UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 333-12091
INTER o ACT SYSTEMS, INCORPORATED
(Exact name of registrant as specified in its charter)
North Carolina 56-1817510
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
14 Westport Avenue
Norwalk, Connecticut 06851
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (203) 750-0300
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No___
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date. As of October 21, 1997 the
registrant had 7,728,555 shares of common stock outstanding.
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INDEX
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Part I - Financial Information
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets - September 30, 1997 and December 31, 1996 .......................................... 1
Consolidated Statements of Income for the three-month and nine-month
periods ended September 30, 1997 and September 28, 1996 and for
the period from February 25, 1993 (Date of Inception) to September 30, 1997 ................................ 2
Consolidated Statements of Cash Flows for the nine-month periods ended
September 30, 1997 and September 28, 1996 and for the period from February 25, 1993
(Date of Inception) to September 30, 1997................................................................... 3
Notes to Consolidated Financial Statements....................................................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................................. 6
Part II - Other Information
Item 1. Legal Proceedings...................................................................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders.................................................................... 10
Item 6. Exhibits and Reports on Form 8-K....................................................................................... 10
Signatures...................................................................................................................... 11
</TABLE>
<PAGE>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
INTER ACT SYSTEMS, INCORPORATED
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<CAPTION>
September 30, December 31,
1997 1996
--------- ---------
(Unaudited) (Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents .................................................................. $ 61,001 $ 88,306
Receivables, net of allowance for doubtful accounts of $10
at September 30, 1997 and December 31, 1996, respectively ............................. 244 617
Other current assets ....................................................................... 3,854 807
--------- ---------
Total current assets .................................................................. 65,099 89,730
Property, plant and equipment, net ............................................................... 25,052 11,690
Bond issuance costs, net of accumulated amortization of $496 and
$169 at September 30, 1997 and December 31, 1996, respectively ............................. 3,439 3,720
Patents, licenses and trademarks, net of accumulated amortization of
$25 and $34 at September 30, 1997 and December 31, 1996, respectively ...................... 1,658 227
Other noncurrent assets .......................................................................... 239 398
--------- ---------
Total assets .......................................................................... $ 95,487 $ 105,765
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Short term debt and current portion of long term debt ...................................... $ -- $ --
Accounts payable ........................................................................... 6,650 1,243
Accrued expenses ........................................................................... 4,906 1,778
Deferred revenue ........................................................................... 715 479
--------- ---------
Total current liabilities ............................................................. 12,271 3,500
Long term debt, net of discount .................................................................. 86,651 76,866
Other noncurrent liabilities ..................................................................... 279 292
--------- ---------
Total liabilities ..................................................................... 99,201 80,658
--------- ---------
Common stock purchase warrants ................................................................... 27,436 24,464
--------- ---------
Stockholders' equity (deficit):
Preferred stock, no par value, authorized 5,000,000 shares; none outstanding ............... -- --
Common stock, no par value, authorized 20,000,000 shares; 7,728,555 and
7,668,555 shares issued and outstanding at September 30, 1997 and
December 31, 1996, respectively ....................................................... 28,251 27,651
Additional paid in capital ................................................................. 768 768
Deferred compensation ...................................................................... (608) (723)
Deficit accumulated during development stage ............................................... (59,561) (27,053)
--------- ---------
Total stockholders' equity (deficit) .................................................. (31,150) 643
--------- ---------
Total liabilites and stockholders' equity (deficit) ................................... $ 95,487 $ 105,765
========= =========
See Notes to Consolidated Financial Statements
1
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<PAGE>
INTER-ACT SYSTEMS, INCORPORATED
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
<TABLE>
<CAPTION>
For the
Three Months Ended Nine Months Ended Period from
-------------------------- -------------------------- February 25, 1993
September 30, September 28, September 30, September 28, (Date of Inception)
1997 1996 1997 1996 to September 30, 1997
------------ ------------ ------------ ------------ ---------------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C>
Gross sales ........................................ $ 425 $ 261 $ 1,193 $ 415 $ 2,366
