<PAGE>
<PAGE>
________________________________________________________________________________
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, 1998
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*ACT SYSTEMS, INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C>
NORTH CAROLINA 56-1817510
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
14 WESTPORT AVENUE
NORWALK, CONNECTICUT 06851
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(203) 750-0300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
------------------------
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.
[x] Yes [ ] 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 November 6, 1998 the
registrant had 7,728,555 shares of common stock outstanding.
________________________________________________________________________________
<PAGE>
<PAGE>
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -- September 30, 1998 (unaudited) and December 31, 1997.............. 1
Consolidated Statements of Income for the three-month and nine-month periods ended September
30, 1998 and September 30, 1997 (unaudited)................................................... 2
Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 1998 and
September 30, 1997 (unaudited)................................................................ 3
Notes to Consolidated Financial Statements....................................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................. 7
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings.................................................................................. 13
Item 4. Submission of Matters to a Vote of Security Holders................................................ 13
Item 6. Exhibits and Reports on Form 8-K................................................................... 14
Signatures....................................................................................................... 15
</TABLE>
<PAGE>
<PAGE>
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTER*ACT SYSTEMS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................................... $ 4,012 $ 45,211
Receivables, net of allowance for doubtful accounts of $60 and $30 at
September 30, 1998 and December 31, 1997, respectively....................... 2,164 813
Other current assets.......................................................... 3,379 3,067
------------- ------------
Total current assets..................................................... 9,555 49,091
Property, plant and equipment, net................................................. 29,193 26,900
Bond issuance costs, net of accumulated amortization of $1,021 and $633 at
September 30, 1998 and December 31, 1997, respectively........................... 2,914 3,302
Patents, licenses and trademarks, net of accumulated amortization of $541 and $95
at September 30, 1998 and December 31, 1997, respectively........................ 9,010 1,687
Other noncurrent assets............................................................ 45 43
------------- ------------
Total assets............................................................. $ 50,717 $ 81,023
------------- ------------
------------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Short-term debt............................................................... $ 5,679 $ --
Accounts payable.............................................................. 2,269 3,204
Accrued expenses.............................................................. 3,534 6,870
Deferred revenue.............................................................. 824 539
------------- ------------
Total current liabilities................................................ 12,306 10,613
Long-term debt, net of discount.................................................... 106,394 91,406
------------- ------------
Total liabilities........................................................ 118,700 102,019
------------- ------------
Common stock purchase warrants..................................................... 27,436 27,436
------------- ------------
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 shares
issued and outstanding at September 30, 1998 and December 31, 1997,
respectively................................................................. 28,251 28,251
Additional paid-in capital.................................................... 768 768
Deferred compensation......................................................... (454) (570)
Cumulative translation adjustments............................................ (30) (14)
Accumulated deficit........................................................... (123,954) (76,867)
------------- ------------
Total stockholders' equity (deficit)..................................... (95,419) (48,432)
------------- ------------
Total liabilities and stockholders' equity (deficit)..................... $ 50,717 $ 81,023
------------- ------------
------------- ------------
</TABLE>
See Notes to Consolidated Financial Statements
1
<PAGE>
<PAGE>
INTER*ACT SYSTEMS, INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Gross sales........................................ $ 2,660 $ 425 $ 4,656 $ 1,193
Less: Retailer reimbursements................. (840) (251) (1,790) (703)
------------- ------------- ------------- -------------
Net sales................................ 1,820 174 2,866 490
------------- ------------- ------------- -------------
Operating expenses:
Direct costs.................................. 2,396 1,961 6,771 4,507
Selling, general and administrative
expenses.................................... 6,475 8,430 23,345 15,514
Depreciation and amortization of
intangibles................................. 2,202 1,109 5,473 2,636
------------- ------------- ------------- -------------
Total operating expenses................. 11,073 11,500 35,589 22,657
------------- ------------- ------------- -------------
Operating loss..................................... (9,253) (11,326) (32,723) (22,167)
------------- ------------- ------------- -------------
Other income (expense)
Interest income............................... 302 939 1,135 3,135
Interest expense.............................. (5,472) (4,835) (15,499) (13,374)
Other expense................................. -- (45) -- (102)
------------- ------------- ------------- -------------
Total other income (expense)............. (5,170) (3,941) (14,364) (10,341)
------------- ------------- ------------- -------------
Net loss........................................... $ (14,423) $ (15,267) $ (47,087) $ (32,508)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Per share information:
Net loss per common share:
Basic......................................... $ (1.87) $ (1.98) $ (6.09) $ (4.23)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Diluted....................................... $ (1.87) $ (1.98) $ (6.09) $ (4.23)
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Common shares used in computing per share amounts
Basic......................................... 7,729 7,701 7,729 7,679
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
Diluted....................................... 7,729 7,701 7,729 7,679
------------- ------------- ------------- -------------
------------- ------------- ------------- -------------
</TABLE>
See Notes to Consolidated Financial Statements
2
<PAGE>
<PAGE>
INTER*ACT SYSTEMS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------- -------------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss...................................................................... $ (47,087) $ (32,508)
Items not affecting cash:
Depreciation and amortization of intangible assets....................... 5,473 2,636
Loss on disposal of assets............................................... 29 1,051
Non-cash interest on discounted bonds.................................... 15,376 13,085
Other items, net......................................................... 114 217
Changes in working capital:
Receivables.............................................................. (1,345) 372
Accounts payable and accrued expenses.................................... (4,287) 7,686
Other current assets..................................................... (311) (2,572)
Deferred revenues........................................................ 285 236
------------- -------------
Net cash used in operating activities............................... (31,753) (9,797)
------------- -------------
Cash flows from investing activities:
Expenditures for property, plant and equipment........................... (7,319) (16,575)
Patent acquisition costs................................................. (2,090) (632)
Other investments........................................................ -- (301)
------------- -------------
Net cash used in investing activities............................... (9,409) (17,508)
------------- -------------
Foreign exchange effects on cash and cash equivalents.............................. (37) --
------------- -------------
Net decrease in cash and cash equivalents.......................................... (41,199) (27,305)
Cash and cash equivalents at beginning of period................................... 45,211 88,306
------------- -------------
Cash and cash equivalents at end of period......................................... $ 4,012 $ 61,001
------------- -------------
------------- -------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest...................................................................... $ 26 $ 86
------------- -------------
------------- -------------
Supplemental disclosure of non-cash financing activities:
Issuance of note payable for patent acquisition............................... $ 5,679 $ --
------------- -------------
------------- -------------
Issuance of common stock in consideration for certain obligations............. $ -- $ 600
------------- -------------
------------- -------------
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE>
<PAGE>
INTER*ACT SYSTEMS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND SEPTEMBER 30, 1997
1. BUSINESS DESCRIPTION
Inter*Act Systems, Incorporated ('Inter*Act' or the 'Company') is one of
the nation's largest in-store operators of customer-interactive electronic
marketing systems. The Company's patented technologies enable consumer products
manufacturers ('Manufacturers') and supermarket retailers ('Retailers') to offer
shopper-specific purchase incentives and messages to customers moments before
shopping begins. The Company's proprietary system, called the Inter*Act Loyalty
Network'TM' ('ILN'), utilizes patented, multimedia touch-screen terminals, or
Smart Kiosks'TM', located in the entrance area of retail grocery stores. These
terminals are connected to each store's point-of-sale scanning system, which
allows the electronic promotions to be immediately redeemed at the check-out.
