As filed with the Securities and Exchange Commission on January 4, 2000 File
No. 333-89593
This Registration Statement is a post-effective amendment to File No. 333-17635
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM SB-2
(Amendment No. 1)
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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VIRTUAL COMMUNITIES, INC.
(Name of small business issuer in its charter)
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Delaware 7371 95-4491750
(State or jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification No.)
589 Eighth Avenue, 7th Floor Avi Moskowitz, President
New York, New York 10018 589 Eighth Avenue, 7th Floor
(212) 931-8600 New York, New York 10018
(Address and telephone number of principal executive offices (212) 931-8600
and principal place of business) (Name, address and telephone number of agent for service)
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Copies to:
Gary N. Jacobs, Esq.
Christensen, Miller, Fink, Jacobs, Glaser, Weil & Shapiro, LLP
2121 Avenue of the Stars, Suite 1800
Los Angeles, CA 90067
(310) 553-3000
Approximate date of proposed sale to the public: As soon as practicable
after this registration statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continued basis pursuant to Rule 415 under the Securities Act of
1933, please check the following box. [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the
same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier registration statement for the
same offering. [_]
If the delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [_]
CALCULATION OF REGISTRATION FEE
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Amount Proposed Proposed
of maximum maximum Amount of
Title of each class of securities to be offering price aggregate registration
securities to be registered registered per share(1) offering price(1) fee(2)
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Common stock................................... 1,794,335 shares(3) $3.172(4) $5,691,630.62(4) $0
Units consisting of one share of common stock
and one class B warrant(5).................... 500,000 6.50 3,250,000 0
Common stock(6)................................ 500,000 shares 8.75 4,375,000 0
Units consisting of one share of common stock,
one class A warrant and one class B
warrant(7).................................... 120,000 6.00 720,000 0
Units consisting of one share of common stock
and one class B warrant(8).................... 120,000 6.50 780,000 0
Common stock(9)................................ 240,000 shares 8.75 2,100,000 0
TOTAL.......................................... $ $0
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(See footnotes following page)
The Registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(g).
(2) Pursuant to Rule 457(a), the registrant has previously paid a registration
fee of $5,953 based on a bona fide estimate of the maximum offering price
in connection with the filing of its registration statement on Form SB-2,
filed with the Commission on October 22, 1999, of which this registration
statement is a pre-effective amendment. The number of securities offered
has not been increased by this pre-effective amendment.
(3) The number of shares of the registrant's common stock to be registered in
connection with the exercise of outstanding warrants of Virtual
Communities, Inc., the registrant's predecessor company, has been
determined based upon (a) the sum of outstanding warrants to purchase
1,558,936 shares of the predecessor company's common stock, and (b) the
exchange ratio of 1.151 shares of the registrant's common stock for each
share of the predecessor company's common stock underlying the warrants.
(4) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(g). Pursuant to Rule 457(g), with respect to the shares of
registrant's common stock being issued upon exercise of the warrants, the
maximum offering price per share is $3.172, the average of the bid and
asked price of a share of the registrant's common stock reported on the
NASDAQ SmallCap Market on December 29, 1999, and the maximum aggregate
offering price is the product of $3.172 and 1,794,335, the maximum number
of shares of common stock expected to be issued upon exercise of the
warrants.
(5) Issuable upon exercise of 500,000 certain outstanding class A warrants.
(6) Issuable upon exercise of the class B warrants underlying the 500,000
class A warrants.
(7) Issuable upon exercise of the unit purchase options.
(8) Issuable upon exercise of the class A warrants underlying the unit purchase
options.
(9) Issuable upon exercise of the class B warrants underlying the unit purchase
options.
EXPLANATORY NOTE
This Registration Statement covers the registration of the following
securities of Virtual Communities, Inc., a Delaware corporation:
. up to 1,794,335 shares of common stock issuable upon exercised certain
outstanding warrants of the registrant's predecessor company assumed by
the registrant pursuant to the terms of that certain Agreement and Plan
of Merger, dated as of June 2, 1999, as amended. Pursuant to the merger
agreement, the registrant's predecessor company Virtual Communities,
Inc. merged with and into a wholly owned subsidiary of the registrant,
and the holders of outstanding warrants of the predecessor company are
entitled to exercise those warrants after the effective time of the
merger for that number of shares of the registrant's common stock that
such holders would have received in the merger if the shares of the
predecessor company's common stock underlying their warrants were held
by them at the effective time of the merger. At the effective time of
the merger, there were outstanding warrants to purchase 1,558,936 shares
of the predecessor company's common stock, and the exchange ratio in the
merger was 1.151 shares of the registrant's stock for each outstanding
share of the predecessor company's common stock. Accordingly, the
registrant has assumed the obligation to issue up to 1,794,335 shares of
its common stock on exercise of the outstanding warrants of the
predecessor company.
. 500,000 redeemable class B warrants issuable upon exercise of certain
outstanding redeemable class A warrants, and 1,000,000 shares of common
stock issuable upon the exercise of such class A and class B warrants.
These class A and class B warrants are the "Selling Securityholder
Warrants" and "Selling Securityholder Class B Warrants" referred to in
the company's Registration Statement on Form SB-2 (File No. 333-17635),
filed with the SEC on February 11, 1997. The company has determined to
register the issuance of these class B warrants and shares of common
stock in lieu of maintaining the effectiveness of that Registration
Statement with respect to such warrants and shares.
. 120,000 units issuable upon exercise of certain outstanding unit
purchase options, each consisting of one share of common stock, one
redeemable class A warrant and one redeemable Class B warrant, 120,000
class B warrants issuable upon the exercise of the class A warrants, and
360,000 shares of common stock issuable on exercise of the redeemable
class A and class B warrants.
Pursuant to Rule 429 under the Securities Act, this registration statement
is also a post-effective amendment to the registrant's registration statement
on Form SB-2 (File No. 333-17635), with respect to 1,380,000 units consisting
of one share of common stock and one redeemable class B warrant, and 2,760,000
shares of common stock underlying the class B warrants registered thereby.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. The prospectus is not an +
+offer to sell these securities and it is not soliciting an offer to buy these +
+securities in any State where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION--DATED DECEMBER 31, 1999
PROSPECTUS
VIRTUAL COMMUNITIES, INC.
(formerly HEURISTIC DEVELOPMENT GROUP, INC.)
1,794,335 shares of common stock
500,000 redeemable class B warrants and
500,000 shares of common stock issuable upon exercise
of outstanding redeemable class A warrants and
500,000 shares of common stock issuable upon exercise of the class B warrants
120,000 units consisting 120,000 shares of common stock,
120,000 redeemable class A warrants and
120,000 redeemable class B warrants
and 120,000 class B warrants issuable upon exercise of the class A warrants,
and 360,000 shares of common stock issuable upon exercise
of the class A and class B warrants
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Investment in these securities involves a high degree of risk.
See "Risk Factors" beginning on page 4.
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Our common stock, our outstanding class A warrants and our outstanding class
B warrants trade on the Nasdaq SmallCap Market under the symbols VCIX, VCIXW
and VCIXZ, respectively. Our outstanding units offered in our 1997 initial
public offering trade on the Nasdaq SmallCap Market under the symbol VCIXU.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is
a criminal offense.
Pursuant to Exemption Application 91/99 filed by Heuristic Development Group,
Inc., the Israeli Securities Authority decided, on May 30, 1999, in accordance
with their authority under Section 41 of the Israel Securities Law, 5728-1968,
to exempt Heuristic Development Group, Inc. from publishing a prospectus
approved by the Authority, with respect to the offering of securities of
Heuristic Development Group, Inc.
The date of this prospectus is December 31, 1999.
TABLE OF CONTENTS
Page
----
Summary.................................................................. 1
Risk Factors............................................................. 4
The Offering............................................................. 18
Use of Proceeds.......................................................... 20
Dividend Policy.......................................................... 20
The Company.............................................................. 21
Directors and Executive Officers......................................... 43
Share Ownership of Management and Certain Stockholders................... 50
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 52
Financial Statements..................................................... 61
Pro Forma Financial Statements........................................... 62
Notes to Pro Forma Financial Statements.................................. 66
Related Party Transactions............................................... 67
Description of Securities................................................ 69
Indemnification and Insurance............................................ 71
Legal Matters............................................................ 71
Experts.................................................................. 71
Where You Can Find More Information...................................... 72
APPENDIX A--Heuristic Development Group Financial Statements for the year
ending December 31, 1998 and for the period from July 20, 1994 through
December 31, 1998 ...................................................... A-1
APPENDIX B--Heuristic Development Group Financial Statements for the
period ending September 30, 1999 and for the period from July 20, 1994
through September 30, 1999 ............................................. B-1
APPENDIX C--Virtual Communities, Inc. Consolidated Financial Statements
for the year ending December 31, 1998................................... C-1
APPENDIX D--Virtual Communities, Inc. Condensed Interim Consolidated
Financial Statements for the period ending September 30, 1999........... D-1
i
SUMMARY
This summary highlights selected information from this prospectus. It does
not contain all of the information that may be important to you. You should
carefully read this entire document and the other documents to which we refer.
Together, these documents will give you a more complete description of the
transactions we are proposing.
Virtual Communities, Inc.
Our company is the product of a merger consummated October 29, 1999, in
which Virtual Communities, Inc. merged with and into a wholly owned subsidiary
of Heuristic Development Group, Inc., our predecessor company.
Prior to the merger, under the name Heuristic Development Group, we were a
development stage company originally organized to research, develop, design and
market fitness-related products. Due to disappointing acceptance of our primary
product, the IntelliFit System, we decided to pursue a strategy of acquisition
of an existing company--culminating in the merger with Virtual Communities,
Inc.
Virtual Communities, Inc., was organized in 1996 to develop, acquire and
operate online communities on the Web that aggregate and publish various news,
media and entertainment content targeted to specific ethnic groups. After the
merger, we changed our name to Virtual Communities, Inc., to reflect that our
primary business is now the development and acquisition of online communities
and related services.
We currently operate five online communities: Virtual Jerusalem, Virtual
Holyland, Virtual Ireland, Virtual Italy and Virtual India. We also recently
began offering online community design and development services to Web site
publishers including content publishing software and interactive components to
attract and retain visitors to a community.
Our principal executive offices are located at 589 8th Avenue, 7th Floor,
New York, NY 10018, telephone (212) 931-8600. Information contained on our Web
site does not constitute a part of this prospectus.
The Offering
This prospectus relates to our offering of the following securities:
. 1,794,335 shares of our common stock to be issued to holders of
outstanding warrants issued by the former Virtual Communities, Inc. upon
exercise of those warrants.
. 500,000 redeemable class B warrants issuable upon exercise of outstanding
redeemable class A warrants, and 1,000,000 shares of our common stock
issuable upon exercise of those class A and class B warrants. We issued
these class A warrants in 1997 in connection with our initial public
offering.
. 120,000 units issuable upon exercise of outstanding unit purchase
options, each consisting of one share of common stock, one redeemable
class A warrant and one redeemable class B warrant, together with an
aggregate of 360,000 shares or our common stock issuable on exercise of
the class A and class B warrants included in these units.
See "THE OFFERING" and "DESCRIPTION OF SECURITIES."
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We have not authorized anyone to give any information or make any
representation about us that differs from, or adds to, the information in this
prospectus or in our documents that are publicly filed with the Securities and
Exchange Commission. The information contained in this prospectus speaks only
as of our date unless the information specifically indicates that another date
applies.
1
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
The following table shows the financial results actually achieved by each of
Heuristic Development Group, Inc. and Virtual Communities, Inc. (the
"historical" figures), as well as the results as if the companies had been
combined for the period shown (the "pro forma combined" figures) under the
following circumstances: (1) that no Virtual Communities, Inc. shareholder
dissents from the merger and (2) that the maximum of 7% of Virtual Communities,
Inc. shareholders dissent from the merger. You should not assume that we would
have achieved the combined pro forma results if Heuristic Development Group,
Inc. and Virtual Communities, Inc. had actually been combined during the
periods shown.
The nine months' historical figures for 1999 for both companies are
unaudited, but we each believe that our figures reflect all normal recurring
adjustments necessary for a fair presentation of the financial position and
results of operations for that period. You should not assume that the results
for a portion of 1999 will be repeated in later periods.
Selected Historical and Pro Forma Data as of September 30, 1999
(U.S. Dollars in thousands)
Heuristic Virtual Pro Forma Pro Forma
Development Communities, Equivalent Equivalent
Group, Inc. Inc. (No dissenting (7% dissenting
Historical Historical shares) shares)
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Total assets............ 2,737 1,146 3,398 2,298
Cash and cash
equivalents............ 2,377 102 2,244 1,144
Total liabilities....... 102 2,608 2,460 2,460
Shareholders equity..... 2,635 (1,462) 938 (162)
Net loss................ (572) (2,978) (3,035) (3,035)
Comparative per share information
The following table sets forth unaudited data concerning the net loss,
dividends and book value per share for Heuristic Development Group, Inc. and
Virtual Communities, Inc. on a pro forma basis after giving effect to the
merger.
No dissenting shares 7% dissenting shares
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Nine Months Nine Months
Ended Year Ended Ended Year Ended
September 30, December 31, September 30, December 31,
1999 1998 1999 1998
------------- ------------ ------------- ------------
Net loss per weighted
average common share
(basic and diluted).... (0.22) (0.17) (0.23) (0.19)
Weighted average common
shares outstanding..... 14,075,382 14,201,440 13,202,249 13,328,307
Dividends declared per
share.................. -- -- -- --
Book value per share at
end of period(l),(2)... 0.07(3) N/A 0.01(4) N/A
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(1) The book value per share is computed by dividing stockholders' equity by
the number of shares of common stock outstanding.
(2) The information is not presented for the year ended December 31, 1998, as a
pro forma balance sheet was not prepared as of this date.
(3) Gives effect to the issuance of approximately 12,473,326 shares of
Heuristic Development Group, Inc. common stock to the Virtual Communities,
Inc. shareholders in connection with the merger assuming no Virtual
Communities, Inc. shareholder dissents to the merger.
2
(4) Gives effect to the issuance of approximately 11,600,193 shares of
Heuristic Development Group, Inc. common stock to the Virtual Communities,
Inc. shareholders in connection with the merger assuming 7% of Virtual
Communities, Inc. shareholders dissent to the merger.
The following tables set forth data concerning the historical net income
(loss), dividends and book value per share for Heuristic Development Group,
Inc. and Virtual Communities, Inc..
Heuristic Development Group, Inc. historical per share data
Nine Months Ended Year Ended
September 30, December 31,
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1999 1998 1998 1997
--------- --------- --------- ---------
Net loss per weighted average
common share (basic and
diluted)......................... (0.36) (0.49) (0.59) (0.91)
Weighted average common shares
outstanding...................... 1,602,056 1,749,234 1,728,114 1,581,160
Dividends declared per share...... -- -- -- --
Book value per share at end of
period(l)........................ 1.64 2.00 1.83 2.5
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(1) The book value per share is computed by dividing stockholders' equity by
the number of shares of common stock outstanding.
Virtual Communities, Inc. historical per share data
Nine Months Ended Year Ended
September 30, December 31,
-------------------- --------------------
1999 1998 1998 1997
--------- --------- --------- ---------
Net loss per weighted average
common share (basic and diluted) (0.35) (0.17) (0.19) (0.35)
Weighted average common shares
outstanding...................... 8,523,409 5,469,441 7,372,636 3,190,824
Dividends declared per share...... -- -- -- --
Book value per share at end of
period(1)........................ (0.17) (0.17) (0.09) (0.22)
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(1) The book value per share is computed by dividing stockholders' equity by
the number of shares of common stock outstanding
3
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. If any of the following risks actually occur, our
business, financial condition or results of operations could be materially
adversely affected, the value of our stock could decline, and you may lose all
or part of your investment.
We face risks associated with our operations
We have a limited operating history and cannot predict the viability of our
online communities and Web site design and development business.
Virtual Communities, Inc., the company with whom we recently merged and
whose Web-based business is now our primary business, was founded in August
1996, merged with us in October 1999 and has a limited operating history. You
should consider the risks and difficulties frequently encountered by companies
like us, an early stage company involved in acquiring, operating and developing
online communities and Web site design and development. These risks include:
. the level of use and consumer acceptance of the online community model,
and thus our ability to attract users and registrants;
. our failure to continue to develop, operate or acquire future Web sites;
. our inability to attract or retain Web site design and development
clients;
. our inability to integrate our own technology and know-how with licensed
technology in both the development and maintenance of our own Web sites
and our clients' Web sites; and
. our failure to anticipate and adapt to a developing demographic market
or the Internet industry.
We have a history of losses and expect to incur losses in the future, and we
may never achieve profitability.
For the year ended December 31, 1998 and the nine months ended September 30,
1999, Virtual Communities, Inc. generated revenues of $819,000 and $613,000,
respectively, and had an accumulated deficit of $5,904,000 as of September 30,
1999. To date, neither Virtual Communities nor Heuristic Development Group,
Inc., our predecessor companies, have been profitable on either a quarterly or
an annual basis, and we expect to incur net losses in the future. We expect our
operating expenses to increase significantly, especially in the areas of sales
and marketing, the development of future communities, and the expansion of our
Web site design and development business, and, as a result, we will need to
increase our revenue substantially to become profitable. If our revenue does
not grow as expected or increases in our expenses are not in line with our
forecasts, we will continue to incur net losses.
Our operating results depend on advertising revenues that could be affected by
cancellation of key contracts and decreases in Web site traffic.
Historically, we derived a material portion of our revenue from the sale of
advertisements on our Web sites. For the year ended December 31, 1998 and the
nine months ended September 30, 1999, advertising revenue represented 62% and
49% of our total revenue, respectively. A majority of our revenue will come
from advertising contracts that are usually six to twelve months in length and
are often cancelable upon three months notice. That means our quarterly revenue
is a function of the contracts we will attract and/or retain within the quarter
and our ability to adjust spending in light of any revenue shortfalls. To date,
the advertising revenue from our Web sites comes from a small group of
customers whose composition periodically changes. For example, during the year
ended December 31, 1998 and the nine months ended September 30, 1999, the five
largest advertisers accounted for approximately 51% and 21% of the total
advertising revenue, respectively. As a result, the cancellation of even a
small number of these advertising contracts could affect our operating results.
4
Advertising revenue is also linked to the level of traffic on our Web sites,
so if traffic is less than the level expected by our advertising customers, our
advertising revenue could be adversely affected. Under most advertising
contracts, we guarantee our advertisers a minimum number of impressions on our
Web sites. Reduced traffic on these Web sites would cause us to fall short in
meeting this minimum requirement and, as a result, we may be required to extend
the length of time that an advertiser may advertise on our Web sites without a
concurrent increase in advertising revenue. This kind of extension would reduce
the availability of space for other advertisers, which would lead to a
reduction in advertising revenue.
It is uncertain whether Web advertising will continue to grow at a rate that
will support our revenue projections. The Internet as a marketing and
advertising medium has not been available for a sufficient period of time to
gauge our effectiveness as compared with traditional media. Many of our
advertisers have only limited experience with the Web as a sales and
advertising medium. In general, advertisers have not yet devoted a significant
portion of their advertising budgets to Web based advertising and may not find
such advertising to be effective for promoting their products and services
relative to traditional print and broadcast media. For 1997, a report by
Jupiter Communications states that advertising on the Web represented less than
0.5% of overall advertising revenue in the United States according to industry
sources.
If our advertising revenues fall below the expectations of securities
analysts and investors, the market price of our shares will likely decline.
If our capital is insufficient to promote our business and we cannot obtain
needed financing, we will not be able to promote our Web sites, exploit
acquisition opportunities and remain competitive.
Since our current revenues are insufficient to pay for our current operating
expenses, following the merger, we will depend on additional investments to
fund our existing and future operations as well as to execute our acquisition
and business plans, launch additional Web sites and expand our marketing and
sales efforts. We think that our available cash is sufficient to support our
current operations through February 15, 2000, and therefore we need to raise
additional funds to maintain and develop our position in the marketplace. We
estimate that it costs approximately $250,000 to launch a new online community
and $200,000, $400,000 and $550,000 to support an online community during our
first, second and third years of operations, respectively. Approximately half
of these amounts are used for marketing purposes. It may be difficult or
impossible for us to obtain financing on favorable terms. Raising funds by
issuing equity securities or convertible debt securities will dilute the
percentage ownership of our current stockholders. Also, if we issue new
securities they may have rights senior to the rights of our common stock. If we
cannot obtain needed financing, we will be unable to execute our business plans
and may be forced to liquidate our assets or file for bankruptcy.
Our independent auditors have expressed doubt over our ability to continue as a
going concern.
The report of independent public accountants on our December 31, 1998
consolidated financial statements includes an explanatory paragraph stating
that the recurring losses incurred from operations and a net capital deficiency
raise substantial doubt about our ability to continue as a going concern. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
We are substantially dependent on one online community for our revenues.
While we currently operate five online communities (virtualjerusalem.com,
virtualholyland.com, virtualireland.com, virtualitaly.com and
virtualindia.com), approximately 99% of our revenues are generated directly or
indirectly from virtualjerusalem.com. Although we plan to market and develop
our other online communities and launch or acquire additional communities, we
cannot assure you that we will successfully complete these plans, or if we
complete these plans, that these communities will generate significant
revenues. Our inability to complete these plans or generate substantial revenue
from other sources would have a material adverse effect on our ability to
generate revenue.
5
Our business model also relies on our plan to develop a community building
business for third parties and our ability to provide content management
systems and interactive elements for prospective clients. We have sold only one
such system to date. Our inability to market and sell our community building
services could adversely affect our ability to increase revenues.
Changes in the political and economic stability of the State of Israel could
adversely affect our operations.
One of our subsidiary companies, Virtual Communities Israel Ltd., which is
integral to our success, is located in the State of Israel. In addition, a
significant number of our content partners and some of our advertisers are
based in Israel. Accordingly, we are directly influenced by the political,
economic and military conditions affecting Israel. Any military or terrorist
action or threat or other significant hostilities involving Israel, the
interruption or curtailment of trade between Israel and our present trading
partners or a significant downturn in the economy or financial conditions in
Israel could have a material adverse effect on our ability to operate our
business. Israel's economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early to mid-1980's, low foreign
exchange reserves, fluctuations in world commodity prices, military conflicts
and civil unrest. Recently, the Israeli economy experienced recessionary
trends, including growing unemployment and a general decline in economic
activity. If such trends continue in 1999, they may have a material adverse
effect on our business, financial condition and results of operations.
In addition, since the establishment of the State of Israel in 1948,
significant hostilities exist, varying in degree and intensity, between Israel
and some Arab countries. Although Israel entered into various agreements with
some Arab countries and the Palestine Liberation Organization, and various
declarations were signed to resolve some of the economic and political problems
in the Middle East, we cannot predict if a full resolution of these problems
will be achieved, or the form of any resolution. Furthermore, all non-exempt
male adult permanent residents of Israel under the age of 50, including certain
of our employees, are obligated to perform military reserve duty and are
subject to being called into active duty under emergency circumstances. While
we operated despite these conditions in the past, we cannot predict the
likelihood of emergency circumstances occurring in the future or the impact of
these conditions on our operations in the future.
Our plans to create or acquire additional Web communities with international
community content are subject to risks that could adversely affect our ability
to operate our business and expand internationally.
Our plans to create or acquire additional Web communities with international
community content, and our plans to form strategic and joint venture
relationships in other parts of the world, will increase our exposure to other
risks and problems inherent in international operations, including:
. the impact of recessions in economies outside the United States and
Israel;
. greater difficulty in accounts receivable collections;
. unexpected changes in regulatory requirements;
. difficulties and costs of staffing, maintaining effective communications
and managing foreign operations due to distance, language and cultural
barriers or otherwise;
. reduced protection for intellectual property rights;
. political and economic instability;
. the introduction of the Euro; and
. fluctuations in currency exchange rates.
Some or all of the above factors could have a material adverse effect on our
ability to expand our business into international markets. In addition, even if
our future plans are successful, we cannot be certain that our investment in
establishing operations in other countries will produce the desired levels of
revenue.
6
Any failure of our network infrastructure could adversely effect our
operations.
Our success depends upon the capacity, reliability and security of our
networking hardware and software infrastructure. We have developed a hardware
and software system that is designed for reliability, however, on isolated
occasions in the past the system has been subject to isolated failures due to
human error or software failure. The system integrates Web site management,
network monitoring, quality assurance, transaction processing and fulfillment
services. In addition, our system, which includes all of our Web sites and our
servers in Israel and the United States and Israel, emphasizes extensive
automation and the back-up of our Web sites using various technologies and a
high degree of redundancy. The system is designed to minimize single points of
failure.
Our system, when completed in December 1999, will have 500 gigabytes of disk
space, which should support over 70 million Web page views per month. We are
continuing to expand and adapt our system infrastructure to keep pace with the
increase in the number of users and registrants who use the free Internet
services we provide. Demands on our infrastructure that exceed our current
forecasts could result in technical operating difficulties with our Web sites.
Any system failure that interferes with the access to our Web sites, and the
use by our users and registrants of the free Internet services that we provide,
could diminish the level of traffic on our Web sites. Continuing or repeated
system failures could impair our reputation and brand name and reduce our e-
commerce referral and advertising revenue. At present, we do not know that we
will be able to scale our systems to handle a larger amount of traffic at
higher transmission speeds. Further, any expansion of our network
infrastructure will require substantial financial, operational and management
resources, all of which could affect the results of our operations by diverting
these resources from other areas of our business that we may seek to develop.
User access to, and the functionality of, our online communities are highly
dependent on third parties and are vulnerable to disruptions beyond our
control.
We use our own network servers that are housed at Frontier Global Services,
Inc.'s facilities in Herndon, Virginia and New York City, and at our facility
in Israel. Our Web sites are connected to the Internet by Frontier Global
Center in the United States and by Netvision Ltd. in Israel via multiple DS-3,
OC-3, and 128Kbs links on a continuous basis. Global Center is responsible for
ensuring that all of our servers have power and connectivity to the Internet.
We manage and monitor our servers and network remotely from our facility in
Israel and, in addition, Global Center monitors our Web sites on a continuous
basis.
Although the agreements we have with Global Center and Netvision provide us
with remedies for service interruptions, we cannot assure you that we will have
uninterrupted access to the Internet for our Web sites, or that our users and
registrants will be able to access our Web sites.
We are currently in discussions with Frontier Global regarding certain
amounts charged by them for services provided to us. We believe that we will be
able to resolve such differences in a mutually satisfactory manner, and, in any
event, such differences are not material to the Company. However, in the event
we are unable to resolve such differences, we could experience a disruption in
the services provided to us by Frontier Global.
A disruption for any reason in the Internet access provided to us by Global
Center or Netvision, any interruption in the service that Global Center or
Netvision receives from other providers, or any failure of Global Center or
Netvision to handle higher volumes of Internet users to our Web sites could
have a material adverse effect on our business, results of operations and
financial condition by reducing the level of traffic on our Web sites.
Despite precautions taken by us and by Global Center and Netvision, our
system is susceptible to natural and man-made disasters such as earthquakes,
fires, floods, power loss and sabotage.
Our system is also vulnerable to disruptions from human error, computer
viruses and attempts by hackers to penetrate our network security. Hackers have
succeeded in penetrating our network security in the past, and we expect these
attempts to continue from time to time. Breaches of our network security could
also disrupt the operation of our Web sites and jeopardize the security of
confidential information stored in our servers. We have recently started
implementing "Firewall" network security in our Israel facility and at Global
Center's United States facilities. "Firewall" is an industry standard product,
manufactured by CheckPoint and installed for us by industry experts, that is
designed to prevent unauthorized entry into network security systems.
7
Although we believe that Firewall will prevent unauthorized entry to our
network security in most instances, we cannot assure you that computer viruses
and hackers will not penetrate our systems in the future.
Any of the events listed above could cause us interference, delays, or
service interruptions and adversely affect our business and results of
operations. Our success is dependent upon, among other things, our ability to
deliver uninterrupted Web site service to the users and registrants of our Web
sites. As a result, we must protect our computer equipment and the information
stored in our servers against damage by fire, natural disaster, power loss,
telecommunications failures, unauthorized intrusion and other catastrophic
events.
Web site services and other services based on software and computer systems
often encounter development and completion delays and the underlying software
may contain undetected errors or failures. In the case of Web sites, these
problems are heightened when the volume of traffic on a site increases. Such
delays and errors and other electronic or telecommunications failures are
generally beyond our control. In addition, we cannot assure you that errors
will not be found in the software underlying our content management systems or
other software that we license for use on our online communities or a Web site
developed by us for a third party. These errors might include bugs in the code
of standard "off the shelf" software product releases, and may result in delays
in the completion or launch of one of our own communities or a community or Web
site or other project that we develop on behalf of others. Other similar
factors include the timing of the commercial release of particular services or
products and the market acceptance thereof, unanticipated costs to cure any
defect if it is subject to cure, the need to refund money paid to us or to pay
for damages caused by the delay or defect.
We depend on our content partners and suppliers to attract users and
registrants to our Web sites.
Our future success depends largely on our ability to attract and maintain a
large base of users and registrants because the larger our base the more likely
commercial enterprises are willing to advertise and sell their products and
services on our Web sites. Moreover, certain advertisers pay us based upon the
number of times a registrant views a particular advertisement. The volume of
users who view our Web sites and the size of our registrant base depends
largely on the ability of our current and future content partners, who supply
content to our Web sites and our ability to reach agreements with web service
providers of interactive elements which we also use, to attract and retain
users and registrants. While no single content partner is material to our
operations, we may not be able to maintain or expand our base of content
partners. If we are unable to obtain content from content partners, we would be
unable to create significant content to attract and maintain our users and
registrants and would likely lose significant advertising and other revenue.
We rely on other companies to provide Internet services for our visitors,
registrants and Community Management Solutions clients.
We rely on the following companies for the Internet services they provide to
our registrants:
Company Service
------- -------
CommTouch Software Ltd. E-mail and personal Web pages
Accuweather, Inc. Weather
NetGravity, Inc. Advertising management
Talk City, Inc. Chat
The Gilad Group--Computer Systems Programming and development
Integration, Ltd.
Homestead, Inc. Personal Homepages
Fairmarket, Inc. Auction services
Reuters Limited News services and photographs
Intershop Communications, Inc. E-commerce software
Screaming Media-Net, Inc. Content Provider
8
If our relationship with any of these companies were to terminate without
sufficient advance notice, and we were unable to establish relationships with
comparable service providers, our ability to provide Internet services to our
registrants, and to operate our own Web sites and to provide such services to
our Community Management Solutions clients, would be adversely affected.
The loss of Avi Moskowitz or other key personnel, or the inability to attract
and retain additional, qualified personnel in both the United States and
Israel, could adversely affect our ability to manage and grow our businesses.
Our success depends to a significant degree upon the continued contributions
of our executive management team, most of whom have worked together only for a
short time. We do not carry key man life insurance on the lives of any of our
employees except for Avi Moskowitz, our Chairman of the Board, Chief Executive
Officer and President. Our success will also depend upon the continued service
of our management team as well as technical, marketing and sales personnel,
graphic artists and editorial staff. Although we have entered into employment
contracts with all the members of our management team, including Mr. Moskowitz,
all of our employees may voluntarily terminate their employment at any time.
Our success also depends upon our ability to attract, hire and retain
additional highly qualified management, technical, sales and marketing and
customer support personnel both in the United States and Israel. Locating
personnel with the combination of skills and attributes required to carry out
our strategy is often a lengthy process and competition for qualified employees
in the Internet industry, both in the United States and Israel, is intense. The
loss of key personnel, or the inability to attract, hire and retain additional,
qualified personnel, could have a material adverse effect on our ability to
manage and grow our businesses.
Our operations could be adversely affected if our investments in our online
communities do not generate a corresponding increase in net revenue.
As the number of Web sites grows, brand and site recognition will play an
increasingly important role. Establishing, developing and promoting our online
communities in the face of pressures from our competitors will be critical to
developing our registered user base, content and strategic partners and
commercial relationships. We will be required to continue to devote substantial
financial and other resources to maintaining the unique content of our online
communities through:
. Web advertising and marketing;
. traditional media advertising campaigns in print, radio and billboards;
and
. providing a high quality online community experience.
The results of our operations could be adversely affected if our investment
of financial and other resources in developing and promoting our online
communities does not generate a corresponding increase in net revenue, or if
the expense of promoting our communities becomes excessive. Changes in the
quality and type of services we offer and our character as perceived by our
registered users could make our communities less attractive to our users,
registrants, advertisers, content and strategic partners, all of which would
have a material adverse effect on our ability to increase our registered user
base and to generate revenue.
Part of our business depends on the growing demand for Web site design and
development services.
Because we are in the business of providing Web site design and development
services, our future success depends, in part, on the continued expansion of,
and reliance of consumers and businesses on, the Internet. The Internet may not
be able to support an increased number of users or an increase in the volume of
data transmissions. As a result, the performance or reliability of the Internet
may be adversely affected as use increases. The improvement of the Internet in
response to increased demand will require timely improvement of
9
the high speed modems and other communications equipment that form the Internet
infrastructure. The Internet has already experienced outages and delays as a
result of damage to portions of our infrastructure.
The effectiveness of the Internet may also decline due to delays in the
development or adoption of new technical standards and protocols designed to
support increased levels of activity. We cannot assure you that the
infrastructure, products or services necessary to maintain and expand the
Internet will be developed, and without these developments, there will be
limited, if any, demand for our Web site design and development services.
Because competition in the online community business is intense, and many of
our competitors have greater resources than us, our ability to maintain or
improve our position in this market could be harmed.
The market for community content aggregators on the Internet is new and
rapidly evolving. Competition for registrants, consumers, users and advertisers
is intense and is expected to increase over time. Barriers to entry are
relatively low. Other companies that are primarily focused on creating online
communities and with whom we compete are:
. competitors to virtualjerusalem.com include: Jewish Communities On-Line
(located at America Online), JCN (www.jcnl8.com; general commercial
Jewish Web sites), Shamash (www.shamash.org; a non-profit Jewish communal
network), Jewish Family & Life (www.jewishfamily.com; a general site
devoted to Jewish topics published by JCN), and the Jerusalem Post
(www.jpost.co.il; the online edition of the newspaper);
. competitors to virtualholyland.com include: crosswalk.com (published by
Didax, Inc.), Jesus2000.com, the Christian Broadcasting Network
(www.wcbn.com), and other Web sites published by ministries and
evangelists worldwide;
. competitors to virtualireland.com include: The Irish Times
(www.ireland.com), Local Ireland (www.local.ie; a quasi-governmental Web
site financed in part by Telecom Eireann), Ask Ireland
(www.askireland.com); published by the government of Ireland), Touchtel's
tourist information site (www.goireland.com), paddynet.com,
irishabroad.com and celtic.com;
. competitors to virtualitaly.com include: DolceVita (www.dolcevita.com, a
fashion and travel site), Made in Italy (www.made-in-italy.com, a travel
and e-commerce site), and Virtual Italia (www.virtualitalia.com, a
general Italian interest site); and
. competitors to virtualindia.com include: Rediff on the Net
(www.rediff.com, an India-oriented online service), India-Today
(www.india-today.com, a news and cultural site) and 123india.com
(www.123india.com, a news information and software site).
We also face competition and competes for users and traffic with Web
directories, search engines, shareware archives, other content Web sites,
online service providers, and traditional media companies such as ABC, America
Online, CBS, CNET, Excite, Infoseek, Lycos, NBC, Microsoft, Time Warner and
Yahoo!. Increased competition from these and other sources could require us to
respond to competitive pressures by establishing pricing, marketing and other
programs, or seeking out additional strategic alliances or acquisitions that
may be less favorable to us than we could otherwise establish or obtain.
Substantially all of our current advertising customers and content partners
also have established collaborative relationships with some of our competitors
or other Web sites. Our advertising customers might also conclude that other
Internet businesses, such as search engines, commercial online services and Web
sites that offer professional editorial content, are more effective sites for
advertising. Moreover, we may be unable to maintain the traffic on our Web
sites or sustain or increase the size of our registered user base, which would
make our Web sites less attractive than those of our competitors. Any of these
factors could adversely affect our ability to maintain or improve our
competitive position.
10
We face increasing competition and competitors with longer operating histories
for our Web site/community design and development services.
We recently started offering third parties, other than our content partners,
Web site design and development services that focus on creating online
communities and Web site content management. The market for these services is
relatively new, intensely competitive and subject to rapid technological
change. We expect competition not only to persist, but also to increase.
Increased competition may result in price reductions, reduced margins and loss
of market share. Our competitors fall into several categories, including
Internet service firms, technology consulting firms, technology integrators,
strategic consulting firms, and in-house information technology, marketing and
design departments of our potential clients. These competitors include Vignette
Ltd., Interwoven, Inc. and Futuretense, Inc.
The barriers to entry for Web site design and development and programming
and development of content management systems are also relatively low, although
higher than less specialized areas of Web site design and development. As a
result, we expect to face additional competition from new market entrants in
these businesses in the future. Since the market for these services is rapidly
evolving, our competitors may be better positioned to service clients. We
compete on the basis of a number of factors, including the breadth and quality
of the services offered, creative design and systems engineering expertise,
pricing, technological innovation, and understanding clients' strategies and
needs. Many of these factors are beyond our control, therefore, existing or
future competitors may develop or offer services that provide significant
advantages over the services offered by us.