Less: Retailer reimbursements .................... (251) (160) (703) (242) (1,379)
-------- -------- -------- -------- --------
Net sales ...................................... 174 101 490 173 987
-------- -------- -------- -------- --------
Operating expenses:
Direct costs ..................................... 1,961 1,224 4,507 2,030 9,525
Selling, general and administrative expenses ..... 8,430 2,658 15,514 5,451 31,548
Depreciation and amortization of intangibles ..... 1,109 387 2,636 734 4,154
-------- -------- -------- -------- --------
Total operating expenses ....................... 11,500 4,269 22,657 8,215 45,227
-------- -------- -------- -------- --------
Operating loss ..................................... (11,326) (4,168) (22,167) (8,042) (44,240)
-------- -------- -------- -------- --------
Other income (expense)
Interest income .................................. 939 828 3,135 1,002 5,436
Interest expense ................................. (4,835) (2,632) (13,374) (2,685) (20,655)
Other expense .................................... (45) -- (102) -- (102)
-------- -------- -------- -------- --------
Total other income (expense) ................... (3,941) (1,804) (10,341) (1,683) (15,321)
-------- -------- -------- -------- --------
Net loss ........................................... $(15,267) $ (5,972) $(32,508) $ (9,725) $(59,561)
======== ======== ======== ======== ========
Loss per common share .............................. $ (1.98) $ (0.78) $ (4.23) $ (1.46)
======== ======== ======== ========
Weighted average number of common shares
outstanding .................................. 7,701 7,669 7,679 6,677
======== ======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements
2
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INTER-ACT SYSTEMS, INCORPORATED
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
For the
Nine Months Ended Period from
------------------------------- February 25, 1993
September 30, September 28, (Date of Inception)
1997 1996 to September 30, 1997
------------ ------------ ---------------------
(Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss ............................................................ $ (32,508) $ (9,725) $ (59,561)
Items not affecting cash:
Depreciation and amortization of intangible assets ............. 2,636 734 4,155
Loss on disposal of assets ..................................... 1,051 74 1,136
Non cash interest on discounted bonds .......................... 13,085 2,626 19,928
Acquired research and development expenses ..................... -- -- 611
Other items, net ............................................... 217 6 660
Changes in working capital:
Receivables .................................................... 372 (121) (244)
Accounts payable and accrued expenses .......................... 7,686 1,266 10,728
Other current assets ........................................... (2,572) (253) (3,719)
Deferred revenues .............................................. 236 130 715
--------- --------- ---------
Net cash used in operating activities ..................... (9,797) (5,263) (25,591)
--------- --------- ---------
Cash flows from investing activities:
Expenditures for property, plant and equipment ................. (16,575) (8,156) (29,880)
Proceeds from disposal of assets ............................... -- 57 57
Patent acquisition costs ....................................... (632) -- (651)
Other investments .............................................. (301) -- (340)
--------- --------- ---------
Net cash used in investing activities ..................... (17,508) (8,099) (30,814)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from issuance of 14% Senior Notes ................. -- 90,865 90,767
Long term debt repayments ...................................... -- (20) (51)
Proceeds from common stock issuance, net ....................... -- 16,335 24,717
Net amount due to stockholders ................................. -- -- 2,112
Net amount due from related parties ............................ -- (414) (139)
--------- --------- ---------
Net cash provided by financing activities ................. -- 106,766 117,406
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents ...................... (27,305) 93,404 61,001
Cash and cash equivalents at beginning of period .......................... 88,306 76 --
--------- --------- ---------
Cash and cash equivalents at end of period ................................ $ 61,001 $ 93,480 $ 61,001
========= ========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest ............................................................ $ 86 $ 95 $ 712
========= ========= =========
Supplemental disclosures of non cash financing activities:
Issuance of common stock in consideration for certain
obligations .................................................... $ 600 $ 2,141 $ 2,741
========= ========= =========
Deferred compensation related to stock options granted .............. $ -- $ 768 $ 768
========= ========= =========
</TABLE>
See Notes to Consolidated Financial Statements
3
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INTER o ACT SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the nine months ended September 30, 1997 and September 28, 1996 (unaudited)
1. Business Description
InteroAct Systems, Incorporated ("InteroAct") develops, owns and operates
proprietary electronic marketing systems that are designed to give consumer
products manufacturers (the "Manufacturers") and retailers the ability to
influence the purchasing behavior of consumers moments before shopping begins
and to track and analyze individual consumer purchasing behavior on an ongoing
basis. The Company's current commercial product offering utilizes interactive
"touch-screen" terminals inside the entrance of retail supermarkets that issue
individually targeted, and immediately usable, coupons and other promotional
incentives based on each consumer's cumulative purchasing history. As of
September 30, 1997, the Company had 1,598 terminals installed in 950 stores
across six grocery chains compared to 614 terminals in 328 stores across four
chains as of September 28, 1996.
