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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (Fee required)
For the fiscal year ended October 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No fee required)
For the transition period from ______ to _______
Commission File No. 0-25668
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
(Name of Small Business Issuer in Its Charter)
DELAWARE 11-3197148
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
4041 N. CENTRAL AVENUE
PHOENIX, ARIZONA 85012
(Address of Principal Executive Offices)
(602) 200-8900
(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
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Title of Each Class Name of Each Exchange on Which Registered
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Class A Common Stock, $0.01 par value per share Nasdaq National Market
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Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No__
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
The Issuer's revenues for the fiscal year ended October 31, 1997 were
$11,100,709.
The aggregate market value of the voting stock held by non-affiliates
of the Registrant on January 20, 1998 was approximately $23,800,000, based on
the closing sales price of the Class A Common Stock on such date as reported by
the Nasdaq National Market.
The number of shares outstanding of each of the Issuer's classes of
common equity, as of January 20, 1998 was: 18,377,737 shares of Class A Common
Stock, $0.01 par value, and 3,733,334 shares of Class B Common Stock, $0.01 par
value.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Definitive Proxy Statement relating to the
Registrant's 1998 Annual Meeting of Stockholders, to be filed by the Registrant
with the Securities and Exchange Commission on or before February 28, 1998, is
hereby incorporated by reference into Part III of this Annual Report on Form
10-KSB. Transitional Small Business Disclosure Format:
Yes __ No X
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INTERACTIVE FLIGHT TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-KSB
TABLE OF CONTENTS
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PART I ......................................................................................................... 1
ITEM 1 -- Description of Business.................................................................... 1
The Company................................................................................... 1
Business Background........................................................................... 2
Strategic Alliance with Hyatt Group........................................................... 3
Merrill Lynch................................................................................. 3
The Entertainment Network..................................................................... 3
General ............................................................................ 3
Entertainment Options................................................................ 4
Technological Aspects of the Entertainment Network................................... 6
Airline Contracts............................................................................. 7
Sales and Marketing........................................................................... 9
Product Development........................................................................... 10
Competition................................................................................... 10
Intellectual Property and Proprietary Rights.................................................. 11
Customer Maintenance and Support.............................................................. 12
Manufacturing, Assembly and Installation...................................................... 12
Government Regulation......................................................................... 13
Employees..................................................................................... 15
ITEM 2 -- Description of Property.................................................................... 15
ITEM 3 -- Legal Proceedings.......................................................................... 15
ITEM 4 -- Submission of Matters to a Vote of Security Holders........................................ 15
PART II......................................................................................................... 16
ITEM 5 -- Market for Common Equity and Related Stockholder Matters................................... 16
ITEM 6 -- Management's Discussion and Analysis of Financial Condition and Results of Operations...... 17
General ..................................................................................... 17
Existing Installations........................................................................ 18
Results of Operations......................................................................... 20
Liquidity and Capital Resources............................................................... 22
Inflation..................................................................................... 23
New Accounting Standard....................................................................... 23
Accounting Standards Not Yet Adopted By the Company........................................... 23
Forward-Looking Information................................................................... 24
ITEM 7 -- Financial Statements....................................................................... 25
ITEM 8 -- Changes In and Disagreements With Accountants on Accounting and Financial Disclosure....... 25
PART III........................................................................................................ 26
ITEMS 9 -- 12 -- Documents Incorporated by Reference.................................................. 26
ITEM 13 -- Exhibits and Reports on Form 8-K.......................................................... 26
SIGNATURES...................................................................................................... 29
FINANCIAL STATEMENTS............................................................................................F-1
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PART I
ITEM 1 -- DESCRIPTION OF BUSINESS
THE COMPANY
Interactive Flight Technologies, Inc. (the "Company") has been engaged
in the development, assembly, installation and operation of a computer-based
in-flight entertainment network (the "Entertainment Network" or the "IFEN-2").
The Entertainment Network provides aircraft passengers the opportunity to view
movies, to play computer games and, in certain cases where permitted by
applicable law, to gamble through an in-seat video touch screen. The IFEN-2
system can also support interactive advertising and shopping once arrangements
are made with advertisers and vendors and once programming for particular
products is created. See "-- The Entertainment Network."
To date, the Company has entered into contracts with three airlines for
the sale and operation of the Entertainment Network:
(i) an agreement with Swissair VKB ("Swissair") to sell to
Swissair nineteen IFEN-2 Entertainment Networks and to install
these systems on Swissair MD-11 and B-747 aircraft.
Originally, the Entertainment Networks were to be installed
throughout the entire aircraft cabin on Swissair aircraft and
the purchase price was to be paid over time out of revenues
from passenger use. However when revenues from passenger use
proved to be insufficient to pay the purchase price, the
Company exercised its right to renegotiate the contract. The
Company ultimately agreed in October of 1997 to install the
Entertainment Network in the entire aircraft cabin on two
Swissair MD-11 aircraft and one B-747 aircraft and in the
first and business class sections of sixteen additional
aircraft for a purchase price of approximately $27 million,
payable in cash. The agreement requires the Company to deliver
enhanced software as a part of the original purchase price.
The Company is currently developing this software; however,
there can be no assurance that the software will be developed
on time or within the original budget.
(ii) an agreement with Debonair Airlines ("Debonair") to install
and operate Entertainment Networks on six Debonair RJ-146
aircraft, with the purchase price to be paid over time from
revenues out of passenger use. In August 1997, the Company
completed the installation of an Entertainment Network on one
Debonair RJ-146 aircraft. In October 1997, the Company
notified Debonair that the revenues being generated by the
Entertainment Network were insufficient to justify continued
operation of the Entertainment Network and further
installations. Accordingly, the Company does not plan to
install the five remaining systems and has stopped supporting
the first installed Entertainment Network.
(iii) an agreement with Alitalia Airlines S.p.A. ("Alitalia") to
sell to Alitalia five first generation Entertainment Networks
and to operate these systems on Alitalia MD-11 aircraft.
Alitalia purchased and paid cash for four systems. The fifth
system was never installed nor paid for by Alitalia.
The Company is continuing to market the Entertainment Network to
additional airlines
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(primarily international carriers who operate wide body aircraft) on a limited
basis. The Company had prolonged discussions with Qantas Airways Limited
("Qantas") during 1996 and 1997; however, Qantas ultimately did not choose the
Entertainment Network for installation on Qantas wide-body aircraft. Based on
recent industry reports, the Company believes that Qantas will ultimately choose
an interactive in-flight system from a competitor. In addition, the Company was
unable to negotiate a definitive agreement with Privitair S.A. ("Privitair") who
had previously executed a non-binding letter of intent. There can be no
assurance that the Company will ever successfully negotiate definitive
agreements with other airlines for the sale of the Entertainment Network. The
Company believes that the market for multi-functional high technology in-flight
entertainment systems is currently very weak. Airline passenger load factors are
currently at higher levels than in the past and accordingly, airlines are
focusing capital expenditures on additional capacity rather than additional
passenger amenities such as those offered by the Entertainment Network. In
addition, the recent acquisition of Hughes-Avicom by Rockwell-Collins represents
the entry of a significantly larger competitor with established avionics
expertise into the in-flight entertainment market.
The Company believes that in the absence of orders from additional
airlines, it will need to redirect some or all of its efforts into other
business areas. The Company has not identified any specific areas for
alternative business development. Initial efforts at locating alternative
business development have not resulted in any definitive opportunities. There
can be no assurance that the Company will find acceptable opportunities for
alternative business development or that the Company will be successful in
entering or operating in alternative business areas. Moreover, the amount of
cash that the Company will have, if any, to use in any new business will depend
on the Company's ability to complete its current contractual commitments,
including warranties, in an efficient manner.
Since commencement of operations, the Company has developed and
licensed a catalogue of proprietary technology and know-how relating to the
Entertainment Network and its related systems. In addition, the Company has a
license for technology from FortuNet, Inc. ("FortuNet"), a gaming equipment
manufacturer that distributes video gaming networks to casinos and other gaming
establishments. The Chief Executive Officer of the Company, who is also a
director and principal stockholder of the Company, is a former employee of
FortuNet and was a substantial contributor to the development of the technology
licensed from FortuNet. See "-- Intellectual Property and Proprietary Rights."
The Company was incorporated in Delaware in August 1994 and is the
successor by merger to In-Flight Entertainment Services Corp., a New York
corporation incorporated in February 1994. The Company completed an initial
public offering of its securities in March 1995. Unless the context requires or
as otherwise indicated, all references to the "Company" include the predecessor
company. The Company's principal executive offices are located at 4041 N.
Central Avenue, Suite 2000, Phoenix, Arizona 85012, and its telephone number is
(602) 200-8900.
BUSINESS BACKGROUND
The potential market for in-flight entertainment networks developed as
the number and length of long-haul flights has increased, as passengers on these
flights seek additional and more sophisticated entertainment options and as
airlines compete for passengers. Several domestic and international airlines
have installed or are in the process of installing video displays that allow
passengers to view movies of their choice, with several movies to choose from.
However, since movies are traditionally provided free of charge to first-class
and business-class passengers, and the potential revenue source available from
interactive services, including secure casino gaming,
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pay-per-view movies, advertising, and shopping channels are still unproven,
airlines must currently justify purchases on increasing passenger satisfaction.
The airline industry as a whole has been experiencing record high passenger load
factors during recent times. As a result, airlines must consider whether to make
capital investments for additional aircraft or to make capital investments in
passenger amenity features such as in-flight entertainment. It has been widely
reported that the airline industry is making significant investments in
additional aircraft. This may possibly have a negative effect on the in-flight
entertainment industry as airlines determine capital expenditure priorities.
Moreover, it has been reported that certain in-flight entertainment systems
installed in aircraft by other entities have not proven reliable. In addition,
the experience of Swissair and the Company to date indicates that the revenue
generating ability of in-flight entertainment equipment, especially from secure
casino gaming, is not sufficient to provide a compelling case for the purchase
of in-flight entertainment equipment. The Company believes that its
Entertainment Network combines improved hardware, software and communications
technologies to meet the requirements of passengers for additional in-flight
entertainment options; however, it is unclear whether airlines will purchase
systems that satisfy passenger desires while passenger load factors remain at
historically high levels.
STRATEGIC ALLIANCE WITH HYATT GROUP
In November 1996, the Company executed a Strategic Alliance Agreement
("Alliance Agreement") to form a strategic alliance with Hyatt Ventures, Inc.
("Hyatt"), an affiliate of Hyatt Corporation. Under the terms of the Alliance
Agreement, Hyatt, directly and through certain of its affiliates (collectively,
the "Hyatt Group") agreed to use its best commercial efforts to assist the
Company in advancing the Company's business with respect to the Entertainment
Network. The Alliance Agreement was terminated in November 1997 as a result of
changing market conditions. No sale transactions were completed by the Company
as a result of Hyatt's efforts, and accordingly, no warrants were earned by
Hyatt and no joint ventures were commenced. Hyatt did receive 60,000 shares of
Class A Common Stock as a result of executing an agreement which was necessary
in order for the Company to participate in a bid process with Qantas. The
Company did not receive a contract from Qantas as a result of that bid process.
Concurrent with the termination of the Alliance Agreement, four members of the
Company's Board of Directors resigned.
MERRILL LYNCH
In August 1997, the Company signed a strategic consulting agreement
with Merrill Lynch. Under the agreement, Merrill Lynch was to advise the Company
of its strategic options. Merrill Lynch contacted a number of parties on behalf
of the Company to ascertain any interest in possible business combinations; no
significant expressions of interest were received.
THE ENTERTAINMENT NETWORK
General
The Company believes that the Entertainment Network is the most
technologically advanced interactive in-flight entertainment system currently
available on a commercial airline. The Entertainment Network is a distributed
network that combines computer, video and audio technologies in an interactive
system capable of providing a variety of entertainment options for airline
passengers on an in-seat terminal. These options currently include secure casino
gaming, video-on-demand and video-in-progress movies, audio-on-demand, arcade
games, the ability for passengers to pay for gaming and other features directly
through their credit cards, and the ability
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(subject to arrangements with advertisers and vendors) to support in-flight
interactive advertising. However, the Company has decided to reduce its
expenditures on the development of its system pending additional orders. There
can be no assurance that competitors will not be able to develop newer and more
technologically advanced in-flight entertainment systems in the future. Indeed,
this can be expected if expenditures by the Company are not increased.
The Entertainment Network provides each first-class and business-class
seat with a 10.4" in-seat video terminal featuring individual color touch
screens which are compatible with airline headphones, enabling passengers to
hear the audio portion of the programming. The first and business class in-seat
video terminals are attached via a hinged arm that fully retracts into the
armrest compartment that separates seats. A smaller version (8.4") of the video
touch screen is utilized in coach class seats where the in-seat video terminal
is mounted as a flip-up attachment to the tray table. In both cases, the in-seat
video terminal is sealed to allow cleaning and to avoid operational disruptions
due to accidental food or beverage spills.
Passengers operate the in-seat video terminal by touching the screen on
which various touch buttons are displayed such as "movies," "shopping," "arcade
games," "casino games," "credit card," "help" and others. In order to access the
Entertainment Network's features which require payment, including casino gaming,
the passenger will first open an account with the cabin file server (the
Entertainment Network's proprietary central computer) by swiping his or her
credit card through the credit card reader slot. Following the flight, records
of the use charges and gaming losses and winnings will be downloaded to the
Central Ground System, which will then post the charges, losses and/or winnings
to the passenger's account. See "-- Technological Aspects of the Entertainment
Network -- Central Ground System." The Company has agreements in place with
MasterCard International(R), Visa International(R) and American Express to
accept credit cards as payment for in-flight transactions.
The Company believes that the size and resolution of the Entertainment
Network screen (640 horizontal dots by 480 vertical dots) provides passengers
with a better viewing experience. The Company believes that earlier generations
of in-flight systems have typically utilized significantly smaller screens and
provided maximum resolution significantly lower than the Entertainment
Network's. However, other competitors have recently announced the availability
of larger and higher resolution screens. There can be no assurance that the
Company will maintain a technological lead over its competitors.
ENTERTAINMENT OPTIONS
Video on Demand. The Entertainment Network currently offers passengers
the ability to choose from up to approximately 20 feature length movies and
short subjects, depending upon their length, from which any passenger can select
a desired movie or short subject for personal viewing. The video-on-demand
capability incorporated into the Entertainment Network permits multiple
passengers to watch the same or different movies on his or her individual
in-seat video terminal, with each passenger having the capability of starting
and stopping their personal display of the movie at any time.
The Entertainment Network is designed to support MPEG (Motion Picture
Experts Group) 1 compression and video-on-demand capability. The MPEG 1 format
has been selected by an international consortium of consumer electronics
manufacturers and movie production companies as a standard for distribution of
digital video information. In addition to the video
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information, the video-on-demand server has also been designed to store audio
tracks in multiple languages. Recently, digital-video-disk (DVD) and
video-on-demand systems have been announced with MPEG 2 data compression
capability. The Company has no current plans and may not have adequate resources
to develop a system compatible with MPEG 2.
Audio-on-Demand. The audio-on-demand feature offers passengers the
ability to choose from a variety of musical and other audio selections for
personal listening. Audio-on-demand permits multiple passengers to listen to the
same or different selections on their individual headsets with each passenger
having the capability of starting and stopping their personal selections at any
time.
Gaming. The Entertainment Network is designed to offer a variety of
video gaming options such as Slots, Keno, Lotto, Poker, Bingo, Blackjack and (on
the Swissair system) certain games offered by the Swiss lottery such as
"Risiko." These games feature outstanding graphics and superior ease of
passenger use.
Due to insignificant gaming revenue generated by the Swissair
Entertainment Networks, the Company is considering termination of its internal
gaming software development and is reviewing the possibility of subcontracting
the development of gaming software to other companies. However, no assurances
can be made that such an agreement can be reached on terms acceptable to the
Company and Swissair. In addition, previous attempts to integrate third party
gaming software have resulted in significant schedule delays in the delivery of
the required features.
Arcade Games. The Entertainment Network is designed to include a choice
of arcade-type games. The Company has developed one video arcade game ("Squish")
internally and has licensed rights to one additional game ("Reversi"). In
addition, the Company has commenced discussions with various entertainment
software developers, but has not yet entered into any agreements or arrangements
to obtain any rights to any other arcade games. In addition, previous attempts
to integrate third party arcade game software have resulted in significant
schedule delays in the delivery of the required features. Given the limited
number of seats equipped with the IFEN-2 system, there can be no assurance that
the Company will be able to successfully conclude agreements with any third
party game developers.