Many of our competitors have longer operating histories in the Web market,
greater name recognition, larger customer bases and significantly greater
resources. In addition to current competitors, it is likely that additional
competitors will enter our markets in the future, and that many of these
competitors will have substantially greater resources than us. We cannot assure
you that we will be able to compete successfully in any of our current markets.
We could be liable for legal proceedings that would injure our business
reputation or result in substantial damages against us.
Our failure or inability to meet a client's expectations in the performance
of Web site design and development services could injure either our or the
client's business reputation or result in a claim for substantial damages
regardless of our responsibility for such failure. In addition, the services we
provide to our clients may include access to confidential or proprietary client
information or the sublicense of software or other proprietary systems.
Although we have implemented policies to prevent such client information or
licenses from being disclosed to unauthorized parties or used inappropriately,
any such unauthorized disclosure or use could result in a claim against us for
substantial damages. Our contractual provisions attempting to limit such
damages may not be enforceable in all instances or may otherwise fail to
protect us from liability for damages. We do not currently have errors and
omissions insurance.
If we cannot integrate future acquisitions into our existing operations, then
we may be unable to manage our operations and expand our business.
We have been approached from time to time to consider and evaluate potential
business combinations, both involving our acquisition of other companies and
potential investments in us or other business combinations. We may engage in
discussions relating to similar transactions in the future. Although we expect
to grow, in part, through business combinations, it is uncertain whether we
will decide to enter into any transaction. If we do enter into a transaction,
we cannot be certain what the terms of the transaction or our timing will be.
11
Acquiring complementary businesses, products and technologies is an integral
part of our business strategy. Some of the risks attendant to this acquisition
strategy are:
. difficulties and expenses of integrating the operations and personnel of
acquired companies into our operations while preserving the goodwill of
the acquired entity;
. the additional financial resources that may be needed to fund the
operations of acquired companies;
. the potential disruption of our business;
. Our management's ability to maximize our financial and strategic position
by incorporating acquired technology or businesses;
. the difficulty of maintaining uniform standards, controls, procedures and
policies;
. the potential loss of key employees of acquired companies;
. the impairment of relationships with employees, content partners,
advertisers and customers as a result of changes in management; and
. increasing competition with other entities for desirable acquisition
targets.
Any of the above risks could prevent us from realizing significant benefits
from our acquisitions
If our important strategic relationships are discontinued for any reason, our
ability to generate revenue from advertising and e-commerce referrals and our
ability to increase sales of our community building business would be adversely
effected.
Although our strategic relationships with our content partners and Internet
services providers are a key factor in our overall business strategy, our
strategic partners may not view their relationships with us as significant to
their own business. There is a risk that parties with whom we have strategic
alliance agreements may not perform their obligations as agreed. Our
arrangements with strategic partners generally do not establish minimum
performance requirements but instead rely on the voluntary efforts of our
partners. In addition, most of our agreements with strategic partners may be
terminated by either party with little notice. If important strategic
relationships are discontinued for any reason, our ability to generate revenue
from advertising and e-commerce referral revenues may be adversely affected.
We face risks typical of the Internet industry
Privacy concerns, government regulation and legal uncertainties could adversely
affect activity on the Internet, including our Web sites.
Laws and regulations that apply directly to communications or commerce over
the Internet are becoming more prevalent. The most recent session of the United
States Congress resulted in Internet laws regarding children's privacy,
copyrights, taxation and the transmission of sexually explicit material. The
European Union recently enacted our own privacy regulations. The law of the
Internet, however, remains largely unsettled, even in areas where there has
been some legislative action. It may take years to determine whether and how
existing laws that govern intellectual property, privacy, libel and taxation
apply to the Internet. The development of laws governing these areas may
decrease the growth in the use of the Internet, including our Web sites, or
give rise to claims by our clients for whom we develop or design Web sites or
other third parties. In addition, the growth and development of the e-commerce
market may prompt calls for more stringent consumer protection laws, both in
the United States and abroad, that may impose additional burdens on companies
conducting business online. The adoption or modification of these laws or
regulations could adversely affect our ability to generate e-commerce referral
revenue.
The Federal Communications Commission is currently reviewing our regulatory
positions on data transmissions over telecommunications networks and could seek
to impose some form of telecommunications
12
carrier regulation on telecommunications functions of information services.
State public utility commissions generally have declined to regulate
information services, although the public service commissions of some states
continue to review potential regulation of such services. Future regulation or
regulatory changes could have an adverse effect on our business and results of
operations.
Imposition of new taxes or fees by the United States Federal government, state
governments or foreign governments on Internet transactions or on the use of
the Internet as a means of communication could adversely effect our advertising
or e-commerce revenue.
Imposition of sales or other taxes on sales of merchandise purchased by
users of our Web sites from our strategic partners' Web sites by states or
countries where these goods are shipped could have a material adverse effect on
the amount of referral fees we receive from these sales. Imposition of new
taxes or fees by the Federal government of the United States or by foreign
governments on Internet transactions or on the use of the Internet as a means
of communication could also adversely effect our advertising or e-commerce
revenue.
We could be liable for online content not covered by our insurance.
The nature and breadth of information disseminated on our Web sites could
expose us to liability in various areas, including claims relating to:
. the content and publication of various materials based on defamation,
libel, negligence, personal injury and other legal theories;
. copyright or trademark infringement and wrongful action due to the
actions of third parties;
. use of third party content made available through our Web sites via links
to our content partners or other Web sites or through content and
material posted by members in chat rooms and on bulletin boards;
. damages arising from the use or misuse of the free e-mail services that
we offer; and
. product information and reviews that we offer.
In the past, these types of claims have been made, sometimes successfully,
against online service providers and other print publications. Claims of these
kinds against us would result in us incurring substantial costs and would also
be a drain on our financial and other resources. If there were a sufficient
number or several severe claims of this nature, we would need to implement
measures to reduce our exposure and potential liability. In addition to being a
drain on our resources, this may also require taking measures that could make
our Web sites or services less attractive to our registrants and users. This in
turn could reduce traffic on our Web sites, negatively impact the size of our
registered user base, and reduce our advertising and e-commerce revenues. We
carry general liability insurance in the aggregate amount of $2 million and
umbrella coverage in an aggregate amount of $2 million. This coverage may be
insufficient to cover expenses and losses arising in connection with any claims
against us. To the extent our insurance coverage does not cover liability or
expenses we incur, our financial and other resources could be strained.
Our inability to protect our intellectual property rights could adversely
affect our ability to operate our businesses.
We consider our names, logos and designs as proprietary and try to protect
them under existing United States and international laws relating to protection
of intellectual property. We also developed internal procedures to control
access and dissemination of proprietary information. Despite our precautions,
third parties may succeed in misappropriating our intellectual property or
independently developing similar intellectual property. Protecting our
intellectual property against infringement could result in substantial legal
and other costs and could divert our limited management resources and attention
from our business plans.
Some of the technology incorporated in our Web sites, and offered to our
content partners and clients of our Web site design and development services,
is based on technology licensed from third parties. As we
13
continue to introduce new services, we may need to license additional
technology. If we are unable to timely license needed technology on
commercially reasonable terms, we could experience delays and reductions in the
quality of our services, all of which could adversely affect our business and
results of operations, our reputation and the value of our proprietary
information could also be adversely affected by actions of third parties to
whom we license our proprietary information and intellectual property. If
someone asserts a claim relating to proprietary information against us, we may
seek licenses to this intellectual property. We may not, however, be able to
obtain licenses on commercially reasonable terms, if at all. The failure to
obtain the necessary licenses or other rights could prevent or limit our
ability to develop our Web sites.
Our inability to incorporate content management software from a third party
into our own Web sites and those of our clients could adversely effect our
ability to develop content on our own Web sites and to expand our Web site
design and development business.
In July 1999, we acquired a license to content management software for use
by us in maintaining content on our own online communities. We also offer this
software in the operation of the Web sites of our content partners and
community-building clients. We cannot assure you that we will be able to
successfully integrate this software into our own Web sites and the Web sites
of our clients. If we are unable to integrate the software into our own, and
our clients' Web sites, our ability to develop content on our own Web sites and
to expand our Web site design and development business could be adversely
affected.
A Year 2000 failure of our hardware or software systems or other systems used
in conjunction with our systems could result in impairment of our service,
reputation and operating results.
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
distinguish whether "00" means 1900 or 2000. This may result in software
failures or the creation of erroneous results causing disruptions of
operations, including an inability to process transactions, send invoices,
publish content on our Web sites or engage in other business activities.
Our applications operate in complex network environments and directly and
indirectly interact with a number of other hardware and software systems. We
are unable to predict to what extent our business may be affected if our
systems or the systems that operate in conjunction with our systems experience
a material Year 2000 failure. We are also subject to the Year 2000 risks
affecting the Internet as a whole.
Known or unknown errors or defects that affect the operation of our software
and systems could result in delay or loss of revenue, interruption of services,
cancellation of contracts and registrants, diversion of development resources,
damage to our reputation, increased service and warranty costs, and litigation
costs, any of which could adversely affect our business, financial condition
and results of operations.
One of the most likely worst-case scenarios for us due to a Year 2000
failure is that access to our Web sites through the Internet would be limited
or impossible due to a telecommunications problem beyond our control. In such a
scenario, we would be dependent on third party telecommunications providers to
remedy the problem.
Another likely worst-case scenario for us is the failure of a server to
function properly due to a Year 2000 issue. We believe that such a failure
could be remedied within 24 hours by our staff or the staff of our service
providers.
14
We are subject to risks related to our stock
Our stock price may be highly volatile, which could result in substantial
losses to investors.
The trading price of our common stock is likely to be highly volatile due to
a variety of factors, including:
. actual or anticipated variations in quarterly operating results and
changes in financial estimates by securities analysts;
. announcements of technological innovations;
. new products or services offered by us or our competitors;
. conditions or trends in the advertising or e-commerce market;
. our announcement of significant acquisitions, strategic partnerships,
joint ventures or capital commitments (or the absence of the same);
. additions or departures of key personnel; and
. sales of common stock or the exercise of our outstanding options,
warrants or unit purchase options.
In addition, the Nasdaq SmallCap Market, where many publicly held Internet
companies are traded, has recently experienced extreme price and volume
fluctuations. These fluctuations are often unrelated or disproportionate to the
operating performance of these companies. These broad market and Internet
industry factors may materially adversely affect the market price of our common
stock, warrants, and units regardless of our actual operating performance.
Your investment in our stock may become illiquid and you may lose your entire
investment.
Under the Nasdaq Stock Market Marketplace Rules, Nasdaq requires Nasdaq
SmallCap Market issuers to comply with applicable requirements for continued
listing on the Nasdaq SmallCap Market. Following the completion of our recent
merger with Heuristic Development Group, Nasdaq initially denied, but
subsequently approved, the listing or our stock and warrants provided that we
successfully raise additional capital to fund our operations by January 31,
2000. There is no assurance that we will raise such funds or that, even if we
do so, we will continue to meet the continued listing requirements in the
future.
If our common stock is not quoted on the Nasdaq SmallCap Market or listed on
another exchange, trading in our common stock would be covered by the Exchange
Act's "penny stock" rules if our common stock is deemed a penny stock (as
defined below). Under these rules, broker-dealers who recommend penny stocks to
persons other than established customers and "accredited investors" must make a
special written suitability determination for the purchaser and receive the
purchaser's written agreement to a transaction prior to sale. Securities are
exempt from these rules if the market price is at least $5.00 per share.
If our securities were to become subject to the regulations applicable to
penny stocks, the market liquidity for these securities would be severely
affected, limiting the ability of broker-dealers to sell these securities and
your ability to sell our common stock in the public market.
Approximately 9,301,073 million, or 64.2%, of our total outstanding shares are
restricted from immediate, but may be sold into the market in the near future,
which could cause the market price of our common stock to drop significantly,
even if our business is profitable.
We have outstanding approximately 14,475,382 shares of common stock, based
on shares outstanding as of December 15, 1999 and assuming (which assumptions
shall apply to the entire discussion under this risk factor):
1. no exercise of any of the outstanding options to purchase approximately
3,175,273 shares of Virtual Communities, Inc. common stock, the outstanding
warrants to purchase approximately 2,438,955 shares of
15
Virtual Communities, Inc. common stock (not including warrants issued to Jesup
& Lamont in connection with our recent merger), or the outstanding class A or
class B warrants or unit purchase options to purchase approximately 5,620,000
shares of our common stock or outstanding warrants to purchase 160,000 shares
of our common stock issued in connection with our recent private placement of
common stock; and
2. no conversion of a $150,000 loan made to us which is convertible into
approximately 297,672 shares of Virtual Communities, Inc. common stock.
Of the 14,475,382 outstanding shares, approximately 4,736,310 shares, or
32.7%, are freely tradable without restriction under the Securities Act.
Of the remaining 9,301,073 shares outstanding, these shares will become
available for resale in the public market as described below.
Approximately 8,991,453 of these shares are subject to tiered lock-up
agreements that our shareholders signed in connection with our merger with
Heuristic Development. These lock-up agreements generally prohibit the sale of
these shares as follows:
Number of months after October 29, 1999 What is permitted under lock-up agreement
--------------------------------------- -----------------------------------------
up to 3 months.......... No sales.
3-6 months.............. Sale of up to 25% of shares held at merger closing
6-9 months.............. Sale of up to 50% of shares held at merger closing
after 9 months.......... Sale of up to 100% of shares held at merger closing.
In addition, the remaining 309,620 restricted shares of our common stock are
subject to lock-up agreements that generally prohibit the sale of these shares
for six months following October 29, 1999, the completion date of the merger.
Notwithstanding the foregoing, we have the discretion to release any party to
the lock-up agreements from the restrictions imposed on them under compelling
circumstances.
Upon the expiration or release in whole or in part of the restrictions
imposed by the lock-up agreements described above, the persons party to those
agreements will be able to sell their shares subject to the restrictions
imposed by the federal securities laws.
As restrictions on resale end, the market price could drop significantly if
the holders of restricted shares sell them or are perceived by the market as
intending to sell them.
In addition, the majority of the holders of warrants exercisable into
approximately 1,794,335 shares of our common stock are subject to the tiered
lock-up agreements described above. In addition, we plan to register our
options that are exercisable into approximately 3,134,254 shares of our common
stock issued under our stock option plans. This registration will permit these
option holders to freely trade our common stock that they receive upon exercise
of their options, subject to any lock-up agreements they have signed and the
restrictions imposed by the federal securities laws. Of these options,
employees and directors holding 2,158,125 of these options signed lock-up
agreements that generally prohibit the sale of the underlying shares for six
months following the completion date of the merger.
In September 1999, Heuristic Development Group filed a Form S-8 registration
statement under the Securities Act to register all shares of common stock
issuable pursuant to outstanding options and all shares of common stock
reserved for issuance under our 1996 Stock Option Plan. This registration
statement became effective immediately upon filing, and shares covered by this
registration statement therefore are eligible for sale in the public markets,
subject to options becoming exercisable, the lock-up agreements described above
and Rule 144 limitations applicable to affiliates. As of December 15. 1999
there were outstanding options to purchase up to 137,000 shares of common stock
that will be eligible for sale in the public market subject to becoming
exercisable and the expiration of the lockup agreements.
16
Anti-takeover provisions in our charter could deter a takeover effort, which
could inhibit your ability to receive an acquisition premium for your shares.
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock without the need for stockholder approval. The Board may also
determine the economic and voting rights of this preferred stock. Issuance of
preferred stock could impede or prevent transactions that would cause a change
in control of our company. This might discourage bids for our common stock at a
premium over the market price of our common stock and adversely affect the
trading price of our common stock. We have no current plans to issue shares of
preferred stock.
The forward-looking statements made in this prospectus might prove inaccurate,
resulting in a material difference between such statements and our actual
results.
Some of the statements under "Summary," "Risk Factors," "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
"Business" and elsewhere in this prospectus constitute forward-looking
statements. These statements involve known and unknown risks, uncertainties and
other factors that may cause our actual results, levels of activity,
performance or achievements following the merger to be materially different
from any future results, levels of activity, performance, or achievements
expressed or implied by such forward-looking statements. Such factors include,
among other things, those listed under "Risk Factors" and elsewhere in this
prospectus.
In some cases, you can identify forward-looking statements by terminology
such as "may," "will," "should," "could," "expects," "plans," "intends,"
"anticipates," "believes," "thinks," "estimates," "predicts," "potential" or
"continue" or the negative of such terms and other comparable terminology.
17
THE OFFERING
This prospectus relates to our offering of the following securities:
Shares to be issued to holders of warrants issued by Virtual Communities, Inc.
prior to the merger.
We are registering 1,794,335 shares of our common stock issuable upon the
exercise of warrants of Virtual Communities, Inc., issued before our recent
merger with that company. In connection with the merger, holders of outstanding
warrants to purchase shares of pre-merger Virtual Communities, Inc., are
entitled to exercise those warrants for that number of shares of our common
stock that such holders would have received in the merger if the shares of
Virtual Communities, Inc. common stock underlying their warrants were held by
them at the effective time of the merger.
At the time of the merger, there were outstanding warrants to purchase
225,113 shares of Virtual Communities, Inc. common stock at exercise prices
ranging from $0.8052 to $2.10 per share. These warrants were issued to the
placement agent in connection with a placement of Series A and B convertible
preferred stock of pre-merger Virtual Communities, Inc. in early 1999. There
were also outstanding warrants to purchase 1,333,823 shares of common stock ,
at exercise prices ranging from $0.30 to $2.10, issued to directors,
shareholders, employees and vendors in consideration for loans granted to
Virtual Communities, Inc., waivers and deferrals of compensation, guarantees of
bank lines of credit and services rendered to Virtual Communities, Inc.
Accordingly, the 1,794,335 shares of our common stock that we will issue to
holders of the former Virtual Communities, Inc. warrants was determined by
multiplying 1,558,936 (the number of shares of pre-merger common stock issuable
on exercise of such warrants) times 1.151, the conversion ratio determined in
accordance with the merger agreement.
All of these warrants are currently exercisable according to their terms.
Shares and warrants to be issued to holders of outstanding class A warrants
In connection with our initial public offering of units in February 1997, a
group of investors received 500,000 redeemable class A warrants in exchange for
warrants that those investors had received in December 1996 as part of a bridge
financing transaction. We are registering the securities underlying such class
A warrants in the registration statement of which this prospectus is a part.
Each class A warrant entitles the holder to purchase one share of common
stock and one class B warrant at an exercise price of $6.50, subject to
adjustment, at any time until February 11, 2002. Each class B warrant entitles
the holder to purchase one share of common stock at an exercise price of $8.75
at any time until February 11, 2002. The class A and class B warrants are
subject to redemption by us at a redemption price of $0.05 per warrant on 30
days' written notice, provided that the closing bid price of the common stock
averages in excess of $9.10 and $12.25, respectively, for any 30 consecutive
trading days ending within 15 days of the notice of redemption. See
"Description of Securities."
Units to be issued to holders of unit purchase options
We are also registering 120,000 units issuable upon exercise of outstanding
unit purchase options granted to the underwriter and finder in connection with
our initial public offering in February 1997, 120,000 class B warrants issuable
upon the exercise of the class A warrants included in such units, and 360,000
shares of common stock issuable on exercise of the redeemable class A and class
B warrants included in such units. Each unit purchase option entitles the
holder to purchase one share of common stock, one redeemable class A warrant
and one redeemable class B warrant at an exercise price of $6.00 at any time
until February 10, 2002. See "Description of Securities--Unit Purchase Option."
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This prospectus is also included in a post-effective amendment to our
registration statement on Form SB-2 (File No. 333-17635), filed with the SEC in
connection with our initial public offering of 1,380,000 units consisting of
common stock, redeemable class A warrants and redeemable class B warrants.
Depending on a number of factors, which include the price of our common
stock, general market conditions, capital raising activities by us, and our
need for additional funds, we may in the near future decide to change the terms
of the class A and class B warrants by lowering one or both of their exercise
prices in order to encourage our warrant holders to exercise their warrants so
that we can raise additional funds from such exercises. To the extent that we
lower the exercise price of the warrants, we will receive less funds that we
would at the current exercise prices. There is no assurance that even if we do
lower the exercise price, our warrant holders will exercise their warrants.
19
USE OF PROCEEDS
Assuming all of the warrants formerly issued by pre-merger Virtual
Communities, Inc. are exercised, we would receive approximately $1,355,714 in
proceeds, minus expenses.
Upon exercise of the currently outstanding warrants issued in connection
with our initial public offering, and warrants issuable upon exercise of such
warrants, we would receive gross proceeds as follows (in each case minus
expenses):
. assuming all of the outstanding class A warrants are exercised, we would
receive $12,220,000 in proceeds;
. assuming all of the outstanding class B warrants are exercised, we would
receive an additional $12,075,000 in proceeds; and
. assuming all of the class B warrants issuable upon exercise of the
outstanding class A warrants are exercised, we would receive an
additional $16,450,000 in proceeds.
In addition, we would receive the following gross proceeds, minus expenses,
upon exercise of the unit purchase options and the warrants underlying the unit
purchase options:
. assuming exercise of all of the outstanding unit purchase options,
$720,000;
. assuming exercise of all of the class A warrants issuable upon exercise
of the unit purchase options, $780,000;
. assuming exercise of all of the class B warrants issuable upon exercise
of the unit purchase options, $1,050,000; and
. assuming exercise of all of the class B warrants issuable upon exercise
of the class A warrants underlying the unit purchase options, an
additional $1,050,000.
We plan to use the proceeds from the exercise of the warrants for general
corporate purposes, including acquisitions of web properties, equipment,
software and licenses, marketing and advertising of our communities and
Community Management Solution business, and general working capital.
We will not receive any proceeds from the sale of shares by warrant holders.
DIVIDEND POLICY
Neither Heuristic Development Group, Inc. nor Virtual Communities, Inc. have
ever paid any dividends, and we do not expect to pay any dividends in the
foreseeable future. Any determination to pay dividends in the future will be at
the discretion of our board of directors, and will be dependent on our future
results of operations, financial conditions, capital expenditures, working
capital requirements and other relevant factors.
20
THE COMPANY
Business Overview
On October 29, 1999, Virtual Communities, Inc., a Delaware corporation,
merged with and into HDG Acquisition Sub, Inc., our wholly owned subsidiary. In
connection with the merger, we changed our name to Virtual Communities, Inc.,
and began trading our securities (former symbol: IFIT) on the NASDAQ SmallCap
Market under the symbol "VCIX" to reflect that our new principal business is
the business of the pre-merger Virtual Communities, which is now our wholly
owned subsidiary.
Prior to the merger, we were a development stage company originally
organized to research, develop, design and market fitness-related products. Our
primary product was the IntelliFit System, a proprietary computerized system
that generates personalized exercise prescriptions and tracks and records
fitness programs. Due to disappointing acceptance of the IntelliFit System, our
management decided to pursue a strategy of investment in or acquisition of an
existing company, culminating in the merger with Virtual Communities, Inc.
The former Virtual Communities, Inc. was incorporated in August 1996 as
Virtual Jerusalem Ltd., Inc. It was founded to develop, acquire and operate
online communities on the Web targeted to members of demographic groups with
interests in their historical ethnic backgrounds and who want to share
information with other members with like interests. In June 1997, Virtual
Communities acquired substantially all of the assets and outstanding shares of
Virtual Jerusalem Ltd., an Israeli corporation formed by the founders of
Virtual Communities that developed and published an Internet Web site called
Virtual Jerusalem. Now that Virtual Communities has merged with our wholly
owned subsidiary, our primary business is that of Virtual Communities.
Accordingly, when we discuss "our" business activities for time periods
prior to the merger in this and other sections of the prospectus, we are
referring to the business of Virtual Communities, Inc. prior to the merger
unless we expressly state otherwise.
We currently operate five online communities: Virtual Jerusalem
(www.virtualjerusalem.com), Virtual HolyLand (www.virtualholyland.com), Virtual
Ireland (www.virtualireland.com), Virtual Italy (www.virtualitaly.com). and
Virtual India (www.virtualindia.com). Rather than create our own content, our
Web sites aggregate comprehensive news and a variety of interactive and
community-building elements selected from existing online entities (called
"content partners") with which we enter into relationships. We wrap the content
we obtain from these content partners with additional features and services to
create a cohesive Web environment targeted to a specific demographic profile.
In consideration for the use of such content, we provide our content partners
with a variety of benefits, including links to their Web sites, a portion of
advertising revenues and interactive Web services.
As a result of our experience in developing our five online communities and
the creation of over one hundred Web sites for our content partners, we began
offering our Web site design and development services to unrelated third party
Web site publishers. Although we had historically provided these services only
to our content partners in exchange for access to content, offering these
custom services to third parties for a fee represents a new business for us.
These services, which we offer to our content partners and other third parties
in the form of "modules," include content management technologies and numerous
interactive elements described in more detail below. We have entered into one
agreement with a third party to date for the provision of these services, and
are currently negotiating with three other parties to provide these services on
a fee basis and have received interest from several other entities for similar
services. (See "Web Site Design and Development".)
Market for Common Equity and Related Stockholder Matters
Our common stock is traded on the Nasdaq SmallCap Market under the trading
symbol "VCIX." Prior to our recent merger on October 29, 1999, our stock traded
under the trading symbol "IFIT." As of December 15,
21
1999, we had approximately 630 stockholders of record. The following table sets
forth the high and low bid quotations for our stock, as well as the closing bid
quotation, as reported on the Nasdaq SmallCap Market for the periods indicated.
High Low Close
------ ----- ------
1999
1st Quarter.............................................. $1.625 $0.75 $1.469
2nd Quarter.............................................. 5.125 1.50 3.188
3rd Quarter.............................................. 4.50 2.56 4.375
1998
1st Quarter.............................................. 2.25 .875 .875
2nd Quarter.............................................. .875 .50 .688
3rd Quarter.............................................. 1.125 .50 .688
4th Quarter.............................................. 1.50 .981 1.00
1997
1st Quarter.............................................. 4.50 3.50 3.50
2nd Quarter.............................................. 3.625 2.75 3.625
3rd Quarter.............................................. 3.625 2.625 2.75
4th Quarter.............................................. 2.75 1.875 1.875
Industry Background
Growth of the Internet
The Internet has emerged as a global medium, enabling millions of people
worldwide to share information, communicate and conduct business
electronically. International Data Corporation ("IDC") estimates that the
number of Web users will grow from approximately 97 million worldwide in 1998
to approximately 320 million worldwide by the end of 2002. This growth is
expected to be driven by the large and growing number of personal computers
("PCs") installed in homes and offices, the decreasing cost of PCs, easier,
faster and cheaper access to the Internet, improvements in network
infrastructure, the proliferation of Internet content and the increasing
familiarity with and acceptance of the Internet by businesses and consumers.
The Internet possesses a number of unique characteristics that differentiate it
from traditional media: lack of geographic or temporal limitations; real-time
access to dynamic and interactive content; and instantaneous communication with
a single individual or with groups of individuals. As a result of these
characteristics, Web usage is expected to continue to grow rapidly. The
proliferation of users, combined with the Web's reach and lower cost of
marketing, has created a powerful channel for conducting commerce, marketing
and advertising.
The growth of online communities and other free Internet services
Traditional use of the Web has consisted largely of one-way communications
in which users self select and view different Web sites containing
professionally created content on topics of general interest such as news,
sports and weather. However, there is a growing demand for online community
sites where users can publish content and engage in community activities
including home page building, and interactive discussion or "chat" forums. In
addition, many users are interested in gaining access to other free services
for entertainment, such as interactive games or video, or for their utility to
the end user, such as e-mail. Online communities provide a medium for such
access and interaction. These communities generate significant volumes of
traffic, as visitors tend to return to those sites where they have established
an online presence or have become familiar with the services. According to
statistics published by Media Metrix, online community sites have recently been
one of the fastest growing sectors of the Web.
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E-commerce and advertising
The growing acceptance of the Web represents a significant opportunity for
businesses to conduct electronic commerce ("e-commerce") over the Internet. The
Internet allows companies to develop one-to-one relationships with customers
worldwide without making significant investments in traditional infrastructure
such as retail outlets, distribution networks and sales personnel. The Internet
is an increasingly significant global medium for e-commerce. According to IDC,
transactions on the Internet are expected to increase from approximately $32
billion in 1998 to approximately $426 billion in 2002, with the number of users
that are buyers of products and services rising from 26% to 40% in the same
period.
Increases in consumer purchases on the Internet are expected to be a
significant factor in the growth of e-commerce. Online shopping is a shopping
experience that offers convenience to the shopper. An online consumer's ability
to quickly comparison shop is greatly enhanced by the ability to quickly access
multiple retailers via the Internet. Products commonly sold on the Internet
include items such as software, books, music CDs, videocassettes, and airline
tickets. More recently, businesses have begun selling specialty retail
products, service items and large ticket household consumer goods, as Internet
usage and familiarity has increased.
According to Forrester Research, total online retail sales in the U.S. are
expected to increase from $7.8 billion in 1998 to $76.3 billion in 2002,
representing a compound annual growth rate of 76.9%. Forrester Research also
projects that the number of U.S. households that shop online will increase from
8.7 million in 1998 to 30.3 million in 2002.
Growth in the Web has also created an important new advertising channel.
Tools not available in traditional advertising media, such as real-time
measurement of "click-throughs" on advertising banners, further increase the
attractiveness of Web advertising by giving advertisers instant feedback on
campaigns. Jupiter Communications projects that the dollar value of advertising
on the Web is expected to increase from approximately $3.0 billion in 1999 to
approximately $7.7 billion in 2002. To date, businesses and advertisers have
typically used traditional navigational sites and professionally created
content sites for the sale and marketing of their products and services online.
Online community sites, however, provide more detailed demographic data and
self-selected groups of consumers with an affinity for particular products.
Advertisers can thus more easily deliver targeted messages in a cost-effective
manner on online community sites.
Our Strategy
Development and publishing of our own communities
Our communities strategy is to create or acquire Web site communities
targeted to affinity groups that provide "Best of the Web" content, interactive
elements, e-commerce and comprehensive portals to existing Internet sites
related to that community. Initially Our management thought that this strategy
would most appeal to demographic groups who are passionate about issues
relating to their community are focused on their historical backgrounds and
homelands, identify with other members of their community and are interested in
the success of their communities. Our management now recognizes that this
strategy can be applied equally as well to Web sites for a specific business
discipline, religion, country or ethnicity.
We select our target groups around which to build or acquire communities
based on their overall size, Internet use and socioeconomic level. These
elements help ensure that the group will be attractive to potential online
advertisers, sponsors and e-commerce vendors. Our management thinks that there
is a substantial opportunity to generate revenue from e-commerce and
advertising that is focused on target groups with these characteristics.
Our strategy entails aggregating content appearing on disparate Web sites on
the Internet into well-defined online communities targeted to these specific
demographic groups. Our management thinks that successful Web site communities
must have the following characteristics:
. a large target market with at least 2 million Internet users;
23
. appeal to potential e-commerce partners, sponsors and advertisers;
. interest in major events that will draw the attention of the community
(for example, the Millennium for the Christian community); and
. a sufficient number of related content Web sites that will provide us
with aggregating potential from which to cull a critical mass of content.
In selecting a large target market, our management thinks that the members
of that demographic group must have the following characteristics:
. a strong interest and passion for a topic, including a continued interest
in news, features and related services; and
. high Internet usage as determined by Internet advertisers (e.g., upper
middle class, and well-educated).
Based on these characteristics, we are currently identifying professional
and expatriate groups in the United States and elsewhere for whom to develop or
acquire online communities. Such virtual expatriate communities may be targeted
to members of the Indian, Asian, African and Spanish communities residing in
the United States and other English speaking countries. The contemplated Web
sites will deliver news and information from such expatriates' former
homelands, offer features on their current lifestyles and customs and provide
an opportunity to interact with other community members. Content for such Web
communities would be derived from local and foreign media content partners with
which we would enter into agreements.
Our management thinks that our strategy of developing and acquiring online
communities will position us as an attractive portal or portal link for major
Internet companies such as America Online, Yahoo/Geocities or Excite/@Home.
Such entities may be interested in our online communities because of their
substantial aggregated content or their ability to deliver strong demographic
audiences well suited for targeted advertising and e-commerce. Other potential
links include magazine publishers and other media entities interested in
targeting niche communities on the Web.
Design and development of online communities for others
Our management believes that as competition for Internet viewers increases,
Web site publishers will need to add increasing amounts of content, services
and interactive elements to their Web sites to attract and maintain viewers.
Increased competition also may require Internet sites to offer a wider array of
services that enable our users to interact with other users, such as chat
rooms, message boards, games, free e-mail services and personal home pages. Our
management believes that adding such services will result in Web sites that are
complex and difficult to manage. Managing these Web sites will likely require
sophisticated software and Web maintenance technologies, including content
management systems, Web site registration elements, statistical reporting
services and advertising management and placement software.
Based on our projection of the increased complexity of Web publishers'
sites, we believe that a growing number of such publishers will prefer a "one
stop shop" solution for their Web sites' needs that offers a comprehensive
package of enabling and enhancing tools, including redevelopment and
maintenance options, content management systems and a flexible choice of
interactive elements. We believe that companies offering such services will
provide Web publishers with the ability to avoid the relatively high cost
associated with entering into numerous individual license and service
agreements with multiple parties to obtain such services.
Our Revenue Sources
Our revenues increased from $402,000 in 1997 to $819,000 in 1998, an
increase of over 104%, we recorded revenue of approximately $613,000 for the
first nine months of 1999. While advertising revenues contributed approximately
$512,000 to revenue for 1998 (or 63% of this revenue), and 49% of first three
quarters of 1999 revenues, we anticipate that the majority of our revenues
after 1999 will be derived from our
24
Web site design and development services. We project that our Web site design
and development services revenues will grow from approximately $275,000 in 1999
(27% of anticipated total revenues) to approximately $5.8 million in 2000 (65%
of anticipated total revenues) and approximately $30 million in 2001 (72% of
anticipated total revenues). In addition, we project that our advertising
revenues will grow from approximately $0.5 million in 1999 (45% of anticipated
total revenues) to approximately $2.6 million in 2000 (29% of total revenues)
and approximately $8.8 million in 2001 (21% of anticipated total revenues).
Below is a more detailed description of our three projected revenue streams.
Web site design and development
In implementing our strategy as discussed above, we developed five online
communities of our own and have designed and developed Web sites for many of
our content partners in exchange for their content. In addition, to leverage
the know-how and technologies we obtained in this process, we are offering Web
site design and development services to third party Web publishers on a fee
basis. We offer these services on a flexible or "modular" basis, allowing Web
site publishers to select individual modules for their specific needs. To
provide these modules to Web site publishers, we have sublicensed modules that
we previously licensed from Internet service providers with which we have
formed prior relationships, or altered programs that we created for our own
online communities. We also intend to license additional modules from entities
with whom we are currently in negotiation or from entities that produce
attractive new technologies. In order to deliver our services to our content
partners and potential third party clients using these licensed technologies,
one of our subsidiaries, Virtual Communities Israel, Ltd., maintains a staff of
Web site designers and programmers who create, update and maintain Web sites.
In exchange for services rendered to our content partners, we receive content.
In exchange for services rendered to third parties, we plan to charge a one
time flat fee of approximately $500,000 depending upon factors such as the
number of modules to be provided, our level of participation in a particular
Web site's advertising and e-commerce revenues and our access to such site's
user registration data. Half of such fee is payable in securities of the third
party.
In August 1999, we, through a wholly owned subsidiary established in August
1999 named VCI Community Solutions, Inc., entered into a web design and
development agreement with Tromaville.com, Inc., a subsidiary of Troma, Inc., a
New York company ("Tromaville"), for the provision of design, development and
maintenance services for a Web site to be produced by us on behalf of
Tromaville. Pursuant to the agreement, we granted to Tromaville a limited, non-
exclusive, worldwide, perpetual royalty-free, nontransferable license to use
our Community Management Solution, which has been installed on the Tromaville
site. We also provided a variety of Community Management Solution elements to
Tromaville including registered user, sweepstakes, greeting card, email a
friend, games, polls, and statistic modules. We will also provide services for
the Tromaville site including, but not limited to free email for registered
users, email list server, advertising management system, e-commerce solution,
on-line classifieds system, chat services, and user created home pages. The
term of the agreement is for one year and is automatically renewed for two
additional one-year terms unless either party elects to terminate the
agreement. In addition to a web design and development fee, we receive a yearly
maintenance service fee commencing with the second year of the term and a
percentage of advertising and e-commerce revenues derived from the Tromaville
site. In the event Tromaville elects to terminate the agreement, we will be
entitled to a buy-out amount based on a formula that takes into consideration
revenues then derived from the Tromaville site and the number of registered
users of such site.
Advertising
Our management thinks that our Web communities have an advertising advantage
over general Web sites in that their target audiences are clearly defined, well
educated and have excess disposable income. These characteristics are the type
of demographic profile that advertisers traditionally seek. We currently have
agreements with a number of advertisers, including: Continental Airlines,
Econophone, Advanced Telecom Systems and Vitamin Shoppe.
