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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
For the fiscal year ended October 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ____________.
COMMISSION FILE NO. 0-25668
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INTERACTIVE FLIGHT TECHNOLOGIES, INC.
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(Name of Small Business Issuer in Its Charter)
DELAWARE 11-3197148
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
4041 N. CENTRAL AVENUE
PHOENIX, ARIZONA 85012
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(Address of Principal Executive Offices)
(602) 200-8900
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(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:
<TABLE>
<S> <C>
Title of each Class Name of Each Exchange on Which Registered
- ----------------------------------------------- -----------------------------------------
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
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Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-K 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, 1998 were
$19,142,961.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant on January 8, 1999 was approximately $15,967,494, 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 8, 1999 was 5,317,900 shares of Class A Common Stock,
$0.01 par value, and 1,185,186 shares of Class B Common Stock, $0.01 par value.
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DOCUMENTS INCORPORATED BY REFERENCE
The Registrant's Definitive Proxy Statement relating to the Registrant's
1999 Annual Meeting of Stockholders, to be filed by the Registrant with the
Securities and Exchange Commission on or before February 28, 1999, 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
PAGE
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PART I.................................................................... 1
ITEM 1 -- DESCRIPTION OF BUSINESS....................................... 1
ITEM 2 -- DESCRIPTION OF PROPERTY....................................... 7
ITEM 3 -- LEGAL PROCEEDINGS............................................. 7
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........... 8
PART II................................................................... 9
ITEM 5 -- MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...... 9
ITEM 6 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................... 9
ITEM 7 -- FINANCIAL STATEMENTS.......................................... 15
ITEM 8 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................... 15
PART III.................................................................. 16
ITEMS 9 - 12 -- DOCUMENTS INCORPORATED BY REFERENCE..................... 16
ITEM 13 -- EXHIBITS AND REPORTS ON FORM 8-K............................. 16
SIGNATURES................................................................ 18
FINANCIAL STATEMENTS...................................................... F-1
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PART I
ITEM I -- DESCRIPTION OF BUSINESS
THE COMPANY
Interactive Flight Technologies, Inc. and subsidiary (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").
On September 15, 1998, the former management and Board of Directors
resigned and elected the current directors as the Board of the Company. The
current Board was reelected by the stockholders of the Company at the Annual
Meeting held on October 30, 1998. The new management of the Company has been
evaluating the in-flight entertainment business and the opportunities presented
by technology related to such business and is developing a strategic plan to
take advantage of the opportunities associated with the in-flight entertainment
business and the technologies related thereto for alternative markets. New
management is pursuing a sale to or a strategic alliance with other entities in
the in-flight entertainment business in order to maximize the potential of the
Entertainment Network. In addition, new management is currently evaluating
technology related businesses that may build upon the Company's core
competencies, as well as other technology related business opportunities. New
management is evaluating how to re-deploy the Company's capital to exploit such
potential alliance and business opportunities. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Outlook: Issues and
Risks."
On July 24, 1998, the Company acquired the assets and business of Johnny
Valet, Inc., a retail dry cleaning plant in San Diego, California. The Company
paid $688,736 in cash and signed a non-interest bearing note for $125,000. The
acquisition represented the Company's initial foray into the dry cleaning
business. In October 1998, the Company's new Board of Directors decided to not
pursue the strategy of consolidating the dry cleaning industry. The Company is
presently attempting to sell this business and will no longer be in the dry
cleaning business.
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 B-200, Phoenix, Arizona
85012, and its telephone number is (602) 200-8900.
SWISSAIR
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."
The Company's only agreement for the Entertainment Network is with Swissair
VKB ("Swissair") which required the Company to install and maintain the
Entertainment Network in the first, business and economy class sections of three
aircraft at no cost to Swissair and in the first and business class of another
sixteen aircraft at an average price of $1.7 million per aircraft. As of October
31, 1998, the Company had completed all installations under the initial Swissair
program. The Company was responsible for maintenance costs through September
1998 for all nineteen aircraft. The Swissair agreement also provides a one-year
warranty (which is extended to three years under the letter of intent described
below) on all of the Entertainment Networks and requires specific software and
hardware upgrades to the Entertainment Networks. Development of these upgrades
is not complete. If the upgrades are not completed by specified deadlines, the
Company may face significant penalties. The Company must also meet operational
reliability criteria for the Entertainment Network through the year 2003 or be
subject to penalties.
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The Company has a letter of intent from Swissair for $4,700,000, which is
for first and business class installations on four Swissair MD-11 aircraft that
were scheduled to be added to the Swissair fleet beginning in November 1998. The
Company has also received a letter of intent from Swissair for $3,975,000 to
extend the warranty on all installed systems for a second and third year. The
Company has had no success in pursuing other major airlines to fill its pipeline
following the completion of the installation phase of the initial Swissair
program in March 1998. Because of the lack of prospects for success in obtaining
additional orders, and in order to reduce its expenses further, prior management
terminated almost all sales and marketing efforts as of May 29, 1998. Although
the Company may respond to any requests for proposals it receives from airlines,
the decision not to continue to invest resources in sales and marketing reflects
the fact that the Company has no significant prospects for additional revenue
from in-flight entertainment other than those related to the two letters of
intent from Swissair. Moreover, the Company's prior decision not to expend money
on developing the next generation of the Entertainment Network means that any
technological leads it had in this area can be expected to dissipate quickly. As
a consequence, the Company may well not be able to compete in the in-flight
entertainment business even if market conditions were to improve.
On October 29, 1998, the Company was notified by Swissair of its decision
to deactivate the Entertainment Networks on all Swissair aircraft. Swissair told
the Company that this precautionary action was taken in response to technical
investigations conducted by the Canadian Transportation Safety Board following
the crash of Swissair Flight No. 111 on September 2, 1998. However, based on
investigation findings, the Company has been informed by representatives of the
Canadian Transportation Safety Board and Swissair that its Entertainment Network
has not been related, in any way, to the cause of the crash of Swissair Flight
No. 111. The Federal Aviation Administration is conducting a review of the
system's installation certification and to date, has found no safety hazards or
violations of Federal Aviation Regulations. The Company and its system
integrator/installation contractor are working closely with Swissair to take the
necessary steps that will allow Swissair to reactivate all systems as quickly as
possible. On December 9, 1998, the Company was notified by Swissair of their
intent to reactivate the system in October 1999. The Company has submitted a
plan to Swissair for earlier reactivation of the Entertainment Network, which is
currently under discussion.
On December 9, 1998, the Company received notice from Swissair stating
their intent to cancel the order for the four additional installations. As of
January 5, 1999, Swissair has paid $645,000 of the $4.7 million order for the
four installations and continues to engage in active discussions with the
Company regarding outstanding financial matters and a reactivation process.
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, 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.
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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.
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 (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. 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.
Technological Aspects of the Entertainment Network
General. The Entertainment Network was designed to provide a network
system platform that permits the distribution of flexible multimedia (audio and
visual) content to individual users on a highly interactive basis. The
Entertainment Network also provides valuable statistical data concerning
end-user access to different entertainment and information options. This type of
network system has applications in alternative markets, which may create new
business opportunities for the Company, although no assurances can be made. The
software architecture that has been developed is a Web-browser architecture,
which readily supports many Internet applications.
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 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
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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.
The Company is currently assessing other uses for the technology involved
in the Entertainment Network besides the in-flight entertainment business.
PRODUCT DEVELOPMENT
During fiscal 1998, the Company continued to expand the functionality of
the Entertainment Network to include features which were contractually committed
to Swissair. Research and development expenses during fiscal 1998 and fiscal
1997 were approximately $1.1 Million and $7.8 Million, respectively. Such
amounts have not been borne by customers. The Company anticipates that research
and development expenses will continue to substantially decrease in the future
as the Company does not plan on developing any new generations of the
Entertainment Network for airlines. Research and development efforts of the
Company will include primarily those efforts that are required by contractual
obligations. Due to the 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 which is not
being utilized by the Company 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. 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."
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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, Matsushita, Rockwell-Collins (Hughes-Avicom), BE Aerospace, and
The Network Connection.
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. 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.
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.
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 1999. See "Item 2 -- Description of Property."
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
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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 Information."
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
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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.
EMPLOYEES
As of January 8, 1999, the Company employed 23 people on a full-time basis
and 3 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 45,000 square
feet of space and are occupied pursuant to three separate leases providing for
monthly rent of approximately $51,700. The leases expire in July 1999. The
Company subleases approximately 4,200 square feet of space to an unrelated party
at a monthly rent of $5,950. As a result of reductions in its work force, the
Company is attempting to sublease additional space under one of its leases.
However, the Company has been mostly 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 facilities for its dry cleaning operations in San
Diego, California pursuant to a lease that expires in August 2000. The lease
provides for monthly rent of approximately $4,900.
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.
