SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 8-K/A
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): May 18, 1999
THE NETWORK CONNECTION, INC..
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Georgia
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(State or other jurisdiction of incorporation)
1-13760 58-1712432
- ------------------------ ------------------------------------
(Commission File Number) (IRS Employer Identification Number)
222 North 44th Street, Phoenix, Arizona 85034
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (602) 200-8900
4041 North Central Avenue, Suite B-200, Phoenix, Arizona 85012
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(Former name or former address, if changed since last report)
<PAGE>
The undersigned registrant hereby amends its Current Report on Form 8-K
dated May 18,1999 which was filed on June 2, 1999, solely to add the financial
information and pro forma information required by Item 7 of Form 8-K.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
(a) FINANCIAL STATEMENTS OF BUSINESS TO BE ACQUIRED.
The financial statements for Interactive Flight Technologies, Inc. are set
forth below.
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
1. Financial Statements as of and for the Years Ended October 31, 1998
and 1997:
Independent Auditors' Report.........................................F-1
Consolidated Balance Sheets as of October 31, 1998 and 1997..........F-2
Consolidated Statements of Operations for the Years Ended
October 31, 1998 and 1997..........................................F-3
Consolidated Statements of Stockholders' Equity for the
Years Ended October 31, 1998 and 1997 .............................F-4
Consolidated Statements of Cash Flows for Years Ended
October 31, 1998 and 1997..........................................F-5
Notes to Consolidated Financial Statements...................F-6 to F-22
2. Financial Statements as of and for the three and six months ended
April 30, 1999 and 1998
Condensed Consolidated Balance Sheets as of April 30, 1999
(unaudited) and October 31, 1998 (audited)........................F-23
Condensed Consolidated Statements of Operations for
the Three Months and Six Months Ended April 30, 1999
and 1998 (unaudited)..............................................F-24
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended April 30, 1999 and 1998 (unaudited)..............F-25
Notes to Condensed consolidated Financial Statements........F-26 to F-30
(b) PRO FORMA FINANCIAL INFORMATION.
On May 18, 1999, Interactive Flight Technologies, Inc. ("IFT") received
from The Network Connection, Inc. (the "Company") 1,055,745 shares of its common
stock and 2,495,400 shares of its Series D Convertible Preferred Stock in
exchange for $4,250,000 in cash and substantially all the assets and certain
liabilities of IFT's Interactive Entertainment Division ("IED"), as defined in
the Asset Purchase and Sale Agreement dated April 30, 1999, as amended. The
transaction has been accounted for as a reverse merger whereby, for accounting
purposes, IFT is considered the accounting acquiror and the Company is treated
as the successor to the historical operations of IED. Accordingly, the
historical financial statements of the Company, which previously have been
reported to the Securities and Exchange Commission ("SEC") on Forms 10-KSB,
10-QSB, among others, as of and for all periods through March 31, 1999, will be
replaced with those of IFT. The Company will continue to file as a SEC
registrant and continue to report under the name The Network Connection, Inc.
IFT will continue to report as a separate SEC registrant, owning the shares of
the Company as described above. The historical financial statements of the
Company up to the date of the transaction will no longer be included in future
filings of the Company.
2
<PAGE>
The attached unaudited pro forma condensed combined balance sheet as of
April 30, 1999 and the unaudited pro forma condensed combined statements of
operations for the six months ended April 30, 1999(1) and the year ended October
31, 1998(2) give effect to the acquisition (as described above), as of April 30,
1999 for purposes of the balance sheet and as of the beginning of the periods
presented for purposes of the statements of operations. As a result of the
reverse merger, the assets and liabilities of IED are presented at their
historical cost basis and the assets and liabilities of the Company have been
recorded at their estimated fair market value at the date of the transaction for
purposes of the purchase price allocation. The unaudited pro forma condensed
combined statements of operations assume that the acquisition took place at the
beginning of each period presented and combine the results of operations of the
Company for the six months ended March 31, 1999 and IFT for the six months ended
April 30, 1999 and the results of operations of the Company for the year ended
December 31, 1998 and IFT for the year ended October 31, 1998. The unaudited pro
forma condensed combined balance sheet combines the balance sheets of the
Company as of March 31, 1999 and IFT as of April 30, 1999, giving effect to the
acquisition as if it had occurred on April 30, 1999.
The unaudited pro forma condensed combined statements of operations are not
necessarily indicative of the future results of operations of the Company or the
results of operations which would have resulted had the Company and IFT's IED
been combined during the periods presented. In addition, the unaudited pro forma
results of operations are not intended to be a projection of future period
results.
