31,
1998, the Company had insignificant revenue from product sales. In prior
periods, the Company had no revenues from product sales. See "RISK FACTORS--
Concentration of Customers; Limited Marketing Experience" and "--Uncertainties
Regarding Market Acceptance of the Company's Products; New Product
Introductions."
Labor and Benefits Expenses. Labor and benefits includes all internal labor
costs and other direct costs related to project performance, such as project
specific independent contractor fees, labor costs, supplies and specific project
related expenditures. The Company's labor and benefits expenses increased by
436% from approximately $787,000 for the year-ended December 31, 1997 to
approximately $3,428,000 for the year-ended December 31, 1998. Labor and
benefits consisted exclusively of salaries, taxes and benefits. The increase in
labor and benefits expenses from fiscal 1997 to fiscal 1998 was directly
attributable to increased costs and independent contractor fees arising out of
the Company's consulting contract with SAFECO, as well as the Company's hiring
of new employees and increasing salaries to senior management. In addition, the
Company hired additional employees during the second half of 1997 and year-ended
December 31, 1998 to meet increased demand and had ten full-time employees at
December 31, 1998, a decrease of 12 from 22 at December 31, 1997.
At December 31, 1998, the Company had seven employees in product
development and software consulting services, one employee in sales and
marketing and two employees in general and administrative. In November 1998 the
Company implemented a restructuring plan, including a reduction in the number of
employees from 23 to 13 total employees. In addition, the Company hires
independent contractors to service project demand for the Company's consulting
services on a project by project basis, and expects to continue to staff
projects with independent contractors. The Company believes that staffing
client projects with independent contractors results in
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<PAGE>
the Company incurring costs that are less than those the Company would
experience if projects were internally staffed. The Company expects that it will
hire additional staff if and as needed to meet demand from current clients and
prospective clients whose projects are anticipated to commence within ninety
days after hiring. The Company expects that its independent contractor costs
will remain relatively constant as it takes on additional consulting contracts
that offset decreases resulting from the termination of its consulting agreement
with SAFECO.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were approximately $2,957,000 and $1,256,000 for the
years-ended December 31, 1998 and 1997, respectively. The amounts for fiscal
1998 includes approximately $1,085,000 as a one-time non-cash compensation
expense for the value of Company securities issued during such period in
exchange for consulting and other services. In each period, the other expenses
consisted primarily of employee recruiting, travel, professional fees, occupancy
costs, telephone and related Internet connectivity fees, computer network costs,
office expenses and supplies, marketing, advertising and new business
development costs. Overall, selling, general and administrative expenses as a
percentage of gross revenue were 139% for the year-ended December 31, 1998 as
compared to 343% for fiscal 1997. The increase in selling, general, and
administrative expenses was primarily a result of the one-time non-cash
compensation expense recorded for securities issued for consulting services and
other services in connection with the Company's financing and investor relations
efforts and, secondarily, of an increase in the Company's sales, marketing and
advertising efforts in anticipation of growth and its 1998 product releases and,
secondarily, of increased professional fees in connection with its financing
efforts in 1998 and the Company entering into a lease for additional office
space. The decrease as a percentage of gross revenue was due to the Company's
increased revenues growing at a greater rate than expenses.
Management believes that selling, general, and administrative expenses will
decrease as a percentage of gross revenue in future periods. General and
administrative expenses have increased due to increased staffing, investment in
infrastructure and associated expenses necessary to manage and support the
Company's growing operations. The Company believes that its general and
administrative expenses will increase in dollar amount for fiscal 1998 as a
result of an anticipated expansion of the Company's administrative staff
required to support its growing operations and as a result of an increase in
expenses associated with being a Exchange Act reporting company. The Company
anticipates that it will begin to devote further resources to product
development in fiscal 1998. All costs incurred in the research and development
of software products and enhancements to existing products have been expensed as
incurred and the cost of acquired software products have been capitalized. The
Company's capitalized software will be amortized as required by GAAP principles
beginning in the first quarter of 1998 when the product was released for sale to
the public.
Net Loss. The Company recognized a net loss of approximately $(4,146,000)
(representing 195% of gross revenue) for fiscal 1998 as compared to a net loss
of $(1,685,000) (representing 461% of gross revenue) for fiscal 1997. The
increase in net loss on an absolute basis is due primarily to the increased
expenses described above which have been only partially offset by increased
revenues from the Company's consulting services.
Interest Expense. Interest expense represents interest expense on Company
debt. Interest expense increased to approximately $16,000 in fiscal 1998 from
$7,000 for fiscal 1997, due to increased borrowings during 1998.
Income Tax. From inception until August 1997, the Company operated as an
S-corporation. As a result, the Company's earnings have been taxed directly to
the Company's shareholders at their individual federal income tax rates, rather
than the Company. The Company became a taxable C-corporation in August 1997. To
date, the Company has not paid income taxes.
As of December 31, 1998, the Company had net operating loss carry-forwards
for federal income tax purposes of approximately $1,297,000. The federal net
operating loss carry-forwards expire in 2012.
Capital Resources And Liquidity
As a result of hiring additional employees, increasing marketing and
increasing its product development efforts in anticipation of product releases
in 1998, the Company's capital requirements have been and will continue to be
significant and its cash requirements have been and will continue to exceed cash
flows from operations. As a result, the Company has been substantially dependent
on sales of its equity securities, cash flow from operations,
23
<PAGE>
and borrowings from affiliates. At December 31, 1998, the Company had cash in
the aggregate amount of approximately $3,298,000, primarily attributable to the
sale of Company Common Stock to foreign investors in May 1998. The Company's
working capital increased an aggregate of $3,163,000, from $62,000 at December
31, 1997 to $3,225,000 at December 31, 1998, primarily due to the sale of equity
securities described in more detail below. Subsequently, in November 1998 the
Company implemented a reorganization which included a reduction in the employee
base from 23 to 13 employees, thereby reducing the Company's cash requirement
for the short term.
Net cash used in operating activities was $2,861,000 for fiscal 1998, as
compared to $728,000 for fiscal 1997. The increase in net cash used in
operating activities was primarily attributable to the Company's net operating
loss.
Net cash used in investing activities was $129,000 for fiscal 1998, as
compared to $279,000 for fiscal 1997. The decrease in net cash used in
investing activities was primarily attributable to decreases in purchases of
equipment, offset by increased capitalized software costs.
Net cash provided by financing activities for fiscal 1998 was $6,074,000,
as compared to $1,206,000 for fiscal 1997. The increase in net cash provided by
financing activities was primarily attributable to the Company's sales of equity
securities in May 1998.
During May 1998, the Company sold 1,534,010 shares of Common Stock to
approximately 117 foreign investors in a private offering. The Company received
gross proceeds of approximately $6,136,040 from such offering, before costs
associated with the offering.
Additionally, in the first half of 1998, the Company borrowed and repaid
$600,000. National Day Corporation loaned such funds to the Company pursuant to
three demand promissory notes which bore interest at 12% per annum. The Company
used part of the proceeds from the Common Stock offering in May 1998 to repay
such loan.
Based on the Company's current proposed plans and assumptions relating to
product releases and sales, the Company anticipates that it will not require
additional capital financing through fiscal 1999. If the Company's plans change
or its assumptions prove to be inaccurate, the Company may be required to seek
additional equity and/or debt financing sooner than currently anticipated. The
Company has no current arrangements related to additional financing. In as much,
there can be no assurance that any additional financing will be available to the
Company when needed, on commercially reasonable terms, or at all. See "RISK
FACTORS--Limited Operating History; No Profitable Operations."
New Accounting Pronouncements
Statement of Financial Standards No. 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities" established accounting and
reporting standards for derivative instruments and for hedging activities. SFAS
133 has no impact on the Company's financial statements, because the Company
does not currently engage in any derivatives or hedging activities.
Statement of Financial Standards No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise" does not apply to the Company.