This fully automated process virtually eliminates misredemption and fraud
associated with paper coupons, estimated by industry sources to cost
manufacturers hundreds of millions of dollars per year. As of September 30,
1998, the Company had 2,648 terminals installed in 1,749 stores across 18
divisions of six grocery chains, compared to 1,598 terminals in 950 stores
across 15 divisions of six chains as of September 30, 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PREPARATION
The accompanying interim financial statements as of September 30, 1998 and
for the nine-month period ended September 30, 1998 and September 30, 1997 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
December 31, 1997.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
NET INCOME (LOSS) PER SHARE
Effective December 31, 1997, the Company adopted SFAS No. 128, 'Earnings
Per Share.' In accordance with SFAS No. 128, net loss per common share amounts
('basic EPS') were computed by dividing net loss by the weighted average number
of common shares outstanding and contingently issuable shares (which satisfy
certain conditions) and excluded any potential dilution. Net loss per common
share amounts -- assuming dilution ('diluted EPS') were computed by reflecting
potential dilution from the exercise of stock options and warrants. SFAS No. 128
requires the presentation of both basic EPS and diluted EPS on the face of the
income statement. Net loss per share amounts for the same prior-year periods
have been restated to conform with the provisions of SFAS No. 128; however, the
result of that restatement was not material. In all periods presented, the
impact of stock options and warrants was anti-dilutive.
COMPREHENSIVE INCOME
During the quarter ended March 31, 1998, the Company adopted SFAS No. 130,
'Reporting Comprehensive Income,' which requires companies to report all changes
in equity during a period, except those resulting from investments by owners and
distributions to owners, for the period in which they are recognized.
Comprehensive income is the total of net income and all other nonowner changes
in equity (or other comprehensive income) such as unrealized gains/losses on
securities classified as
4
<PAGE>
<PAGE>
available-for-sale, foreign currency translation adjustments and minimum pension
liability adjustments. Comprehensive and other comprehensive income must be
reported on the face of annual financial statements or in the case of interim
reporting, in the footnotes to the financial statements. For the nine-month
period ended September 30, 1998 and 1997, the Company's operations did not give
rise to material items includible in comprehensive income which were not already
included in net income. Accordingly, the Company's comprehensive income is the
same as its net income for all periods presented.
3. LEGAL PROCEEDINGS
In February 1996, the Company filed suit against Catalina Marketing
Corporation ('Catalina') alleging that Catalina has infringed United States
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 counterclaim alleging that the Company is
infringing a newly issued Catalina Patent U.S. Patent No. 5,612,868 (the ''868
Patent'). The Company has answered denying the allegations, raising affirmative
defenses and seeking declaratory judgment of non-infringement, invalidity and
unenforceability of the '868 Patent. Discovery on the claims and counterclaims
will proceed 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.
In January 1998, Catalina Marketing International, Inc. ('Catalina
International,' a subsidiary of Catalina) filed suit against the Company
alleging that the Company has infringed United States Patent No. 4,674,041 (the
''041 Patent') which Catalina International acquired by assignment in December
1997. Catalina International alleges that the Company is infringing the '041
Patent by making, using and offering for sale devices and systems that
incorporate and employ inventions covered by the '041 Patent. Also in February
1998, Catalina International amended its complaint to join as additional parties
defendant Thermo Information Solutions, Inc. ('Thermo') and Coleman Research
Corporation ('Coleman'), who have manufactured kiosks pursuant to an agreement
with the Company. Catalina International seeks injunctive and declaratory relief
as well as unspecified money damages against all defendants, and has filed a
motion for preliminary injunction against the Company seeking to stop alleged
infringement of the '041 Patent pending trial. Various other motions are pending
in the United States District Court in the District of Connecticut, including
the Company's motion for a more definite statement. The Company intends to
defend against Catalina International's claims vigorously, and to pursue
available remedies against Catalina International. This action was recently
consolidated with the litigation involving the '446 Patent and the '868 Patent
for purposes of discovery and trial.
On May 27, 1998, the Company filed a new suit against Catalina alleging
that Catalina has infringed United States Patents Nos. 5,201,010; 5,338,165;
5,430,644; 5,448,471; 5,592,560; 5,621,812; 5,659,469; and 5,638,457
(collectively, the 'Deaton Patents'), which the Company acquired by assignment
on or about May 22, 1998. The Company alleges that Catalina is infringing the
Deaton Patents by making, using, selling and offering for sale devices and
systems that incorporate and employ inventions covered by the Deaton Patents.
The Company is seeking an injunction against Catalina to stop further
infringement of these patents, treble damages and the costs and expenses
incurred in connection with the suit.
Catalina has answered denying the allegations, raising certain affirmative
defenses, and seeking declaratory judgment of non-infringement, invalidity or
unenforceability of the Deaton Patents. Catalina has also challenged some of the
claims of six of the Deaton Patents by provoking an interference proceeding in
the U.S. Patent and Trademark Office.
The Company intends to vigorously protect its rights under the Deaton
Patents both in the interference proceeding and in the new lawsuit.
5
<PAGE>
<PAGE>
4. ISSUANCE OF PREFERRED STOCK SUBSEQUENT TO DATE OF BALANCE SHEET
In October 1998, the Company issued 173,278 shares of 10% Series A
Mandatorily Convertible Preferred Stock ('Preferred Stock') at a price of $100
per share for total proceeds of $17.3 million. Dividends on the Preferred Stock
will accrue from the date of issuance at a rate of 10% per annum, payable
semi-annually on the last day of June and December of each year, commencing on
December 31, 1998. Dividends will be payable in cash, by delivery of shares of
Preferred Stock, or by a combination thereof at the Company's option. The shares
have certain voluntary and mandatory conversion rights into the Company's Common
Stock under certain events, such as an initial public stock offering.
The following table sets forth as of September 30, 1998 the consolidated
short-term debt and capitalization of the Company and as adjusted to give effect
to the issuance of Preferred Stock. The table should be read in conjunction with
the Company's Consolidated Financial Statements, including the Notes thereto,
included elsewhere in this report and the annual report on Form 10-K for the
year ended December 31, 1997.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
---------------------------
ACTUAL AS ADJUSTED(1)
--------- --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Short-term debt and current portion of long-term debt..................... $ 5,679 $ 5,679
--------- --------------
--------- --------------
Capitalization:
Long-term debt, net of discount...................................... $ 106,394 $ 106,394
--------- --------------
Common stock purchase warrants....................................... 27,436 27,436
--------- --------------
Stockholders' equity (deficit):
Preferred stock, $100 par value, authorized 5,000,000 shares; issued
173,278 shares(1).................................................. -- 17,328
Common stock, no par value, authorized 20,000,000 shares; 7,728,555
shares issued and outstanding...................................... 28,251 28,251
Additional paid-in capital........................................... 768 768
Deferred compensation................................................ (454) (454)
Cumulative translation adjustments................................... (30) (30)
Accumulated deficit.................................................. (123,954) (123,954)
--------- --------------
Total stockholders' equity (deficit)............................ (95,419) (78,091)
--------- --------------
Total capitalization............................................ $ 38,411 $ 55,739
--------- --------------
--------- --------------
</TABLE>
- ------------
(1) The As Adjusted capitalization reflects the issuance of 173,278 shares of
10% Series A Mandatorily Convertible Preferred Stock; par value $100.
6
<PAGE>
<PAGE>
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. This report contains certain statements regarding future operating
results and anticipated growth, the accuracy of which is subject to many risks
and uncertainties. Such trends, and their anticipated impact on the Company,
could differ materially from those discussed in this report. Operating results
for the nine months ended September 30, 1998 are not necessarily indicative of
the results that may be expected for the year ending December 31, 1998 or any
other period.
The Company is one of the nation's largest in-store operators of
customer-interactive electronic marketing systems. The Company's patented
technologies enable consumer products manufacturers ('Manufacturers') and
supermarket retailers ('Retailers') to offer shopper-specific purchase
incentives and messages to customers moments before shopping begins. The
Company's proprietary system, called the Inter*Act Loyalty Network'TM' ('ILN'),
utilizes patented, multimedia touch-screen terminals, or Smart Kiosks'TM',
located in the entrance area of retail grocery stores. These terminals are
connected to each store's point-of-sale scanning system, which allows the
electronic promotions to be immediately redeemed at check-out. This fully
automated process virtually eliminates the misredemption and fraud associated
with paper coupons, estimated by industry sources to cost Manufacturers hundreds
of millions of dollars per year.