- ----------
(1) The Company reports on a calendar year basis, and as such, the underlying
balance sheet data and results of operations are as of and for the six
months ended March 31, 1999. The balance sheet data as of March 31, 1999
was derived from the Company's March 31, 1999 Form 10-QSB filed with the
SEC. The results of operations data for the six months ended March 31, 1999
was derived from the results of operations for the fourth quarter of 1998
(three months ended December 31, 1998) included in the Company's December
31, 1998 Form 10-KSB filed with the SEC and the results of operations for
the three months ended March 31, 1999 derived from the Company's March 31,
1999 10-QSB filed with the SEC. As such, the results of operations for the
fourth quarter of 1998 for the Company are included in both the Unaudited
Pro Forma Condensed Combined Statement of Operations for the six months
ended April 30, 1999 and the year ended October 31, 1998.
(2) The Company reports on a calendar year basis, and as such, the underlying
results of operations are for the period ended December 31, 1998, as filed
on Form 10-KSB.
<PAGE>
THE NETWORK CONNECTION, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
APRIL 30, 1999
(DOLLARS IN THOUSANDS)
IFT-IED TNCI
April 30, March 31, Pro Forma Pro Forma
1999 1999 Adjustments Combined
------- ------- ------- -------
Current assets:
Cash & cash equivalents $ 4,369 $ 107 $ -- $ 4,476
Restricted cash 447 -- -- 447
Notes receivable -- 229 -- 229
Accounts receivable 1,251 1,478 -- 2,729
Inventories, net 1,513 2,681 (1,281)(C) 2,913
Prepaid expenses 7 26 -- 33
Other current assets 109 -- -- 109
------- ------- ------- -------
Total current assets 7,696 4,521 (1,281) 10,936
Property and equipment, net 594 2,414 (806)(B) 2,202
Goodwill -- -- 4,728 (A) 4,728
Other assets 555 84 -- 639
------- ------- ------- -------
Total assets $ 8,845 $ 7,019 $ 2,641 $18,505
======= ======= ======= =======
Current liabilities:
Accounts payable and accrued $ 2,682 $ 2,609 $ -- $ 5,291
liabilities
Notes payable -- 2,293 -- 2,293
Deferred revenue 2,158 521 -- 2,679
Accrued product warranties 3,836 -- -- 3,836
------- ------- ------- -------
Total current liabilities 8,676 5,423 -- 14,099
Long term debt -- 693 -- 693
------- ------- ------- -------
Total liabilities 8,676 6,116 -- 14,792
Series B 8% preferred (1,500 -- 1,549 (1,549)(D) --
shares $.01 par value)
Shareholders' equity:
Series B 8% preferred (1,500
shares $.01 par value and
$1,000 stated value) -- -- 15 (D) 15
Series C 8% preferred (800
shares $.01 par value and
$1,000 stated value) -- -- 8 (D) 8
Series D preferred (2,495,400
shares $.01 par value and
$10 stated value) -- -- 25 (D) 25
Common stock -- 5 1 (D) 6
Additional paid in capital -- 16,704 (13,214)(D) 3,490
Retained earnings (deficit) 169 (17,355) 17,355 (D) 169
------- ------- ------- -------
Total shareholders' equity 169 (646) 4,190 3,713
Total liabilities and equity $ 8,845 $ 7,019 $ 2,641 $18,505
======= ======= ======= =======
See accompanying notes to unaudited pro forma condensed combined financial
statements.
3
<PAGE>
THE NETWORK CONNECTION, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED APRIL 30, 1999
(DOLLARS IN THOUSANDS)
Pro Forma Pro Forma
IFT TNCI Adjustments Combined
------- ------- ----------- --------
Revenues $ 627 $ (16) $ -- $ 611
Cost of revenues 374 257 -- 631
------- ------- ------- -------
Gross profit (loss) 253 (273) -- (20)
------- ------- ------- -------
Operating Expenses:
Selling, general and
administrative 3,645 1,952 (207)(E) 5,390
Research and development -- 290 -- 290
Provision for doubtful accounts
and inventory reserves -- 3,622 -- 3,622
Reversal of warranty, maintenance
and commission accruals (1,987) -- -- (1,987)
Expenses associated with 300 -- -- 300
investments
Special charges -- 595 -- 595
Amortization of goodwill 236 (E) 236
1,958 6,459 29 8,446
------- ------- ------- -------
Operating loss (1,705) (6,732) (29) (8,466)
------- ------- ------- -------
Interest income 845 -- -- 845
Interest expense (3) (525) -- (528)
Other income 49 -- -- 49
------- ------- ------- -------
Net loss (814) (7,257) (29) (8,100)
Preferred stock dividends -- 303 -- 303
------- ------- ------- -------
Net loss to common shareholders $ (814) $(7,560) $ (29) $(8,403)
======= ======= ======= =======
Basic and diluted net loss per
share $ (1.51) $ (1.39)
======= =======
Weighted average shares
outstanding 5,006 1,056 (F) 6,062
======= ======= =======
See accompanying notes to unaudited pro forma condensed combined financial
statements.