Year 2000 Compliance
The Company's products are designed to be Year 2000 compliant and do not
contain any date- or time-dependent code strings, fields, variables or other
mechanisms that inhibit their use or reliability following the turn of the
century. As Interactive Objects develops, tests, and releases new products, and
upgrades existing products it actively verifies that any date-related items are
Year 2000 compliant. See "RISK FACTORS--Year 2000 Issues."
24
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Financial Statements
Independent Auditors' Report
Balance Sheet as of December 31, 1998
Statements of Operations for the Years ended December 31, 1998 and 1997
Statements of Stockholders' Equity for the Years ended December 31, 1998
and 1997
Statements of Cash Flows for the Years ended December 31, 1998 and 1997
Notes to Audited Financial Statements
25
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Interactive Objects, Inc.
Seattle, Washington
We have audited the accompanying balance sheet of Interactive Objects, Inc. as
of December 31, 1998, and the related statements of operations, stockholders'
equity, and cash flows for the years ended December 31, 1998 and 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Interactive Objects, Inc. as of
December 31, 1998, and the results of its operations and its cash flows for the
years ended December 31, 1998 and 1997, in conformity with generally accepted
accounting principles.
/s/ Peterson Sullivan P.L.L.C.
February 10, 1999
26
<PAGE>
INTERACTIVE OBJECTS, INC.
BALANCE SHEET
as of December 31, 1998
<TABLE>
<CAPTION>
December 31,
1998
------------------
ASSETS
Current Assets
<S> <C>
Cash....................................................................................... $ 3,298,278
Certificate of deposit..................................................................... 106,145
Accounts receivable........................................................................ 14,000
Prepaid expenses........................................................................... 147,431
-------------------
Total current assets................................................................... 3,565,854
Furniture and equipment, at cost, less accumulated depreciation of $84,610.................... 226,598
Other Assets
Deposits................................................................................... 6,934
-------------------
Total Assets........................................................................... $ 3,799,386
===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable........................................................................... $ 85,395
Accrued expenses........................................................................... 225,095
Total current liabilities.............................................................. 340,490
Stockholders' Equity
Preferred stock, $.01 par value; 2,000,000 authorized, no shares issued and outstanding..... --
Common stock, $.01 par value; 50,000,000 shares authorized, 14,708,927 shares issued and
outstanding................................................................................ 147,089
Additional paid-in capital................................................................. 9,000,485
Retained deficit........................................................................... (5,688,678)
-------------------
3,458,896
-------------------
Total Liabilities and Stockholders' Equity............................................. $ 3,799,386
===================
</TABLE>
27
<PAGE>
INTERACTIVE OBJECTS, INC.
STATEMENTS OF OPERATIONS
Years Ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
------------------ ------------------
Revenues
<S> <C> <C>
Service revenue $ 2,122,846 $ 365,631
Expenses
Labor and benefits 3,427,782 787,458
Selling, general and administrative 2,956,963 1,256,432
--------------------------------------
6,384,745 2,043,890
--------------------------------------
Loss from operations before interest expense (4,261,899) (1,678,259)
Other income 24,800 --
Interest income 107,703 --
Interest expense (16,118) (7,007)
--------------------------------------
Net Loss $(4,145,514) $(1,685,266)
======================================
Basic earnings (loss) per share of common stock $ (0.30) $ (0.18)
======================================
</TABLE>
28
<PAGE>
INTERACTIVE OBJECTS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
Common Common Additional Retained
Shares Stock Paid-in Capital Deficit Total
----------- -------- ---------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1996................ 782,600 3,000 83,830 (84,586) 2,244
Reclassification of undistributed losses
on effective date of change from S
corporation status to C corporation status -- -- (226,688) 226,688 --
Effect on capital structure resulting from
reverse purchase
Cancellation of shares of Interactive at
the time of reverse purchase............ (782,600) -- -- -- --
Issuance of stock as consideration for
shares cancelled above.................. 7,460,800 8,191 (8,191) -- --
Acquisition of Asia Pacific.............. 1,100,082 1,650 (5,150) -- (3,500)
Exchange of note payable for common stock.
The note was for $62,500 with accrued
interest of $12,502....................... 112,607 169 74,833 -- 75,002
Issuance of stock for cash................. 3,071,428 4,607 1,210,443 -- 1,215,050
Issuance of stock in exchange for services. 1,200,000 1,800 778,200 -- 780,000
Net loss................................... -- -- -- (1,685,266) (1,685,266)
--------------------------------------------------------------------
Balances, December 31, 1997................ 12,944,917 19,417 1,907,277 (1,543,164) 383,530
--------------------------------------------------------------------
Convert share price from $.0015 to $.01.... -- 110,032 (110,032) -- --
Issuance of stock in exchange for cash..... 1,534,010 15,340 6,120,700 -- 6,136,040
Issuance of stock in exchange for services. 230,000 2,300 917,700 -- 920,000
Issuance of stock purchase warrants in
exchange for services..................... -- -- 164,840 -- 164,840
Net loss................................... -- -- -- (4,145,514) (4,145,514)
--------------------------------------------------------------------
Balances, December 31, 1998................ 14,708,927 $147,089 $9,000,485 $(5,688,678) $ 3,458,896
====================================================================
</TABLE>
See Notes to Financial Statements
29
<PAGE>
INTERACTIVE OBJECTS, INC.
STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
------------------ ------------------
Cash Flows from Operating Activities
<S> <C> <C>
Net loss $(4,145,514) $(1,685,266)
Adjustments to reconcile net loss to net cash used in operating activities:
Issuance of stock and stock purchase warrants in exchange for services 1,084,840 780,000
Depreciation and amortization 53,499 17,023
Disposal of capitalized software costs 165,000 --
Changes in operating assets and liabilities:
Accounts receivable (3,302) (10,698)
Prepaid expenses and deposits (106,928) (43,893)
Accounts payable (100,543) 164,513
Accrued expenses 192,201 50,618
--------------------------------------
Cash used in operating activities (2,860,747) (727,703)
--------------------------------------
Cash Flows from Investing Activities
Purchase of equipment (89,646) (177,862)
Investment in certificate of deposit (4,836) (101,309)
Capitalization of software costs (35,000) --
--------------------------------------
Cash used in investing activities (129,482) (279,171)
--------------------------------------
Cash Flows from Financing Activities
Issuance of common stock 6,136,040 1,286,552
Proceeds of notes payable 600,000 --
Payments on notes payable (662,500) (80,500)
--------------------------------------
Cash provided by financing activities 6,073,540 1,206,052
--------------------------------------
Net increase in cash 3,083,311 199,178
Cash, beginning of year 214,967 15,789
--------------------------------------
Cash, end of year $ 3,298,278 $ 214,967
======================================
</TABLE>
30
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Note 1. Organization and Significant Accounting Policies
Organization
Neoteric Media, Inc. d/b/a Interactive Objects, Inc. ("Neoteric") was
incorporated under the laws of Washington on October 20, 1995. Effective August
31, 1997, the stockholders of Neoteric exchanged their stock for the common
stock of another company named Asia Pacific Chemical Engineering Co., Ltd.
("Asia Pacific"). Because Neoteric is the continuing company, this business
combination has been accounted for as a reverse purchase. Asia Pacific had no
assets, but did have liabilities of $3,500. The assumption of these liabilities
was considered the cost of Asia Pacific. Asia Pacific's operations, which were
insignificant, have been included in these financial statements since the
effective date of the exchange.
Subsequent to the business acquisition, Neoteric merged into Asia Pacific and
Asia Pacific changed its name to Interactive Objects, Inc. ("Interactive
Objects").
Concentration of Market and Credit Risk
In 1997 and 1998, Interactive Objects sold computer consulting services. Revenue
from consulting services provided to two international companies (Microsoft and
SAFECO) accounted for almost all of total revenue during each of the last two
years. In 1999, Interactive Objects is focusing more attention on development
and licensing of its intellectual property, building strategic partnerships, and
enhancing its software consulting group.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
Accordingly, actual results could differ from the estimates that were used.