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ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 30, 1998, the Company held its 1998 Annual Meeting of
Stockholders. At the Annual Meeting, the following matters were submitted to a
vote of stockholders:
1. The following five individuals, constituting the full Board of Directors
of the Company, were nominated and elected to serve as the directors of the
Company:
Irwin L. Gross FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
Charles T. Condy FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
Stephen Schachman FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
M. Moshe Porat FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
James W. Fox FOR: 6,575,259
WITHHOLD AUTHORITY: 47,182
2. The holders of 6,575,259 shares of Common Stock voted in favor of, the
holders of 6,505 shares of Common Stock voted against, and the holders of 64,139
shares of Common Stock abstained with respect to the proposed amendment to the
Amended and Restated Certificate of Incorporation of the Company for a Staggered
Board.
3. The holders of 6,575,259 shares of Common Stock voted in favor of, the
holders of 132,900 shares of Common Stock voted against, and the holders of
12,103 shares of Common Stock abstained with respect to the proposed amendment
to the Amended and Restated Certificate of Incorporation of the Company for the
Reverse Stock Split.
4. The holders of 6,651,926 shares of Common Stock voted in favor of, the
holders of 25,252 shares of Common Stock voted against, and the holders of
10,367 shares of Common Stock abstained with respect to the ratification of the
selection of KPMG LLP, independent certified public accountants, to serve as
independent accountants for the Company.
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PART II
ITEM 5 -- MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Class A Common Stock and Class B Warrants traded 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 and October 30, 1998, the Board of Directors
authorized the Company to repurchase shares of its Class A Common Stock on the
open market. As of January 8, 1999, the Company had repurchased 867,267 shares
at prices ranging from $0.75 to $3.00 per share. The Company expects to make
additional open market purchases of its shares in the future.
CLASS A COMMON STOCK HIGH LOW
- -------------------- -------- --------
November 1, 1996 through January 31, 1997................. 39 22 7/8
February 1, 1997 through April 30, 1997................... 25 7/8 9 15/16
May 1, 1997 through July 31, 1997......................... 22 1/8 9 15/16
August 1, 1997 through October 31, 1997................... 10 7/8 3
November 1, 1997 through January 31, 1998................. 4 5/8 1 7/8
February 1, 1998 through April 30, 1998................... 3 11/16 2 6/16
May 1, 1998 through July 31, 1998......................... 3 1/2 1 7/8
August 1, 1998 through October 31, 1998................... 3 1/8 1 7/8
The closing sales price of the Class A Common Stock as of January 8, 1999
as reported by the Nasdaq National Market was $3.125 per share.
As of January 8, 1999, there were 33 record holders of Class A Common
Stock.
On October 30, 1998, the stockholders of the Company approved a
one-for-three reverse stock split on the Company's Class A Common Stock and
Class B Common Stock. The reverse stock split was effective as of the close of
business on November 2, 1998. All references to the number of common shares,
price per share and stock option data elsewhere herein have been restated as
appropriate to reflect the effect of the reverse stock split for all periods
presented.
ITEM 6 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with, and is
qualified in its entirety by, Interactive Flight Technologies, Inc. and
subsidiary (the "Company") Consolidated Financial Statements and the Notes
thereto appearing elsewhere herein. Historical results are not necessarily
indicative of trends in operating results for any future period.
HISTORICAL OVERVIEW
Interactive Flight Technologies, Inc. and subsidiary 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 also
operates a retail dry cleaning facility in San Diego, California which it is in
the process of selling.
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Former management had determined to exit the in-flight entertainment
business in May 1998, except for continuing efforts associated with meeting its
contractual obligations with its only customer, Swissair. This decision was
based on a number of factors including industry trends, financial resources of
the Company and the Company's inability to attract new customers.
SWISSAIR
The Company's main agreement with Swissair required the Company to install
and maintain the Entertainment Network in the first, business and economy class
sections of three aircraft at no cost to Swissair and in the first and business
classes of another sixteen aircraft at an average price of $1.7 million per
aircraft. As of October 31, 1998, the Company had completed all installations
under the initial Swissair program. The Company was responsible for maintenance
costs through September 1998 for all nineteen aircraft and specific software and
hardware upgrades to the Entertainment Networks that are not yet completed. The
Swissair agreement also provided for a one-year warranty on all of the
Entertainment Networks. The Company has also received a letter of intent dated
April 1, 1998, from Swissair to extend the warranty on all installed systems for
a second and third year at a price of $3,975,000.
On April 1, 1998, the Company also entered into a letter of intent with
Swissair for a $4.7 million order for first and business class installations on
four Swissair MD-11 aircraft that are being added to the Swissair fleet. As of
October 31, 1998, none of the installations on the four aircraft were completed
though the Company had purchased or contracted for purchase, the majority of
materials required for the installations. On December 9, 1998, the Company
received notice from Swissair stating their intent to cancel the order for the
four additional installations. Inventory on-hand and outstanding purchase
commitments for inventory relating to the four additional installations totaling
$1,005,427 and $1,800,000, respectively, have been reflected in the Company's
consolidated financial statements and notes thereto, as of October 31, 1998. As
of January 8, 1999, Swissair had paid $645,000 of the $4.7 million order for the
four installations and continues to engage in active discussions with the
Company regarding outstanding financial matters related to current receivables,
inventory, purchase commitments and extended warranty obligations. Significant
uncertainty exists surrounding these matters and no assurances can be given that
such events will be resolved on favorable terms to the Company.
RESULTS OF OPERATIONS
Revenue for the year ended October 31, 1998 was $19,142,961, an increase of
$8,042,252 (or 72%) over revenue of $11,100,709 for the year ended October 31,
1997. Revenues in each year consist of equipment sales (principally from the
installation of the Entertainment Networks on Swissair aircraft) and service
income. During the year ended October 31, 1998, the Company completed
installations under the initial Swissair program in ten business classes and
eighteen first classes whereas installations completed in fiscal 1997 were in
nine business classes and one first class. Revenues from equipment sales rose
71% from $10.5 million in fiscal 1997 to $18.0 million in fiscal 1998 due to the
increased installations in fiscal 1998. Service income of $1,104,342 for the
year ended October 31, 1998 was principally generated from programming services
provided to Swissair, the Company's share of gaming profits generated by the
Swissair systems and revenue earned under the Swissair extended warranty Letter
of Intent. Also included in service income for the year ended October 31, 1998
is revenue of $326,000 generated by the Company's dry cleaning operations
acquired on July 24, 1998. Service income of $575,881 for the year ended October
31, 1997 was primarily derived from a Product Identification/Product Development
Agreement with an airline and entertainment programming services provided to
customers.
Cost of equipment sales and service income for the year ended October 31,
1998 was $15,762,119, a decrease of $9,116,341 (or 37%) over the comparable
figure of $24,878,460 for the fiscal year ended October 31, 1997. Cost of
equipment sales includes materials, installation and maintenance costs, as well
as estimated one-year warranty costs and costs of upgrades to the Swissair
Entertainment Networks that the Company is contractually committed to providing
to Swissair. The
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<PAGE>
decrease in cost of equipment sales is primarily a result of the inclusion of
provisions for inventory obsolescence, unusable inventory and rework adjustments
of $11,496,748 in cost of equipment sales for fiscal 1997. The 1997 provision
for inventory obsolescence was a result of the Company purchasing inventory for
installation in the economy sections of Swissair aircraft and actually
completing only three economy installations. The unusable inventory and rework
adjustments primarily resulted from the Company's redesign of the tray table
utilized in the Entertainment Networks for the economy section of an aircraft.
The decrease in cost of equipment sales for fiscal 1998 is also attributable to
reductions in maintenance costs and estimated one-year warranty costs as the
reliability of the Entertainment Networks has improved. Additionally, the
Company recognized a reduction in installation costs from its subcontractor
during fiscal 1998. Included in cost of service income for fiscal 1998 is
$225,047 of production costs related to the Company's dry cleaning operations.
Provisions for doubtful accounts for the year ended October 31, 1998 were
$9,869 compared to $216,820 for the year ended October 31, 1997. Fiscal 1998
provisions resulted from the Company's dry cleaning operations and fiscal 1997
provisions resulted from entertainment programming services provided to a
previous customer.
Bad debt recoveries of $1,064,284 during the year ended October 31, 1997
resulted from the recovery of accounts receivable under a customer agreement
which were reserved for during the Company's fourth quarter of its fiscal year
ended October 31, 1996.
Research and development expenses for the year ended October 31, 1998 were
$1,092,316, a decrease of $6,729,324 (or 86%) over expenses of $7,821,640 for
the year ended October 31, 1997. The decrease in expenses reflects the Company's
decision not to develop the next generation of the Entertainment Network and the
resulting reduction in staff and professional fees. The Company does not plan to
continue its research and development in the in-flight entertainment business
beyond those efforts that are required contractually by the Swissair agreement.