25
Current average advertising prices on the Virtual Jerusalem Web site are
approximately $10 to $25 cost-per-thousand page views ("CPM"), depending upon
the length of the advertisement. To date, our typical advertisement agreement
provides for a three to six month term, with total advertising revenue per
agreement of $1,500 to $5,000 per month.
We recently shifted our advertising focus by trying to gather sponsor
advertisers who would sponsor a whole page or channel. These sponsors would
enter into a yearlong commitment, rather than the short-term advertisement
contracts currently provided by us. Our management thinks that these sponsors
should be attracted to these sponsorship offerings since they do not have to
share our advertising space with other advertisers. In addition, this format
provides increased click-through rates while providing more brand building
opportunities for the sponsor. Several of our most recent advertisers entered
into six to twelve month sponsor agreements with us.
E-commerce
To generate e-commerce revenue, we enter into agreements with vendors that
offer online sales capabilities, and establish links from our Web sites to the
vendor's Web sites. We have several of these agreements in place for the sale
of products on the Virtual Jerusalem Web site and the Virtual HolyLand Web site
and plan to enter into additional relationships for each of our existing and
future Web sites. We receive commissions, calculated as a percentage of the
total transaction amount, from our e-commerce partners every time a Web site
user purchases an e-commerce partners' product or service through one of our
Web sites. We receive commissions ranging from 20% to 30% from our local or
specialized e-commerce partners, such as Mesorah/Art-Scroll, Dvir Software and
Encyclopedia Judaica, and 5% to 25% from larger online vendors, such as
Amazon.com, e-toys.com, reel.com and ArtSelect.com. We anticipate that each Web
site community's e-commerce opportunities will derive from both global vendors,
such as Amazon.com, as well as local vendors that are particularly focused on
individual communities, such as Encyclopedia Judaica on the Virtual Jerusalem
Web site.
E-commerce vendors are attracted to our Web site communities since each
community targets a well-defined, passionate demographic group. At the same
time, our users know the desired e-commerce vendors will be attracted to their
community due to our unique content and forum. We intend to create stronger e-
commerce relationships with our members by gathering information about
registered users' personal buying habits and "purchase events," such as
birthdays, anniversaries and holidays, and targeting those users with direct e-
mails sent in advance of the purchase events.
We recently entered into a license agreement with Intershop Communications,
Inc. whereby we will create online shopping centers in our communities and
offer our content partners and Community Management Solution customers the
ability to create their own stores using software developed by Intershop. (See
"Licenses, Service Agreements and Trademarks.")
Our Marketing Efforts
We market our Web sites by:
. engaging in comprehensive advertising campaigns, including print
advertisements, radio spots and online advertising, designed to
introduce each of our Web sites to our targeted audience in the
United States;
. disseminating press releases to announce the launch of our new Web
sites, additional features and the addition of new content partners; and
. contracting with our content partners to publicize their affiliation
with our Web sites to their constituent organizations and members, and
encouraging these partners to link their Web sites to our Web sites
(e.g., the International Christian Embassy in Jerusalem created a link
to Virtual HolyLand).
26
In the future, we intend to supplement the activities of our outside
agencies by indexing our Web sites on the Internet's major search engines and
by further encouraging our content partners to publicize our Web sites in their
print and online publications through the use of stories and advertisements
prepared by us.
Specific marketing efforts for Virtual Jerusalem
Previously, marketing activities for the Virtual Jerusalem Web site were
limited to our representation at large gatherings of Jewish organizations
(e.g., the General Assembly of Jewish Federations in North America), popular
Jewish events (e.g., parades in the United States) and the placement of print
advertisements in Virtual Jerusalem's content partners' print publications. In
March 1999, we launched a multi-month significant keyword campaign for the
Virtual Jerusalem Web site on Yahoo! and began a major print campaign that
includes the placement of full-page advertisements in most major Jewish weekly
and monthly publications across the United States. The print campaign, called
"This Week on VJ," highlights Virtual Jerusalem's Holidays sites, new and
existing content partners and interactive elements on Virtual Jerusalem, e-
commerce specials and sweepstakes and promotions designed to encourage Virtual
Jerusalem user registration.
Specific marketing efforts for Virtual HolyLand
The marketing campaign for Virtual HolyLand includes online, print and radio
advertisements with an emphasis on introducing this Web site to the Evangelical
community during the fourth quarter of 1999 and the first quarter of 2000. We
are also seeking to promote Virtual HolyLand by retaining Pat Boone, a well-
known Christian entertainer to serve as official spokesperson for Virtual
HolyLand. Pursuant to a six month Agreement with Mr. Boone entered into in
August 1999, Mr. Boone promotes the site at trade shows and on his nationally
syndicated radio program in consideration for a monthly fee.
Specific marketing efforts for Virtual Ireland
The marketing campaign for Virtual Ireland includes online, print and
television advertisements in an effort to introduce this Web site to the Irish
community in the U.S. during the third and fourth quarters of 1999. We also
sponsor sweepstakes on the Virtual Ireland site for free trips to Ireland in
order to encourage registration on the site.
Specific marketing efforts for Virtual Italy and Virtual India
The marketing campaigns for Virtual Italy and India, to be rolled out in the
first quarter of 2000, respectively, will include newspaper and other print and
online advertisements, promotions and grass roots efforts with organizations in
the Italian American and India communities, respectively.
Web site design and development
Although we have not yet engaged in any formal marketing activities to offer
our Web site design and development services to Web site publishers who are not
content partners, we intend to do so in the near future. In December 1999, we
signed a letter of intent with Vanco Ltd., a network services company based in
the U.K. ("Vanco") to market, distribute and provide technical support for our
Content Management Solution community building technology in Europe and the
U.K. Pursuant to a proposed distribution agreement which we intend on entering
into with Vanco, we will grant exclusivity to Vanco to market and sell our
Content Management Solution technology in Europe and the U.K. for a one year
period provided Vanco sells at least two systems during the first 150 days of
the proposed agreement and eight such systems during the first year of the
proposed agreement, and further provided, that Vanco offers certain after sale
technical support on our behalf to our customers in Europe and the U.K.
Pursuant to the proposed agreement, Vanco would be prohibited from selling any
other turnkey community solution. The parties may also enter into a joint
venture within one year of the signing of the proposed agreement for the
purpose of jointly distributing and providing support services for our products
and systems. The proposed agreement is subject to prior due diligence by
27
both parties and is meant to be signed in January 2000, although the parties
may mutually elect to extend the period for execution of the proposed
agreement.
Competition
As described below, we have a variety of competitors for each of our Web
sites and for each of the markets in which our businesses operate.
In addition, we acknowledge that there are many other Internet companies,
such as theglobe.com, Geocities and Xoom.com, that attract significant numbers
of registered users to their "community" Web sites that may compete for our
potential users, registrants, content partners, advertisers, e-commerce vendors
and sponsors. However, our management thinks that most of these Web sites focus
primarily on providing free personal web pages to their users and do not offer
the same level of a targeted demographics and information that our Web sites
offer. Moreover, our management thinks that Web sites like ivillage.com target
communities that are so broad (e.g., women) that focused e-commerce and
advertising may become difficult.
Competitors to Virtual Jerusalem
We have numerous competitors in the Jewish and Israeli Web markets,
including, but not limited to: Jewish Communities On-Line (on America OnLine);
JAN (wwwjcnl8.com; general commercial Jewish Web sites); Shamash
(www.shamash.org; a non-profit Jewish communal network); Shema Yisrael
(www.shemayisrael.co.il; a non-profit Ultra Orthodox site); and the Jerusalem
Post (jpost.co.il; the on-line edition of the newspaper). In addition, this Web
site competes against other Web sites that simply offer a shopping Channel
focused on the Jewish market. Although our management acknowledges that each of
such entities compete with Virtual Jerusalem in particular markets, our
management believes that none of these competitors cater to as broad a market
and that none have reached the critical mass of content and feature services of
Virtual Jerusalem.
Competitors to Virtual HolyLand
In the Evangelical Christian market, our primary competitors are
crosswalk.com (published by Didax, Inc.), Jesus2000.com, cbn.com (published by
the Christian Broadcasting Network) and other Web sites published by ministries
and evangelists.
Competitors to Virtual Ireland
Our competition for Virtual Ireland include The Irish Times Web site
(www.ireland.com), Local Ireland (www.local.ie; a governmental Web site
financed in part by Telecom Eireann), Ask Ireland (sponsored by the Irish
government) and Touchtel's tourist information site (www.goireland.com). Other
competitive Web sites include paddynet.com, irishabroad.com and celtic.com
containing local news and free e-mail services.
Competitors to Virtual Italy
Our competition for Virtual Italy includes DolceVita (www.dolcevita.com; a
fashion and travel site), Made in Italy (www.made-in-italy.com; a travel and e-
commerce site) and Virtual Italia (www.virtualitalia.com; a general Italian
interest site).
Competitors to Virtual India
Competitors to virtualindia.com include: Rediff on the Net (www.rediff.com,
an India-oriented online service), India-Today (www.india-today.com, a news and
cultural site) and 123india.com (www.123india.com, a news information and
software site).
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Competitors to our Web site design and development services
We face competition from a number of sources, including potential clients
that perform Web site development services in-house or contract with others for
such services. These sources include Web site service boutique firms, including
Vignette Ltd., a British company, FutureTense, Inc., a Massachusetts company,
Interwoven, a U.S. company, on-line services companies, advertising agencies,
direct access Internet and Internet-services and access providers as well as
specialized and integrated marketing communication firms, all of which are
entering the Web site design and development market in varying degrees. Many of
our competitors or potential competitors have longer operating histories,
longer client relationships and significantly greater financial, management,
technological, development, sales, marketing and other resources than we have.
Potential future competitors
In addition to current competitors, given the low barriers to entry, it is
likely that additional competitors will enter our markets in the future, and
that many of such competitors will have substantially greater financial,
management, technological, sales, marketing and other resources than we have.
We cannot assure you that in the future we will be able to compete successfully
in any of our current markets, and our inability to do so would have a material
adverse impact on our business, financial condition and operating results.
We Currently Operate Five Web Sites
We currently operate five Web sites: Virtual Jerusalem, Virtual HolyLand,
Virtual Ireland, Virtual Italy and Virtual India. A brief description of each
is provided below.
Virtual Jerusalem
Virtual Jerusalem, located on the Web at www.virtualjerusalem.com,
aggregates a variety of Jewish and Israel related content from the Web as well
as offering interactive features and services. This Web site includes a portal,
called the Maven Index, to over 10,000 Jewish related Web sites. Popular
elements include the Kotel Kam (an Internet zoom camera which transmits live
pictures of the Western Wall), "Send a Prayer to the Western Wall" (permitting
members to post a message online that is downloaded by us and placed in the
Western Wall) and "Time Travel Through Jerusalem" (which features multi-media
tours by historical figures). Virtual Jerusalem also contains a series of
Jewish Holiday Web pages with games, quizzes and a variety of educational
content. The Web site also offers members a range of community features and
services including forums, free e-mail, personal Web pages, interactive guest
book, global weather forecasts and classified advertisements.
Virtual Jerusalem also contains several channels ("Channels"), each of which
features topical content that is updated daily. These Channels, and their
descriptions, include:
. News contains content from Israel and Jewish newswire services, leading
Israel and United States based local newspapers and radio stations;
. Travel features Israel travel information from major Israel tourist
information providers, interactive tours of Jerusalem, information on
immigration to Israel, study programs and an online Hebrew language
course;
. Torah is a repository of educational and religious material, including
online courses in Judaism, interactive elements for children and adults,
weekly bible lessons and resource materials;
. Living contains sections on health and parenting, food, books, films,
Jews in sports, music, dance, humor, art, drama and self-improvement;
. Shop features sites that market and sell books, Judaica, multimedia
products, food, music, art and other products;
29
. History contains historical content related to Israel, the Holocaust and
Diaspora Jewry through interactive features such as a timeline and
virtual exhibits; and
. VJTeens contains links to many of the pages currently contained on
Virtual Jerusalem that are suitable for young adults, including a
homework helper feature, pen pals, bulletin boards and build your own
Web pages.
Virtual Jerusalem's target market, registered user base, user demographics and
traffic statistics
According to the 1998 American Jewish Yearbook (published by the American
Jewish Committee), the Jewish population in the United States is approximately
6 million, as compared to a world Jewish population of 13 million. According to
Jupiter Communications, approximately 38% of Americans currently use the
Internet. Assuming the same Internet usage by the Jewish population as the
general population, the current number of Jewish Internet users based in the
United States is approximately 2.3 million. Our management thinks that based on
the relatively high socioeconomic profile of this population relative to the
general population as a whole, the number of Jewish Internet users based in the
United States could be as much as 50% more than this figure, or up to
approximately 3.4 million people. Since our introduction, our management
believes that Virtual Jerusalem has attracted over 350,000 unique users, of
which approximately 160,000 have registered as of December 15, 1999. According
to our tracking of the number of registrants to Virtual Jerusalem, this Web
site is currently adding approximately 10,000 new registered users each month.
Our management thinks that with increased promotion and marketing of Virtual
Jerusalem, the number of registered users will increase to 170,000 and 430,000
by the end of 1999 and 2000, respectively.
According to the 1997 Annual Survey of American Jewish Opinion (conducted
for the American Jewish Committee by Market Facts, Inc.), 55% of American Jews
claimed that being Jewish is very important in their lives and 34% percent of
American Jews claimed it was "fairly" important. According to this same survey,
American Jews rated being part of the Jewish people as the quality most
important for personal Jewish identity, and the celebration of Jewish holidays
as the activity most important for personal Jewish identity. Virtual Jerusalem
focuses on both these elements by offering comprehensive news and features
relating to the Jewish community and Israel and a comprehensive selection of
Jewish holiday "megasites" containing a host of interactive elements and
activities geared to all ages.
Virtual Jerusalem's registered user base provides us with a profile of
demographic information. We record and maintain real time statistics of our
registered users. Although these statistics are self-reported by the
registrants, and subject to errors in reporting, imperfect survey samples, data
gathering, tabulation and statistical analysis, these statistics reveal the
following demographic information about the Web site's registrants:
. the average annual salary is $57,000;
. 45% are employed full-time, 13% are students, 5% are self-employed and
4% are retired;
. the average age is 39, with 67% between the ages of 20 and 60, and 10%
are between the ages of 10 and 19;
. 60% are male;
. 67% are from North America, 6% are from Israel and 3% from the United
Kingdom;
. 15% of the North American registrants are from New York, 7.1 % are from
California, 5% are from New Jersey, and 5% are from Florida; and
. 22% are non-Jewish.
Our management thinks that the advertisers, sponsors, content partners and
e-commerce partners that we solicit for revenues, content and features favor
these demographics.
30
According to Nielson/IPro's monthly reports, Virtual Jerusalem's number of
visits per month, average length per visit and monthly page views, are as
follows:
. Total visits were 436,017 in December 1997, 909,764 in December 1998 and
972,449 in October 1999;
. Average length per visit (in minutes) was 6:13 in December 1997, 9:11 in
December 1998; and 8:41 in October 1999; and
. Monthly page views were approximately 1.6 million in December 1997,
approximately 5.2 million in December 1998 and approximately 4.2 million
in October 1999.
Virtual HolyLand
Virtual HolyLand, located on the Web at www.virtualholyland.com, was
launched on Christmas Day 1998 and aggregates content from a variety of
Christian Web sites on the Internet. Virtual HolyLand offers visitors a wide
range of community features and services including chat rooms and forums, free
e-mail, personal Web pages, interactive guest book, global weather forecasts,
classified advertisements, virtual tours of Christian places of interest and a
planned online shopping experience. The Web site also offers Channels featuring
up-to-the-minute news from Israel, Millennium-related activities, prayer,
travel information and interactive elements, These Channels, and their
descriptions, include:
. Israel Now offers the latest news from Israel's leading news providers
and Israel English language radio;
. ZionTraveler assists tourists planning a trip to Israel, provides a
database of more than 2,000 Israeli tourist sites and provides a special
comprehensive Millennium section covering events occurring in Israel
during the year 2000;
. Prayer features an inspirational site including interactive access to
several of Jerusalem's and Israel's most awe-inspiring holy sites and
churches, recordings of church services, texts of some of the world's
most famous prayers and a miracles section with true stories of recovery
and healing;
. CyberPilgram includes a collection of interactive features that deliver
the Holy Land through the computer including online pilgrimages using
360-degree pictures and Internet zoom cameras, video and sound, personal
tours through the Holy City, the opportunity to plant a tree in a
special Millennium Forest near Nazareth or the Sea of Galilee and the
ability to send greeting cards;
. Land of Promise allows visitors to explore the history of the Holy Land
in an exciting and interactive way including a 2,000 year time line and
"news" from the time of the Bible;
. Kids Club is geared toward children and teenagers with features and
activities including Bible Questions and Bible News, exploration of
sites in the Holy Land, opinion polls, greeting cards and other family-
safe entertainment material; and
. Online Shopping Mall will feature a secure environment in which shoppers
can purchase religious products from Israel, including artifacts,
keepsakes, publications, tapes or videos. We intend to partner with
established online merchants for the sale of these products.
Virtual HolyLand has agreements with several major content partners,
including Bridges for Peace, International Christian Embassy and Friends of
Israel Gospel Ministry. Responses to our requests for additional content from
Christian-related Web sites have been favorable.
Virtual HolyLand's target market and user demographics
According to the National Survey of Religion and Politics, the number of
evangelicals in the United States, as determined by assessing denominational
affiliation, including membership in evangelical
31
churches and ministries, totals approximately one quarter of the United States
population, or approximately 70 million people. Virtual HolyLand is targeted at
these estimated 70 million potential users.
Evangelicals believe in a diversity of religious movements. According to
estimates of the National Survey of Religion and Politics ("NSRP"),
approximately 35% of the population of the United States identify themselves as
evangelical Christians. Baptists, Methodists, Assembly of God followers, and
Pentecostal followers are included in these estimates. According to the NSRP,
three quarters of evangelicals in the United States do not identify with a
specific religious movement and may relate to specific personalities or
ministries such as the Reverends Billy Graham, Oral Roberts, Pat Robertson,
John Haggert, Jack Halyford, Kenneth Hagan, Jimmy Swaggert and Chuck Smith.
In demographic terms, evangelicals closely resemble the population of the
United States at large with regards to gender and age, and trail the average
population only modestly in education and income. SOMA Communications, Inc., a
Christian broadcast market research firm, estimates that over 70% of Christians
in the United States who use the Internet have annual incomes in excess of
$75,000, and Christianity Today, a publisher of Christian periodicals,
estimates that American Christians are 25% more likely to own a computer and
15% more likely to own a modem than the general population of the United
States. Although their demographics indicate higher levels of religious
commitment, their profile largely resembles that of the rest of the population
of the United States. Based on estimates of the current Internet usage in the
United States of 38% of the population, our management estimates that there are
approximately 27 million potential users of Virtual HolyLand from this target
community alone. Our goal is to register 95,000 and 410,000 users on Virtual
HolyLand by the end of 1999 and 2000, respectively. As of December 15, 1999, in
excess of 16,000 persons registered on the Virtual HolyLand site.
Virtual Ireland
Virtual Ireland, located on the Web at www.virtualireland.com, was launched
on Saint Patrick's Day 1999 and aggregates content from a variety of Irish Web
sites on the Internet. Virtual Ireland offers members a range of interactive
elements, community features and services including bulletin boards, free e-
mail, global weather forecasts, pen pals, video and audio files, a shopping
center and greeting cards. The Web Site also offers or will offer seven
Channels including:
. News featuring content from online news providers in Ireland, the United
Kingdom and the United States, updated headlines, opinion pieces and
analysis, live radio broadcasts from Dublin, features from the more
whimsical side of life in "Irish Gems," an interactive poll and site-wide
bulletin boards;
. The Craic contains the very best of Irish arts with a music section
featuring folk, classical and traditional Irish music, reviews and
literary features, humor and an arts section full of the best in Irish
visual art, film, dance, theater and photography;
. To Ireland! will feature interactive activities including tours, online
images, hotels, restaurants and heritage sites, topical information on
current events posted daily, a guestbook with tips and hints from other
visitors and Irish study programs;
. Living contains lifestyle features, Irish recipes, the best Irish
eateries in the United States, personals, emigration, parenting and self
help;
. Sports features fall news and results services covering amateur and
professional league sports, including Gaelic football, hurling, soccer
and rugby; and
. TimeTravel will explore Irish history in an interactive manner.
To date, we have entered into agreements with seventeen content partners for
Virtual Ireland. These partners include Appletree Press--Ireland's Eye (one of
Ireland's largest book publishers), Swift Communications (publishers of one of
the leading Irish search engines on the Web), IAIS (Irish American
32
Information Service), The Irish Emigrant (an Irish newspaper), Irishfood.com (a
Web site featuring foods from Ireland), Irishradio.com, Regional Media Bureau
of Ireland (a publisher of 27 local Irish newspapers), The Irish World Online,
Gathering of the Irish (irishclans.com), Boston Irish Pub and Restaurant Guide,
CELT (Corpus of Electronic Texts) and The Wild Geese Today + Erin's Far Flung
Exiles.
Virtual Ireland's target market, registered user base, user demographics and
traffic statistics
There is an estimated world Irish Diaspora of approximately 70 million
people. In the United States, according to the United States Census Report for
1998, 39 million people consider themselves to be of Irish descent. This report
also estimates that Irish families comprise approximately 9% of the total
population of the United States, but account for approximately 12% of
households with a net worth of more than $1 million. Our management thinks that
the strong ties of Irish descents to their heritage represent a significant
potential demographic market. We are currently running numerous print, radio
and television media directed towards this large American Irish population. As
of December 15, 1999, over 42,000 users have registered on Virtual Ireland
since our launch in March 1999. We recently hired an Editor for the Virtual
Ireland site who is currently hiring additional editorial staff for this site.
In the future, we plan to develop a marketing team specifically devoted to the
Irish community.
Virtual Italy
Virtual Italy, located on the Web at www.virtualitaly.com, was launched on
Columbus Day in October 1999 and offers a variety of content and interactive
elements targeted to the Italian American community in particular. In addition
to daily news and weather, Virtual Italy offers free email addresses and
personal homepages, greeting cards, chat rooms and bulletin boards, guestbooks,
quizzes and games.
The site includes the following channels:
News offers the latest news and pictures from Reuters and other sources
related to Italy and the Italian American community;
Travel assists travelers planning a trip to Italy, highlights specific
tourist sites and explores Italian communities around the United States;
Interact features the interactive elements and activities on the Virtual
Italy Site from free personal homepages to free email addresses on My Virtual
Italy to a host of elements that assist visitors in communicating with each
other, like guestrooms, polls, chat rooms and bulletin boards. Virtual Italy
also offers sweepstakes for free trips to Italy.
Resources, currently in development, will offer selections from the variety
of elements on the site, such as visitors' recipes and restaurant reviews in
the Italian Kitchen, "Top Site" search capabilities for locating "Best of the
Italian Web" sites, maps and calendars.
We are in the process of hiring an editorial team to administer the Virtual
Italy site and enter into additional content partner agreements for the use of
content on the site.
Virtual Italy's target market, registered user base and user demographics and
traffic statistics
There are an estimated 15 million persons in the United States who identify
themselves as Italian Americans according to the Population Division of the
1990 U.S. Census Bureau. However, the Census Bureau estimates that as many as
one in ten Americans are descended from Italian families and that Italian
Americans are the fifth largest ethnic group in the U.S. with our population
concentrated in the Northeast, California, Florida and Illinois. The average
Italian American is a city dweller, college educated and had an average annual
income of $33,000. Due to the recent launch of the Virtual Italy site in
October 1999, we have not collected statistics on the site. We launched Virtual
Italy with an ad campaign on Yahoo! and a public relations effort and intends
to roll out a comprehensive marketing campaign for the site during the first
quarter of 2000 which will
33
include newspaper and other print and online advertisements, promotions and
grass roots efforts with organizations in the Italian American community.
Approximately 2,000 persons have registered on Virtual Italy since our launch
in October 1999.
Virtual India
Virtual India, located on the Web at www.virtualindia.com was launched
during the Diwali Festival in November 1999 and places the latest news from the
India world alongside interactive elements that allow community members to
interact in a family safe environment. Virtual India is targeted to the Indian
American community. Virtual India offers free email addresses and personal
homepages, greeting cards, chat rooms and bulletin boards, global weather
reports, pen pal searches and games.
The site includes the following channels:
News publishes and updates the latest news and pictures from the Indian
world. The News channel allows site visitors to react to events as they unfold
with frequently changing readers' polls.
Travel explores the possibilities for vacations in India through features
articles and facilitators travel planning.
Win! Offers site visitors contests and competitions with prizes including
free airline tickets to India.
Interact enables site visitors to connect with each other in a variety of
ways including, free personal homepages, meeting in chat rooms, engaging in
discussions using bulletin boards and using free email addresses.
We are in the process of hiring an editorial team to administer the Virtual
India site and enter into additional content partner agreements for use of
content on the site.
Virtual India's target market, registered user base and user demographics and
traffic statistics
There are an estimated half million persons in the United States who
identify themselves as Asian Indian Americans according to the Population
Division of the 1990 U.S. Census Bureau. Though Indian population is growing
with a 111 percent increase between 1980 and 1990, Asian Indians tend to live
in and around major metropolitan areas. Asian Indians made up 1.2 percent of
New York City's population in 1990. In 1990, 30 percent of Asian Indians were
employed in professional specialty occupations, compared with 13 percent of all
U.S. employees. The median annual income for Asian Indian households is
$44,700. Due to the recent launch of Virtual India in November 1999, it has not
yet been possible for us to collect meaningful statistics from the site. We are
currently in the process of hiring extra staff for the site and intend to
launch a strategic marketing campaign during the first quarter of 2000.
Content Partners
A key component of our aggregation business strategy is our relations with
our content partners. we leverage existing online content by developing
"supersites" that serve as anchors for our content partners. Our management
thinks that these content partners recognize the benefits of being anchored to
a "supersite" which include some or all of the following:
. exposure of their Web content to additional readership beyond that which
their Web site alone attracts;
. increased traffic on their Web sites generated by the links from our Web
sites to their sites;
. the opportunity to earn revenues from shared advertising on co-branded
Web pages;
. the receipt of Internet services from us through an interactive panel
which may be laced on their sites called iPanel is which includes links
to chat services, weather guest books, online forums and e-mail lists
that would otherwise require expensive and multiple licenses and
technology; and
34
We "wrap" the content we obtain from these content partners with an array of
our own additional features and interactive services to create a cohesive Web
environment targeted to a specific demographic profile. In July 1999 we
acquired a license (see "Technology Acquisitions") that will allow our content
partners to quickly and easily place excerpts from their own Web sites on our
Web sites. This will facilitate the continual update of our Web communities
with minimal maintenance or supervision by our editorial staff.
Our Efforts to Accumulate Registered Users
We encourage user registration on our Web sites in several ways. Several
interactive elements on our Web sites, such as our user-controlled web camera
on Virtual Jerusalem and Virtual Holyland require registration in order for
users to access such features. We also encourage visitors to register by
offering sweepstakes for valuable prizes, including weekly trips to Israel (on
the Virtual Jerusalem and Virtual HolyLand Web sites) and trips to Ireland (on
the Virtual Ireland Web site). Entry to the sweepstakes requires registration.
Future Communities and Projects
We plan to develop or acquire additional Web sites in 1999 and 2000 that
target ethnic groups with attractive demographics. Such online expatriate
communities may include members of the Asian, African and Spanish expatriate
communities residing in the United States and other English speaking countries.
Our plans for the themes of our future Web sites may also include topics
unrelated to ethnic subjects, including accounting, medical, legal and other
professional target audiences as well as Web sites appealing to teenagers.
In developing our own Web sites, our management seeks opportunities where
they can aggregate a sufficient number of content partners to create an online
community that will attract enough members of the sites' target audience to
appeal to advertisers and generate advertising and e-commerce revenue. Our
plans support this objective by:
. providing and developing efficient methods for our content partners to
publish varied content on our Web sites;
. adding additional services and features to the Web site for the purpose
of creating an anchor "supersite" that will attract additional members
and generate e-commerce and advertising revenue;
. offering numerous benefits to our content partners; and
. developing attractive interactive elements for our users.
In acquiring additional Web sites, our management seeks opportunities where
an existing site on the Internet offers substantial content and services to a
defined, specific readership.
In September 1999, we launched vjradio.com, a Web site on which 24 hour
audio programming is available via real-time streaming technology. Programming
includes regularly scheduled Israel news, music and audio features from Virtual
Jerusalem's content partners and others with whom we intend on entering into
content relationships for use of their audio content on the Internet.
The Modules
Our management believes that based on our existing licenses, future licenses
that we obtain from Internet service providers, equipment we have acquired and
Virtual Communities Israel, Ltd.'s programming staff, we will be able to offer
an array of interactive modules to Web site publishers through our Community
Management Solution. We already use many of these modules successfully on our
own online communities. The modules which we either currently license, or are
trying to secure licenses for, include:
. Site Search and Polling Engines;
. Sweepstakes Modules;
35
. Greeting Cards;
. Weather Services;
. E-mail an Article to a Friend;
. Free User E-mail Services;
. Registered User Databases;
. E-mail List Servers;
. Advertising Management Systems;
. Bulletin Boards / Forums;
. Comprehensive Statistics and Traffic Measurement Modules;
. Site Indexing;
. E-Commerce Solutions;
. Chat Services;
. Online Classifieds Advertising;
. Free User Created Home Pages;
. Games Modules;
. Calendars; and
. Auctions.
(See "Proprietary Technology, Trademarks and Licenses" for a description of
licenses presently owned by us.)
To create a Web site for a Web site publisher, we first create a design
template for the publisher's Web site. Content appropriate to the publisher's
Web site is then plugged' into the design template. A design template could
potentially include multimedia (video or audio), graphics or text components,
as required. Headlines, search boxes or Web links to other content stories can
be included on each Web page. Additional modules, including poll questions,
quizzes, greeting cards, chat and other interactive features may also be added.
By integrating data and design, we provide Web site publishers with complete
control over the presentation of their content on the Internet.
To complete our Web design and development services, our technical and
support services include system administration, programming integration of all
components of a Web site, project management and hosting of Web sites on our
servers. Our servers are monitored continuously for connectivity and power by
Global Center pursuant to an agreement with us. In addition, we maintain
Firewall protection and other security services such as secure servers for
financial transactions.
Community Content Server
In addition to the above, we offer Web site publishers another module called
the Community Content Server (see "Technology Acquisitions"). The Community
Content Server provides Web site publishers with the tools required for
creating and maintaining a continually generated Internet Web site. The
Community Content Server consists of a suite of products designed to solve the
complex problems of creating and maintaining Web site publishing by aiding in
the following:
. management of data flow from text form to published Web site form through
to data archiving;
. editing data at each stage of the publishing process;
36
. creating attractive and sophisticated designs in HTML language;
. publishing a Web site as required (up to several times a day); and
. technical administration.
The Community Content Server can be used to build, edit and manage Web sites
of all sizes and requires little technical experience to permit flexible
development of Web sites. The Community Content Server manages the publication
of large quantities of data from PCs to Internet sites. The application program
for the Community Content Server is written in open source code Perl language
software and uses industry standard databases. To help ensure the longevity of
the Community Content Server as a publishing tool, the Community Content Server
was developed with an open industry standard development platform and
development tools to reduce development risks. Moreover, Perl language software
engineers are available in Israel and the U.S. for development and support in
coordination with us.
How the Community Content Server Works
The Community Content Server prompts a user for data on a "User Entry
Screen" which is a data entry screen on a database. This screen allows for the
simultaneous entry, modification and deletion of data while immediately and
automatically updating the associated Web pages of a Web site. By utilizing the
Community Content Server, Web site publishers can directly interact with the
database screens via the Internet. Once data reaches the Web site by means of a
standard database, the Community Content Server allows for the further editing
of the published data by enabling the user to select the articles, stories,
graphics, or other components to be published on the Internet. The remainder of
the data may be kept or archived to be used at a later date. The selected
information is then transferred from the database and published "live" on the
Internet by simply selecting the "publish" key. The publishing process can take
place as many times as required, making it convenient to publish information
that changes daily or even hourly, such as breaking news.
The Community Content Server also allows for the easy removal of content
published on the Internet. Content may be saved for future use, by moving it to
a viewable and searchable archive or by simply removing it from the database
altogether.
Our database would support all of our existing modules and the Community
Content Server, and would also support the entering, modifying, searching,
deleting, placement time and archival of any content that a Web site publisher
wants to publish. The Community Content Server is designed to make it
relatively easy and efficient for Web site publishers to alter their content
contributions and dynamically update their Web sites as often as they wish
while providing a powerful search and archiving tool that does not require
programming or production resources.
The Community Content Server is also designed to allow the loading of
existing text files and graphics, in any format, to a database Web site, via an
Internet browser. This freely available Web interface allows for this function
to be done from one's office, home or abroad with password security protection.
In July 1999, we entered into a software license agreement with Cortext
Ltd., an Israeli company that develops content management software ("Cortext").
Pursuant to the agreement, Cortext licensed to us, on a worldwide, royalty
free, non-exclusive, transferable, perpetual and sublicenseable basis, Web
publishing tool kit software developed by Cortext. We may use the software for
our online communities and for web sites maintained by our content partners.
The agreement also allows us to resell and distribute the software to third
parties under certain conditions. The agreement also calls for Cortext to
provide support services for the software and upgrades to the same if and when
developed by Cortext. In addition, Cortext shall provide development services
for the software to us for a period of six months from the completion of
milestones set forth in the license agreement. We use such software as part of
our Community Content Server.
37
Licenses, Service Agreements and Trademarks
Community Content Server
For a detailed description of the Community Content Server, see "Community
Content Server," and "Technology Acquisitions."
Weather Services
We have a license agreement with Accuweather, Inc., a Pennsylvania company
("Accuweather") that provides online weather services. The agreement as amended
requires that Accuweather make available to us selected weather forecasts,
satellite images and other weather services for our three existing online
communities, including forecasts for cities of specific interest to each
community and general weather information for over 450 cities around the world.
The term of the agreement is for 18 months starting December 22, 1998, and
Accuweather may terminate the agreement on 30 days written notice in the event
of a breach of the agreement by us. We pay Accuweather a monthly fee for such
services, but are entitled to 25% of any revenues received by Accuweather from
users of our Web sites who independently subscribe for additional Accuweather
services.
E-mail List Services
We have a license agreement with Revnet Systems, Inc., an Alabama company
("Revnet") that provides software for e-mail list processing applications. The
agreement is a license for a product developed by Revnet called "Unity Mail
Server" that enables the licensee to establish and manage information
distribution lists or groups while allowing participation by third party
subscribers. The license provides for unrestricted subscriber capacity for a
period of one year starting December 31, 1998, and includes free upgrades and
technical support.
Free E-mail Services
We have a custom e-mail service agreement with CommTouch Software Software,
Inc., a California company that provides Web-based e-mail products and
services. The agreement requires CommTouch Software to provide us with a
customized e-mail service, including upgrades hosted on CommTouch Software
servers. These services are available for our Web sites and other Web sites
residing on our servers. These services allow us to provide users of our online
communities with free e-mail addresses and allow us to advertise on the e-mail
messages mailed by our users. Per the agreement, CommTouch Software is required
to customize the e-mail services to each of our own Web sites and provide
continuous customer support service. The agreement also obligates us to place
Web links on the custom e-mails back to CommTouch Software's service pages, to
actively promote CommTouch Software's service on our Web sites and in other
media in order to attract end users to the service, to use commercially
reasonable efforts to market and sell advertisements for the custom e-mail
service, and to pay CommTouch Software a quarterly fee according to revenue
sharing arrangements. The term of the agreement is for one year starting June
30, 1999.
Free Home Pages
In August 1999, we entered into an agreement with Homestead Technologies,
Inc., a California company ("Homestead") that develops co-branded sites where
Internet users may create free personal homepages. Pursuant to the agreement,
Homestead and we will create sites co-branded using technology developed by
Homestead. Homestead will provide us with all necessary hardware, software, and
bandwidth necessary for the co-branded sites. We are obligated to promote such
site on our communities and email newsletters to our registered database and
maintain links to the co-branded sites from our communities. In consideration
for us providing Homestead with access to our registered user base and
collective statistical data on users of the cobranded sites, Homestead creates
the co-branded sites and pays us a portion of revenues from advertisements
placed on the user homepages. We may also place banners on the co-branded site
pages and retain a percentage
38
of revenues collected from the same. The parties also agree to create an
integrated registration process for the free home page service.
Auction Services
In July 1999, we entered into an agreement with FairMarket, Inc., a
Massachusetts company ("Fairmarket") that develops and operates Internet
auction sites. Pursuant to the agreement, Fairmarket provides us with the use
of a co-branded branded turnkey online auction service known as the FairMarket
Auction Place and support services. The auction service shall be available from
each of our communities and Fairmarket may distribute product and related
pricing information for products located on our auction service throughout
Fairmarket's network of auction sites. We are entitled to determine the
transaction fees for users of the auction service including listing and
merchandising fees. In addition to a set-up fee for each community, we pay a
monthly hosting fee to Fairmarket for each of our communities using the auction
service and a percentage of transaction and bidder bounty fees. We are entitled
to retain all advertising revenues received from ads placed on the auction
service page. FairMarket also provides us with continuous support and software
upgrades. The agreement is for a period of one year with automatic renewal for
additional one-year terms unless terminated by either party on 30 days written
notice.