2. Summary of Significant Accounting Policies
The accompanying interim financial statements as of September 30, 1997 and
for the three-month and nine-month periods ended September 30, 1997 and
September 28, 1996 are unaudited; however, in the opinion of management, all
adjustments, which consist of normal recurring accruals, necessary for a fair
presentation of the financial position and results of operations from such
interim periods, are included. The results of operations for the interim periods
presented are not necessarily indicative of results to be expected for an entire
year. For further information refer to the consolidated financial statements and
notes thereto included in the Company's annual report on Form 10-K for the year
ended September 28, 1996.
On February 13, 1997, the Company elected to change its fiscal year end
from the last Saturday in September to December 31, effective December 31, 1996.
The interim periods in 1996 ended on the last Saturday of the month, which, in
the case of September, ended on September 28, 1996.
Certain prior year amounts have been reclassified to conform with the
current year presentation.
Net income per common share is computed by dividing the net income
applicable to common stockholders by the weighted average number of common
shares outstanding during the period. The impact of outstanding options and
warrants has not been included, as their inclusion would be anti-dilutive.
3. Litigation
In February 1996, the Company filed suit against Catalina Marketing
Corporation alleging that Catalina has infringed United States Letters Patent
No. 4,554,446 ( the "`446 Patent") under which the Company is licensee. The
Company alleges that Catalina is infringing the patent by making, using and
offering for sale devices and systems that incorporate and employ inventions
covered by the `446 Patent. The Company is seeking an injunction against
Catalina to stop further infringement of the patent, treble damages and the
costs and expenses incurred in connection with the suit. The complaint has been
amended to add additional detail, and Catalina has answered denying the
allegations, raising certain affirmative defenses, and seeking declaratory
judgment of non-infringement, invalidity or unenforceability of the `446 Patent.
In May 1997, Catalina asserted a second counterclaim alleging that the Company
is infringing a newly issued Catalina Patent U.S. Patent No. 5,612,868. The
Company has answered denying the allegations, raising affirmative defenses and
seeking declaratory judgment of non-infringement, invalidity and
unenforceability of U.S. Patent No. 5,612,868. Discovery on the claims and
counterclaims is proceeding and various motions are pending before the United
States District Court in the District of Connecticut. As with any litigation,
the ultimate outcome of the suit cannot be predicted. However, the Company
intends to pursue the action vigorously.
4
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4. Additional Warrants Issued
The Company consummated a private offering of securities (the "Private
Placement") on August 2, 1996 for which it received net proceeds of
approximately $90.8 million. The Private Placement consisted of 142,000 units of
$142 million principal amount of 14% Senior Discount Notes Due 2003 (the
"Notes") and warrants (the "Warrants") to purchase initially an aggregate of
1,041,428 shares of common stock of the Company at $.01 per share. If the
Company has not completed a Qualifying Initial Public Offering (as herein
defined) by September 30, 1997, the Warrants that had not been exercised
entitled the respective holders to purchase an aggregate of 1,338,918 shares of
common stock at $.01 per share. Such Qualifying Initial Public Offering was not
completed by September 30, 1997, therefore the Company recorded additional
Common Stock Purchase Warrants of $3.0 million reflecting the valuation of an
additional 297,490 shares, or 2.095 shares issuable per warrant.
5
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis is qualified by reference to and
should be read in conjunction with the Company's Unaudited Consolidated
Financial Statements, including the Notes thereto, included elsewhere in this
Report. The Company's net sales and results of operations during the periods
presented have not been significantly affected by inflation. Operating results
for the three and nine months ended September 30, 1997 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997 or any other period.
Comparisons of operating results for the three-month and nine-month periods
ended September 30, 1997 and September 28, 1996 can be misleading given that the
Company's principal activities during the period from inception (February 25,
1993) through September 28, 1996 were related to the development, testing and
initial installation of the InteroAct Loyalty Network ("ILN") and were limited
by the Company's relatively small capital base.