Software Consulting Services Revenue Recognition
For most contracts, software consulting service revenue (including post-contract
customer support) is recognized as the services are performed and is determined
by multiplying the hours incurred by an established hourly rate. On occasion,
other contracts stipulate billings be made at certain points based on
performance of specified tasks. In these situations, software consulting
revenue is recognized as billings are made at the amount of the billing. This
revenue recognition method is not materially different than recognizing revenue
as services are performed.
Advertising Costs
Advertising costs are expensed as incurred and totaled $148,691 for 1998, and
$91,278 for 1997.
Cash
Cash includes cash balances held at a bank and all highly liquid debt
instruments with original maturities of three months or less. Cash balances are
in excess of amounts insured by the Federal Deposit Insurance Corporation.
No cash payments for income taxes were made during the years ended December 31,
1998 and 1997. Interactive Objects paid $16,118 for interest during 1998 and
$7,007 in 1997.
Certificate of Deposit
Certificates of deposit are stated at market value which approximates cost.
31
<PAGE>
Accounts Receivable
Interactive Objects uses the allowance method for recognizing bad debts.
Management believes no allowance is necessary at December 31, 1998.
Furniture and Equipment
Furniture and equipment are depreciated using the straight-line method over the
estimated useful lives of the related assets.
Capitalized Computer Software
Interactive Objects purchased Visual Gateway Interface from a partnership
partially owned by a stockholder of Neoteric and recorded it at a cost of
$130,000. It was paid for with cash of $67,500, a note payable for $62,500, and
80,000 shares of common stock of Neoteric (due to the reverse purchase, this is
equivalent to 762,688 shares of Interactive Objects common stock at December 31,
1997). At the time of the transaction, the stock was determined to have an
insignificant value. The costs to acquire Visual Gateway Interface and other
software created and purchased during 1998 of $165,000 were written off during
1998.
Taxes on Income
Interactive Objects accounts for income taxes under an asset and liability
approach that requires the recognition of deferred tax assets and liabilities
for expected future tax consequences of events that have been recognized in
Interactive Objects' financial statements or tax returns. In estimating future
tax consequences, Interactive Objects generally considers all expected future
events other than enactments of changes in the tax laws or rates.
For a portion of 1997, Interactive Objects (then Neoteric) was an S corporation
for income tax purposes, so income tax effects were recognized at the
stockholder level. Pro forma tax expense and related per share data if
Interactive Objects had been a C corporation for all periods presented would be
the same as that presented in the financial statements. Interactive Objects
incurred losses in 1997. If it were a C corporation, any benefit from these
losses would be fully reserved.
Earnings Per Share
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("FAS 128") which
is effective for interim and annual financial statements for periods ending
after December 15, 1997. Under FAS 128, basic and diluted earnings per share
are to be presented. Basic earnings per share is computed by dividing income
available to common shareholders by the weighted average number of common shares
outstanding in the period. Diluted earnings per share takes into consideration
common shares outstanding (computed under basic earnings per share) and
potentially dilutive common shares. Stock purchase warrants outstanding have
not been reflected as exercised for the purposes of computing diluted earnings
or loss per share since the exercise of such warrants would be antidilutive.
Accordingly, basic and diluted earnings or loss per share are the same. The
weighted average number of shares was 13,985,718 and 9,191,569 for the years
ended December 31, 1998 and 1997.
In order to be comparative, the number of shares of common stock outstanding
used to calculate earnings per share has assumed the Interactive Objects (then
Neoteric) shareholders had exchanged their 782,600 of Neoteric stock for
7,460,800 shares of Asia Pacific stock as of January 1, 1997.
Preferred Stock
The rights and restrictions of preferred stock is to be determined by
Interactive Objects when the stock is issued. Each preferred stock issuance
will be in a series, and each series will have the same rights and restrictions.
32
<PAGE>
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," encourages, but does not require, companies to record
compensation cost for stock-based employee compensation plans at fair value.
Interactive Objects has chosen to account for stock-based compensation using
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, compensation cost for stock options granted to
employees is measured as the excess, if any, of the quoted market price of
Interactive Object's stock at the date of the grant over the amount an employee
is required to pay for the stock.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" is effective for years beginning after December 15, 1997. The primary
objective of this statement is to report and disclose a measure of all changes
in equity of an entity that result from transactions and other economic events
of the period other than transactions with owners. Interactive Objects had no
items that resulted in difference between comprehensive income and the net loss
as shown on the statement of operations.
New Accounting Standards
Statement of Financial Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" established accounting and reporting standards for
derivative instruments and for hedging activities. Because Interactive Objects
does not currently engage in any derivatives or hedging activities, there is no
impact on its financial statements.
Statement of Financial Standards No. 134, "Accounting for Mortgage-Backed
Securities Retained After the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise" does not apply to the Company.
Note 2. Consulting Agreement
Interactive Objects has a consulting agreement with a company ("consultant")
that is a shareholder of Interactive Objects. The agreement provides for
monthly payments of $3,000 to the consultant until June 2000. The consultant
acquired common stock of Interactive Objects for services rendered as part of
the organizational changes described in Note 1 which resulted in total ownership
of 1.2 million common shares. The consultant was not a shareholder when the
consulting agreement was signed, but became a shareholder when the 1.2 million
shares were issued.
Compensation expense associated with the portion of the consulting agreement for
obtaining equity financing was based on a value of $.65 per share, which was
determined based on discounting the then-market price of Interactive Objects'
common stock, because the shares issued to the consultant were restricted and
because the volume of trading of Interactive Objects' stock that was not
restricted was relatively low. Finally, the value was discounted further
because of the risks involved with Interactive Objects being a relatively new
company. The resulting compensation expense recognized for the stock issuance
was $780,000 in 1997. In addition, Interactive Objects paid the consultant
$18,000 during the year ended December 31, 1997 and $60,000 during the year
ended December 31, 1998.
Note 3. Notes Payable
A note payable (a convertible promissory note) to a stockholder for $73,194 was
converted into 112,607 shares of Interactive Objects common stock during 1997.
This conversion was made at the election of the stockholder. The conversion
rate was determined to be at $0.65 per share and was established by negotiations
between the stockholder and Interactive Objects. The market for Interactive
Objects common stock was very limited at the time the negotiations took place.
33
<PAGE>
Note 4. Leases
Interactive Objects leases office space under an operating lease expiring in
November 2000. A portion of the office space is subleased. The following are
the future minimum rental payments required (and future sublease payments to be
received) for the years ending December 31:
<TABLE>
<CAPTION>
Sublease Net
Total Payments Payments
------------------- ------------------- -------------------
<S> <C> <C> <C>
1999 $130,663 $51,681 $ 78,982
2000 124,998 47,374 77,624
------------------- ------------------- -------------------
$255,661 $99,055 $156,606
=================== =================== ===================
</TABLE>
Rent expense was $153,224, net of $23,504 in sublease rentals for the year ended
December 31, 1998. During the year ended December 31, 1997, there were no
sublease rentals and rent expense was $42,566.
Note 5. Warrants Outstanding
At December 31, 1998, Interactive Objects had stock purchase warrants
outstanding for the purchase of 1,028,401 shares of its common stock at prices
ranging from $4.00 to $7.00 per share. These warrants were issued in exchange
for services and were valued at the fair value of the services received. The
warrants are exercisable at any time. Of the total warrants outstanding, 75,000
warrants expire during 1999 and 953,401 expire during 2000.
Subsequent to December 31, 1998, the board of directors of Interactive Objects
repriced stock purchase warrants for the purchase of 500,000 shares of its
common stock from $4.00 to $1.41. The amount of expense attributable to the
repricing was not material.
