As filed with the Securities and Exchange Commission on October 22, 1999
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
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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HEURISTIC DEVELOPMENT GROUP, 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.)
1219 Morningside Drive, Suite 102 Gregory L. Zink, President
Manhattan Beach, California 90266 1219 Morningside Drive, Suite 102
(310) 378-1749 Manhattan Beach, California 90266
(310) 378-1749
(Address and telephone number of
principal executive offices (Name, address and telephone number of
and principal place of business) agent for service)
--------------
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................................... 2,121,712 shares(3) $4.797(4) $10,177,852.46(4) $2,830
Units consisting of one share of common stock
and one class B warrant(5).................... 500,000 6.50 3,250,000 904
Common stock(6)................................ 500,000 shares 8.75 4,375,000 1,217
Units consisting of one share of common stock,
one class A warrant and one class B
warrant(7).................................... 120,000 6.00 720,000 201
Units consisting of one share of common stock
and one class B warrant(8).................... 120,000 6.50 780,000 217
Common stock(9)................................ 240,000 shares 8.75 2,100,000 584
TOTAL.......................................... $21,402,852.46 $5,953
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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.
Pursuant to Exemption Application 91/99 filed by Heuristic Development
Group, Inc., the Israeli Securities Authority decided, on May 30, 1999, in
accordance with its 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.
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(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(g).
(2) Calculated pursuant to Section 6(b) of the Securities Act and Rule 457
thereunder.
(3) The number of shares of common stock of the Heuristic Development Group,
Inc. ("HDG") to be registered in connection with the exercise of
outstanding warrants of Virtual Communities, Inc. ("VCI") following the
proposed merger involving the two companies has been determined based on
(a) the sum of outstanding warrants to purchase 1,558,936 shares of VCI
common stock, and (b) the maximum expected exchange ratio of 1.361 shares
of registrant's common stock for each share of VCI common stock underlying
the VCI 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 VCI warrants,
the maximum offering price per share is $4.797, the average of the bid and
asked price of a share of HDG common stock reported on the NASDAQ SmallCap
Market on October 21, 1999, and the maximum aggregate offering price is the
product of $4.797 and 2,121,712, the maximum number of shares of HDG common
stock expected to be issued upon exercise of the VCI warrants following
consummation of the merger.
(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 Heuristic Development Group, Inc., a Delaware corporation
("HDG"):
. up to 2,121,712 shares of common stock, $.01 par value per share,
issuable by HDG upon exercise of certain outstanding warrants of Virtual
Communities, Inc., a Delaware corporation. Pursuant to that certain
Agreement and Plan of Merger, dated as of June 2, 1999, as amended, VCI
will merge with and into HDG Acquisition Sub, Inc., a wholly owned
subsidiary of HDG, and the holders of the VCI warrants will, upon
consummation of the merger, be entitled to exercise those warrants after
the effective time of the merger for that number of shares of HDG common
stock that such holders would have received in the merger if the shares
of VCI common stock underlying their warrants were held by them at the
effective time of the merger. The conversion ratio for the number of
shares of HDG common stock issuable to holders of VCI securities is
based on a formula, and will not be determined until the closing date of
the merger. Accordingly, the exact number of shares of HDG common stock
issuable upon exercise of the VCI warrants cannot presently be
determined.
. 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.
This Registration Statement is also a post-effective amendment to HDG's
Registration Statement on Form SB-2 (File No. 333-17635), filed with the SEC in
connection with HDG's initial public offering of 1,380,000 Units consisting of
common stock, redeemable class A warrants and redeemable class B warrants.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+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 OCTOBER 22, 1999
PROSPECTUS
HEURISTIC DEVELOPMENT GROUP, INC.
2,121,712 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
This prospectus relates to the following securities of Heuristic Development
Group, Inc., a Delaware corporation ("HDG"):
. Up to 2,121,712 shares of common stock, $.01 par value per share, issuable
by HDG upon exercise of certain outstanding warrants of Virtual
Communities, Inc., a Delaware corporation. Pursuant to that certain
Agreement and Plan of Merger, dated as of June 2, 1999, as amended, VCI
will merge with and into HDG Acquisition Sub, Inc., a wholly owned
subsidiary of HDG, and the holders of the VCI warrants will, upon
consummation of the merger, be entitled to exercise those warrants after
the effective time of the merger for that number of shares of HDG Common
Stock that such holders would have received in the merger if the shares of
VCI common stock underlying their warrants were held by them at the
effective time of the merger. The conversion ratio for the number of
shares of HDG Common Stock issuable to holders of VCI common stock is
based on a formula, and will not be determined until the closing date of
the merger. Accordingly, the exact number of shares of HDG Common Stock
issuable upon exercise of the VCI warrants cannot presently be determined.
