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 unaudited Consolidated Financial Statements of the Company and the Notes thereto, and other financial information included elsewhere in this report. Operating results for the three months ended March 31, 2000 are not necessarily indicative of the results that may be expected for the year ending December 31, 2000 or any other period.

The Company believes it operates the world's largest fully electronic marketing network linked to supermarket and pharmacy retailers' point-of-sale ("POS") databases that serves on-line promotions and advertisements to shoppers seamlessly in-store, at home and in the office. The Company's patented technologies enable consumer products manufacturers ("Manufacturers") and supermarket retailers ("Retailers") to use historical purchase behavior data to develop targeted purchase incentives and messages which the Company delivers to customers before shopping begins. The Company's proprietary system, called the Inter.Act e-Marketing NetworkSM ("IEMN"), currently comprises over 5,000 server-based terminals located inside the front entrance of stores in more than 20 retail chains in the U.S. and Europe, as well as a recently launched Company-owned Internet web site called ShopperPerks.comSM The Company's web site and its in-store ShopperPerks(TM) portals, are linked directly to each store's point-of-sale scanning system via Company-owned in- store servers. This on-line network gives Inter-Act's business partners exclusive access to offer all shoppers (whether Internet users or not) same- day, personalized savings that are electronically downloaded to participating Retailers' cash register systems. Delivering highly targeted, pre-shopping promotions on the IEMN historically has generated average consumer response, or redemption, rates above 25%, which the Company believes is superior to the response rate of any other marketing or advertising medium in the industry.

During 1998 and to a limited extent in 1999, the Company recognized revenue as electronic discounts were redeemed at store cash registers. Manufacturers paid a fee to the Company for each redemption. The fee was composed of (i) a retailer processing fee, (ii) a redemption fee and (iii) the face value of the coupon. The Company, in turn, passed through both the retailer processing fee, which was included in direct operating expenses, and the face value of the coupon to the Retailer, while retaining the redemption fee. The Company recorded as net sales the redemption fee and the retailer processing fee paid by the Manufacturers.

Beginning in 1998 and through 1999, the Company also had arrangements with Manufacturers whereby the Company received a fixed payment over a fixed period, generally one year. In these cases, the Company recognized revenue on a ratable basis over the fixed period during which it is providing service or exclusivity to such Manufacturers, as well as the retailer processing fee paid by the Manufacturers.

In 2000, the Company began receiving variable fees from Manufacturers for each product redeemed and fixed fees for project management of each promotion. The Company recognizes revenue as electronic discounts are redeemed at the store cash register and, for the project management fee, on a ratable basis over the fixed period over which it is providing services or exclusivity to such Manufacturers. The Company believes that more Manufacturers will agree to promote more products on the IEMN with this new pricing format, since the cost per product sold is expected to be lower, but there is no assurance that this will be the case.

Certain Manufacturers pay the Company in advance for a portion of anticipated redemptions or a portion of the fixed contract amount, as applicable and these amounts are recorded as deferred revenue until earned through redemption activity or, for fixed fee arrangements, through the passage of time, during the contract period.

Direct costs of the Company consist of expenditures for direct store support, paper used in the terminals 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 IEMN that are not funded by a Manufacturer contract. Manufacturer participation in the IEMN to date has been characterized by a substantial number of trial commitments leading to increasing dollar commitments to the IEMN from those Manufacturers as the network approaches a more national footprint. 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 not generated significant operating revenue relative to its expenses, 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 $124.9 million as of March 31, 2000 and has incurred cumulative losses of $230.3 million through March 31, 2000. The Company expects to incur substantial additional costs to install additional ShopperPerks portals in retail supermarket stores and to sponsor selected promotions to demonstrate the utility of the IEMN to consumers, Retailers and Manufacturers. The Company expects to incur net losses in the remainder of 2000 and may operate at a loss for the foreseeable future. There can be no assurance that the Company will achieve profitability or, if achieved, sustain such profitability.

Three Months Ended March 31, 2000 Compared With Three Months Ended March 31, 1999

The Company had an installed base of over 5,000 terminals in 2,448 stores as of March 31, 2000 as compared to 2,631 terminals in 1,777 stores as of March 31, 1999. (2000 store count includes 160 Grand Union stores that have been taken offline to implement a Retailer technology upgrade.) During the first quarter of 2000, the Company installed the IEMN in an additional division of A&P, A&P New Orleans, a chain located principally in Louisiana. The Company continued the fulfillment of its contract with Sainsbury's by installing the IEMN in 100 additional stores in the United Kingdom.

Net sales during the three-month period ended March 31, 2000 decreased to $1.0 million from $3.2 million in the 1999 period, primarily as a result of lower deposits from trial activity in the first quarter 2000 compared to the first quarter 1999.