Advertisements. The IFEN-2 also has the ability to display
advertisements. These advertisements are expected to be interspersed between
movies and other video programs, between portions of the audio programs, or
shown on the arcade games and casino games either as ticker tape messages
scrolling across the top or bottom of the screen or as messages flashing
periodically on the screen. Given the limited number of seats equipped with the
IFEN-2 system, there can be no assurance that the Company will be able to
successfully conclude agreements with any advertisers.
Language Selection. The Entertainment Network provides passengers with
the convenience of using the in-seat video terminals in multiple languages that
are accessible by using the touch screen. If the passenger chooses a particular
language selection, the operation of the in-seat video terminal is designed to
switch to the selected language (although movies may only be available in a
limited number of languages).
The options that will actually be available on any particular flight
will depend upon applicable regulations, the ability of the Company to license
or otherwise obtain the rights to
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programming software, the preferences of the airline and the performance and
reliability of the installed system. The price, if any, charged to passengers
for various entertainment options will be determined by each airline and/or the
Company and will be based upon a number of factors, including airline marketing
strategies, the cost of similar entertainment options available in other media,
the fee, if any, charged by a licensor of such programming and other factors. In
addition, use of passenger identification and other information, especially
information obtained via credit cards, is limited by certain privacy statutes
and regulations.
TECHNOLOGICAL ASPECTS OF THE ENTERTAINMENT NETWORK
Gaming Management. The Entertainment Network is designed to provide
airline management with the capability for real time gaming management by
tracking the entire gaming process on all of the system's in-seat video
terminals collectively or individually. In particular, the Entertainment Network
is designed to store the complete history of all wagers and game outcomes on all
of the in-seat video terminals. The stored information may include
passenger/player identification numbers, the times of transactions, the bet
amounts, the amounts won or lost, the cards played, the keno balls called and
alarms for management, such as large consistent winnings and progressive jackpot
hits. If desired, the IFEN-2 design can be customized to permit all gaming
related information, including the alarms, to be observable in flight on the
screen on the cabin file server, or on the ground after periodic downloading
using a Central Ground System described below. The system is also designed to
limit the wagers, aggregate losses and winnings by any individual player to any
amounts selected by the airline.
The Entertainment Network is also designed to provide security for
in-flight gaming by centralizing the critical process of generating random
numbers at remote points, instead of generating random numbers in each in-seat
video terminal independently. Since the in-seat video terminals do not generate
the random numbers, passengers are unable to fix outcomes by tampering with the
in-seat video terminals, as may happen with regular slot machines. The software
and the electronics of the Entertainment Network are designed to also contain
multiple layers of proprietary security measures.
Distributed Network Architecture. The capabilities and reliability of
any interactive system are determined, to a large extent, by the architecture of
the communication network. The Entertainment Network is based on a distributed
network designed to provide centralized control while reducing the possibility
that a single point of failure will disrupt the operation of more than a small
portion of the network. The Entertainment Network is centrally controlled on an
aircraft by the cabin file server. The cabin file server is the central computer
designed to coordinate and control all functions of the Entertainment Network.
The cabin file server provides security for transactions on the Entertainment
Network by providing multiple layers of software and hardware security systems.
These security systems are designed to record all transactions for later
downloading to the Central Ground System, as well as control the generation of
all random factors that determine the outcome of any casino games being played
by the passengers.
The cabin file server controls a number of cluster controllers, and
each cluster controller controls a group of approximately 32 in-seat video
terminals. Consequently, the failure of one in-seat video terminal should not
affect the operation of other terminals on the aircraft. Similarly, the failure
of an individual cluster controller is expected to affect only the in-seat video
terminals controlled by that cluster controller, and not the operation of the
other in-seat video terminals on the aircraft. Further, even if the cabin file
server fails, each cluster controller is designed to
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continue to operate autonomously without the cabin file server, except for
certain gaming management functions which are performed by the cabin file
server.
The distributed network architecture is also designed to permit the
Entertainment Network to deliver the short transaction response time required
for interactive applications, while using lightweight and inexpensive hardware.
Since interactive applications generally require several computerized
communications transactions per event, an ordinary cabin file server can
experience software overload, thereby creating a system failure at some or all
of the in-seat video terminals. By designing the Entertainment Network to shift
a portion of the workload to each cluster controller, the Company believes the
distributed network architecture can reduce those performance problems.
Central Ground System. Located at the Company's executive offices in
Phoenix, Arizona, the Central Ground System is a computer system developed by
the Company to serve as the control focal point for all of the Company's
installed Entertainment Networks. The Central Ground System is provided with
accounting and statistical data accumulated by the Entertainment Networks during
flight. The Central Ground System can then process this data in order to, among
other things, post the passenger transactions to their respective credit card
processing centers and provide airline management with a variety of accounting
and statistical reports. In addition, the Central Ground System can upload new
information to the Entertainment Networks as needed, such as new games, shopping
catalogs or other programming software. If real time downloading is not
implemented, the data interchange between the aircraft and the Central Ground
System will occur on the ground via a direct local telephone or radio link, or
by using a removable magnetic cartridge. The Central Ground System is intended
to store the complete history of all passenger transactions and allow airline
management to access comprehensive data logs for each individual in-seat video
terminal, subject to applicable privacy rules governing credit card processing.
AIRLINE CONTRACTS
Swissair. Effective July 18, 1996, the Company entered into an
agreement with Swissair which was amended and restated effective October 22,
1996 and subsequently superceded with an agreement dated October 29, 1997.
Pursuant to the final agreement, the Company is to install the IFEN-2 system on
sixteen MD-11 aircraft and three B-747 aircraft in exchange for approximately
$27 Million. The Entertainment Networks are being installed in the first,
business and economy class sections of three aircraft and in the first and
business class sections of the remaining sixteen aircraft. The agreement
requires the Company to provide maintenance services through September 1998 and
provide a one-year warranty on all of the systems. Under the agreement, the
Company is obligated to deliver to Swissair several software and hardware
upgrades whose development is not yet completed. There can be no assurance that
the Company will be able to complete the development within the currently
expected schedule or budget and the Company will face significant penalties
under the agreement if agreed upon upgrades are not delivered timely. The
Company does not expect to receive any additional revenue associated with the
delivery of the software and hardware upgrades. The Company is also required to
provide certain support services, upgrades and training of Swissair personnel
through December 2003, as well as meet and maintain certain operational
reliability criteria. As of October 31, 1997, the Company had completed
installations of the Entertainment Network on eleven Swissair aircraft. The
remaining installations are expected to be completed by March 1998.
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The IFEN-2 systems installed on the aircraft include various gaming
options, including Slots, Keno and Risiko (a Swiss lottery game). In addition to
the other standard IFEN-2 features described above under "-- The Entertainment
Network," the Swissair systems also permit passengers to view, among other
things, the Swissair "moving map" (which shows aircraft location, airspeed and
other flight information) and certain Swissair flight and airport information.
Effective October 22, 1996, the Company also executed an agreement (the
"ILL Agreement") with Interkantonale Landeslotterie ("ILL"), the operator of the
Swiss lottery based in Zurich, Switzerland, under which the IFEN-2 systems
installed on Swissair aircraft will allow passengers to participate in various
Swiss lottery games. Pursuant to the ILL Agreement and the agreement with
Swissair, all revenues generated by the casino gaming features of the nineteen
Swissair Entertainment Networks are to be split between the three parties. All
net gaming profits are to be divided between the parties with 4% being paid to
the ILL and the remaining 96% being divided between the Company and Swissair
based on a priority of expenses. As of October 31, 1997, no gaming revenues had
been distributed to the three parties.
The Company also has a Media Programming Services Agreement with
Swissair. Pursuant to the agreement, the Company may bill Swissair for costs
incurred related to the supply of program material and other entertainment
programming costs. Swissair receives all entertainment programming revenues
generated by the Entertainment Networks installed on the nineteen aircraft.
Under the terms of the agreement, the Company and Swissair will receive 60% and
40%, respectively, of all advertising revenue from the Entertainment Networks.
Additionally, shopping revenues generated by the systems will be divided 40% to
the Company and 60% to Swissair. As of October 31, 1997, no advertising or
shopping revenues had been generated by the systems.
Debonair. An agreement with Debonair provided for the Company to
deliver IFEN-2 systems for six RJ-146 Debonair aircraft. The aggregate purchase
price to be paid by Debonair for the hardware components of the six IFEN-2
systems and related spare parts was approximately $5.8 Million. As long as
Debonair utilized the casino gaming features of the systems, payment of the
purchase price of these systems was to be made solely through a revenue-sharing
arrangement. The revenue-sharing arrangement provided that the Company would
receive a percentage of revenues generated by the Entertainment Networks,
principally casino gaming revenues, until the aggregate purchase price plus
accrued interest for all six Entertainment Networks was paid, and thereafter the
Company would receive a reduced percentage of such revenues.
In August 1997, the Company completed the installation of the
Entertainment Network on one Debonair aircraft. After evaluating the operating
results of this system, the Company determined that the revenue-sharing
arrangement did not provide sufficient revenue to justify the cost of installing
Entertainment Networks on the five additional Debonair aircraft. As a result,
the Company does not plan to proceed with additional installations on Debonair
aircraft and has stopped supporting and operating the Entertainment Network
installed on the first aircraft as of October 31, 1997.
Alitalia. The Alitalia Agreement provided for the Company to sell five
first generation Entertainment Networks for installation on Alitalia aircraft
during fiscal 1996. The agreement required the Company to perform maintenance,
repair, overhaul and modifications of the Entertainment Network, as needed, at
no charge to Alitalia for a period of five years from acceptance by Alitalia.
Also, for a period of eight years from installation, all upgrades in the basic
Entertainment Network that may be developed by the Company were to be provided
to Alitalia free of charge.
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Pursuant to the agreement, the company delivered five systems to
Alitalia, four of which were installed on Alitalia aircraft and the fifth system
being utilized by Alitalia as spare parts for the four installed systems. Of the
approximate $2.7 Million purchase price for the five systems, the Company
received approximately $2.1 Million and will not receive the remaining $0.6
Million. Although required by the agreement, Alitalia did not purchase
sufficient spare parts to support continued operation of the Entertainment
Networks. Alitalia has notified the Company that it does not intend to continue
operation of the systems, and the Company has indicated that it will not support
the systems because of the actions of Alitalia. See "Item 6 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations."
SALES AND MARKETING
Concurrently with its efforts to perform under its existing contract
with Swissair, the Company has been marketing the Entertainment Network to
additional airlines. The Company markets the Entertainment Network to airlines
directly and generally seeks to obtain long-term contracts. See "-- Airline
Contracts." Based on the high load factors, the Company has reduced its overall
sales efforts and is concentrating on a few airlines considering the purchase of
a new in-flight entertainment system.
Because the Company believes the demand for in-flight entertainment
systems is greater on longer flights, the Company has focused its marketing
efforts on airlines with long-haul routes. In addition, because gaming can
generally be expected to generate greater revenues and profitability than other
features of the Entertainment Network, and because the use of gaming devices is
prohibited on flights to and from the United States, the Company is directing
its sales efforts primarily toward international carriers or domestic carriers
with international routes. In addition, the Company will also be subject to the
laws of foreign jurisdictions that may similarly restrict or prohibit the gaming
or other activities offered on the Entertainment Network. See "Government
Regulation."
The purchase price of an Entertainment Network is relatively high -
estimated to range from approximately $700,000 to $6,500,000 per aircraft
depending upon various factors such as the size and type of the aircraft, the
requested system features and the degree of demonstrated commercial viability
and market penetration of the Entertainment Network. To counter this fact, the
Company's marketing efforts emphasize the many features of the Entertainment
Network as a way to generate increased revenues for the airline. The Company
believes that some of its competitors are willing to sell substantially similar
systems at a lower sales price than the Company due to their larger market share
and more efficient manufacturing capabilities. In addition, due to the effects
of the Asian currency crisis, certain of the Company's competitors may have a
significant advantage in pricing their systems for delivery to airlines based in
Asia.
The high system purchase price also tends to result in a relatively
extensive sales cycle, which can include the evaluation of the Company's
technology, a test installation of the Entertainment Network and negotiation of
related agreements. The sales cycle is also dependent upon a number of other
factors beyond the Company's control such as the financial condition, safety and
maintenance concerns and purchasing patterns of particular airlines and the
airline industry in general. Historically, airline profitability has been
extremely cyclical and, since the passage of deregulation legislation, many
airlines have historically had difficulty operating at a profit.
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<PAGE> 12
PRODUCT DEVELOPMENT
During fiscal 1997, the Company continued to expand the functionality
of the Entertainment Network to include additional features, and the IFEN-2
version now includes new features such as secure casino gaming, the ability for
passengers to pay for gaming and other features directly through their credit
cards, interactive in-flight shopping and advertising capability, and enhanced
video on demand. Further, the IFEN-2 version is lighter and, the Company
believes, easier to maintain than the first generation Entertainment Network and
includes in-seat terminals for coach class seats as well as first and business
classes.
Research and development expenses during fiscal 1997 and fiscal 1996
were approximately $7.8 Million and $5.3 Million, respectively. Such amounts
have not been borne by customers. The Company anticipates that research and
development expenses will substantially decrease in the future as the Company
does not plan on developing any new generations of the Entertainment Network.
Research and development efforts of the Company will include only those efforts
that are required by contractual obligations. Due to the recent decision to not
develop the next generation of the Entertainment Network, the Company has
reduced the number of personnel involved in product development. Due to this
decision and the significant shortage of qualified product development and
program management personnel, many employees have departed the Company. While
the Company has attempted to institute an employee retention program, there can
be no assurance that these efforts will be successful. The Company will have to
retain contract employees to complete some or all of its obligations to
Swissair. This would result in a significant increase in the expected
development costs as well as negatively impact the expected delivery schedule.
The Company has arrangements with certain movie distributors pursuant
to which the Company chooses from lists of available movies from each
distributor and compiles the lists for presentation to the airlines. However,
with the exception of certain casino gaming software licensed from FortuNet and
a limited number of casino and arcade games developed to date by the Company,
the Company does not currently own or have rights to use or include any
entertainment or other programming software for use on the Entertainment
Network. See "-- The Entertainment Network -- Entertainment Options." The
Company intends to evaluate additional programming software for availability on
the Entertainment Network. Although the Company has had discussions with certain
entertainment software developers, it has not yet entered into any long-term
agreements or arrangements to obtain rights to any such programming software
other than "Reversi."
COMPETITION
The Company believes that the market for technologically advanced
in-flight entertainment systems is emerging quite slowly. The Company believes
that airlines are currently more interested in acquiring less technologically
advanced in-flight entertainment systems at a lower cost than the Entertainment
Network. The competition to provide technologically advanced in-flight
entertainment systems to the airlines is intense. The Company is aware of
several other companies that provide systems that compete with the Entertainment
Network, some of which have been installed on aircraft. These competitors have
substantially greater financial, customer support, marketing, engineering and
other resources than the Company and, accordingly, have a significant
competitive advantage over the Company. The Company's principal competitors
include Sony,
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Matsushita, Rockwell-Collins (Hughes-Avicom), BE Aerospace, and TNCI. In
addition, the recent acquisition of Hughes-Avicom by Rockwell-Collins represents
the entry of a significantly larger competitor with established avionics
expertise into the in-flight entertainment market. Sony and Matsushita are both
based in Japan. The current economic and currency issues in Asia may give them
an additional advantage over the Company in making sales to airlines that are
also based in Asia.
The Company believes that it competes with other companies primarily on
the basis of its advanced hardware and software technology, the variety of
entertainment options available for the Entertainment Network, and the fact that
it has delivered technologically advanced in-flight entertainment systems to
Swissair that are currently in use. There can be no assurance, however, that the
Company will be able to compete successfully for additional sales in the
in-flight entertainment market.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
Since the commencement of operations, the Company has developed a
catalogue of proprietary technology and know-how relating to the Entertainment
Network and its related systems. To date, the Company has not filed any patent
applications with respect to such proprietary technology and know-how, but may
elect in the future to do so.