The majority of the Company's Manufacturer contracts to date have been
based on a pay-on-redemption format. The Company recognizes revenue for these
contracts as electronic discounts are redeemed at store cash registers.
Manufacturers pay a fee to the Company for each redemption. The fee is composed
of (1) a retailer processing fee, (2) a redemption fee and (3) the face value of
the coupon. The Company, in turn, passes through both the retailer processing
fee, which is included in direct operating expenses, and the face value of the
coupon to the Retailer, while retaining the redemption fee. The Company records
as net sales the redemption fee and the retailer processing fee paid by the
Manufacturers. Certain Manufacturers pay the Company in advance for a portion of
anticipated program expenditures, and these amounts are recorded as deferred
revenue until earned through redemptions. The Company also negotiates flat-fee
contracts with certain manufacturers and recognizes revenue from these
proportionally over the promotion cycles stipulated by the contract.
Direct costs of the Company consist of expenditures for direct store
support, paper used in the kiosks to print shopping lists and recipes, direct
marketing costs, telecommunications between the stores and the Company and
retailer processing fees. Selling, general and administration expenses include
items relating to sales and marketing, administration, non-paid promotional
expenses and royalties payable under certain patent agreements.
Non-paid promotional expenses represent consumer discounts and retailer
processing fees paid to the Retailer by the Company on promotions offered on the
ILN that are not funded by a Manufacturer contract. Manufacturer participation
in the ILN to date has been characterized by a substantial number of trial
commitments leading to increasing dollar commitments to the ILN from those
Manufacturers as the network approaches a more national footprint. Successful
trials have recently led to multi-cycle/multi-brand category contracts or
letters of intent signed in the nine-month period ended September 30, 1998 with
Manufacturers, including General Mills, Procter & Gamble, Pepsi, Frito-Lay and
Pillsbury among others. See ' -- Nine Months Ended September 30, 1998 Compared
with Nine Months Ended September 30, 1997.' As the network grows and is more
widely accepted by Manufacturers, the Company believes that the need for
non-paid promotions will diminish and that revenues from Manufacturers will
increase.
To date, the Company has generated minimal operating revenue, has incurred
significant losses and has experienced substantial negative cash flow from
operations. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development. The Company had an accumulated stockholders' deficit of
$95.4 million as of September 30, 1998, having incurred a loss of $47.1 million
during the nine months of 1998. The Company expects to incur substantial
additional costs to install additional ILN terminals in retail supermarket
stores and to sponsor selected promotions to demonstrate the utility of the ILN
to consumers, Retailers and Manufacturers. The Company expects to incur net
losses in the remainder of
7
<PAGE>
<PAGE>
1998 and may operate at a loss for the foreseeable future, and there can be no
assurance that the Company will ever be able to achieve profitability or, if
achieved, to sustain such profitability.
The Company had an installed base of 2,648 terminals in 1,749 stores as of
September 30, 1998 as compared to 1,598 terminals in 950 stores as of September
30, 1997. During the first nine months of 1998, the Company entered into
contracts to install the ILN in Weis Markets, a chain located principally in
Pennsylvania, and, through a subsidiary, in Sainsbury's, one of the largest
Retailers in the United Kingdom.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1997
Manufacturers promoting on the ILN system for at least one week during the
1998 and 1997 periods increased to 64 from 38, respectively, while total
products promoted increased to 127 from 88. Net sales during the nine-month
period ended September 30, 1998 increased to $2.9 million from $490,000 in the
1997 period, primarily as a result of the larger installed base of ILN
terminals. During the second and third quarter, the Company continued to sign
contracts with new ILN clients such as Pepsi, Frito-Lay and others. In addition,
the Company began to rollout a trial of the ILN in Sainsbury's stores in the
United Kingdom. The trial phase of the United Kingdom rollout includes
promotions sponsored by several major manufacturers including Procter & Gamble,
Unilever, Coca-Cola, Kellogg's, and many others. There can be no assurance that
the Company will realize the full commitments by U.S. Manufacturers under
contract on the pay-on-redemption format.
Operating loss for the nine-month period ended September 30, 1998 was $32.7
million versus $22.2 million in the 1997 comparable period. The increased loss
was primarily due to higher employee costs, non-paid promotions, legal fees and
depreciation and amortization expense. Higher employee costs of approximately
$6.6 million represents an increase of 127 employees, from 168 employees at
September 30, 1997 to 295 employees at September 30, 1998. Most of the increase
in headcount represents additional client service and field service personnel to
support the increase in number of terminals and stores installed. Non-paid
promotion expense increased by $1.3 million in the 1998 nine-month period, to
$4.5 million from $3.2 million in the comparable 1997 period. Legal expense,
primarily costs associated with patent litigation (not expected to extend the
life of related patents and, therefore, not capitalized) increased by $1.0
million over the comparable 1997 period (See Note 3 to Consolidated Financial
Statements). Depreciation and amortization expense increased by $2.8 million
reflecting the addition of approximately 1,050 terminals installed in 799 stores
from September 30, 1997 to September 30, 1998 and to higher amortization related
to patents purchased during 1997 and 1998.
All other expenses increased by approximately $3.6 million in order to
support higher headcounts and the higher installed base of ILN terminals.
Offsetting the increased expenses was higher revenue of $2.4 million and certain
write-offs of obsolete fixed assets recorded in 1997 in the amount of $2.3
million.
Net loss for the nine-month period ended September 30, 1998 increased by
approximately $14.6 million from $32.5 million to $47.1 million primarily due to
higher operating losses of $10.6 million, higher interest expense of $2.1
million and lower interest income of $2.0 million. Interest expense of $15.5
million represents non-cash interest expense on issuance of $142 million of 14%
Senior Discount Notes on August 2, 1996 (See ' -- Liquidity and Capital
Resources'). Interest income of $1.1 million for the first nine months of 1998
declined from the first nine months of 1997 reflecting a decreased average cash
balance during the first nine months of 1998 versus the comparable period in
1997. Cash and cash
8
<PAGE>
<PAGE>
equivalents at September 30, 1998 were $4.0 million as compared to $61.0 million
at September 30, 1997.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 1997
Net sales were $1.8 million in the three-month period ended September 30,
1998 as compared to $174,000 in the three-month period ended September 30, 1997,
primarily as a result of the larger installed base of ILN terminals.
Third quarter operating loss of $9.3 million was $2.1 million lower than in
the third quarter 1997, primarily reflecting higher sales of $1.6 million, lower
non-paid promotion expense of $921,000 and a 1997 write-off of obsolete fixed
assets of $2.3 million offset by higher employee cost of $1.5 million and higher
depreciation and amortization expense of $1.1 million.
Net loss for the three-month period ended September 30, 1998 decreased to
$14.4 million from $15.3 million during the same three-month period in 1997 due
to increased interest expense of $637,000 and lower interest income of $637,000
offset by lower operating losses of $2.1 million.
LIQUIDITY AND CAPITAL RESOURCES
For the nine-month period ended September 30, 1998, cash used in operating
activities was $31.8 million as compared to $9.8 million during the nine-month
period ended September 30, 1997. From inception to September 30, 1998, the
Company generated minimal revenue yet incurred increased expenses related to the
development of its ILN technology, test marketing the product and recruiting
additional personnel. The Company has funded its operations through private
issuance of debt and equity securities. From its inception through September 30,
1998, the Company's shareholders 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 debt
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 representing $142 million in aggregate 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. As of September 30, 1997, a Qualifying Initial Public
Offering (as defined in the Notes) had not been completed and as a result
thereof, the Warrants were then adjusted to entitle respective holders to
purchase an aggregate of 1,338,918 shares of common stock at $.01 per share.