News Services
In September 1999, we entered into an agreement with Reuters Limited, a U.K.
company, for the supply of Reuters' online media services for distribution on
our communities. The agreement calls for Reuters to supply our world news
services, including a number of daily print and audio stories and photographs
and a license for software designed to receive, classify and manage the news
stories, photos and graphics transmitted from Reuters to us. We pay a monthly
service fee for these news services. The agreement is for a period of two
years.
Customized Content
In December 1999, we entered into an agreement with ScreamingMedia.Net, Inc.
a Delaware corporation ("ScreamingMedia") for customized content for use on
VCI's Virtual Ireland, Virtual Italy and Virtual India communities. The
agreement calls for ScreamingMedia to supply us with news and information from
a wide range of content providers via ScreamingMedia's content engine
technology that employs custom filters created for each of its clients. In
addition to a set-up fee, we pay ScreamingMedia a monthly fee for the service.
The term of the agreement is one year, with automatic renewal for additional
one-year periods unless terminated by either party on 90 days written notice.
E-Commerce
In September 1999, we entered into an agreement with Intershop
Communications, Inc., a San Francisco, California based developer of e-commerce
software and applications ("Intershop"). Pursuant to the agreement, Intershop
granted us a license to software that allows us to design and build on-line
stores from existing templates and create on-line "malls" for each of our
communities and Community Management Solution customers. The software also
allows us to create online stores for our content partners, or, alternatively,
provide them with the ability to build their own e-commerce solution. Pursuant
to the agreement, Intershop provides us with continuous support services and
software upgrades. We pay Intershop a license fee for the software products and
an annual customer service fee for Intershop's ongoing support services and
software upgrades. The agreement is for a period of three years with automatic
renewal for additional one-year terms unless terminated by either party upon 30
days written notice. The licenses granted to us under the terms of the
agreement survive the expiration or earlier termination of the agreement.
39
Chat Services
We have an agreement with Talk City, Inc., a California company ("Talk
City") that provides supporting software that enables Web sites to offer chat
services to their users. Per the agreement, Talk City provides us with all
necessary facilities, servers, connectivity, related equipment and technology
to host chat rooms on our servers. Talk City is responsible for continuous
coverage of the chat rooms to ensure the enforcement of their Code of Conduct.
Talk City is responsible for selling and managing advertising on the chat room
sites, however we may also sell advertising but must pay a percentage of gross
revenues collected by us to Talk City. The agreement requires us to pay Talk
City an annual fee for our three online communities and up to an additional
fifteen Web sites. The term of the agreement is for one year starting June 17,
1999 and is automatically renewed for additional one year terms unless canceled
on thirty days notice by either party.
Advertising Management System
We have a license agreement with NetGravity, Inc., a California company
("NetGravity") that provides software-enabling licensees to manage advertising
on their Web sites. Our license is a perpetual, worldwide, non-exclusive and
non-transferable license that enables us to manage advertising on our own Web
sites and on Web sites of our content partners as well as any other Web sites
residing on our servers. In exchange for this license we pay NetGravity a one-
time license fee for the first year plus an additional fee for support services
during the first and successive years of the license. An optional subscription
maintenance for the second year of the license is also available for an
additional fee. NetGravity may terminate the license upon thirty days notice to
us if we are delinquent in our payments to NetGravity.
OnLine Bulletin Boards/Forums
We have a perpetual, non-exclusive, worldwide license from Infopop
Corporation (formerly Madrona Park, Inc.), a Virginia internet software company
for a popular online discussion forum program called the "Ultimate Bulletin
Board" which we use on our online communities. We paid Infopop a flat fee for
such license. Infopop provided source code to us, which we integrated with our
user registration system. The license permits us to modify the source code for
our own use, however, this license may not be resold or distributed.
Internet Camera
We have a non-exclusive, non-transferable license agreement with Perceptual
Robotics, Inc., an Illinois company that provides the software, maintenance and
support required to manipulate an interactive camera on the Internet. The
software allows up to twenty simultaneous users to control a telerobotic camera
and view panoramic images within Jerusalem. The license's term is for one year
starting September 3, 1998, for which we paid a flat fee excluding annual
software support and upgrades.
NT Server Licenses and Microsoft Office Software
We have approximately forty licenses from Microsoft for the use of our
Microsoft Office software on PCs and the PCs of our subsidiaries' employees in
the U.S. and Israel. We also have twenty client access licenses from Microsoft
for our Windows NT server software, required for the operation of our computer
servers on which our Web sites and the Web sites of many of our content
partners reside. Our management believes that we have acquired a sufficient
number of licenses from Microsoft for our current needs.
Maven Index and Search Engine
We have an agreement with Matthew Album, an individual ("Album") who
developed a comprehensive, proprietary database of over 10,000 Jewish related
Web sites known as the "Maven Index" which resides at www.maven.co.il
("Maven"). Per the agreement, we provide Maven with technical, Web site design,
hosting, marketing and e-mail services and Album, in exchange, updates the
Maven database regularly and provides
40
technical services required to operate the database. The term of the agreement
is three years starting March 9, 1998, and contains a license that permits us
to publish Maven on the Virtual Jerusalem site while requiring Album to place
Web links on Maven to that site's homepage. Mr. Album and we evenly split
revenues from advertisements placed on Maven. In the event the agreement is
terminated by us for cause, or by Album without cause, we receive a non-
exclusive right to use Maven. For five years following such termination
(provided that Maven remains on the Virtual Jerusalem site), we are obligated
to pay Album a decreasing portion of the advertising revenues that we derive
from Maven.
Classifieds Advertising
We have an agreement with CabiNet Systems Ltd., an Israeli company
("CabiNet") that develops Internet matching service technology called
Teleboard. Per the agreement, CabiNet set up a server at our server maintenance
facility on which our Teleboard Web site is located. This site includes a
database, search and virtual agent program that allow users to access anonymous
messaging services for communication between registrants on the Teleboard Site.
Registration for the Teleboard site is free. We provide links to a Teleboard
site that was co-branded with our online communities. We share with CabiNet
advertising revenue on the co-branded Teleboard service on a split basis with
the higher amount going to the party that locates the advertiser. If and when
the parties agree to charge a fee for use of the Teleboard service, the parties
agreed to share revenues on an even basis. The agreement was for a period of
one year, starting March 4, 1998, which was extended for an additional year,
but may be terminated on 60 days notice by either party.
Server Maintenance and Support
We have a Master Service Agreement with Global Center Inc., a California
internet service provider ("Global Center"), that provides us with hosting
services and connectivity to the Internet for our servers on which our own Web
sites and the Web sites of our content partners reside. Global Center also
provides continuous supervision of our servers ensuring that such servers are
connected to power sources and viewable on the Internet. Global Center also
assists in correcting any possible malfunctions of our servers, which are
housed at Global Center's server installations in Herndon, Virginia and New
York City. For these services, we pay a monthly fee. Per the agreement, Global
Center is not liable for injury to our business, lost revenues or profits
resulting from any negligence on their part at our server maintenance
facilities. The initial term was for a period of six months starting September
4, 1997 which term has been extended for several additional six-month periods.
Trademarks
In April 1999, we filed five service mark applications with the Assistant
Commissioner for Trademarks in the United States for the following names and
designs used by us: Virtual Communities, Inc., Virtual Jerusalem, Virtual
HolyLand, Virtual Ireland and IsraelWire, together with designs for each of
them. The applications are currently under review by the U.S. Trademark Office.
These names and service marks for these sites are currently used in our
business. We intend to file additional applications for other online
communities and Web properties that we may establish in the future, including
an application for vjradio.com. There is no assurance that we will be
successful in obtaining approval of such applications, and if obtained, of
enforcing such service marks. We are aware of the fact that there are a number
of entities incorporated in a number of states in the U.S. that currently use
the name "Virtual Communities" and that at least one such entity has filed an
application for protection for such name, although such entity provides
somewhat different Internet services than we do. Our management cannot assure
you if and when the U.S. Trademark Office will rule on such applications, or
that such applications will ever be granted or enforceable.
Technology Acquisitions
We recently received a license from an Israeli software development company
for Web publishing software that will form the basis of our Community Content
Server module (see "Community Content Server"
41
for a description of the software). This module would be sublicensed by us to
Web site publishers as part of our Community Management Solution services (see
"The Modules") and used for our own online communities.
In May 1999, we signed a term sheet with this entity and a third party who
owns 50% of the rights related to the software, which contemplates that we
would acquire 60% of this entity's equity over time. We have twice extended the
term of the Term Sheet until January 20, 2000 in consideration for an aggregate
advance payment of $145,000 of the proposed acquisition price. Although we are
still negotiating the terms of the stock purchase agreement with this entity,
employees of Virtual Communities Israel, Ltd. have already begun working with
this entity's programmers to configure and integrate the licensed software for
our online communities and for sublicense to third parties. We anticipate the
stock purchase agreement could be finalized in the first quarter of 2000. In
the event the agreement is not finalized, the advance payment shall be used to
secure additional licenses from this entity.
In December 1999, we entered into a Software License and Support Agreement
with iMediation Inc, ("iMediation"), a California company that provides web
user tracking software. Pursuant to the agreement, iMediation has granted us a
three year license for its use of iMediation software that enables the
automated tracking of web traffic to or within our online communities and/or
those communities maintained by us. In addition to a software license fee, we
pay an additional fee for software support services during the term. We are
entitled to use the software on up to eight of our communities. Thereafter, we
must pay an additional fee on a per community basis. We have the right to
convert this license into a perpetual license for a flat rate for up to 20
communities. The agreement is for a total of 3 years, however, it may be
terminated at the end of each year.
Employees and Facilities
As of December 31, 1999, we, together with our Israeli subsidiaries, Virtual
Communities Israel Ltd. and V.C.I. Internet Properties Ltd., employed 88 full-
time employees, 56 of whom are located in Virtual Communities Israel, Ltd.'s
offices in Jerusalem, Israel, 3 of whom are located in V.C.I. Internet
Properties, Ltd.'s offices in Eli, Israel, and 29 of whom are based in our
offices in New York, New York. Over the next several months, we intend to
retain an additional 10 persons for Virtual Communities Israel, Ltd.'s
Jerusalem office where such personnel will be engaged in Web site production,
programming, editorial services, client services and administration and an
additional 12 persons for our New York office where such personnel will be
engaged in sales and marketing, web sit development and editorial services and
administration. In addition, Avi Moskowitz, our Chief Executive Officer and
President, relocated from Israel to the U.S. in June 1999.
Our Web site servers are housed in server parks in Herndon, Virginia and in
New York, New York where they receive 24-hour maintenance and back-up services
pursuant to an agreement with Global Center, Inc.
Our offices and those of our Israeli subsidiaries, Virtual Communities
Israel, Ltd. and V.C.I. Internet Properties, Ltd., are located at 589 Eighth
Avenue, New York, New York 10018, Jerusalem Technology Park, Malcha, Jerusalem,
Israel 91481 and Yishuv Eli 37, Eli, Israel 44828, respectively.
Legal Proceedings
We are not a party to any material legal proceedings.
42
DIRECTORS AND EXECUTIVE OFFICERS
Directors and Principal Officers
The following table sets forth the names, ages (as of December 15, 1999) and
positions of all of our directors, executive officers and key personnel.
Name Age Position
---- --- --------
Avi Moskowitz........ 35 Chairman of the Board, Chief Executive Officer,
President and Director
Michael S. Harwayne.. 29 Vice President of Business Development and Marketing
Deborah Gaines....... 45 Editorial Director
Sonja Simon.......... 65 Secretary
Peter A. Jacobs...... 55 Director
David Morris......... 29 Director
Robert J. Levenson... 55 Director
Fred S. Lafer........ 70 Director
Jonathan W. Seybold.. 56 Director
Allan Dalfen......... 55 Director
David L. Kahn........ 43 Executive Vice President--Virtual Communities
Israel, Ltd.
Ellen Cohl........... 32 Vice President, Finance--Virtual Communities Israel,
Ltd.
Avi Moskowitz founded Virtual Communities, Inc. in August 1996 and served as
Chairman of the Board, Chief Executive Officer, President and Director ever
since. In January 1996, Mr. Moskowitz also founded Virtual Communities Israel
Ltd and served as the entity's sole Director and Chief Executive Officer until
May 1999. From 1994 until 1996, Mr. Moskowitz was a principal of NetMedia,
Ltd., an Israel Internet service provider. From 1986 through 1994, Mr.
Moskowitz was President of MedPlus Inc., a New York-based value-added reseller
of healthcare software systems. Mr. Moskowitz attended Yeshiva College of
Yeshiva University. Mr. Moskowitz is the son-in-law of Sonja Simon, our
Secretary.
Michael S. Harwayne joined Virtual Communities, Inc. in February 1999. From
1995 to 1999, Mr. Harwayne was employed at McKinsey & Company, Inc. where he
was an Associate until 1997, when he was promoted to Engagement Manager. From
1991 to 1993, he held several positions at the International Data Group,
including account representative and management associate to PC World magazine
and circulation manager of Multimedia World. Mr. Harwayne received a Bachelor
of Arts degree, magna cum laude, from Harvard College in 1991 and received his
MBA at Harvard's Graduate School of Business in 1995.
Deborah Gaines has been Editorial Director since October 1999. Before
joining Virtual Communities, Inc., Ms. Gaines served as Managing Editor for the
Hearst magazine group at Women.com from 1998-99, where she was responsible for
the launch of new web sites for Redbook and Good Housekeeping. From 1997-98,
she was Managing Editor of iVillage: The Women's Network. She has also held
editorial positions at Money magazine and Baby magazine, and written about
travel for the New York Post, Ladies' Home Journal, Modern Bride and others.
Ms. Gaines graduated from Yale University and has an M.A. in literature from
Columbia University.
Peter A. Jacobs has been a Director of Virtual Communities, Inc. since April
1998. Since December 1998, he has been a director of Hillsdown Holdings PLC, a
publicly traded U.K. food and furniture company, and he has also been Chairman
of Hillsdown since March 1999. In December 1998, Mr. Jacobs became Chairman of
Healthcall, Ltd., a doctor's deputizing service, and in November 1998, he
became a director of Bank Leumi U.K. Since March 1998, Mr. Jacobs has been a
director of Allied Domecque, Ltd., a U.K.-based food, beverage and spirits
company. From May 1991 until August 1999, Mr. Jacobs was Chief Executive
Officer of BUPA, the U.K.'s largest private health care provider and health
insurer. Mr. Jacobs received a BSC in Mechanical Engineering in 1966 and a DMS
in Management Studies in 1969 from Aspon University, Birmingham, England.
43
Robert J. Levenson has been a Director since October 1999. Since 1992, he
has been a Director of First Data Corp. ("FDC"), a company whose shares are
listed on the New York Stock Exchange, and an Executive Vice President of FDC
since July 1993. He formerly served as Senior Executive Vice President, Chief
Operating Officer, and Member of the Office of the President of Medco
Containment Services, Inc., a provider of managed care prescription benefits.
Mr. Levenson was a Director of Medco Containment Services, Inc. from October
1990 until December 1992. From 1985 until October 1990, Mr. Levenson was Group
President and Director of ADP. Mr. Levenson is a director of Vestcom
International, Inc., Superior Telecom, Inc. and Emisphere Technologies, Inc.
Fred S. Lafer has been a Director since October 1999. From 1994 to the
present, Mr. Lafer has been President of the Taub Foundation, a charitable
foundation. Prior thereto, until 1996, Mr. Lafer was Senior Vice President and
Secretary of Automatic Data Processing, Inc., a provider of employer, financial
and data services. He is also a member of the Board of Vestcom International.
David Morris has been a Director of Virtual Communities, Inc. since April
1998. Since May 1998, he has been a director of ENG Ltd., a U.K. computer
maintenance company. Since February 1998, he has been a director of Vanco Ltd.,
a provider of wide area management network systems. Since June 1997, Mr. Morris
has been an employee of Monhouse Ltd., a U.K.-based management company and,
since June 1998, he has been a director of Monhouse. He has also been a
director of Oldstone Properties, a property investment/development company
since June 1997, and a director of Voyeur Ltd. and PC Cloths, Ltd., two U.K.-
based clothing companies since February 1998. From 1996 through 1997, Mr.
Morris restructured closed-end investment trusts for Brewin Dolphin Ltd., a
U.K. stock brokerage firm. From January 1995 to December 1995, Mr. Morris was
employed by Net Media Ltd., an Israeli Internet service provider, partially
owned by Mr. Moskowitz. Mr. Morris received a Bachelor of Arts degree from
University of Westminster, London in 1993.
Jonathan W. Seybold has been a Director since our inception in July 1994 and
was re-elected a Director in October 1999 in connection with the merger. Mr.
Seybold founded Seybold Seminars, Inc., a company that conducts large scale,
technology-based trade shows and conferences and Seybold Publications, a
company that publishes reports on publishing systems, desktop publishing and
digital data applications. Mr. Seybold served as President of Seybold Seminars
and Seybold Publications from 1981 to 1993.
Allan Dalfen has been a Director since December 1995 and was re-elected a
Director in October 1999 in connection with the merger. Mr. Dalfen currently
serves as President of Kent Spiegel Direct Inc., the sporting goods and fitness
division of Kent & Spiegel. Since January 1995, Mr. Dalfen has also served as
President of Dalfen Corporation, an investment corporation. From October 1992
to December 1994, Mr. Dalfen served as President and Chief Executive Officer of
Vestro Foods, Inc. and from 1979 to 1992, Mr. Dalfen served as President and
Chief Executive Officer of Waiger Health and Fitness. Mr. Dalfen is currently a
director of Vestro Foods, Inc.
Sonja Simon has been Secretary of Virtual Communities, Inc. since September
1996 and was a director of Virtual Communities, Inc. until October 1999. Since
1997, Ms. Simon has been a consultant to Global Computer Associates, Inc., a
privately held company based in New York, which provides computer consulting
services to Chase Manhattan Bank. From 1994 through 1996, she was a consultant
for Parsee Information Corp., which provides computer consulting services to
Citibank, N.A. From 1991 to 1994, Mrs. Simon was a data processing consultant
for FYI Systems, New York, which provides services to Simon & Schuster. Prior
to 1991, Ms. Simon worked for IBM in engineering and sales for over 30 years.
Ms. Simon is the mother-in-law of Avi Moskowitz, the Chairman of the Board.
David L. Kahn has been the Executive Vice President of one of our
subsidiaries, Virtual Communities Israel Ltd. since October 1996. From 1990 to
1996, Mr. Kahn was an associate of Corrine Davar Property Consultants, a
Jerusalem real estate firm. Mr. Kahn received a Bachelors Degree in Political
Science from Yeshiva University, New York in 1978 and a J.D. Degree from
Benjamin N. Cardozo School of Law, New York in 1981.
44
Ellen Cohl became the Controller of Virtual Communities Israel, Ltd. in
August 1997 and Vice President, Finance of Virtual Communities, Inc. in October
1999. From 1995 through 1997, she was a Senior Auditor with Luboshitz Kasierer
& Co., the Israeli affiliate of Arthur Andersen & Co., the accountants for
Virtual Communities, Inc., VCFL and V.C.I. Internet Properties, Ltd.. During
1994, Mrs. Cohl was a Special Project Leader at Deloitte & Touche LLP, New
York. From July 1992 through April 1994 she was a Senior Auditor with Bank
Leumi Trust Company. Mrs. Cohl is a Certified Public Accountant and received a
Bachelor of Science Degree from New York University in 1988, and a Masters
Degree in Business Administration from Baruch College, The City University of
New York in 1995.
All of the above directors and nominees will hold office from the effective
time until the next annual meeting of the stockholders and until their
successors have been duly elected and qualified. All of the above executive
officers serve at the direction of our Board of Directors.
There are no family relationships among any of the directors or executive
officers other than between Mr. Moskowitz and Ms. Simon, who is Mr. Moskowitz's
mother-in-law.
Executive Compensation
The table below provides information concerning the annual and long-term
compensation for services rendered during the year ended December 31, 1998 by:
. Avi Moskowitz, our Chairman of the Board, Chief Executive Officer and
President, who served Virtual Communities, Inc. in that capacity prior to
the merger.
. Gregory L. Zink, who was President and acting Chief Executive Officer of
Heuristic Development Group, Inc., prior to the merger.
Long Term
Compensation
Annual Compensation Awards
------------------------------------------ ------------
Securities
Name and Principal Other Annual Underlying
Position Year Salary ($) Bonus ($) Compensation ($) Options (#)
------------------ ---- ---------- --------- ---------------- ------------
Avi Moskowitz(1)....... 1998 $104,950 $ 0 $17,900(2) 439,682(3)
Chairman of the Board,
President and Chief
Executive Officer
Gregory L. Zink........ 1998 $ 97,500 $ 0 $ 0 $ 0(4)
President and Acting
Chief Executive
Officer
- --------
(1) Mr. Moskowitz's compensation for 1998 was received pursuant to an
employment agreement, effective as of January 1, 1998, between Mr.
Moskowitz and Virtual Jerusalem Ltd. This employment agreement was
terminated in May 1999.
(2) Includes: $2,500 in the form of employer contributions to a "continuing
education" savings plan; $7,000 in the form of amounts paid by Virtual
Jerusalem Ltd. for "Managers Insurance," a type of pension, insurance and
severance fund commonly offered by Israeli employers; $6,400 in the form of
the use of a company automobile and related expenses; and $2,000 in the
form of supplemental health insurance and holiday gifts. In 1999, Mr.
Moskowitz received, in part for services rendered to Virtual Jerusalem Ltd.
during 1998, $22,197 in the form of reimbursement for vacation time not
taken since 1997.
(3) Represents 278,542 shares of common stock underlying options granted to Mr.
Moskowitz in 1997, and 161,140 shares of common stock underlying warrants
issued, to Mr. Moskowitz in 1998.
45
Option Grants
The following table provides information regarding warrants issued during
the year ended December 31, 1998 to Avi Moskowitz. Virtual Communities, Inc.
has never granted stock appreciation rights.
Option Grants in Last Fiscal Year Individual Grants
-------------------------------------------------------------------
Percent of Total
Options Granted to
Employees
Number of (net of forfeitures)
Securities in Fiscal Exercise or Base
Underlying Year Ended Price Per Share Expiration
Name Options Granted December 31, 1998 ($/Share) Date
- ---- --------------- -------------------- ---------------- -------------
Avi Moskowitz........... 115,100(1) 41.9%(2) $1.00 June 30, 2001
46,040(1) 16.7 (2) $0.65 Dec. 31, 2001
- --------
(1) These warrants were issued in consideration of Mr. Moskowitz's personal
guarantee of Virtual Communities Israel, Ltd. bank lines of credit and for
Mr. Moskowitz's agreement to defer and reduce a portion of his salary from
July 1998 through February 1999.
(2) Based on an aggregate of 274,906 warrants issued (net of forfeitures) to
employees in the year ended December 31, 1998, including warrants issued to
Avi Moskowitz.
Fiscal Year End Option Values
The following table provides information concerning unexercised options held
by Avi Moskowitz as of December 31, 1998. Avi Moskowitz did not exercise any
options during the year ended December 31, 1998.
Aggregated Option Exercises in Last Fiscal
Year and Fiscal Year-End Option Values
----------------------------------------------------------------
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Options at Fiscal Year End at Fiscal Year End(1)
--------------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ------------- -------------- ----------- -------------
Avi Moskowitz.. 92,846(2) 185,695(2) $60,350 $120,702
161,140(3) 0(3) 0 0
- --------
(1) Assumes a market price for the common stock of Virtual Communities, Inc. at
December 3l, 1998 of $0.65 per share.
(2) Represents 278,542 shares of Virtual Communities, Inc. common stock
underlying options held by Mr. Moskowitz as of December 31, 1998.
(3) Represents 161,140 shares of Virtual Communities, Inc. common stock
underlying warrants held by Mr. Moskowitz as of December 31, 1998.
Director Compensation
None of our directors receive cash compensation or expense reimbursement for
services provided as a director, including attendance at meetings of the Board
of Directors or at meetings of committees of the Board of Directors of which
they are members, except that David Morris was reimbursed by Virtual
Communities, Inc. for travel and lodging in the amounts of $4,600 and $1,706 in
April and June 1999, respectively.
In January 1998, Virtual Communities, Inc. granted to each of David Morris,
Sonja Simon and Peter A. Jacobs options to purchase 57,550 shares of our common
stock pursuant to the 1998 Stock Option Plan, exercisable at a price equal to
$0.65 per share. These options vest in equal amounts over three years.
In September 1999, David Morris was granted an additional option to purchase
57,550 shares of our common stock pursuant to the 1999 Stock Option Plan in
consideration for financial consulting services provided to Virtual
Communities, Inc. since 1997.
46
In September 1999, Avi Moskowitz was granted an additional five-year option
to acquire 230,200 shares at $2.10 per share in consideration for his
relocation to New York.
Employment Agreement
In June 1999, Virtual Communities, Inc. entered into an employment agreement
with Avi Moskowitz, our President and Chief Executive Officer. The agreement is
for an initial three-year term, which will extend automatically unless either
party gives written notice at least 90 days prior to the end of the initial
term. If the agreement is automatically renewed, it will continue until
terminated by either party pursuant to the agreement. Mr. Moskowitz receives an
annual base salary of $182,700 (subject to change at the discretion of the
Board of Directors), and will be eligible to receive annual bonuses as may from
time-to-time be awarded by the Board of Directors. The agreement entitles Mr.
Moskowitz to incentive stock options to purchase 230,200 shares of our common
stock, which options vest over three years and are subject to the 1999 Stock
Incentive Plan and a related option agreement, and provides that Mr. Moskowitz
is eligible for such other options as may be granted by the Board of Directors.
Mr. Moskowitz is also entitled to other benefits including the use of an
automobile and life insurance, and is entitled to participate in benefit plans
that may be established by us. During the term of his employment and for one
year thereafter, Mr. Moskowitz is prohibited from engaging in any business
competitive with us. The agreement also imposes confidentiality and assignment
of work product obligations on Mr. Moskowitz.
In the event the agreement is terminated due to Mr. Moskowitz's death, for 6
months following his death we are obligated to pay the premiums for any
continuation coverage for Mr. Moskowitz's immediate family pursuant to the
Consolidated Omnibus Budget Reconciliation Act ("COBRA'). In the event the
agreement is terminated because Mr. Moskowitz becomes permanently disabled, for
6 months following such termination we are obligated to pay the premiums for
any continuation coverage for Mr. Moskowitz and his immediate family pursuant
to COBRA. At any point during the term of the agreement, we are able to
terminate Mr. Moskowitz "without cause" (as defined in the agreement) upon 12
months notice, provided Mr. Moskowitz receives his compensation during the
notice period. At any point during the term of the agreement, Mr. Moskowitz is
able to terminate the agreement for "good reason" (as defined in the
agreement), and we will be obligated to pay Mr. Moskowitz's compensation as if
Mr. Moskowitz had been terminated by us without cause.
Pursuant to a separate arrangement, Virtual Communities, Inc. reimbursed Mr.
Moskowitz for $10,000 of the expenses he incurred in moving his family from
Israel to the New York City area.
Stock Option Plans
Prior to the merger, Virtual Communities, Inc. had adopted a 1997 Stock
Option Plan, 1998 Stock Option Plan and 1999 Stock Option Plan. We have assumed
these plans, and all outstanding options under them,, and our Board of
Directors or a committee of our Board will be the administrator of the plans.
Each plan has terms substantially similar to the other. The purpose of each
plan is to provide an incentive to employees, directors and consultants of our
company and our subsidiaries, and to offer additional inducement in obtaining
the services of such persons. The Virtual Communities, Inc. Board of Directors
adopted the 1997, 1998, and 1999 plans on May 20, 1997, December 13, 1998, and
April 28, 1999, respectively. The shareholders of Virtual Communities, Inc.
approved the 1997 plan on May 20, 1997, and the shareholders approved the 1998
and 1999 plans in September 1999.
Each plan provides for the grant of both incentive stock options and non-
qualified stock options. The 1997 and 1998 plans limit the number of shares of
common stock subject to options granted under the plan to any one employee
during any one calendar year to 250,000. The 1999 plan originally set this
limit at 100,000, but was amended and restated to increase this limit to
300,000 shares.
47
Virtual Communities, Inc. reserved 726,000 shares of common stock for
issuance under the 1997 plan. As of June 30, 1999, options for all 726,000
shares were granted and outstanding, and no options had been exercised. With
respect to the 1998 plan, 524,000 shares were reserved for issuance. As of
December 15, 1999, options for all 524,000 shares (603,124 post merger shares)
were granted and outstanding, and no options had been exercised. With respect
to the 1999 plan, 500,000 shares were originally reserved for issuance. The
amended and restated 1999 plan increased the number of shares reserved for
issuance by 500,000 for a total of 1,000,000 shares. As of December 15, 1999,
options for 998,717 shares were granted and outstanding (1,149,523 post
shares), options for 1,283 shares were available for grant, and no options had
been exercised.
In addition, at our Annual Meeting held in October 1999, our shareholders
approved a 1999 Incentive Stock Option Plan and reserved for issuance 1,000,000
shares under the Plan. As of December 15, 1999, options for 608,000 shares were
granted and outstanding options for 392,000 shares were available for grant and
no options had been exercised.
Each plan is administered by the Board of Directors or a committee thereof
subject to the provisions of each plan, the plan administrator has the
authority to determine which eligible persons shall receive grants, the time of
grant, the type of grant and the number of shares underlying the options, the
term of the options, the vesting schedule and other option terms.
The exercise price for options granted under the plans is to be determined
by the plan administrator. However, the exercise price of all incentive stock
options must be at least equal to the fair market value of the underlying
shares on the date of grant. With respect to any optionee who owns capital
stock possessing more than 10% of the voting power of all classes of stock, the
exercise price of any incentive stock option must be not less than 110% of the
fair market value of the underlying shares on the date of grant. Each plan
provides for cashless exercise.
The plan administrator establishes the term of each option granted pursuant
to the plans. The maximum term, however, for incentive stock options is ten
years. With respect to any incentive stock option granted to an optionee who
owns capital stock possessing more than 10% of the voting power of all classes
of stock, the maximum term is five years. Options are subject to earlier
termination as provided in the plans.
Options are exercisable at such times and in such installments as the plan
administrator provides in the terms of the individual option agreement. Subject
to the terms of the plans, an optionee shall not have the rights of a
shareholder until the date of issuance of a stock certificate to the optionee
for the shares underlying the exercised option.
Except as provided in the individual option agreement, any optionee whose
relationship with us has terminated for any reason other than death or
disability may exercise his or her options (if otherwise exercisable) for 3
months following the date of termination if the employee optionee has resigned,
or for one year following the date of termination if the employee optionee is
terminated by us, or the optionee is our director or consultant. If, however,
such relationship is terminated by us for cause or without our consent, the
optionee's options terminate immediately. With respect to non-employee
directors, except as provided in the individual option agreement, a non-
employee director optionee whose directorship with us has terminated for any
reason other than death or disability may exercise his or her options (if
otherwise exercisable) for three months following the date of termination. If
such directorship is terminated for cause, the options terminate immediately.
The plans also provide that in the event of the death or disability of an
optionee, such optionee (or the optionee's representative) is entitled, under
the appropriate circumstances, to exercise their options (if otherwise
exercisable) for up to one year from the date of death or termination due to
disability.
In the event of a stock dividend, recapitalization, certain mergers, split-
up, combination or exchange of shares or similar corporate event which results
in a change in the number or kind of our shares of common stock, the aggregate
number and kind of shares subject to options under the plans and the related
exercise price
48
shall be adjusted accordingly. In the event of "corporate transactions" or a
"change in control" (as defined in the plans), or upon our dissolution, an
optionee's vesting rights under the plans are accelerated.
With respect to the 1997, 1998 and 1999 plans, no option may be granted
after May 31, 2007, December 31, 2001 and December 31, 2001, respectively. Each
plan may be terminated or amended by the Board of Directors generally without
shareholder approval. However, shareholder approval is required for certain
types of amendments as provided in the plans. No termination or amendment of
the plans may be made that adversely affects the rights of an existing
optionholder, without such person's consent.
Options granted under the plans may not be transferred other than by will or
pursuant to the laws of descent and distribution.
49
SHARE OWNERSHIP OF MANAGEMENT AND CERTAIN STOCKHOLDERS
The following table sets forth, as of December 15, 1999, information as to
the beneficial ownership of our common stock by:
(1) each person serving as a director on such date,
(2) each person who qualifies as a "named executive officer" as defined in
Item 402(a)(2) of Regulation S-B under the Exchange Act;
(3) all of such directors and executive officers as a group; and
(4) each person known to us as having beneficial ownership of more than 5%
of our common stock.
Name and Address of Beneficial Number of Shares Percentage of Shares
Owner(1) Beneficially Owned Beneficially Owned(2)
- ------------------------------ ------------------ --------------------
Avi Moskowitz(3)..................... 493,779 3.4%
Peter A. Jacobs(4)................... 187,018 1.3%
David Morris(5)...................... 153,057 1.1%
Sonja Simon(6)....................... 19,184 0.1%
Michael Harwayne..................... 0 0%
Robert J. Levenson & Mira
Levenson(7)......................... 47,619 0.3%
Jonathan Seybold(8).................. 173,464 1.2%
Allan Dalfen(9)...................... 7,000 0.1%
Fred Lafer........................... 47,619 0.3%
Paul and Hannah Lindenblatt(10)...... 830,446 5.7%
Roth Trust(11)....................... 1,981,447 13.7%
Net Results Holdings, LLC(12)........ 1,746,117 12.1%
Line Holdings Ltd.(13)............... 2,780,000 19.2%
All Directors and Executive
Officers............................ 1,128,740 7.8%
- --------
(1) Except as otherwise provided, the address for all beneficial owners is
c/o Virtual Communities, Inc., 589 Eighth Avenue, New York, NY 10018.
Except as indicated in the footnotes to this table and pursuant to
applicable community property laws, the beneficial owners have sole
voting and investment power with respect to all shares of common stock
set forth opposite their names.
(2) Percentage of our common stock shares beneficially owned is based upon
14,475,382 shares of common stock outstanding following the merger.
(3) Includes options exercisable for 185,694 shares of common stock
exercisable within 60 days after December 15, 1999. Also includes
warrants exercisable for 161,140 shares of common stock exercisable
within 60 days after December 15, 1999. Does not include 1,981,447 shares
of common stock held by the Roth Trust, of which Mr. Moskowitz is a
potential beneficiary. Mr. Moskowitz disclaims beneficial ownership of
these shares.
(4) Includes options exercisable for 19,184 shares of common stock and
warrants exercisable for 3,764 shares of common stock exercisable within
60 days after December 15, 1999.
(5) Includes options exercisable for 19,184 shares of common stock
exercisable within 60 days after December 15, 1999. Also includes
warrants exercisable for 133,873 shares of common stock exercisable
within 60 days after December 15, 1999. Does not include 798,553 shares
of common stock held by Line Holdings Ltd., which is controlled by a
trust of which Mr. Morris is a potential beneficiary. Also does not
include 286,280 shares of common stock held by Business Systems
Consultants Ltd., which is controlled by a trust of which Mr. Morris is a
potential beneficiary. Also does not include warrants exercisable for
22,667 shares of common stock exercisable within 60 days after December
15, 1999, held by Line Holdings Ltd., which is controlled by a trust of
which Mr. Morris is a potential beneficiary. Also does not include
warrants exercisable for 226,402 shares of common stock exercisable
within 60 days after
50
December 15, 1999, held by Business Systems Consultants Ltd., which is
controlled by a trust of which Mr. Morris is a potential beneficiary. Mr.
Morris disclaims beneficial ownership of the common stock held by Line
Holdings Ltd. and Business Systems Consultants Ltd., and the warrants to
purchase shares of common stock held by Line Holdings Ltd. and Business
Systems Consultants Ltd. The address for Business Systems Consultants Ltd.
is 31-33 Le Pollet Street, Peterport, Guernsey, Channel Islands GY1 4JG.
Does not include warrants exercisable for 144,560 shares of common stock,
exercisable 60 days after December 15, 1999.
(6) Includes options exercisable for 19,184 shares of common stock
exercisable within 60 days after December 15, 1999. Mother-in-law of Mr.
Moskowitz. Mr. Moskowitz disclaims beneficial ownership of these shares.
(7) Mr. and Mrs. Levenson's address is 39 Hawthorne Road, Essex Falls, NJ
07021.
(8) Includes 70,732 shares and warrants for 70,732 shares exercisable within
60 days after December 15, 1999, held by the Seybold Family Trust and
options to purchase 16,000 shares of our common stock. Mr. Seybold is a
trustee of such Trust, the beneficiaries of which are his wife and his
children. The address of such trust is P.O. Box 1315 East Sound,
Washington 98245. The address of Mr. Seybold is c/o Virtual Communities,
Inc., 589 8th Avenue, New York, New York 10018.
(9) Includes options to purchase 7,000 shares of our common stock. The
address of such individual is c/o Virtual Communities, Inc., 589 8th
Avenue, New York, New York 10018.