Note 6. Income Taxes
The reconciliation of income tax on income computed at the federal statutory
rates to income tax expense is as follows:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Tax at statutory rate $ 1,409,475 $ 572,990
Change in valuation allowance for deferred tax asset (1,036,320) (261,120)
Costs associated with raising capital (nondeductible) (373,155) (265,200)
Effect of loss being taxed at stockholder level - (46,670)
------------ ------------
Income tax expense $ - $ -
============ ============
</TABLE>
Interactive Objects' deferred tax asset as of December 31, 1998, is as follows:
<TABLE>
<S> <C>
Net operating loss carryforwards $ 1,297,440
Accrued vacation deductible for tax when paid 9,180
-------------
1,306,620
Less valuation allowance for deferred tax asset (1,306,620)
-------------
Net deferred tax asset $ -
=============
</TABLE>
34
<PAGE>
Interactive Objects has net operating loss carryforwards of $3,853,000 and
$768,000 at December 31, 1998 and 1997, respectively. These losses at December
31, 1998, expire in 2012 and 2018.
Note 7. Stock-Based Compensation
Interactive Objects established a fixed employee stock-based compensation plan
in 1998. Under this plan, Interactive Objects may grant options for up to
2,000,000 shares of common stock. The exercise price of each option is equal to
the market price of the Company's stock on the date of grant. Generally, the
maximum term of the options is ten years, and they vest over four years at a
rate of 25% per year on each anniversary date of the grant or according to
individual agreements.
The fair value of each option granted is estimated on the grant date using the
Black-Scholes model. The following assumptions were made in estimating fair
value:
<TABLE>
<CAPTION>
Assumption
-----------------------------
<S> <C> <C>
Dividend yield 0.0%
Risk-free interest rate 4.5%
Expected life 3 years
Expected volatility 90.50%
</TABLE>
Interactive Objects applies APB Opinion 25 in accounting for its stock
compensation plan. Accordingly, no compensation expense has been recognized in
these financial statements. Had compensation expense been determined on the
basis of fair value pursuant to FASB Statement No. 123, net loss would have been
$(4,588,514) (reported amount was $(4,145,514). Earnings per share (basic and
diluted) would have been $(.33) (reported amount was $(.30)).
The following is a summary of the status of the plan during 1998:
<TABLE>
<CAPTION>
Number Weighted Average
Of Shares Exercise Price
----------------- -----------------
<S> <C> <C>
Outstanding at January 1, 1998 - $ --
Granted 1,482,875 1.42
Exercised - --
Forfeited - --
----------------- -----------------
Outstanding at December 31, 1998 1,482,875 $ 1.42
================= =================
Weighted average fair value of options granted during 1998 $ .32
=================
</TABLE>
At December 31, 1998, outstanding options had an exercise price range of $1.41
to $2.62. There were 1,482,875 options outstanding with a weighted average
remaining contractual life of ten years and a weighted average exercise price of
$1.42. There were 541,791 options exercisable with a weighted average exercise
price of $1.42 at December 31, 1998.
Subsequent to December 31, 1998, Interactive Objects established a performance-
based bonus plan whereby stock options are to be granted to employees based on
the financial performance of the company during 1999. According to the bonus
plan, the options will be granted at fair market value at the time of the grant
subject to vesting provisions under the employee stock compensation plan.
35
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(a) OF THE
EXCHANGE ACT
The following table sets forth the names and ages of the current directors
and executive officers of the Company and the principal offices and positions
with the Company held by each person. The Company's Board of Directors is
divided into three classes and currently consists of five directors of which
there are currently two vacancies from the resignations of Ryan Smith and John
Guarino in October 1998. The Company is searching for qualified candidates to
fill the Board vacancies that currently exist; however, as of the date of this
Report, no persons have been identified. The members of each class serve three-
year terms, with one class elected annually. The terms of office for Class I
directors (Brent Nelson and Thad E. Wardall) expire at the Annual Meeting of
Shareholders to be held in 1999; the term of office for the Class II director
(Steven G. Wollach) expires at the Annual Meeting of Shareholders to be held in
2000; and the terms of office for Class III directors (currently vacant) expire
at the Annual Meeting of Shareholders to be held in 2001.
The executive officers of the Company are elected annually by the Board of
Directors and serve terms of one year or until their death, resignation or
removal by the Board of Directors. There are no family relationships between any
of the directors and executive officers. Pursuant to the terms of a consulting
agreement between the Company and Northwest Capital Partners, L.L.C., Northwest
Capital has the right to nominate one director for election to the Company's
Board of Directors. Northwest Capital's nominee is Brent Nelson. See "CERTAIN
TRANSACTIONS." Other than the foregoing right of Northwest Capital, there are
no arrangements or understandings between any director or executive officer and
any other person pursuant to which any person was selected as a director or
executive officer.
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Steven G. Wollach 44 President, Chief Financial Officer, Treasurer and Director
Steve Jackson 31 Executive Vice President
Dale Western 37 Vice President of Engineering and Development
Mark Phillips 25 Chief Technology Officer
Robin L. Byrd 36 Corporate Secretary
Thad E. Wardall 52 Director
Brent Nelson 37 Director
</TABLE>
Set forth below is biographical information for the directors and executive
officers:
Directors
Steven G. Wollach, age 44, was recently appointed President of the Company
on October 27, 1998 in connection with the Company's restructuring. He has
served as a Director of the Company since September 16, 1997, as Chief Financial
Officer of the Company since October 1997 and as Treasurer of the Company's
Board of Directors since October 1997. From 1995 through 1997, Mr. Wollach
served as an independent contractor for various venture capital firms. Prior to
1995, for several years Mr. Wollach worked in the accounting/audit/tax
departments at Laventhol and Horwath and Seidman and Seidman. Mr. Wollach holds
a B.S. in Business, with a major in Accounting from Wayne State University.
Thad E. Wardall, age 52, has served as a Director of the Company since
September 16, 1997. From March 1996 to September 1997, Mr. Wardall served as a
Director of Neoteric Media, Inc. From June 1991 to February 1996, Mr. Wardall
served as the International Facilities Project Manager for Microsoft
Corporation. During his time at Microsoft, Mr. Wardall traveled to 27 countries
and had oversight responsibilities for 36 high-tech subsidiary office projects.
Mr. Wardall holds a Bachelor of Architecture degree from Washington State
University.
36
<PAGE>
Brent Nelson, age 37, has served as a Director of the Company since
September 16, 1997. Mr. Nelson presently serves as the managing partner of
Northwest Capital Partners, L.L.C., a venture capital firm located in Bellevue,
Washington. See "CERTAIN TRANSACTIONS." Mr. Nelson presently serves on the
boards of directors of Eclipse Entertainment Group Inc., a film development,
production and distribution company, and Titan Resources Inc., a natural
resource company with interests in oil and gas exploration and development. Mr.
Nelson holds a diploma in marketing and general business from Douglas College,
Vancouver, B.C., Canada.
Executive Officers
In addition to Mr. Wollach, the following are the executive officers of the
Company:
Steve Jackson, age 31, has served as Executive Vice President since January
1999. Prior to that, he served as Chief Technology Officer of the Company from
December 1997. From 1990 to 1996, Mr. Jackson served as Systems Engineer and
Program Manager of Microsoft Corporation. During his time at Microsoft, Mr.
Jackson managed several product development teams and was a lead member of the
Company's Desktop Management Task Force and Licensing Services Application
Programming Interface industry standards groups. From 1988 to 1990, Mr. Jackson
served as Systems Engineer, Network Architect, and Software Design Engineer of
O/E Systems, Inc. From 1987 to 1988, Mr. Jackson served as Director of Training
and Sales Representative of Entree Computer Systems.
Dale Western, age 37, was appointed as the Company's Vice President of
Product Development in October 1998. From April 1993 through October 1998, Mr.