In the second quarter of 1997, the Company changed the reference to its
proprietary interactive multimedia system from InteroAct Promotion Network
("IPN") to InteroAct Loyalty Network ("ILN") in order to more closely align the
marketing of InteroAct's products and services to the supermarket industry,
whose participants are increasingly pursuing frequent shopper or "loyalty" card
programs, as well as to consumer products manufacturers, who typically seek to
win new customer loyalty. InteroAct Loyalty Network is a service mark of
InteroAct Systems, Incorporated and an application for federal registration of
the mark is pending. Applications for InteroAct Promotion Network and Coupon
Central are also pending.
Results of Operations
The following table provides information concerning the Company's store
installations as of September 30, 1997 and September 28, 1996 and redemption
volumes and Manufacturer/brand information for the nine-month periods ended
September 30, 1997 and September 28, 1996, respectively.
Sept. 30, Sept. 28,
1997 1996
--------- ---------
Installed terminals ..................................... 1,598 614
Installed stores ........................................ 950 328
Uninstalled stores under contract or letter of intent ... 2,473 2,177
Nine Months Ended
Sept. 30, 1997 Sept. 28, 1996
-------------- --------------
Total redemptions ...................... 8,323,500 2,154,000
Total paid redemptions ................. 1,231,000 477,000
Average redemptions/day/store .......... 44 48
Paid redemptions/day/store ............. 7 11
Manufacturers promoting on ILN ......... 38 26
Products promoting on ILN .............. 88 84
Nine and Three Months Ended September 30, 1997 Compared with Nine and Three
Months Ended September 28, 1996
The Company installed 70 terminals in 70 stores in the third quarter of
1997, bringing the total terminals and stores installed to 1,598 and 950,
respectively, as of September 30, 1997. During the third quarter of 1997, the
Company signed letters of intent with Harris Teeter Corporation and Weis
Markets, together representing approximately 200 stores.
Total redemptions for the nine-month period ended September 30, 1997
increased by approximately 6.2 million redemptions over the comparable period in
1996. Average redemptions/day/store decreased to 44 from 48 for the period ended
September 30, 1997 versus the comparable period in 1996. The Company attributed
6
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the decrease to reduced number of available incentives offered on the ILN
terminals in the second quarter of 1997 and lower supermarket sales activity in
the Company's key markets during the third quarter of 1997. The reduced number
of incentives offered in the second quarter resulted from a management decision
to decrease the number of "non-paid" promotions offered on the system in order
to reallocate such promotion funds to coincide with retailer event promotions
later in the year. Non-paid promotions, which accounted for 86% of total
redemptions for the nine months ended September 30, 1997 represent consumer
incentives and retailer handling fees paid for by InteroAct as opposed to
contracted Manufacturers, and are placed on the ILN in order to manage consumer
usage levels. As the network grows and is more widely accepted by Manufacturers,
the Company believes that the need for non-paid promotions will diminish
substantially. Comparable store sales trends for food retailers were reported to
be down by approximately 2% in certain chains located in the northeast portion
of the United States during the third quarter of 1997 versus the comparable 1996
period. Management believes such sales trends experienced by food retailers
directly affect the Company's redemption activity and revenue earned. Brand
manufacturers promoting on the ILN system for at least one week during the 1997
and 1996 periods increased to 38 from 26, respectively, while total products
promoted increased to 88 from 84. Net sales during the nine-month period ended
September 30, 1997 increased to $490,000 from $173,000 in the 1996 period,
primarily as a result of the larger installed base of ILN terminals. During the
three-month period ended September 30, 1997, net sales increased to $174,000
from $101,000 in the same period in 1996. Third quarter 1997 redemptions were
3.3 million as compared to 1.4 million redemptions in the same period of 1996
and average redemptions/day/store were 40 and 54 for the three-month periods
ended September 30, 1997 and September 28, 1996, respectively.
Operating loss for the nine-month period ended September 30, 1997 was $22.2
million versus $8.0 million in the 1996 comparable period. The increased loss
was primarily due to higher employee costs, non-paid promotions, fixed asset
adjustments, legal fees and depreciation expense. Higher employee costs of
approximately $3.9 million represents an increase of 91 employees, from 77
employees at September 28, 1996 to 168 employees at September 30, 1997. Most of
the increase in headcount represents additional sales and field service
personnel to support the increase in number of terminals and stores installed.