In October 1994, the Company entered into an Intellectual Property
License and Support Services Agreement with FortuNet, which was amended and
restated on November 7, 1996 (as amended, the "FortuNet License"). FortuNet is a
licensed gaming equipment manufacturer that distributes to casinos and other
gaming establishments video gaming networks which incorporate certain of the
technologies developed by FortuNet and licensed to the Company for airline use.
The FortuNet License grants the Company a worldwide, perpetual license to
FortuNet's current and future patents, copyrights, trade secrets and related
know-how covering a computerized system for use in all fields other than bingo
halls. Further, this license is exclusive to the Company within the airline
industry. As consideration, the Company must pay FortuNet an annual license fee
of $100,000 in monthly installments through November 2002. The Company was
previously required to compensate FortuNet for certain development, support and
maintenance services, but this obligation has been terminated. Further, the
restated version of the FortuNet License no longer prohibits the Company from
engaging in any gaming activities outside of airplanes. In exchange for these
amendments and certain other modifications, the Company issued to FortuNet a
warrant to purchase fifty thousand shares of Class A Common Stock.
The FortuNet License covers three United States patents and three
foreign patents as well as certain unpatented technology. The licensed patents
include United States patents claiming (i) an electronic bingo game, (ii) an
electronic game network and a predetermined set of game cards, and (iii) an
electronic game network capable of executing concurrently at least two different
games. The FortuNet License also covers certain corresponding foreign patents.
The FortuNet License also includes United States and foreign copyrights, trade
secrets, know-how and any other proprietary technology and intellectual
properties now owned by FortuNet that cover the technology.
The use of the Company's technology, including the patented technology
licensed from FortuNet, may give rise to claims that the Company's products
infringe the patents of others. The Company is aware of a number of United
States and foreign patents which include claims relating
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<PAGE> 14
to technologies similar to those included in the Entertainment Network. The
Company has agreed to pay costs and damages in connection with any patent
infringement claims brought against Swissair, Debonair or Alitalia as a result
of their use of the Entertainment Network.
There can be no assurance that the issued patents licensed from
FortuNet will provide the Company with any significant competitive advantage or
that challenges will not be instituted against the validity or enforceability of
any patent licensed by the Company or, if instituted, that such challenges will
not be successful. Certain of the patents underlying the technology licensed
from FortuNet are the subject of litigation to which the Company is not a party.
The cost of litigation to uphold the validity and protect against infringement
of patents can be substantial. Furthermore, there can be no assurance that
others will not independently develop substantially equivalent or more advanced
proprietary information and techniques or otherwise gain access to the Company's
current or future-created unpatented trade secrets or obtain such technology or
duplicate the Entertainment Network. In addition, to the extent that consultants
(including FortuNet), key employees or other third parties apply technological
information developed by them or by others to Company projects, disputes may
arise as to the proprietary rights to such information which may not be resolved
in favor of the Company. In addition, there can be no assurance that the Company
can meaningfully protect its intellectual property in foreign countries,
particularly in countries where there are no patents corresponding to those
patents licensed from FortuNet.
CUSTOMER MAINTENANCE AND SUPPORT
The Company's airline contracts call for the Company to provide airline
customers with periodic upgrades of the software incorporated in the
Entertainment Network. The Company trains airline personnel on the use of the
Entertainment Network after an initial airline installation and for a short
period thereafter. The Company is also generally obligated to provide support
for the installed systems over the life of the contracts and, in the case of
Swissair, provide maintenance for a specific time period. The Company's strategy
is to contract with one or more third parties to provide international customer
support and maintenance service for the Entertainment Network. In addition to
service and repair functions, it is expected that such entity would be
responsible for removing and replacing, on a regular basis, any software
products which are not transmitted via the Central Ground System and for
removing and transmitting to the Central Ground System the removable magnetic
cartridge containing transaction data and billing information generated by the
aircraft's Entertainment Network. Because the Company is not expected to have
the personnel or financial resources to perform this function directly, the
failure to obtain such an arrangement could have a material adverse affect on
the Company's ability to perform under its contracts or to obtain purchase
commitments from additional airlines. See "-- Airline Contracts."
MANUFACTURING, ASSEMBLY AND INSTALLATION
The Company obtains most of the components of the Entertainment Network
from commercially available sources. To date, the Company has engaged in only
limited manufacturing operations and, when required components have not been
commercially available, has subcontracted out substantially all component
manufacturing. The Company has leased manufacturing and warehouse facilities in
Phoenix that it uses to assemble the Entertainment Networks. The Company
anticipates that this facility will be sufficient to satisfy the Company's needs
through 1998. See "Item 2 -- Description of Property."
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<PAGE> 15
Installation of the Entertainment Network on an aircraft is estimated
to require at least four to seven days, depending upon the number of installed
seats, and longer for the initial installations. Moreover, due to the high cost
of grounding an airplane, the Company anticipates that installations are more
likely to be scheduled during the off-season for the airline customer, generally
the winter months. Because of the manpower and experience required to perform
installations, and due to the inherent relationship between installation and the
Supplemental Type Certificate ("STC") application and compliance process, the
Company has contracted with Hollingsead International to perform system
installation on all Swissair aircraft. The Company anticipates that future
installations, if any, will be performed by an experienced third-party
subcontractor such as Hollingsead International. See "-- Government Regulation."
GOVERNMENT REGULATION
The installation and use of the Entertainment Network on any particular
aircraft requires prior certification and approvals from the Federal Aviation
Administration ("FAA") and certification and approvals from aeronautical
agencies of foreign governments. Because the installation of the Entertainment
Network is considered a major modification to an aircraft, the Company must
apply for and be granted an STC from the FAA. This is a multi-step process
involving required interim approvals. A separate STC will be required with
respect to each aircraft type on which the Entertainment Network will be
installed. Once an STC is issued with respect to an aircraft type, the unit may
be installed on other aircraft of the same type with the same configuration
provided each installation is performed in a manner as specified by the aircraft
specific STC. To date, the Company has obtained STCs for Swissair B747 and MD-11
aircraft, Debonair RJ-146 aircraft and Alitalia MD-11 aircraft.
Because the process of obtaining an STC is highly technical, the
Company has entered into agreements with Hollingsead International and its
subsidiary Elsinore Aerospace Services (collectively, "Hollingsead") to assist
the Company in the application and approval process. Hollingsead is an FAA
designated engineering representative experienced in in-flight entertainment
systems and has the authority to approve, subject to final FAA review, certain
aspects of the Company's STC applications.
Once the Company identifies the specific aircraft type on which the
Entertainment Network will be installed, it will, through the subcontractor,
make application to the FAA for the STC for that aircraft type. Thereafter, the
FAA will initially establish the certification criteria required to be met for
approval, which will include an in-flight test. The FAA, or its designee,
subject to FAA review, will review all necessary certification and technical
drawings, manuals and procedures for adequacy and compliance; issue necessary
interim approvals including permission to conduct a flight test of the
Entertainment Network; review the results of the flight test; perform
inspections to ensure that both the components of the Entertainment Network and
their installation and operation conform to the certification requirements; and
issue the STC. In addition, the Company or its subcontractor must obtain from
the FAA a Parts Manufacturer Approval ("PMA") with respect to the components of
the Entertainment Network to be installed on each specific aircraft type for
which an STC is granted. There can be no assurance that the Company will be
issued the STCs and PMAs for which it applies or that if such approvals are
granted, that they will be granted within a reasonable time frame or within the
amount budgeted by the Company for such approvals. See "Item 6 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Forward Looking Statements."
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<PAGE> 16
The FAA, in the issuance of the STC, will consider such factors as
whether the Entertainment Network will interfere with the operational and
navigational equipment installed on the aircraft; whether the electrical
components of the Entertainment Network are compatible with those of the
aircraft; whether the components of the Entertainment Network installed in the
passenger seats will interfere with emergency egress from the aircraft; whether
the components of the Entertainment Network will, if subjected to heat or fire,
emit toxic fumes; and similar safety and flight-related concerns.
Federal law grants to the FAA the authority to reexamine at any time
the basis upon which certification and approval of the Entertainment Network may
be granted and, if appropriate, to amend or revoke such certifications and
approvals, subject to certain appeal rights.
In addition to approvals required to be obtained from the FAA, the
Company may be required to obtain certification and approval of the
Entertainment Network from the aeronautical authorities of foreign countries. In
many cases, through technical working agreements between the FAA and the foreign
aeronautical authorities, such authorities accept the FAA issuance of the STC as
approval, although certain country authorities reserve the right to
independently review the data and the compliance criteria which support the
issuance of the STC and to reach an independent determination on whether to
approve the equipment for installation and operation. There can be no assurance
that necessary foreign government approvals will be obtained, or if obtained,
within a reasonable time frame or within the amount budgeted by the Company for
this aspect of the project.
United States law, with certain exceptions, currently prohibits the
knowing transportation of gaming devices on aircraft operated in interstate air
transportation. In addition, states may prohibit the transportation and use of
gaming devices on flights operating between two points in a single state.
Federal law also prohibits the installation, transportation or operation of
gaming devices by any U.S. or foreign air carrier or for such carriers to permit
their use on aircraft operated to or from the United States in foreign air
transportation. However, Federal law does not restrict flights by foreign air
carriers between non-U.S. points, even if the aircraft routing includes a
segment to or from the U.S. Federal law does not restrict the transportation of
gaming devices installed on aircraft operating into or out of the U.S., provided
that such devices are disabled. The United States Secretary of Transportation
was directed by law to conduct a study and to report to Congress on the safety,
commercial and operational issues posed by gaming devices aboard commercial
aircraft. However, in a study released in 1996, the Secretary did not recommend
that Congress take any action to revise current law and recommended that further
studies be conducted to determine, among other things, the competitive need for
gaming devices on such flights. Moreover, the laws regarding the transmission of
gaming data into, out of, or within United States territory, even where such
data was lawfully obtained in another jurisdiction, are unclear. As a result,
there can be no assurance that the transmission of such data will not be
restricted or prohibited. Because gaming can generally be expected to generate
greater revenues and profitability than other entertainment options expected to
be available on the Entertainment Network, the inability to offer gaming on
flights may have a material adverse impact on the Company's business and on the
market acceptance by airlines of the Entertainment Network. The Company will
also be subject to the laws of foreign jurisdictions which may similarly
restrict or prohibit the gaming or other activities offered on the Entertainment
Network.
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<PAGE> 17
EMPLOYEES
As of January 20, 1998, the Company employed 53 people on a full-time
basis and 8 people on a temporary basis. None of the employees is covered by a
collective bargaining agreement. The Company considers its relations with its
employees to be good.
ITEM 2 -- DESCRIPTION OF PROPERTY
The Company's principal executive offices and assembly and warehouse
facilities, located in Phoenix, Arizona, contain approximately 57,900 square
feet of space and are occupied pursuant to three separate leases providing for
an annual aggregate rental of approximately $64,000, subject in part to annual
increases. Two of the leases expire in July 1999 and the other (covering
assembly space) expires in October 1998. As a result of a reduction in work
force, the Company is attempting to sublease the executive office space under
the two leases that expire in July 1999 and consolidate its facilities to the
warehouse location. However, the Company has been unsuccessful in this effort
and there can be no assurance that the Company will be able to sublet its
facilities on terms that are favorable to the Company. The Company also leases
approximately 2,300 square feet of office space in Los Angeles, California at an
annual rent of $40,000 under a lease expiring in August 1998. As a result of the
consolidation of the Company's operations to Phoenix, the Company is attempting
to sublet the Los Angeles space to a third party. However, given the term of the
lease remaining and the amount of similar space available, the Company does not
expect to be successful in this effort.
The Company has no policy regarding investments in real estate, real
estate mortgages or securities of persons primarily engaged in real estate
activities. However, the Company currently holds no such investments.
ITEM 3 -- LEGAL PROCEEDINGS
The Company is not currently a party to any pending legal proceedings.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders
during the fourth quarter of fiscal 1997.
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<PAGE> 18
PART II
ITEM 5 -- MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Class A Common Stock and Class B Warrants traded
separately on the Nasdaq SmallCap Market under the symbols FLYT and FLYTZ,
respectively, beginning March 7, 1995, the date of the Company's initial public
offering. The Class B Warrants were called by the Company and ceased trading on
January 16, 1997. The Class A Common Stock began trading on the Nasdaq National
Market on May 19, 1997. The following table sets forth the high and low last
sale prices for the Company's securities as reported by the Nasdaq SmallCap
Market and the Nasdaq National Market. These prices do not reflect retail
mark-ups, markdowns, or commissions and may not necessarily represent actual
transactions.
On December 17, 1997, the Board of Directors authorized the Company to
repurchase shares of its Class A Common Stock on the open market. As of January
20, 1998, the Company had repurchased 264,000 shares at prices ranging from
$0.75 to $1.00 per share. The Company expects to make additional open market
purchases of its shares in the future.
<TABLE>
<CAPTION>
CLASS A COMMON STOCK HIGH LOW
---- ---
<S> <C> <C>
November 1, 1995 through January 31, 1996 .......................... $ 12 1/4 $ 7 1/2
February 1, 1996 through April 30, 1996............................. 12 3/4 9 1/4
May 1, 1996 through July 31, 1996................................... 16 1/8 8 3/8
August 1, 1996 through October 31, 1996 ............................ 15 3/4 9
November 1, 1996 through January 31, 1997........................... 13 7 5/8
February 1, 1997 through April 30, 1997............................. 8 5/8 3 5/16
May 1, 1997 through July 31, 1997 .................................. 7 3/8 3 5/16
August 1, 1997 through October 31, 1997............................. 3 5/8 1
</TABLE>
The closing sales price of the Class A Common Stock as of January 20,
1998 as reported by the Nasdaq National Market was $1 5/16 per share.
As of January 20, 1998, there were 79 record holders of Class A Common
Stock.
Effective February 23, 1998, the requirements for continued listing on
the Nasdaq National Market will change. Among the changes will be a requirement
that listed company's securities trade at a bid price of $1 or greater.
Effective with the implementation of the new requirements, if the Company's
Class A Common Stock trades at a bid price below $1 for 30 consecutive days, the
Class A Common Stock will no longer be qualified for listing on the Nasdaq
National Market and may be moved to the Nasdaq SmallCap Market, or the Over the
Counter Bulletin Board. The Company's Class A Common Stock has periodically
traded below a $1 bid price after November 11, 1997, and it is possible that the
Company's Class A common stock could be removed from trading on the Nasdaq
National Market.
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<PAGE> 19
ITEM 6 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Interactive Flight Technologies, Inc. ("the Company") has been engaged
in the development, manufacture, installation and operation of a computer-based
in-flight entertainment network ("Entertainment Network" or "system"), which
provides aircraft passengers the opportunity to view movies, purchase goods and
services, play computer games and, in certain cases where permitted by
applicable law, gamble through an in-seat video touch screen.
The Company had originally based its business plan on allowing airlines
to finance the purchase of the system out of a share of gaming revenues without
paying any money down. However, gaming revenues from the operation of the system
have proven to be significantly less than originally estimated, and are
insufficient to support the financing of the system. As a result, the Company
has determined that it will not finance the purchase of additional Entertainment
Networks based on contingent future system generated revenues. Instead, the
Company has been seeking to have airlines finance the purchase and installation
of the system themselves, with the Company receiving only a limited percentage
in revenues from the Entertainment Networks.
The decision of the Company not to finance system purchases out of
future contingent revenues has eliminated certain potential customers who do not
have the resources to finance the systems independently. Moreover, the Company
must now justify the costs of the Entertainment Networks (both purchase and
operational) based solely on a perceived competitive need, rather than on
ancillary revenue. The perception of that need may depend on the phase of the
business cycle in the airline industry, as potential purchasers are more likely
to invest in competitive factors at times when competition for customers is
intense. With load factors at a historically high level, this is a difficult
phase of the industry cycle to justify purchases. Accordingly, there is no
assurance that the customers currently considering purchase of the systems, or
indeed any customers, will ultimately purchase the Entertainment Network at a
purchase price at which the Company could make a profit.
Because of the long lead-time for aircraft installments, the Company
must schedule programs well in advance, and its success depends on its ability
to continue to obtain major orders. The Company has been pursuing other major
airlines to fill its pipeline following the scheduled completion of the
installation phase of the Swissair program in March 1998. The Company has not
succeeded in this effort to date and there can be no assurance that the Company
will be successful in this effort in the future.