Western served as practice director for PLATINUM technology, Inc. From June 1984
through April 1993, Mr. Western served in various capacities with The Boeing
Company, including as Application Architect for the Computer Services Division,
CAE Software Engineer for the Electronics Division and as System Architect for
the Commercial Airplane Division. Mr. Western holds a B.S. in Computer Science
and a B.S. in Electrical Engineering from Michigan Technological University.
Mark Phillips, age 25, was recently appointed as Chief Technology Officer
of the Company in January 1999. Mr. Phillips has been employed with the Company
since January 1998, serving as a senior software engineer and developer. Prior
to the Company, Mr. Phillips served as a senior software engineer and developer
for Saltmine Creative, Inc. from July 1997 to January 1998, for Oo-moja Software
from December 1996 to July 1997, for MetaBridge, Inc. from June 1996 to July
1997. In addition, Mr. Phillips worked as a developer with the University of
Washington Human Interface Technologies Lab from September 1996 to July 1998.
Mr. Phillips earned his B.S. in Comparative History of Ideas, with a minor in
Computer Science Engineering and Architecture Design from the University of
Washington.
Robyn L. Byrd, age 36, was recently appointed as Corporate Secretary of the
Company in December 1998. Ms. Byrd has served a variety of administrative
positions with the Company since her date of employment in November 1997. Prior
to the Company, Ms. Byrd has served as office manager for Millstone Coffee, Inc.
since 1996 and as a customer service manager with Fukuda Denshi America from
1992 to 1996. Ms. Byrd received her Bachelor of Arts from the University of
Washington.
Information Regarding the Board of Directors and its Committees
In October 1997, the Board of Directors established an Audit Committee. The
Audit Committee's functions include reviewing the Company's internal controls
and recommending to the Board of Directors the engagement of the Company's
independent accountants, reviewing with such accountants a plan for and the
results of their examination of the Company's financial statements and
determining the independence of such accountants. The members of the Audit
Committee during 1997 and the first half of 1998 were Messrs. Nelson and
Wollach. The Audit Committee met twice in 1997. Effective on August 19, 1998,
the Audit Committee was reconstituted to be comprised of Messrs. Nelson, Wardall
and Wollach.
In October 1997, the Board of Directors established a Compensation
Committee. The Compensation Committee's functions include making recommendations
regarding the Company's employee stock option plan and decisions concerning
salaries and incentive compensation for employees and consultants of Company.
The members
37
<PAGE>
of the Compensation Committee during 1997 and the first half of 1998
were Messrs. Wollach and John Guarino. The Compensation Committee met three
times in 1997. Effective on August 19, 1998, the Compensation Committee was
reconstituted to be comprised of Messrs. Nelson, Wardall and Wollach.
During 1997, the Company's Board of Directors met eight times. Each
director attended at least 75% of the total number of meetings of the Board of
Directors and committees on which he was eligible to attend.
Compensation of Directors
During 1998, Company directors were compensated for their service on the
Company's Board of Directors and any committees on which they served. The
Company's non-employee directors, Brent Nelson and Thad E. Wardall, each
received a one-time grant of stock options to purchase 25,000 shares of Common
Stock and were eligible to receive additional options to purchase 5,000 shares
of Common Stock for each Board meeting attended, up to a total of 50,000 shares
each. Steve Wollach received a one-time grant of stock options to purchase
50,000 shares of Common Stock and was eligible to receive additional options to
purchase 10,000 shares of Common Stock for each Board meeting attended, up to a
total of 100,000 shares. Ryan Smith and John Guarino, as employee directors,
each received a one-time grant of stock options to purchase 12,500 shares of
Common Stock and were eligible to receive additional options to purchase 2,500
shares of Common Stock for each Board meeting attended, up to a total of 25,000
shares each. Each of the Company's directors received the maximum number of
stock options that such director was eligible to receive. All of such options
vest one year from the date of grant.
In addition, during 1998, each member of the Compensation Committee
received options to purchase up to 5,000 shares (for non-employee directors) and
1,000 shares (for employee directors) for each committee meeting attended. Each
member of the Audit Committee received options to purchase up to 15,000 shares
(for non-employee directors) and 5,000 shares (for employee directors) for each
committee meeting attended.
Effective on August 19, 1998, the Board of Directors adopted a new
compensation policy for the directors. Under the new policy, each director of
the Company in office on such date and immediately following each annual
shareholders' meeting thereafter will receive an annual grant of stock options
to purchase 25,000 shares of Common Stock, at an exercise price equal to the
closing trade price on the date of grant. The stock options will vest 100% on
the one-year anniversary of the date of grant, provided that such director has
attended at least 75% of all meetings of the Board of Directors during such
period. In addition, each member of the Audit Committee and the Compensation
Committee will receive an annual grant of stock options to purchase 5,000 shares
of Common Stock, at an exercise price equal to the closing trade price on the
date of grant, which options will vest 100% on the one-year anniversary of the
date of grant.
ITEM 10. EXECUTIVE COMPENSATION
Summary Compensation Table. The following table sets forth all
compensation paid to or earned by persons who served as the Company's Chief
Executive Officer during the fiscal year ended December 31, 1998 (the "Named
Executive Officers"). No other executive officer of the Company received
compensation in salary and bonus in excess of $100,000 during 1998.
<TABLE>
<CAPTION>
Annual Compensation
Name and Principal Position Year Salary Bonus
------- -----
<S> <C> <C> <C>
Steven G. Wollach (1)....................... 1998 $117,500 $17,500
President and Chief Financial Officer 1997 15,385 --
Ryan Smith (2).............................. 1998 -- --
Former Chief Executive Officer 1997 $ 25,961 --
</TABLE>
(1) Mr. Wollach was appointed by the Board of Directors on October 27, 1998 to
serve as the Company's President to replace Ryan Smith who resigned from
his positions as Chief Executive Officer and Director in early October
1998.
(2) Mr. Smith resigned from his positions as Chief Executive Officer and
Director in October 1998.
38
<PAGE>
Option Grant Table. The following table sets forth grants of stock options
to each of the Named Executive Officers during fiscal 1998 pursuant to the
Company's 1998 Stock Option Plan.
<TABLE>
<CAPTION>
Number of Shares Percent of Total
Underlying Options Granted
Options Granted to Employees in Exercise Price
Name (#) Fiscal Year (1) Expiration Date
<S> <C> <C> <C> <C>
Steven G. Wollach........... 60,000 (2) 2.2% $1.41 01/01/08
140,000 (3) 5.2 1.41 01/01/08
97,500 (4) 3.5 1.41 01/01/08
5,000 (4) 0.2 1.41 05/22/08
10,000 (4) 0.4 1.41 08/19/08
25,000 (5) 0.9 1.41 08/19/08
200,000 (2) 7.4 1.41 11/01/08
200,000 (3) 7.4 1.41 11/01/08
Ryan Smith (6).............. 12,500 (4) 0.5% $2.31 01/01/08 (6)
2,500 (4) 0.1 2.37 01/01/08 (6)
2,500 (4) 0.1 2.13 01/01/08 (6)
2,500 (4) 0.1 2.75 01/01/08 (6)
2,500 (4) 0.1 1.88 01/01/08 (6)
2,500 (4) 0.1 2.47 01/01/08 (6)
25,000 (5) 0.9 3.44 11/01/08 (6)
</TABLE>
(1) On November 4, 1998, all stock options held by then-current officers,
directors and employees were repriced to the closing trading price of the
Common Stock on the OTC Bulletin Board on such date.
(2) Consists of options granted under Mr. Wollach's employment agreement, which
were fully vested as of the date of grant.
(3) Consists of options granted under Mr. Wollach's employment agreement, which
vest monthly over two years beginning November 1, 1998.
(4) Consists of options granted to the Named Executive Officer for his service
on the Board of Directors and any committee, which vest 100% on the one-
year anniversary of the Board or committee meeting which he attended.
(5) Consists of options granted to the Named Executive Officer for his service
on the Company's Board of Directors, which vest 100% on the one-year
anniversary if the Named Executive Officer attends at least 75 percent of
the Board meetings during the year.