Non-paid promotion expense increased by $2.3 million in the 1997 nine-month
period, to $3.2 million from $0.9 million in the comparable 1996 period. During
the third quarter, the Company recorded a non-cash charge of $2.3 million for
fixed assets that have been deemed to be obsolete. Legal expense, primarily
costs associated with patent litigation, increased by $1 million over the
comparable 1996 period (See Note 3 to Notes to Consolidated Financial
Statements). Depreciation expense increased by $1.9 million reflecting the
addition of approximately 1,000 terminals installed in 600 stores from September
28, 1996 to September 30, 1997. Third quarter 1997 operating loss of $11.3
million was $7.2 million higher than in the third quarter 1996, primarily
reflecting additional headcount and expenses associated with increased
installations of terminals, fixed asset adjustments of $2.3 million, increased
legal expense of $1.0 million, increased non-paid promotion expense of $722,000
and higher depreciation expense of $722,000.
Net loss for the nine month period ended September 30, 1997 increased by
approximately $22.8 million from $9.7 million to $32.5 million primarily due to
higher operating losses of $14.2 million and increased interest expense of $10.7
million offset by an increase in interest income of $2.1 million. Interest
expense of $13.4 million during the first nine months of 1997 reflects the
interest expense on the issuance of $142 million of senior discount notes on
August 2, 1996. (See "-Liquidity and Capital Resources"). Interest income of
$3.1 million for the first nine months of 1997 reflects an increased average
cash balance during the first nine months of 1997 versus the comparable period
in 1996. Cash and cash equivalents at September 30, 1997 were $61.0 million as
compared to $93.5 million at September 28, 1996. On August 2, 1996, the Company
received net proceeds of $90.8 million related to the Private Placement. (See
"-Liquidity and Capital Resources"). Net loss for the three-month period ended
September 30, 1997 was $15.3 million, an increase of $9.3 million compared to
the same three-month period in 1996 due to increased operating losses and
interest expense of $7.2 million and $2.2 million, respectively.
Liquidity and Capital Resources
Cash used in operating activities was $9.8 million during the nine months
ended September 30, 1997. From February 25, 1993, (Date of Inception) to
September 30, 1997 the net cash used in operating activities was $25.6 million
as the Company generated minimal revenue yet incurred expenses related to the
development of
7
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its ILN technology, test marketing the product and recruiting personnel. The
Company has funded its operations through private sales of debt and equity
securities. From its inception through September 30, 1997, the Company's
stockholders had contributed $27.7 million of equity to the Company of which
$2.0 million was originally issued as debt and subsequently converted to equity.
The Company consummated a private offering of securities (the "Private
Placement") on August 2, 1996 for which it received net proceeds of
approximately $90.8 million. The Private Placement consisted of 142,000 units of
$142 million principal amount of 14% Senior Discount Notes Due 2003 (the
"Notes") and warrants (the "Warrants") to purchase initially an aggregate of
1,041,428 shares of common stock of the Company at $.01 per share. If the
Company has not completed a Qualifying Initial Public Offering (as herein
defined) as of September 30, 1997, the Warrants that had not been exercised
entitled the respective holders to purchase an aggregate of 1,338,918 shares of
common stock at $.01 per share. Such Qualifying Initial Public Offering was not
completed by September 30, 1997, therefore the Company recorded additional
Common Stock Purchase Warrants of $3.0 million reflecting the valuation of an
additional 297,490 shares, or 2.095 shares issuable per warrant.
In January 1997, the Company consummated an exchange offer (the "Exchange
Offer"), whereby the holders of the Notes issued in the Private Placement
exchanged such Notes for new Notes (the "Exchange Notes") that were registered
under the Securities Act of 1933, as amended. The Exchange Notes do not bear
legends restricting the transfer thereof.
Cash provided by financing activities was $117.4 million for the period
from February 25, 1993 (Date of Inception) through September 30, 1997. Financing
activities during the nine-month period ended September 30, 1997 provided no
cash. As of September 30, 1997, the Company had cash and cash equivalents of
$61.0 million and working capital of $52.8 million as compared to cash and cash
equivalents of $88.3 million and working capital of $86.2 million at December
31, 1996.