In the absence of the system being offered as original equipment by
airplane manufacturers, the ability of the Company to convince major airlines to
purchase its system depends in large part upon the airline having decided to
initiate a major cabin upgrade, a decision over which the Company has little or
no control. Once such a decision has been reached by the airline, the Company
must compete with other vendors on the basis of such factors as price, weight
and features. The Company believes that it presently compares favorably with
other competitors in these matters; however, the Company must find ways to
overcome concerns about the Company's relatively small financial resources
compared to the hundreds of millions of dollars involved in an in-flight
entertainment purchase decision by a major airline. In addition, as with all
technically oriented purchases, the Company must contend with questions about
deferring
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<PAGE> 20
purchase decisions pending future developments. There can be no assurance that
customers will in fact decide to buy now rather than wait, that the Company will
in fact be able to compete successfully on price, weight and features, or that
the Company can find a way to adequately address concerns about its size.
The Company believes that it has cash and liquidity resources in excess
of that required to fulfill its current contractual commitments, although this
will depend in large part on the ability of the Company to fulfill those
obligations in an efficient manner. The Company could use those additional
resources towards pursuing additional customers and development efforts in the
in-flight entertainment business or could seek to use the resources in other
businesses. At the present time, based on the low level of demand in the
industry at this point in the business cycle, the Company intends to limit the
resources it expends in pursuing new in-flight entertainment business until and
unless it obtains another customer. In particular, the Company is reducing its
workforce and overhead since the Company's current backlog consists of Swissair
only. The Company has also decided not to develop the next generation of the
Entertainment Network unless a new customer is obtained. The Company's future
research and development efforts will consist only of those efforts that are
required contractually by the Swissair agreement. Conserving cash in this manner
may permit the Company to pursue alternative businesses, but could well mean
that the Company will not be able to continue to compete in the in-flight
entertainment business even if market conditions improve. Additionally, the
Company believes that in the absence of orders from additional airlines, it will
need to redirect some or all of its efforts into other business areas. The
Company has not identified any specific areas for alternative business
development. There can be no assurance that the Company will find acceptable
opportunities for alternative business development or that the Company will be
successful in entering or operating in alternative business areas. In addition,
the Company has used, and may continue to use, a portion of its excess cash to
repurchase its own shares in the market.
EXISTING INSTALLATIONS
The Company has installed Entertainment Networks on aircraft operated
by three European airlines: Swissair, Debonair and Alitalia Airlines S.p.S.
("Alitalia").
The Swissair agreement originally required the Company to manufacture,
assemble, deliver, install, certify, operate and maintain the system on
Swissair's long-haul fleet. Under the agreement, the Company agreed to finance
the purchase price (approximately $72 Million plus certain costs of installation
and upgrades) out of revenues from passenger use of the systems. Under a
provision allowing renegotiations based on insufficient gaming revenues, the
parties executed a new agreement in October 1997.
The terms of the new Swissair agreement provide for the Company to be
responsible for all costs including materials, installation and maintenance
through September 1998 for the installation of the system in the first, business
and economy class sections of two MD-11 and one B-747 aircraft. Title to these
three systems will transfer to Swissair one-year after installation. As of
October 31, 1997, the estimated costs of these three systems are fully reserved.
For another sixteen aircraft, Swissair will purchase Entertainment Networks
covering only first and business class for an average of $1.7 million per
aircraft. The Company will be responsible for the installation and maintenance
costs through September 1998 for the sixteen aircraft. The Swissair agreement
also provides a one-year warranty on all of the Entertainment Networks and
specific upgrades to the Entertainment Networks currently being installed. The
Company is obligated
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to deliver several software and hardware upgrades whose development is not yet
complete. If the upgrades are not completed by specified deadlines, the Company
will face significant penalties. The Company must also meet and maintain certain
operational reliability criteria for the Entertainment Networks or be subject to
certain penalties.
The Company has completed the installation of Entertainment Networks in
the economy, business and first class sections of two Swissair MD-11 aircraft as
of October 31, 1997. The Company has also completed the installation of
Entertainment Networks in the business class section of nine Swissair MD-11
aircraft as of October 31, 1997. The remaining installations are expected to be
completed by March of 1998. The Company is working to further improve the
reliability of the system through software revisions and through design
improvements. The Company believes that the reliability goals for the system can
be met; however, there can be no assurance that technical obstacles may not
prove more difficult than anticipated or that as yet undetermined issues will
not appear. The Company is subject to certain penalties, which could be
substantial, if the Entertainment Networks do not meet and maintain certain
operational reliability criteria through the year 2003. This may require the
Company to continue to maintain a presence in the in-flight entertainment
business even if it pursues other businesses.
In conjunction with the Swissair agreement, the Company has an
agreement with Interkantonale Landeslotterie, a Swiss non-profit organization
that organizes lotteries in Switzerland (ILL). Pursuant to the agreements, any
net gaming profits generated from the Swissair Entertainment Networks are to be
divided between the three parties with 4% being paid to the ILL and the
remaining 96% being divided between the Company and Swissair based on a priority
of expenses.
Pursuant to a separate Media Programming Services Agreement with
Swissair, the Company may bill Swissair for costs incurred related to the supply
of program material and other entertainment programming costs. Swissair receives
all entertainment programming revenues generated by the Entertainment Networks.
Advertising and shopping revenues generated by the systems are split between the
Company and Swissair.
The Debonair agreement originally required the Company to manufacture,
assemble, deliver, install, operate and maintain the system on six Debonair
aircraft. As long as Debonair utilized the casino gaming features of the
systems, payment of the purchase price of these systems was to be made solely
through a revenue-sharing agreement. The Company completed the first
installation of a Debonair aircraft in August 1997. In October 1997, the Company
notified Debonair that the revenues being generated by the Entertainment Network
were insufficient to justify continued operation of the Entertainment Network
and further installations. Accordingly, the Company does not plan to install the
five remaining systems and has stopped supporting the first installed
Entertainment Network.
Pursuant to the contract with Alitalia, the Company delivered five
first generation systems for installation on Alitalia aircraft during fiscal
1996. However, Alitalia installed only four of the five Entertainment Networks
and did not purchase sufficient spare parts to support continued operation of
the systems. Alitalia has notified the Company that it does not intend to
continue operation of the systems, and the Company has indicated that it will
not support the systems because of the actions of Alitalia. As of October 31,
1997, the final outcome of this matter is unclear.
-19-
<PAGE> 22
RESULTS OF OPERATIONS
Revenue for the year ended October 31, 1997 was $11,100,709, an
increase of $8,115,307 (or 272%) over revenue of $2,985,402 for the year ended
October 31, 1996. Equipment sales generated during fiscal 1997 were principally
from the installation of the Entertainment Network on Swissair aircraft. As of
October 31, 1997, the Company had completed installations on eleven Swissair
MD-11 aircraft. Equipment sales generated during fiscal 1996 were a result of
the delivery of five first generation Entertainment Networks under the Alitalia
agreement. Service income of $575,881 for the year ended October 31, 1997 was
principally generated from a Product Identification/Product Development
Agreement with Qantas which was terminated as of July 31, 1997. The Company also
provided programming services to Alitalia and another air carrier during fiscal
1997. Service income of $313,478 for the year ended October 31, 1996 was a
result of programming services provided to Alitalia and another air carrier.
Cost of equipment sales and service income for the year ended October
31, 1997 were $24,878,460, an increase of $20,301,183 (or 444%) over cost of
sales of $4,577,277 for the year ended October 31, 1996. The increase in cost of
sales is partly due to the installation and maintenance costs of aircraft under
the Swissair agreement. Pursuant to the Swissair agreement, the Company is
responsible for all costs related to the installation of the Entertainment
Networks on the Swissair aircraft and maintenance costs of the systems until
September 1998. Both the installation and maintenance required under the
Swissair agreement are out-sourced by the Company to third parties. Under the
Alitalia agreement, all installation and maintenance costs of the systems were
the responsibility of Alitalia. The increase in cost of sales for fiscal 1997 as
compared to fiscal 1996 is also due to inventory adjustments. Provisions for
inventory obsolescence, unuseable inventory and rework adjustments of
$11,496,748 were recorded in cost of equipment sales during fiscal 1997 compared
to none during fiscal 1996. The 1997 provision for inventory obsolescence was a
result of the Company purchasing inventory for installation in the economy
sections of all nineteen Swissair aircraft. The original Swissair agreement
requiring installation in the economy section of nineteen aircraft was
subsequently reduced to economy installations in only three aircraft. The
unuseable inventory and rework adjustments primarily resulted from the Company's
re-design of the tray table utilized in the Entertainment Networks for the
economy section of an aircraft. Estimated warranty costs for the systems are
also included in cost of sales as well as costs of upgrades to the Entertainment
Networks that the Company is contractually committed to providing to Swissair.
Provisions for doubtful accounts were $216,820 for the year ended
October 31, 1997, compared to $1,732,377 for the year ended October 31, 1996.
Fiscal 1997 provisions resulted from uncollectible programming service fees
provided under the Alitalia agreement. The 1996 provision related to three
systems delivered under the Alitalia agreement that were deemed uncollectible
after repeated failed attempts to collect as of October 31, 1996. During fiscal
1997, the Company was successful in its collection efforts on two of the
Alitalia systems and recognized bad debt recoveries of $1,064,284.
Research and development expenses for the year ended October 31, 1997
were $7,821,640, an increase of $2,543,057 (or 48%) over expenses of $5,278,583
for the year ended October 31, 1996. The increase reflects the Company's
continued development of the Entertainment Network during fiscal 1997 and
resulted from increased staff and facilities as well as development fees paid to
third parties. The Company does not plan to continue its research and
development beyond those efforts that are required contractually by the Swissair
agreement. The
-20-
<PAGE> 23
Swissair agreement requires the Company to provide specific upgrades to the
Entertainment Network currently being installed on Swissair aircraft. The
Company expects to complete the development and implementation of these upgrades
by December 1998 and does not plan to develop any further upgrades to the
Entertainment Network. However, the Company expects to continue to require
certain efforts in this area to back up its reliability guarantees through the
year 2003. The estimated costs of these upgrades are being expensed concurrent
with the installation of the systems on Swissair aircraft and the related
revenue recognition.
Marketing and administration expenses for the year ended October 31,
1997 were $12,574,223, an increase of $2,600,356 (or 26%) over expenses of
$9,973,867 for the year ended October 31, 1996. The increase was primarily due
to increases in administrative, production and program management staff and
additional executive officers. Due to the Company's growth in size and increased
marketing efforts, the Company also incurred additional facility expense, trade
show costs and professional fees. During fiscal 1997, the Company recorded an
expense of $466,875 upon the issuance of restricted Class A Common Stock to
Hyatt Ventures, Inc. in exchange for the execution of an agreement necessary
during a bid process with Qantas. During fiscal 1996, the Company recorded
expenses of $1,545,847 and $919,596 upon the issuance of warrants and Class A
Common Stock, respectively. The warrants were issued pursuant to an agreement
whereby Banner Aerospace, Inc. agreed to provide logistical support to enhance
the Company's chance of obtaining business with a major European airline. The
stock was issued upon the exercise of employee stock options which, because of a
cashless exercise, resulted in a charge to compensation expense equal to the
value of the shares issued.
Special charges for the year ended October 31, 1997 were $19,649,765
compared to $1,266,390 for the year ended October 31, 1996. Special charges in
fiscal 1997 primarily resulted from the requirement to install Entertainment
Networks on three aircraft pursuant to the Swissair agreement and installations
required by the Debonair agreement. The Swissair agreement requires the Company
to deliver and install Entertainment Networks in the first, business and economy
class sections of two MD-11 aircraft and one B-747 aircraft at no charge. The
Company is responsible for all Entertainment Network costs of the three
aircraft, including materials, installation, upgrades, a one-year warranty and
maintenance through September 1998. The estimated material, installation,
maintenance, upgrade and warranty costs for these three systems of $14,292,404
were recorded as a special charge in fiscal 1997. Pursuant to the Debonair
agreement, the Company installed the Entertainment Network on one Debonair
aircraft in August 1997. The purchase price of the system was to be made solely
through a revenue-sharing agreement. After evaluating the results of the
revenue-sharing arrangement, the Company determined that the casino-gaming
feature did not provide sufficient revenue to justify the continued operation of
the system nor further installations of the Entertainment Network on Debonair
aircraft. As a result, the Company stopped supporting and operating the system
installed on the Debonair aircraft and will not proceed with additional Debonair
installations. The costs of the installed Entertainment Network of $956,447 and
inventory on-hand for future Debonair installations of $2,881,962 were written
off as a special charge in fiscal 1997. Additionally, the Company recorded a
special charge of $1,518,952 for the write-down of a system integration lab
utilized in software development and testing. The lab equipment will not be
utilized in the Company's future operations. The Company expects to expend cash
of approximately $5.4 million related to these special charges during the year
ended October 31, 1998. Special charges in fiscal 1996 resulted from severance
agreements executed with former officers of the Company in the amount of
$752,500. In addition, the Company terminated an agreement with a foreign sales
representative and consultant and, as a result, recorded a special charge of
$420,000. The Company also settled an outstanding breach of contract claim with
an individual with whom the Company had engaged in prior negotiations to become
an officer, and in connection therewith recorded special charges of $93,890.
-21-
<PAGE> 24
Interest expense was $13,423 for the year ended October 31, 1997
compared to $2,076 for the year ended October 31, 1996. The increase is due to
capital lease agreements that the Company entered into during fiscal 1997. The
leases expire in September 1999.
Interest income for the year ended October 31, 1997 was $2,170,675, an
increase of $1,592,408 (or 275%) over income of $578,267 for the year ended
October 31, 1996. The interest arose principally out of short-term investments
of working capital. The increase is attributable to increased funds available
for such investments as a consequence of the exercise of Class B Warrants during
December 1996.
Other expense of $203,649 for the year ended October 31, 1997 resulted
from the loss on disposal of property and equipment.
Based on a preliminary study, the Company believes its computer
information systems enable the proper processing of transactions relating to the
year 2000 and beyond. Accordingly, the Company does not expect the amounts
required to be expensed over the next three years to have a material effect on
its financial position or results of operations. The amount expensed in fiscal
1997 related to the year 2000 was immaterial.
LIQUIDITY AND CAPITAL RESOURCES
As of October 31, 1997 the Company had working capital of approximately
$33.2 million compared to $13.1 million as of October 31, 1996. The Company's
primary source of funding has been through equity offerings. The Company
increased its working capital in December 1996 from Class B Warrant exercises
(prompted by the reduction in the exercise price to $7.50 and the Company's
notice of redemption of the remaining Class B Warrants) from which the Company
received proceeds (net of expenses of $4.5 million) of approximately $69.1
million. The Company expects that losses will continue for the foreseeable
future and, as a result, unless funds are received from additional financing,
working capital is expected to continue to decrease.
During fiscal 1997, the Company utilized $34.2 million of cash in
operating activities, an increase of $21.3 million from the $12.9 million of
cash utilized in operating activities during fiscal 1996. The increase in cash
utilized in operations is primarily a result of an increase in the net loss and
an increase in inventories and accounts receivable offset by provisions for
inventory and special charges.
Purchases of property and equipment for the year ended October 31, 1997
were $10.3 million compared to $3.5 million for the year ended October 31, 1996.
Capital expenditures for fiscal 1997 were primarily related to the installation
of the Entertainment Networks on three aircraft under the Swissair agreement in
which the Company retains title for a period of one-year after installation and
the installation of the Entertainment Network on one Debonair aircraft. Capital
expenditures were also incurred for demonstration equipment, a trade show booth
and research and development equipment, including a system integration lab,
during fiscal 1997.
As of October 31, 1997, the Company's material capital commitments were
(i) purchase orders of approximately $9.1 million relating primarily to
inventory purchases and (ii) its obligations under the Swissair agreement.