. 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 decided 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.
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 the company 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."
The company's common stock, its outstanding class A warrants and its
outstanding class B warrants trade on the Nasdaq SmallCap Market under the
symbols IFIT, IFITW and IFITZ, respectively. The company's outstanding units
offered in its 1997 initial public offering trade on the Nasdaq Small Cap
Market under the symbol IFITU.
AN INVESTMENT IN THESE SECURITIES INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 8.
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.
The date of this Prospectus is October 22, 1999.
TABLE OF CONTENTS
Page
----
Summary................................................................... 3
Risk Factors.............................................................. 8
The Offering.............................................................. 26
Use of Proceeds........................................................... 28
The Company............................................................... 29
Directors and Executive Officers.......................................... 50
Share Ownership of Management and Certain Stockholders.................... 58
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 62
Pro Forma Financial Statements............................................ 73
Related Party Transactions................................................ 79
Description of Securities................................................. 81
Indemnification and Insurance............................................. 82
Legal Matters............................................................. 83
Experts................................................................... 83
Where You Can Find More Information....................................... 83
APPENDIX A--HDG 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--HDG Financial Statements for the period ending June 30, 1999
and for the period from
July 20, 1994 through June 30, 1999...................................... B-1
APPENDIX C--VCI Consolidated Financial Statements for the year ending
December 31, 1998........................................................ C-1
APPENDIX D--VCI Condensed Interim Consolidated Financial Statements for
the period ending
June 30, 1999............................................................ D-1
We have not authorized anyone to give any information or make any
representation about HDG 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. Therefore, if anyone does give you different or additional
information, you should not rely on it.
If you are in a jurisdiction where it is unlawful to offer to exchange or
sell, or to ask for offers to exchange or buy, the securities offered by this
prospectus, or if you are a person to whom it is unlawful to direct such
activities, then the offer presented by this prospectus does not extend to you.
The information contained in this prospectus speaks only as of its date
unless the information specifically indicates that another date applies.
Certain information in this prospectus about VCI has been supplied by VCI.
2
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.
Heuristic Development Group, Inc.
HDG is a development stage company originally organized to research,
develop, design and market fitness-related products. Our primary product is the
IntelliFit System, a proprietary computerized system which generates
personalized exercise prescriptions and tracks and records fitness programs.
Due to disappointing acceptance of the IntelliFit System, we decided to pursue
a strategy of investment in or acquisition of an existing company.
On June 2, 1999, we entered into a definitive merger agreement with Virtual
Communities, Inc. VCI was organized to develop, acquire and operate online
communities on the World Wide Web (the "Web") that aggregate and publish
various news, media and entertainment content targeted to specific demographic
groups. These online communities also provide e-commerce and advertising
services. VCI currently operates three online communities: Virtual Jerusalem,
Virtual Holyland and Virtual Ireland. VCI also recently began offering Web site
design and development services to Web site publishers.
Our principal executive offices are located at 1219 Morningside Drive, Suite
102, Manhattan Beach, California 90266, telephone (310) 378-1749.
The Offering
Shares to be issued to VCI warrant holders
After consummation of the merger holders of outstanding warrants to purchase
shares of VCI common stock will be 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 VCI common stock underlying their warrants were
held by them at the effective time of the merger. Accordingly, the number of
shares of our common stock that we may issue to holders of the VCI warrants
will be determined by multiplying 1,558,936 (the number of shares of VCI common
stock issuable on exercise of such warrants) times the conversion ratio
determined in accordance with the merger agreement.
The merger agreement provides that such conversion ratio is determined by
the following formula:
"VCI Valuation"/VCI common shares outstanding
--------------------------------------------------
(HDG "Cash Value" x a "multiplier")/HDG common shares outstanding
The "VCI Valuation" amount equals $22,000,000 plus any gross proceeds raised
by VCI from the sale of stock between June 2, 1999 (the date as of which the
merger agreement was signed) and the date the merger is completed. We
anticipate that the VCI Valuation will be between $23,032,500 and $24,100,000
and the number of shares of VCI common stock outstanding immediately prior to
the merger will be between 10,836,947 and 11,345,280 shares. (VCI's outstanding
shares give effect to the conversion of its outstanding preferred stock into
common stock.)
3
HDG's "Cash Value" is the total amount of our cash and cash equivalent
assets (with certain defined adjustments) at the effective time of the merger.