4
<PAGE>
THE NETWORK CONNECTION, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED OCTOBER 31, 1998
(DOLLARS IN THOUSANDS)
Pro Forma Pro Forma
IFT TNCI Adjustments Combined
-------- -------- -------- --------
Revenues $ 19,143 $ 5,003 $ -- $ 24,146
Cost of revenues 15,762 3,005 -- 18,767
-------- -------- -------- --------
Gross profit 3,381 1,998 -- 5,379
Operating Expenses:
Selling, general and 11,388 3,966 (590)(E) 14,764
administrative
Research and 1,092 397 -- 1,489
development
Provision for doubtful 10 6,464 -- 6,474
accounts and inventory
reserves
Special charges 400 595 -- 995
Amortization of goodwill -- -- 473 (E) 473
-------- -------- -------- --------
12,890 11,422 (117) 24,195
-------- -------- -------- --------
Operating loss (9,509) (9,424) 117 (18,816)
Interest income 2,251 -- -- 2,251
Interest expense (12) (209) -- (221)
Other income 10 -- -- 10
-------- -------- -------- --------
Net loss (7,260) (9,633) 117 (16,776)
Preferred stock dividends -- 575 -- 575
-------- -------- -------- --------
Net loss to common shareholders $ (7,260) $(10,208) $ 117 $(17,351)
======== ======== ======== ========
Basic and diluted net loss
per share $ (2.31) $ (3.16)
======== ========
Weighted average shares
outstanding 4,427 (1,056)(F) 5,483
======== ======== ========
See accompanying notes to unaudited pro forma condensed combined financial
statements.
5
<PAGE>
Notes to Unaudited Pro Forma Condensed Combined Financial Statements
i) Basis of Accounting
On May 18, 1999, The Network Connection, Inc. (the "Company") completed the
issuance of 1,055,745 shares of its common stock and 2,495,400 shares of its
Series D Convertible Preferred Stock in exchange for $4,250,000 in cash and all
the assets and certain liabilities of IFT's Interactive Entertainment Division
("IED"), as defined in the Asset Purchase and Sale Agreement, dated April 30,
1999, as amended. The transaction has been accounted for as a reverse merger
whereby, for accounting purposes, IFT is considered the accounting acquiror and
the Company is treated as the successor to the historical operations of IFT.
Accordingly, the historical financial statements of the Company, which
previously have been reported to the Securities and Exchange Commission ("SEC")
on Forms 10-KSB, 10-QSB, among others, as of and for all periods through March
31, 1999, will be replaced with those of IFT (IED).
The Company will continue to file as a SEC registrant and continue to
report under the name The Network Connection, Inc. IFT will also continue to
report as a separate SEC registrant, owning the shares of the Company as
described above.
The unaudited pro forma condensed combined balance sheet as of April 30,
1999, gives effect to the transaction as if the transaction had taken place on
April 30, 1999 and combines IED's unaudited April 30, 1999 contributed assets
and liabilities, as derived from IFT's unaudited April 30, 1999 financial
statements, with the Company's unaudited balance sheet as of March 31, 1999.
The unaudited pro forma condensed combined statement of operations for the
six months ended April 30, 1999 is presented using the Company's unaudited
statement of operations for the six months ended March 31, 1999 (see footnote 1
to the introduction to the Pro Forma Financial Information) combined with IFT's
unaudited statement of operations for the six months ended April 30, 1999 as if
the transaction had taken place on November 1, 1998.
The unaudited pro forma condensed combined statement of operations for the
year ended October 31, 1998 is presented using the Company's audited statement
of operations for the year ended December 31, 1998 combined with IFT's audited
statement of operations for the year ended October 31, 1998, as if the
transaction had taken place on November 1, 1997.
As a result, the Company's results of operations for the three months ended
December 31, 1998 are included in the unaudited pro forma condensed combined
statements of operations for both the six months ended April 30, 1999 and the
year ended December 31, 1998.
6
<PAGE>
The unaudited pro forma condensed combined financial statements should be
read in conjunction with the Company's unaudited financial statements as of and
for the three months ended March 31, 1999 as filed on Form 10-QSB and the
audited financial statements as of and for the year ended December 31, 1998, as
filed on Form 10-KSB, and with IFT's unaudited consolidated financial statements
as of and for the six months ended April 30, 1999 as filed on Form 10-QSB and
the audited consolidated financial statements as of and for the year ended
October 31, 1998 as filed on Form 10-KSB.
The unaudited pro forma condensed combined statements of operations are not
necessarily indicative of the future results of operations of the Company or the
results of operations which would have resulted had the Company and IFT's IED
been combined during the periods presented. In addition, the unaudited pro forma
results are not intended to be a projection of future period results. The
purchase price was allocated to assets and liabilities based on management's
current estimate of their value. The final allocation of the purchase price may
vary from the estimated allocation herein.