Therefore, the Company recorded additional Common Stock Purchase Warrants of
$3.0 million reflecting the valuation of the additional 297,492 shares, or 2.095
shares issuable per warrant. In January 1997, the Notes were exchanged for
identical Notes registered under The Securities Act of 1933 as amended (the
'Exchange Notes').
At September 30, 1998, the Company had a working capital deficiency of $2.8
million, compared to working capital of $38.5 million at December 31, 1997.
As adjusted to give effect to the issuance of the 'Preferred Stock' (See
Item 4), the Company had working capital of $14.5 million as of September 30,
1998. Total cash and cash equivalents at September 30, 1998 and December 31,
1997 was $4.0 million and $45.2 million, respectively. The Company's current
level of indebtedness, amounting to approximately $112.1 million, primarily
represents long-term debt resulting from the Private Placement. In October 1998,
the Company issued 173,278 shares of 10% Series A Mandatorily Convertible
Preferred Stock ('Preferred Stock') at a price of $100 per share for total
proceeds of $17.3 million.
Cash used in investing activities was $9.4 million and $17.5 million in the
nine months ended September 30, 1998 and September 30, 1997, respectively,
primarily related to expenditures for ILN equipment and patent acquisitions.
During the nine-month period ended September 30, 1998, the
9
<PAGE>
<PAGE>
Company installed 808 terminals in 601 stores. A majority of the terminals used
in installations during the first nine months had been purchased in the latter
part of 1997. The Company expects to spend approximately $10 million on ILN
equipment during 1998.
As of March 24, 1998, the Company terminated its three-year exclusive
terminal supply relationship with Coleman and its subsidiary Thermo
(collectively, the 'Vendors'). As part of this mutual termination agreement, the
Company agreed to pay $4.5 million, in installments, to pay balances on
previously purchased ILN equipment, to acquire certain inventory and to obtain
early release from the exclusivity provision of the original contract to allow
the Company to pursue relationships with new vendors. Of this amount, $4.1
million was charged to operating expense during 1997 and approximately $400,000
related to supplies and terminal parts acquired by the Company in the agreement
and were reflected in other current assets as of December 31, 1997. As of
November 6, 1998, the total obligation has been paid to the Vendors as part of
the mutual termination agreement.
The Company continues 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. The
Company intends to raise additional equity or debt capital to fund its ongoing
1998 and 1999 expansion plans and is currently in the process of offering up to
$40 million of convertible preferred stock, of which $17.3 million has been
issued on October 19, 1998, to its shareholders and a limited number of other
investors. In addition, the Company has received several multi-year equipment
leasing proposals from equipment manufacturers for future purchases of ILN
equipment. There is no assurance that such additional capital or equipment
financing can be obtained. In the event that such additional capital or
equipment financing is not obtained, the Company believes that existing cash and
cash equivalents, together with reduced or delayed operating and capital
expenditures, will be sufficient to meet the Company's operating requirements
into the second quarter of 1999. 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 slower development in additional
revenue. For example, revenues could be delayed if the Company experiences
delays in installations of the ILN such that any growth in paid redemption
volume is delayed. No cash interest will be payable on the Notes prior to
February 1, 2000. The Notes will accrue cash interest at a rate of 14% per
annum, commencing on August 1, 1999, payable semi-annually on February 1 and
August 1 of each year commencing on February 1, 2000.
If additional funds are raised through the issuance of equity securities,
the percentage ownership of the shareholders will 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 any earnings would be reduced by the associated interest expense. The
Indenture related to the Exchange Notes 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 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.
During the second quarter of 1998, the Company acquired by assignment all
rights, title and interest in and to (i) U.S. Patents Nos. 5,621,812; 5,638,457;
5,675,662; 5,237,620; 5,305,196; 5,448,471; 5,430,644; 5,659,469; 5,201,010;
5,327,508; 5,388,165; and 5,592,560; and related intellectual property rights;
and (ii) certain foreign counterpart patent applications, including PCT
Application No. PCT/US94/08221 and EPC Application #95906202.7. These patents
and applications generally disclose systems for targeted marketing in retail
stores utilizing a database including customer identification codes and purchase
histories of identified customers. Consideration for such assignment included
cash and share of the Company's Common Stock. Management believes that these
patents will provide the Company with a significant competitive advantage in its
target market.
Catalina Marketing Corp. ('Catalina'), one of the Company's competitors,
has challenged some of the claims of certain of these patents by provoking an
interference proceeding in the U.S. Patent and Trademark Office. Management
believes that Catalina has done so in recognition that the patents present a
significant impediment to Catalina's efforts to participate in the field of
using historical
10
<PAGE>
<PAGE>
information to enhance the effectiveness of in-store promotions, and the Company
intends to vigorously protect its property rights to the technology that
supports its products and services.
YEAR 2000 COMPLIANCE
Since December 1996, the Company has been surveying, assessing, and
remediating all known date-sensitive equipment, software, systems, and
business-critical service vendors for Year 2000 compliance. The project included
both information technology ('IT') and non-information technology. As an
information service provider, the Company considers its kiosk network as
integral to its IT infrastructure and the compliance project treated all aspects
of the network as such. Non-IT technology was considered limited to building
security and services for the central and satellite offices and was addressed as
a set of business-critical service vendors. The survey and assessment phase is
substantially complete for all areas except for external vendors. The details of
each are discussed in the following paragraphs.
In July 1998, the project finished its source code review of all in-house
software and has since corrected all problems identified as part of plant
review. The changes are incorporated into a software release currently in beta
test, scheduled to complete deployment early in the first quarter of 1999. In
parallel to the source code review and remediation, the project began a thorough
test of all production systems in July 1998. The tests exercise all components
of the system, including in-house software, third-party software, and client
software. Testing is on track to complete in the fourth quarter of 1998. With
testing 50% complete, it has so far found relatively few problems (low single
digits) that were not already identified by the source code review and
remediation. Any problems found during testing will be corrected through
existing software maintenance procedures. On the completion of the full Year
2000 testing, on-going compliance testing will be added to the standard
regression tests to ensure that system changes do not introduce compliance
issues.
The project has completed its assessment of all central office and in-store
computer equipment and identified the systems that will require upgrades to
become Year 2000 compliant. The largest problem areas identified were
approximately 600 of 4,500 in-store computer systems that were not compliant due
to problems with the on-board firmware. Only two systems required hardware
replacement; the others can be upgraded in place with new compliant firmware.
Those systems are scheduled for upgrade largely in the fourth quarter of 1998
with a few systems planned for upgrade in early first quarter 1999.
The project initially identified 18 'mission-critical' service vendors and
has contacted all to determine Year 2000 compliance status. So far seven have
responded. Recently the project team decided to expand the criteria for
determining mission critical vendors to include, among others, those providing
power and phone service to the individual stores where the Company has kiosks
installed. As part of this expansion, all outside vendors will be reviewed,
increasing the vendor count to over 600. Those vendors will be contacted in the
fourth quarter of 1998.
A total estimate for the conversion is $260,000, which is being expensed as
incurred. To date approximately $140,000 has been spent. Approximately $120,000
of the cost is related to reprogramming or replacing software; approximately
$70,000 is related to replacement or upgrade of hardware; and $60,000 is related
to project management and administrative expenses. All of those costs are being
funded through operating cash flows. These costs are an immaterial part of the
Company's Technology Division. The Company has not deferred any information
technology projects due to addressing the Year 2000 issue.