The Swissair agreement requires the Company to provide specific upgrades to the
Entertainment Network currently installed on Swissair aircraft. The Company
expects to complete the development of these upgrades in the first quarter of
fiscal 1999 and does not plan to develop any further upgrades to the
Entertainment Network. The anticipated costs of developing these upgrades were
included as cost of equipment sales in the Company's consolidated statements of
operations at the time of installation. The Company expects to continue any
development efforts that are required to support the Swissair system reliability
guarantees through the year 2003, subject to the development of a successful
reactivation plan.
General and administrative expenses for the year ended October 31, 1998
were $11,387,872, a decrease of $1,186,351 (or 9%) over expenses of $12,574,223
for the year ended October 31, 1997. The decrease in expenses reflects the
Company's reduction in staff in administrative areas, including production,
marketing and program management departments. As of May 29, 1998, the Company
terminated almost all sales and marketing efforts related to the Entertainment
Network. The decrease in expenses during fiscal 1998 was partly offset by the
payment of $3,053,642 in severance to three former executives of the Company.
Special charges for the year ended October 31, 1998 were $400,024 compared
to $19,649,765 for the year ended October 31, 1997. Special charges in fiscal
1998 primarily resulted from equipment write-offs of $1,006,532. The write-offs
were for excess computers, furniture and other equipment that the Company is not
utilizing in its operations and is in the process of disposing. The equipment
write-offs were partly offset by a recovery of special charges expensed in
fiscal 1997. During fiscal 1998, a recovery of $190,000 was recognized as a
special charge credit as a result of a reduction in the number of Entertainment
Networks requiring maintenance. The Company also recognized a recovery of
$416,508 related to Swissair's decision to not develop the system for the front
row in the economy sections of its aircraft. Special charges in fiscal 1997
primarily resulted from the installment of the Entertainment Networks on three
Swissair aircraft and installations required by the Debonair agreement. The
Company was responsible for the costs of installing the system on three Swissair
aircraft, including materials, installation, upgrades, a one-year warranty and
maintenance through
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<PAGE>
September of 1998. The costs for these three systems of $14,292,404 were
recorded as a special charge during fiscal 1997. Due to the termination of the
Debonair agreement, the costs of the installed system ($956,447) and all
inventory on-hand under the Debonair agreement ($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-off of a system integration lab utilized in
software development and testing. The lab equipment will not be utilized in the
Company's future operations.
Interest expense was $11,954 for the year ended October 31, 1998 compared
to $13,423 for the year ended October 31, 1997. The expense is attributable to
the Company's capital leases for furniture that expire in September of 1999.
Interest income for the year ended October 31, 1998 was $2,251,055, an
increase of $80,380 (or 4%) over income of $2,170,675 for the year ended October
31, 1997. The interest arose principally out of short-term investments of
working capital. The increase in income is due to the higher average cash
balance during fiscal 1998 compared to fiscal 1997.
Other income of $10,179 for the year ended October 31, 1998 represents
proceeds from the sale of scrapped inventory. Other expense of $203,649 for the
year ended October 31, 1997 represents the loss on disposals of property and
equipment.
LIQUIDITY AND CAPITAL RESOURCES
At October 31, 1998, the Company had working capital of approximately $23.1
million. The Company's primary source of funding has been through equity
offerings. Excluding any payments to be received under the Swissair Letter of
Intent to extend the warranty, the Company's backlog consisted only of
installations on four Swissair aircraft, which have subsequently been cancelled
as discussed above. Therefore, the Company does not expect any significant
profit from its in-flight entertainment business for the foreseeable future. As
a result, working capital may continue to decrease.
During the year ended October 31, 1998, the Company used $3.2 million of
cash in operating activities, a decrease of $31 million from the $34.2 million
of cash utilized in operating activities during fiscal 1997. The decrease in
cash utilized in operations in fiscal 1998 compared to fiscal 1997 is primarily
a result of a decrease in the net loss. The cash utilized in operations during
fiscal 1998 resulted from decreases in accounts receivable and inventories and
an increase in accrued product warranties, partly offset by the net loss and
decrease in accounts payable, accrued liabilities and deferred revenue.
Purchases of property and equipment for the year ended October 31, 1998
were $77,013 compared to $10.3 million for the year ended October 31, 1997.
Capital expenditures for fiscal 1997 were primarily related to the manufacture
of the system under the Debonair agreement, the installation of systems on three
aircraft under the Swissair Agreement, and research and development equipment.
During fiscal 1998, the Company's restricted cash increased by $1.0 million
for payments required under consulting and severance agreements with three
former executives of the Company. The Company also loaned $447,939 to a related
party for the purchase of 99,542 shares of the Company's Class A Common Stock.
The note is secured by 99,542 shares of the Company's Class A Common Stock,
bears interest at the prime rate plus 1% and is due in October 2001.
In connection with a stock repurchase program during the year ended October
31, 1998, the Company purchased a total of 844,667 shares of the Company's Class
A Common Stock in open market activities at a total cost of $2,315,983. On
October 30, 1998, the Board of Directors authorized another repurchase program
whereby the Company may repurchase up to 666,667 shares of its Class A Common
Stock on the open market.
At October 31, 1998, the Company's material capital commitments were
purchase orders of approximately $1.8 million relating primarily to inventory
purchases for its obligations under the Swissair Agreements.
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<PAGE>
The Company is currently using its working capital to finance its current
expenses, including product development, inventory purchases, repairs and other
expenses associated with the delivery and installation of the Swissair systems
and general and administrative costs. The Company believes that its current cash
balances plus interest received on such balances will be sufficient to meet the
Company's currently anticipated cash requirements for at least the next twelve
months.
OUTLOOK: ISSUES AND RISKS
On September 15, 1998 the former Board of Directors of the Company resigned
and elected the current directors as the new Board of the Company. On October
30, 1998, the stockholders reelected the new Board at the Annual Stockholders'
Meeting. The Company and its Board of Directors are in the process of developing
a strategic plan for the Company to maximize shareholder value, though no
assurances can be given as to the ultimate implementation and success of such
plan. The Company is developing strategies to leverage off certain core
competencies developed in the in-flight entertainment business to enter new
markets with the technology. Further, the Company is investigating strategic
alliances for the in-flight entertainment business and other technology related
business opportunities. The Company believes its in-flight entertainment system
core technology has value and the Company has begun a process to actively market
the system and its related technology to or to form strategic alliances with
respect thereto with its competitors and other avionics manufacturers. There can
be no assurances that the Company will be successful in locating a buyer or a
strategic partner for its system and technology.
In November 1998, the Company entered into a Letter of Intent to acquire a
27.5% equity interest in Inter Lotto Ltd. (Inter Lotto). Inter Lotto is a United
Kingdom company involved in the operation of lotteries. Pursuant to the Letter
of Intent, the Company would pay pounds 200,000 to an unrelated third party for
the 27.5% equity interest and enter into a management agreement with Inter Lotto
whereby the Company would have the authority and responsibility for the
management of Inter Lotto's operations. Prior to the closing of the transaction,
the Company has committed to providing advances to Inter Lotto to fund their
current operations. The closing is subject to completion of due diligence and
other conditions.
In December 1998, the Company entered into a Letter of Intent to acquire a
55% interest in Information Paradigms, Inc. (IPI). IPI has developed software
for use by investment management companies. Pursuant to the Letter of Intent,
the Company would commit up to $3,000,000 of capital in the form of a secured
convertible interest-bearing note. The note would be convertible to equity of
IPI at the Company's option. The closing of the transaction is subject to
completion of due diligence and other conditions.
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. There can be no assurances that the Company will be
successful in developing an alternative business strategy or that it will be
successful in locating, evaluating, purchasing and operating other businesses.
In addition, the Company has used in the past, and may continue to use, a
portion of its cash to repurchase its own shares.
The Company's contract with Swissair requires the Company to support the
Entertainment Networks installed on Swissair aircraft through 2003. The Company
must meet operational reliability criteria for the systems and the Company is
working to further improve the reliability of the systems 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
these operational reliability criteria through the year 2003. Avoiding these
penalties may require the Company to continue to maintain a presence in the
in-flight entertainment business. The Company believes that Swissair's decision
to deactivate the Entertainment Networks will not result in penalties.
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<PAGE>
On July 24, 1998, pursuant to a strategic initiative of former management,
the Company acquired the assets and business of Johnny Valet, Inc., a retail dry
cleaning plant in San Diego, California, for $813,736. The acquisition
represented the Company's initial foray into the dry cleaning business. In
October 1998, the Company's new Board of Directors decided to not pursue the
strategy of consolidating the dry cleaning industry and determined that it would
sell the assets of Johnny Valet, Inc. There can be no assurances that the
Company will be successful in divesting its dry cleaning operation in a timely
manner or that the Company will be able to recover its investment.
YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the year, thus rendering them incapable of
properly managing and manipulating data that includes 21st century dates. The
Company has performed an assessment of its Entertainment Network for year 2000
issues. The Entertainment Network is a Microsoft based network system that uses
a four-digit year identifier and is therefore year 2000 compliant. The Company
believes that its products have no inherent date sensitive features. The Company
has also reviewed its existing software systems utilized in the planning,
purchasing, manufacturing, product development and accounting areas and believes
these systems are all year 2000 compliant. The Company does not believe the year
2000 issue will pose significant operational problems for the Company.