Cash used in investing activities was $17.5 million and $30.8 million in
the nine months ended September 30, 1997 and for the period from February 25,
1993 (Date of Inception) through September 30, 1997, respectively, primarily
related to expenditures for ILN equipment. During the nine-month period ended
September 30, 1997, the Company installed 975 terminals in 615 stores. The
Company expects to spend approximately $23 million on ILN equipment during 1997
of which, $15.1 million had been expended during the nine-month period ended
September 30, 1997. Of the estimated $23 million of ILN equipment to be
purchased in 1997, approximately $6.6 million relates to ILN equipment for
planned 1998 installations, the majority of which the Company expects to be
installed during the first quarter of 1998.
During the third quarter of 1997, the Company acquired certain exclusive
and nonexclusive rights for Patent No. Re. 34,915 for a "Paperless System for
Distributing, Redeeming and Clearing Merchandise Coupons." Consideration for
such patent included cash, shares of InteroAct stock and royalty payments based
on a formula of the Company's future revenue stream. The term of such agreement
is for as long as the patent remains valid and enforceable, subject to certain
termination rights as set forth in such agreement. Management believes that by
obtaining the rights to this patent, the Company will experience a significant
competitive edge in the electronic discount redemption industry in the future.
The Company offers product promotions for which it bears the full cost of
each redemption without reimbursement from Manufacturers. During the nine months
ended September 30, 1997, the Company incurred approximately $3.2 million of
such promotion expense.
The Company will continue to use the net proceeds from the Private
Placement to fund capital expenditures, working capital requirements and
operating losses incurred in connection with the increased commercialization of
its ILN during 1997. The Company believes that existing cash and cash
equivalents will be sufficient to meet the Company's currently anticipated
operating and capital expenditure requirements through the second quarter of
1998. However, the Company intends to seek additional capital prior to that time
to fund its planned expansion in 1998 and to address any liquidity needs caused
by shortfalls in revenue. Because of the Company's early stage of development
and the risks inherent in its business, there are a number of material
uncertainties that could result in shortfalls in revenue. For example,
shortfalls could occur if the Company experiences delays in installations of the
ILN such that any growth in paid redemption volume is delayed. If additional
funds are raised through the issuance of equity securities, the percentage
ownership of the stockholders may experience additional dilution, or such equity
securities may have rights, preferences or privileges senior to the Common
Stock. If additional funds are raised through debt financing, such financing
will increase the financial leverage of the Company and earnings would be
reduced by the associated interest expense. The Indenture permits the Company to
incur additional indebtedness, subject to certain limitations. There can be no
assurance that additional financing will be available when needed on terms
favorable to the Company or at all. If adequate funds are not available on
acceptable terms, the Company may be unable to continue its planned ILN
installations, expand both the number and dollar amount of Manufacturer
8
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commitments, or respond to competitive pressures, any of which could have a
material adverse effect on the Company's results of operations and financial
condition.
For a further description of the Notes and Warrants, see Notes 1, 7, and 8
to the September 28, 1996 and September 30, 1995 Consolidated Financial
Statements filed with the Company's Annual Report on Form 10-K for the fiscal
year ended September 28, 1996.
Recently Issued Accounting Pronouncements
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share". This
statement establishes standards for computing and presenting earnings per share
("EPS"), replacing the presentation of currently required primary EPS with a
presentation of Basic EPS. For entities with complex capital structures, the
statement requires the dual presentation of both Basic EPS and Diluted EPS on
the face of the statement of operations. Under this new standard, Basic EPS is
computed based on weighted average shares outstanding and excludes any potential
dilution; Diluted EPS reflects potential dilution from the exercise or
conversion of securities into common stock or from other contracts to issue
common stock and is similar to the currently required fully diluted EPS. SFAS
128 is effective for financial statements issued for periods ending after
December 15, 1997, including interim periods, and earlier application is not
permitted. When adopted, the Company will be required to restate its EPS data
for all prior periods presented. The Company does not expect the impact of the
adoption of this statement to be material to previously reported EPS amounts.