From the progress the compliance project has made to date, the Company does
not consider there to be significant risk from areas over which the Company has
direct control, such as hardware and software that make up the Inter*Act Loyalty
Network. Although the Company anticipates minimal business disruption as a
result of Year 2000 issues, breakdowns in the service infrastructure that
supports the network could have an impact on operations. Possible consequences
include, but are not limited to, loss of communication links with certain
stores, loss of electric power to the central office or to isolated store
systems, inability to process transactions because of failure in our retail
clients' point of sales systems, and an inability to execute purchases for new
equipment, or engage in similar business activities.
11
<PAGE>
<PAGE>
To date, the Company has not established a contingency plan for possible
Year 2000 issues. Where needed, the Company will establish contingency plans
based on our actual testing experience with our vendor base and our assessment
of outside risk. We expect contingency plans to be in place by July 31, 1999.
CAUTIONARY STATEMENT FOR PURPOSE OF THE 'SAFE HARBOR' PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
The statements contained in this report on Form 10-Q that are not
historical facts are forward-looking statements (as such term is defined in the
Private Securities Litigation Reform Act of 1995), which can be identified by
the use of forward-looking terminology such as believes, expects, may, will,
should, or anticipates or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategy that involve risks and
uncertainties. In addition, from time to time the Company or its representatives
have made or may make forward-looking statements, orally or in writing. Such
forward-looking statements may be included in, but are not limited to, various
filings made by the Company with the Securities and Exchange Commission, or
press releases or oral statements made by or with the approval of an authorized
executive officer of the Company. Forward-looking statements are based on
management's current views and assumptions and involve risks and uncertainties
that could significantly affect expected results. The Company wishes to caution
the reader that factors, such as those listed below, in some cases have affected
and could affect the Company'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, negative cash flow 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 (as defined herein) and the
uncertainty of market acceptance for the ILN, (iii) the uncertainty as to
whether the Company will be able to manage its growth effectively, (iv) the
early stage of the Company's products and services and technical and other
problems that the Company has experienced and may experience, (v) risks related
to the Company's substantial leverage and debt service obligations, (vi) the
Company's dependence on third parties such as those who manufacture ILN
terminals, (vii) the intensely competitive nature of the consumer product and
promotional industry, (viii) risks that the Company's rights related to patents,
proprietary information and trademarks may not adequately protect its business,
(ix) 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 Part I.
Item 7. 'Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Risk Factors' on the Form 10-K for the year ended December 31,
1997 for a more specific description of these risks. The Company's discussion of
its Year 2000 compliance project under the heading 'Year 2000 Compliance' also
contains forward-looking statements that are subject to risks and uncertainties
that could cause the actual results to differ from those projected. These
include the risks associated with unforeseen technological issues connected with
the Company's own Year 2000 compliance project and the compliance efforts of
third parties on whose systems the Company relies.
12
<PAGE>
<PAGE>
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In February 1996, the Company filed suit against Catalina alleging that
Catalina has infringed 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 counterclaim alleging that the Company is
infringing a newly issued Catalina Patent, the '868 Patent. The Company has
answered denying the allegations, raising affirmative defenses and seeking
declaratory judgment of non-infringement, invalidity and unenforceability of the
'868 Patent. Discovery on the claims and counterclaims will proceed 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.
In January 1998, Catalina International filed suit against the Company
alleging that the Company has infringed the '041 Patent which Catalina
International acquired by assignment in December 1997. Catalina International
alleges that the Company is infringing the '041 Patent by making, using and
offering for sale devices and systems that incorporate and employ inventions
covered by the '041 Patent. Also in February 1998, Catalina International
amended its complaint to join as additional parties' defendant Thermo and
Coleman, who have manufactured kiosks pursuant to an agreement with the Company.
Catalina International seeks injunctive and declaratory relief as well as
unspecified money damages against all defendants, and has filed a motion for
preliminary injunction against the Company seeking to stop alleged infringement
of the '041 Patent pending trial. Various other motions are pending in the
United States District Court in the District of Connecticut, including the
Company's motion for a more definite statement. The Company intends to defend
against Catalina International's claims vigorously, and to pursue available
remedies against Catalina International. This action was recently consolidated
with the litigation involving the '446 Patent and the '868 Patent for purposes
of discovery and trial.
On May 27, 1998, the Company filed a new suit against Catalina alleging
that Catalina has infringed United States Patents Nos. 5,201,010; 5,338,165;
5,430,644; 5,448,471; 5,592,560; 5,621,812; 5,659,469; and 5,638,457
(collectively, the 'Deaton Patents'), which the Company acquired by assignment
on or about May 22, 1998. The Company alleges that Catalina is infringing the
Deaton Patents by making, using, selling and offering for sale devices and
systems that incorporate and employ inventions covered by the Deaton Patents.
The Company is seeking an injunction against Catalina to stop further
infringement of these patents, treble damages and the costs and expenses
incurred in connection with the suit.
Catalina has answered denying the allegations, raising certain affirmative
defenses, and seeking declaratory judgment of non-infringement, invalidity or
unenforceability of the Deaton Patents. Catalina has also challenged some of the
claims of six of the Deaton Patents by provoking an interference proceeding in
the U.S. Patent and Trademark Office.
The Company intends to vigorously protect its rights under the Deaton
Patents both in the interference proceeding and in the new lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
13
<PAGE>
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<C> <S>
*(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 filed as exhibit
3(a)2 to the Company's Form 10-Q Quarterly Report for the period ended June 30, 1997.
3(a)(3) -- Articles of Amendment of the Company dated September 2, 1998 and effective September 3, 1998.
*3(b) -- Amended and Restated Bylaws of the Company, filed as Exhibit 3(b) to the Company's Form 10-Q
Quarterly Report for the period ended June 30, 1997.
*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.
*10(hh) -- Patent Purchase Agreement dated May 22, 1998, between the Company, Credit Verification Corporation
and David W. Deaton, filed as Exhibit 10(hh) to the Company's Form 10-Q Quarterly Report for the
period ended June 30, 1998. (Portions of this exhibit have been omitted pursuant to a request for
confidential treatment.)
*10(ii) -- Voting Agreement among shareholders dated as of November 1, 1996, filed as Exhibit 10(ii) to the
Company's Form 10-Q Quarterly Report for the period ended June 30, 1998.
*10(jj) -- Company's 1997 Long-Term Incentive Plan, as amended, filed as Exhibit 10(jj) to the Company's Form
10-Q Quarterly Report for the period ended June 30, 1998.
*10(kk) -- Management Services Agreement dated June 17, 1998, between the Company and Vanguard Cellular
Financial Corp., filed as Exhibit 10(kk) to the Company's Form 10-Q Quarterly Report for the period
ended June 30, 1998.
27. -- Financial Data Schedule.
</TABLE>
- ------------
* 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, 1998.
14
<PAGE>
<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.
INTER*ACT SYSTEMS, INCORPORATED
<TABLE>
<CAPTION>
DATE
----
<S> <C>
By /s/ STEPHEN R. LEEOLOU November 12, 1998
.......................................................
STEPHEN R. LEEOLOU
CHAIRMAN & CHIEF EXECUTIVE OFFICER
By /s/ RICHARD A. VINCHESI November 12, 1998
.......................................................
RICHARD A. VINCHESI
SENIOR VICE PRESIDENT,
CHIEF OPERATING OFFICER &
CHIEF FINANCIAL OFFICER
</TABLE>
15
<PAGE>
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
STATEMENT OF DIFFERENCES
------------------------
The trademark symbol shall be expressed as.............................. 'TM'
<PAGE>
<PAGE>
ARTICLES OF AMENDMENT
OF
INTER*ACT SYSTEMS, INCORPORATED
The undersigned corporation hereby submits pursuant to Sections 55-6-02 and
55-10-06 of the North Carolina General Statutes these Articles of Amendment for
the purpose of amending its Articles of Incorporation.