Delays in the installations of the IEMN in 1999 contributed to the decrease in sales during the first quarter of 2000.

Operating loss for the three-month period ended March 31, 2000 was $12.4 million versus $7.9 million in the 1999 comparable period. The decrease in operating results for the quarter resulted from decreased revenue of $2.2 million and higher selling, general and administrative costs of $1.7 million and higher depreciation and amortization expenses of $919,000 partially offset by decreased direct costs of $314,000. Selling, general, and administrative expenses increased primarily due to severance and relocation costs of $202,000 relating to the headquarters move from Connecticut to Charlotte, increased company sponsored promotions of $426,000, and increased advertisement expenditures of $566,000. These expenses were partially offset by a reduction in salaries of $332,000 due to lower headcount and a reduction in legal fees of $294,000. Depreciation and telecommunication charges increased by $919,000 and $126,000 respectively, reflecting the addition of approximately 2,405 terminals installed in 671 additional stores from March 31, 1999 to March 31, 2000.

Net loss for the three-month period ended March 31, 2000 increased by approximately $4.2 million from $11.6 million to $15.8 million primarily due to higher operating losses of $4.5 million in the 2000 period, partially offset by lower interest expense of $2.1 million due to the Exchange Offer (See "Liquidity and Capital Resources") and augmented by an extraordinary gain on the repurchase of debt of $1.7 million in the 1999 period. Interest expense of $3.5 million represents primarily non-cash interest expense on the issuance of $69.7 million of 14% Senior Discount Notes on August 2, 1996 (See "Liquidity and Capital Resources"). Interest income of $21,000 for the first three months of 2000 reflects a decreased average cash balance during the first three months of 2000 versus the comparable period in 1999.

Liquidity and Capital Resources

At March 31, 2000, the Company had net working capital of $(4.4) million, compared to working capital of $627,000 at December 31, 1999. Total cash and cash equivalents at March 31, 2000 and December 31, 1999 was $3.8 million and $9.9 million, respectively. At March 31, 2000 long-term debt was $73.6 million compared to $68.0 million at December 31, 1999. The long-term debt consists of PIK Notes, accrued interest, accrued dividends, and capital leases.

Cash used in operating activities during the period ended March 31, 2000 was $9.0 million, as compared to $8.8 million at March 31, 1999. Cash has been used primarily for the development of the Company's IEMN technology, test marketing and deploying the product and compensation of personnel.

Cash used in investing activities during the period ended March 31, 2000, was $3.3 million, reflecting disbursements for net capital expenditures. Such net capital expenditures were primarily for IEMN equipment and components, fixtures, furniture and equipment for expansion in Europe, and other equipment. For the period ended March 31, 1999, cash used in investing activities was $1.3 million primarily reflecting disbursements for net capital expenditures.

Net cash provided by financing activities during the period ended March 31, 2000 and 1999 was $6.2 million and $9.2 million, respectively, resulting primarily from the net proceeds from private offerings of preferred stock.

Since its inception in 1993, the Company has generated revenue well below its expenses, primarily related to the development of its IEMN technology, test marketing and deploying the product and compensation of personnel. To date, the Company has funded its operations through private sales of equity and debt securities. The Company will require additional equity or debt financing to fund capital expenditures, working capital requirements and operating losses to be incurred in connection with the increased commercialization of its IEMN.

From inception through March 31, 2000, the Company's shareholders have contributed approximately $173.0 million of equity to the Company through private offerings of common stock, the conversion of approximately $2.0 million in stockholder debt to common stock and private offerings of preferred stock.

The private offerings of common stock and conversion of stockholder indebtedness occurred primarily from inception through 1996. During the year ended December 31, 1997, the Company issued an aggregate of 60,000 shares of common stock in exchange for intellectual property and services. No common stock was issued during the year ended December 31, 1998. The Company issued approximately 15,000 shares of common stock in exchange for services during the year ended December 31, 1999.

In 1996, the Company consummated a private offering of debt securities (the "Private Placement") 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 "Discount Notes") and warrants (the "Discount Note Warrants") to purchase initially an aggregate of 1,041,428 shares of common stock of the Company at $.01 per share. As required by the Warrant Purchase Agreement, the Discount Note Warrants were adjusted effective September 30, 1997 to entitle the respective holders to purchase an aggregate of 1,338,918 shares of common stock at $.01 per share because the Company had not completed a qualifying initial public offering. Accordingly, 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 Company exchanged for the outstanding Discount Notes issued in the Private Placement new and identical Discount Notes that were registered under the Securities Act of 1933, as amended. As discussed below, the first interest payment on the Discount Notes in the amount of $8.7 million was scheduled to be paid in February 2000.