Cautionary Statement on Forward Looking Statements
Except for historical matters, matters discussed in Part I, Item 2.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," are "forward-looking statements" (as such term is defined in the
Private Securities Litigation reform Act of 1995). In addition, from time to
time the Company or its representatives have made or may make forward -looking
statements, orally or in writing. Forward-looking statements are based on
management's current views and assumptions and involve risks and uncertainties
that could significantly affect expected results. InteroAct wishes to caution
the reader that the factors below in some cases have affected and could affect
InteroAct's actual results, causing actual results to differ materially from
those in any forward-looking statement. These factors include: (i) the Company's
limited operating history, significant losses, accumulated deficit and expected
future losses, (ii) the dependence of the Company on its ability to establish,
maintain and expand relationships with Manufacturers to promote brands on the
ILN, the lengthy sales cycle in marketing the ILN to Manufacturers and the
uncertainty of market acceptance for the ILN, (iii) the pressure that rapid
growth places on the Company's managerial, operational and financial resources,
the uncertainty as to whether the Company will be able to manage its growth
effectively, the early stage of the Company's products and services and
technical and other problems that the Company has experienced and may experience
with the accelerated installation of the ILN, (iv) risks related to the
Company's substantial leverage and debt service obligations, (v) the effective
subordination of the Notes to the obligations of its subsidiaries, (vi) the
consequences of the Company's possible need for additional financing, (vii) the
lack of product diversification and the Company's dependence on the consumer
products advertising and promotional business and its expenditures, (viii) the
Company's dependence on third parties such as Thermo Information Solutions,
Inc., the manufacturer of ILN terminals, (ix) the intensely competitive nature
of the consumer product and promotional industry and the greater resources of
most of the Company's competitors, (x) risks that the Company's rights related
to patents, proprietary information and trademarks may not adequately protect
its business, (xi) the possible inability of new management to perform their
respective roles and the possible conflicts of interest of the Company's
directors, officers and principal shareholders in certain transactions with the
Company. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risk Factors" of the Form 10-K for the
fiscal year ended September 28, 1996 for a more specific description of these
risks.
9
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In February 1996, the Company filed suit against Catalina Marketing
Corporation alleging that Catalina has infringed United States Letters Patent
No. 4,554,446 ( the "`446 Patent") under which the Company is licensee. The
Company alleges that Catalina is infringing the patent by making, using and
offering for sale devices and systems that incorporate and employ inventions
covered by the `446 Patent. The Company is seeking an injunction against
Catalina to stop further infringement of the patent, treble damages and the
costs and expenses incurred in connection with the suit. The complaint has been
amended to add additional detail, and Catalina has answered denying the
allegations, raising certain affirmative defenses, and seeking declaratory
judgment of non-infringement, invalidity or unenforceability of the `446 Patent.
In May 1997, Catalina asserted a second counterclaim alleging that the Company
is infringing a newly issued Catalina Patent U.S. Patent No. 5,612,868. The
Company has answered denying the allegations, raising affirmative defenses and
seeking declaratory judgment of non-infringement, invalidity and
unenforceability of U.S. Patent No. 5,612,868. Discovery on the claims and
counterclaims is proceeding and various motions are pending before the United
States District Court in the District of Connecticut. As with any litigation,
the ultimate outcome of the suit cannot be predicted. However, the Company
intends to pursue the action vigorously.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
*(a)(1) Articles of Incorporation of the Company, as amended, filed as
Exhibit 3(a) to the Company's Registration Statement of Form S-4
(Registration 333-12091)
*3(a)(2) Articles of Amendment of the Company dated May 21, 1997 and
effective June 3, 1997.
*3(b) Amended and Restated Bylaws of the Company
*4(a) Specimen Certificate of the Company's Common Stock, filed as Exhibit
4(a) to the Company's Registration Statement of Form S-4
(Registration 333-12091)
*4 (b) Indenture dated August 1, 1996, between the Company and Fleet
National Bank, as trustee, relating to $142,000,000 in principal
amount of 14% Senior Discount Notes due 2003, filed as Exhibit 4(b)
to the Company's Registration Statement of Form S-4
(Registration 333-12091)
*4 (c) Warrant Agreement dated August 1, 1996, between the Company and
Fleet National Bank, as Warrant Agent, filed as Exhibit 10 (l) to
the Company's Annual Report on Form 10-K for the year ended
September 28, 1996.
27. Financial Data Schedule.
* Incorporated by reference to the statement or report indicated.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the three months ended
September 30, 1997.
10
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTERoACT SYSTEMS, INCORPORATED
By __________________________________________________
Stephen R. Leeolou
Chairman & Chief Executive Officer
By:__________________________________________________
Richard A. Vinchesi
Senior Vice President,
Chief Operating Officer & Chief Financial Officer
11
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