The Company continues to evaluate the estimated costs associated with its
year 2000 compliance efforts and does not expect the future costs to be
material. However, no assurance can be given that the Company will not incur
additional expenses pursuing year 2000 compliance. Furthermore, even if the
Company's systems are year 2000 compliant, there can be no assurance that the
Company will not be adversely affected by the failure of others to become year
2000 compliant. For example, the Company may be adversely affected by, among
other things, warranty and other claims made by the Company's customers related
to product failures caused by the year 2000 problem, the disruption or
inaccuracy of data provided to the Company by non-year 2000 compliant third
parties, and the failure of the Company's service providers to become year 2000
compliant. The Company will continue to monitor the progress of its material
vendors and customers and formulate a contingency plan at that point in time
when the Company does not believe a material vendor or customer will be
compliant. Despite the Company's efforts to date, there can be no assurance that
the year 2000 problem will not have a material adverse effect on the Company in
the future.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 currently anticipated to be
applicable for the unrealized gains or losses on investment securities included
in the consolidated statement of stockholders' equity.
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 will result in more detailed information
in the notes to the Company's financial statements than is currently required
and provided.
14
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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, 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 resolve its differences with Swissair on a favorable
basis, 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 risks and
uncertainties involved in the Company's other proposed business ventures, 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 consolidated financial statements of the Company for the fiscal
year ended October 31, 1998 are located beginning at page F-1 of this Annual
Report on Form 10-KSB.
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.
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<PAGE>
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 1999 Annual
Meeting of Stockholders to be filed by the Registrant with the Securities and
Exchange Commission on or before February 28, 1999.
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
EXHIBIT
NUMBER DESCRIPTION
------- -----------
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(l) -- Employment Agreement between the Registrant and Michail
Itkis dated as of October 31, 1994
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(l) -- 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
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EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
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.
10.20(6) -- Debonair Termination Agreement, dated as of February 13,
1998
10.21(6) -- Lease Termination Agreement, dated as of May 27, 1998
10.22(6) -- Lease Surrender Agreement, dated as of May 12, 1998
10.23(7) -- Amendment to Severance Compensation Agreement, dated as of
August 28, 1998
10.24(7) -- Second Amendment to Employment Agreement, dated as of August
28, 1998
10.25(7) -- Second Amendment to Employment Agreement, dated as of August
28, 1998
23 -- Consent of KPMG LLP
27 -- Financial Data Schedule
- ------------------
(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
1O-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 on March 17, 1997, File No. 0-25668.
(6) Incorporated by reference from the Registrant's Quarterly Report on Form
10-QSB for the fiscal quarter ended April 30, 1998, filed with the
Securities and Exchange Commission on June 5, 1998, File No. 0-25668.
(7) Incorporated by reference from the Registrant's Quarterly Report on Form
10-QSB for the fiscal quarter ended July 31, 1998, filed with the Securities
and Exchange Commission on September 15, 1998, File No. 0-25668.
(B) REPORTS ON FORM 8-K.
During the quarter ended October 31, 1998, the Company filed a Current
Report on Form 8-K dated September 1, 1998, in which the Company disclosed
information under "Item 5 -- Other Events" and a Current Report on Form 8-K
dated October 29, 1998, in which the Company disclosed information under "Item 5
- -- Other Events."
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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 14, 1999 By: /s/ IRWIN L. GROSS
---------------------------------
Irwin L. Gross,
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/ IRWIN L. GROSS Chief Executive Officer and Director January 14, 1999
- -----------------------------
Irwin L. Gross
/s/ JAMES W. FOX President and Director January 14, 1999
- -----------------------------
James W. Fox
/s/ MORRIS C. AARON Chief Financial Officer January 14, 1999
- ----------------------------- (Principal Financial Officer)
Morris C. Aaron
/s/ MARCHEA E. MALONE Vice President - Finance January 14, 1999
- ----------------------------- (Chief Accounting Officer)
Marchea E. Malone
/s/ CHARLES T. CONDY Director January 14, 1999
- -----------------------------
Charles T. Condy
/s/ STEPHEN SCHACHMAN Director January 14, 1999
- -----------------------------
Stephen Schachman
/s/ M. MOSHE PORAT Director January 14, 1999
- -----------------------------
M. Moshe Porat
</TABLE>
18
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report...................................... F-2
Consolidated Balance Sheets as of October 31, 1998 and 1997....... F-3
Consolidated Statements of Operations for the years ended
October 31, 1998 and 1997....................................... F-4
Consolidated Statements of Stockholders' Equity for the
years ended October 31, 1998 and 1997........................... F-5
Consolidated Statements of Cash Flows for the years ended
October 31, 1998 and 1997....................................... F-6
Notes to Consolidated Financial Statements........................ F-7 to F-23
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Interactive Flight Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Interactive
Flight Technologies, Inc. and subsidiary as of October 31, 1998 and 1997, and
the related consolidated statements of operations, stockholders' equity and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Interactive Flight
Technologies, Inc. and subsidiary as of October 31, 1998 and 1997, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
KPMG LLP
Phoenix, Arizona
December 11, 1998
F-2
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
OCTOBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $27,914,551 36,890,454
Restricted cash........................................... 1,039,311 --
Short-term investment securities.......................... 1,762,049 1,697,023
Accounts receivable....................................... 1,135,342 5,654,118
Inventories, net.......................................... 1,005,427 6,110,761
Prepaid expenses.......................................... 567,601 253,771
Assets held for use....................................... 699,196 --
Other current assets...................................... 379,046 606,883
----------- -----------
Total current assets.................................. 34,502,523 51,213,010
Investment securities....................................... 1,928,555 440,061
Note receivable from related party.......................... 447,939 --
Property and equipment, net................................. 780,035 2,959,539
Other assets................................................ 605,150 166,845
----------- -----------
Total assets.......................................... $38,264,202 54,779,455
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,447,815 5,747,833
Accrued liabilities....................................... 3,939,633 5,590,095
Deferred revenue.......................................... 453,022 2,383,904
Accrued product warranties................................ 5,369,008 4,610,687
Current maturities of capital lease obligations........... 76,840 80,753
Note payable.............................................. 125,000 --
----------- -----------
Total current liabilities............................. 11,411,318 18,413,272
Accrued severance costs, noncurrent......................... -- 55,000
Capital lease obligations, less current maturities.......... -- 76,840
----------- -----------
Total liabilities..................................... 11,411,318 18,545,112
----------- -----------
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; 6,125,908 and
6,063,332 shares issued and outstanding, respectively... 183,777 181,900
Class B common stock, six votes per share, par value $0.01
per share, 4,000,000 shares authorized; 1,244,445 shares
issued and outstanding including 1,066,667 shares placed
in escrow............................................... 37,334 37,334
Additional paid-in capital................................ 112,223,734 112,037,882
Net unrealized gains on investment securities............. 6,754 --
Accumulated deficit....................................... (83,282,732) (76,022,773)
Treasury stock, at cost; 844,667 shares................... (2,315,983) --
----------- -----------
Total stockholders' equity............................ 26,852,884 36,234,343
----------- -----------
Total liabilities and stockholders' equity............ $38,264,202 54,779,455
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenue:
Equipment sales.......................................... $18,038,619 10,524,828
Service income........................................... 1,104,342 575,881
----------- -----------
19,142,961 11,100,709
----------- -----------
Costs and expenses:
Cost of equipment sales.................................. 15,523,282 24,646,334
Cost of service income................................... 238,837 232,126
Provision for doubtful accounts.......................... 9,869 216,820
Research and development expenses........................ 1,092,316 7,821,640
General and administrative expenses...................... 11,387,872 12,574,223
Special charges.......................................... 400,024 19,649,765
Bad debt recoveries...................................... -- (1,064,284)
----------- -----------
28,652,200 64,076,624
----------- -----------
Operating loss..................................... (9,509,239) (52,975,915)
Other:
Interest expense......................................... (11,954) (13,423)
Interest income.......................................... 2,251,055 2,170,675
Other income (expense)................................... 10,179 (203,649)
----------- -----------
Net loss........................................... $(7,259,959) (51,022,312)
=========== ===========
Basic and diluted net loss per share of common stock....... $ (1.22) (8.89)
=========== ===========
Weighted average shares outstanding........................ 5,933,004 5,738,987
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CLASS A CLASS B NET UNREALIZED