In March 1999, the Company repurchased a portion of the Discount Notes with an aggregate face value of approximately $2.4 million, for an aggregate of $194,000 in cash. The Discount Note Warrants originally issued in connection with the issuance of these Discount Notes were not repurchased by the Company and continue to be outstanding. This repurchase of Discount Notes resulted in an extraordinary gain on extinguishment of debt of $1.7 million. In October 1999, the Company repurchased additional Discount Notes with a face value of approximately $15.0 million for an aggregate of $3.0 million in cash. Discount Note Warrants to purchase 141,435 shares of the Company's common stock originally issued in connection with the issuance of these Discount Notes were also repurchased by the Company in this transaction at no additional cost. In December 1999, the $15.0 million of Discount Notes and related Discount Note Warrants repurchased in October 1999 were resold by the Company for $3.0 million cash.

In December 1999, the Company completed an exchange offer (the "Exchange Offer") of 14% Senior Pay-in-Kind Notes Due 2003 of Inter.Act Operating Co., Inc., a wholly owned subsidiary of the Company (the "PIK Notes"), 14% Series B Senior Mandatorily Redeemable Convertible Preferred Stock of the Company (the "Series B Preferred Stock") and common stock purchase warrants (the "Exchange Offer Warrants") for its outstanding Discount Notes. In the Exchange Offer, each holder of $1,000 principal amount of Discount Notes received $500 principal amount of PIK Notes, one share of Series B Preferred Stock having an initial liquidation preference of $500 and one Exchange Offer Warrant to purchase 17.96 shares of common stock for an exercise price of $.01. Because 100% of the outstanding Discount Notes (other than those held by the Company) were tendered in the Exchange Offer, the issuer of the PIK Notes, Inter.Act Operating Co., Inc., merged with and into its parent, the Company, on December 30, 1999. Consequently, the PIK Notes are direct obligations of the Company.

The PIK Notes mature on August 1, 2003 and accrue interest at a rate of 14% per annum from and after August 1, 1999, payable semiannually on February 1 and August 1 of each year, beginning February 1, 2000. The Company may, at its option, elect not to make interest payments in cash prior to the date that is 18 months following the earlier of an initial public offering of the Company's common stock or a Change in Control (as defined in the Indenture governing the PIK Notes). To the extent that the Company does not pay interest in cash, the interest accrued on the PIK Notes will be paid by the issuance of additional promissory notes, which will have substantially the same terms, including date of maturity and interest rate, as the PIK Notes. On February 1, 2000 the Company issued additional PIK Notes in the aggregate principal amount of $4 million. As payment of the interest accrued on the PIK Notes.

As a result of the Exchange Offer, the Company's long-term debt was reduced by one half and cash interest payments were rescheduled to 2003.

In May 1998 the Company issued, in connection with the acquisition of certain intellectual property, a note payable. This note, which was amended in June 1999, bears interest currently at 10.0% per year on the $5.7 million principal balance and is payable on June 1, 2000. If, prior to the maturity of this note, the Company completes a qualifying initial public offering of Common Stock or consummates a change of control, the then-outstanding principal balance and accrued interest would be convertible into shares of the Company's common stock at a conversion price of $8.50 per share, which management believes represents the fair value of the Company's Common Stock at the time of the June 1999 amendment. The Company does not expect to complete a qualifying initial public offering or consummate a change of control prior to June 1, 2000 and expects to negotiate an extension of the payment date with the holder. This note is reflected as a current liability in the Company's consolidated balance sheet as of March 31, 2000.

The Company's first private offering of preferred stock began in July 1998 when the Board of Directors authorized the sale of up to $40 million of 10% Series A Mandatorily Convertible Preferred Stock (the "Series A Preferred Stock"), first to the Company's shareholders and then to other investors at a price of $100 per share. The Series A Preferred Stock originally offered was convertible into common stock at a conversion rate of $10.00 per share of common stock. In March 1999, the Board of Directors and shareholders of the Company approved

certain changes to the Series A Preferred Stock and the Board increased the aggregate offering of Series A Preferred Stock to $70 million. Such changes consisted of (i) a reduction in the conversion price from $10.00 to $8.50 per share of common stock into which each share of Series A Preferred Stock is convertible, (ii) an increase in the number of votes per share of Series A Preferred Stock from 10 to the number of shares of common stock into which it is convertible (initially 11.7647), (iii) accrual of dividends on the Series A Preferred Stock semi-annually, as opposed to quarterly, to be paid only in shares of Series A Preferred Stock and (iv) the addition of anti-dilution provisions. Such changes are applicable to all shares of Series A Preferred Stock issued prior to the effective date of the changes and all additional shares of Series A Preferred Stock issued in the private offering. The offering of Series A Preferred Stock was closed in 1999. As of December 31, 1999, the Company had issued and sold 498,868 shares of Series A Preferred Stock at a price of $100 per share for total proceeds of approximately $49.9 million, all of which were received in cash with the exception of $100,000. All such shares continue to be outstanding as of March 31, 2000. Accrued dividends, payable in Series A Preferred Stock, were $5.3 million as of March 31, 2000.