1. The name of the corporation is Inter*Act Systems, Incorporated.
2. The Articles of Incorporation of the corporation are hereby amended by
attaching thereto the Statement of Rights and Preferences of the 10% Series A
Mandatorily Convertible Preferred Stock attached hereto.
3. The foregoing amendment to the Articles of Incorporation was duly
adopted by the Board of Directors effective July 27, 1998.
4. The foregoing amendment was adopted without shareholder action pursuant
to the authority vested in the Board of Directors to establish one or more
series within the class of preferred stock and to establish the designations,
preferences, limitations and relative rights (including conversion rights) of
such shares, said authority having been duly granted in Article 2 of the
Articles of Incorporation of the corporation as reflected in the Articles of
Amendment filed with the Secretary of State of North Carolina on June 3, 1997.
This the 2nd day of September, 1998.
INTER*ACT SYSTEMS, INCORPORATED
By:/s/ Stephen R. Leeolouu
-------------------------
Stephen R. Leeolou, Chief
Executive Officer
<PAGE>
<PAGE>
Statement of Rights and Preferences of the
10% Series A Mandatorily Convertible Preferred Stock
of Inter*Act Systems, Incorporated
Section 1. Number and Designation. A series consisting initially of
400,000 shares of the authorized preferred stock of the corporation, no par
value, is designated "10% Series A Mandatorily Convertible Preferred Stock" (the
"Series A Preferred Stock"). The number of shares of Series A Preferred Stock
shall not be increased but may be decreased from time to time by resolution of
the Board of Directors; provided, that the number of authorized shares of Series
A Preferred Stock shall be increased by the number of shares of Series A
Preferred Stock issued in respect of dividends pursuant to Section 3(b) hereof.
Section 2. Ranking. For purposes of this Statement of Rights and
Preferences, any stock of any class or classes of the corporation shall be
deemed to rank:
(a) prior to the Series A Preferred Stock, either as to dividends or upon
liquidation, if the holders of such class or classes shall be entitled to the
receipt of dividends or of amounts distributable upon dissolution, liquidation
or winding up of the corporation, as the case may be, in preference or priority
to the holders of Series A Preferred Stock;
(b) on a parity with Series A Preferred Stock (the "Parity Stock"), either
as to dividends or upon liquidation, whether or not the dividend rates, dividend
payment dates or redemption or liquidation prices per share or sinking fund
provisions, if any, shall be different from those of Series A Preferred Stock,
if the holders of such stock shall be entitled to the receipt of dividends or of
amounts distributable upon dissolution, liquidation or winding up of the
corporation, as the case may be, without preference or priority, one over the
other, as between the holders of such stock and the holders of Series A
Preferred Stock; or
(c) junior to Series A Preferred Stock, either as to dividends or upon
liquidation, if such class shall be the common stock, no par value, of the
corporation (the "Common Stock") or if the holders of Series A Preferred Stock
shall be entitled to receipt of dividends or of amounts distributable upon
dissolution, liquidation or winding up of the corporation, as the case may be,
in preference or priority to the holders of shares of such class or classes.
Section 3. Dividends and Distributions.
(a) For each quarterly dividend period (a "Dividend Period") dividends
payable on each share of Series A Preferred Stock shall be payable at a rate of
10% per annum of the initial liquidation preference of $100 per share divided by
four. Each Dividend Period shall commence on the January 1, April 1, July 1 and
October 1 following the last day of the preceding Dividend Period and shall end
on and include the day next preceding the first day of the next Dividend Period.
Dividends shall be cumulative from the date of original issue and shall be
payable, when, as and if declared by the Board of Directors or by a duly
authorized committee thereof, on
<PAGE>
<PAGE>
March 31, June 30, September 30 and December 31 of each year, commencing on
December 31, 1998. Each such dividend shall be paid to the holders of record of
shares of Series A Preferred Stock as they appear on the stock register of the
corporation on such record date, not exceeding 45 days preceding the payment
date thereof, as shall be fixed by the Board of Directors of the corporation or
by a duly authorized committee thereof. Dividends on account of arrears for any
past Dividend Periods may be declared and paid at any time, without reference to
any regular dividend payment date, to holders of record on such date, not
exceeding 45 days preceding the payment date thereof, as may be fixed by the
Board of Directors of the corporation or by a duly authorized committee thereof.
(b) Dividends payable on shares of Series A Preferred Stock for any period
greater or less than a full Dividend Period, shall be computed on the basis of a
360-day year consisting of twelve 30-day months and the actual number of days
elapsed in the period. Notwithstanding paragraph (a) of this Section 3, the
corporation may, in its sole discretion, but is not obligated to, pay any or all
dividends, including without limitation any or all dividends in arrears, in
additional shares of Series A Preferred Stock. The corporation shall pay such
dividend by issuing to such holder of Series A Preferred Stock additional shares
of Series A Preferred Stock having an aggregate initial liquidation preference
equal to the amount of cash dividends otherwise payable to such holder.
(c) No full dividends shall be declared or paid or set apart for payment on
the Preferred Stock of any series ranking, as to dividends, on a parity with or
junior to the Series A Preferred Stock for any period unless full cumulative
dividends have been or contemporaneously are declared and paid or declared and a
sum sufficient for the payment thereof set apart for such payment on the Series
A Preferred Stock for all Dividend Periods terminating on or prior to the date
of payment of such full cumulative dividends. When dividends are not paid in
full, as aforesaid, upon the shares of Series A Preferred Stock and any other
series of Parity Stock, all dividends declared upon shares of this Series and
such other series of Parity Stock shall be declared pro rata so that the amount
of dividends declared per share on the Series A Preferred Stock and such other
Parity Stock shall in all cases bear to each other the same ratio that accrued
and unpaid dividends per share on the shares of Series A Preferred Stock and
such other Parity Stock bear to each other. Holders of shares of Series A
Preferred Stock shall not be entitled to any dividend, whether payable in cash,
property or stock, in excess of full cumulative dividends, as herein provided,
on the Series A Preferred Stock. No interest, or sum of money in lieu of
interest, shall be payable in respect of any dividend payment or payments on the
Series A Preferred Stock which may be in arrears.
(d) So long as any shares of Series A Preferred Stock are outstanding, no
dividend (other than a dividend in Common Stock or in any other stock ranking
junior to this series as to dividends and upon liquidation and other than as
provided in paragraph (c) of this Section 3) shall be declared or paid or set
aside for payment or other distribution declared or made upon the Common Stock
or upon any other stock ranking junior to or on a parity with this Series as to
dividends or upon liquidation, nor shall any Common Stock or any other stock of
the corporation
3
<PAGE>
<PAGE>
ranking junior to or on a parity with this Series as to dividends or upon
liquidation be redeemed, purchased or otherwise acquired for any consideration
(or any moneys be paid to or made available for a sinking fund for the
redemption of any shares of any such stock) by the corporation (except by
conversion into or exchange for stock of the corporation ranking junior to the
Series A Preferred Stock as to dividends and upon liquidation) unless, in each
case, the full cumulative dividends on all outstanding shares of Series A
Preferred Stock shall have been paid or declared and set aside for payment for
all past Dividend Periods.
Section 4. Voting Rights.