The "multiplier" will depend on the amount of our Cash Value as described
below:
If our Cash Value equals: then the multiplier will be:
------------------------- ----------------------------
$2,500,000 or more............................ 1.15
less than $2,500,000.......................... 1.00
We anticipate that our cash value will be between $2.5 million and
$2.7 million.
For Example
. If at the effective time of the merger, the VCI valuation is $23,032,500
(based on $1,032,500 of equity capital raised by VCI since the date of
the merger agreement), there are 10,836,947 shares of VCI common stock
outstanding, HDG's cash value is $2,700,000, the multiplier is 1.15, and
there are 1,602,056 shares of HDG common stock outstanding, the
conversion ratio will be 1.097. Accordingly, each outstanding warrant to
purchase a share of VCI common stock would entitle the holder to receive
1.097 shares of our common stock upon exercise of such warrant after the
consummation of the merger.
. Applying the same formula, if at the effective time of the merger, the
VCI valuation is $24,100,000 (based on $2,100,000 of equity capital
raised by VCI since the date of the merger agreement), there are
11,345,280 shares of VCI common stock outstanding, HDG's cash value is
$2,499,000, the multiplier is 1.00, and there are 1,602,056 shares of
HDG common stock outstanding, the conversion ratio will be 1.361.
Accordingly, each outstanding warrant to purchase a share of VCI common
stock would entitle the holder to receive 1.361 shares of our common
stock upon exercise of such warrant after the consummation of the
merger.
These examples are provided for explanatory purposes only, as the actual
calculation of the conversion ratio cannot be determined in advance of the
effective date of the merger.
We anticipate that the conversion ratio will be between 1.097 and 1.361.
This means that we anticipate issuing between 1,710,153 and 2,121,712 shares of
our common stock to the holders of the VCI warrants, assuming the exercise of
all the outstanding VCI warrants.
There are outstanding warrants to purchase 225,113 shares of VCI 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 VCI's placement
of Series A and B convertible Preferred Stock in early 1999. VCI also has
outstanding warrants to purchase 1,333,823 shares of its common stock, at
exercise prices ranging from $0.30 to $2.10, issued to certain directors,
shareholders, employees and vendors in consideration for certain loans granted
to VCI, waivers and deferrals of compensation, guarantees of bank lines of
credit and services rendered to VCI.
Shares and warrants to be issued to certain holders of outstanding class A
warrants
In connection with the company's initial public offering of units in
February 1997, certain investors in the company received 500,000 redeemable
class A warrants in exchange for warrants that such 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
4
February 11, 2002. The class A and class B warrants are subject to redemption
by the company 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 certain
outstanding unit purchase options granted to the underwriter and finder in
connection with the company's 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."
5
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
The following table shows the financial results actually achieved by each of
HDG and VCI (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 VCI shareholder
dissents from the merger and the minimum of 75% of HDG escrowed share and
Option holders convert their Escrowed Shares and Options into Warrants and (2)
that the maximum of 7% of VCI shareholders dissent from the merger and that the
maximum of 100% of HDG Escrowed Share and Option holders convert their Escrowed
Shares and Options into Warrants. You should not assume that HDG and VCI would
have achieved the combined pro forma results if they had actually been combined
during the periods shown.
HDG's and VCI's six months' historical figures for 1999 are unaudited, but
HDG and VCI each believes that its own 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 June 30, 1999
(U.S. Dollars in thousands)
Pro Forma Pro Forma
Equivalent Equivalent
HDG VCI (No dissenting (7% dissenting
Historical Historical shares) shares)
---------- ---------- -------------- --------------
Total assets............ 2,931 1,153 3,731 2,636
Cash and cash
equivalents............ 2,819 368 2,834 1,739
Total liabilities....... 105 1,544 1,649 1,649
Shareholders equity..... 2,826 (391) 2,082 987
Net loss................ (382) (1,839) (1,924) (1,924)
Comparative per share information
The following table sets forth unaudited data concerning the net loss,
dividends and book value per share for HDG and VCI on a pro forma basis after
giving effect to the merger.
No dissenting shares 7% dissenting shares
--------------------------- ---------------------------
Six Months Six Months
Ended Year Ended Ended Year Ended
June 30, December 31, June 30, December 31,
1999 1998 1999 1998
---------- ------------ ---------- ------------
Net loss per weighted
average common share
(basic and diluted).... (0.14) (0.18) (0.15) (0.19)
Weighted average common
shares outstanding..... 13,825,445 13,951,503 12,969,808 13,095,866
Dividends declared per
share.................. -- -- -- --
Book value per share at
end of period(l),(2)... 0.15 (3) N/A 0.08 (4) N/A
- --------
(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 12,223,389 shares of HDG
common stock to the VCI shareholders in connection with the merger assuming
no VCI shareholder dissents to the merger.