In December 1999, the Company issued to tendering holders of the Company's Discount Notes in the Exchange Offer described above 139,575 shares of 14% Series B Senior Mandatorily Redeemable Convertible Preferred Stock (the "Series B Preferred Stock"), all of which were issued and outstanding as of March 31, 2000. The shares of Series B Preferred Stock have a liquidation preference of $500.00 per share and rank senior, as to dividends and liquidation preference, to all other classes of the Company's capital stock. Dividends on the Series B Preferred Stock accrue from August 1, 1999, at the rate of 14% per annum of the liquidation preference (determined as of the respective dividend payment date) per share, payable semi-annually on the first day of February and August of each year, commencing on February 1, 2000, and are cumulative to the extent unpaid. Accrued dividends on the Series B Preferred Stock were $6.5 million as of March 31, 2000.

In December 1999, the Company's Board of Directors designated an additional series of preferred stock, the 10% Series C Mandatorily Redeemable Convertible Preferred Stock (the "Series C Preferred Stock") and authorized the issuance and sale in a private offering up to 250,000 units consisting of one share of Series C Preferred Stock and one warrant to purchase approximately 7.14 shares of the Company's common stock at a price of $14.00 per share. As of March 31, 2000, 147,330 units had been issued and sold for total proceeds of approximately $14.7 million, all of which were received in cash. The shares of Series C Preferred Stock have a liquidation preference of $100.00 per share and rank, as to dividends and liquidation preference, equal to the Series A Preferred Stock, junior to the Series B Preferred Stock and senior to the Company's common stock. Dividends on the Series C Preferred Stock are payable only in shares of Series C Preferred Stock and accrue from the date of issuance, at the rate of 10% per annum of the liquidation preference, payable semi-annually on the first day of March and September of each year, commencing on the last day of March and September of each year, and are cumulative to the extent unpaid. Accrued dividends, payable in Series C Preferred Stock, were $276,000 as of March 31, 2000.

The Company will require additional equity or debt financing to fund capital expenditures, working capital requirements and operating losses to be incurred in connection with the increased commercialization of its IEMN. In 1999, the Company entered into an agreement with a leasing company to lease up to $3.0 million of terminals and related equipment in the U.S., with a right of first refusal on up to $10.0 million in additional lease financing. The Company is working with its leasing source and other third parties to secure additional lease financing for the purchase of IEMN equipment in the United States and Europe. In addition, the Company is negotiating with private investors for additional equity and debt capital. There is no assurance that such additional equipment financing or additional capital can be obtained. If additional funds are raised through the issuance of equity securities, shareholders may experience 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.

If the Company is unsuccessful in raising the required additional capital or equipment or other debt financing, the Company would be unable to continue its planned IEMN installations, expand either the number

and dollar amount of Manufacturer commitments, respond to competitive pressures, or continue its business operations as presently conducted, any of which could have a material adverse effect on the Company's results of operations and financial condition. In the event that the Company is only partially successful, however, the Company believes that existing cash and cash equivalents and reduced or delayed operating and capital expenditures will be sufficient to meet the Company's operating requirements only until the second quarter of 2001.

Cautionary Statement for Purpose of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995

The statements contained in this Quarterly 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 forwarding-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 from operations and expected future losses, (ii) the dependence of the Company on its ability to establish, maintain and expand relationships with consumer product manufacturers to promote brands on the IEMN (as defined herein) and the uncertainty of market acceptance for the IEMN, (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 may experience, (v) risks related to the Company's leverage and debt service obligations, (vi) risks inherent in the necessity for the Company to raise additional equity or debt financing to fund continuing losses, (vii) the Company's dependence on third parties, (viii) the intensely competitive nature of the consumer product and promotional industry,
(ix) risks that the Company's rights related to patents, proprietary information and trademarks may not adequately protect its business, (x) risks relating to the relocation of the Company's corporate offices, including potential costs involved in the relocation as well as the need for new employees to develop the skills necessary to develop the Company's business and (xi) the possible inability of new management to perform their respective roles. See Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Factors" of the Company's Annual Report on Form 10K/A for the year ended December 31, 1999 for a more specific description of these risks.