COMMON STOCK COMMON STOCK ADDITIONAL GAINS ON
-------------------- ------------------- PAID-IN INVESTMENT ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL SECURITIES DEFICIT
--------- -------- --------- ------- ------------ -------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance as of October 31, 1996...... 2,700,683 $ 81,020 1,320,000 $39,600 $ 42,587,712 $ -- $(25,000,461)
Class A common stock issued for
services received (20,000
shares)......................... 20,000 600 -- -- 466,275 -- --
Class A common stock issued
pursuant to Class B warrant
exercise offer.................. 3,266,587 97,998 -- -- 73,491,777 -- --
Registration costs................ -- -- -- -- (4,481,164) -- --
Redemption of Class B warrants.... -- -- -- -- (40,576) -- --
Class A common stock issued under
stock option plan pursuant to
cashless exercise option........ 507 16 -- -- 13,858 -- --
Automatic conversion of Class B
shares to Class A shares upon
sale to non-holder of Class B
shares.......................... 75,555 2,266 (75,555) (2,266) -- -- --
Net loss.......................... -- -- -- -- -- -- (51,022,312)
--------- -------- --------- ------- ------------ ------ ------------
Balance as of October 31, 1997...... 6,063,332 181,900 1,244,445 37,334 112,037,882 -- (76,022,773)
Net unrealized gains on investment
securities...................... -- -- -- -- -- 6,754 --
Issuance of common stock pursuant
to bonus plan................... 62,576 1,877 -- -- 185,852 -- --
Treasury stock purchases (844,667
shares)......................... -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- -- (7,259,959)
--------- -------- --------- ------- ------------ ------ ------------
Balance as of October 31, 1998...... 6,125,908 $183,777 1,244,445 $37,334 $112,223,734 $6,754 $(83,282,732)
========= ======== ========= ======= ============ ====== ============
<CAPTION>
TOTAL
TREASURY STOCKHOLDERS'
STOCK EQUITY
----------- -------------
<S> <C> <C>
Balance as of October 31, 1996...... $ -- $17,707,871
Class A common stock issued for
services received (20,000
shares)......................... -- 466,875
Class A common stock issued
pursuant to Class B warrant
exercise offer.................. -- 73,589,775
Registration costs................ -- (4,481,164)
Redemption of Class B warrants.... -- (40,576)
Class A common stock issued under
stock option plan pursuant to
cashless exercise option........ -- 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)
----------- -----------
Balance as of October 31, 1997...... -- 36,234,343
Net unrealized gains on investment
securities...................... -- 6,754
Issuance of common stock pursuant
to bonus plan................... -- 187,729
Treasury stock purchases (844,667
shares)......................... (2,315,983) (2,315,983)
Net loss.......................... -- (7,259,959)
----------- -----------
Balance as of October 31, 1998...... $(2,315,983) $26,852,884
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(7,259,959) (51,022,312)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization........................... 1,338,017 1,815,779
Expense recognized upon issuance of stock options,
warrants and shares of Class A common stock............ -- 480,749
Provision for doubtful accounts......................... 9,869 216,820
Provision for inventory valuation....................... -- 8,297,933
Special charges......................................... (606,507) 19,649,765
Loss on disposals of property and equipment............. 1,006,531 203,649
Changes in assets and liabilities, net of acquisition:
Decrease (increase) in accounts receivable............ 4,505,074 (3,815,139)
Decrease in provision for doubtful accounts........... -- (1,949,197)
Decrease (increase) in inventories.................... 5,105,334 (12,563,721)
Increase in note receivable........................... (447,939) --
(Increase) decrease in prepaid expenses, other current
assets and other assets.............................. (532,338) 183,394
(Decrease) increase in accounts payable............... (4,284,167) 1,673,893
Decrease in accrued liabilities....................... (892,345) (584,655)
(Decrease) increase in deferred revenue............... (1,930,882) 2,383,904
Increase in accrued product warranties................ 758,321 836,667
----------- -----------
Net cash used in operating activities.............. (3,230,991) (34,192,471)
----------- -----------
Cash flows from investing activities:
Maturities of investment securities....................... 2,468,880 6,810,275
Purchases of investment securities........................ (4,015,616) (2,137,084)
Purchases of property and equipment....................... (77,013) (10,341,561)
Proceeds from sale of equipment........................... 3,620 --
Increase in restricted cash............................... (1,039,311) --
Purchase of Johnny Valet, Inc............................. (688,736) --
----------- -----------
Net cash used in investing activities.............. (3,348,176) (5,668,370)
----------- -----------
Cash flows from financing activities:
Payments on capital lease obligations..................... (80,753) (53,085)
Repurchase of common stock................................ (2,315,983) --
Proceeds from issuance of common stock.................... -- 73,589,775
Registration costs........................................ -- (4,481,164)
Redemption of Class A and Class B warrants................ -- (40,576)
----------- -----------
Net cash provided by (used in) financing
activities....................................... (2,396,736) 69,014,950
----------- -----------
Net increase (decrease) in cash and cash
equivalents...................................... (8,975,903) 29,154,109
Cash and cash equivalents at beginning of year.............. 36,890,454 7,736,345
----------- -----------
Cash and cash equivalents at end of year.................... $27,914,551 36,890,454
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) DESCRIPTION OF BUSINESS
Interactive Flight Technologies, Inc. and subsidiary (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. The
Company also operates a retail dry cleaning facility in San Diego, California.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Interactive
Flight Technologies, Inc. and its wholly-owned subsidiary. All significant
intercompany accounts and transactions have been eliminated in consolidation.
(C) REVERSE STOCK SPLIT
On October 30, 1998, the stockholders of the Company approved a
one-for-three reverse stock split on the Company's Class A common stock and
Class B common stock. One share will be issued for three shares of Common Stock
held by stockholders of record as of the close of business on November 2, 1998.
All references to the number of common shares, per share amounts and stock
option data elsewhere in the consolidated financial statements and related
footnotes have been restated as appropriate to reflect the effect of the reverse
split for all periods presented.
(D) 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.
(E) RESTRICTED CASH
At October 31, 1998, the Company held restricted cash of $1,039,311 in a
trust fund for payments required under consulting and severance agreements with
three former executives of the Company. See Note 13.
(F) INVESTMENT SECURITIES
Investment securities consist of debt securities 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" ("SFAS No. 115") the debt securities are classified
as available-for-sale and carried at fair value, based on quoted market prices
or classified as held-to-maturity and carried at amortized cost. The net
unrealized gains or losses on these investments are reported in stockholders'
equity, net of tax. The specific identification method is used to compute the
realized gains and losses on the debt securities.
F-7
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES -- (CONTINUED)
(G) INVENTORIES
Inventories consisting principally of entertainment network components are
stated at the lower of cost (first-in, first-out method) or market.
(H) GOODWILL
The Company classifies as goodwill the excess of the purchase price over
the fair value of the net assets acquired in a purchase transaction and goodwill
is amortized over 10 years using the straight line method. At October 31, 1998,
goodwill is included in assets held for sale on the consolidated balance sheet.
See Note 5.
(I) PROPERTY AND EQUIPMENT
Property and equipment are stated at the lower of cost or net realizable
value. 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.
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.
(J) 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. Revenue earned pursuant to extended warranty agreements is recognized
ratably over the warranty period.
(K) DEFERRED REVENUE
Deferred revenue represents the gross profit on advance billings of
equipment sales as allowed under installation and extended warranty contracts.
(L) 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.
(M) 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 with an
initial warranty period. Revenue and expenses under extended warranty agreements
are recognized ratably over the term of the extended warranty.
F-8
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES -- (CONTINUED)
(N) IMPAIRMENT OF LONG-LIVED ASSETS
The Company records impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
(O) 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 carryforwards. 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.
(P) LOSS PER SHARE
In 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
128, "Earnings per Share". SFAS No. 128 replaced the calculation of primary and
fully diluted loss per share with basic and diluted loss per share. Unlike
primary loss per share, basic loss per share excludes any dilutive effects of
options, warrants and convertible securities. Diluted loss per share is very
similar to the previously reported fully diluted loss per share. All loss per
share amounts for all periods have been presented, and where appropriate,
restated to conform to the SFAS No. 128 requirements. Weighted average shares
for purposes of the loss per share calculation do not include 1,066,667 shares
placed in escrow at October 31, 1998 and 1997 due to the fact that they are
contingently issuable and 685,610 and 710,717 stock options outstanding at
October 31, 1998 and 1997, respectively, because their inclusion would have been
anti-dilutive.
(Q) 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
SFAS No. 123, "Accounting for Stock-Based Compensation". See Note 9.
(R) RECLASSIFICATIONS
Certain reclassifications have been made to the 1997 consolidated financial
statements to conform to the 1998 presentation.
(S) 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.
F-9
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES -- (CONTINUED)
(T) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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 currently anticipated to be applicable
for the unrealized gains or losses on investment securities included in the
consolidated statement of stockholders' equity.
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, will 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.