The Company's revenues have been generated from sales, installation and
servicing of the Entertainment Networks aboard commercial aircraft. The
contracts the Company executed in the past generally provide for the Company to
install the system on an aircraft and to be paid for the equipment and related
installation and maintenance out of revenue generated by passenger use of the
installed system on the aircraft. As a result, the Company expended significant
capital amounts for the test installations (which require the assembly and
installation of approximately 30
-22-
<PAGE> 25
to 280 in-seat video terminals, cabin file servers, cluster controllers,
video-on-demand servers and seat electronic boxes and cabling the first,
business and/or economy class sections of the aircraft) and subsequent assembly,
installation and maintenance of the system on each aircraft.
The Company is currently using its working capital to finance its
current expenses, including installations, equipment purchases, product
development, inventory and other expenses associated with the delivery and
installation of the Swissair systems. The Company believes that its current cash
balances will be sufficient to meet the Company's currently anticipated cash
requirements for at least the next twelve months. However, in the event the
Company obtains additional orders for systems (as to which there can be no
assurance), the Company may require significant additional financing for
manufacture, assembly and installation of any such future orders. The Company
may also in the future elect to explore business opportunities, including
additional applications for its technologies other than in-flight entertainment.
To do so, the Company would require significant additional capital for research
and development and, if such development efforts are successful, for marketing,
manufacturing and installing its new products. Alternatively, the Company is
considering seeking opportunities to acquire or develop other business in which
to deploy its cash resources. No assurance can be given that any such
alternative opportunities could be located, or if located, could be successfully
acquired and operated profitably.
INFLATION
Management does not believe that inflation has had a material affect on
the Company's sales during the past two fiscal years. Changes in the Company's
supplier prices did not have a significant impact on cost of sales during fiscal
1997 or fiscal 1996.
NEW ACCOUNTING STANDARD
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), allows companies to elect to account for
stock-based compensation plans using a method based upon fair value or
continuing to measure compensation expense for those plans using the intrinsic
value method prescribed by Accounting Principles Board Opinion No. 25 -
"Accounting for Stock Issued to Employees" ("APB 25"). Companies electing to
continue using the intrinsic value method must make pro forma disclosures in
fiscal 1997 of net earnings and earnings per share as if the fair value based
method had been applied. The Company will continue using the method prescribed
by APB 25; therefore, SFAS 123 will not have an impact on the Company's results
of operations or financial position.
ACCOUNTING STANDARDS NOT YET ADOPTED BY THE COMPANY
The Financial Accounting Standards Board ("FASB") has issued several
new pronouncements that are not yet adopted by the Company.
In February 1997, the FASB issued SFAS No. 128, "Earnings per Share,"
which specifies the computation, presentation, and disclosure requirements for
earnings per share for entities with publicly held common stock. This statement
will not be effective for the Company until the fiscal quarter ending January
31, 1998 and will require presentation of basic earnings per share and diluted
earnings per share.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of
Information about
-23-
<PAGE> 26
Capital Structure", to consolidate existing disclosure requirements. This new
standard contains no change in disclosure requirements for the Company. It will
be effective for the Company for the fiscal year ending October 31, 1998.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," to establish standards for reporting and display of comprehensive
income (all changes in equity during a period except those resulting from
investments by and distributions to owners) and its components in financial
statements. This new standard, which will be effective for the Company for the
fiscal year ending October 31, 1999, is not currently anticipated to have a
significant impact on the Company's financial statements based on the current
financial structure and operations of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information," to establish standards for reporting
information about operating segments in annual financial statements, selected
information about operating segments in interim financial reports and
disclosures about products and services, geographic areas and major customers.
This new standard, which will be effective for the Company for the fiscal year
ending October 31, 1999, may require the Company to report financial information
on the basis that is used internally for evaluating segment performance and
deciding how to allocate resources to segments, which may result in more
detailed information in the notes to the Company's financial statements than is
currently required and provided.
FORWARD-LOOKING INFORMATION
Except for historical information contained herein, the
matters discussed in this ITEM 6 and elsewhere in this Annual Report on Form
10-KSB are forward-looking statements (within the meaning of Section 27A of the
Securities Act of 1993, as amended and Section 21E of the Securities Exchange
Act of 1934, as amended) that are subject to certain risks and uncertainties
that could cause actual results to differ materially from those set forth in
such forward-looking statements. Such risks and uncertainties include, but are
not limited to, the failure of passenger use of the systems to generate
sufficient revenues, the inability of the Company to convince customers to
purchase its systems, the failure to execute definitive agreements with
additional airlines on favorable terms or at all, cost overruns in connection
with the Company's current contracts, failure of installed systems to perform in
accordance with system specifications, the failure of the Company to receive
sufficient financing to perform under any new airline contracts or to perform
sufficient future research and development, the impact of competition and
downward pricing pressures, the effect of changing economic conditions and
conditions in the airline industry, the inability of the Company to evaluate
other businesses, the impact of any changes in domestic and foreign regulatory
environments or the Company's inability to obtain requisite government
approvals, risks in technology development, the risks involved in currency
fluctuations, and the other risks and uncertainties detailed herein.
ITEM 7 -- FINANCIAL STATEMENTS
The audited financial statements of the Company for the fiscal year
ended October 31, 1997 are located beginning at page F-1 of this Annual Report
on Form 10-KSB.
-24-
<PAGE> 27
ITEM 8 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
There are no items or circumstances to be disclosed under this Item 8.
-25-
<PAGE> 28
PART III
ITEMS 9 -- 12 -- DOCUMENTS INCORPORATED BY REFERENCE
Information with respect to Items 9, 10, 11 and 12 of Form 10-KSB is
hereby incorporated by reference into this Part III of Form 10-KSB from the
Registrant's Definitive Proxy Statement relating to the Registrant's 1998 Annual
Meeting of Stockholders to be filed by the Registrant with the Securities and
Exchange Commission on or before February 28, 1998.
ITEM 13 -- EXHIBITS AND REPORTS ON FORM 8-K
The exhibits listed in the Index to Exhibits below are filed as part of
the Annual Report on Form 10-KSB.
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C> <C>
1.1(1) - Revised Form of Underwriting Agreement
3.1(1) - Certificate of Ownership and Merger
3.2(1) - Amended and Restated Certificate of Incorporation of the Registrant
3.3(1) - Certificate of Amendment of Amended and Restated Certificate of Incorporation of Registrant
3.4(1) - By-laws of the Registrant
4.1(1) - Warrant Agreement, dated as of March 7, 1995, by and among the Registrant, D. H. Blair
Investment Banking Corp. and American Stock Transfer & Trust Company
4.2(4) - Form of Amendment to March 7, 1995 Warrant Agreement, to be entered into by and among
the Registrant, D. H. Blair Investment Banking Corp., and American Stock Transfer & Trust Company
4.3(4) - Warrant Agreement, dated as of October 24, 1996, by and among the Registrant, D. H. Blair
Investment Banking Corp., and American Stock Transfer & Trust Company
4.4(4) - Form of Amendment to October 24, 1996 Warrant Agreement, to be entered into by and among the
Registrant, D. H. Blair Investment Banking Corp., and American Stock Transfer & Trust Company
4.5(1) - Form of Underwriter's Unit Purchase Option
4.6(1) - Specimen of Class A Common Stock Certificate
4.7(1) - Specimen of Class B Common Stock Certificate
4.10(2) - Specimen of Class D Warrant Certificate
4.11(4) - Stock Purchase Warrant, dated as of November 7, 1996, issued to FortuNet, Inc.
4.12(4) - Stock Purchase Warrant, dated as of November 12, 1996, issued to Houlihan Lokey Howard & Zukin
10.1(3) - Amended and Restated 1994 Stock Option Plan
10.2(4) - Severance Agreement between the Registrant and Steven M. Fieldman dated as of November 4, 1996
10.3(1) - Employment Agreement between the Registrant and Michail Itkis dated as of October 31, 1994
</TABLE>
-26-
<PAGE> 29
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C> <C>
10.4(4) - Employment Agreement between the Registrant and John Alderfer, dated as of October 2, 1996
10.5(4) - Severance Agreement between the Registrant and Lance Fieldman dated as of November 4, 1996
10.6(1) - Amended and Restated Shareholders' Agreement by and among Yuri Itkis, Michail Itkis, Boris
Itkis, Steven M. Fieldman, Donald H. Goldman, Lance Fieldman and Registrant dated as of
October 6, 1994
10.7(4) - Amended and Restated Intellectual Property License and Support Services Agreement by and
between FortuNet, Inc. and Registrant dated as of November 7, 1996
10.8(1) - Amended and Restated Escrow Agreement by and between the Registrant, American Stock
Transfer & Trust Company, Yuri Itkis, Michail Itkis, Boris Itkis, Steven M. Fieldman,
Donald H. Goldman and Lance Fieldman
10.9(4) - Sublease and Consent, dated July 16, 1996 between the Registrant and AGF 4041 Limited Partnership
10.10(4) - Office Lease, dated July 15, 1996, between the Registrant and AGF 4041 Limited Partnership
10.11(4) - Standard Industrial/Commercial Single-Tenant Lease-Net, dated as of June 27, 1996, between
the Registrant and 44th Street and Van Buren Limited Partnership
10.12(1) - Form of Indemnification Agreement
10.14(4) - Strategic Alliance Agreement, dated as of November 12, 1996, between the Registrant and Hyatt Ventures, Inc.
10.15(4) - Registration Rights Agreement, dated as of November 12, 1996, between the Registrant and Hyatt Ventures, Inc.
10.16(4) - Amendment No. 2 to Amended and Restated Shareholders' Agreement, dated as of November 12, 1996
10.18(5) - Employment Agreement between the Registrant and Thomas Metzler, dated as of November 18, 1996
10.19 - Termination Agreement, dated November 10, 1997, between the Registrant and Hyatt Ventures, Inc.
23 - Consent of KPMG Peat Marwick LLP
27 - Financial Data Schedule
</TABLE>
- ---------------
(1) Incorporated by reference from the Registrant's Registration Statement
on Form SB-2, Registration No. 33-86928.
(2) Incorporated by reference from the Registrant's Quarterly Report on
Form 10-QSB for the fiscal period ended July 31, 1996, filed with the
Securities and Exchange Commission on September 16, 1996, File No.
0-25668.
(3) Incorporated by reference from the Registrant's Registration Statement
on Form SB-2, Registration No. 333-02044.
(4) Incorporated by reference from the Registrant's Registration Statement
on Form S-3, Registration No. 333-14013.
(5) Incorporated by reference from the Registrant's Quarterly Report on
Form 10-QSB for the fiscal quarter ended January 31, 1997, filed with
the Securities and Exchange Commission
-27-
<PAGE> 30
on March 17, 1997, File No. 0-25668.
(b) REPORTS ON FORM 8-K.
The Company did not file any reports on Form 8-K during the
fourth quarter of the fiscal year ended October 31, 1997.
-28-
<PAGE> 31
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
Registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Dated: January 26, 1998 By: /s/ Michail Itkis
--------------------------------
Michail Itkis
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Michail Itkis Chief Executive Officer and Director January 26, 1998
- -----------------------------
Michail Itkis
/s/ Thomas M. Metzler President and Director January 26, 1998
- -----------------------------
Thomas M. Metzler
/s/ John W. Alderfer Chief Financial Officer and Director January 26, 1998
- ----------------------------- (Principal Financial Officer)
John W. Alderfer
</TABLE>
-29-
<PAGE> 32
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Index to Financial Statements
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report F-2
Balance Sheets as of October 31, 1997 and 1996 F-3
Statements of Operations for the years ended October 31, 1997 and 1996 F-4
Statements of Stockholders' Equity for the years ended October 31, 1997
and 1996 F-5
Statements of Cash Flows for the years ended October 31, 1997 and 1996 F-6
Notes to Financial Statements F-8
</TABLE>
F-1
<PAGE> 33
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Interactive Flight Technologies, Inc.:
We have audited the accompanying balance sheets of Interactive Flight
Technologies, Inc. as of October 31, 1997 and 1996, and the related statements
of operations, stockholders' equity and cash flows for the years then ended.
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 Flight
Technologies, Inc. as of October 31, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Phoenix, Arizona
December 17, 1997
F-2
<PAGE> 34
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Balance Sheets
<TABLE>
<CAPTION>
OCTOBER 31,
-----------------------------
ASSETS 1997 1996
------------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $36,890,454 $ 7,736,345
Investment securities 2,137,084 6,810,275
Accounts receivable, net 5,654,118 106,602
Inventories, net 6,110,761 4,726,935
Prepaid expenses 253,771 186,871
Other current assets 606,883 987,932
----------- ------------
Total current assets 51,653,071 20,554,960
Property and equipment, net 2,959,539 4,659,500
Deposits 166,845 93,030
----------- ------------
Total assets $54,779,455 $ 25,307,490
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,747,833 $ 4,073,940
Accrued liabilities 4,248,222 1,177,134
Deferred revenue 2,383,904 --
Accrued severance costs 55,000 567,500
Accrued maintenance costs 1,286,873 --
Accrued product warranties 4,610,687 1,671,045
Current maturities of capital lease obligations 80,753 --
------------ ------------
Total current liabilities 18,413,272 7,489,619
Accrued severance costs, noncurrent 55,000 110,000
Capital lease obligations, less current
maturities 76,840 --
------------ ------------
Total liabilities 18,545,112 7,599,619
------------ ------------
Stockholders' equity:
Preferred stock, par value $0.01 per share.
5,000,000 shares authorized, none issued. -- --
Class A common stock, one vote per share, par
value $0.01 per share, 40,000,000 shares
authorized; 18,189,995 and 8,102,047 shares
issued and outstanding, respectively 181,900 81,020
Class B common stock, six votes per share,
par value $0.01 per share, 4,000,000 shares
authorized; 3,733,334 and 3,960,000 shares
issued and outstanding, respectively,
including 3,200,000 shares placed in escrow 37,334 39,600
Additional paid-in capital 112,037,882 42,587,712
Accumulated deficit (76,022,773) (25,000,461)
------------ ------------
Total stockholders' equity 36,234,343 17,707,871
------------ ------------
Total liabilities and stockholders' equity $ 54,779,455 $ 25,307,490
============ ============
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 35
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Statements of Operations
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Revenue:
Equipment sales $ 10,524,828 $ 2,671,924
Service income 575,881 313,478
------------- -------------
11,100,709 2,985,402
------------- -------------
Costs and expenses:
Cost of equipment sales 24,646,334 3,711,702
Cost of service income 232,126 865,575
Provision for doubtful accounts 216,820 1,732,377
Research and development expenses 7,821,640 5,278,583
Marketing and administrative expenses 12,574,223 9,973,867
Special charges 19,649,765 1,266,390
Bad debt recoveries (1,064,284) --
------------- -------------
64,076,624 22,828,494
------------- -------------
Operating loss 52,975,915 19,843,092
Other:
Interest expense (13,423) (2,076)
Interest income 2,170,675 578,267
Other expense (203,649) --
------------- -------------
Net loss $ 51,022,312 $ 19,266,901
============= =============
Net loss per share of common stock $ (2.96) $ (3.11)
============= =============
Weighted average shares outstanding 17,216,961 6,198,366
============= =============
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 36
<TABLE>
<CAPTION>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Statements of Stockholders' Equity
CLASS A CLASS B
COMMON STOCK COMMON STOCK
-------------------------- --------------------------
SHARES AMOUNT SHARES AMOUNT
------------ ---------- ------------ ----------
<S> <C> <C> <C> <C>
Balance as of November 1, 1995 3,220,000 $ 32,200 4,000,000 $ 40,000
Class A common stock issued pursuant to Class A
warrant exercise offer 4,655,320 46,553 -- --
Class A common stock issued pursuant to Class A
warrant call 112,020 1,120 -- --
Class A common stock issued under stock option plan
for cash 4,750 48 -- --
Class A common stock issued under stock option plan
pursuant to cashless exercise option 69,957 699 -- --
Warrants issued for services received (624,250
warrants) -- -- -- --
Redemption of Class A warrants
Registration costs -- -- -- --
Automatic conversion of Class B shares to Class A
shares upon sale to non-holder of Class B shares 40,000 400 (40,000) (400)
Net loss -- -- -- --
------------ ---------- ------------ ----------
Balance as of October 31, 1996 8,102,047 81,020 3,960,000 39,600
Class A common stock issued for services received
(60,000 shares) 60,000 600 -- --
Class A common stock issued pursuant to Class B
warrant exercise offer 9,799,760 97,998 -- --
Registration costs -- -- -- --
Redemption of Class B warrants -- -- -- --
Class A common stock issued under stock option plan
pursuant to cashless exercise option 1,522 16 -- --
Automatic conversion of Class B shares to Class A
shares upon sale to non-holder of Class B shares 226,666 2,266 (226,666) (2,266)
Net loss -- -- -- --
------------ ---------- ------------ ----------
Balance as of October 31, 1997 18,189,995 $ 181,900 3,733,334 $ 37,334
============ ========== ============ ==========
</TABLE>
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
PAID-IN ACCUMULATED STOCKHOLDERS'
CAPITAL DEFICIT EQUITY
--------------- ---------------- ---------------
<S> <C> <C> <C>
Balance as of November 1, 1995 $ 14,230,432 $ (5,733,560) $ 8,569,072
Class A common stock issued pursuant to Class A
warrant exercise offer 26,721,537 -- 26,768,090
Class A common stock issued pursuant to Class A
warrant call 783,020 -- 784,140
Class A common stock issued under stock option plan
for cash 36,640 -- 36,688
Class A common stock issued under stock option plan
pursuant to cashless exercise option 918,897 -- 919,596
Warrants issued for services received (624,250
warrants) 1,545,847 -- 1,545,847
Redemption of Class A warrants (133) -- (133)
Registration costs (1,648,528) -- (1,648,528)
Automatic conversion of Class B shares to Class A
shares upon sale to non-holder of Class B shares -- -- --
Net loss -- (19,266,901) (19,266,901)
--------------- ---------------- ---------------
Balance as of October 31, 1996 42,587,712 (25,000,461) 17,707,871
Class A common stock issued for services received
(60,000 shares) 466,275 -- 466,875
Class A common stock issued pursuant to Class B
warrant exercise offer 73,491,777 -- 73,589,775
Registration costs (4,481,164) -- (4,481,164)
Redemption of Class B warrants (40,576) -- (40,576)
Class A common stock issued under stock option plan
pursuant to cashless exercise option 13,858 -- 13,874
Automatic conversion of Class B shares to Class A
shares upon sale to non-holder of Class B shares -- -- --
Net loss -- (51,022,312) (51,022,312)
--------------- ---------------- ---------------
Balance as of October 31, 1997 $ 112,037,882 $ (76,022,773) $ 36,234,343
=============== ================ ===============
See accompanying notes to financial statements.