(a) Except as otherwise expressly provided herein or as required by law,
the holders of each share of Series A Preferred Stock shall be entitled to ten
votes per share on all matters submitted to shareholders for voting, voting
together with the holders of Common Stock as a single group, and shall be
entitled to notice of any shareholders' meeting in accordance with applicable
law and the Bylaws of the corporation. Except as provided in the next succeeding
sentence, the approval of holders of 75% of the outstanding shares of Series A
Preferred Stock shall be required prior to the corporation's issuing any shares
of a class of preferred stock that ranks on a parity with or senior to the
Series A Preferred Stock. Notwithstanding the foregoing sentence, the
corporation may issue up to $90 million of Series A Preferred Stock and Parity
Stock without the approval of any holders of Series A Preferred Stock. The
corporation may not amend or alter any of this Statement of Rights and
Preferences without the approval of the holders of 75% of the outstanding Series
A Preferred Stock
Section 5. Conversion of Series A Preferred Stock. The holders of Series A
Preferred Stock shall have conversion rights as follows (the "Conversion
Rights"):
(a) Right to Convert. Each share of Series A Preferred Stock shall be
convertible, at the option of the holder thereof, at any time after the date of
issuance of such share at the office of the corporation or any transfer agent
for such stock, into ten fully paid and nonassessable shares of Common Stock.
(b) Mandatory Conversion. Each share of Series A Preferred Stock shall
automatically be converted into ten shares of Common Stock, upon (i) the closing
of the sale of the Common Stock in a Qualified Public Offering (defined below),
(ii) the closing of any Transaction (as defined in Section 5(g) below) in which
each holder of shares of Series A Preferred Stock is entitled to receive an
amount of cash or marketable securities having a current market value at least
equal to the Liquidation Preference of such shares of Series A Preferred Stock
(a "Qualified Transaction") or (iii) the vote or written consent of holders of
not less than 75% of the outstanding shares of Series A Preferred Stock. Notice
of any Qualified Public Offering or Qualified Transaction shall be given to each
holder of Series A Preferred Stock at least thirty days prior to anticipated
date of closing and conversion. "Qualified Public Offering" means a firm
commitment, public offering of the Common Stock pursuant to a registration
statement declared effective under the Securities Act of 1933, as amended,
underwritten by a
4
<PAGE>
<PAGE>
securities firm of nationally recognized standing with an aggregate offering
price to the public of not less than $30 million and a price per share not less
than one-tenth of the Liquidation Preference (defined below) per share of the
Series A Preferred Stock determined as of the date of the closing of such public
offering.
(c) Mechanics of Conversion.
(i) To convert shares of Series A Preferred Stock into shareCommon
Stock, the holder of such shares of Series A Preferred Stock shall (A)
surrender the certificate or certificates therefor, duly endorsed, at the
office of the corporation or of any transfer agent for such stock, (B) give
written notice to the corporation at such office that it elects to convert
the same, (C) state therein the name or names in which it wishes the
certificate or certificates for shares of Common Stock to be issued and (D)
deliver to the corporation an executed joinder agreement pursuant to which
such holder agrees to become a party to and be bound by the Shareholders'
Agreement dated as of April 16, 1993 among the corporation and the holders
of Common Stock, as amended (the "Shareholders' Agreement"). The
corporation shall, as soon as practicable thereafter and at its expense,
issue and deliver to such holder a certificate or certificates for the
number of shares of Common Stock to which such holder is entitled. Such
conversion shall be deemed to have been made immediately prior to the close
of business on the date of surrender of the shares of Series A Preferred
Stock to be converted, and the person or persons entitled to receive the
shares of Common Stock issuable upon such conversion shall be treated for
all purposes as the record holder or holders of such shares of Common Stock
on such date.
(ii) If the conversion is mandatory pursuant to Section 5(b) of this
Statement of Rights and Preferences, the conversion shall be conditioned
upon the closing with the underwriters of the sale of securities pursuant
to such Qualified Public Offering, the closing of such Qualified
Transaction or the vote or written consent of holders of not less than 75%
of the outstanding shares of Series A Preferred Stock, as the case may be,
and the Series A Preferred Stock shall be deemed to have been converted
immediately prior to the occurrence of such event.
(d) Reservation of Stock Issuable Upon Conversion. The corporation shall at
all times reserve and keep available out of its authorized but unissued shares
of Common Stock, free of preemptive rights, solely for the purpose of effecting
the conversion of the shares of Series A Preferred Stock, such number of its
shares of Common Stock as shall from time to time be sufficient to effect the
conversion of all outstanding shares of Series A Preferred Stock; and if at any
time the number of authorized but unissued shares of Common Stock shall not be
sufficient to effect the conversion of all then outstanding shares of Series A
Preferred Stock, the corporation will take such corporate action as may, in the
opinion of its counsel, be necessary to increase its authorized but unissued
shares of Common Stock to such number of shares as shall
5
<PAGE>
<PAGE>
be sufficient for such purpose, including, without limitation, engaging in best
efforts to obtain the requisite shareholder approval of any necessary amendment
to these Articles of Incorporation.
(e) Fractional Shares. No fractional share shall be issued upon the
conversion of any share or shares of Series A Preferred Stock. All shares of
Common Stock (including fractions thereof) issuable upon conversion of more than
one share of Series A Preferred Stock by a holder thereof shall be aggregated
for purposes of determining whether the conversion would result in the issuance
of any fractional share. If, after the aforementioned aggregation, the
conversion would result in the issuance of a fraction of a share of Common
Stock, the corporation shall, in lieu of issuing any fractional share, pay the
holder otherwise entitled to such fraction a sum in cash equal to the same
fraction of the fair market value per share as of the date of conversion.
(f) No Dilution or Impairment. The corporation will not, by amendment of
its Articles of Incorporation or through any reorganization, transfer of assets,
consolidation, merger, share exchange, dissolution, issue or sale of securities
or any other voluntary action, avoid or seek to avoid the observance or
performance of any of the terms to be observed or performed hereunder by the
corporation, including without limitation the adjustments required under this
Section 5, and will at all times in good faith assist in the carrying out of all
the provisions of this Section 5 and in the taking of all such action as may be
necessary or appropriate in order to protect the Conversion Rights of the
holders of Series A Preferred Stock against dilution or other impairment.
(g) Changes in Common Stock. In case at any time the corporation shall
initiate any transaction or be a party to any transaction (including, without
limitation, a merger, consolidation, share exchange, sale, lease or other
disposition of all or substantially all of the corporation's assets, charter
amendment, recapitalization or reclassification of the Common Stock or a "Stock
Sale," as defined below) in connection with which the previously outstanding
Common Stock shall be changed into or exchanged for different securities of the
corporation or capital stock or other securities of another corporation or
interests in a non-corporate entity or other property (including cash) or any
combination of the foregoing (each such transaction being herein called a
"Transaction"), then, as a condition of the consummation of the Transaction,
lawful, enforceable and adequate provision shall be made so that the holders of
Series A Preferred Stock shall be entitled to receive upon conversion of their
shares of Series A
6
<PAGE>
<PAGE>
Preferred Stock at any time on or after the consummation of the Transaction, in
lieu of the shares of Common Stock issuable upon such conversion prior to such
consummation, the securities or other property (including cash) to which such
holders of Series A Preferred Stock would have been entitled upon consummation
of the Transaction if such holders had converted their shares of Series A
Preferred Stock immediately prior thereto (subject to adjustments from and after
the consummation date as nearly equivalent as possible to the adjustments
provided for in this Section 5). If a purchase, tender or exchange offer is made
to and accepted by the holders of more than 50% of the outstanding Common Stock
(a "Stock Sale"), and if the holders of Series A Preferred Stock so designate in
a written notice given to the corporation, such holders of Series A Preferred
Stock shall be entitled to receive upon the conversion of their shares of Series
A Preferred Stock at any time on or after the consummation of the Stock Sale in
lieu of the shares of Common Stock issuable upon conversion prior to the
consummation of the Stock Sale, the securities or other property to which such
holders of Series A Preferred Stock would have been entitled if such holders had
converted their shares of Series A Preferred Stock prior to the expiration of
such purchase, tender or exchange offer and had accepted such offer (subject to
adjustments from and after the consummation of such purchase, tender or exchange
offer as nearly equivalent as possible to the adjustments provided for in this
Section 5). The corporation will not effect any Transaction unless prior to the
consummation thereof each corporation or entity (other than the corporation)
which may be required to deliver any securities or other property upon the
conversion of Series A Preferred Stock as provided herein shall assume, by
written instrument delivered to the holders of Series A Preferred Stock, the
obligation to deliver to such holders such securities or other property as in
accordance with the foregoing provisions such holders may be entitled to
receive. The foregoing provisions of this Section 5(g) shall similarly apply to
successive Transactions.