(10) Sister and brother-in-law of Mr. Moskowitz. Mr. Moskowitz disclaims
beneficial ownership of these shares.
(11) The address of the Roth Trust is c/o Line Holdings Ltd., 57-63 Line Wall
Road, Gibraltar.
(12) Includes warrants exercisable into 72,563 shares of common stock held by
an affiliate of Net Results Holdings, LLC exercisable within 60 days
after December 15, 1999 The address of Net Results Holdings, LLC is 151
West 25th Street, New York, New York 10001.
(13) Shares are held for the benefit of various trusts including the Roth
Trust. Potential beneficiaries thereof currently have neither voting
power nor the power to direct the vote of such shares nor any investment
power, including the power to dispose or direct the disposition of the
shares that are held by the trusts. Potential beneficiaries of the trust
do not have the foreseeable right within 60 days to acquire ownership,
voting power and/or investment power over such securities. Includes
warrants exercisable for 22,667 shares of common stock exercisable within
60 days after December 15, 1999, which is controlled by a trust. The
address for Line Holdings Ltd. is 57-63 Line Wall Road, Gibraltar. Line
Holdings disclaims beneficial ownership of all such shares that it holds
on behalf of the various trusts.
51
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following description of our financial condition and results of
operations should be read in conjunction with the information included in this
prospectus. The description contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ significantly from the
results discussed in the forward-looking statements as a result of the risk
factors set forth above and elsewhere in this prospectus.
Overview
Our business involves the development and operation of Internet communities
as well as providing technical, marketing and advertising services to over 150
content partners who supply us with content for such communities. We currently
operate five online communities: Virtual Jerusalem (www.virtualjerusalem.com),
Virtual HolyLand (www.virtualholyland.com), Virtual Ireland (
www.virtualireland.com), Virtual Italy (www.virtualitaly.com) and Virtual India
(www.virtualindia.com). Rather than create our own content, we aggregate
content, including news and features, from our content partner Web sites. In
consideration for our use of their content, we offer our content partners a
variety of benefits such as a portion of advertising revenues, links back to
their sites, interactive elements, Web site hosting and other Internet
services. We supplement the content on our Web sites by adding a variety of
interactive and community-enhancing elements, such as free e-mail, weather,
bulletin boards and chat services. We obtain the rights to use these elements
or "modules" by licensing the technologies from Internet service providers. Our
communities are presented in an easy to use channel format and are designed to
create a cohesive and comprehensive Web environment targeted to specific
demographic profiles. Based on our expertise in designing and developing Web
sites for our content partners, we also recently began offering Web site design
and development services to others on a fee for services basis.
Our first online community, Virtual Jerusalem, was launched in May 1996 by
Virtual Communities Israel, Ltd.. Substantially all of the assets and stock of
Virtual Communities Israel, Ltd. was acquired by Virtual Communities, Inc. in
June 1997. Virtual Jerusalem contains content from over 100 Jewish and Israel-
related news providers and content partners, many of whom we entered into
exclusive relationships with for the use of their content on the Internet. In
addition, Virtual Jerusalem contains many interactive elements designed to
encourage users to return to the site on a regular basis, and access to over
10,000 other Jewish related Web sites.
In December 1998, we launched our second online community, Virtual HolyLand,
which is targeted to Evangelical Christians, and in March 1999 we launched our
third online community, Virtual Ireland, which is targeted to people of Irish
descent. In October 1999, we launched Virtual Italy targeted to the Italian
American community. In November 1999, we launched Virtual India targeted to the
Indian American community. We anticipate launching additional communities in
the year 2000.
In the third quarter of 1999, we launched vjradio.com, a Web site on which
24 hour audio programming is available via real-time streaming technology.
Programming includes regularly scheduled Israel news, music and audio features
from the Virtual Jerusalem's content partners and others with whom we intend on
entering into content relationships for use of their audio content on the
Internet. We anticipate incurring additional administrative and licensing costs
related to the establishment of this site but believes that this project will
provide us with sufficient revenues from online advertising to offset the
increased costs.
Revenues from banner advertising, most of which were placed on Virtual
Jerusalem, accounted for approximately 44% and 62% of our total revenue for
fiscal years ended December 31, 1997 and 1998, respectively. Our remaining
revenues were derived from commissions on sales of products marketed through
our online communities and from Web production and hosting service fees.
Advertising is offered to our advertisers at rates that are based upon an
industry accepted CPM (cost per thousand page views delivered) basis. Discounts
of up to 20% from our advertising rates, are offered to certain advertisers
based on several
52
factors, including the duration and gross dollar amount of advertising
campaigns. We currently sell banner ads for six to twelve month periods,
although in many instances such contracts are cancelable by an advertiser after
a three-month period. Cancellations by advertisers have been negligible. Barter
advertising accounted for approximately 15% and 28% of our advertising revenues
for the fiscal years ended December 31, 1997 and 1998, respectively. Revenue
from barter transactions is calculated based upon the fair market value of the
goods or services received.
We project increased revenues from banner advertising sales as we continue
to expand our advertising sales staff, add online communities and solicit
advertisers which seek the types of Web sites developed by us since such sites
deliver an audience comprised of a specific demographic profile to which such
advertisers can tailor a targeted campaign.
We are also expanding our current e-commerce programs on the Virtual
Jerusalem and introducing similar programs for our other online communities. We
currently enter into agreements with online sellers of books, multimedia
products and other goods related to the theme of our online communities from
which we receive a percentage of gross sales ranging from 5% to 30%. We provide
links to these third party Web sites for which we receive a percentage of sales
from users who make purchases on those third party sites where such users
originated from our sites. We expect e-commerce transactions to generate a
significant percentage of our revenues in the future. To the extent that the
number of anticipated users on our online communities is less than anticipated,
that such users do not engage in e-commerce transactions or that we do not
establish attractive e-commerce programs on our communities, revenues generated
from e-commerce will be less than projected.
We also anticipate deriving additional significant revenue from our entry
into the fee-based Web design and development business. We began offering these
services in June 1999. These services include web design, programming and the
development and sublicensing of interactive elements and a content management
system for which we have received a license from a software developer. We
believe there is a significant market among Web site publishers for these Web
services, which would allow such Web publishers to reduce their operating costs
and administrative overhead and expand the interactive services available on
their Web sites.
We believe that the continued expansion of our operations and marketing
efforts is essential to achieving our financial goals. We therefore intend to
continue to substantially increase expenditures in all areas of our operations,
resulting in continued increases in cost of revenues and selling, general and
administrative expenses. To the extent that such expenses precede or are not
subsequently followed by increased revenues, our business, financial condition
and operating results will be materially adversely affected.
Virtual Communities, Inc., was incorporated in August 1996 as a Delaware
corporation and commenced operations in June 1997 when it acquired
substantially all of the assets and equity of Virtual Communities Israel, Ltd.
Virtual Communities Israel, Ltd. develops and maintains our online communities
and, in some instances, the Web sites of our content partners, pursuant to a
cost plus agreement and a financial services agreement which Virtual
Communities Israel, Ltd. entered into with Virtual Communities, Inc. in July
1997 and amended in September 1999.
Historical Results of Operations
Historical Comparison of Nine Months Ended September 30, 1999 and 1998
Revenue
Revenue to date has almost exclusively been generated by the Virtual
Jerusalem site. Revenues from the newer communities are expected to gain
momentum in 2000.
Total revenues for the nine months ended September 30, 1999 were $613,000, a
decrease of $42,000 or 6% from the same period in 1998. Our primary source of
revenue to date derives from banner advertising fees. Revenues from banner
advertising amounted to $409,000, or 62%, and $300,000, or 49%, of our total
revenues
53
for the nine months ended September 30, 1998 and September 30, 1999,
respectively. To date, we have signed banner advertising contracts for revenues
expected to be recognized in the fourth quarter of 1999 amounting to $380,000
and $151,000 in 2000. Of the 27 new advertising clients that we retained in
1999, eleven clients have entered into annual advertising contracts.
Although quarterly banner advertising revenues have increased consistently
over the five quarters ended September 30, 1999, the decrease from the first
three quarters of 1998 resulted essentially from two sources. First, the first
three quarters of 1998 had benefitted from a special Passover promotion, which
was not repeated in the first three quarters of 1999. Second, almost no revenue
was recorded in the first three quarters of 1999 for Tower Air, as their
advertising contract was completed on December 31, 1998. Through its
completion, the Tower Air contract had contributed an average revenue of
$36,000 per quarter in 1998. In May 1999, however, we signed a barter
advertising agreement with Continental Airlines in which we received airline
tickets, equivalent in value to $160,000, in exchange for advertising
placements on the Virtual Jerusalem for equivalent value commencing in the
second quarter of 1999. Revenue from barter transactions is calculated based
upon the fair market value of the goods or services received.
We also earn revenue from Web site hosting, Web links to and promotion of
our content partner's Web sites on our online communities and from Web site
production services. In general, these hosting, Web link and promotion revenues
are recognized ratably over the service period, pursuant to annual agreements
that provide for annual fees. Therefore, these revenues were fairly consistent
between the periods of comparison. Hosting, Web link and promotion revenues
accounted for 22% and 23% of total revenue for the three quarters ended
September 30, 1998 and 1999, respectively. Production revenue is recognized
upon performance of production services. Production revenues accounted for 10%
and 6% of total revenue for the three quarters ended September 30, 1998 and
1999, respectively.
The five largest advertising clients in the first three quarters of 1999
accounted for 21% of total revenue. Due to the relative importance of
advertising revenue to our total revenue, as well as the significance of total
advertising revenue that we realize from our five largest advertising clients,
our success will depend largely upon our ability to broaden and diversify our
advertising base. If we lose advertisers, fail to attract new advertisers or
are forced to reduce advertising rates in order to retain or attract
advertising clients, our business, financial condition and operating results
will be materially adversely affected.
Cost of Revenue
Cost of revenue consists primarily of expenditures for technical support of
our online communities, Internet access and connectivity, Web site production,
content development and maintenance and client services. Cost of revenue
amounted to $513,000, or 78%, and $1,139,000, or 186% of revenue for the nine
months ended September 30, 1998 and 1999, respectively. This increase is
primarily due to the 105% increase in the hiring of additional technical and
Web site support personnel from January 1, 1999 to September 30, 1999, and the
increased overhead and support services necessary to support expanded
operations.
In addition, a significant portion of cost of revenue relates to bartered
content material expense, which includes content used by us on our online
communities. Bartered content material expense amounted to $76,000, or 12% of
revenue, in the first three quarters of 1998, and $64,000, or 10% of revenue,
in the first three quarters of 1999. Bartered content material expense is
recorded concurrently with revenue.
Selling, General and Administrative
Selling and marketing expenses consist of salaries, travel expenses for
sales staff, sales commissions, advertising revenue sharing with content
partners, marketing expenses for our online communities, marketing materials
and promotions. Sales and marketing amounted to $308,000, or 47% of revenue,
for the nine months ended September 30, 1998, and $813,000, or 133% of revenue,
for the nine months ended September 30, 1999. The increase is consistent with
our plan, which commenced during the first half of 1999, to market our online
54
communities aggressively, in order to increase the numbers of users and
encourage their registration on our online communities.
General and administrative expenses consist primarily of salaries and legal
and professional services. In addition, our rent, utilities and administrative
employee benefits are included in general and administrative expenses. General
and administrative expenses accounted for $646,000, or 99% of revenue, for the
nine months ended September 30, 1998, and $1,136,000, or 183% of revenue for
the nine months ended September 30, 1999. This increase is primarily due to the
hiring of additional personnel between January 1, 1999 and September 30, 1999,
and the increase in overhead and support services necessary to support expanded
operations.
Historical Comparison of Years Ended December 31, 1998 and 1997
Revenue
Total revenues for fiscal years ended December 31, 1997 and December 31,
1998 were $402,000 and $819,000, respectively. Revenue to date has almost
exclusively been generated by the Virtual Jerusalem.
Our primary source of revenue to date derives from banner advertising fees.
Revenues from banner advertising accounted for approximately 44% and 62% of
total revenues for fiscal years ended December 31, 1997 and 1998, respectively.
Of the total banner advertising revenue earned, barter advertising accounted
for 14% and 28% of such revenues for fiscal years ended December 31, 1997 and
1998, respectively. Revenue from barter transactions is calculated based upon
the fair market value of the goods or services received.
To date, we have not derived significant revenue from e-commerce
commissions. E-commerce commission revenues accounted for 5% of total revenues
for both 1997 and 1998 fiscal years. We expect e-commerce transactions to
generate a significant percentage of our revenues in the future as e-commerce
partners are added to our online communities. We are currently researching the
availability of e-commerce programs to support our projected expanding e-
commerce business.
We also earn revenue from Web site hosting, Web links and promotion of
content partner Web sites on our online communities and from Web site
production services. These hosting, Web link and promotion revenues are
recognized ratably over the service period pursuant to annual agreements that
provide for annual fees. Production revenue is recognized upon performance of
production services. Hosting, Web link and promotion revenues accounted for 27%
and 21% for fiscal years ended December 31, 1997 and December 31, 1998,
respectively. Production revenues accounted for 12% for both 1997 and 1998
fiscal years.
The five largest advertising clients in 1998 accounted for over 30% of total
revenue in 1998, with Tower Air accounting for approximately 16% of such total
revenue. In the first half of 1999, almost no revenue was recorded for Tower
Air, however, total revenue did continue to rise over preceding quarters. In
May 1999, we signed a barter advertising agreement with Continental Airlines
largely for airline tickets, equivalent in value to $160,000, in exchange for
advertising placements on the Virtual Jerusalem for equivalent value. Due to
the relative importance of advertising revenue to our total revenues as well as
the significance of total advertising revenue that we realize from our five
largest advertising clients, our success will depend largely upon our ability
to broaden and diversify our advertising base. If we lose advertisers, fail to
attract new advertisers or are forced to reduce advertising rates in order to
retain or attract advertising clients, our business, financial condition and
operating results will be materially adversely affected.
Cost of Revenue
Cost of revenue consists primarily of expenditures for technical support of
our online communities, Internet access and connectivity, Web site production,
content development and maintenance and client
55
services. Cost of revenue amounted to $602,000, or 150% of revenue, in 1997,
$721,000, or 88% of revenue, in 1998.
In addition, a significant portion of cost of revenues is bartered content
material expense. Content barter expenses amounted to $100,000 in 1998, or 12%
of revenue. Bartered content material expense is recorded concurrent with
revenue recognition. There was no recording of bartered content material
expense in 1997, as we changed our revenue recognition policy as of January
1998 to be in line with the industry standard.
Selling, General and Administrative
Selling and marketing expenses consist of salaries, travel expenses for
sales staff, sales commissions, advertising revenue sharing with content
partners, marketing expenses for our online communities, marketing materials
and promotions. We plan to market our online communities aggressively going
forward, in order to increase the numbers of users and encourage their
registration on our online communities. Sales and marketing amounted to
$192,000, or 48% of revenue, in 1997, and $451,000, or 55% of revenue, in 1998.
General and administrative expenses consist primarily of salaries and legal
and professional services. In addition, our rent, utilities and administrative
employee benefits are included in general and administrative expenses. General
and administrative expenses accounted for $657,000, or 163% of revenue, in
1997, and $890,000, or 109% of revenue, in 1998. This increase was primarily
due to the increase in hiring of additional personnel between January 1, 1998
and December 31, 1998, and the increase in overhead and support services
necessary to support expanded operations.
Financing Expenses
We incurred significant financing charges in 1998, primarily in the fourth
quarter, as a result of financing through loans, and the issuance of shares and
warrants in consideration of interest. The method of obtaining capital in 1999
changed, and currently consists of the sale of equity by a placement agent that
charges an 8% cash fee on proceeds raised on behalf of Virtual Communities,
Inc., plus a warrant to purchase that number of shares of our common stock
equal to 10% of the total number of shares of such common stock sold by the
agent, calculated on an as converted basis.
Provision for Income Taxes
At December 31, 1998, we had approximately $2.1 million in federal net
operating loss carryforwards. The federal net operating loss carryforwards will
expire between calendar years 2012 and 2018 if not utilized. In addition, the
Tax Reform Act of 1986 contains provisions that may limit the net operating
loss carryforwards available for use in any given period upon the occurrence of
various events, including a significant change in ownership interests. To date,
we have not utilized any portion of our net operating loss carryforwards to
reduce our overall income tax liability.
Liquidity and Capital Resources
Prior to 1999, we funded our operations, working capital needs and capital
expenditures primarily through private placements of our common stock, cash
flow from operations and the issuance of short-term convertible loans and
notes. On February 17, 1999, we received $815,000 in net proceeds from the sale
of 9,550 shares of our series A preferred stock. At the same time we issued
5,000 shares of our series A preferred stock upon the conversion of a $500,000
convertible secured promissory note issued by us on December 31, 1998.
Through September 1999, we received net proceeds of $825,000 from the sale
of 10,325 shares of our series B preferred stock. As of September 30, 1999, we
had cash and cash equivalents of $102,000 as compared to total liabilities of
$2,608,000.
56
In June 1999, Virtual Communities Israel, Ltd., one of our Israeli
subsidiaries, entered into a three-year lease for approximately 10,000 square
feet of office space in Jerusalem for approximately $45,000 in quarterly
leasehold costs which payments commenced in December 1999. In July 1999, we
entered into a five-year lease for approximately 5,000 square feet of office
space in New York City for a rental fee of approximately $22,500 per quarter.
In October 1999, we exercised our option to lease an additional 5,000 square
feet of office space in the same building for a five-year time at a monthly
rental of approximately $8,250. Cash outlays, excluding rent and deposits, for
both leaseholds, including leasehold improvements, furniture, technical systems
and professional fees, amount to approximately $800,000. In addition, the
lessor of the new Jerusalem premises is contributing $236,500 in buildout costs
that Virtual Communities Israel, Ltd. is obligated to repay over the course of
the lease term. In January 1999, Virtual Communities Israel, Ltd. entered into
a three-year lease for approximately 3,800 square feet of office space in
Jerusalem which it vacated upon our move to new premises in August 1999 and
which it intends to sublet. Although Virtual Communities Israel, Ltd. believes
that it will be able to sublet such space, our management cannot assure you
that it will be successful in doing so, and in the event such space cannot be
sublet, we would be obligated to pay approximately $15,000 in quarterly
leasehold fees in addition to the lease costs for our new premises until
December 2001.
We anticipate that we will continue to increase our capital expenditures in
the near future due to anticipated growth in our operations, infrastructure,
and personnel. In addition to the commitments relating to the new leaseholds,
improvements to infrastructure, additional licenses for interactive elements
(including content management software) and Web site security are expected to
amount to approximately $115,000 monthly through the first quarter of the year
2000.
Marketing expenditures are expected to approach $65,000 per month per each
of our Web sites by the fourth quarter of 1999 in order to reach projected
levels of registered users, traffic, and revenue from banner advertisements and
e-commerce transactions on such online communities.
We maintain an operating line of credit with Israel General Bank in the
amount of $560,000. As of November 30, 1999, the amount outstanding on this
line of credit totaled $480,000. Israel General Bank has also provided us with
a $58,000 guarantee for three months rent on the leaseholds occupied by Virtual
Communities Israel, Ltd..
On December 14, 1999, the Company received a total of $985,400 for the
private placement sale to accredited investors of 400,000 shares of restricted
common stock and a three-year warrant, exercisable for 40,000 shares of common
stock at a purchase price of $2.46 per share. The Company made the private
placement offering under Section 4(2) of the Securities Act of 1933, as amended
(the "Securities Act"). The terms of the offering provided for issuance of the
restricted common stock at a purchase price equal to 35% below the market
valuation of the Company's publicly traded common stock and the issuance of a
warrant exercisable for the purchase of one share of common stock for each ten
shares purchased. The warrants become exercisable six months after the date of
issuance. The restricted shares of common stock and the shares of common stock
to be issued upon exercise of the warrant may be offered for public resale only
if registered under the Securities Act of 1933 or an exemption therefrom. The
Company has agreed to provide the purchasers with certain registration rights
with respect to the restricted common stock and the common stock underlying the
warrants. Such registration rights commence six months from the date of
purchase and if the registration is declared effective by the Securities and
Exchange Commission, public resale of such securities shall be permitted. The
Company paid approximately $50,000 and issued warrants exercisable for 120,000
shares of common stock on the same terms and conditions as the warrants issued
in the private placement as financial advisory consultant fees related to the
closing of the first tranche of the private placement offering. The Company
expects to continue the private placement offering to accredited investors in
subsequent tranches through the first quarter of 2000, up to an aggregate
amount of $5 million, on terms substantially similar to the first tranche. The
terms and conditions of the private placement offering were duly authorized by
the Company's Board of Directors as being reasonable and in the best interests
of the Company, with particular regard to the Company's need for operating
capital and the limited availability of other reasonable financing
alternatives.
57
We anticipate that our existing cash balance combined with the net proceeds
which may be realized from the sale of additional shares pursuant to our
private placement offering and anticipated revenue from operations will be
sufficient to meet our working capital and capital expenditure needs through
February 15, 2000. If the cash that we generate from our operations is
insufficient to satisfy our liquidity requirements after this period, then we
may need to sell additional securities. The sale of additional equity or
convertible debt securities may result in additional dilution to our
shareholders. We will need to obtain additional capital or modify our growth
strategy. We may not be able to raise any additional capital or obtain such
capital on acceptable terms
The "Year 2000" Issue
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software
that records only the last two digits of the calendar year may not be able to
distinguish whether "00" means 1900 or 2000. This may result in software
failures or the creation of erroneous results causing disruptions of
operations, including an inability to process transactions, send invoices,
publish content on our Web sites or engage in other business activities.
State of Readiness
The following outlines our state of readiness as to the Year 2000 issue with
respect to each section of our operations.
Infrastructure. The Year 2000 problem could affect the systems, transaction
processing computer applications and devices used by us to operate and monitor
all major aspects of our business, including financial systems, customer
services, infrastructure and networks.
We believe that we have identified and have, where appropriate, modified
substantially all of the major systems, software applications and related
equipment used in connection with our internal operations that needed to be
modified or upgraded in order to minimize the possibility of a material
disruption to our business due to the Year 2000 problem.
Facility Systems. Systems such as heating, sprinklers, test equipment and
security systems at our facilities also may be affected by the Year 2000
problem. We are currently assessing the potential effect of, and costs of
remedying, the Year 2000 problem on our facility systems. We estimate that the
total cost to us of completing any required modifications, upgrades or
replacements of these systems will not have a material adverse effect on our
business or results of operations, as these facility systems are currently
being built or installed in our Israel and United States facilities by vendors
with a full understanding of Year 2000 compliance.
Software. We are conducting an internal review of the software systems we
use for site management, network monitoring, quality assurance and transaction
processing. We are also reviewing our computer infrastructure, including
network equipment and servers. We do not anticipate material problems with
network equipment, as our current configuration was installed within the last
three years. Similarly, we purchased most of our servers in 1998 and 1999. With
this relatively current equipment, we do not anticipate material Year 2000
compliance problems, and expects to replace any servers that cannot be updated
either in the normal replacement cycle or on an accelerated basis. We also
internally standardized our personal computers on Windows 98, using reasonably
current service packs. Our vendors advised us that these packs are Year 2000
compliant. We use multiple software systems for internal business purposes,
including accounting, e-mail, development, human resources, customer service
and support and sales tracking systems. All of these applications have been
purchased within the last three years, and our vendors have advised us that
these applications are Year 2000 compliant. For those applications that may
prove problematic with respect to the Year 2000 issue, such as MS Excel and
Access, we have developed a process to check and remedy these applications by
the end of September 1999.
58
Hardware. We have made verbal inquiries of vendors of, and have reviewed the
relevant vendor documentation for, those systems that we believe to be mission
critical to our business with respect to the Year 2000 readiness of such
systems. We have received various verbal assurances of Year 2000 readiness from
certain of our vendors, and have received written assurance from both Compaq
(servers) and IBM (personal computers).
We are currently performing further operational tests on all hardware,
despite vendor assurances. We generally do not have contractual rights to
assert against our vendors should their equipment or software fail due to Year
2000 issues.
If any of our third party equipment or software does not operate properly
with regard to the Year 2000 issue, we may incur unexpected expenses to remedy
any problems. These expenses could potentially include purchasing replacement
hardware and software.
Other third parties. We have received assurances from Global Center and
Netvision, our United States and Israeli internet service providers
respectively, that our internet services will not be disrupted due to a
Year 2000 issue.
We have not determined the state of Year 2000 compliance of certain third-
party suppliers of services such as our content partners, marketing and
advertising partners, telephone companies, long distance carriers, financial
institutions and electric companies, as each relates to our business. The
failure of any of these service suppliers to timely remedy any Year 2000 issues
in a manner compatible with our systems could severely disrupt our ability to
carry on our business.
Costs
We anticipate that our review of Year 2000 issues and any remedial efforts
will continue throughout 1999. The costs incurred to date to remedy our Year
2000 issues have not been material. If any Year 2000 issues are uncovered with
respect to our systems, we believe that we will be able to resolve these
problems without material difficulty, as replacement systems should be
generally available on commercially reasonable terms. We presently estimate
that the total remaining cost of addressing any Year 2000 issues will not
exceed $10,000.
Risks
Our applications operate in complex network environments and directly and
indirectly interact with a number of other hardware and software systems. We
are unable to predict to what extent our business may be affected if our
systems or the systems that operate in conjunction with our systems experience
a material Year 2000 failure. We are also subject to the Year 2000 risks
affecting the Internet as a whole.
Known or unknown errors or defects that affect the operation of our software
and systems could result in delay or loss of revenue, interruption of services,
cancellation of contracts and memberships, diversion of development resources,
damage to our reputation, increased service and warranty costs, and litigation
costs, any of which could adversely affect our business, financial condition
and results of operations.
The most likely worst-case scenario for us due to a Year 2000 failure is
that access to our Web sites through the internet would be limited or
impossible due to a telecommunications problem beyond our control. In such a
scenario, we would be dependent on third party telecommunications providers to
remedy the problem.
Another likely worst-case scenario for us is the failure of one of our
servers to function properly due to a Year 2000 issue. We believe that such a
failure could be remedied within 24 hours by our staff or the staff of our
service providers.
59
Contingency Plans
Our Year 2000 analysis has been derived based on a number of assumptions,
including the assumption that we have already identified our most significant
Year 2000 issues and have already engaged in a program to remedy any issues. In
view of our Year 2000 review and remediation efforts to date, the development
of our products and services within the last several years, the recent
installation of our networking equipment and servers, we have engaged in making
contingency plans which have been completed. However, we can make no assurances
that our assumptions are accurate, and actual results could differ materially
from those we anticipate.
Notwithstanding the above, our contingency plans to address Year 2000 issues
may pose a significant risk to our on-going operations. These plans include
reinstallation of software and temporary use of back-up equipment and software.
There can be no assurance that contingency plans implemented by us will be
adequate to meet our needs without materially impacting our operations, that
such plan will be successful or that our results of operations will not be
materially and adversely affected by the delays and inefficiencies inherent in
conducting operations in an alternative manner.
Recently Issued Accounting Standards and Pronouncements Not Yet Adopted
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employer's Disclosure About
Pensions And Other Postretirement Benefits," which standardizes the disclosure
requirements for pensions and other post-retirement benefits. The adoption of
this statement did not impact our disclosures.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." Under the provisions of this
statement, software development is divided into three phases: (1) the
preliminary project stage, which includes conceptual formulation and selection
of alternatives; (2) the application development stage, which includes the
design of a chosen path, coding, installation of hardware and testing; and (3)
the post-implementation/operation stage, which includes training and
application maintenance. Generally, only internal and external costs incurred
during the second phase, the application development stage, may be capitalized,
with the exception of date conversion and training costs, which are to be
expensed when incurred during this phase. This statement is not effective for
our 1998 financial statements. Our management does not expect this statement to
have significant impact on our financial statements.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, "Reporting on the Costs of Start-up Activities."
This statement requires that the cost of start-up activities, including
organizational costs, be expensed as incurred and is not effective for our 1998
financial statements. Our management does not expect this statement to have a
significant impact on our financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement requires that every derivative
instrument, including derivative instruments embedded in other contracts, be
recorded on the balance sheet as either an asset or liability measured at our
fair value. The statement is effective for all fiscal years beginning after
June 15, 1999. As we are currently not a party to any derivative financial
instrument and do not anticipate becoming a party to any derivative
instruments, our management does not expect this statement to have a
significant impact on our financial statements.
60
FINANCIAL STATEMENTS
Heuristic Development Group, Inc. Financial Statements
The audited balance sheet of Heuristic Development Group, Inc. as of
December 31, 1998 and the related statements of operations, changes in
stockholders' equity and cash flows for each of the years in the two-year
period then ended and for the period from July 20, 1994 (our inception) through
December 31, 1998, is attached to this prospectus as Appendix A. The unaudited
balance sheet of Heuristic Development Group, Inc. as of September 30, 1999 and
related statements of operations, changes in stockholders' equity and cash
flows for the period then ended and for the period from July 20, 1994 through
September 30, 1999, is attached to this prospectus as Appendix B.
Financial Statements
The audited consolidated balance sheet of Virtual Communities, Inc., as of
December 31, 1998 and the related statements of operations, changes in
stockholders' deficiency and cash flows for each of the years in the two-year
period then ended is attached to this prospectus as Appendix C. The unaudited
condensed interim consolidated balance sheet of Virtual Communities, Inc., as
of September 30, 1999 and related statements of operations, changes in
stockholders' deficiency and cash flows for the period then ended is attached
to this prospectus as Appendix D.
61
PRO FORMA FINANCIAL STATEMENTS
Introduction to Pro Forma Financial Statements (Unaudited)
The accompanying unaudited pro forma balance sheet presents the financial
position of VCI and HDG as of September 30, 1999, assuming the merger has been
completed as of the balance sheet date. The merger was actually consummated
subsequently on October 29, 1999.
The pro forma statements of operations for the year ended December 31, 1998
and for the nine months ended September 30, 1999 for VCI and HDG, respectively,
reflect the merger, as if the merger had occurred on the first day of the
fiscal year presented and carried forward to the interim period presented,
taking into effect certain events that occurred subsequent to the periods
presented.
Separate combined balance sheets have been presented for each of the
following circumstances: (1) adjusted to reflect pro forma activity, with the
assumption that no VCI stockholder dissents the merger, and (2) adjusted to
reflect pro forma activity, with the assumption that the maximum of 7% VCI
stockholder dissent to the merger. If more than 7% of VCI stockholders had
voted against the transaction, the transaction would not have been consummated.
It has been determined that the number of dissenting shares, if any, will fall
within this range.
In the merger, each outstanding share of VCI Common Stock was exchanged for
HDG Common Stock, at an exchange ratio of approximately 1.151 of a share of HDG
Common Stock to one share of VCI Common Stock. As a result of the merger, VCI
Shareholders collectively acquired approximately 12,473,326 shares of HDG
Common Stock or approximately 89% of the then outstanding HDG Common Stock
excluding Escrow Shares and Treasury Stock. Furthermore, all of the HDG
Escrowed Share and Escrow Option holders converted their Escrow Shares and
Options into Warrants. If less than 75% of the HDG Escrowed share and Escrowed
Option holders had not convert their Escrowed Shares and Options into Warrants,
the transaction would not have been consummated. The merger was accounted for
as a capital transaction, which is equivalent to the issuance of stock by VCI
for HDG's net monetary assets, accompanied by a recapitalization of VCI.
The calculation of the exchange ratio of 1.151 was made based on HDG's Cash
Value of $2,572,600 at the time of the merger. In addition, for purposes of
calculating the exchange ratio, HDG Escrow Shares and Treasury Stock were
excluded.
Further, the calculation of the exchange rate of 1.151 took into
consideration a conversion price of $2.10 for each share of VCI's Series B
Preferred Stock. For example, one share of Series B Preferred Stock purchased
for $100 converted into approximately 47.6 shares of VCI common stock. This
conversion price would have automatically reset to $1.45 per share in the event
that the merger would not have been consummated by October 31, 1999. If the
conversion price would have been reset to $1.45, the exchange ratio would have
decreased.
The pro forma financial information does not purport to be indicative of the
results which would have actually been obtained had such transactions been
completed as of the assumed dates and for the periods presented or which may be
obtained in the future.
62
VIRTUAL COMMUNITIES, INC. (VCI) AND HEURISTIC DEVELOPMENT GROUP, INC. (HDG)
PRO FORMA BALANCE SHEET
AS OF SEPTEMBER 30, 1999
(U.S. Dollars in thousands)
(Unaudited)
Additional
VCI HDG Pro Forma Pro Forma
(Unaudited) (Unaudited) Combined Adjustments Combined Adjustments Combined
----------- ----------- -------- ----------- -------- ------------ -----------
(no dissenting shares) (7% dissenting shares)
ASSETS
------
Current Assets
Cash and cash equivalents... 102 2,377 2,479 (235)(c) 2,244 (1,100)(e) 1,144
Trade receivables........... 278 278 278 278
Other receivables........... 66 310 376 (250)(d) 126 126
------ ------ ------- ------ -----------
Total current assets....... 446 2,687 3,133 2,648 1,547
------ ------ ------- ------ -----------
Fixed Assets, Net............. 586 -- 586 586 586
------ ------ ------- ------ -----------
Severance Pay Deposits........ 79 -- 79 79 79
------ ------ ------- ------ -----------
Other Assets.................. 35 50 85 85 85
------ ------ ------- ------ -----------
Total assets............... 1,146 2,737 3,883 3,398 2,298
====== ====== ======= ====== ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
(DEFICIENCY)
--------------------
Current Liabilities
Short-term bank borrowings.. 396 -- 396 396 396
Short-term loans............ 400 -- 400 (250)(d) 150 150
Payables and
accrued expenses........... 1,693 102 1,795 1,795 1,795
------ ------ ------- ------ -----------
Total current liabilities.. 2,489 102 2,591 2,341 2,341
------ ------ ------- -----------
Long-Term Liabilities
Accrued severance pay ...... 119 -- 119 119 119
------ ------ ------- ------ -----------
Total long-
term liabilities.......... 119 -- 119 119 119
------ ------ ------- ------ -----------
Total liabilities.......... 2,608 102 2,710 2,460 2,460
------ ------ ------- ------ -----------
Shareholders' Equity
(Deficiency)
Share Capital............... 1 21 22 121 (a) 143 (11)(e) 132
Treasury Stock.............. -- (150) (150) 150 (b) -- --
Additional paid-in capital.. 4,441 8,441 12,882 (5,798)(a) 6,779 (1,089)(e) 5,690
(150)(b)
(155)(c)
Accumulated deficit......... (5,904) (5,677) (11,581) 5,677 (a) (5,984) (5,984)
(80)(c)
------ ------ ------- ------ -----------
Total shareholders' equity
(deficiency).............. (1,462) 2,635 1,173 938 (162)
------ ------ ------- ------ -----------
Total liabilities and
shareholders' equity
(deficiency).............. 1,146 2,737 3,883 3,398 2,298
====== ====== ======= ====== ===========
63
VIRTUAL COMMUNITIES, INC. (VCI) AND
HEURISTIC DEVELOPMENT GROUP, INC. (HDG)
PRO FORMA STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(U.S. Dollars in thousands, except share and per share data)
(Unaudited)
VCI HDG
For the nine For the nine Pro Forma Pro Forma
months ended Months ended Adjustments Combined Adjustments Combined
September 30 September 30 (no dissenting (no dissenting (7% dissenting (7% dissenting
1999 1999 shares) shares) shares) shares)
------------ ------------ -------------- -------------- -------------- --------------
(Unaudited)
REVENUES................ 613 -- 613 613
------ --------- ---------- ----------
COST AND EXPENSES
Cost of revenues........ 1,139 -- 1,139 1,139
Selling, general and
Administrative
expenses............... 1,949 594 2,543 2,543
Financing expenses
(income), net.......... 74 (108) (34) (34)
Expenses of merger...... 429 86 (515)(h) -- --
------ --------- ---------- ----------
3,591 572 3,648 3,648
------ --------- ---------- ----------
Net loss................ (2,978) (572) (3,035) (3,035)
====== ========= ========== ==========
Net Loss per share...... (0.36) (0.22) (0.23)
========= ========== ==========
Weighted average number
of shares outstanding.. 1,602,056 14,075,382 (f) 13,202,249 (g)
========= ========== ==========
64
VIRTUAL COMMUNITIES, INC. (VCI) AND
HEURISTIC DEVELOPMENT GROUP, INC. (HDG)
PRO FORMA STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
(U.S. Dollars in thousands, except share and per share data)
(Unaudited)
Pro Forma Pro Forma
Adjustments Combined Adjustments Combined
VCI HDG (no dissenting (no dissenting (7% dissenting (7% dissenting
(Audited) (Audited) shares) shares) shares) shares)
--------- --------- -------------- -------------- -------------- --------------
REVENUES................ 819 -- 819 819
------ --------- ---------- -----------
COST AND EXPENSES
Cost of revenues........ 721 -- 721 721
Selling, general and
administrative
expenses............... 1,341 1,201 2,542 2,542
Financing expenses
(income),
net.................... 191 (173) 18 18
------ --------- ---------- -----------
2,253 1,028 3,281 3,281
------ --------- ---------- -----------
Net loss.............. (1,434) (1,028) (2,462) (2,462)
====== ========= ========== ===========
Net Loss per share...... (0.59) (0.17) (0.19)
========= ========== ===========
Weighted average number
of shares outstanding.. 1,728,114 14,201,440 (f) 13,328,307 (g)
========= ========== ===========
65
NOTES TO PRO FORMA FINANCIAL STATEMENTS
(In thousands, except share data)
(Unaudited)
1) Basis of Presentation
The pro forma balance sheet combines the balance sheets of VCI and HDG as of
September 30, 1999, assuming the merger has been completed as of the balance
sheet date. The merger was actually consummated subsequently on October 29,
1999.