(6) Mr. Smith resigned from his positions as an officer and director of the
Company in October 1998. All of his stock options expired without being
exercised 90 days from the date of termination, in accordance with the
terms of the Company's stock option plan.
Aggregated Option Exercises and Fiscal Year-End Option Values. The
following table sets forth information concerning the fiscal year-end value of
unexercised options held by each of the Named Executive Officers at December 31,
1998. None of the Named Executive Officers exercised any stock options in
fiscal 1998.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised Options In-the-Money Options
at Fiscal Year-End at Fiscal Year-End
Name Exercisable Unexercisable Exercisable Unexercisable
<S> <C> <C> <C> <C>
Steven G. Wollach........... 369,166 368,333 $11,444 $11,418
Ryan Smith (1).............. -- -- -- --
</TABLE>
39
<PAGE>
(1) Mr. Smith resigned from his positions as an officer and director of the
Company in October 1998. All of his stock options expired without being
exercised 90 days from the date of termination, in accordance with the
terms of the Company's stock option plan.
Employment Contracts. Effective November 1, 1998, the Company entered into
a new employment agreement with Mr. Wollach to serve as President and Chief
Financial Officer of the Company. The employment agreement runs through December
31, 1999 and provides for an annual base salary to Mr. Wollach of $135,000,
subject to annual adjustment by the Board of Directors, together with an annual
discretionary bonus as determined by the Board. The agreement also provides for
performance-based bonus compensation Mr. Wollach of up to a total of $135,000
during calendar year 1999, based on the following performance criteria: listing
of the Common Stock on The Nasdaq SmallCap Market ($25,000 bonus); effectiveness
of the registration statement on Form SB-2 ($15,000); satisfaction of Company
quarterly financial goals as set in advance by the Board of Directors ($5,000
bonus per quarter, up to aggregate of $20,000); satisfaction of Company yearly
financial goals as set in advance by the Board of Directors ($5,000 bonus);
closing of any acquisition by the Company, by purchase, merger or otherwise, of
on-going businesses, intellectual property, software or other assets, which
acquisition is accounted for using the purchase or pooling method of accounting
($40,000 bonus per acquisition); and closing trade price of the Common Stock as
reported on the OTC Bulletin Board greater than or equal to $4.00 (one-time
$25,000 bonus). Upon termination of the employment agreement by the Company
without cause (as defined in the agreement), Mr. Wollach shall be entitled to
severance payments equal to the product of his then-current base salary
multiplied by a fraction, the numerator of which is the number of partial and
complete calendar quarters between his original date of hire (September 1997)
and the date of termination (up to a maximum of 12), and the denominator of
which shall be 12. However, in the event of a change of control, Mr. Wollach's
amount of severance will be as determined by the Board, and at least equal to
his total salary and bonuses during the prior 12 months.
Mr. Wollach's employment agreement also provides for a grant of additional
stock options to purchase up to 400,000 shares of Common Stock, of which options
for 200,000 shares are immediately vested and options for 200,000 shares vest
monthly over a period of two years from the date of the employment agreement.
The employment agreement also amended Mr. Wollach's prior stock option grant of
200,000 shares to provide that options for 60,000 shares would be immediately
vested and options for 140,000 shares vest monthly over a period of two years
from the date of the employment agreement. All of Mr. Wollach's options
accelerate and become fully vested in the event of a merger, sale of
substantially all of the Company's assets, reorganization, liquidation or change
of control of the Company. All such stock options are exercisable at an exercise
price of $1.406, the price at which outstanding Company options were repriced as
of November 4, 1998.
In addition, the Company has entered into employment agreements with
Messrs. Jackson and Western, effective January 1, 1998 and October 12, 1998,
respectively. Each of the employment agreements is for a term of one year and
provides for an annual base salary to each of Messrs. Jackson and Western of
$100,000 and $100,000, respectively, subject to annual adjustment by the Board
of Directors, together with an annual discretionary bonus to be determined by
the Board of Directors. In addition, Mr. Western received a signing bonus in the
form of stock options to purchase up to 10,000 shares of Common Stock pursuant
to the Company's 1998 Stock Option Plan, which options vest 90 days from his
date of hire. Mr. Western also received stock options to purchase up to an
additional 100,000 shares of Common Stock which options vest annually over four
years. All such options are exercisable at an exercise price of $1.093, the fair
market value of the Common Stock on the date of hire. The foregoing employment
agreements with Messrs. Jackson and Western also provide for severance payments
to such executive officers upon the termination of employment by the Company
without cause. The amount of severance payments will be equal to two months'
salary for Mr. Jackson and two weeks' salary for Mr. Western.
Additionally, pursuant to a non-competition agreement with the Company,
each of such executive officers has agreed not to compete with the Company for a
period of 12 months following the qualified termination of his employment, as
defined in his respective employment agreement. The Company, at its option, may
extend the non-compete period for an additional 12 months provided the Company
pays the employee an amount equal to 50% of the highest base salary rate the
Company paid him in the last year of employment.
40
<PAGE>
In addition, in October 1997 the Company's Board of Directors adopted an
executive compensation policy for certain of its executive officers. This policy
provides for incentive-based equity compensation to the Company's executive
officers based on the Company's performance and its achieving certain financial
targets established by the Board of Directors for each fiscal year. Under the
policy, if the Company meets between 50 and 100 percent of its financial targets
for the fiscal year, the executive officers entitled to participate in the
policy, as determined by the Board of Directors, will receive stock options
under the Company's 1998 Stock Option Plan to purchase such number of shares of
Common Stock as determined by the Board of Directors. If the Company fails to
meet at least 50 percent of its financial targets, no additional equity
compensation will be paid. Eligible executive officers who serve less than the
full year may be entitled to receive their pro rata portion of any equity
compensation payable under the policy. For fiscal year 1998, the Company does
not expect to pay any equity compensation to its officers under its executive
compensation policy.
In January 1999, the Board of Directors adopted a new executive bonus plan
for fiscal year 1999. The purpose of the plan is to provide incentive equity
compensation to the Company's executive management team and other employees
based on the Company meeting certain financial performance goals as set by the
Board. Satisfaction of the financial performance goals will be determined upon
review of the Company's audited financial statements for 1999. The plan provides
for the grant of stock options to purchase up to 1,500,000 shares of Common
Stock, of which options for up to 750,000 shares will be available to the
management team and options for up to 750,000 shares will be available for other
Company employees. Options under the plan may be granted upon satisfaction of
the financial goals and at the then fair market value of the Common Stock and at
such vesting schedules as set by the Board.
1998 Stock Option Plan
On April 15, 1998, the Company's shareholders approved the 1998 Stock
Option Plan (the "Option Plan") as adopted by the Board of Directors on January
1, 1998. The purpose of the Option Plan is to promote the success of the
Company's business by attracting the best available personnel for positions of
substantial responsibility, and to provide an incentive to officers, directors,
employees, consultants and advisors of the Company. The Option Plan provides for
the granting of both incentive stock options (stock options that are intended to
qualify for favorable tax treatment under Section 422) and nonqualified stock
options. The Option Plan is not qualified under Section 401(a) of the Code and
is not subject to the Employee Retirement Income Security Act of 1974. The
Company has reserved a total of 2,000,000 shares of Common Stock for issuance
under the Option Plan. As of March 23, 1999, the Company had awarded options to
purchase an aggregate of 1,648,750 shares of Common Stock, which options are
exercisable at a weighted average exercise price of approximately $1.40 per
share. On November 4, 1998, the Company repriced all outstanding stock options
held by current employees and directors to a price of $1.406, representing the
last trade price of the Common Stock on the OTC Bulletin Board on such date. In
addition, as a result of the restructuring in November 1998 in which the Company
reduced its employee base from 23 to 13 employees and the resignations of
Messrs. Smith and Guarino as officers of the Company, options for 50,375 shares
terminate if not exercised within 90 days after the date of the restructuring.