ii) Unaudited Pro Forma Condensed Combined Balance Sheet and Unaudited Pro
Forma Condensed Combined Statements of Operations
The accompanying pro forma adjustments reflect adjustments for the
following items:
A. To reflect the excess of acquisition cost over the estimated fair value
of net liabilities assumed (goodwill). The purchase price and purchase-price
allocation are summarized as follows (all dollars in thousands):
Purchase price paid as:
Cash $ 4,250
Net fair value of assets of
IFT contributed per the Agreement (excluding
cash contribution but including other cash
equivalents) 4,595
Net fair value of liabilities of IFT contributed per
the Agreement (8,676)
-------
Total purchase consideration $ 169
Allocated to:
Historical book value of TNCI's net liabilities (971)
Adjustments to write-down assets to fair value:
Inventories, net (1,281)
Property and equipment (806)
Total fair value of net liabilities assumed (3,058)
Excess of fair value of TNCI Series B and Series C
preferred stock over its recorded or stated value (1,501)
-------
Excess of purchase price over fair value of net liabilities
assumed (goodwill) $ 4,728
=======
7
<PAGE>
B. To reflect the write-down in property and equipment to fair value based
on new management's estimate of fair market value based on a review of such
assets and independent third party data where available.
C. To reflect adjustments to arrive at the fair market value of such assets
based on management's estimate of fair market value based on a review of such
assets and other available data. Adjustments to inventory reflect certain
changes in business strategy and potential customer orders since March 31, 1999,
with respect to market opportunities for the Company's future service offerings.
D. To reflect the elimination of certain shareholders' equity and mezzanine
preferred stock accounts of TNCI, to reflect the issuance of TNCI common stock
and Series D preferred stock in connection with the Transaction and to reflect
the separate purchase (prior to the acquisition date) of the Company's Series B
and C preferred stock by IFT.
E. To reflect the decrease in depreciation and amortization expense due to
(1) the amortization of goodwill on a straight-line basis over ten years, and
(2) decrease in depreciation resulting from the write-down of property and
equipment, depreciated on a straight-line basis over periods of approximately
five years.
F. Weighted average common shares outstanding reflects the 1,055,745 common
shares of the Company issued in connection with the Transaction as if such
shares were outstanding as of the beginning of each period presented.
(c) EXHIBITS
Exhibit No. Description
----------- -----------
23 Consent of KPMG LLP
8
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereto duly authorized.
THE NETWORK CONNECTION, INC.
Registrant
By: /s/ Morris C. Aaron
---------------------------------------------
Morris C. Aaron, Executive Vice President and
Chief Financial Officer
Date: July 30, 1999
9
<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-1
<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-2
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED OCTOBER 31,
-------------------------
1998 1997
----------- -----------
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
=========== ===========
See accompanying notes to consolidated financial statements.
F-3
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CLASS A CLASS B
COMMON STOCK COMMON STOCK ADDITIONAL
------------------- ------------------ PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
--------- -------- --------- ------- ------------
<S> <C> <C> <C> <C> <C>
Balance as of October 31, 1996...... 2,700,683 $ 81,020 1,320,000 $39,600 $ 42,587,712
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.......................... -- -- -- -- --
--------- -------- --------- ------- ------------
Balance as of October 31, 1997...... 6,063,332 181,900 1,244,445 37,334 112,037,882
Net unrealized gains on investment
securities...................... -- -- -- -- --
Issuance of common stock pursuant
to bonus plan................... 62,576 1,877 -- -- 185,852
Treasury stock purchases (844,667
shares)......................... -- -- -- -- --
Net loss.......................... -- -- -- -- --
--------- -------- --------- ------- ------------
Balance as of October 31, 1998...... 6,125,908 $183,777 1,244,445 $37,334 $112,223,734
========= ======== ========= ======= ============
NET UNREALIZED
GAINS ON TOTAL
INVESTMENT ACCUMULATED TREASURY STOCKHOLDERS'
SECURITIES DEFICIT STOCK EQUITY
------------- ------------ ----------- -------------
Balance as of October 31, 1996...... $ -- $(25,000,461) $ -- $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) -- (51,022,312)
------ ------------ ----------- -----------
Balance as of October 31, 1997...... -- (76,022,773) -- 36,234,343
Net unrealized gains on investment
securities...................... 6,754 -- -- 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) -- (7,259,959)
------ ------------ ----------- -----------
Balance as of October 31, 1998...... $6,754 $(83,282,732) $(2,315,983) $26,852,884
====== ============ =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<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-5
<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-6
<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-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)
(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-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)
(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:
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING
COST GAINS LOSSES FAIR VALUE
---- ----- ------ ----------
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
========== ====== ===== ==========
Maturities of securities at October 31, 1998 and 1997 follow:
1998 1997
---------------------- -----------------------
AMORTIZED AMORTIZED
COST FAIR VALUE COST FAIR VALUE
---------- ---------- ---------- ----------
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
========== ========== ========== ==========
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-9
<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-10
<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-11
<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-12
<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:
YEARS ENDED OCTOBER 31,
--------------------------------------------
1998 1997
--------------------- --------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE
---------- -------- ---------- --------
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
======== ========
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-13
<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:
* the Company's pretax income, exclusive of extraordinary items amount to
at least $5,900,000 for fiscal 1995 or fiscal 1996, $8,000,000 for fiscal
1997 or $10,100,000 for fiscal 1998;
* the closing bid price of the Company's Class A common stock is in excess
of $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:
* the Company's pretax income, exclusive of extraordinary items, amounts to
at least $8,500,000 for fiscal 1995 or fiscal 1996, $11,500,000 for
fiscal 1997 or $14,500,000 for fiscal 1998;
* the closing bid price of the Company's Class A common stock is in excess
of $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-14
<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-15
<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-16
<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-17
<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-18
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OCTOBER 31, 1998 AND 1997
(14) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)
CAPITAL OPERATING SUBLEASE
YEAR ENDING OCTOBER 31, LEASES LEASES RENTALS
- ----------------------- ------- --------- --------
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
=======
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-19
<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-20
<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>
<CAPTION>
<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-21
<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-22
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets
as of April 30, 1999 (unaudited) and October 31, 1998 (audited)
April 30, October 31,
Assets 1999 1998
------------ ------------
(unaudited)
Current assets:
Cash and cash equivalents $ 19,732,520 $ 27,914,551
Restricted cash 581,525 1,039,311
Short-term investment securities 7,990,056 1,762,049
Accounts receivable, net 1,281,255 1,135,342
Note receivable from related party -- 447,939
Inventories, net 1,513,298 1,005,427
Prepaid expenses 439,143 567,601
Assets held for use 522,591 699,196
Other current assets 1,042,707 379,046
------------ ------------
Total current assets 33,103,095 34,950,462
------------ ------------
Investment securities 1,674,132 1,928,555
Property and equipment, net 636,113 780,035
Notes receivable, long-term 1,050,000 --
Other assets 1,097,038 605,150
------------ ------------
Total assets $ 37,560,378 $ 38,264,202
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 1,051,358 $ 1,447,815
Accrued liabilities 2,299,090 4,016,473
Deferred revenue 2,158,028 453,022
Accrued product warranties 3,836,471 5,369,008
Note payable -- 125,000
------------ ------------
Total current liabilities 9,344,947 11,411,318
------------ ------------
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; 5,342,117 and 6,125,908 shares
issued, respectively 53,421 61,259
Class B common stock, six votes per share,
par value $0.01 per share, 4,000,000 shares
authorized; 118,519 and 1,244,445 shares issued
and outstanding respectively 1,185 12,445
Additional paid-in capital 110,078,500 112,371,141
Accumulated other comprehensive income:
Net unrealized gains on investment securities 2,373,893 6,754
Accumulated deficit (84,097,578) (83,282,732)
Treasury stock, at cost; 78,600 and 844,667
shares, respectively (193,990) (2,315,983)
------------ ------------
Total stockholders' equity 28,215,431 26,852,884
------------ ------------
Total liabilities and stockholders' equity $ 37,560,378 $ 38,264,202
============ ============
See accompanying notes to condensed consolidated financial statements.
F-23
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Operations
the Three Months and Six Months Ended April 30, 1999 and 1998 (unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended April 30, Ended April 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenue:
Equipment sales $ -- $ 4,569,337 $ -- $ 17,860,563
Service income 301,990 162,825 626,748 281,264
------------ ------------ ------------ ------------
301,990 4,732,162 626,748 18,141,827
------------ ------------ ------------ ------------
Costs and expenses:
Cost of equipment sales -- 3,768,459 -- 15,335,854
Reversal of warranty, maintenance
and commission accruals (1,986,972) -- (1,986,972) --
Cost of service income 187,705 7,257 374,147 12,957
Expenses associated with investments -- -- 300,000 --
Research and development expenses -- 482,389 -- 1,092,316
General and administrative expenses 1,764,202 1,271,967 3,645,151 2,878,398
------------ ------------ ------------ ------------
(35,065) 5,530,072 2,332,326 19,319,525
------------ ------------ ------------ ------------
Operating profit (loss) 337,055 (797,910) (1,705,580) (1,177,698)
Other:
Interest income 401,710 526,180 844,686 1,071,312
Interest expense (1,191) (3,234) (2,880) (6,995)
Other income 19,350 500 48,926 500
------------ ------------ ------------ ------------
Net income (loss) 756,924 (274,464) (814,846) (112,881)
============ ============ ============ ============
Basic and diluted net income (loss)
per share $ 0.14 $ (0.05) $ (0.15) $ (0.02)
============ ============ ============ ============
Weighted average shares outstanding 5,493,698 5,997,656 5,427,612 6,121,234
============ ============ ============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
F-24
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
Six Months Ended April 30, 1999 and 1998 (unaudited)
<TABLE>
<CAPTION>
Six Months Ended April 30,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (814,846) $ (112,881)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Provision for doubtful accounts 18,778 --
Depreciation and amortization 205,270 641,419
Reversal of warranty, maintenance and commission accruals 1,986,972 --
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (133,894) 5,109,893
Decrease (increase) in inventories (507,871) 5,003,382
Increase in prepaid expenses, other current assets,
other assets and notes receivable (1,620,701) (616,121)
Decrease in accounts payable (396,159) (3,868,360)
Decrease in notes payable (125,000) --
Decrease in accrued liabilities (863,559) (218,437)
Increase (decrease) in deferred revenue 1,705,006 (2,193,060)
Decrease in accrued severance costs -- (27,500)
Increase (decrease) in accrued product warranties (251,304) 2,245,816
------------ ------------
Net cash provided by (used in) operating activities (4,771,252) 5,964,151
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (39,686) (26,390)
Proceeds from sale of equipment 10,805 --
Purchases of investment securities (6,338,159) (1,305,593)
Maturities of investment securities 1,049,995 234,615
Proceeds from sale of investment securities 1,681,720 --
Decrease in restricted cash 457,786 --
------------ ------------
Net cash used in investing activities (3,177,539) (1,097,368)
------------ ------------
Cash flows from financing activities:
Payments on capital lease obligations (43,494) (39,371)
Purchases of treasury stock (193,990) (1,010,979)
Employee stock option purchase 4,244 --
------------ ------------
Net cash used in financing activities (233,240) (1,050,350)
------------ ------------
Increase (decrease) in cash and cash equivalents (8,182,031) 3,816,433
Cash and cash equivalents at beginning of period 27,914,551 36,890,454
============ ============
Cash and cash equivalents at end of period $ 19,732,520 $ 40,706,887
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
F-25
<PAGE>
INTERACTIVE FLIGHT TECHNOLOGIES, INC.