The pro forma statements of operations for the year ended December 31, 1998
and for the nine months ended September 30, 1999 for VCI and HDG, respectively,
reflect the merger, as if the merger had occurred on the first day of the
fiscal year presented and carried forward to the interim period presented,
taking into effect certain events that occurred subsequent to the periods
presented.
Separate combined balance sheets have been presented for each of the
following circumstances: (1) adjusted to reflect pro forma activity, with the
assumption that no VCI stockholder dissents the merger, and (2) adjusted to
reflect pro forma activity, with the assumption that the maximum of 7% VCI
stockholder dissent to the merger. If more than 7% of VCI stockholders had
voted against the transaction, the transaction would not have been consummated.
No pro forma adjustments have been provided for (1) any Options or Warrants
held for conversion into VCI and HDG shares, or (2) payments in lieu of
fractional shares.
The historical balance sheets used in the presentation of the pro forma
financial statements have been derived from VCI's unaudited and HDG's unaudited
financial statements as of September 30, 1999. The historical statements of
operations for the year ended December 31, 1998 and nine months ended September
30, 1999 have been derived from the VCI's audited and unaudited statements of
operations, respectively, and from HDG's audited and unaudited statements of
operations, respectively.
2) Unaudited Pro Forma Adjustments
A description of the adjustments included in the unaudited pro forma
financial statements are as follows:
(a) Reflects the recapitalization of VCI through the elimination of HDG's
accumulation deficit and the adjustment of equity accounts upon the
exchange of VCI Common Stock into 12,473,326 shares of HDG Common
Stock.
(b) Reflects the elimination of HDG's Treasury Stock.
(c) Reflects the payment of an estimated $155 in connection with HDG
expenses, and reflects the payment of an estimated $80 in connection
with VCI expenses for professional services and other expenses in
connection with the merger.
(d) Reflects the elimination of the intercompany Note of $250,000 purchased
by HDG from VCI.
(e) Reflects 7% of the shares of the VCI common stock are not converted
into shares of HDG common stock due to dissenting votes. Accordingly it
is assumed that these VCI stockholders will receive payment at a per
share value of approximately $1.45 instead of HDG shares. The number of
shares not converted represents the maximum number of VCI Common Stock
that may dissent to the merger without precluding the consummation of
the merger.
(f) Reflects the weighted average shares outstanding for HDG of 1,728,114
and 1,602,056, respectively for the year ended December 31, 1998 and
the nine months ended September 30, 1999, plus the number of HDG shares
issued to VCI upon consummation of the merger, in the estimated amount
of 12,473,326, assuming no VCI stockholder dissents the merger.
(g) Reflects the weighted average shares outstanding for HDG of 1,728,114
and 1,602,056, respectively for the year ended December 31, 1998 and
the nine months ended September 30, 1999, plus the number of HDG shares
issued to VCI upon consummation of the merger, in the estimated amount
of 12,473,326, less 873,133, the maximum number of VCI Common Stock
that may dissent the merger without precluding the consummation of the
merger.
(h) Reflects elimination of merger costs recorded in the period presented,
assuming the merger had occurred on the first day of the period.
66
RELATED PARTY TRANSACTIONS
In connection with the signing of the merger agreement, substantially all of
these optionholders signed agreements not to dispose of their securities for a
period of 180 days after the consummation of the merger.
In connection with the merger, our board of directors and stockholders
approved a new 1999 stock incentive plan.
In January 1996, Virtual Communities Israel, Ltd. purchased equipment,
intellectual property rights and contractual rights from Avi Moskowitz, our
President, Chief Executive Officer and Director, and his wife Helen Moskowitz,
in return for an obligation to pay $100,000. In June 1997, Virtual Communities
Israel, Ltd. sold these assets to Virtual Communities, Inc., and we assumed the
payment obligation. In December 1998, Virtual Communities, Inc. permitted the
Moskowitzes to convert $60,000 of this obligation into shares of the company's
common stock at a rate of $.47 per share. Virtual Communities, Inc. paid the
remaining $40,000 to the Moskowitzes in the form of cash and by barter between
May 1998 and January 1999.
In 1996 and 1997, Net Results Holdings, LLC ("NRH") loaned to Virtual
Communities Israel, Ltd., on an interest-free basis, an aggregate of $250,000.
Harry Fox, a former director of Virtual Communities, Inc., is a 33.6%
shareholder of NRH and our Chief Executive Officer and a director. In August
1998, Virtual Communities, Inc. permitted NRH to convert the loan into
1,673,554 shares of Virtual Communities, Inc. common stock at a rate of
approximately $.17 per share. NRH owns approximately 13.5% of our outstanding
capital stock.
In April 1997, Virtual Communities, Inc. borrowed $100,000 from Business
Systems Consultants ("BSC"), an entity that is affiliated with the family of
David Morris, a Virtual Communities, Inc. director. In December 1998, Virtual
Communities, Inc. permitted BSC to convert the principal and accrued interest
of $16,900 into 286,280 shares of Virtual Communities, Inc. common stock at a
rate of $.47 per share. While the original conversion rate on the loan was $.60
per share, Virtual Communities, Inc. lowered the conversion rate as an
incentive to BSC to convert the loan. In consideration of the BSC loan, Virtual
Communities, Inc. also issued to BSC three two-year warrants, each expiring
December 31, 2000, to acquire a total of 220,992 shares of Virtual Communities,
Inc. common stock at exercise prices ranging from $.30 to $.65 per share. In
June 1997, Virtual Communities, Inc. issued BSC a two-year warrant, expiring
December 31, 2000, to acquire 4,834 shares of Virtual Communities, Inc. common
stock at an exercise price of $.60 per share. This warrant was issued in
consideration of a 30-day loan to Virtual Communities, Inc. from BSC in the
amount of $50,000, which Virtual Communities, Inc. repaid in July 1997. In
September 1999, David Morris was issued two three-year warrants to acquire up
to 243,902 shares of common stock at an exercise price of $2.10 per share in
consideration of his father's guarantee of a $500,000 line of credit to Virtual
Communities, Inc..
In June 1997, Peter A. Jacobs, a Virtual Communities, Inc. director, loaned
Virtual Communities, Inc. $50,000. In January 1998, Mr. Jacobs converted this
loan into 95,916 shares of Virtual Communities, Inc. common stock at a rate of
$.60 per share. In February 1998, Mr. Jacobs loaned Virtual Communities, Inc.
an additional $2,706, which amount was converted in December 1998 into 7,207
shares of Virtual Communities, Inc. common stock at the rate of $.47 per share.
At this time, Mr. Jacobs also purchased 61,233 shares of common stock from
Virtual Communities, Inc. for $25,000, or $.47 per share.
During 1997 and 1998, Virtual Communities Israel, Ltd. rented approximately
2,500 square feet of office space and obtained administrative services from
Versaware, Ltd., an Israeli subsidiary of Versaware Technologies, Inc. ("VTI").
Harry Fox, a former director of VCT, is the Chairman and Chief Executive
Officer, and a 31% shareholder, of VTI. Virtual Communities Israel, Ltd. paid
Versaware, Ltd. $97,000 in 1997, and $129,000 in 1998 for this space and these
services. With respect to the Versaware arrangement:
In February 1998, Virtual Communities, Inc. issued to Versaware, Ltd., a
two-year warrant, expiring February 15, 2000, to purchase 16,306 shares of
common stock at an exercise price of $.66. This warrant was
67
issued in consideration of Versaware, Ltd.'s agreement to give Virtual
Communities Israel, Ltd. a 90-day extension for the payment of approximately
$47,000 due to Versaware, Ltd. through May 15, 1998.
In August 1998, Virtual Communities, Inc. issued to Versaware, Ltd. a two-
year warrant, expiring August 24, 2000, to purchase 15,375 shares of common
stock at an exercise price of $.66 in consideration of Versaware, Ltd.'s
agreement to give Virtual Communities Israel, Ltd. a 100-day extension for the
payment of approximately $75,119 due to Versaware, Ltd. through August 24,
1998.
In December 1998, Virtual Communities, Inc. issued to Versaware, Ltd. a two-
year warrant, expiring December 31, 2000, to purchase 40,882 shares of common
stock at an exercise price of $.66 in consideration of Versaware, Ltd.'s
agreement to give Virtual Communities Israel, Ltd. a 125-day extension for the
payment of approximately $115,000 due to Versaware, Ltd. through from September
through December 1998.
In addition, during 1997 and 1998, Virtual Communities, Inc. sublet office
space and obtained office services from NRH. Harry Fox, a former director of
Virtual Communities, Inc., is a 33.6% shareholder of NRH and our Chief
Executive Officer and a director. Pursuant to this arrangement, Virtual
Communities, Inc. paid NRH $9,000 during 1997, and $19,000 during 1998. As of
July 1999, Virtual Communities, Inc. ceased subletting office space from NRH.
In February 1998, Virtual Communities, Inc. borrowed $50,000 from George
Moskowitz, the brother of Avi Moskowitz, our President, Chief Executive Officer
and Director. This convertible loan bore interest at the rate of 10% per annum.
In consideration for the loan and for a 5-month extension of the maturity date,
Virtual Communities, Inc. issued to George Moskowitz a two-year warrant,
expiring February 2000, to purchase 61,233 shares of common stock at an
exercise price of $.66 per share. The loan, and interest thereon, was repaid by
the Virtual Communities, Inc. in January 1999. In August 1998, George Moskowitz
loaned Virtual Communities, Inc. an additional $50,000. This loan bore interest
at the rate of 12% per annum and was due in September 1998. In consideration
for this loan, Virtual Communities, Inc. provided George Moskowitz with $4,200
of goods and services available to Virtual Communities, Inc. through our barter
arrangements with our customers and agreed to issue George Moskowitz 11,510
shares of common stock for each 30-day period the loan remained outstanding
following the maturity date. In December 1998, Virtual Communities, Inc. issued
to George Moskowitz 41,955 shares of common stock in consideration of his
agreement to extend the loan through December 1998. In addition, in December
1998, Mr. Moskowitz converted the principal and accrued interest on the loan
into 128,202 shares of common stock at the rate of $.47 per share.
In February 1999, Virtual Communities, Inc. entered into an employment
agreement with Michael Harwayne, our Vice President of Business Development and
Marketing. Beginning June 1999, Mr. Harwayne's annual salary was adjusted to
$125,000. Pursuant to the agreement, Virtual Communities, Inc. granted to
Mr. Harwayne options to purchase 115,100 shares of our common stock with an
exercise price of $0.81 per share and options to purchase 50,000 shares in
October 1999 at an exercise price of $2.10 per share. Such options vest equally
over three years. Mr. Harwayne is also eligible to receive an additional 57,550
options should Mr. Harwayne meet performance targets as determined by our board
of directors. The agreement may be terminated by either party upon sufficient
notice as provided in the agreement, except that we may terminate Mr. Harwayne
for cause without notice.
In August and September 1999, Virtual Communities Israel, Ltd. increased our
line of credit from Israel General Bank by a total of $500,000 to $560,000. The
additional amount of the line is secured by a guarantee from Conrad Morris, the
father of David Morris, a director of Virtual Communities, Inc.. In
consideration for providing the guarantee, Virtual Communities, Inc. issued to
David Morris two three-year warrants exercisable into a total of 243,902 shares
of common stock at an exercise price of $2.10 per share. One warrant, for the
purchase of 90,435 shares vests quarterly so that 22,609 shares vest for each
quarter the guarantee remains in effect. The other warrant, exercisable into
153,466 shares, vests on a semi-annual basis so that a minimum of 76,733 shares
are exercisable for every half-year that the guarantee remains in effect.
Virtual Communities, Inc. also agreed to pay Conrad Morris a fee equal to two
and one quarter percent (2.25%) of the amount of the line
68
as further consideration for his guarantee. We have agreed to limit Conrad
Morris's guarantee of the line to no more than $100,000.
On December 14, 1999, the Company received a total of $985,400 for the
private placement sale to accredited investors of 400,000 shares of restricted
common stock and a three-year warrant, exercisable for 40,000 shares of common
stock at a purchase price of $2.46 per share. The Company made the private
placement offering under Section 4(2) of the Securities Act of 1933, as amended
(the "Securities Act"). The terms of the offering provided for issuance of the
restricted common stock at a purchase price equal to 35% below the market
valuation of the Company's publicly traded common stock and the issuance of a
warrant exercisable for the purchase of one share of common stock for each ten
shares purchased. The warrants become exercisable six months after the date of
issuance. The restricted shares of common stock and the shares of common stock
to be issued upon exercise of the warrant may be offered for public resale only
if registered under the Securities Act of 1933 or an exemption therefrom. The
Company has agreed to provide the purchasers with certain registration rights
with respect to the restricted common stock and the common stock underlying the
warrants. Such registration rights commence six months from the date of
purchase and if the registration is declared effective by the Securities and
Exchange Commission, public resale of such securities shall be permitted. The
Company paid approximately $50,000 in financial advisory consultant fees
related to the closing of the first tranche of the private placement offering.
The Company expects to continue the private placement offering to accredited
investors in subsequent tranches through the first quarter of 2000, up to an
aggregate amount of $5 million, on terms substantially similar to the first
tranche. The terms and conditions of the private placement offering were duly
authorized by the Company's Board of Directors as being reasonable and in the
best interests of the Company, with particular regard to the Company's need for
operating capital and the limited availability of other reasonable financing
alternatives.
The purchasers of the first tranche of the private placement described above
were Paul and Hannah Lindenblatt, the sister and brother-in-law of Avi
Moskowitz, the Company's chairman of the Board, President and Chief Executive
Officer. The purchasers are not involved in the management or control of the
Company nor are they otherwise affiliated with the Company or its management,
and their respective holdings of common stock after such purchase represent in
the aggregate less than 5% of outstanding shares of the Company's common stock.
The sale of the first tranche of the private placement to the purchasers was
made without regard to any familial relationship, at arms length, on the same
terms and conditions of the private placement offering to other accredited
investors.
DESCRIPTION OF SECURITIES
As of the date of this prospectus, our authorized capital stock consists of
50,000,000 shares of common stock, par value $.01 per share, and 5,000,000
shares of "blank check" preferred stock, par value $.01 per share. No other
classes of capital stock are authorized under our certificate of incorporation.
Common stock
The issued and outstanding shares of our common stock are duly authorized,
validly issued and nonassessable. Holders of the our common stock have no
preemptive, redemption, conversion, subscription or sinking fund rights. The
holders are entitled to receive dividends when and as declared by our board of
directors out of funds legally available for payment. Upon our liquidation,
dissolution or winding up, the holders of our common stock may share ratably in
our assets, subject to the rights and preferences of any outstanding preferred
stock.
Each holder of our common stock is entitled to one vote per share of common
stock held of record by such holder. Our common stockholders do not have any
right to cumulate votes for the election of our directors.
69
Preferred Stock
Our board of directors has the power, without further vote of the
stockholders, to authorize the issuance of up to 5,000,000 shares of preferred
stock and to fix the terms, limitations, rights, privileges and preferences of
any of these shares of preferred stock. This power includes the ability to
establish voting, dividend, redemption, conversion, liquidation and other
rights and preferences for any or these shares. There are presently no shares
of preferred stock outstanding.
Redeemable Warrants
Class A Warrants. Each class A warrant entitles the registered holder to
purchase one share of common stock and one class B warrant at an exercise price
of $6.50 at any time until 5:00 P.M., New York City time, on February 10, 2002.
The class A warrants are redeemable on 30 days' written notice at a redemption
price of $.05 per class A warrant if the "closing price" of our common stock
for any 30 consecutive trading days ending within 15 days of the notice of
redemption averages in excess of $9.10 per share. "Closing price" means the
closing bid price if listed in the over-the-counter market on NASDAQ or
otherwise or the closing sale price if listed on the NASDAQ National Market or
a national securities exchange. All class A warrants must be redeemed if any
are redeemed.
Class B Warrants. Each class B warrants entitles the registered holder to
purchase one share of common stock at an exercise price of $8.75 at any time
after issuance until 5:00 P.M. New York City Time, on February 10, 2002. The
class B warrants are redeemable on 30 days' written notice at a redemption
price of $.05 per class B warrants, if the closing price (as defined above) of
our common stock for any 30 consecutive trading days ending within 15 days of
the notice of redemption averages in excess of $12.25 per share. All class B
warrants must be redeemed if any are redeemed.
General. The warrants provide for adjustment of the exercise price and for a
change in the number of shares issuable upon exercise to protect holders
against dilution in the event of a stock dividend, stock split, combination or
reclassification of the common stock or upon issuance of shares of common stock
at prices lower than the market price of the common stock, with exceptions.
We have reserved from our authorized but unissued shares a sufficient number
of shares of common stock for issuance upon the exercise of the class A
warrants and the class B warrants. Shares issued upon exercise of warrants and
payment in accordance with the terms of the warrants will be fully paid and
non-assessable.
For the life of the warrants, the holders thereof have the opportunity to
profit from a rise in the market value of the common stock, with a resulting
dilution in the interest of all other stockholders. So long as the warrants are
outstanding, the terms on which we could obtain additional capital may be
adversely affected. The holders of the warrants might be expected to exercise
them at a time when we would, in all likelihood, be able to obtain any needed
capital by a new offering of securities on terms more favorable than those
provided for by the warrants.
The warrants do not confer upon the warrantholder any voting or other rights
of a stockholder of the company. Upon notice to the warrantholders, we have the
right to reduce the exercise price or extend the expiration date of the
warrants.
Unit Purchase Options
We granted to the underwriter and a finder in connection with our initial
public offering a unit purchase option and a finder's unit purchase option,
respectively, to purchase up to an aggregate of 120,000 units. These units
consist of one share of common stock, one redeemable class A warrant and one
redeemable class B warrants. The class A warrants and the class B warrants
included in the unit purchase option and the finder's unit purchase option will
only be subject to redemption at any time after the unit purchase option and
the finder's unit purchase option have been exercised and the underlying
warrants are outstanding. The unit
70
purchase option and the finder's unit purchase option are exercisable during
the three-year period commencing February 11, 1999 at an exercise price of
$6.00 per unit (120% of the initial public offering price) subject to
adjustment to protect against dilution.
Transfer Agent
American Stock Transfer & Trust company, New York, New York, serves as
transfer agent for the shares of common stock and warrant agent for the
warrants.
Registration Rights
We have agreed upon request to register under the Securities Act during the
four-year period commencing February 11, 1998, on two separate occasions, the
securities issuable upon exercise of the unit purchase option and the finder's
unit purchase option, the initial such registration to be at our expense and
the second at the expense of the holders. We have also granted "piggyback"
registration rights to holders of the unit purchase option and finder's unit
purchase option.
INDEMNIFICATION AND INSURANCE
We indemnify and hold harmless our and our subsidiaries' present and former
officers and directors, including former officers and directors of Heuristic
Development Group and pre-merger Virtual Communities, Inc., and its
subsidiaries, against any costs or expenses to the fullest extent permitted by
Delaware law. Also, the rights of present and former directors and officers to
indemnification under the respective companies' former certificates of
incorporation, bylaws and similar documents will continue in force for a period
of six years after October 29, 1999, the effective time of the merger of the
companies. For a period of six years after the effective time of the merger, we
will maintain in effect policies of directors' and officers' liability
insurance covering acts and omissions occurring prior to the effective time of
the merger for the benefit of present and former directors and officers, on
terms no less favorable than those provided by the companies prior to their
merger.
LEGAL MATTERS
The validity of our common stock to be issued upon exercise of the warrants,
if and when such warrants are exercised, will be passed upon for us by Wuersch
& Gering LLP.
EXPERTS
The financial statements of Heuristic Development Group, Inc. as of December
31, 1998 and for each of the years in the two year period ended December 31,
1998, and for the period from July 20, 1994 (Heuristic Development Group,
Inc.'s inception) through December 31, 1998, appearing in this prospectus and
in the registration statement of which this prospectus is a part, have been
audited by Richard A. Eisner & Company, LLP, as set forth in their report
thereon that appears elsewhere in this prospectus, and are included in reliance
upon such report given on the authority of such firm as experts in accounting
and auditing.
The consolidated financial statements of Virtual Communities, Inc., as of
December 31, 1997 and 1998 and for the years then ended included in this
prospectus and elsewhere in the registration statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
report with respect thereto and are included herein in reliance upon the
authority of said firm as experts in giving said report. Reference is made to
said report, which includes an explanatory paragraph with respect to the
uncertainty regarding our ability to continue as a going concern as discussed
in Note 1 to the financial statements.
71
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
any reports, statements or other information that we file at the Commission's
public reference rooms in Washington, D.C., New York, New York and Chicago,
Illinois. Please call the Commission at 1-800-SEC-0330 for further information
on the public reference rooms. Our public filings are also available to the
public from commercial document retrieval services and at the Web site
maintained by the Commission at "http://www.sec.gov." Reports, proxy statements
and other information concerning our company also may be inspected at the
offices of the National Association of Securities Dealers, Inc., 1735 K Street,
N.W., Washington, D.C. 20006.
We have filed with the Securities and Exchange Commission a registration
statement on Form SB2 with respect to the securities to be issued in the
offering described in this prospectus. This prospectus is a part of that
registration statement. As allowed by Commission rules, this prospectus does
not contain all the information that stockholders can find in the registration
statement or the exhibits to the registration statement.
72
APPENDIX A
HEURISTIC DEVELOPMENT GROUP, INC.
FINANCIAL STATEMENTS FOR THE YEAR ENDING
DECEMBER 31, 1998 AND FOR THE PERIOD FROM
JULY 20, 1994 THROUGH DECEMBER 31, 1998
A-1
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Heuristic Development Group, Inc.
Manhattan Beach, California
We have audited the accompanying balance sheet of Heuristic Development
Group, Inc. (a development stage company) as of December 31, 1998, and the
related statements of operations, changes in stockholders' equity (capital
deficiency) and cash flows for each of the years in the two-year period then
ended and for the period from July 20, 1994 (inception) through December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards required that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements enumerated above present fairly, in
all material respects, the financial position of Heuristic Development Group,
Inc. at December 31, 1998 and the results of its operations and cash flows for
each of the years in the two-year period then ended and for the period from
July 20, 1994 (inception) through December 31, 1998 in conformity with
generally accepted accounting principles.
As described in Note A the Company has decided to pursue a strategy of an
investment in, or acquisition of, an existing company. However, there can be no
assurances that an appropriate investment or acquisition will be identified.
Richard A. Eisner & Company, LLP
New York, New York
February 5, 1999
A-2
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
BALANCE SHEET
December 31, 1998
ASSETS
Current assets:
Cash and cash equivalents........................................... $3,140,000
Prepaid expenses and other current assets........................... 32,000
----------
Total current assets................................................ $3,172,000
----------
Capitalized software costs.......................................... 50,000
Furniture and equipment (net of accumulated depreciation)........... 12,000
Organizational costs (net of accumulated amortization).............. 4,000
----------
TOTAL............................................................... $3,238,000
==========
LIABILITIES
Current liabilities:
Accounts payable.................................................... $ 18,000
Accrued expenses.................................................... 12,000
----------
Total current liabilities........................................... 30,000
----------
STOCKHOLDER'S EQUITY
Preferred stock--$ .01 par value, authorized 5,000,000 shares;
issued and outstanding none
Common stock--$ .01 par value, authorized 20,000,000 shares;
issued 2,101,326 shares (includes 349,370 shares held in
escrow).......................................................... 21,000
Additional paid-in capital........................................ 8,441,000
Deficit accumulated during the development stage.................. (5,104,000)
-----------
3,358,000
(150,000)
Treasury stock at cost (149,900 shares)...........................
-----------
Total stockholders' equity.................................... 3,208,000
-----------
TOTAL....................................................... $ 3,238,000
===========
The accompanying notes to financial statements are an integral part hereof.
A-3
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
STATEMENTS OF OPERATIONS
July 20,
1994
(Inception)
through
Year Ended December 31, December
------------------------ 31,
1997 1998 1998
----------- ----------- -----------
Costs and expenses:
Research and development:
Direct expenditures.................... $ 338,000
Payments under research services
agreement............................. 137,000
-----------
Total research and development......... 475,000
General and administrative............ $ 1,050,000 $ 638,000 3,399,000
Loss on sale and write down of
equipment............................ 178,000 7,000 185,000
Write down of capitalized software to
estimated net realizable value........ 456,000 456,000
Acquisition breakup fee................ 100,000 100,000
----------- ----------- -----------
Total costs and expenses............... 1,228,000 1,201,000 4,615,000
----------- ----------- -----------
(Loss) from operations................. (1,228,000) (1,201,000) (4,615,000)
Interest expense and amortization of
debt discount and expense............. (406,000) (2,000) (748,000)
Interest income........................ 193,000 175,000 381,000
----------- ----------- -----------
Net (loss) / Comprehensive (loss)...... $(1,441,000) $(1,028,000) $(4,982,000)
=========== =========== ===========
Net (loss) per share--Basic and
Diluted........................... $ (0.91) $ (0.59)
=========== ===========
Weighted average shares outstanding.... 1,581,160 1,728,114
=========== ===========
The accompanying notes to financial statements are an integral part hereof.
A-4
HEURISTIC DEVELOPMENT GROUP, INC.
(A development stage company)
STATEMENTS OF CASH FLOWS
July 20, 1994
Year Ended December 31, (Inception) to
------------------------ December 31,
1997 1998 1998
----------- ----------- --------------
Cash flows from operating activities:
Net (loss)........................... $(1,441,000) (1,028,000) (4,982,000)
Adjustments to reconcile net (loss)
to net cash (used in) operating
activities:
Depreciation and amortization........ 51,000 12,000 153,000
Loss on sale and write down of
equipment........................... 178,000 7,000 185,000
Write down of capitalized software to
estimated net realizable value...... 456,000 456,000
Acquisition breakup fee.............. 100,000 100,000
Value of preferred stock charged to
research and development............ 50,000
Amortization of loan acquisition
costs............................... 95,000 160,000
Amortization of debt discount........ 297,000 500,000
Fair value of options granted........ 236,000
Accrued interest on notes payable--
stockholders........................ 64,000
Changes in operating assets and
liabilities:
(Increase)/decrease in prepaid
expenses and other current assets... (68,000) 50,000 (71,000)
(Decrease)/increase in accounts
payable and accrued expenses........ (164,000) 4,000 24,000
----------- ----------- ----------
Net cash (used in) operating
activities.......................... (1,052,000) (399,000) (3,125,000)
----------- ----------- ----------
Cash flows from investing activities:
Deposit for letter of intent......... (100,000) (100,000)
Acquisition of fixed assets.......... (59,000) (7,000) (337,000)
Capitalized software costs........... (179,000) (506,000)
Proceeds from sale of equipment...... 13,000 11,000 24,000
----------- ----------- ----------
Net cash (used in) investing
activities.......................... (225,000) (96,000) (919,000)
----------- ----------- ----------
Cash flows from financing activities:
Proceeds from sale of common stock
and exercise of options............. 6,900,000 419,000
Proceeds from the sale of preferred
stock............................... 550,000
Proceeds from borrowings--notes
payable--stockholders............... 1,194,000
Proceeds from Bridge notes........... 1,000,000
Repayment of Bridge notes............ (1,000,000) (1,000,000)
Initial public offering expenses..... (1,201,000) 5,501,000
Repayment of notes payable--
stockholders........................ (170,000) (170,000)
Loan acquisition costs............... (160,000)
Purchase of treasury stock........... (150,000) (150,000)
----------- ----------- ----------
Net cash provided by (used in)
financing activities................ 4,529,000 (150,000) 7,184,000
----------- ----------- ----------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS..................... 3,252,000 (645,000) 3,140,000
Cash and cash equivalents--beginning
of period............................ 533,000 3,785,000
----------- ----------- ----------
Cash and cash equivalents--end of
period............................... $ 3,785,000 $ 3,140,000 3,140,000
=========== =========== ==========
Supplemental and noncash disclosures:
Warrants issued in connection with
Bridge notes........................ 500,000
Common stock issued for conversion of
debt, accrued interest, preferred
stock and preferred dividends....... 1,084,000 1,084,000
Initial public offering expenses
charged to additional paid-in
capital............................. 198,000
Interest paid........................ 14,000 2,000 16,000
The accompanying notes to financial statements are an integral part hereof.
A-5
HEURISTIC DEVELOPMENT GROUP, INC.
(A development stage company)
STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY
Preferred Stock Common Stock Deficit Accumulated
Par Value $.01 Par Value $.01 Treasury Stock Additional During the Development
----------------- ------------------ ------------------- Paid-in ------------------------
Shares Amt Shares Amount Shares Amount Capital Stage Total
--------- ------- --------- ------- -------- --------- ---------- ----------- -----------
Issuance of common stock
for cash in August
1994................... 212,456 $ 2,000 $ 68,000 $ 70,000
Issuance of preferred
stock for cash in
August 1994............ 550 $ -- 550,000 550,000
Issuance of preferred
stock in connection
with obtaining
assignment rights to
developed technology in
August 1994............ 50 -- 50,000 50,000
Net (loss) for the
period from July 20,
1994 (inception) to
December 31, 1994...... $ (230,000) (230,000)
------- ------- --------- ------- -------- --------- ---------- ----------- -----------
Balance--December 31,
1994................... 600 -- 212,456 2,000 668,000 (230,000) 440,000
Surrentder of common
stock in October 1995.. (17,928)
Exercise of options in
December 1995.......... 81,947 1,000 299,000 300,000
Net (loss) for the year
ended December 31,
1995................... (876,000) (876,000)
------- ------- --------- ------- -------- --------- ---------- ----------- -----------
Balance--December 31,
1995................... 600 -- 276,475 3,000 967,000 (1,106,000) (136,000)
Exercise of options in
March 1996............. 30,733 10,000 10,000
Issuance of common stock
for cash in March
1996................... 9,218 37,000 37,000
Surrender of common
stock in March 1996.... (21,770)
Surrender of common
stock in June 1996..... (15,239)
Exercise of options in
August 1996............ 5,358 2,000 2,000
Surrender of common
stock in August 1996... (3,163)
Compensation expense in
connection with grant
of options in August
1996................... 236,000 236,000
Warrants issued in
connection with Bridge
notes.................. 500,000 500,000
Net (loss) for the year
ended December 31,
1996................... (1,407,000) (1,407,000)
------- ------- --------- ------- -------- --------- ---------- ----------- -----------
Balance--December 31,
1996................... 600 -- 281,612 3,000 1,752,000 (2,513,000) (758,000)
Proceeds of Initial
Public Offering, net of
expenses, in February
1997................... 1,380,000 14,000 5,487,000 5,501,000
Conversion of debt,
accrued interest,
preferred stock, and
preferred dividends to
common stock in
February 1997.......... (600) -- 439,714 4,000 1,202,000 (122,000) 1,084,000
Net (loss) for the year
ended
December 31,1997....... (1,441,000) (1,441,000)
------- ------- --------- ------- -------- --------- ---------- ----------- -----------
Balance--December 31,
1997 -- -- 2,101,326 21,000 $8,441,000 $(4,076,000) $ 4,386,000
Purchase of Treasury
stock.................. (149,900) $(150,000) (150,000)
Net (loss) for the year
ended December 31,
1998................... (1,028,000) (1,028,000)
------- ------- --------- ------- -------- --------- ---------- ----------- -----------
Balance--December 31,
1998.................. -- $ -- 2,101,326 $21,000 (149,900) $(150,000) $8,441,000 $(5,104,000) $ 3,208,000
======= ======= ========= ======= ======== ========= ========== =========== ===========
The accompanying notes to financial statements are an integral part hereof.
A-6
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
NOTE A--THE COMPANY AND BASIS OF PRESENTATION:
Heuristic Development Group, Inc. (the "Company"), is a development stage
company. The Company is engaged in the development and marketing of the
IntelliFit software, a product which generates personalized exercise
prescriptions based on, among other things, an individual's weight, ability,
medical history, goals, fitness level and exercise preferences, and tracks and
records fitness progress. The IntelliFit software interacts with a user by
applying algorithms to an individual's personal profile and adjusting a user's
exercise prescription based on progress, frequency of workouts and other
variables. The Company believes that this interactive feature helps motivate
users to continue exercising, and allows users to reach their goals more
quickly.
To date, the Company has been engaged primarily in research and development
activities relating to the IntelliFit software and has conducted only limited
marketing activities. The Company believes that product development has been
substantially completed and that the IntelliFit software is a viable product
for a company which has complementary products and an existing field sales
department. The Company has therefore initiated discussions with OEM customers
regarding the sale or licensing of the IntelliFit software for incorporation
into the OEM customers existing product lines. The Company has not yet
generated any significant revenue.
Additionally, the Company believes that the year 2000 issue has been
adequately addressed during development of the product and will not affect its
usefulness.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As reflected in the accompanying
financial statements, the Company has incurred substantial losses since
inception and such losses are expected to continue during the development
stage.
In February 1997, the Company successfully completed its initial public
offering ("IPO") and received net proceeds of $5.5 million. In connection with
the IPO (i) all of the Series A preferred stock ($600,000) together with
accrued dividends of $122,000 through August 31, 1996 were converted into
175,793 shares of common stock and (ii) notes payable--stockholders and accrued
interest aggregating $1,084,000 were converted into 263,921 shares of common
stock.
NOTE B--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
[1] CAPITALIZED SOFTWARE COSTS:
In accordance with Statement of Financial Accounting Standards No. 86, the
Company capitalizes certain costs associated with the development of computer
software. Such costs will be amortized over their estimated useful lives
commencing with sales of the software products.
Development costs incurred prior to achievement of technological feasibility
were expensed.
[2] FURNITURE AND EQUIPMENT:
Furniture and equipment are carried at cost. Depreciation is provided using
the straight-line method over the useful lives of the assets which range from
three to seven years.
[3] INCOME TAXES:
The Company has applied to the accompanying financial statements provisions
required by accounting standards which require the use of the liability method
of accounting for income taxes. Deferred taxes are recognized for temporary
differences in the recognition of income and expenses for financial reporting
and
A-7
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
income tax purposes, principally due to capitalized start up costs and
compensation expense in connection with the grant of options.
[4] CASH EQUIVALENTS:
The Company considers all highly liquid investments with a maturity of three
months or less to be cash equivalents. Cash and cash equivalents are held at a
national bank which is highly capitalized.
[5] NET LOSS PER SHARE AND SUPPLEMENTAL NET LOSS PER SHARE OF COMMON STOCK:
During 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" ("SFAS No. 128"). SFAS No. 128 requires the
reporting of earnings per basic share and earnings per diluted share. Earnings
per basic share are calculated by dividing net income (loss) by the weighted
average outstanding shares during the period. Earnings per diluted share are
calculated by dividing net income (loss) by the basic shares and all dilutive
securities including options. Adoption of SFAS No. 128 had no effect on prior
periods.
The Company has not included potential common shares in the diluted per
share computation as the result would be antidilutive. As described in Note
E(3), the stockholders have agreed to place 349,370 shares in escrow and
accordingly, such shares have been excluded from the computation.
Supplemental net loss per share in 1996 gives effect to the conversion in
1997 of preferred stock and notes payable--stockholders into common stock as if
such transactions had occurred on January 1, 1996. (Note A)
[6] USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reporting period.
Actual results could differ from those estimates.
[7] STOCK BASED COMPENSATION:
During 1996, the Company implemented Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
The provisions of SFAS No. 123 allow companies to either expense the estimated
fair value of stock options or to continue to follow the intrinsic value method
set forth in APB Opinion 25, "Accounting for Stock Issued to Employees" ("AAPB
25") but disclose the pro forma effects on net income (loss) had the fair value
of the options been expensed. The Company has elected to continue to apply APB
25 in accounting for its stock option incentive plans (Note E [2]).
[8] ORGANIZATIONAL COSTS:
Organizational costs incurred by the Company are being amortized over five
years.
[9] FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying value of cash and cash equivalents and accounts payable
approximates fair value because of the short-term maturity of those
instruments.
A-8
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE C--FURNITURE AND EQUIPMENT:
Furniture and equipment are summarized as follows:
Computer Equipment.................................................. $ 5,000
Furniture, fixtures and software.................................... 14,000
Office equipment.................................................... $30,000
-------
$49,000
Less accumulated depreciation....................................... 22,000
Balance......................................................... $27,000
=======
During 1997, management decided to sell excess office equipment and selected
components of the IntelliFit System. As a result of such sales, the Company
decided to write down the remaining physical components and housings of the
IntelliFit System and shorten their estimated useful lives to one year. The
loss of $178,000 on the sale and write down of this equipment was recorded in
1997.