(2) INVESTMENTS
A summary of investments by major security type at October 31, 1998 and
1997 follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
OCTOBER 31, 1998
Available-for-sale:
Corporate debt securities................ $3,683,850 $6,754 $ -- $3,690,604
========== ====== ===== ==========
OCTOBER 31, 1997
Held-to-maturity:
Corporate debt securities................ $2,137,084 $ 306 $(131) $2,137,259
========== ====== ===== ==========
</TABLE>
Maturities of securities at October 31, 1998 and 1997 follow:
<TABLE>
<CAPTION>
1998 1997
----------------------- -----------------------
AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Available-for-sale:
Due within one year.................. $1,759,728 $1,762,049 $ -- $ --
Due after one year................... 1,924,122 1,928,555 -- --
---------- ---------- ---------- ----------
$3,683,850 $3,690,604 $ -- $ --
========== ========== ========== ==========
Held-to-maturity:
Due within one year.................. $ -- $ -- $1,697,023 $1,697,062
Due after one year................... -- -- 440,061 440,197
---------- ---------- ---------- ----------
$ -- $ -- $2,137,084 $2,137,259
========== ========== ========== ==========
</TABLE>
A one-time reclassification was made effective October 31, 1998 upon
reassessment of the appropriateness of the classifications of all securities
held. Securities with an amortized cost of $3,683,850 were transferred from
securities classified as held-to-maturity to securities classified as
available-for-sale. The unrealized gain on the securities transferred was
$6,754. The Company
F-10
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(2) INVESTMENTS -- (CONTINUED)
reclassified the securities since they may be sold in response to needs for
liquidity or changes in interest rates.
(3) ACCOUNTS RECEIVABLE
Accounts receivable consists of the following as of October 31, 1998 and
1997:
1998 1997
---------- ----------
Trade accounts receivable.................... $1,130,648 $4,883,043
Other........................................ 4,694 771,075
---------- ----------
Accounts receivable..................... $1,135,342 $5,654,118
========== ==========
(4) INVENTORIES
Inventories consist of the following as of October 31, 1998 and 1997:
1998 1997
---------- -----------
Raw materials............................... $2,192,442 $ 4,074,492
Work in process............................. 3,439,888 4,828,173
Finished goods.............................. 4,102,702 8,387,991
---------- -----------
9,735,032 17,290,656
Less provision for inventory valuation...... (8,729,605) (11,179,895)
---------- -----------
Inventories, net....................... $1,005,427 $ 6,110,761
========== ===========
(5) ASSETS HELD FOR USE
On July 24, 1998, the Company purchased the assets of Johnny Valet, Inc. a
retail dry cleaning plant in San Diego, California. The Company paid $688,736 in
cash and signed a note payable for $125,000. The non-interest-bearing note is
due on January 10, 1999. The acquisition was accounted for utilizing the
purchase method of accounting with the purchase price being allocated to the
assets acquired and liabilities assumed based on their fair values. The excess
of the purchase price over the fair value of assets acquired of $543,150 was
recorded as goodwill and is being amortized over ten years.
In October 1998, the Company decided to not continue to pursue its strategy
of consolidating the dry cleaning industry and determined that it would sell the
assets of Johnny Valet, Inc. Goodwill was written down by $106,000 to reflect a
reduction in the estimated amortizable life of the goodwill. The net assets held
for use total $699,196 and have been classified as current assets on the
consolidated balance sheet as of October 31, 1998. Operations of Johnny Valet,
Inc. for the period from July 24, 1998 to October 31, 1998 resulted in a loss of
$134,820 net of tax, including goodwill write-downs, and are included in the
consolidated statement of operations for the year ended October 31, 1998.
(6) NOTE RECEIVABLE
On October 21, 1998, the Company loaned Ocean Castle Investments, LLC
(Ocean Castle) $447,939 to execute a block purchase of shares of the Company's
Class A common stock from an unrelated third party. The Company's Chief
Executive Officer is a principal of Ocean Castle. The note bears interest at the
prime rate plus 1% with all interest and principal due October 21, 2001. The
note is secured by 99,542 shares of the Company's Class A common stock.
F-11
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(7) PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of October 31, 1998 and
1997:
1998 1997
---------- -----------
Leasehold improvements...................... $ 237,551 $ 472,901
Purchased software.......................... 149,703 274,617
Furniture................................... 138,609 526,900
Equipment................................... 903,873 2,744,073
Shipsets and shipsets under construction.... -- 8,496,431
---------- -----------
1,429,736 12,514,922
Less accumulated depreciation............... (649,701) (9,555,383)
---------- -----------
Property and equipment, net............ $ 780,035 $ 2,959,539
========== ===========
During the year ended October 31, 1998, the Company recorded equipment
write-offs of $1,006,532 which are included in special charges on the
consolidated statement of operations. The write-offs are principally related to
excess computers, furniture and other equipment that the Company is not
utilizing.
During the year ended October 31, 1997, the Company recorded equipment
write-offs of $1,518,952 which are included in special charges in the
consolidated statement of operations. The write-offs 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.
(8) ACCRUED LIABILITIES
Accrued liabilities consist of the following as of October 31, 1998 and
1997:
1998 1997
---------- ----------
Accrued development and support costs........ $1,845,915 $2,534,689
Accrued maintenance costs.................... 402,418 1,286,873
Due to related parties (see note 13)......... 880,000 55,000
Other accrued expenses....................... 811,300 1,713,533
---------- ----------
Accrued liabilities..................... $3,939,633 $5,590,095
========== ==========
(9) STOCK OPTION PLANS
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 200,000 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 800,000. 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.
F-12
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(9) STOCK OPTION PLANS -- (CONTINUED)
In June 1997, the Company established a 1997 Stock Option Plan (the 1997
Plan). Options exercisable for a total of 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 1998, 240,499 stock
options with up to a three-year vesting period were granted at exercise prices
ranging from $1.875 to $4.50. As of October 31, 1998, 258,557 stock options
under the 1997 Plan remained available for grant.
On February 10, 1998, the Company adopted a plan to reduce the exercise
price on the stock options under the Company's 1994 and 1997 Plans on specified
dates to $2.625 provided the holder is a current employee on the applicable
future dates. The exercise price on one-half of each outstanding option was
reduced to $2.625 on October 10, 1998 pursuant to the plan. A similar reduction
in the exercise price for the remaining half of the options will occur on April
10, 1999, provided the option holder is still employed by the Company at that
time.
During the year ended October 31, 1998, the Company granted stock options
to purchase 33,333 shares of Class A common stock at an exercise price of $4.50
to each of three stockholders of the Company. The options were granted in
exchange for consulting services. See Note 13.
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.
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:
YEARS ENDED OCTOBER 31,
-----------------------------
1998 1997
----------- ------------
Net loss:
As reported............................. $(7,259,959) $(51,022,312)
=========== ============
Pro forma............................... $(7,666,463) $(53,486,930)
=========== ============
Basic and diluted net loss per share:
As reported............................. $ (1.22) $ (8.89)
=========== ============
Pro forma............................... $ (1.29) $ (9.32)
=========== ============
Pro forma net losses reflect only options granted in fiscal 1998, 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.
F-13
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(9) STOCK OPTION PLANS -- (CONTINUED)
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 1998 and 1997:
YEARS ENDED OCTOBER 31,
------------------------
1998 1997
------ ------
Dividend yield.................................. 0% 0%
Expected volatility............................. 71.62% 71.62%
Risk free interest rate......................... 5.65% 6.12%
Expected lives (years).......................... 5.0 5.0
Activity related to the stock option plans is summarized below:
<TABLE>
<CAPTION>
YEARS ENDED OCTOBER 31,
------------------------------------------------------
1998 1997
------------------------ ------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE
---------- -------- ---------- --------
<S> <C> <C> <C> <C>
Balance at the beginning of year............. 710,717 $24.15 534,900 $29.43
Granted...................................... 240,499 3.01 282,233 22.32
Exercised.................................... -- -- (2,983) 21.72
Forfeited.................................... (265,606) 21.94 (103,433) 23.82
-------- --------
Balance at the end of year................... 685,610 17.42 710,717 24.15
======== ========
Exercisable at the end of year............... 426,311 24.70 428,928 24.48
======== ========
Weighted-average fair value of options
granted during the year.................... $ 1.91 $ 14.04
======== ========
</TABLE>
The following table summarizes the status of outstanding stock options as
of October 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------ ----------- ------------ -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 1.87 - $13.50....................... 279,029 9.58 $ 4.20 42,533 $10.60
$15.00 - $23.82....................... 7,750 7.83 19.55 5,250 18.94
$24.00................................ 249,582 7.92 24.00 246,113 24.00
$28.86 - $43.14....................... 149,249 7.67 31.00 132,415 30.75
------- -------
685,610 426,311
======= =======
</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, 507 shares of stock were issued upon the exercise of 2,950
options during the fiscal year ended October 31, 1997. Compensation expense of
$13,874 is included in the accompanying consolidated statement of operations for
the year ended October 31, 1997.
(10) 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
F-14
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(10) BENEFIT PLAN -- (CONTINUED)
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, 1998 or 1997.
(11) 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.