The Option Plan is administered by the Board of Directors which has full
power and authority to administer and interpret the Plan and to adopt such rules
and agreements for the administration of the Option Plan as the Board of
Directors deems necessary or advisable.
The Board of Directors selects the participants to receive stock options
and determines the number of shares, the type of option and the exercise price
as well as the time or times at which options may be exercised and other terms
and conditions. For incentive stock options, the exercise price may not be less
than the fair market value of the Common Stock on the date of grant. For
nonqualified stock options, the exercise price may be less than the fair market
value of the Common Stock on the date of grant. In no case, however, may options
(whether incentive stock options or nonqualified stock options) be granted under
the Option Plan at an exercise price which is less than the initial public
offering price of the shares of Common Stock offered hereby. In the event of
stock dividends, stock splits and similar capital changes, the Option Plan
provides for appropriate adjustments in the number of shares available for
options and the number of shares subject to and exercise prices of outstanding
options.
The term of each option granted under the Option Plan may be no more than
ten years from the date of grant. Options granted to employees expire 90 days
following termination of employment (but in no event later than
41
<PAGE>
the date of expiration of the option), except in the case of permanent
disability or death. In the case of termination of employment due to permanent
disability or death, the option terminates one year from the date that the
employee ceases work as a result of disability or death (but in no event later
than the date of expiration of such option). The Board of Directors has the
authority to extend the expiration dates of any outstanding option in
circumstances it deems appropriate, provided that it may not extend an option
beyond the original term of such option.
The exercise price of options is generally payable in cash. For
nonqualified options, the option holder must also pay to the Company, at the
time of purchase, the amount of federal, state, and local withholding taxes
required to be withheld by the Company. Under certain limited circumstances,
shares of Common Stock may be used for payment of the exercise price or
satisfaction of withholding obligations.
Notwithstanding any vesting requirements of an option, in the event of a
merger, reorganization, sale of substantially all of the assets of the Company,
change of control of the Company, liquidation, dissolution or other corporate
transaction wherein the Company is not the surviving corporation, an option
holder typically has the right to immediately exercise all of his or her
options, whether vested or unvested.
The options are assignable only (i) by will or by the laws of descent and
distribution or (ii) in the case of a nonqualified stock option, by gift to
immediate family members of the optionee, to partnerships of which the only
partners are members of the optionee's immediate family and trusts established
solely for the benefit of such immediate family members.
The Option Plan may be modified, amended or terminated by the Board of
Directors except with respect to options granted prior to such action.
Notwithstanding the foregoing, shareholder approval is required for any
amendment which increases the number of shares subject to the Option Plan (other
than in connection with the anti-dilution provisions described above or the
assumption or substitution of options in connection with certain mergers and
other similar events. The Board of Directors may delegate its power and
authority with respect to the Option Plan to a committee thereof.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the ownership
of the Company's Common Stock as of March 23, 1999 by: (i) each director, (ii)
the Company's current President and its former Chief Executive Officer, (iii)
all directors and executive officers of the Company as a group, and (iv) each
person who is known by the Company to beneficially own more than 5% of the
Common Stock. The information includes options exercisable by the respective
person within 60 days of March 23, 1999 (the "Vested Options"). Except as
otherwise noted, the address of each such person is c/o Interactive Objects,
Inc., 17720 NE 65th, Suite 202, Redmond, WA 98052.
<TABLE>
<CAPTION>
Shares of Common Stock
Beneficially Owned (1)
Number Percent
Beneficial Owner Of Shares of Total (2)
<S> <C> <C>
Ryan Smith (3).......................................................... 1,680,800 11.4%
1020 W. Lake Sammamish Parkway N.E.
Bellevue, WA 98008
Jay R. Paulson.......................................................... 1,600,000 10.9
1839 280th Ave. N.E.
Carnation, WA 98014
John J. Guarino (4)..................................................... 1,200,000 8.2
15515 184th Pl. N.E.
Woodinville, WA 98072
Thad E. Wardall (5)..................................................... 3,783,407 25.6
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Brent Nelson (6)........................................................ 3,245,800 22.0
Steve Wollach (7)....................................................... 3,019,966 20.0
All executive officers and directors as a group (seven persons) (8)..... 5,608,823 36.6%
</TABLE>
(1) This table is based on information supplied by executive officers, directors
and shareholders. Subject to applicable community property laws, each
shareholder named in the table has sole voting and investment power with
respect to the shares set forth opposite such shareholder's name.
(2) Based on 14,708,927 shares of Common Stock issued and outstanding as of
March 23, 1999.
(3) All of Mr. Smith's shares are subject to the terms of that certain
settlement agreement between him and the Company, dated March 4, 1999. See
"CERTAIN TRANSACTIONS."
(4) Includes 900,000 shares held by Mr. Guarino that are subject to the terms of
that certain settlement agreement between him and the Company, dated March
4, 1999. See "CERTAIN TRANSACTIONS."
(5) Includes an aggregate of 2,580,800 shares for which Mr. Wardall has the
right to vote, pursuant to the terms of the Company's settlement agreements
with each of Messrs. Smith and Guarino. Mr. Wardall disclaims beneficial
ownership over all such shares. See "CERTAIN TRANSACTIONS." Also includes
50,000 shares of Common Stock subject to Vested Options held by Mr. Wardall.
(6) Includes an aggregate of 2,580,800 shares for which Mr. Nelson has the right
to vote, pursuant to the terms of the Company's settlement agreements with
each of Messrs. Smith and Guarino. Mr. Nelson disclaims beneficial
ownership over all such shares. See "CERTAIN TRANSACTIONS." Also includes
65,000 shares of Common Stock subject to Vested Options held by Mr. Nelson,
and 600,000 shares of Common Stock held of record by Northwest Capital
Partners, L.L.C. for which Mr. Nelson serves as president and managing
partner; Mr. Nelson disclaims beneficial ownership over all of such except
to the extent of his pecuniary interest therein. See "CERTAIN TRANSACTIONS."
(7) Includes an aggregate of 2,580,800 shares for which Mr. Wollach has the
right to vote, pursuant to the terms of the Company's settlement agreements
with each of Messrs. Smith and Guarino. Mr. Wollach disclaims beneficial
ownership over all such shares. Also includes 414,166 shares of Common
Stock subject to Vested Options held by Mr. Wollach.
(8) Consists of Messrs. Wollach, Nelson, Wardall, Western, Phillips, and Jackson
and Ms. Byrd. See "MANAGEMENT." Includes an aggregate of 2,580,800 shares
for which each of Messrs. Wardall, Nelson and Wollach has the right to vote,
pursuant to the terms of the Company's settlement agreements with each of
Messrs. Smith and Guarino; over all of which shares Messrs. Wardall, Nelson
and Wollach disclaim beneficial ownership. Also includes 610,416 shares of
Common Stock subject to Vested Options held by the executive officers and
directors as a group.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On July 11, 1997, the Company entered into a three-year consulting
agreement with Northwest Capital Partners, L.L.C. to serve as the Company's
financial advisor. Brent Nelson, a director and shareholder of the Company, also
serves as president and managing partner of Northwest Capital. Pursuant to the
terms of the consulting agreement, the Company is obligated to pay Northwest
Capital a fee of $5,000 per month for 36 months from December 31, 1997, in
consideration for Northwest Capital's efforts and assistance in raising capital
for the Company. This monthly fee was decreased by mutual agreement of the
parties to $3,000 beginning November 1, 1998. Under the agreement, the Company
issued 1,200,000 shares of Common Stock to Northwest Capital in consideration
for its assistance with the Neoteric Acquisition and other financings for the
Company. In addition, for the three-year period from September 10, 1997, the
Company granted to Northwest Capital certain rights of first
43
<PAGE>
refusal on any offering of Company securities by the Company involving more than
1,000 shares of stock. Under the terms of the consulting agreement, Northwest
Capital also has the right for a period of five years to nominate one director
for election to the Company's Board of Directors, and its director nominee is
Brent Nelson. In addition, for a three-year period following the term of the
consulting agreement, the Company has granted to Northwest Capital a right of
first refusal to act as financial advisor to the Company.