NOTE D--REPAYMENT OF NOTES PAYABLE--STOCKHOLDERS AND BRIDGE LOAN
In February 1997, the company repaid $170,000 of notes payable--stockholders
and approximately $1,084,000 of notes payable--stockholders, including accrued
interest, was converted to 263,921 shares of common stock.
Additionally, Bridge notes of $1,000,000 and related interest were repaid.
NOTE E--STOCKHOLDERS' EQUITY:
[1] PREFERRED STOCK:
In August 1994, the Company authorized and issued 600 shares of its $.01 par
value Series A preferred stock the "Series A Preferred". The authorized capital
for the preferred stock was increased to 5,000,000 shares with a par value of
$.01 per share. In conjunction with the IPO all of the Series A preferred stock
($600,000) together with accrued dividends of $122,000 were converted into
175,793 shares of common stock.
[2] STOCK OPTION PLANS:
The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options. Under APB 25, where the exercise
price of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation is recognized.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123. Such information has been determined as if the
Company had accounted for its employee stock options under the fair value
method of that statement. The effect of applying SFAS No. 123 on 1996 and 1997
pro forma net income is not necessarily representative of the effects on
reported net income for future years due to, among other things:
(1) the vesting period of the stock options and the (2) fair value of
additional stock options in future years. The weighted average fair value of
the options granted during 1996 and 1997 are estimated as $1.19 and $1.91,
respectively, on the date of grant using the Black-Scholes option-pricing model
with the following assumptions:
1996 1997
---- ----
Dividend yield................................................... 0% 0%
Expected volatility.............................................. 0.30 0.30
Risk-free interest rate.......................................... 6.0 % 6.14%
Expected life in years........................................... 3 5
A-9
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
Had compensation cost for the Company's stock option plans been determined
based upon the fair value at the grant date for awards under the plans
consistent with the methodology prescribed under SFAS No.123, the Company's net
loss and net loss per share including pro forma amounts would have been as
follows:
1996 1997
----------- -----------
Net Loss As Reported.............................. $(1,407,000) $(1,441,000)
Pro forma......................................... (1,413,000) (1,451,000)
Net Loss per share As Reported.................... (3.78) (0.91)
Pro forma......................................... (3.80) (0.92)
The Company's Stock Option Plan (the "Plan") adopted in October 1996,
provides for issuance of 250,000 shares of the Company's common stock. In
October 1996, options to purchase 200,000 shares of common stock at $5.00 per
share were granted to officers/stockholders exercisable in four equal annual
installments commencing one year from the date of grant. None of these options
were exercised and all 200,000 of these options were rescinded upon the
resignation of these officers/stockholders from the Company during 1997.
The Plan provides for grant of options to employees, officers, directors and
consultants of the Company. Options may be either "incentive stock options"
within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended or nonqualified options. The Plan expires in October 2006. Incentive
options granted under the Plan are exercisable for a period of up to 10 years
from the date of grant at an exercise price which is not less than the fair
market value of the common stock on the date of the grant, except that the term
of an incentive option granted under the Plan to a stockholder owning more than
10% of the outstanding voting power may not exceed five years and its exercise
price may not be less than 110% of the fair market value of the common stock on
the date of the grant.
Upon effectiveness of the IPO in 1997, the Company granted five-year options
to purchase 6,000 shares of common stock to directors. Such options are
exersisable at $5.00 per share commencing on year from the date of grant.
Additional information with respect to stock option activity is summarized
as follows:
Weighted
Average
Shares Price Expiration Date
-------- ----- --------------------------
Granted--year ended December 31,
1994........................... 115,359 $2.70 December 1995--August 1996
Granted--year ended December 31,
1995........................... 2,679 $ .33 August 1997--August 1999
Exercised--year ended December
31, 1995....................... (81,947) $3.67
Balance at December 31, 1995.... 36,091 $ .33 May 1996--August 1999
Granted--August 1996............ 78,674 $ .50 August 2006
Granted--October 1996........... 200,000 $5.00 October 1997--October 2000
Exercised--year ended December
31, 1996....................... (36,091) $ 33
Balance at December 31, 1996.... 278,674 $3.73 October 1997--August 2001
Granted--February 1997.......... 6,000 $5.00 February 2002
Rescinded--year ended December
31, 1997....................... (200,000) $5.00
Balance at December 31, 1997.... 84,674 $ .82
=====
A-10
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
For the options issued in August 1996 to two former officers/stockholders,
the Company has recorded related compensation expense of $236,000. In
connection with the public offering certain of these options are subject to
escrow provisions as a condition of the offering (NOTE E[3]).
[3] ESCROW SHARES/OPTIONS:
In connection with the public offering, the underwriter had required, as a
condition of the offering, that an aggregate of 349,370 shares of the Company's
common stock and outstanding options to purchase 50,630 shares be placed in
escrow until certain pretax income levels or market value targets are met. The
escrow shares and escrow options will be released from escrow upon the Company
meeting a minimum pretax income as defined, ranging from $3.3 million to $5.7
million for the years ending December 31, 1998 to December 31, 2000 or if the
bid price of the Company's common stock averages in excess of $12.50 per share
for 30 consecutive business days during the first period ended August 11, 1998
and $16.75 per share during the period ended February 11, 2001. If the
conditions are not met by March 31, 2001, all shares remaining in escrow will
be returned to the Company as treasury shares for cancellation. There will be a
nondeductible charge to earnings for the fair value of these shares and options
upon their release.
[4] WARRANTS:
In connection with the sale of bridge notes in December 1996, the Company
issued warrants for the purchase of 500,000 shares of common stock. Upon
completion of the IPO, the warrants were converted into Class A Warrants as
described in Note F.
NOTE F--SALE OF COMMON STOCK:
In February and March 1997, the Company sold 1,380,000 units, resulting in
net proceeds to the Company of $5.5 million. Each unit ("unit") offered by the
Company consists of one share of common stock, $.01 par value ("Common Stock"),
one redeemable Class A warrant ("Class A Warrants") and one redeemable Class B
warrant ("Class B Warrants"). Each Class A Warrant entitles the holder to
purchase one share of Common Stock and one Class B Warrant at an exercise price
of $6.50, subject to adjustment, at any time until February 14, 2002. Each
Class B Warrant entitles the holder to purchase one share of Common Stock at an
exercise price of $8.75, subject to adjustment, at any time until February 14,
2002. Commencing one year from the date of issuance the Class A Warrants and
Class B Warrants (collectively, the "Warrants") are subject to redemption by
the Company at a redemption price of $.05 per Warrant on 30 days written
notice, provided the closing bid price of the Common Stock averages in excess
of $9.10 per share in the case of Class A Warrants and $12.25 per share in the
case of Class B Warrants for any 30 consecutive trading days ending within
15 days of the notice of redemption.
NOTE G--COMMITMENTS AND OTHER MATTERS:
RESEARCH SERVICES AGREEMENT:
Pursuant to an agreement, expiring on December 31, 1998, to assist the
Company in updating, designing, developing and implementing the software system
used in the IntelliFit System, the Company paid the following amounts to a
related party:
PERIOD/YEAR ENDED AMOUNT
----------------- --------
December 31, 1994................................................... $ 20,000
December 31, 1995................................................... 110,000
December 31, 1996................................................... 244,000
December 31, 1997................................................... 179,000
A-11
HEURISTIC DEVELOPMENT GROUP, INC.
(a development stage company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
EMPLOYMENT AGREEMENT:
The Company has a three year employment agreement with an officer providing
for an annual base salary of $90,000 commencing February 1, 1997. The agreement
provides for a bonus at the discretion of the Board of Directors and severance
salary.
RELATED PARTY TRANSACTIONS:
The Company paid $40,000 to the President and stockholder of the Company for
consulting services performed during 1997.
NOTE H--INCOME TAXES:
At December 31, 1996 and December 31, 1997, the Company had available net
operating loss carryforwards to reduce future taxable income of approximately
$1,584,000 and $3,309,000, respectively. The net operating loss carryforwards
expire in various amounts through 2012. The Company's ability to utilize its
net operating loss carryforwards is subject to annual limitations as required
under Section 382 of the Internal Revenue Code pursuant to ownership change
arising during 1997 from the IPO and conversion of preferred stock and notes
payable into common stock.
At December 31, 1996 and December 31, 1997, the Company has deferred tax
assets of approximately $963,000 and $1,497,000, respectively, representing the
benefits of its net operating loss carryforwards and deferred taxes resulting
from capitalized start-up costs and compensation expense in connection with the
grant of options. The Company has provided a 100% valuation allowance for such
assets since the likelihood of realization cannot be determined.
A-12
APPENDIX B
VIRTUAL COMMUNITIES, INC.
(PREVIOUS NAME: HEURISTIC DEVELOPMENT GROUP, INC.)
FINANCIAL STATEMENTS FOR THE PERIOD ENDING SEPTEMBER 30, 1999
AND FOR THE PERIOD FROM JULY 20, 1994 THROUGH SEPTEMBER 30, 1999
(Unaudited)
B-1
VIRTUAL COMMUNITIES, INC.
(Previous Name: HEURISTIC DEVELOPMENT GROUP, INC.)
(a development stage company)
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, 1999
(Unaudited)
September 30, December 31,
1999 1998
------------- ------------
ASSETS
------
Current assets:
Cash and cash equivalents........................... $ 2,377,000 $ 3,140,000
Short term loan to VCI.............................. 250,000 --
Prepaid expenses and other current assets........... 60,000 32,000
----------- -----------
Total current assets................................ 2,687,000 3,172,000
Capitalized software costs.......................... 50,000 50,000
Furniture and equipment (net of accumulated
depreciation)...................................... -- 12,000
Organizational costs (net of accumulated
amortization)...................................... -- 4,000
----------- -----------
TOTAL ASSETS........................................ $ 2,737,000 $ 3,238,000
=========== ===========
LIABILITIES
-----------
Current liabilities:
Accounts payable.................................... $ 11,000 $ 18,000
Accrued expenses.................................... 91,000 12,000
----------- -----------
Total current liabilities........................... 102,000 30,000
----------- -----------
STOCKHOLDERS' EQUITY
--------------------
Preferred stock--$ .01 par value, authorized
5,000,000 shares issued and outstanding none
Common stock--$ .01 par value, authorized 20,000,000
shares issued and outstanding 2,101,326 shares
(includes 349,370 shares held in escrow) at
September 30, 1999 and December 31, 1998........... 21,000 21,000
Additional paid-in capital.......................... 8,441,000 8,441,000
Accumulated Deficit during the development stage.... (5,677,000) (5,104,000)
----------- -----------
2,785,000 3,358,000
Treasury stock (149,900 shares) at September 30,
1999 and December 31, 1998......................... (150,000) (150,000)
----------- -----------
Total stockholders' equity........................ 2,635,000 3,208,000
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...... $ 2,737,000 $ 3,238,000
=========== ===========
B-2
VIRTUAL COMMUNITIES, INC.
(Previous Name: HEURISTIC DEVELOPMENT GROUP, INC.)
(A DEVELOPMENT STAGE COMPANY)
CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended July 20, 1994
September 30 September 30 (Inception) to
-------------------- ---------------------- September 30,
1998 1999 1998 1999 1999
--------- --------- ----------- --------- --------------
Costs and expenses:
Research and
development:
Direct expenditures..... $ 338,000
Payments under research
services agreement..... 137,000
-----------
Total research and
development............ 475,000
General and
administrative........ $ 124,000 $ 235,000 $ 438,000 $ 667,000 4,079,000
Loss on sale and write
down of equipment..... 7,000 13,000 185,000
Write down of
capitalized software
to estimated net
realizable value...... 456,000 456,000 456,000
Acquisition breakup
fee.................... 100,000 100,000 100,000
--------- --------- ----------- --------- -----------
Total costs and
expenses............... 680,000 235,000 1,001,000 680,000 5,295,000
--------- --------- ----------- --------- -----------
Loss from operations.... (680,000) (235,000) (1,001,000) (680,000) (5,295,000)
Interest expense and
amortization of debt
discount and expense... (2,000) -- (2,000) -- (748,000)
Interest income......... 42,000 45,000 138,000 108,000 489,000
--------- --------- ----------- --------- -----------
Net loss................ $(640,000) $(190,000) $ (865,000) $(572,000) $(5,554,000)
========= ========= =========== ========= ===========
Net loss per share--
Basic and Diluted.. $ (0.37) (0.12) (0.49) (0.36)
========= ========= =========== =========
Weighted average shares
outstanding............ 1,743,789 1,602,056 1,749,234 1,602,056
========= ========= =========== =========
B-3
VIRTUAL COMMUNITIES, INC.
(Prior Name: HEURISTIC DEVELOPMENT GROUP, INC.)
(A Development Stage Company)
STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended July 20, 1994
September 30, (Inception) to
----------------------- September 30,
1998 1999 1999
---------- ----------- --------------
Cash flows from operating activities:
Net loss............................. $ (865,000) (572,000) (5,554,000)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Depreciation and amortization....... 8,000 2,000 170,000
Loss on sale and write down of
equipment.......................... 7,000 13,000 185,000
Write down of capitalized software
to estimated net realizable value.. 456,000 456,000
Deposit for letter of intent........ 100,000 100,000
Value of preferred stock charged to
research and development........... 50,000
Amortization of loan acquisition
costs.............................. 160,000
Amortization of debt discount....... 500,000
Fair value of options granted....... 236,000
Accrued interest on notes payable--
stockholders....................... 64,000
Changes in operating assets and
liabilities:
(Increase) decrease in prepaid
expenses and other current assets... 21,000 (28,000) (99,000)
Net (decrease) increase in accounts
payable and accrued expenses........ (17,000) 72,000 96,000
---------- ----------- ----------
Net cash used in operating
activities......................... (290,000) (513,000) (3,636,000)
---------- ----------- ----------
Cash flows from investing activities:
Issuance of short term loan to VCI... 0 (250,000) (250,000)
Deposit for letter of intent......... (100,000) (100,000)
Acquisition of fixed assets.......... (6,000) 0 (339,000)
Capitalized software costs........... -- (506,000)
Proceeds from sale of equipment...... 11,000 0 24,000
---------- ----------- ----------
Net cash used in investing
activities......................... (95,000) (250,000) (1,171)
---------- ----------- ----------
Cash flows from financing activities:
Proceeds from sale of common stock
and exercise of options............. 419,000
Proceeds from the sale of preferred
stock............................... 550,000
Proceeds from borrowings--notes
payable--stockholders............... 1,194,000
Proceeds from Bridge notes........... 1,000,000
Repayment of Bridge notes............ (1,000,000)
Proceeds from public offering, net of
expenses............................ 5,501,000
Repayment of notes payable--
stockholders........................ (170,000)
Loan acquisition costs............... (160,000)
Purchase of treasury stock........... (27,000) (150,000)
---------- ----------- ----------
Net cash provided by (used in)
financing activities............... (27,000) 0 7,184,000
---------- ----------- ----------
NET INCREASE (DECREASE) IN CASH........ (412,000) (763,000) 2,377,000
Cash and cash equivalents--beginning of
period................................ 3,785,000 3,140,000
---------- ----------- ----------
Cash and cash equivalents--end of
period................................ 3,373,000 $ 2,377,000 2,377,000
========== =========== ==========
Supplemental and noncash disclosures:
Preferred stock issued in connection
with assignment agreement........... 50,000
Warrants issued in connection with
Bridge notes........................ 500,000
Common stock issued for conversion of
debt, accrued interest, preferred
stock and preferred dividends....... 1,084,000
Interest paid........................ 2,000 16,000
B-4
VIRTUAL COMMUNITIES, INC.
(Prior Name: HEURISTIC DEVELOPMENT GROUP, INC.)
(a development stage company)
NOTES TO FINANCIAL STATEMENTS
(NOTE A)--Basis of Presentation:
The accompanying unaudited condensed financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with instructions for Form 10-QSB and Item 310(b) of
Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for financial
statements. In the opinion of management, all adjustments consisting of normal
recurring accruals considered necessary for a fair presentation have been
included. Operating results for the nine-month period ended September 30, 1999,
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. For further information, refer to the financial
statements and footnotes thereto included in the Registrant Company's annual
report on Form 10-KSB for the year ended December 31, 1998.
(NOTE B)--The Company:
As of September 30, 1999 Heuristic Development Group, Inc. (the "Company"
prior to its name change--See Note C") was a development stage company formed
in 1994 to research, develop, design and market fitness-related products. The
Company's sole product as of September 30, 1999 has been IntelliFit, a
proprietary computerized system which generates personalized exercise
prescriptions and tracks and records fitness programs.
Based on feedback from test sites and beta customers, and the disappointing
acceptance of the IntelliFit product, the Company revamped its business model
in the second half of 1997. The Company no longer believes that it can be
successful in selling or licensing the IntelliFit product to customers and
supporting the product in the field. The Company still believes, however, that
the IntelliFit software may be a viable product for a company which has
complementary products or an existing field sales organization, and plans to
pursue licensing or selling the IntelliFit system to such a buyer.
Additionally, because the IntelliFit software operates on a Macintosh OS
operating system, the Company believes that the IntelliFit software has no
exposure to the year 2000 problem that may result from the date change at the
end of 1999. However, because there are currently no operations using the
IntelliFit software, the Company is unable to assess whether the IntelliFit
software would have any year 2000-related problems when installed or operated
in conjunction with other non-Macintosh OS networks and systems.
(NOTE C)--Subsequent Event:
On October 29, 1999, Virtual Communities, Inc. ("VCI") merged with and into
HDG Acquisition Sub, Inc., a wholly owned subsidiary of Heuristic Development
Group, Inc. ("HDG"). Previously, on June 3, 1999, HDG and VCI had entered into
a Plan and Agreement of Merger (the "Merger") that was subsequently amended on
September 8, 1999. VCI shareholders approved the merger by means of a Consent
of Shareholders dated as of October 26, 1999 and HDG shareholders approved the
merger at HDG's Annual Meeting held on the same date.
In connection with the Merger, HDG changed its name to Virtual Communities,
Inc. and began trading its securities (former symbol: IFIT) on the NASDAQ Small
Cap Market on Monday, November 1, 1999 under the symbols: "VCIX" for the common
stock, "VCIXU" for the Units, "VCIXW" for the Class A Warrants and "VCIXZ" for
the Class B warrants. As a result of the Merger, VCI shareholders received
1.151 shares of HDG common stock for each share of VCI common stock held by
them. After the Merger, there were a total of 14,075,382 shares of the Company
outstanding. HDG's Board of Directors and management resigned and were
B-5
VIRTUAL COMMUNITIES, INC.
(Prior Name: HEURISTIC DEVELOPMENT GROUP, INC.)
(a development stage company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
replaced with VCI's Board of Directors and management. Following the Merger,
VCI shareholders control HDG, holding 88.6% of the Common Stock of the Company
with HDG shareholders holding 11.4%. On September 30, 1999, the Company filed a
Registration Statement on Form S-4B, which included the financial statements of
VCI for the period ending December 31, 1998 and unaudited financial statements
for the period ending June 30, 1999, which are incorporated herein by reference
thereto.
The Merger was accounted for as a capital transaction, which is equivalent
to the issuance of stock by VCI for HDG's net monetary assets, accompanied by a
recapitalization of VCI.
Proforma revenue, net loss and loss per share of the combined entity as of
September 30, 1999 was $613,000, $3,965,000 and $0.28, respectively. This pro
forma information reflect the merger as if the merger had occurred January 1,
1999 and carried forward to September 30, 1999, taking into effect certain
events that occurred subsequent to the period presented. Furthermore, this pro
forma information does not purport to be indicative of the results which would
have actually been obtained had such transaction been completed as of September
30, 1999 or which may be obtained in the future.
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. As reflected in the accompanying
financial statements, the Company has incurred substantial losses since
inception and such losses continued through the merger date.
B-6
APPENDIX C
VIRTUAL COMMUNITIES, INC.
CONSOLIDATED FINANCIAL STATEMENTS
as of December 31, 1998
C-1
VIRTUAL COMMUNITIES, INC.
Contents
Page
--------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS............................... H-3
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets.......................................... H-4
Consolidated Statements of Operations................................ H-5
Consolidated Statements of Changes in Shareholders' Deficiency....... H-6
Consolidated Statement of Cash Flows................................. H-7
Notes to the Consolidated Financial Statements....................... H-8-H-13
C-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of
Virtual Communities, Inc.
We have audited the accompanying consolidated balance sheets of Virtual
Communities, Inc., a Delaware corporation, and subsidiaries as of December 31,
1997 and 1998, and the related consolidated statements of operations, changes
in shareholders' deficiency and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Virtual Communities, Inc.
and subsidiaries as of December 31, 1997 and 1998, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1B to the
consolidated financial statements, the Company has suffered recurring net
losses from operations and has a net capital deficiency that raises substantial
doubt about its ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1B. The financial statements
do not include any adjustments relating to the recoverability and
classification of asset carrying amounts or the amounts and classification of
liabilities that might result should the Company be unable to continue as a
going concern.
Arthur Andersen, LLP
New York, New York
March 10, 1999
C-3
VIRTUAL COMMUNITIES, INC.
CONSOLIDATED BALANCE SHEETS
(U.S. Dollars in thousands except per share data)
December 31
---------------
Note 1998 1997
---- ------- -------
ASSETS
------
Current Assets
Cash and cash equivalents................................ 574 34
Trade receivables, net of allowance of $11 in 1998 ($6 in
1997)................................................... 139 120
Other receivables........................................ 35 14
------- -------
Total current assets.................................... 748 168
======= =======
Fixed Assets, Net......................................... (3) 181 182
--- ------- -------
Severance Pay Deposits.................................... (8) 31 15
--- ------- -------
Total assets............................................ 960 365
======= =======
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
----------------------------------------
Current Liabilities
Short-term bank borrowings............................... (4) 101 69
Shareholders' loans...................................... (5) 200 --
Payables and accrued expenses............................ (6) 782 546
--- ------- -------
Total current liabilities............................... 1,083 615
Long-Term Liabilities
Convertible Loans........................................ (7) 575 550
Accrued severance pay.................................... (8) 74 44
--- ------- -------
Total long-term liabilities............................. 649 594
------- -------
Shareholders' Deficiency
Share capital (a)
Shares of $0.0001 par value Authorized--19,000,000 common
stock and 1,000,000 preferred stock; issued and
outstanding--8,425,749 common stock (1997--3,783,334)... 1 --
Additional paid-in capital............................... 2,153 648
Accumulated deficit...................................... (2,926) (1,492)
------- -------
Total shareholders' deficiency.......................... (772) (844)
------- -------
Total liabilities and shareholders' deficiency.......... 960 365
======= =======
The accompanying notes form an integral part of the financial statements.
C-4
VIRTUAL COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(U.S. Dollars in thousands except per share data)
For the year ended
December 31
--------------------
Note 1998 1997
---- --------- ---------
REVENUES............................................. 819 402
--------- ---------
COST AND EXPENSES
Cost of revenues................................... (10) 721 602
Selling, general and administrative expenses....... (11) 1,341 849
Financing expenses, net............................ 191 56
--------- ---------
2,253 1,507
========= =========
Net loss......................................... 1,434 1,105
========= =========
NET LOSS PER SHARE................................... (0.19) (0.35)
========= =========
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING.................................. 7,372,636 3,190,824
========= =========
The accompanying notes form an integral part of the financial statements.
C-5
VIRTUAL COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' DEFICIENCY
(U.S. Dollars in thousands except per share data)
Number of Additional
ordinary Share paid-in Accumulated
shares capital capital deficit Total
--------- ------- ---------- ----------- ------
Balance as of January 1,
1997........................ 2,733,499 -- -- (387) (387)
Shares issued................ 1,049,835 -- 630 -- 630
Options issued............... -- -- 18 -- 18
Net loss..................... -- -- -- (1,105) (1,105)
--------- --- ----- ------ ------
Balance as of December 31,
1997........................ 3,783,334 -- 648 (1,492) (844)
Shares issued................ 4,642,415 1 1,433 -- 1,434
Options issued............... -- -- 72 -- 72
Net loss..................... -- -- -- (1,434) (1,434)
--------- --- ----- ------ ------
Balance as of December 31,
1998........................ 8,425,749 1 2,153 (2,926) (772)
========= === ===== ====== ======
The accompanying notes form an integral part of the financial statements.
C-6
VIRTUAL COMMUNITIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(U.S. Dollars in thousands except per share data)
For the year ended
December 31
--------------------
1998 1997
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss............................................... (1,434) (1,492)
Adjustments to reconcile net loss to net cash used in
operating activities (see below)...................... 274 1,238
--------- ---------
Net cash used in operating activities................ (1,160) (254)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets............................... (77) (88)
Investment in subsidiary............................... -- (10)
Investment in other assets............................. -- (400)
--------- ---------
Net cash used in investing activities................ (77) (498)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Short-term bank borrowings, net........................ 32 (12)
Receipt of shareholders' loans......................... 200 --
Receipt of convertible loans........................... 624 150
Issuance of shares..................................... 921 648
--------- ---------
Net cash provided by financing activities............ 1,777 786
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS.................... 540 34
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR........... 34 --
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR................. 574 34
========= =========
ADJUSTMENT TO RECONCILE NET LOSS TO NET CASH USED IN
OPERATING ACTIVITIES:
Items not affecting operating cash flows:
Depreciation......................................... 78 26
Accrued severance pay, net........................... 14 21
Nonrecurring expense................................. -- 796
Changes in operating assets and liabilities:...........
Decrease (increase) in trade receivables, net........ (19) 285
Decrease (increase) in other receivables............. (21) 14
Increase in payables and accrued expenses............ 222 96
--------- ---------
274 1,238
========= =========
INTEREST PAID............................................ 23 15
========= =========
NONCASH TRANSACTIONS
Issuance of shares upon conversions of loans........... 585 --
========= =========
PURCHASE OF SUBSIDIARY
Assets and liabilities at date of purchase:
Working capital (excluding cash)..................... -- 106
Fixed assets......................................... -- (120)
Convertible loans.................................... -- 400
Other goodwill-type intangible assets................ -- (396)
--------- ---------
-- (10)
========= =========
The accompanying notes form an integral part of the financial statements.
C-7
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(U.S. Dollars in thousands except per share data)
NOTE 1--GENERAL
A. Virtual Communities, Inc., (the "Company"), a Delaware corporation, was
incorporated in 1996 and commenced its operations in June 1997. The Company is
an Internet publisher engaged in developing and operating Web communities,
acquiring related technologies and providing internet hosting, marketing and
advertising services.
The Company's first Web community, "Virtual Jerusalem" ("VJ"), located on
the World Wide Web at www.virtualjerusalem.com, is an aggregation of Jewish and
Israel related content on the Internet. The VJ site contains over a hundred
sites and thousands of pages of news, features and interactive content and
services, as well as access to thousands of additional related sites on the
Internet.
The Company acquired the majority of the net assets and shares of Virtual
Jerusalem Ltd. ("VJL"), an Israeli company for book purposes, in June 1997. VJL
commenced operations in January 1996 and introduced the VJ site in May 1996.
VJL develops and maintains the VJ Web site and the Company's affiliated sites
on behalf of the Company. VJL is considered a predecessor of the Company.
In June 1998, the Company formed a new company registered under the laws of
Israel, VCI Internet Properties Ltd. ("VCIIP") for the purpose of publishing
and operating an Israel news service and Web site formed by the Company in June
1998, called "IsraelWire". IsraelWire provides online news from Israel on a
continuous basis. The Company owns 99% of the shares of VCIIP.
In December 1998, the Company launched its second Web community, Virtual
HolyLand ("VHL"), located on the Web at www.virtualholyland.com, which is
targeted to the Evangelical Christian market. The Company has entered into
agreements with several content partners for use of their content on the VHL
site.
B. The Company incurred net losses in 1997 and 1998 amounting approximately
to $2.5 million and anticipates that it will continue to incur losses for some
time. The Company's continued existence is dependent on its ability to generate
more revenues and on obtaining additional financing from its shareholders and
outside sources. These matters raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not include
any adjustments that might be necessary should the Company be unable to
continue as a going concern. The Company raised an initial amount during
February 1999 (see Note 9E) and intends to raise additional capital through a
private placements in 1999 (see Note 7A).
C. The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 2--ACCOUNTING POLICIES
The consolidated financial statements have been prepared in conformity with
generally accepted paaccounting principles. The significant accounting policies
followed in the preparation of the financial statements applied on a consistent
basis are:
A. CASH AND CASH EQUIVALENTS
All highly liquid investments with an original maturity of three months or
less are considered cash equivalents.
C-8
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(U.S. Dollars in thousands except per share data)
B. FIXED ASSETS, NET
These assets are presented at cost. Depreciation is calculated by the
straight-line method over the estimated useful lives of the assets ranging as
follows:
Year
----
Computers............................................................... 3-4
Furniture and office equipment.......................................... 7-14
C. REVENUE RECOGNITION
The Company's primary source of revenue to date has been from online Web
site advertising fees. The Company recognizes revenues earned from advertising
fees ratably over the term of the advertising contract. The Company also earns
revenues from hosting and exposure of content partner owned Web sites, and from
site production services. Hosting and exposure revenues are recognized ratably
over the service period, which is usually annually. Revenues from production
services are recognized upon completion of such services.
D. BARTER ARRANGEMENTS
The Company enters into barter arrangements with certain customers, whereby
the Company's advertising, hosting and exposure or production services are
exchanged for goods or services.
Revenues and expenses from barter transactions are measured on the basis of
the fair value of the goods or services sold or, if more clearly evident, the
fair value of the assets or services received.
In regard to advertising barter transactions, barter revenue is recognized
over the term of the advertising contract, whereas barter expenses are
recognized as incurred. Approximately 15% and 28% of the advertising revenue
recorded by the Company in 1997 and 1998, respectively, related to barter in
exchange for airline tickets or promotional services at trade events. Revenue
from barter is calculated based upon the fair market value of the goods or
services received. The fair value of the airline tickets or promotional
services received by the Company are determined based on the respective
customer's listed prices.
In addition, approximately 38% of the hosting and exposure revenue recorded
by the Company in 1998, relating to Web sites hosted on the Company's server,
were attributed to barter relationships. In exchange for these services the
Company received either content material published on the Company's site or
promotional services in various publications or at public events. The fair
value of the Company's hosting and exposure fees are determined by the standard
rate charged to cash buyers. This annual fee is recognized ratably over the
twelve-month period to which the annual fee relates. In 1997 there were no
revenues from barter of hosting and exposure.
In 1998, approximately 76% of production revenue were attributed to barter
relationships, in exchange for content material published on the Company's
site. The fair value of the Company's production fees is determined by the
standard rates charged to cash buyers. This revenue is recognized as the
Company provides the production service. In 1997, there were no revenues from
barter of production services.
Barter expenses are included in selling, general and administrative expenses
section of the statements of operations.
C-9
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(U.S. Dollars in thousands except per share data)
E. LOSS PER SHARE
In accordance with SFAS 128, net earnings (loss) per Ordinary share amounts
("Basic EPS") are computed by dividing net earnings (loss), adjusted for
preferred stock as required, by the weighted average number of common shares
outstanding and excluding any dilution. Net earnings (loss) per Ordinary share
amounts assuming dilution ("Diluted EPS") are computed by reflecting potential
dilution of the Company's securities. Basic and Diluted EPS are the same for
the years ended December 31, 1998 and 1997 since all securities are considered
antidilutive.
NOTE 3--FIXED ASSETS, NET
December 31
------------
1998 1997
----- -----
Computers...................................................... 291 219
Furniture and office equipment................................. 27 22
----- -----
318 241
Less--accumulated depreciation................................. 137 59
----- -----
Net book value................................................. 181 182
===== =====
NOTE 4--SHORT-TERM BANK BORROWINGS
December 31
------------
1998 1997
----- -----
Bank overdrafts................................................. 41 69
Bank loan....................................................... 60 --
----- -----
101 69
===== =====
Bank overdrafts (in New Israeli Shekels) bear interest of approximately 17%
per annum. Bank loan (in U.S.$) bears interest of approximately 7% per annum.
NOTE 5--SHORT TERM SHAREHOLDERS LOANS
In May 1998, the Company received interest free three month bridge loans
from two individuals in the aggregate amount of $200 (the "May 1998 Loans"). In
consideration for the May 1998 Loans, the Company agreed to issue a total of
30,000 shares of common stock for each month that the loans were not repaid for
the first ninety days, after which time the Company agreed to issue a total of
60,000 shares of common stock for each additional month (or a pro-rated amount
for each partial month) that the May 1998 Loans remains unpaid. As a result,
the Company recorded interest expense in the amount of $155. Subsequent to the
balance sheet date, the Company repaid the loans and repurchased a total of
330,000 shares that were issued to the lenders as of December 9, 1998, for a
total of $132, or $0.40 a share. The lenders agreed to accept such payment
together with repayment of the May 1998 loans in lieu of any shares that may
have accrued to them prior to repayment.
C-10
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(U.S. Dollars in thousands except per share data)
NOTE 6--PAYABLES AND ACCRUED EXPENSES
December 31
------------
1998 1997
----- -----
Accounts payable............................................... 274 226
Payroll, government institutions and others.................... 245 84
Accrued expenses and deferred income........................... 263 236
----- -----
782 546
===== =====
NOTE 7--CONVERTIBLE LOANS
A. On December 31, 1998, the Company issued a one year secured convertible
promissory note in the principal amount of $500 (the "Note") to Virtual
Acquisition Co., LLC ("VAC"), a company affiliated with principals of Jesup &
Lamont Securities Corp., a New York investment bank ("Jesup"). Jesup has
entered into an agreement with the Company whereby Jesup has agreed to raise $5
million through the private placement of the Company's securities on a "best
efforts" basis, no later than April 5, 1999.
Subsequent to balance sheet date (in February 1999), the Note was converted
into 5,000 shares of Series A preferred stock, thereby eliminating such debt,
simultaneously with the sale of 9,550 preferred stock of the Company by Jesup
for $955 (See Note 9E). In consideration for the Note, the Company issued to
VAC a five year warrant (the "VAC Warrant") expiring December 31, 2003 to
purchase of 479,856 shares of common stock at an exercise price of $0.52 per
share.
B. In October 1998, the Company received a three month loan in the principal
amount of $25. The loan accrues interest at the rate of 12% per annum and is
convertible into 38,462 shares of common stock of the Company at a rate of
$0.65 per share. In consideration for such loan, the Company issued the lender
2,500 shares of common stock of the Company. The Company repaid the loan with
the accrued interest in January 1999.
C. In February 1998, the Company received from a related party a ninety day
loan (the "Loan"), extendable for an additional ninety day period, in the
principle amount of $50 . The Loan bears interest at the rate of 10% per annum
and is convertible into 75,757 shares of common stock of the Company at the
rate of $0.66 per share. In consideration for the Loan, the Company agreed to
issue a warrant to purchase 5,000 shares of common stock for each month that
the Loan remained outstanding. As of December 31, 1998, the related party had
accrued a warrant for a total of 53,300 shares of common stock at an exercise
price of $0.66 per share. The Company repaid the Loan, together with accrued
interest in January 1999.
NOTE 8--ACCRUED SEVERANCE PAY
The Company's obligation for severance pay to employees in Israel is
partially covered by payments to insurance companies. The accrual for severance
pay and deposits with insurance companies in respect of severance pay are
included in the balance sheet.
NOTE 9--SHARE CAPITAL
A. During 1998, the Company issued 2,682,023 shares in respect of loans and
convertible loans granted to the Company during 1997 (1,786,056 to related
parties), and additional 1,960,392 shares were issued in respect of loans that
were granted to the Company during 1998 (154,096to related parties) and to some
shareholders of the Company.
C-11
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(U.S. Dollars in thousands except per share data)
B. The Company reserved 726,000 shares of common stock for issuance under
its 1997 Stock Option Plan ("1997 SOP") and an additional 524,000 shares for
issuance under a similar 1998 Stock Option Plan ("1998 SOP"). Actual grants are
as follows:
No. of Exercise
options price
------- --------
Granted in 1997 to employees............................... 423,500 $0.40
-------
Balance at December 31, 1997............................... 423,500
Granted in 1998 to employees............................... 610,000 $0.65
Forfeited (employees) in 1998.............................. (60,500)
-------
Balance at December 31, 1998 973,000
=======
Compensation cost under the alternative fair value accounting method under
FASB statement No. 123, "Accounting for Stock Based Compensation", had not been
provided since the effect is estimated to be immaterial.
C. The Company granted options and warrants to shareholders and lenders
relating to loans, amounting to 60,500 and 1,061,418 in 1997 and 1998,
respectively (60,500 and 252,044 to related parties in 1997 and 1998
respectively). The exercise price per share of common stock ranges from $0.30
to $1.00.
D. Subsequent to the balance sheet date, the Company committed to issue
91,250 shares of the Company to a consultant of the Company and 21,277 shares
to a non-affiliated investor.
E. In February 1999, the Company raised gross proceeds of $955 (before
issuance expenses) through the issuance of 9,550 shares of Series A Preferred
Stock to 35 accredited investors. At the same time, a $500 secured convertible
promissory note provided to the Company by Virtual Acquisition Co. LLC on
December 31, 1998, was converted into 5,000 shares of Series A preferred stock
thereby eliminating such debt (see Note 7). Holders of the Series A preferred
stock have the right to convert their stock into common stock of the Company at
any time. The Series A preferred stock has the same voting rights as the common
stock based upon its conversion into common stock.