F-5
</TABLE>
<PAGE> 37
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
-----------------------------
1997 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(51,022,312) $(19,266,901)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,815,779 544,569
Expense recognized upon issuance of stock
options, warrants and shares of Class A
common stock 480,749 2,465,443
Provision for doubtful accounts 216,820 1,732,377
Provision for inventory valuation 8,297,933 --
Special charges 19,649,765 --
Loss on disposals of property and equipment 203,649 --
Changes in assets and liabilities:
Increase in accounts receivable (3,815,139) (1,804,066)
Decrease in allowance for doubtful accounts (1,949,197) --
Increase in inventories (12,563,721) (2,680,711)
Decrease (increase) in prepaid expenses,
other assets and deposits 183,394 (765,836)
Increase in accounts payable 1,673,893 3,488,243
Increase (decrease) in accrued liabilities and
accrued maintenance costs (17,155) 1,017,101
Increase in deferred revenue 2,383,904 --
Increase (decrease) in accrued severance costs (567,500) 677,500
Increase in accrued product warranties 836,667 1,671,045
------------ ------------
Net cash used in operating activities (34,192,471) (12,921,236)
------------ ------------
Cash flows from investing activities:
Maturities of investment securities 6,810,275 --
Purchases of investment securities (2,137,084) (6,810,275)
Purchases of property and equipment (10,341,561) (3,508,983)
------------ ------------
Net cash used in investing activities (5,668,370) (10,319,258)
------------ ------------
Cash flows from financing activities:
Payments on capital lease obligations (53,085) --
Proceeds from issuance of common stock 73,589,775 27,588,918
Registration costs (4,481,164) (1,648,528)
Redemption of Class A and Class B warrants (40,576) (133)
------------ ------------
Net cash provided by financing activities 69,014,950 25,940,257
------------ ------------
Net increase in cash and cash equivalents 29,154,109 2,699,763
Cash and cash equivalents at beginning of year 7,736,345 5,036,582
------------ ------------
Cash and cash equivalents at end of year $ 36,890,454 $ 7,736,345
============ ============
</TABLE>
F-6
<PAGE> 38
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Statements of Cash Flows, Continued
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
----------------------------------
1997 1996
------------- ----------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW ACTIVITIES:
Cash paid for interest $ 13,423 $ 2,076
============== ==========
NONCASH FINANCING ACTIVITIES:
Capital lease obligations incurred $ 210,678 $ --
============== ==========
Issuance of stock under stock option plan pursuant
to cashless exercise option $ 13,874 $ 919,596
============== ==========
Issuance of stock for services received $ 466,875 $ --
============== ==========
Issuance of warrants for services received $ -- $1,545,847
============== ==========
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE> 39
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements
October 31, 1997 and 1996
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
DESCRIPTION OF BUSINESS AND FINANCIAL CONDITION
Interactive Flight Technologies, Inc. (the Company or IFT) is engaged in
the development, manufacturing and marketing of a computer-based in-flight
entertainment network (entertainment network or shipsets) which provides
aircraft passengers the opportunity to view movies, purchase goods and
services, play computer games and, in certain cases where permitted by
applicable law, gamble through an in-seat video touch screen.
For the years ended October 31, 1997 and 1996, the Company had net losses
of $51,022,312 and $19,266,901, respectively, and as of October 31, 1997,
an accumulated deficit of $76,022,773. In addition, the Company currently
has only one open order with Swissair and no orders in backlog. The Company
believes that in the absence of orders from additional airlines, it will
need to redirect some or all of its efforts into other business areas.
However, the Company has not identified any specific areas for alternative
business development to date. In spite of the current financial condition
of the Company, it believes that it will be able to meet its financial
obligations as they become due.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities at the date of purchase of three months or less to be cash and
cash equivalents.
INVESTMENT SECURITIES
Investment securities consist of debt securities maturing within one year
with a maturity greater than three months at the time of purchase. In
accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", these
securities, which the Company has the ability and intent to hold to
maturity, are carried at amortized cost.
INVENTORIES
Inventories consisting principally of entertainment network components are
stated at the lower of cost (first-in, first-out method) or market. Once a
part has become an integral component identifiable to a specific contract,
pursuant to which the Company will retain title to the entertainment
network for a period of time after it becomes operational, it is
transferred to shipsets under construction.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
are provided using the straight-line method over the estimated useful lives
of the assets ranging from three to seven years. Leasehold improvements are
depreciated using the straight-line method over the shorter of the
underlying lease term or asset life.
F-8
<PAGE> 40
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
Assets acquired under capital lease arrangements have been recorded at the
present value of the future minimum lease payments and are being amortized
on a straight line basis over the estimated useful life of the asset or
lease term, whichever is shorter. Amortization of this equipment is
included in depreciation and amortization expense.
REVENUE RECOGNITION
The Company's revenue derived from sales and installation of equipment is
recognized upon installation and acceptance by the customer. Fees derived
from servicing installed shipsets is recognized when earned, according to
the terms of the service contract. Revenue pursuant to contracts that
provide for revenue sharing with the airlines and/or others is recognized
as cash is received in the amount of IFT's retained portion of the cash
pursuant to the revenue sharing agreement.
DEFERRED REVENUE
Deferred revenue represents the gross margin on equipment sold to airlines
prior to installation on an aircraft and advance billing of revenue allowed
under contracts.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred except for
development costs required by a customer contract. Development costs
incurred pursuant to contractual obligations are allocated to aircraft
based on seat installations. These development costs are expensed as cost
of goods sold upon installation of the complete aircraft and acceptance by
the customer.
WARRANTY COSTS
The Company provides, by a current charge to income, an amount it estimates
will be needed to cover future warranty obligations for products sold.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carry forwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
LOSS PER SHARE
Loss per share is computed by dividing net loss by the weighted average
number of common shares outstanding. Usually equivalent shares in the form
of stock options or other common stock equivalents are included in the
calculation only when the effects are dilutive. Primary and fully diluted
earnings per share is presented when the difference between the methods is
greater than 3%. However, pursuant to certain rules of the Securities and
Exchange Commission, the calculation also includes equity securities,
including options and warrants, issued within one year of an initial public
offering with an issue price less than the initial public offering price,
even if the effect is anti-dilutive. The treasury stock approach was used
in determining the dilutive effect of such issuances. The computation of
fully dilutive loss per share results in antidilution. Shares held in
escrow are not treated as outstanding during any period.
F-9
<PAGE> 41
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
Stock-Based Compensation
In accordance with the provisions of Accounting Principals Board Opinion No. 25,
"Accounting for Stock Issued to Employees (APB 25)," the Company measures
stock-based compensation expense as the excess of the market price at the grant
date over the amount the employee must pay for the stock. The Company's policy
is to generally grant stock options at fair market value at the date of grant;
accordingly, no compensation expense is recognized. As permitted, the Company
has elected to adopt the pro forma disclosure provisions only of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation." (SFAS No. 123). See Note 6.
Reclassifications
Certain reclassifications have been made to the 1996 financial statements
to conform to the 1997 presentation.
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 disclosure of contingent assets and liabilities at the date of the
financial statements. Additionally, such estimates and assumptions affect
the reported amounts of revenue and expenses during the reporting period.
Actual results could differ from those estimates.
Recently Issued Accounting Pronouncements
In February 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, "Earnings per Share," which specifies the computation,
presentation, and disclosure requirements for earnings per share for
entities with publicly held common stock. This statement will not be
effective for the Company until the fiscal quarter ending January 31,
1998 and will require presentation of basic earnings per share and
diluted earnings per share, as defined in the statement.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of
Information about Capital Structure," to consolidate existing disclosure
requirements. This new standard contains no change in disclosure
requirements for the Company. It will be effective for the Company for
the fiscal year ending October 31, 1998.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," to establish standards for reporting and display of
comprehensive income (all changes in equity during a period except those
resulting from investments by and distributions to owners) and its
components in financial statements. This new standard, which will be
effective for the Company for the fiscal year ending October 31, 1999, is
not currently anticipated to have a significant impact on the Company's
financial statements based on the current financial structure and
operations of the Company.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of
an Enterprise and Related Information," to establish standards for
reporting information about operating segments in annual financial
statements, selected information about segments in interim financial
reports and disclosures about products and services, geographic areas and
major customers. This new standard, which will be effective for the
Company for the fiscal year ending October 31, 1999, may require the
Company to report financial information on the basis that is used
internally for evaluating segment performance and deciding how to
allocate resources to segments, which may result in more detailed
information in the notes to the Company's financial statements than is
currently required and provided.
F-10
<PAGE> 42
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
(2) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following as of October 31, 1997 and
1996:
<TABLE>
<CAPTION>
1997 1996
---------- -----------
<S> <C> <C>
Trade accounts receivable $4,883,043 $ 1,838,979
Due from vendor 771,075 --
---------- -----------
5,654,118 1,838,979
Less allowance for doubtful accounts (note 15) -- (1,732,377)
---------- -----------
Accounts receivable, net $5,654,118 $ 106,602
========== ===========
</TABLE>
(3) INVENTORIES
Inventories consist of the following as of October 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------ ----------
<S> <C> <C>
Raw materials $ 4,074,492 $3,554,656
Work in process 4,828,173 176,228
Finished goods 8,387,991 996,051
------------ ----------
17,290,656 4,726,935
Less allowance for inventory valuation (note 15) (11,179,895) --
------------ ----------
Inventories, net $ 6,110,761 $4,726,935
============ ==========
</TABLE>
(4) PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of October 31, 1997
and 1996:
<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
Leasehold improvements $ 472,901 $ 375,708
Purchased software 274,617 245,710
Furniture 526,900 214,366
Equipment 2,744,073 1,904,644
Shipsets and shipsets under construction 8,496,431 2,370,873
------------ -----------
12,514,922 5,111,301
Less accumulated depreciation (note 12) (9,555,383) (451,801)
------------ -----------
Property and equipment, net $ 2,959,539 $ 4,659,500
============ ===========
</TABLE>
F-11
<PAGE> 43
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
During the year ended October 31, 1997, the Company recorded equipment
write-downs of $1,518,952 which are included in special charges on the
statements of operations. The write-downs principally related to a system
integration lab utilized in software development and testing. The lab
equipment will not be utilized in the Company's future operations.
Additionally, as of October 31, 1997, shipsets and shipsets under
construction were fully reserved.
See Note 12.
(5) ACCRUED LIABILITIES
Accrued liabilities consist of the following as of October 31, 1997 and
1996:
<TABLE>
<CAPTION>
1997 1996
--------------- ---------------
<S> <C> <C>
Accrued development costs $2,534,689 $ --
Accrued commissions 303,321 792,071
Due to related parties -- 69,240
Due to officers, directors and employees 6,576 25,840
Other accrued expenses 1,403,636 289,983
---------- ----------
Accrued liabilities $4,248,222 $1,177,134
========== ==========
</TABLE>
(6) STOCK OPTION PLAN
In October 1994, the Company adopted a Stock Option Plan (the 1994 Plan)
which provides for the issuance of both incentive and nonqualified stock
options to acquire up to 600,000 shares of the Company's Class A common
stock. In November 1996, the Company amended and restated the 1994 Plan
to increase the maximum shares that may be issued and sold under the plan
to 2,400,000. The Company has granted options to purchase stock to
various parties. All options were issued at a price equal to or greater
than the market price of the Company's common stock at the date
immediately prior to the grant and have a term of ten years. Options
generally become exercisable after one to three years at the discretion
of the Board of Directors. No further options will be granted under this
plan.
In June 1997, the Company established a 1997 Stock Option Plan (the 1997
Plan). Options exercisable for a total of 1,500,000 shares of the
Company's Class A common stock are issuable under the 1997 Plan. The 1997
Plan is administered by the Board of Directors of the Company (or a
committee of the Board) which determines the terms of options granted
under the 1997 Plan, including the exercise price and the number of
shares subject to the option. The 1997 Plan provides the Board of
Directors with the discretion to determine when options granted
thereunder shall become exercisable. During fiscal 1997, 99,500 stock
options with up to a three year vesting period were granted at exercise
prices ranging from $1.12 to $6.75. As of October 31, 1997, 1,400,500
stock options under the 1997 Plan remained available for grant.
In accordance with the provisions of APB 25, the Company measures
stock-based compensation expense as the excess of the market price at the
grant date over the amount the employee must pay for the stock. The
Company's policy is to generally grant stock options at fair market value
at the date of grant, so no compensation expense is recognized. As
permitted, the Company has elected to adopt the disclosure provisions
only of SFAS No. 123.
F-12
<PAGE> 44
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
Had compensation cost for the Company's stock-based compensation plans
been determined consistent with SFAS No. 123, the Company's net loss and
net loss per share on a pro forma basis would be as indicated below:
<TABLE>
<CAPTION>
Years ended October 31,
1997 1996
---------------- --------------
<S> <C> <C>
Net loss:
As reported $ (51,022,312) $ (19,266,901)
================ ==============
Pro forma $ (53,486,930) $ (21,122,525)
================ ==============
Net loss per share:
As reported $ (2.96) $ (3.11)
================ ==============
Pro forma $ (3.11) $ (3.41)
================ ==============
</TABLE>
Pro forma net losses reflect only options granted in fiscal 1997 and
1996. Therefore, the full impact of calculating compensation cost for
stock options under SFAS No. 123 is not reflected in the pro forma net
loss amounts presented above because compensation cost is reflected over
the options' vesting period and compensation cost for options granted
prior to November 1995 are not considered under SFAS No. 123.