On September 23, 1996, Neoteric Media entered into an asset purchase
agreement with Steve Jackson, an officer and shareholder of the Company for the
purchase of a software application developed by Mr. Jackson in consideration for
$67,500 in cash, a promissory note for $62,500 and 80,000 shares of common stock
of Neoteric Media (which shares represented 640,000 shares of common stock
following the Neoteric Acquisition). The promissory note was subsequently paid
in full in accordance with its terms. Neoteric Media also entered into a one-
year employment agreement with Mr. Jackson effective on September 23, 1996 that
provided for compensation based on a percentage of sales of the software
application. That employment agreement expired by its terms and the Company has
subsequently entered into a new employment agreement with Mr. Jackson effective
January 1, 1998. See "MANAGEMENT--Executive Compensation and Other Information--
Employment Contracts."
On September 23, 1996, Thad E. Wardall, a director and shareholder of the
Company, loaned $125,000 to Neoteric Media to fund the acquisition of the
software application developed by Mr. Jackson. The loan was evidenced by a
promissory note, secured by a lien on certain of the Company's assets.
Subsequently, on August 25, 1997, the Company entered into a note exchange
agreement with Mr. Wardall for the exchange of the prior promissory note for a
new convertible promissory note in principal amount of $73,194 (the "Wardall
Note"). On October 7, 1997, Mr. Wardall exercised his option to convert all
outstanding principal and accrued interest on the Wardall Note into 112,607
shares of Common Stock (at a conversion rate of $0.65 per share) and the
security interest terminated.
In October 1998, Ryan Smith, the Company's former Chief Executive Officer
and Chairman of the Board, and John Guarino, the Company's former Senior Vice
President and a Director, resigned from their respective positions as officers
and directors of the Company. Effective in March 1999, the Company entered into
settlement agreements with each of Messrs. Smith and Guarino releasing the
Company from all matters arising out of their prior employment with the Company.
Pursuant to the terms of the settlement agreements, each of Messrs. Smith and
Guarino has granted to the Company transferable rights to purchase up to
1,680,800 shares and 900,000 shares, respectively, currently held by such
shareholders at a purchase price of $.50 per share. As part of the settlement,
the Company irrevocably agreed to purchase, of such total shares, 550,000 shares
held by Mr. Smith and 400,000 shares held by Mr. Guarino, requiring cash
payments by the Company to Messrs. Smith and Guarino of $275,000 and $200,000
within 20 days of the effective date of the settlement. The remaining shares
subject to the Company's option rights have been placed in an escrow, and may be
released upon exercise of the options or upon expiration of the option periods
with respect thereto. Commencing on October 15, 1999, and for every three
months thereafter, up to 20% of the remaining shares will be released from the
escrow. Pursuant to the terms of the settlement agreements, each of Messrs.
Smith and Guarino have granted an irrevocable proxy to each of the Company's
three directors, Messrs. Wollach, Nelson and Wardall, to vote the shares while
held in the escrow. In addition, each of Messrs. Smith and Guarino have also
agreed to certain contractual restrictions on their ability to sell shares of
Company stock while the escrow is in effect.
The Company is currently in negotiations and expects to enter into
mediation and/or arbitration with Jay Paulson, a former officer and significant
shareholder of the Company, in connection with certain severance and other
matters arising out of his employment with the Company. In addition, the Company
has been served with a complaint filed by Mr. Paulson in King County Superior
Court in the State of Washington on November 18, 1998 (case no. 98-2-27751-1SEA)
for declaratory and injunctive relief and unspecified damages in connection with
a requested transfer of restricted securities held by Mr. Paulson. The Company
believes it has taken appropriate action and intends to vigorously defend this
lawsuit.
Except as described above, there have not been, nor is there currently
proposed, any transaction or series of similar transactions to which the Company
was or is to be a party in which the amount involved exceeds $60,000 and in
which any director, executive officer or holder of more than 5% of the Common
Stock of the Company had or will have a direct or indirect material interest.
44
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------------ ---------------------------------------------------------------------------------------------
<C> <S>
2.1 * Acquisition Agreement between Asia Pacific Chemical Engineering Corp. and Neoteric Media,
Inc., dated August 27, 1997
3.1 * Articles of Incorporation filed April 14, 1998
3.2 * Articles of Merger filed April 16, 1998, for reincorporation of Interactive Objects, Inc.
in the State of Washington
3.3 * Bylaws
4.1 * Specimen Common Stock Certificate
4.2 * Form of Common Stock Purchase Warrant
4.2 * Form of Common Stock Purchase Warrant
10.1 * 1998 Stock Option Plan
10.2 * Seattle Office Sublease Agreement between Interactive Objects, Inc. and Intermind
Corporation, dated December 30, 1997
10.2A * Olympic Tower Master Office Lease Agreement between Duchess Properties Ltd. and Intermind
Corporation, dated August 29, 1995, as amended September 1, 1996, and as amended
February 1, 1997
10.3 * Consulting Agreement between Interactive Objects, Inc. and Northwest Capital Partners,
L.L.C., dated July 11, 1997
10.3A * First Amendment to Consulting Agreement, dated August 25, 1998
10.4 * Employment Agreement with Steven G. Wollach, dated November 1, 1998
10.5 * Employment Agreement with Dale Western, dated October 12, 1998
10.6 * Employment Agreement with Steve Jackson, dated January 1, 1998
10.7 ** Settlement Agreement with Ryan Smith, dated March 4, 1999
10.8 ** Settlement Agreement with John Guarino, dated March 4, 1999
27.1 Financial Data Schedule
</TABLE>
* Incorporated herein by reference from the exhibits filed as part of
Registrant's Form SB-2 (file no. 333-62345).
** Incorporated herein by reference from Form 8-K filed on March 24, 1999.
(b) No reports on Form 8-K were filed during the last quarter of the fiscal
year ended December 31, 1998.
45
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized on March 26, 1999.
INTERACTIVE OBJECTS, INC.
By: /s/ Steven G. Wollach
----------------------
Steven G. Wollach, President
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities
indicated on March 26, 1999.
/s/ Steven G. Wollach
----------------------
Steven G. Wollach
President, Chief Financial Officer and
Director (principal executive,
financial and accounting officer)
/s/ Brent Nelson
-----------------
Brent Nelson
Director
/s/ Thad E. Wardall
--------------------
Thad E. Wardall
Director
46
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE FOLLOWING SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION AS OF DECEMBER 31,
1998 THAT HAS BEEN EXTRACTED FROM THE AUDITED FINANCIAL STATEMENTS OF
INTERACTIVE OBJECTS, INC. (THE "COMPANY") AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS. THE COMPANY'S FINANCIAL STATEMENTS AS OF
DECEMBER 31, 1998 HAVE BEEN AUDITED BY PETERSON SULLIVAN, P.L.L.C., INDEPENDENT
AUDITORS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,298,278
<SECURITIES> 106,145
<RECEIVABLES> 14,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 3,565,854
<PP&E> 311,208
<DEPRECIATION> 84,610
<TOTAL-ASSETS> 3,799,386
<CURRENT-LIABILITIES> 340,490
<BONDS> 0
0
0
<COMMON> 147,089
<OTHER-SE> 3,311,807
<TOTAL-LIABILITY-AND-EQUITY> 3,799,386
<SALES> 2,122,846
<TOTAL-REVENUES> 2,122,846
<CGS> 6,384,745
<TOTAL-COSTS> 6,384,745
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 16,118
<INCOME-PRETAX> (4,145,514)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,145,514)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,145,514)
<EPS-PRIMARY> (0.30)
<EPS-DILUTED> (0.30)
</TABLE>