(h) Other Action Affecting Common Stock. In case at any time or from time
to time the corporation shall take any action affecting the Common Stock, other
than an action described in Section 5(g) hereof, then, unless in the opinion of
the Board of Directors of the corporation such action will not have a material
adverse effect upon the rights of the holders of Series A Preferred Stock
(taking into consideration, if necessary, any prior actions which the Board of
Directors deemed not to materially adversely affect the rights of the holders),
the conversion formula set forth in Section 5(a) shall be adjusted in such
manner and at such time as the Board of Directors of the corporation may in good
faith determine to be equitable in the circumstances.
(i) Issue Taxes. The corporation shall pay any and all issue and other
taxes that may be payable in respect of any issue or delivery of shares of
Common Stock on conversion of shares of Series A Preferred Stock pursuant
hereto; provided, that the corporation shall not be obligated to pay any
transfer taxes resulting from any transfer requested by any holder in connection
with any such conversion.
Section 6. Liquidation Preference.
(a) Series A Preferred Stock. In the event of any liquidation, dissolution
or winding up of the corporation, either voluntary or involuntary, the holders
of the Series A Preferred Stock shall be entitled to receive, prior and in
preference to any distribution of any of the assets or surplus funds of the
corporation to the holders of any stock ranking junior to the Series A Preferred
Stock, an amount equal to $100.00 per share plus the amount of accrued and
unpaid dividends thereon (the "Liquidation Preference")(such Liquidation
Preference to be adjusted for any combinations, consolidations, stock
distributions or stock dividends with respect to shares of the Series A
Preferred Stock). If upon the occurrence of any such liquidation, dissolution or
winding up of the corporation the assets and funds to be distributed among the
holders of the Series A Preferred Stock shall be insufficient to permit the
payment to such holders of the full Liquidation Preference, then the entire
assets and funds of the corporation legally available for
7
<PAGE>
<PAGE>
distribution after payment of any amounts due and owing to holders of any stock
ranking senior to the Series A Preferred Stock shall be distributed ratably
among the holders of Series A Preferred Stock based upon the number of shares of
Series A Preferred Stock then held by them.
(b) Consolidation, Merger, etc. Not a Liquidation. The consolidation or
merger of the corporation with or into any other entity, the acquisition of the
capital stock of the corporation in a share exchange or the sale, lease or other
disposition of all or substantially all of the assets, property or business of
the corporation shall not be deemed to be a liquidation, dissolution or winding
up of the corporation within the meaning of this Section 6.
(c) Valuation of Securities. Any securities to be distributed pursuant to
this Section 6 in a liquidation, dissolution or winding up of the corporation
shall be the fair market value thereof, as determined in good faith by the Board
of Directors of the corporation or, if so required by a holder of Series A
Preferred Stock, as determined by a national or regional investment bank or a
national accounting firm mutually selected by such holder and the corporation,
the fees and expenses of which shall be paid by the corporation.
(d) Notice. Written notice (the "Notice") of any such liquidation,
dissolution or winding up of the corporation within the meaning of this Section
6, which states the payment date, the place where said payments shall be made
and the date on which Conversion Rights (as defined in Section 5) terminate as
to such shares (which shall be not less than 20 days after the date such notice
is given), shall be given by first class mail, postage prepaid, or by telecopy,
facsimile or recognized overnight courier, not less than 30 nor more than 60
days prior to the payment date stated therein, to the then holders of record of
Series A Preferred Stock and Common Stock, such Notice to be addressed to each
such holder at its address as shown on the records of the corporation.
Section 7. Redemption Rights.
(a) The corporation shall have the right at any time after November 1, 2005
to redeem, out of funds legally available therefor, any outstanding shares of
Series A Preferred Stock, in whole or in part, for a redemption price equal to
the Liquidation Price per share of the Series A Preferred Stock (calculated as
if the corporation liquidated on the date of redemption). On November 1, 2008,
the corporation shall redeem, out of funds legally available therefor, any
outstanding shares of Series A Preferred Stock, in whole or in part, for a
redemption price equal to the Liquidation Price per share of the Series A
Preferred Stock (calculated as if the corporation liquidated on the date of
redemption).
(b) In the event that fewer than all the outstanding Series A Preferred
Stock are to be redeemed, except as otherwise provided by law, the number of
shares to be redeemed shall be determined by the Board and the shares to be
redeemed shall be determined by lot or pro rata as may be determined by the
Board or by any other method as may be determined by the Board in its sole
discretion to be equitable.
8
<PAGE>
<PAGE>
(c) In the event the corporation shall redeem shares of Series A Preferred
Stock, notice of such redemption shall be given by first class mail, postage
prepaid, mailed not less than 30 nor more than 60 days prior to the redemption
date, to each holder of record of the shares to be redeemed, at such holder's
address as the same appears on the stock register of the Corporation. Each such
notice shall state: (i) the redemption date; (ii) the number of shares of Series
A Preferred Stock to be redeemed and, if fewer than all the shares held by such
holder are to be redeemed, the number of such shares to be redeemed from such
holder; (iii) the redemption price; and (iv) the place or places where
certificates for such shares are to be surrendered for payment of the redemption
price.
(d) Notice having been mailed as aforesaid, from and after the redemption
date (unless default shall be made by the corporation in providing money for the
payment of the redemption price), the redeemed shares of Series A Preferred
Stock shall no longer be deemed to be outstanding, and all rights of the holders
thereof as stockholders of the corporation (except the right to receive from the
corporation the redemption price) shall cease. Upon surrender in accordance with
said notice of the certificates for any shares so redeemed (properly endorsed or
assigned for transfer, if the Board shall so require and the notice shall so
state), such shares shall be redeemed by the corporation at the redemption price
aforesaid. In case fewer than all the shares represented by any such certificate
are redeemed, a new certificate shall be issued representing the unredeemed
shares without cost to the holder thereof.
(e) Any shares of Series A Preferred Stock which shall at any time have
been redeemed shall, after such redemption, have the status of authorized but
unissued shares of preferred stock, without designation as to series until such
shares are once more designated as part of a particular series by the Board.
9
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 9-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JAN-01-1998 JUL-01-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<CASH> 4,012,000 4,012,000
<SECURITIES> 0 0
<RECEIVABLES> 2,164,000 2,164,000
<ALLOWANCES> 60,000 60,000
<INVENTORY> 0 0
<CURRENT-ASSETS> 9,555,000 9,555,000
<PP&E> 29,193,000 29,193,000
<DEPRECIATION> 9,497,000 9,497,000
<TOTAL-ASSETS> 50,717,000 50,717,000
<CURRENT-LIABILITIES> 12,306,000 12,306,000
<BONDS> 106,394,000 106,394,000
0 0
0 0
<COMMON> 28,251,000 28,251,000
<OTHER-SE> (123,670,000) (123,670,000)
<TOTAL-LIABILITY-AND-EQUITY> 50,717,000 50,717,000
<SALES> 0 0
<TOTAL-REVENUES> 2,866,000 1,820,000
<CGS> 0 0
<TOTAL-COSTS> 35,589,000 11,073,000
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 15,499,000 5,472,000
<INCOME-PRETAX> (47,087,000) (14,423,000)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (47,087,000) (14,423,000)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (47,087,000) (14,423,000)
<EPS-PRIMARY> (6.09) (1.87)
<EPS-DILUTED> (6.09) (1.87)
</TABLE>