(A) STOCK REPURCHASE ACTIVITY
In connection with a stock repurchase program authorized by the Board of
Directors on December 17, 1997, the Company purchased a total of 844,667 shares
of the Company's Class A common stock in open market activities at a total cost
of $2,315,983. On October 30, 1998, the Board of Directors authorized another
repurchase program whereby the Company may repurchase up to 666,667 shares of
its Class A common stock on the open market.
(B) ESCROW SHARES
As a condition of the Company's initial public offering in March 1995, the
underwriter required that an aggregate of 1,066,667 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, 416,667 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:
o 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;
o the closing bid price of the Company's Class A common stock is in excess
of $48.00 for a 30-day period during the 18-month period following the
public offering or in excess of $60.00 for a 30-day period in the
subsequent 18-month period.
The remaining 650,000 escrow shares will be released from escrow, if and
only if, one or more of the following conditions is/are met:
o 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;
o the closing bid price of the Company's Class A common stock is in excess
of $66.00 for a 30-day period during the 18-month period following the
public offering or in excess of $84.00 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. Management believes the criteria will not
be met and such shares would then revert to the Company's treasury.
F-15
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(11) STOCKHOLDERS' EQUITY -- (CONTINUED)
(C) WARRANTS
The following table summarizes warrant activity for the years ended October
31, 1998 and 1997:
<TABLE>
<CAPTION>
CLASS B CLASS C CLASS D CLASS E
----------- ------- ------- -------
<S> <C> <C> <C> <C>
Outstanding as of October 31, 1996............ 3,536,482 55,000 55,000 --
Issued in connection with advisory services... -- -- -- 50,000
Issued in connection with amendment of license
agreement................................... -- -- -- 16,667
Exercise of Class B warrants.................. (3,266,587) -- -- --
Redemption of Class B warrants................ (269,895) -- -- --
----------- ------- ------- -------
Outstanding as of October 31, 1997 and
October 31, 1998............................ -- 55,000 55,000 66,667
=========== ======= ======= =======
Exercise price................................ $ 29.25 $ 33.00 $ 42.00 $ 24.00
=========== ======= ======= =======
</TABLE>
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 are exercisable as
of October 31, 1998.
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 $22.50 per
share from $29.25 per share upon the exercise of each Class B warrant exercised
by December 24, 1996. As a result of this offer, 3,266,587 shares of Class A
common stock were issued upon the exercise of 3,266,587 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 269,895 Class B warrants at $.15 per warrant.
In November 1996, the Company issued stock purchase warrants to purchase
50,000 shares of Class A common stock at $29.63 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 $24 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
16,667 shares of Class A common stock at $32.25 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 $24 per share, such
price being the trading price of the Class A common stock at the close of the
previous business day.
(D) 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 93,333 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 $18.00 per unit, subject to
certain events.
F-16
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(12) 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:
1998 1997
----------- ------------
Computed expected tax benefit...................... $ 2,468,386 $ 17,347,586
Change in valuation allowance...................... (2,127,293) (17,328,254)
Nondeductible severance payments................... (416,498) --
Other.............................................. 75,405 (19,332)
----------- ------------
$ -- $ --
=========== ============
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax asset are presented below:
1998 1997
----------- ------------
Deferred tax assets:
Net operating loss carryforward.................. $18,836,132 $ 13,014,307
Property and equipment........................... 1,135,837 3,088,482
Deferred start-up costs.......................... 825,091 1,159,948
Accrued product warranty costs................... 1,825,463 1,567,634
Issuance of stock options and warrants........... 864,577 866,879
Provision for inventory valuation................ 2,968,066 3,801,164
Accrued liabilities.............................. 1,198,426 1,299,329
Deferred revenue................................. 154,027 810,527
Other............................................ 133,205 205,261
----------- ------------
27,940,824 25,813,531
Less valuation allowance........................... (27,940,824) (25,813,531)
----------- ------------
Net deferred tax asset..................... $ -- $ --
=========== ============
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, 1998, the Company has a net
operating loss (NOL) carryforward for federal income tax purposes of
approximately $55,400,000, which begins to expire in 2009, and a research and
experimentation tax credit of approximately $247,000. 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, though it is not expected to
materially effect the amount of the NOL carryforward.
(13) RELATED PARTY TRANSACTIONS
During the year ended October 31, 1998, the Company executed severance
agreements with three former officers, pursuant to which the Company paid the
former officers $3,053,642. In addition, the
F-17
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(13) RELATED PARTY TRANSACTIONS -- (CONTINUED)
Company executed consulting agreements with the three former officers with
varying terms expiring through September 1999. The consulting agreements require
payments totaling $735,000 over the various terms. As of October 31, 1998,
$133,750 has been paid under the consulting agreements, $175,000 has been
included in accrued liabilities in the consolidated balance sheet and $308,750
has been included in general and administrative expenses in the consolidated
statement of operations. Additionally, the Company's stockholders' agreement
with principal stockholders covering certain corporate governance matters was
canceled.
The Company's Chief Executive Officer is a principal of Ocean Castle
Investments, LLC (Ocean Castle) which maintains administrative offices for the
Company's Chief Executive Officer, Corporate Secretary and certain other
employees of the Company. The Company has an agreement with Ocean Castle whereby
the Company will pay for all reasonable and ordinary expenses incurred by Ocean
Castle in operating such offices and furthering the Company's business.
During the year ended October 31, 1998, Ocean Castle executed consulting
agreements with two principal stockholders of the Company. The rights and
obligations of Ocean Castle under the agreements were assumed by the Company.
The consulting agreements require payments aggregating $1,000,000 to each of the
consultants through December 2003 in exchange for advisory services. Each of the
consultants also received stock options to purchase 33,333 shares of Class A
common stock at an exercise price of $4.50. Additionally, the Company also
granted stock options to purchase 33,333 shares of Class A common stock at an
exercise price of $4.50 to another stockholder of the Company. The options were
granted in exchange for consulting services.
During the year ended October 31, 1998, the Company extended by one year a
consulting agreement with a former officer of the Company pursuant to which the
Company will pay $55,000 for services received during the period November 1999
through October 2000.
The Company has entered into a consulting agreement with First Lawrence
Capital Corp. (First Lawrence) to perform various financial advisory services
related to ongoing business development and management. The managing director of
First Lawrence is also a director of the Company. After the date of the
independent auditors' report, the Company retained, on a full time basis as
President and Chief Operating Officer, the services of the managing director of
First Lawrence effective December 12, 1998. Accordingly, the Company will enter
into an employment contract with such individual. During the year ended October
31, 1998, the Company paid $11,846 under the First Lawrence consulting
agreement. The Company executed a consulting agreement with the Whitestone
Group, LLC, a shareholder of First Lawrence. Pursuant to the agreement, the
Company will pay $250,000 for consulting services received during fiscal 1998.
The Company has an Intellectual Property License and Support Services
Agreement (the License Agreement) for certain technology with FortuNet, Inc.
(FortuNet). FortuNet is owned by a principal stockholder and previous director
of the Company. The License Agreement provides for an annual license fee of
$100,000 commencing in October 1994 and continuing through November 2002. The
Company paid FortuNet $100,000 during each of the years ended October 31, 1998
and 1997. As of October 31, 1998, the remaining commitment of $400,000 is
included in accrued liabilities on the consolidated balance sheet.
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 former director of the
Company. The Company paid the Firm $811,687 during the year ended October 31,
1997.
F-18
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(13) RELATED PARTY TRANSACTIONS -- (CONTINUED)
The Company had a consulting agreement with Worldwide Associates
(Worldwide) to perform various consulting services. The chairman and president
of Worldwide is also a former director of the Company. The Company paid
Worldwide $56,063 during the year ended October 31, 1997.
In November 1996, the Company executed a Strategic Alliance Agreement
(Alliance Agreement) with Hyatt Ventures, Inc. (Hyatt), an affiliate of Hyatt
Corporation. The president of Hyatt is also a former director of the Company.
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. In January 1997, the Company issued 20,000
unregistered shares of Class A common stock to Hyatt in connection with Hyatt
acting as a guarantor on behalf of the Company in certain contract negotiations.
As a result of the stock issuance, a charge of $466,875 is included in the
consolidated 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, 1998, $55,000
remains to be paid under these agreements.
(14) COMMITMENTS AND CONTINGENCIES
(A) LAWSUIT
On March 6, 1998, the Company was named as a nominal defendant in a
derivative action filed in the Supreme Court of the State of New York, County of
New York, entitled Barington Capital Group, L.P. et al. v. Yuri Itkis et al.
(No. 98103878). The lawsuit named ten former officers and directors of the
Company and alleged various breaches of fiduciary duty. On October 21, 1998, the
Company settled the lawsuit with Barington Capital Group, L.P. ("Barington"). As
part of the settlement, the Company engaged Barington to provide investment
banking services for a period of twelve months and has paid Barington a retainer
of $250,000 and a twelve-month consulting fee of $360,000. The Company also paid
Barington $150,000 for reimbursement of litigation and proxy solicitation
expenses. The agreement requires the payment of additional fees should the
Company utilize the services of Barington through October of 1999.