The 9,550 and the 5,000 Series A preferred stock above will automatically
convert into 1,807,004 shares of common stock upon the completion of at least
$4 million in additional financing by the Company at a 10% minimum premium over
the Series A conversion price of $0.8052 per share, upon an underwritten public
offering of shares of common stock that yields gross proceeds of at least $25
million or upon a reverse merger of the Company into an existing public
company.
NOTE 10--COST OF REVENUES
For the year
ended
December 31
--------------
1998 1997
------ ------
Salaries and related expenses................................ 426 416
Content material............................................. 103 --
Internet connectivity........................................ 50 58
Rent and maintenance......................................... 46 89
Other........................................................ 96 39
------ ------
721 602
====== ======
C-12
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(U.S. Dollars in thousands except per share data)
NOTE 11--SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
For the year
ended
December 31
--------------
1998 1997
------- ------
Salaries and related expenses................................. 718 475
Rent and maintenance.......................................... 80 71
Advertising................................................... 109 35
Legal and professional expenses............................... 60 90
Travel........................................................ 77 42
Other expenses................................................ 297 136
------- -----
1,341 849
======= =====
During the year the Company rented office space and obtained administrative
services from related parties in consideration of $148 (1997 -- $106).
NOTE 12--TAXES ON INCOME
A. Carryforward losses for tax purposes approximate $2.1 million. Due to the
uncertainty of realizing the benefit of the loss carryforward, a valuation
allowance for the related deferred tax asset has been recorded.
B. VJL is subject to the Israeli Income Tax Law (Adjustments for Inflation),
1985, which provides for an adjustment for the effects of inflation on taxable
income in respect of that portion of shareholders' equity not invested in
inflation-resistant assets. The carryforward loss for tax purposes is
approximately $100.
# # # # #
C-13
APPENDIX D
VIRTUAL COMMUNITIES, INC.
CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
as of September 30, 1999
(In U.S. dollars)
(Unaudited)
D-1
VIRTUAL COMMUNITIES, INC.
CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 1999
Contents
Page
--------
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets.......................................... D-3
Consolidated Statements of Operations................................ D-4
Consolidated Statements of Shareholders' Equity (Deficiency)......... D-5
Consolidated Statements of Cash Flows................................ D-6
Notes to the Consolidated Financial Statements....................... D-7-D-10
D-2
VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. Dollars in thousands except per share data)
September 30 December 31
1999 1998
------------ -----------
(Unaudited) (Audited)
ASSETS
------
Current Assets
Cash and cash equivalents............................ 102 574
Trade receivables, net of allowance of $ 18 in 1999
and $11 in 1998..................................... 278 139
Other receivables.................................... 66 35
------ ------
Total current assets................................ 446 748
------ ------
Fixed Assets, Net..................................... 586 181
------ ------
Severance Pay Deposits................................ 79 31
------ ------
Other Assets.......................................... 35 --
------ ------
Total assets........................................ 1,146 960
====== ======
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
----------------------------------------
Current Liabilities
Short-term bank borrowings........................... 396 101
Shareholders' loans.................................. 150 200
Convertible note..................................... 250 --
Payables and accrued expenses........................ 1,693 782
------ ------
2,489 1,083
------ ------
Long-Term Liabilities
Convertible Loans.................................... -- 575
Accrued severance pay ............................... 119 74
------ ------
119 649
------ ------
Total liabilities................................... 2,608 1,732
------ ------
Shareholders' Deficiency
Share capital
Shares of $0.0001 par value Preferred stock, Series A
and B authorized-- 1,000,000 shares; issued and
outstanding as of September 30, 1999--14,550 shares
and 10,325 shares Series A and B, respectively
(December 31, 1998--none)........................... -- --
Common stock authorized--19,000,000 shares; issued
and outstanding--8,538,276 shares as of September
30, 1999 and 8,425,749 shares as of December 31,
1998................................................ 1 1
Additional paid-in capital........................... 4,441 2,153
Accumulated deficit.................................. (5,904) (2,926)
------ ------
Total shareholders' deficiency...................... (1,462) (772)
------ ------
Total liabilities and shareholders' deficiency...... 1,146 960
====== ======
The accompanying notes form an integral part of the financial statements.
D-3
VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(U.S. Dollars in thousands except share and per share data)
For the three
months ended For the nine months
September 30 ended September 30
-------------------- --------------------
1999 1998 1999 1998
--------- --------- --------- ---------
(Unaudited) (Unaudited)
REVENUES........................... 268 141 613 655
--------- --------- --------- ---------
COST AND EXPENSES
Cost of revenues................. 583 186 1,139 513
Selling, general and
administrative expenses......... 620 348 1,949 954
Financing expenses, net.......... 16 67 74 115
Expenses of merger............... 188 0 429 0
--------- --------- --------- ---------
1,407 601 3,591 1,582
========= ========= ========= =========
Net loss....................... (1,139) (460) (2,978) (927)
========= ========= ========= =========
NET LOSS PER SHARE................. (0.13) (0.08) (0.35) (0.17)
========= ========= ========= =========
WEIGHTED AVERAGE NUMBER OF
SHARES OUTSTANDING................ 8,538,276 5,469,441 8,523,409 5,469,441
========= ========= ========= =========
The accompanying notes form an integral part of the financial statements.
D-4
VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY (DEFICIENCY)
(U.S. Dollars in thousands except share data)
(Unaudited)
Number of Number of
Series A Series B Number of Additional
preferred preferred ordinary Share paid-in Accumulated
shares shares shares capital capital deficit Total
--------- --------- --------- ------- ---------- ----------- ------
Balance as of January 1,
1999................... -- -- 8,425,749 1 2,153 (2,926) (772)
Common stock issued..... -- -- 112,527 -- 148 -- 148
Series A preferred stock
issued upon conversion
of convertible loans... 5,000 -- -- -- 500 -- 500
Series A preferred stock
issued, net of issuance
costs.................. 9,550 -- -- -- 815 -- 815
Series B preferred stock
issued, net of issuance
costs.................. -- 10,325 -- -- 825 -- 825
Net loss................ -- -- -- -- -- (2,978) (2,978)
------ ------ --------- --- ----- ------ ------
Balance as of September
30, 1999............... 14,550 10,325 8,538,276 1 4,441 (5,904) (1,462)
====== ====== ========= === ===== ====== ======
The accompanying notes form an integral part of the financial statements.
D-5
VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. Dollars in thousands)
For the nine
months ended
September 30
---------------
1999 1998
------- ------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss..................................................... (2,978) (927)
Adjustments to reconcile net loss to net cash used in
operating activities (see below)............................ 811 270
------- -----
Net cash used in operating activities...................... (2,167) (657)
------- -----
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets..................................... (513) (62)
------- -----
Net cash used in investing activities...................... (513) (62)
------- -----
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in short-term bank borrowing........................ 295 68
Receipt of shareholders' loans............................... 150 --
Repayment of shareholders' loans............................. (200) --
Receipt of convertible note.................................. 250 --
Repayment of convertible loans (*)........................... (75) (17)
Issuance of common stock..................................... 148 649
Issuance of preferred stock, Series A and B.................. 1,640 --
------- -----
Net cash provided by financing activities.................. 2,208 700
------- -----
DECREASE IN CASH AND CASH EQUIVALENTS.......................... (472) (19)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............... 574 34
------- -----
CASH AND CASH EQUIVALENTS AT END OF PERIOD..................... 102 15
======= =====
ADJUSTMENT TO RECONCILE NET LOSS TO NET CASH USED IN OPERATING
ACTIVITIES:
Items not involving operating cash flows:
Depreciation............................................... 108 35
Accrued severance pay, net................................. 37 44
Changes in operating assets and liabilities
Increase in receivables.................................... (170) (73)
Increase in payable and accrued expenses................... 836 264
------- -----
811 270
======= =====
NONCASH TRANSACTIONS
Issuance of preferred stock, Series A upon conversions of
loans (*)................................................... 500 --
======= =====
D-6
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
(Unaudited)
NOTE 1--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in
the United States relating to the provision of interim financial information.
Accordingly, they do not include all of the information and notes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments considered necessary for a fair
presentation have been included. Operating results for the nine month period
ended September 30, 1999, are not necessarily indicative of the results that
may be expected for the year ending December 31, 1999. For further information,
refer to the financial statements and notes for the year ended December 31,
1998.
NOTE 2--SHAREHOLDERS' LOANS
In January 1999, the Company received a six month, interest-free loan in the
principal amount of $150,000 from a non-affiliated shareholder of the Company.
In the event the loan is not repaid in six months, the loan will incur interest
at the rate of 10% per annum commencing July 1999. The Company and the lender
have agreed to negotiate a potential joint venture whereby the Company would
develop, produce, host on its server and promote through its online communities
a web site that will promote and offer online insurance services, as permitted
by law. In the event the venture is agreed upon, the Company will be required
to contribute up to $200,000 in services to implement the venture and the loan
will be forgiven by the lender in consideration of additional services by the
Company in the amount of the loan. In the event the parties do not proceed with
the joint venture within six months from the date of the loan, the lender is
entitled to convert all or a portion of the loan into common stock of the
Company at a rate of $0.58 per share until such time as the Company repays the
loan, provided, however, that the Company's investment bankers agree to such
conversion.
NOTE 3--SHARE CAPITAL
A. During the nine month period ended September 30, 1999, the Company issued
91,250 shares of common stock of the Company at $0.805 per share to a
consultant of the Company and 21,277 shares at $0.47 per share to a non-
affiliated investor.
B. In February 1999, the Company raised gross proceeds of $955,000 (before
issuance expenses) through the issuance of 9,550 shares of Series A preferred
stock to 35 accredited investors. At the same time, a $500,000 Secured
Convertible Promissory Note provided by the Company to Virtual Acquisition Co.
LLC (a company affiliated with principals of Jesup & Lamont, a New York
investment bank) on December 31, 1998, was converted into 5,000 shares of
Series A preferred stock thereby eliminating such debt. Holders of Series A
preferred stock converted their stock into 2,079,862 shares of common stock of
Heuristic Development Group, Inc ("HDG") following the Company's merger with a
wholly owned subsidiary of HDG on October 29, 1999. (See Footnote 7--Subsequent
Events.)
C. In June and September 1999, the Company raised gross proceeds of
$1,032,500 (before issuance expenses) through the issuance of 10,325 shares of
Series B preferred stock to 25 accredited investors. Holders of the Series B
preferred stock converted their stock into 565,909 shares of common stock of
HDG pursuant to the Company's merger with HDG in October 29, 1999. (See
Footnote 7--Subsequent Events.)
D-7
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS--(Continued)
(Unaudited)
NOTE 4--MERGER AGREEMENT
On June 3, 1999, the Company ("VCI") entered into a merger agreement with a
to-be-formed wholly owned subsidiary (the "SUB") of Heuristic Development Group
Inc. ("HDG"), a Delaware corporation whose securities are traded publicly on
NASDAQ SmallCap Market (under the symbol "IFIT"). VCI and HDG require, among
other things, the approval of their respective shareholders to complete the
merger. Upon completing the merger, VCI will become a subsidiary of HDG.
Virtual Communities Israel Ltd. and V.C.I. Internet Properties Ltd. will remain
subsidiaries of VCI following the merger. Upon completion of the merger, VCI's
shareholders will have the right to exchange their shares in VCI for shares in
HDG. Holders of options and warrants to acquire VCI common stock, including
individuals who have been granted options under VCI's Stock Option Plans (SOPs)
will continue to hold such options/warrants which shall be exercisable under
the same terms and conditions as under the SOPs or the warrant agreements, as
applicable, provided, however, that upon their exercise of their
options/warrants, employees will receive shares of HDG common stock in lieu of
shares in VCI pursuant to a precise conversion ratio that was negotiated by VCI
and HDG and is defined in the merger agreement. The conversion ratio to be
applied to the VCI shares that are the subject of SOP's and warrants is the
same ratio to be applied to the receipt by the VCI shareholders of HDG shares
in exchange for their shares of VCI following the merger. On October 29, 1999,
the merger was completed. (See Note 7B-Subsequent Events.)
NOTE 5--COMMITMENTS
In May and June 1999, VCI entered into two lease agreements. One agreement
is for approximately 5,000 square feet of office space in New York City that
serves as the VCI's corporate headquarters and sales, marketing and business
development offices. The term of the lease is for five years with monthly rent
commencing at approximately $7,500 per month for a total commitment of
approximately $550,000 over the course of the term. The other lease is for
office space in Jerusalem, Israel at the Jerusalem Technology Park that houses
the VCI's subsidiary's operations. The term of the Jerusalem lease is for three
years with options to extend the lease for three additional one year terms. The
rent is $18,400 per month assuming VCI's subsidiary secures Approved Enterprise
status under the laws of the State of Israel, or $22,100 per month in the event
VCI's subsidiary does not receive the same, for a total commitment of up to
approximately $800,000 over the course of the three year term.
NOTE 6--CONVERTIBLE NOTES
In September 1999, the Company entered into a Note Purchase Agreement with
HDG to issue up to $750,000 12% Senior Convertible Notes (the "Notes") to HDG.
$250,000 of such Notes were issued by the Company upon the execution of the
Note Purchase Agreement. In the event that VCI does not obtain shareholder
approval on or before October 3, 1999 HDG shall not be obligated to acquire the
additional $500,000 Notes. The Notes are secured by a Security Agreement
pursuant to which HDG's has a security interest in all of VCI's assets which
serves as collateral for the Notes and a UCC Financing Statement. All principal
plus all accrued interest shall be due and payable on the earlier of (i) the
termination of the Merger Agreement between VCI and HDG and, (ii) December 31,
1999 (unless the parties extend the date for execution of the Merger
Agreement.)
The Notes are also convertible at a rate of $1.45 per share in the event the
anticipated merger does not close. Pursuant to the Note Purchase Agreement, VCI
also granted to HDG certain registration rights for the convertible shares and
the shares underlying the Warrant. Pursuant to the Note Purchase Agreement, VCI
and HDG also executed an amendment to the Merger Agreement eliminating a number
of elements required for
D-8
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS--(Continued)
(Unaudited)
closing and stipulating that in the event VCI shareholders do not approve the
merger by October 3, 1999, HDG may cancel the Merger Agreement.
In connection with the Notes, the Company issued to HDG a Warrant
exercisable for a period of five years for the purchase of 500,000 shares of
its Common Stock. In the event that the merger closes pursuant to the Merger
Agreement, the Warrant shall expire immediately. The Warrant is exercisable
immediately upon the termination of such merger at a price of $1.45 per share
subject to adjustment.
NOTE 7--SUBSEQUENT EVENTS
A. In early October 1999, VCI sold an additional $500,000 of the 12% Senior
Convertible Notes (the "Notes") to HDG pursuant to the Note Purchase Agreement
with HDG following VCI securing approval by its shareholders of the Merger with
HDG. Upon consummation of the Merger with HDG on October 29, 1999, the Notes
were automatically deemed redeemed by the Company and all unpaid principal,
together with any accrued but unpaid interest, was added to the "cash value",
as such term was defined in the merger agreement between the Company and HDG.
In connection with the Notes, the Company issued to HDG a Warrant exercisable
for a period of five years for the purchase of 500,000 shares of its Common
Stock. The Warrant expired upon the completion of the merger.
B. On October 29, 1999, the Company merged with a wholly-owned subsidiary
(the "SUB") of HDG, a Delaware corporation whose securities were traded
publicly on NASDAQ SmallCap Market (under the symbol "IFIT") and became a
subsidiary of HDG. Virtual Communities Israel Ltd. and V.C.I. Internet
Properties Ltd. remain as subsidiaries of the Company following the merger.
HDG's Board resigned upon the completion of the merger and HDG Shareholders
approved a new Board nominated by the Company. HDG's management was replaced by
the Company's management and changed its name to Virtual Communities, Inc.
VCI's shareholders exchanged their shares in VCI for 12,473,326 shares in HDG,
representing 88.62% of the common stock outstanding following the merger.
Pursuant to the merger agreement, holders of options and warrants to acquire
VCI common stock, including individuals who have been granted options under
VCI's Stock Option Plans (SOPs) continue to hold such options/warrants which
are exercisable under the same terms and conditions as under the SOPs or the
warrant agreements, as applicable, provided, however, that upon their exercise
of their options/warrants, holders will receive shares of HDG common stock at a
1.151 for 1 conversion ratio that was negotiated between the Company and HDG.
The conversion ratio was applied to the Company's outstanding shares.
C. On December 14, 1999, the Company received a total of $985,400 for the
private placement sale to accredited investors of 400,000 shares of restricted
common stock and a three-year warrant, exercisable for 40,000 shares of common
stock at a purchase price of $2.46 per share. The Company made the private
placement offering under Section 4(2) of the Securities Act of 1933, as amended
(the "Securities Act"). The terms of the offering provided for issuance of the
restricted common stock at a purchase price equal to 35% below the market
valuation of the Company's publicly traded common stock and the issuance of a
warrant exercisable for the purchase of one share of common stock for each ten
shares purchased. The warrants become exercisable six months after the date of
issuance. The restricted shares of common stock and the shares of common stock
to be issued upon exercise of the warrant may be offered for public resale only
if registered under the Securities Act of 1933 or an exemption therefrom. The
Company has agreed to provide the purchasers with certain registration rights
with respect to the restricted common stock and the common stock underlying the
warrants. Such registration rights commence six months from the date of
purchase and if the registration is declared effective by the Securities and
Exchange Commission, public resale of such securities
D-9
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS--(Continued)
(Unaudited)
shall be permitted. The Company paid approximately $50,000 in financial
advisory consultant fees related to the closing of the first tranche of the
private placement offering. The Company expects to continue the private
placement offering to accredited investors in subsequent tranches through the
first quarter of 2000, up to an aggregate amount of $5 million, on terms
substantially similar to the first tranche. The terms and conditions of the
private placement offering were duly authorized by the Company's Board of
Directors as being reasonable and in the best interests of the Company, with
particular regard to the Company's need for operating capital and the limited
availability of other reasonable financing alternatives.
D. In October 1999, the Company issued a three year warrant exercisable into
160,206 shares of Common Stock at an exercise price of $2.10 per share to Jesup
& Lamont Capital Markets, Inc. as partial consideration for services rendered
by it to the Company in connection with the Company's merger with HDG.
E. In December 1999, the Company agreed to issue a three year warrant
exercisable into 120,000 shares to Venture Capital USA, Inc. in connection with
certain financial consulting services provided to the Company. The exercise
price shall be $2.46 per share.
D-10
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 24. Indemnification of Directors and Officers.
The Restated Certificate of Incorporation and By-Laws of the Registrant
provide that the Registrant shall indemnify any person to the full extent
permitted by the Delaware General Corporation Law (the "DGCL"). Section 145 of
the DGCL, relating to indemnification, is hereby incorporated herein by
reference.
In accordance with Section 102(a)(7) of the DGCL, the Certificate of
Incorporation of the Registrant eliminates the personal liability of directors
to the Registrant or its stockholders for monetary damages for breach of
fiduciary duty as a director with certain limited exceptions set forth in
Section 102(a)(7).
Item 25. Other Expenses of Issuance and Distribution.
All expenses other than the Commission's filing fees are estimated.
Amount
-------
SEC Registration Fee................................................ $ 6,100
Printing Fees and Expenses.......................................... 15,000
Accounting Fees and Expenses........................................ 20,000
Legal Fees and Expenses............................................. 25,000
Miscellaneous Expenses.............................................. 5,000
-------
Total............................................................. $71,100
Item 26. Recent Sales of Unregistered Securities.
In December 1996, the company issued 20 units, each unit consisting of a
note in the principal amount of $50,000 bearing interest at 10% per annum and
warrants to purchase 25,000 shares of common stock at an exercise price of
$3.00 per share to accredited investors for an aggregate purchase price of
$1,000,000.
The units were issued pursuant to an exemption from registration provided by
Regulation D promulgated under Section 4(2) of the Securities Act. D.H. Blair
Investment Banking Corp. acted as the Registrant's placement agent in
connection with this private placement. In connection therewith, the registrant
paid sales commissions in the aggregate amount of $100,000 and a non-
accountable expense allowance in the aggregate amount of $30,000.
On December 14, 1999, the Company received a total of $985,400 for the
private placement sale to accredited investors of 400,000 shares of restricted
common stock and a three-year warrant, exercisable for 40,000 shares of common
stock at a purchase price of $2.46 per share. The Company made the private
placement offering under Section 4(2) of the Securities Act of 1933, as amended
(the "Securities Act"). The terms of the offering provided for issuance of the
restricted common stock at a purchase price equal to 35% below the market
valuation of the Company's publicly traded common stock and the issuance of a
warrant exercisable for the purchase of one share of common stock for each ten
shares purchased. The warrants become exercisable six months after the date of
issuance. The restricted shares of common stock and the shares of common stock
to be issued upon exercise of the warrant may be offered for public resale only
if registered under the Securities Act of 1933 or an exemption therefrom. The
Company has agreed to provide the purchasers with certain registration rights
with respect to the restricted common stock and the common stock underlying the
warrants. Such registration rights commence six months from the date of
purchase and if the registration is declared effective by the Securities and
Exchange Commission, public resale of such securities shall be permitted. The
Company paid approximately $50,000 and issued warrants exercisable for 120,000
shares of common stock on the same terms and conditions as the warrants issued
in the private placement as financial advisory consultant fees related to the
closing of the first tranche of the private placement offering. The Company
expects to continue the private placement offering to accredited investors in
subsequent tranches through the first quarter of 2000, up to an aggregate
amount of $5 million, on terms substantially similar to the
II-1
first tranche. The terms and conditions of the private placement offering were
duly authorized by the Company's Board of Directors as being reasonable and in
the best interests of the Company, with particular regard to the Company's need
for operating capital and the limited availability of other reasonable
financing alternatives.
The purchasers of the first tranche of the private placement described above
were Paul and Hannah Lindenblatt, the sister and brother-in-law of Avi
Moskowitz, the Company's chairman of the Board, President and Chief Executive
Officer. The purchasers are not involved in the management or control of the
Company nor are they otherwise affiliated with the Company or its management,
and their respective holdings of common stock after such purchase represent in
the aggregate less than 5% of outstanding shares of the Company's common stock.
The sale of the first tranche of the private placement to the purchasers was
made without regard to any familial relationship, at arms length, on the same
terms and conditions of the private placement offering to other accredited
investors.
In October 1999, the Company issued a three year warrant exercisable into
160,206 shares of Common Stock at an exercise price of $2.10 per share to Jesup
& Lamont Capital Markets, Inc. as partial consideration for services rendered
by it to the Company in connection with the Company's merger with HDG.
In December 1999, the Company agreed to issue a three year warrant
exercisable into 120,000 shares to Venture Capital USA, Inc. in connection with
certain financial consulting services provided to the Company at an exercise
price of $2.46 per share.
Item 27. Exhibits.
(a) The following is a list of Exhibits filed herewith as a part of this
Registration Statement:
Exhibit No. Description of document
----------- -----------------------
2(1) Agreement and Plan of Merger between Heuristic Development Group
and Virtual Communities dated June 2, 1999, as filed with the
Commission as Exhibit 2.1 to Heuristic Development Group's Form
10-Q for the quarter ended on June 30, 1999, is incorporated by
reference.
2(2) Amendment to Agreement and Plan of Merger between Heuristic
Development Group and Virtual Communities, dated September 8,
1999, as filed with the Commission as Annex L to Heuristic
Development Group's Registration Statement on Form S-4 Amendment
No. 1 (File No. 333-87373), is incorporated by reference.
2(3) Amendment No. 2 to Agreement and Plan of Merger between Heuristic
Development Group and Virtual Communities, dated October 29, 1999.
3(1) Certificate of Incorporation of Heuristic Development Group, as
amended, as filed with the Commission as Exhibit XI to Appendix A
to Heuristic Development Group's Registration Statement on Form S-
4 Amendment No. 1 filed on September 30, 1999 (File No. 333-
87373), is incorporated by reference.
3(2) Bylaws of Heuristic Development Group, as amended, as filed with
the Commission as Exhibit XII to Appendix A to Heuristic
Development Group's Registration Statement on Form S-4 Amendment
No. 1 filed on September 30, 1999 (File No. 333-87373), is
incorporated by reference.
5(1) Opinion of Wuersch & Gering, LLP.*
10(1) Software License and Support Agreement between iMediation Inc. and
Virtual Communities, dated December 30, 1999.
10(2)(a) Partner Agreement between Intershop Communications, Inc. and
Virtual Communities, dated September 30, 1999.
10(2)(b) Professional Services Agreement between Intershop Communications,
Inc. and Virtual Communities, dated September 30, 1999.
10(3) Agreement between Jewish Telegraphic Agency, Inc. and Virtual
Jerusalem, dated September, 1996, filed with the Commission as
Exhibit 10(1) to Heuristic Development Group's Registration
Statement on Form S-4 on September 17, 1999 (File No. 333-87373),
is incorporated by reference.
II-2
Exhibit No. Description of document
----------- -----------------------
10(4) Letter Agreement between Continental Airlines, Inc. and Virtual
Communities, Inc. dated May 18, 1999, as filed with the Commission
as Exhibit (10)2 to Heuristic Development Group's Registration
Statement on Form S-4 on September 17, 1999 (File No. 333-87373),
is incorporated by reference.
10(5) Agreement between Jewish Television Network and Virtual Jerusalem,
Ltd. dated March 23, 1997, as filed with the Commission as Exhibit
10(3) to Heuristic Development Group's Registration Statement on
Form S-4 on September 17, 1999 (File No. 333-87373), is
incorporated by reference.
10(6) Agreement between Matthew Album and Virtual Communities, Inc.,
dated March 2, 1998, as filed with the Commission as Exhibit 10(4)
to Heuristic Development Group's Registration Statement on Form S-
4 on September 17, 1999 (File No. 333-87373), is incorporated by
reference.
10(7) Agreement between Haaretz Daily Newspaper Ltd. and Virtual
Communities, Inc., dated July 15, 1998, as filed with the
Commission as Exhibit 10(5) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(8) Netgravity Adserver License Agreement between Netgravity, Inc. and
Virtual Communities dated June 30, 1999, as filed with the
Commission as Exhibit 10(6) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(9) Software License Agreement between Cortext Ltd. and Planet
Communications Ltd., on the one hand, and Virtual Communities,
Inc., on the other hand, dated July 16, 1999, as filed with the
Commission as Exhibit 10(7) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(10) Web Design and Development Agreement between VCI Community
Solutions, Inc. and Tromaville.com, Inc., dated August 6, 1999, as
filed with the Commission as Exhibit 10(8) to Heuristic
Development Group's Registration Statement on Form S-4 on
September 17, 1999 (File No. 333-87373), is incorporated by
reference.
10(11) Frontier Global Center, Inc. Master Service Agreement between
Frontier GlobalCenter, Inc. and Virtual Communities dated March
15, 1998, as filed with the Commission as Exhibit 10(9) to
Heuristic Development Group's Registration Statement on Form S-4
on September 17, 1999 (File No. 333-87373), is incorporated by
reference.
10(12) Financial Services Agreement between Virtual Communities, Inc. and
Virtual Communities Israel, Ltd. dated September 1, 1999, as filed
with the Commission as Exhibit 10(10) to Heuristic Development
Group's Registration Statement on Form S-4 on September 17, 1999
(File No. 333-87373), is incorporated by reference.
10(13) Cost Plus Agreement between Virtual Communities, Inc. and Virtual
Communities Israel, Ltd. dated September 1, 1999, as filed with
the Commission as Exhibit 10(11) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(14) Lease Agreement between Allied Investments Ltd., as Lessor, and
Virtual Jerusalem, as Lessee, dated December 29, 1998, as filed
with the Commission as Exhibit 10(12) to Heuristic Development
Group's Registration Statement on Form S-4 on September 17, 1999
(File No. 333-87373), is incorporated by reference.
10(15) Letter Guarantee to Allied Investments from Israel General Bank
Ltd.. dated December 23, 1998, as filed with the Commission as
Exhibit 10(13) to Heuristic Development Group's Registration
Statement on Form S-4 on September 17, 1999 (File No. 333-87373),
is incorporated by reference.
10(16) Lease Agreement between J.T.P. The Jerusalem Technology Park Ltd.,
as Lessor, and Virtual Communities Israel, Ltd., as Lessee, dated
May 19, 1999, as filed with the Commission as Exhibit 10(14) to
Heuristic Development Group's Registration Statement on Form S-4
on September 17, 1999 (File No. 333-87373), is incorporated by
reference.
II-3
Exhibit No. Description of document
----------- -----------------------
10(17) Letter Guarantee to J.T.P. The Jerusalem Technology Park Ltd. from
Israel General Bank Ltd.. dated August 16, 1999, as filed with the
Commission as Exhibit 10(15) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(18) Lease Agreement between Eighth Avenue Loft Associates and Virtual
Communities, Inc. dated June 14, 1999, as filed with the
Commission as Exhibit 10(16) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(19) Employment Agreement between Deborah Gaines and Virtual
Communities, dated October 25, 1999.
10(20) Employment Agreement between Avi Moskowitz and Virtual
Communities, Inc. dated June 1, 1999, as filed with the Commission
as Exhibit 10(17) to Heuristic Development Group's Registration
Statement on Form S-4 on September 17, 1999 (File No. 333-87373),
is incorporated by reference.
10(21) Employment Agreement between Michael Harwayne and Virtual
Communities, Inc. dated February, 1999, as filed with the
Commission as Exhibit 10(18) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(22) Employment Agreement between Mark McCourt and Virtual Communities,
Inc. dated February, 1999, as filed with the Commission as Exhibit
10(19) to Heuristic Development Group's Registration Statement on
Form S-4 on September 17, 1999 (File No. 333-87373), is
incorporated by reference.
10(23) Warrant to Purchase Shares of Common Stock of Virtual Communities,
Inc. No. W-15, between Virtual Communities and Avi Moskowitz dated
December 31, 1998, as filed with the Commission as Exhibit 10(20)
to Heuristic Development Group's Registration Statement on Form S-
4 on September 17, 1999 (File No. 333-87373), is incorporated by
reference.
10(24) Warrant to Purchase Shares of Common Stock of Virtual Communities,
Inc. No. W-17, between Virtual Communities and Avi Moskowitz dated
June, 1998, as filed with the Commission as Exhibit 10(21) to
Heuristic Development Group's Registration Statement on Form S-4
on September 17, 1999 (File No. 333-87373), is incorporated by
reference.
10(25) Warrants to Purchase Shares of Common Stock of Virtual
Communities, Inc. Nos. W-14, W-25 and W-26 between Virtual
Communities and David Morris dated June, 1998, as filed with the
Commission as Exhibit 10(22) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(26) 1997 Stock Option Plan of Virtual Communities, as filed with the
Commission as Exhibit 10(23) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(27) 1998 Stock Option Plan of Virtual Communities, as filed with the
Commission as Exhibit 10(24) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
10(28) 1999 Stock Option Plan of Virtual Communities, as filed with the
Commission as Exhibit 10(25) to Heuristic Development Group's
Registration Statement on Form S-4 on September 17, 1999 (File No.
333-87373), is incorporated by reference.
II-4
Exhibit No. Description of document
----------- -----------------------
10(29) 1996 Stock Option Plan of Heuristic Development Group, as filed
with the Commission as Exhibit 10.1 to Heuristic Development
Group's Registration Statement on Form SB-2 filed on December 11,
1996 (File No. 333-17635), is incorporated by reference.
10(30) Escrow Agreement among Heuristic Development Group, American Stock
Transfer & Trust Company, and shareholders of Heuristic
Development Group, , as filed with the Commission as Exhibit 10.2
to Heuristic Development Group's Registration Statement on Form
SB-2 filed on December 11, 1996 (File No. 333-17635), is
incorporated by reference.
10(31) Form of Indemnification Agreement, as filed with the Commission as
Exhibit 10.3 to Heuristic Development Group's Registration
Statement on Form SB-2 filed on December 11, 1996 (File No. 333-
17635), is incorporated by reference.
10(32) Assignment dated August 22, 1994 between Nautilus Group Japan,
Ltd. and Heuristic Development Group, as filed with the Commission
as Exhibit 10.4 to Heuristic Development Group's Registration
Statement on Form SB-2 filed on December 11, 1996 (File No. 333-
17635), is incorporated by reference.
10(33) Exclusive Distribution License Agreement dated June 1995 between
Nautilus Group Japan, Ltd. and Heuristic Development Group, as
filed with the Commission as Exhibit 10.5 to Heuristic Development
Group's Registration Statement on Form SB-2 filed on December 11,
1996 (File No. 333-17635), is incorporated by reference.
10(34) Letter Agreement dated November 27, 1996 between Nautilus Group
Japan, Ltd. and Heuristic Development Group, as filed with the
Commission as Exhibit 10.6 to Heuristic Development Group's
Registration Statement on Form SB-2 filed on December 11, 1996
(File No. 333-17635), is incorporated by reference.
10(35) Office Lease dated August 1, 1996 between Paulistic Productions
and Heuristic Development Group, as filed with the Commission as
Exhibit 10.7 to Heuristic Development Group's Registration
Statement on Form SB-2 filed on December 11, 1996 (File No. 333-
17635), is incorporated by reference.
10(36) Retainer Agreement dated August 16, 1994 between TransPac Software
and Heuristic Development Group, as filed with the Commission as
Exhibit 10.8 to Heuristic Development Group's Registration
Statement on Form SB-2 filed on December 11, 1996 (File No. 333-
17635), is incorporated by reference.
10(37) Employment Agreement dated as of December 1, 1996 between
Heuristic Development and Steven R. Gumins, as filed with the
Commission as Exhibit 10.9 to Heuristic Development Group's
Registration Statement on Form SB-2 filed on December 11, 1996
(File No. 333-17635), is incorporated by reference.
10(38) Employment Agreement dated as of December 1, 1996 between
Heuristic Development Group and Deborah E. Griffin, as filed with
the Commission as Exhibit 10.10 to Heuristic Development Group's
Registration Statement on Form SB-2 filed on December 11, 1996
(File No. 333-17635), is incorporated by reference.
10(39) Conversion Agreement between Heuristic Development Group and
holders of Indebtedness, as filed with the Commission as Exhibits
10.11 and 10.12 to Heuristic Development Group's Registration
Statement on Form SB-2 filed on December 11, 1996 (File No. 333-
17635), is incorporated by reference.
21(1) List of Subsidiaries
23(1) Consent of Arthur Andersen, LLP.
II-5
Exhibit No. Description of document
----------- -----------------------
23(2) Consent of Richard A. Eisner & Company, LLP.
23(3) Consent of Wuersch & Gering, LLP (see Exhibit 5(1)).*
24(1) Certified resolutions of the Board of Directors of Virtual
Communities, Inc., taken at a special meeting of the Board held
December 16, 1999, appointing Avi Moskowitz as attorney in fact
for the filing of the company's Registration Statement on Form SB-
2.
- --------
* To be filed by amendment
Item 28. Undertakings.
(a) (a) Heuristic Development Group hereby undertakes:
(1) To file, during any period in which it offers or sells
securities, a post-effective amendment to this registration statement
to:
(i) Include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) Reflect in the prospectus any facts or events which,
individually or together, represent a fundamental change in the
information in the registration statement. Notwithstanding the
foregoing, any increase or decrease in volume of securities
offered (if the total value of securities offered would not
exceed that which was registered) and any deviation from the low
or high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the Securities
and Exchange Commission pursuant to Rule 424(b) if, in the
aggregate, the changes in volume and price represent no more
than a 20% change in the maximum aggregate offering price set
forth in the "Calculation of Registration Fee" table in the
effective registration statement; and
(iii) Include any additional or changed material information on
the plan of distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement relating to
the securities offered, and the offering of the securities at that time
to be the initial bona fide offering.
(3) File a post-effective amendment to remove from registration any
of the securities that remain unsold at the end of the offering.
(e) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
Heuristic Development Group pursuant to the foregoing provisions, or otherwise,
Heuristic Development Group has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act of 1933 and is, therefore,
unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by Heuristic Development Group of expenses incurred or
paid by a director, officer or controlling person of Heuristic Development
Group in the successful defense of any action, suit or proceeding) is asserted
by such director, officer or controlling person in connection with the
securities being registered, Heuristic Development Group will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
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SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets
all of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of New York, State of New York, on December 31, 1999.
HEURISTIC DEVELOPMENT GROUP, INC.
By: /s/ Avi Moskowitz
Name: Avi Moskowitz
Title: President, Chief Executive
Officer and
Chairman of the Board
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Avi Moskowitz President, Chief Executive December 31, 1999
____________________________________ Officer and Chairman of
Avi Moskowitz the Board
/s/ Jonathan W. Seybold Director December 31, 1999
____________________________________
Jonathan W. Seybold
/s/ David Morris Director December 31, 1999
____________________________________
David Morris
/s/ Peter Jacobs Director December 31, 1999
____________________________________
Peter Jacobs
/s/ Fred Lafer Director December 31, 1999
____________________________________
Fred Lafer
/s/ Ellen Cohl Chief Financial and December 31, 1999
____________________________________ Accounting Officer
Ellen Cohl
II-7