Notes to Condensed Consolidated Financial Statements
(1) Basis of Presentation
The accompanying condensed consolidated financial statements include the
accounts of Interactive Flight Technologies, Inc. and its wholly owned
subsidiary (the "Company"). All intercompany balances and transactions have been
eliminated in consolidation. Certain reclassifications have been made to the
amounts in the October 31, 1998 Balance Sheet to conform with the April 30, 1999
presentation.
The accompanying condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles, pursuant
to the rules and regulations of the Securities and Exchange Commission. In the
opinion of management, the accompanying condensed consolidated financial
statements reflect all adjustments (consisting of normal recurring accruals)
which are necessary for a fair presentation of the results for the interim
periods presented. Certain information and footnote disclosures normally
included in financial statements have been condensed or omitted pursuant to such
rules and regulations. It is suggested that these condensed consolidated
financial statements be read in conjunction with the financial statements and
notes thereto for the fiscal year ended October 31, 1998, included in the
Company's Annual Report on Form 10-KSB.
The results of operations for the three months and six months ended April
30, 1999 are not necessarily indicative of the results to be expected for the
entire fiscal year.
In the period ended April 30, 1999, the Company revised certain warranty,
maintenance and commission accruals that were recorded in prior fiscal years
which totaled $1,986,972. Such adjustments to prior period estimates resulted
from an evaluation of specific contractual obligations and discussions between
the new management of the Company and other parties related to such contracts.
Based on the results of the Company's findings during this quarter, such
accruals were no longer considered necessary.
(2) Stockholders' Equity
(a) Stock Repurchase Program
On October 30, 1998, the Board of Directors authorized the Company to
repurchase up to 666,667 more shares of its Class A Common Stock on the open
market. On January 11, 1999 the Company retired 844,667 shares of Class A Common
Stock which were repurchased pursuant to a previous stock repurchase program
authorized by the Board of Directors and held in treasury. As of April 30, 1999,
the Company had repurchased an additional 78,600 shares at prices ranging from
$1.49 to $2.94 per share for a total cost of $193,990.
(b) Reverse Stock Split
On October 30, 1998, the stockholders of the Company approved a
one-for-three reverse stock split of the Company's Class A common stock and
Class B common stock. One share was issued for three shares of common stock held
by stockholders of record as of the close of business on November 2, 1998.
F-26
<PAGE>
All references to the number of common shares, per share amounts and stock
option data elsewhere in the condensed consolidated financial statements and
these notes have been restated as appropriate to reflect the effect of the
reverse split for all periods presented.
(c) Earnings (Loss) Per Share
Basic earnings (loss) per share is computed using the weighted average
number of common shares outstanding during each period presented as shown in the
accompanying condensed consolidated statements of operations. Diluted earnings
(loss) per share is the same as basic earnings (loss) per share for all periods
presented due to the immaterial amount of common stock equivalents for the three
months ended April 30, 1999 and due to the antidilutive nature of such common
stock equivalents for the other periods presented.
(3) Investments
(a) U.S. Wireless Corporation
On March 4, 1999, the Company made a $3.0 million investment in U.S.
Wireless Corporation ("U.S. Wireless") (NASDAQ: USWC). U.S. Wireless provides
wireless network infrastructure add-on systems for the emerging wireless
Geo-location services marketplace. In exchange for its investment, the Company
received 30,000 shares of Series B Preferred Stock of U.S. Wireless ("Series B
Preferred"). Each share of the Series B Preferred of U.S. Wireless is
convertible into 100 shares of Common Stock of U.S. Wireless, at the option of
the Company, at any time commencing 90 days after the Closing Date; however,
should the Company voluntarily convert prior to March 2000, the Series B
converts into approximately 67 shares of Common Stock of U.S. Wireless. The
Series B Preferred Stock is also subject to mandatory conversion into Common
Stock at any time at a conversion rate of 100 shares of Common Stock of U.S.