For purposes of the SFAS No. 123 pro forma net loss and net loss per
share calculations, the fair value of each option grant is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in fiscal 1997 and
1996:
<TABLE>
<CAPTION>
Years ended October 31,
1997 1996
------------- -------------
<S> <C> <C>
Dividend yield 0% 0%
Expected volatility 71.62% 71.62%
Risk free interest rate 6.12% 6.11%
Expected lives 5.0 years 3.0 years
</TABLE>
F-13
<PAGE> 45
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
Activity related to the stock option plans is summarized below:
<TABLE>
<CAPTION>
Year ended October 31, 1997 Year ended October 31, 1996
-------------------------------------- --------------------------------------
Weighted Average Weighted
Exercise Price Average
Number of Shares Number of Shares Exercise Price
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Balance at the beginning
of year 1,604,700 $ 9.81 243,750 $ 4.91
Granted 846,700 7.44 1,529,500 10.21
Exercised (8,950) 7.24 (124,300) 5.54
Expired (310,300) 7.94 (44,250) 8.69
---------- ----------
Balance at the end of year 2,132,150 8.05 1,604,700 9.81
========== ==========
Exercisable at the end of
year 1,406,783 8.16 414,700 8.36
========== ==========
Weighted-average fair
value of options granted
during the year $ 4.68 $ 5.43
========== ==========
</TABLE>
The following table summarizes the status of outstanding stock options as
of October 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------------- -----------------------------------
Weighted
Average Weighted Weighted
Number of Remaining Average Number of Average
Options Contractual Life Exercise Price Options Exercise Price
Range of Exercise Prices Outstanding Exercisable
---------------- ---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
$1.12 - $4.50 174,500 8.32 years $ 4.29 118,000 $ 4.43
$5.00 - $7.94 104,400 9.00 6.70 22,200 5.43
$8.00 1,452,750 8.08 8.00 969,583 8.00
$9.62 - $14.38 400,500 8.71 10.25 297,000 10.38
-------------- -------------
$1.12 - $14.38 2,132,150 8.27 8.05 1,406,783 8.16
============== =============
</TABLE>
At the discretion of the Board of Directors, the Company may allow
optionees to elect to receive shares equal to the market value of the
option, in lieu of delivery of the exercise price in cash. The market
value of the shares issued is charged to compensation expense. As a
result of optionees selecting this exercise option, only 1,522 and 74,707
shares of stock were issued upon the exercise of 8,850 and 124,300
options during the fiscal years ended October 31, 1997 and 1996,
respectively. Compensation expense of $13,874 and $919,596 is included in
the accompanying statements of operations for the years ended October 31,
1997 and 1996, respectively.
F-14
<PAGE> 46
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
(7) BENEFIT PLAN
The Company has adopted a defined contribution benefit plan that complies
with section 401(k) of the Internal Revenue Code and provides for
discretionary Company contributions. Employees who complete three months
of service are eligible to participate in the Plan. The Company did not
make any contributions to the Plan for the years ended October 31, 1997
or 1996.
(8) STOCKHOLDERS' EQUITY
The Company's capital stock consists of Class A and Class B common stock.
Holders of Class A common stock have one vote per share and holders of
Class B common stock have six votes per share. Shares of Class B common
stock are automatically convertible into an equivalent number of shares
of Class A common stock upon the sale or transfer of such shares to a
non-holder of Class B common stock.
ESCROW SHARES
As a condition of the Company's initial public offering in March 1995,
the underwriter required that an aggregate of 3,200,000 shares of the
Company's Class B common stock be designated as escrow shares. The escrow
shares are not assignable or transferable until certain earnings or
market price criteria have been met. If the conditions are not met by
January 31, 1999, such shares will be canceled and contributed to the
Company's capital.
Of the escrow shares, 1,250,000 shares will be released from escrow, on a
pro rata basis, if and only if, one or more of the following conditions
is/are met:
- the Company's pretax income, exclusive of extraordinary items
amount to at least $5,900,000 for fiscal 1995 or fiscal 1996,
$8,000,000 for fiscal 1997 or $10,100,000 for fiscal 1998;
- the closing bid price of the Company's Class A common stock is in
excess of $16.00 for a 30-day period during the 18-month period
following the public offering or in excess of $20.00 for a 30-day
period in the subsequent 18-month period.
The remaining 1,950,000 escrow shares will be released from escrow, if
and only if, one or more of the following conditions is/are met:
- the Company's pretax income, exclusive of extraordinary items,
amounts to at least $8,500,000 for fiscal 1995 or fiscal 1996,
$11,500,000 for fiscal 1997 or $14,500,000 for fiscal 1998;
- the closing bid price of the Company's Class A common stock is in
excess of $22.00 for a 30-day period during the 18-month period
following the public offering or in excess of $28.00 for a 30-day
period in the subsequent 18-month period.
The shares will also be released under certain circumstances if the
Company is acquired or merged.
As restrictions on such shares are removed, they will be accounted for as
issued for services rendered and the fair value of such shares will be
charged to operations as compensation expense.
F-15
<PAGE> 47
WARRANTS
The following table summarizes warrant activity for the years ended
October 31, 1997 and 1996:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS D CLASS E
--------------- ----------------- --------------- --------------- ------------------
<S> <C> <C> <C> <C> <C>
Outstanding as of
November 1, 1995 4,770,000 3,220,000 -- -- --
Issued in connection
with sales contract -- 294,250 165,000 165,000 --
Exercise of Class A
warrants (4,767,340) 7,095,196 -- -- --
Redemption of Class A
warrants (2,660) -- -- -- --
--------------- ----------------- --------------- --------------- ------------------
Outstanding as of October
31, 1996 -- 10,609,446 165,000 165,000 --
Issued in connection
with advisory
services -- -- -- -- 150,000
Issued in connection
with amendment of
license agreement -- -- -- -- 50,000
Exercise of Class B
warrants -- (9,799,760) -- -- --
Redemption of Class B
warrants -- (809,686) -- -- --
--------------- ----------------- --------------- --------------- ------------------
Outstanding as of October
31, 1997 -- -- 165,000 165,000 200,000
=============== ================= =============== =============== ==================
Exercise price $ 7.00 $ 9.75 $ 11.00 $ 14.00 $ 8.00
=============== ================= =============== =============== ==================
</TABLE>
Each Class A warrant entitled the holder to one share of Class A common
stock and one Class B warrant. Each Class B, Class C, Class D and Class E
warrant entitles the holder to one share of Class A common stock. All
outstanding warrants were exercisable as of October 31, 1997.
On April 12, 1996, the Company offered to the holders of its Class A
warrants to reduce the exercise price of the Class A warrants to $5.75
per share from $7.00 per share and to issue an extra one-half Class B
warrant (in addition to one share of Class A common stock and one Class B
warrant regularly issuable upon the exercise of each Class A warrant)
upon the exercise of each Class A warrant exercised by May 17, 1996. As a
result of this offer, 4,655,320 shares of Class A common stock and
6,983,176 Class B warrants were issued upon the exercise of 4,655,320
Class A warrants, yielding net proceeds of approximately $25,160,000, net
of commissions and expenses approximating $1,609,000. On June 25, 1996,
the Company notified the remaining Class A warrant holders of its intent
to call all outstanding Class A warrants for redemption on July 25, 1996.
As a result, 112,020 Class A warrants were exercised, resulting in the
issuance of 112,020 shares of Class A common stock and Class B warrants
and net proceeds of approximately $744,000, net of commissions and
expenses approximating $40,000. The remaining 2,660 Class A warrants were
redeemed at $.05 per warrant.
F-16
<PAGE> 48
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
On November 22, 1996, the Company offered to the holders of its Class B
warrants to reduce the exercise price of the Class B warrants to $7.50
per share from $9.75 per share upon the exercise of each Class B warrant
exercised by December 24, 1996. As a result of this offer, 9,799,760
shares of Class A common stock were issued upon the exercise of 9,799,760
Class B warrants, yielding net proceeds of approximately $69,100,000, net
of commissions and expenses approximating $4,480,000. Previously on
October 23, 1996, the Company had notified the remaining Class B warrant
holders of its intent to call all outstanding Class B warrants for
redemption on January 17, 1997. The Company redeemed 809,686 Class B
warrants at $.05 per warrant.
In April and May 1996, the Company issued stock purchase warrants to
purchase 624,250 shares of Class A common stock at various exercise
prices (see above schedule) in connection with an agreement with Banner
Aerospace to provide logistical support to enhance the Company's chances
of obtaining business with a major European airline, resulting in a
$1,545,847 charge in the statement of operations for the year ended
October 31, 1996.
In November 1996, the Company issued stock purchase warrants to purchase
150,000 shares of Class A common stock at $9.875 per share to Houlihan
Lokey Howard & Zukin in exchange for advisory services. The exercise
period of the warrants expires in November 2001. On January 6, 1997, the
Company lowered the exercise price of the stock purchase warrants to $8
per share, such price being the trading price of the Class A common stock
at the close of the previous business day.
In November 1996, the Company issued stock purchase warrants to purchase
50,000 shares of Class A common stock at $10.75 per share in connection
with the amendment and restatement of a License Agreement with FortuNet.
The exercise period of the warrants expires in November 2001. On January
6, 1997, the Company lowered the exercise price of the stock purchase
warrants to $8 per share, such price being the trading price of the Class
A common stock at the close of the previous business day.
UNIT PURCHASE OPTIONS
In conjunction with the Company's initial public offering in March 1995,
the Company agreed to sell to the underwriter and its designees, for
nominal consideration, a unit purchase option to purchase up to 280,000
units. Each unit consists of one share of Class A common stock, one
redeemable Class A warrant and one redeemable Class B warrant. The
warrants are not subject to redemption by the Company unless, on the
redemption date, the unit purchase option has been exercised and the
underlying warrants are outstanding. The unit purchase option is
exercisable during the four-year period commencing one year from the date
of the initial public offering at an exercise price of $6.00 per unit,
subject to certain events.
(9) INCOME TAXES
Income tax benefit differed from the amounts computed by applying the
U.S. Federal corporate income tax rate of 34% to net loss as a result of
the following:
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
<S> <C> <C>
Computed expected tax benefit $ 17,347,586 $ 6,550,746
Change in valuation allowance (17,328,254) (6,544,334)
Other nondeductible expense (19,332) (6,412)
------------------- -------------------
$ -- $ --
=================== ===================
</TABLE>
F-17
<PAGE> 49
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax asset are presented below:
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ 13,014,307 $ 4,925,697
Depreciation 3,088,482 12,457
Deferred start-up costs 1,159,948 1,281,599
Accrued product warranty costs 1,567,634 568,155
Issuance of stock options and warrants 866,879 548,963
Allowance for inventory valuation 3,801,164 --
Accrued liabilities 1,299,329 --
Deferred revenue 810,527 --
Allowance for doubtful accounts -- 589,008
Other 205,261 559,398
------------------- -------------------
25,813,531 8,485,277
Less valuation allowance (25,813,531) (8,485,277)
------------------- -------------------
Net deferred tax asset $ -- $ --
=================== ===================
</TABLE>
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management has provided a valuation allowance for 100% of the
deferred tax assets as the likelihood of realization cannot be
determined. As of October 31, 1997, the Company has a net operating loss
(NOL) carryforward for federal income tax purposes of approximately
$38,280,000, which begins to expire in 2009, and a research and
experimentation tax credit of approximately $457,000. The Company likely
underwent a change in ownership in accordance with Internal Revenue Code
Section 382, the effect of which has not yet been determined by the
Company. This change would effect the timing of the utilization of the
NOL, as well as the amount of the NOL which may ultimately be utilized.
(10) RELATED PARTY TRANSACTIONS
The Company has an Intellectual Property License and Support Services
Agreement (the License Agreement) for its core system technology for
airline use from FortuNet, Inc. (FortuNet). FortuNet is owned by a
principal stockholder of the Company. The License Agreement provides for
an annual license fee of $100,000 commencing in October 1994 and
continuing for so long as the Company owns current and future rights that
remain unexpired, valid and enforceable. In November 1996, the License
Agreement was amended and restated to expand the field of use of the
license and to provide for additional consideration in the form of stock
purchase warrants to purchase 50,000 shares of Class A common stock
exercisable for a five-year period at an exercise price of $8.00. The
Company paid FortuNet $100,000 during each of the years ended October 31,
1997 and 1996.
F-18
<PAGE> 50
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
Concurrent with the License Agreement, the Company entered into a
consulting agreement with Yuri Itkis, a related party who is a principal
stockholder and previous director of the Company and sole stockholder of
FortuNet. In November 1996, the consulting agreement was terminated. The
Company paid Yuri Itkis $100,000 during the year ended October 31, 1996
pursuant to the terms of the consulting agreement.
The Company had a letter agreement dated May 28, 1996 with a specialty
investment-banking firm (the Firm) to act as the Company's financial
advisor. The senior managing director of this Firm is also a previous
director of the Company. The terms of the agreement called for a $50,000
non-refundable retainer fee upon execution of the agreement and
additional retainer fees of $20,000 per month through December 31, 1997.
In the event that certain specified transactions occurred, to which the
Firm had advised the Company, the Firm was to be paid 1% of the first
$100,000,000 of the aggregate consideration and .75% of all consideration
in excess of $100,000,000. The Company paid the Firm $811,687 and
$169,190 during the years ended October 31, 1997 and 1996, respectively.
Additionally, in November 1996, the Company issued stock purchase
warrants to purchase 150,000 shares of Class A common stock exercisable
for a five-year period at an exercise price of $8.00.
The Company had a consulting agreement with Worldwide Associates
(Worldwide) to perform various consulting services. The chairman and
president of Worldwide is also a previous director of the Company. The
terms of the agreement called for annual consulting fees of $50,000 and a
fee equal to 1% of gross revenues received by the Company pursuant to
contracts obtained through significant advice or assistance provided by
Worldwide. The Company paid Worldwide $56,063 and $41,667 during the
years ended October 31, 1997 and 1996, respectively.
In January 1997, the Company issued 60,000 unregistered shares of Class A
common stock to Hyatt Ventures, Inc. (Hyatt) in connection with Hyatt
acting as a guarantor on behalf of the Company in certain contract
negotiations. The president of Hyatt is also a previous director of the
Company. As a result of the stock issuance, a charge of $466,875 is
included in the statement of operations for the year ended October 31,
1997.
During the year ended October 31, 1996, the Company executed severance
agreements with three former officers pursuant to which the Company will
pay severance of $752,500 over a three-year period. As of October 31,
1997, $110,000 remains to be paid under these agreements. The severance
expense is included as a special charge in the accompanying statement of
operations for the year ended October 31, 1996.
As consideration for services rendered in connection with obtaining
additional sources of financing, a certain director received $100,000 in
cash during the year ended October 31, 1996.
F-19
<PAGE> 51
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
(11) COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' AGREEMENT
In October 1994, the Company entered into a stockholders' agreement with
principal stockholders covering certain corporate governance matters. The
agreement was amended and restated in November 1996 to include Hyatt
Ventures, Inc. On November 10, 1997, the agreement was amended again to
terminate Hyatt Ventures, Inc.'s rights. The agreement provides for among
other matters, prior consent for any future issuance of Class A common
stock under certain conditions, rights for nomination of directors by
each group of the principal stockholders, a right of first refusal to
purchase any shares of a principal stockholder offering to sell and not
to compete with the Company while being a stockholder of the Company and
for a period of three years thereafter.
LEASE OBLIGATIONS
The Company leases office space and furniture under operating and capital
leases that expire at various dates through August 1999. The future
minimum lease commitments under these leases are payable as follows:
<TABLE>
<CAPTION>
OPERATING LEASES
CAPITAL LEASES
-------------------- -------------------
<S> <C> <C>
YEAR ENDING OCTOBER 31:
1998 $ 92,878 $ 778,514
1999 80,548 280,336
-------------------- -------------------
Total minimum lease payments 173,426 $ 1,058,850
===================
Less amount representing interest (15,833)
--------------------
Present value of net minimum lease payments 157,593
Less current maturities 80,753
--------------------
Capital lease obligations $ 76,840
====================
</TABLE>
Rental expense under operating leases totaled $920,412 and $398,250 for
the years ended October 31, 1997 and 1996, respectively.
Amounts capitalized under capital lease agreements are as follows:
<TABLE>
<CAPTION>
OCTOBER 31,
1997
--------------------
<S> <C>
Furniture $ 302,085
Less accumulated amortization (83,334)
--------------------
$ 218,751
====================
</TABLE>
F-20
<PAGE> 52
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
LAWSUIT
On October 25, 1996, the Company settled a lawsuit in which an individual
who performed certain services for the Company and with whom the Company
had been engaged in negotiations to become an officer of the Company
claimed breach of an alleged contract and wrongful discharge. The terms
of the settlement required the Company to pay the plaintiff $54,885 over
nine months and issue an option to purchase 5,800 shares of Class A
common stock at a exercise price of $4.40 per share. As a result, $93,890
is included as a special charge in the accompanying statement of
operations for the year ended October 31, 1996.