(B) LEASE OBLIGATIONS
The Company leases office space and furniture under operating and capital
leases that expire at various dates through August 2000. The future minimum
lease commitments under these leases and sublease rentals are as follows:
F-19
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(14) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
<TABLE>
<CAPTION>
CAPITAL OPERATING SUBLEASE
YEAR ENDING OCTOBER 31, LEASES LEASES RENTALS
- ----------------------- ------- --------- --------
<S> <C> <C> <C>
1999.................................................... $80,548 $ 459,008 $ 53,550
2000.................................................... -- 48,970 --
------- --------- --------
Total minimum lease payments............................ 80,548 $ 507,978 $ 53,550
========= ========
Less amount representing interest....................... (3,708)
-------
Present value of net minimum lease payments............. $76,840
=======
</TABLE>
Rental expense under operating leases totaled $960,745 and $920,412 for the
years ended October 31, 1998 and 1997, respectively.
Amounts capitalized under capital lease agreements are as follows as of
October 31, 1998 and 1997:
1998 1997
--------- --------
Furniture.............................................. $ 302,085 $302,085
Less accumulated amortization.......................... (293,794) (83,334)
--------- --------
$ 8,291 $218,751
========= ========
(C) SALES COMMITMENTS AND SPECIAL CHARGES
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.
Pursuant to an agreement with Swissair, Swissair purchased 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 was material, installation,
maintenance through September 1998, one-year warranty and upgrade costs for the
sixteen aircraft. As of October 31, 1998, the Company had completed
installations of the entertainment network on all of these aircraft. The
agreement also required the Company to install the entertainment network in the
first, business and economy class sections of three additional aircraft, at no
charge to Swissair. The Company was responsible for all costs including
entertainment network components, installation and maintenance through September
1998 for the three aircraft. As of October 31, 1998, the Company had completed
installations of the entertainment network on all of these aircraft and title to
each of these three shipsets had been transferred to Swissair. 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 consolidated
statement of operations as a special charge for the year ended October 31, 1997.
During the fiscal year ended October 31, 1998, the Company recognized a recovery
of special charges of $606,508. The recovery of special charges resulted from a
reduction in the number of entertainment networks requiring maintenance in the
economy class sections of the Swissair aircraft and a reduction in development
expenses. The Company has also entered into two letters of intent with Swissair.
The first relates to a $4,700,000 order for first and business class
installations on four Swissair MD-11 aircraft that are being added to the
Swissair fleet.
F-20
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(14) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
The Company has also received a letter of intent from Swissair to extend the
warranty on all installed systems for a second and third year at a price of
$3,975,000. On December 9, 1998, the Company received notice form Swissair
stating their intent to cancel the order for the four additional installations.
As a result, the Company and Swissair are engaged in discussions regarding
outstanding financial matters. 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.
On October 29, 1998, the Company was notified by Swissair of its decision
to deactivate the entertainment networks on all Swissair aircraft. Swissair told
the Company that this precautionary action was taken in response to recent
technical investigations conducted by the Canadian Transportation Safety Board
following the crash of Swissair Flight No. 111 on September 2, 1998 off the
coast of Nova Scotia. However, based on investigation findings, the Company has
been informed by representatives of the Canadian Transportation Safety Board and
Swissair that its entertainment network has not been related, in any way, to the
cause of the crash of Swissair Flight No. 111. The Company and its system
integrator/installation contractor are working closely with Swissair to take the
necessary steps that will allow Swissair to reactivate the systems as quickly as
possible.
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. In February 1998, the
Company and Debonair signed a Termination Agreement. Pursuant to the agreement,
Debonair removed the entertainment network from its aircraft and the Company
paid Debonair $134,235 as full and final settlement of all of its obligations
with Debonair. Included in the accompanying consolidated 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 write-down 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, property
and equipment write-downs of $1,006,532 and $1,518,952 were recorded as special
charges during fiscal 1998 and 1997, respectively.
Pursuant to an agreement with Alitalia, the Company delivered five first
generation shipsets for installation on Alitalia aircraft during fiscal 1996.
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. As of October 31, 1998, the Company has accrued for estimated product
warranty costs that were to be incurred under the original agreement.
(D) PURCHASE COMMITMENTS
As of October 31, 1998, the Company had approximately $1,800,000 of
purchase commitments with various vendors in anticipation of the fulfillment of
the Company's sales commitments.
(15) 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 amounts.
Fair value estimates are made at a specific point in time and are based on
relevant market information and information about the financial instrument; they
are subjective in nature and involve
F-21
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED)
uncertainties, matters of judgment and, therefore, cannot be determined with
precision. These estimates do not reflect any premium or discount that could
result from offering for sale, at one time, the Company's entire holdings of a
particular instrument. Changes in assumptions could significantly affect these
estimates.
Since the fair value is estimated as of October 31, 1998, the amounts that
will actually be realized or paid at settlement or maturity of the instruments
could be significantly different.
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 $3,690,604. The carrying amount of
accounts receivable, accounts payable and accrued liabilities 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 and note payable
approximate the terms in the marketplace at which they could be replaced.
Therefore, the fair value approximates the carrying value of these financial
instruments.
(16) 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, 1998, one customer accounted for 98% of the Company's sales and outstanding
accounts receivable from this customer was approximately $1,100,000. For the
year ended October 31, 1997, one customer accounted for 95% of the Company's
sales and outstanding accounts receivable from this customer were approximately
$4,900,000.
(17) SUPPLEMENTAL FINANCIAL INFORMATION
A summary of additions and deductions related to the provisions for
doubtful accounts and inventory valuation for the years ended October 31, 1998
and 1997 are as follows:
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
BEGINNING END
OF YEAR ADDITIONS DEDUCTIONS OF YEAR
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
PROVISIONS FOR DOUBTFUL ACCOUNTS:
Year ended October 31, 1998....... $ -- $ -- $ -- $ --
=========== =========== ========== ===========
Year ended October 31, 1997....... $ 1,732,377 $ 216,820 $1,949,197 $ --
=========== =========== ========== ===========
</TABLE>
During the year ended October 31, 1998, the Company recorded a provision
for doubtful accounts of $9,869 which is included in assets held for use.
<TABLE>
<S> <C> <C> <C> <C>
PROVISIONS FOR INVENTORY VALUATION:
Year ended October 31, 1998....... $11,179,895 $ -- $2,450,290 $ 8,729,605
=========== =========== ========== ===========
Year ended October 31, 1997....... $ -- $11,179,895 $ -- $11,179,895
=========== =========== ========== ===========
</TABLE>
F-22
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(17) SUPPLEMENTAL FINANCIAL INFORMATION -- (CONTINUED)
Supplemental disclosure of cash flow information is as follows:
YEARS ENDED OCTOBER 31,
-----------------------
1998 1997
---------- ----------
Cash paid for interest................................ $ 11,954 $ 13,423
======== ========
Noncash investing and financing activities:
Acquisition:
Fair value of assets acquired.................... $813,736 $ --
Cash paid........................................ 688,736 --
Note payable..................................... 125,000 --
======== ========
Capital lease obligations incurred.................. $ -- $210,678
======== ========
Issuance of stock under stock option plan pursuant
to cashless exercise option...................... $ -- $ 13,874
======== ========
Issuance of stock for services received............. $187,729 $466,875
======== ========
Certain assets including accounts receivable, prepaid expenses, and
property and equipment totaling $699,196 have been reclassified in the October
31, 1998 consolidated balance sheet to assets held for use.
F-23
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
The Stockholders and Board of Directors
Interactive Flight Technologies, Inc.:
We consent to the use of our report dated December 11, 1998 incorporated herein
by reference.
KPMG LLP
Phoenix, Arizona
January 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information
extracted from the Consolidated Financial Statements
as of October 31, 1998 and is qualified in its entirety
by reference to such Consolidated Financial Statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> NOV-01-1997
<PERIOD-END> OCT-31-1998
<CASH> 28,953,862
<SECURITIES> 3,690,604
<RECEIVABLES> 1,135,342
<ALLOWANCES> 0
<INVENTORY> 1,005,427
<CURRENT-ASSETS> 34,502,523
<PP&E> 1,429,736
<DEPRECIATION> 649,701
<TOTAL-ASSETS> 38,264,202
<CURRENT-LIABILITIES> 11,411,318
<BONDS> 0
0
0
<COMMON> 221,111
<OTHER-SE> 26,631,773
<TOTAL-LIABILITY-AND-EQUITY> 38,264,202
<SALES> 18,038,619
<TOTAL-REVENUES> 19,142,961
<CGS> 15,523,282
<TOTAL-COSTS> 15,762,119
<OTHER-EXPENSES> 12,880,212
<LOSS-PROVISION> 9,869
<INTEREST-EXPENSE> 11,954
<INCOME-PRETAX> (7,259,959)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,259,959)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,259,959)
<EPS-PRIMARY> (1.22)
<EPS-DILUTED> (1.22)
</TABLE>