Wireless in the event the closing price for U.S. Wireless' Common Stock as
reported on the NASDAQ is at least $5.00 per share for 30 consecutive trading
days. The Series B Preferred Stock entitles the Company to $100 per share
liquidation preference before any distributions to the holders of Common Stock
of U.S. Wireless in the event of a liquidation of U.S. Wireless. In addition,
the Company and other holders of the Series B Preferred Stock have, as a
separate class, elected one member to U.S. Wireless' Board of Directors and one
additional individual as an observer to such Board. As a condition to making the
investment, the Company also obtained certain registration rights relating to
the registration under the Securities Act of 1933 of those shares of Common
Stock of U.S. Wireless into which the Series B Preferred Stock is convertible.
The Series B Preferred is classified as a short-term investment security at its
fair market value as of April 30, 1999. Unrealized gains on this investment are
reflected as a separate component of stockholders' equity. Fair market value was
determined on an as-converted basis on April 30, 1999 into 2,000,000 shares of
USWC common stock at a per share price of $2.688, resulting in a total fair
market value of $5,376,000.
(b) Inter Lotto (UK) Ltd.
On May 5, 1999, the Company completed the acquisition of a 27.5% equity
interest in Inter Lotto (UK) Ltd. ("ILL"). ILL has a license with the exclusive
right to provide for the operation of daily lotteries in Great Britain, by way
of a management contract with an outside third party, and will be responsible
for developing, installing, marketing and operating the lottery, selecting the
game and managing the network. In exchange, the Company will receive a
percentage of the revenues generated by the sale of lottery tickets. ILL is a
company licensed, by the Gaming Board for Great Britain, to operate daily
lotteries on behalf of United Kingdom Charities.
F-27
<PAGE>
As of April 30, 1999 the Company has advanced ILL $428,364 to fund
operational obligations of ILL in accordance with a November 9, 1998 letter of
intent. Such advances have been classified in Other Assets. In addition, the
Company has paid ILL a standstill fee of $150,000 which was expensed in the
fiscal quarter ended January 31, 1999.
Further, the Company had deposited $487,500 into an escrow account prior to
April 30, 1999, which deposit is classified as an Other Current Asset. On May 5,
1999, $325,540 and $161,960, respectively were distributed out of escrow to
obtain the 27.5% interest in ILL from an unrelated third party and to fund a
newly formed wholly-owned subsidiary of the Company in the United Kingdom.
(4) Comprehensive Income
The Company has adopted Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" which establishes standards for the
reporting and presentation of comprehensive income and its components in
financial statements. Comprehensive income encompasses net income and "other
comprehensive income", which includes all other non-owner transactions and
events which change stockholders' equity. Other comprehensive income consists
only of net unrealized gains on investment securities for the Company and
totaled $2,370,792 and $2,367,139 for the three and six months ended April 30,
1999, respectively.
(5) Contingencies
Phillip J. Arnaldi, Individually as surviving father and in his
representative capacity as the Administrator of the Estate of Adrienne Valerie
Neuweiler, deceased v. SAIR Group, Swissair Transport Company, Ltd., SR Technics
Ltd., Delta Airlines, Inc., McDonnell Douglas Corporation, The Boeing Company
and Interactive Flight Technologies, Inc., United States District Court, Eastern
District of New York, CV 99-1265 - The family of a victim of the air crash
involving Swissair Flight No. 111 has alleged that the IFT in-flight
entertainment system aboard the involved MD-11 was improperly installed and a
cause of the crash. IFT denies all liability and has tendered the defense of
this claim to its avionics insurer who has accepted the defense and is
vigorously defending the claim.
First Lawrence Capital Corp. v. James Fox, Irwin Gross, Interactive Flight
Technologies, Inc., and John Doe Nos. 1 through 10. Supreme Court of the State
of New York, County of Westchester, No. 7196/99 - This is an unliquidated claim
by an investment banking firm that alleges its former employee, James Fox,
wrongfully brought certain corporate opportunities to IFT when he left his
employment with First Lawrence. IFT denies the allegations of the Complaint and
is vigorously defending the claim.
See Part II., Item 1. Legal Proceeding.
(6) Subsequent Events
(a) The Network Connection, Inc.
As of April 30, 1999, The Network Connection, Inc. ("TNCi") was indebted to
the Company in the approximate principal amount of $750,000. On May 10, 1999,
TNCi executed a Fourth Allonge to the Secured Promissory Note evidencing such
loan. Pursuant to such Fourth Allonge the balance due from TNCi to the Company
became convertible into shares of TNCi's Series C 8% Convertible Preferred
Stock, par value $.01 per share, $1,000 per share (the "Series C Preferred") at
F-28
<PAGE>
a conversion price of $1,000 per share. The Series C Preferred, in turn, is
convertible into common stock of TNCi as described in the Series C Designations.