SALES REPRESENTATIVE AGREEMENT
As of October 31, 1997, the Company has an agreement with a
non-affiliated sales representative in a foreign country to market and
promote the Company's product and to assist in negotiations with
airlines. The agreement provides for a commission equal to 15% of the
purchase price and expires in September 1998. No sales were consummated
under this agreement during the year ended October 31, 1997.
SALES REPRESENTATIVE TERMINATION AGREEMENT
On November 2, 1996, the Company entered into a termination agreement
with Starlite Aviation Services, a sales representative for the Company.
The terms of the termination agreement provided for the payment of
$210,000 immediately, $210,000 upon the closing of the Class B Warrant
Exercise Offer, and an additional $286,929 upon the installations of the
entertainment network pursuant to certain contracts. Termination expense
totaling $420,000 is included as a special charge in the accompanying
statement of operations for the year ended October 31, 1996.
STRATEGIC ALLIANCE AGREEMENT
In November 1996, the Company executed a Strategic Alliance Agreement
(Alliance Agreement) to form a strategic alliance with Hyatt Ventures,
Inc. (Hyatt), an affiliate of Hyatt Corporation. Under the terms of the
Alliance Agreement, Hyatt, directly and through certain of its
affiliates, agreed to use its best commercial efforts to assist the
Company in advancing the Company's business with respect to the
entertainment network. The Alliance Agreement was terminated in November
1997 as a result of changing market conditions. No sale transactions were
completed by the Company as a result of Hyatt's efforts, and accordingly,
no warrants were earned by Hyatt and no joint ventures were commenced.
Hyatt did receive 60,000 shares of Class A Common Stock as a result of
executing an agreement which was necessary in order for the Company to
participate in a bid process with Qantas. The Company did not receive a
contract from Qantas as a result of that bid process. Concurrent with the
termination of the Alliance Agreement, four members of the Company's
Board of Directors resigned.
SALES COMMITMENTS
The Company has entered into sales contracts with three airlines,
Schweizerische Luftverkehr AG (Swissair), Debonair Airways, Ltd.
(Debonair) and Alitalia Airlines, S.p.A. (Alitalia) for the manufacture
and installation of its in-flight entertainment network, and to provide
hardware and software upgrades, as defined in the agreements.
F-21
<PAGE> 53
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
Pursuant to an agreement with Swissair, Swissair will purchase shipsets
for the first and business class sections of sixteen aircraft for an
average of $1.7 million per aircraft. Included in the purchase price is
material, installation, maintenance through September 1998, one-year
warranty and upgrade costs for the sixteen aircraft. As of October 31,
1997, the Company had completed installations of the entertainment
network on nine of these aircraft. The agreement also requires the
Company to install the entertainment network in the first, business and
economy class sections of an additional three aircraft, at no charge to
Swissair. The Company is responsible for all costs including
entertainment network components, installation and maintenance through
September 1998 for the three aircraft. As of October 31, 1997, the
Company had completed installations of the entertainment network on two
of these aircraft. Title to each of these three shipsets will be
transferred to Swissair after the shipsets have been installed and
operating for one year. The estimated material, installation, maintenance
and one-year warranty and upgrade costs for these three shipsets of
$14,292,404 is included in the accompanying statement of operations as a
special charge for the year ended October 31, 1997. The Swissair
agreement also subjects the Company to certain penalties, which could be
substantial, if the entertainment networks do not meet certain
operational reliability criteria.
The Company's agreement with Swissair and an agreement with
Interkantonale Landeslotterie, a Swiss non-profit organization which
organizes lotteries in Switzerland (ILL), provides for all revenues
generated by the casino-gaming features of the nineteen Swissair
entertainment networks to be split between the Company, Swissair and ILL.
Pursuant to the agreements, all net gaming profits are to be divided
between the three parties with 4% being paid to the ILL and the remaining
96% being divided between the Company and Swissair based on a priority of
expenses. No gaming profits were distributed in fiscal 1997 or 1996.
The Company also has a Media Programming Services Agreement with
Swissair. Pursuant to the agreement, the Company may bill Swissair for
costs incurred related to the supply of program material and other
entertainment programming costs. Swissair receives all entertainment
programming revenues generated by the entertainment networks installed on
the nineteen aircraft. Under the terms of the agreement, the Company and
Swissair will receive 60% and 40%, respectively, of all advertising
revenue from the entertainment networks. Additionally, shopping revenues
generated by the entertainment networks will be divided 40% to the
Company and 60% to Swissair. No advertising or shopping revenues were
distributed in fiscal 1997 or 1996.
Pursuant to an agreement with Debonair, the Company was to manufacture,
install, operate, and maintain the entertainment network on six Debonair
aircraft for a period of eight years from installation. As long as
Debonair utilized the casino gaming features of the shipsets, payment of
the purchase price of these shipsets was to be made solely through a
revenue-sharing agreement. In August 1997, the Company completed the
installation of the shipset on one Debonair aircraft. After evaluating
the operating results of this shipset, the Company determined that the
revenue-sharing arrangement did not provide sufficient revenue to justify
the cost of installing entertainment networks on five additional Debonair
aircraft. As a result, the Company will not proceed with additional
installations on Debonair aircraft and has stopped supporting and
operating the shipset installed on the first aircraft as of October 31,
1997. Included in the accompanying statement of operations for the year
ended October 31, 1997 are special charges of $956,447 for the cost of
the first completed shipset and $2,881,962 to reserve for all inventory
related to the Debonair program.
F-22
<PAGE> 54
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
Pursuant to an agreement with Alitalia, the Company delivered five first
generation shipsets for installation on Alitalia aircraft during fiscal
1996. The agreement required the Company to perform maintenance, repair,
overhaul and modifications of the entertainment network, as needed, at no
charge to Alitalia for a period of five years from acceptance by
Alitalia. Also, for a period of eight years from installation, all
upgrades in the basic entertainment network that may be developed by the
Company were to be provided to Alitalia free of charge. However, Alitalia
installed only four of the five shipsets and did not purchase sufficient
spare parts to support continued operation of the entertainment networks.
Alitalia has notified the Company that it does not intend to continue
operation of the shipsets, and the Company has indicated that it will not
support the shipsets because of the actions of Alitalia. As of October
31, 1997, the Company has accrued for estimated product warranty costs
that were to be incurred under the original agreement.
PURCHASE COMMITMENTS
As of October 31, 1997, the Company had approximately $9,100,000 of
purchase commitments with various vendors in anticipation of the
fulfillment of the Company's sales commitments.
(12) SPECIAL CHARGES
Pursuant to an agreement with Swissair, the Company agreed to install the
entertainment network in the first, business and economy class sections
of three Swissair aircraft at no charge. The Company is responsible for
all costs including material costs, installation and maintenance of the
entertainment networks through September 1998. The Company also provided
a one-year warranty and agreed to upgrade the shipsets to the next
generation of software currently being developed by the Company at no
charge. The estimated costs for these three shipsets of $14,292,404 is
included as a special charge in the accompanying statement of operations
for the fiscal year ended October 31, 1997.
Pursuant to an agreement with Debonair, the Company installed an
entertainment network on one Debonair aircraft. The payment of the
purchase price for the entertainment network was to be made solely
through a revenue-sharing agreement. After evaluating the operating
results of the entertainment network, the Company determined that the
revenue-sharing arrangement did not provide sufficient revenue to justify
the operation of the shipset. Therefore, the Company, in effect, provided
this entertainment network to Debonair at no charge. The Company has
stopped supporting and operating the shipset and will not proceed with
further installations under the Debonair agreement. Included in the
accompanying statement of operations for the year ended October 31, 1997
are special charges of $956,447 for the cost of the first completed
shipset and $2,881,962 to reserve for all inventory related to the
Debonair program.
In connection with these current agreements with Swissair and Debonair
and the absence of any new entertainment network orders for the Company,
a system integration lab write-down of $1,518,952 was recorded as a
special charge during fiscal 1997.
The Company expects to expend cash of approximately $5.4 million related
to these special charges during the year ended October 31, 1998.
Severance expense of $752,500 is included as a special charge in the
accompanying statement of operations for the year ended October 31, 1996
as a result of severance agreements executed with three former officers
of the Company. Additionally, a legal settlement of $93,890 and payments
under a sales representative termination agreement of $420,000 were
recorded as a special charge during the year ended October 31, 1996. See
Note 11.
F-23
<PAGE> 55
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 "Disclosure about
Fair Value of Financial Instruments" requires that the Company disclose
estimated fair values for its financial instruments. The following
summary presents a description of the methodologies and assumptions used
to determine such amount.
The carrying amount of cash and cash equivalents approximates fair value
because their maturity is generally less than three months. The fair
value of investment securities is approximately $2,137,259. The carrying
amount of accounts receivable, accounts payable and accrued expenses
approximate fair value as they are expected to be collected or paid
within ninety days of year-end. The fair value of capital lease
obligations approximate the terms in the marketplace at which they could
be replaced. Therefore, the fair value approximates the carrying value of
these financial instruments.
(14) RISK RELATED TO CONCENTRATION IN THE VOLUME OF BUSINESS
Sales of entertainment networks by the Company are typically made to a
relatively few number of customers. This concentration of business among
a few customers exposes the Company to significant risk. For the year
ended October 31, 1997, one customer accounted for 95% of the Company's
sales and outstanding accounts receivable from this customer was
approximately $4,900,000. For the year ended October 31, 1996, one
customer accounted for 90% of the Company's sales and outstanding
accounts receivable from this customer was approximately $1,800,000.
(15) SUPPLEMENTAL FINANCIAL INFORMATION
A summary of additions and deductions related to the allowances for
accounts receivable and inventories for the years ended October 31, 1997
and 1996 are as follows:
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING OF END OF
YEAR ADDITIONS DEDUCTIONS YEAR
--------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
ALLOWANCES FOR DOUBTFUL
ACCOUNTS:
Year ended October 31, 1997 $ 1,732,377 $ 216,820 $ 1,949,197 (1) $ --
=============== ================ ================ ================
Year ended October 31, 1996 $ -- $ 1,732,377 $ -- $ 1,732,377
=============== ================ ================ ================
ALLOWANCES FOR INVENTORY
VALUATION:
Year ended October 31, 1997 $ -- $ 11,179,895 (2) $ -- $ 11,179,895
=============== ================ ================ ================
Year ended October 31, 1996 $ -- $ -- $ -- $ --
=============== ================ ================ ================
</TABLE>
F-24
<PAGE> 56
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Financial Statements, Continued
(1) A 1997 bad debt recovery of $1,064,284, related to the $1,949,197
in deductions to the 1997 allowances for doubtful accounts, was
included in the statements of operations.
(2) Special charges in 1997 included $2,881,962 related to the
$11,179,895 in additions to allowances for inventory valuation.
(16) SUBSEQUENT EVENT
On December 17, 1997, the Board of Directors authorized the Company to
repurchase shares of its Class A Common Stock on the open market. As of
January 20, 1998, the Company had repurchased 264,000 shares at prices
ranging from $0.75 to $1.00 per share.
F-25
<PAGE> 1
TERMINATION AGREEMENT
This Termination Agreement is made and entered into by and between
Interactive Flight Technologies, Inc., a Delaware corporation ("IFT") and Hyatt
Ventures, Inc., a Delaware corporation ("Hyatt) effective as of November 10,
1997.
A. The parties hereto are parties to certain agreements including the
Strategic Alliance Agreement dated as November 12, 1996 (the Strategic
Agreement") and the Registration Rights Agreement dated as of November 12, 1996
(collectively, the "Prior Agreements") as well as the Amendment No. 2 to Amended
and Restated Shareholders' Agreement dated as of November 12, 1996 (the
"Shareholders' Agreement").
B. Based on the current market for in-flight entertainment systems and
other factors, IFT has requested and Hyatt has agreed that the parties
discontinue the strategic alliance set forth in the Prior Agreements.
C. As a result, except as set forth below the parties wish to terminate
the Prior Agreements as set forth herein.
Now, therefore, in consideration of these premises and the mutual
covenants set forth herein, the parties hereto agree as follows:
1. TERMINATION. All of the rights and obligations of the parties
pursuant to the Prior Agreements are hereby terminated, except for (i) the
rights of confidentiality set forth in Section 4.6 of the Strategic Agreement;
(ii) until December 31, 1999, the standstill rights set forth in Section 4.7 of
the Strategic Agreement; (iii) the options set forth in Section 4.9 of the
Strategic Agreement; (iv) until December 31, 1999, the rights to insurance set
forth in Section 4.10 of the Strategic Agreement; (v) the rights to
indemnification set forth in Section 4.11 of the Strategic Agreement; and (vi)
the rights of set forth in Article 7of the Strategic Agreement for actions taken
prior to the date hereof. The parties agree that no warrants were or are
issuable pursuant to the Strategic Agreement. All of the obligations and rights
of Hyatt under the Shareholders' Agreement are hereby terminated.
2. RESIGNATIONS. Simultaneously with the execution hereof, John
Pritzker and Adam Aaron are resigning from the Board of Directors of IFT.
3. PUBLIC ANNOUNCEMENTS. Neither party shall issue or cause (or permit
any of its direct affiliates to issue or cause) the publication of any press
release or any other public announcement with respect to, or otherwise make any
public statement concerning, the termination of their strategic alliance without
the prior consent of the other, which consent shall not unreasonably withheld or
except as may be required by law, regulation or by obligations pursuant to any
listing agreement with any national securities exchange or the NASDAQ National
Market System; provided, however, that in
<PAGE> 2
the event such disclosure is so required, the disclosing party shall give prior
written notice of such disclosure to the non-disclosing party.
4. GENERAL. The provisions of Sections 8.1, 8.2, 8.4, 8.5, 8.6, 8.7,
8.9, 8.10, 8.11 and 8.12 of the Strategic Agreement will continue for the
purposes of this Agreement, and are hereby expressly incorporated herein as set
forth herein and full, except that the term "Agreement" shall refer to this
Termination Agreement, and the address of Theodore E. Guth shall be changed to
Guth Rothman & Christopher LLP, 10866 Wilshire Boulevard, Suite 1250, Los
Angeles, California 90024.
In witness whereof, each of IFT and Hyatt has caused this agreement to
be executed by its duly authorized officer, in each case as of the date first
written above.
HYATT VENTURES, INC. INTERACTIVE FLIGHT
TECHNOLOGIES, INC.
By:__________________________ ___________________________________
By: Michail Itkis
Its: ________________________ Its: Chief Executive Officer
We consent to the termination of all of the rights and obligations of Hyatt
under the Shareholders' Agreement.
____________________ ____________________ ____________________
Michail Itkis Yuri Itkis Boris Itkis
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Stockholders and Board of Directors
Interactive Flight Technologies, Inc.:
We consent to incorporation by reference in the registration statement (No.
333-15767 on Form S-8) of Interactive Flight Technologies, Inc. of our report
dated December 17, 1997, relating to the balance sheets of Interactive Flight
Technologies, Inc. as of October 31, 1997 and 1996, and the related statements
of operations, stockholders' equity, and cash flows for each of the years in the
two-year period ended October 31, 1997, which report appears in the October 31,
1997 annual report on Form 10-KSB of Interactive Flight Technologies, Inc.
KPMG Peat Marwick LLP
Phoenix, Arizona
January 23, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS AS OF OCTOBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1997
<PERIOD-START> NOV-01-1996
<PERIOD-END> OCT-31-1997
<CASH> 36,890,454
<SECURITIES> 2,137,084
<RECEIVABLES> 5,654,118
<ALLOWANCES> 0
<INVENTORY> 6,110,761
<CURRENT-ASSETS> 51,653,071
<PP&E> 12,514,922
<DEPRECIATION> 9,555,383
<TOTAL-ASSETS> 54,779,455
<CURRENT-LIABILITIES> 18,413,272
<BONDS> 0
0
0
<COMMON> 219,234
<OTHER-SE> 36,015,109
<TOTAL-LIABILITY-AND-EQUITY> 54,779,455
<SALES> 10,524,828
<TOTAL-REVENUES> 11,100,709
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<NET-INCOME> (51,022,312)
<EPS-PRIMARY> (2.96)
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</TABLE>