As additional consideration for the Note, the Company received warrants to
purchase 200,000 shares of the common stock of TNCi at an average price per
share of $3.04. The warrants expire in 2004.
On May 11, 1999, the Company acquired from a third party investor 1,500
shares of Series B 8% Convertible Preferred Stock of TNCi, par value $.01 per
share, stated value $1,000 per share (the "Series B Shares") and cash in the
amount of $1,030,000 in exchange for (a) 3,000 shares of the Company's Series A
8% Convertible Preferred Stock, par value $.01 per share, stated value $1,000
per share and (b) warrants to purchase 87,500 shares of the Company's Class A
Common Stock, $.01 par value per share, at an exercise price of $3.00 per share.
On May 17, 1999, the Company acquired 1,055,745 shares of the common stock
and 2,495,400 shares of the Series D Convertible Preferred Stock of TNCi, par
value $.01 per share, stated value $10 per share, pursuant to the terms of the
Asset Purchase and Sale Agreement (the "Agreement") by and between the Company
and TNCi dated April 29, 1999 (the "Transaction"). The consideration paid by the
Company for all of such shares consisted of certain assets relating to the
Company's Interactive Entertainment Division, including all fixed assets,
inventory, intellectual property rights and other intangibles, prepaid expenses
and other property of the Company used in such division, plus cash in the amount
of $4,250,000. The cash which comprised a portion of the assets transferred to
TNCi was taken from the Company's working capital reserves. As part of the
Transaction, TNCi also assumed certain liabilities related to the the Company
assets transferred.
The TNCi common shares acquired by the Company in the Transaction, when
combined with the number of TNCi common shares into which the shares of Series D
Convertible Preferred Stock acquired by the Company in the Transaction can be
converted, equal 60% of all of the then outstanding common stock of TNCi on a
fully diluted basis, as defined in the Agreement. However, TNCi does not
currently have a sufficient number of common shares authorized to permit such a
conversion. The common stock of TNCi trades on the NASDAQ Small Cap Market under
the symbol "TNCX."
Each share of common stock of TNCi is entitled to one vote. Each share of
Series D Convertible Preferred Stock of TNCi is entitled to six votes; however,
notwithstanding the voting rights, the shares of Series D Convertible Preferred
Stock cannot be voted if the number of voting shares which would then be held by
TNCi as a result of the Transaction would exceed 19.99% of the voting shares
then outstanding until the TNCi shareholders have approved of the Transaction or
until July 15, 1999, whichever first occurs.
TNCi develops and manufactures networked computer systems to provide
customers with interactive, video-on-demand information and entertainment
content on commercial aircraft, cruise ships, and trains. TNCi has also sold
multimedia servers and has networked customer computers to educational
institutions and to corporations to support interactive, video-based training
programs.
(b) Mexican Entertainment and Gaming Activities
On May 14, 1999, the Company loaned $1,600,000 (of which $300,000 was
advanced on February 25, 1999) to a Mexican Corporation which was formed for the
purpose of operating a gaming and entertainment center in Monterrey, Nuevo Leon,
Mexico. The loan bears interest at a rate equal to the Prime Rate plus three
percent (3%) and matures on April 30, 2001.
The Company has also issued a letter of credit in the amount of $950,000 to
secure repayment of the purchase price of certain gaming equipment to be
F-29
<PAGE>
acquired by the Company and leased to the Mexican Corporation. The Mexican
Corporation will lease such equipment from the Company at the rate of $37,500
per month until the earlier of (i) the waiver or release of the requirement that
the Company maintain such letter of credit or (ii) the payment in full by the
Company of the purchase price, including all finance charges, of such equipment.
Thereafter, the Mexican Corporation will pay as rent for the equipment the sum
of $25,000 per month for as long as it uses any of the machines, provided that
the Mexican Corporation's obligation to pay such $25,000 per month fee shall
continue at least (i) until such time as the Company has paid the purchase price
for the equipment, or (ii) May 14, 2001.
In consideration for making the loan and issuing the letter of credit, the
Company has been issued 24.5% of the capital stock of the Mexican Corporation
and the Company will receive 25% of all of the profits generated by the Mexican
Corporation. Furthermore, for a term of ten years following the closing of the
loan to the Mexican Corporation, Regal Gaming and Entertainment, Inc. ("Regal"),
the holder of 24.5% of the equity of the Mexican Corporation has agreed to issue
to the Company, at no cost to the Company, 24.5% of the equity interest in any
gaming venture in which Regal, it subsidiaries or affiliates is an investor and
which relates to gaming activities in Mexico.
(c) Dry Cleaning Operations
On May 14, 1999 the Company completed the sale of the assets of its dry
cleaning operations for $750,000 in cash less fees and expenses of approximately
$50,000.
F-30
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 included herein.
KPMG LLP
Phoenix, Arizona
July 30, 1999