(4) Gives effect to the issuance of approximately 11,367,752 shares of HDG
common stock to the VCI shareholders in connection with the merger assuming
7% of VCI shareholders dissent to the merger.
6
The following tables set forth data concerning the historical net income
(loss), dividends and book value per share for HDG and VCI.
HDG historical per share data
Six Months Ended June 30, Year Ended December 31,
-------------------------- ------------------------
1999 1998 1998 1997
------------ ------------ ----------- -----------
Net loss per weighted
average common share
(basic and diluted).... (0.24) (0.13) (0.59) (0.91)
Weighted average common
shares outstanding .... 1,602,056 1,751,956 1,728,114 1,581,160
Dividends declared per
share.................. -- -- -- --
Book value per share at
end of period(l)....... 1.76 2.38 1.83 2.5
- --------
(1) The book value per share is computed by dividing stockholders' equity by
the number of shares of common stock outstanding.
VCI historical per share data
Six Months Ended June 30, Year Ended December 31,
-------------------------- ------------------------
1999 1998 1998 1997
------------ ------------ ----------- -----------
Net loss per weighted
average common share
(basic and diluted).... (0.22) (0.12) (0.19) (0.35)
Weighted average common
shares outstanding..... 8,515,975 3,891,667 7,372,636 3,190,824
Dividends declared per
share.................. -- -- -- --
Book value per share at
end of period(1)....... (0.05) (0.31) (0.09) (0.22)
- --------
(1) The book value per share is computed by dividing stockholders' equity by
the number of shares of common stock outstanding
7
RISK FACTORS
The risks and uncertainties described below are not the only ones facing HDG
and VCI. Additional risks and uncertainties not presently known to us or risks
that we do not consider significant may also impair either HDG or VCI. If any
of the following risks materialize, our business, financial condition or
results of operations could be materially adversely affected. This could cause
the trading price of our common stock to decline, and you could lose all or
part of your investment.
Risks Particular to VCI
We cannot assure you that VCI will be profitable because its online community
and Web site design and development businesses have operated for a short period
of time.
HDG is not actively pursuing its historic business. VCI was founded in
August 1996 and has a limited operating history. You should consider the risks
and difficulties frequently encountered by companies like VCI, 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 Internet, online services
and the online community model;
. VCI's inability to generate significant advertising revenue or e-commerce
revenue;
. VCI's inability to maintain and increase levels of traffic on its Web
sites, including virtualjerusalem.com, virtualholyland.com and
virtualireland.com;
. the failure of VCI's servers, networking systems and server
administrators to efficiently handle its Web traffic;
. VCI's failure to continue to develop, operate or acquire future Web
sites;
. VCI's inability to attract or retain users and registrants;
. VCI's inability to meet minimum guaranteed Web site impressions under its
advertising agreements;
. VCI's inability to attract or retain content and other strategic partners
to its Web sites;
. VCI's inability to attract or retain Web site design and development
clients;
. VCI's inability to license, and to obtain the right to sublicense, the
software necessary to develop and maintain its own Web sites and its
clients' Web sites;
. VCI's inability to integrate its own technology and know-how with
licensed technology in both the development and maintenance of its own
Web sites and its clients' Web sites;
. VCI's failure to anticipate and adapt to a developing demographic market
or the Internet industry;
. VCI's inability to identify other Web sites or technologies for
acquisition, and if consummated, its inability to efficiently integrate
those acquisitions into its existing operations;
. VCI's inability to upgrade and develop its systems and infrastructure and
attract and hire new personnel in a timely and effective manner; and
. VCI's inability to effectively manage rapidly expanding operations and
limited working capital.
VCI cannot be certain that its business strategy will be successful or that
it will successfully address these risks.
In April 1999, we terminated all of our prior operations, and following the
merger our operations will consist solely of VCI's operations which we are
acquiring in the merger. Although VCI experienced growth in
8
revenues, users and registrants in recent periods, these growth rates may not
be sustainable and may decrease in the future.
To date, neither HDG nor VCI has been profitable on either a quarterly or an
annual basis, and, following the completion of the merger, we expect to incur
net losses in the future. We expect VCI's operating expenses to increase
significantly, especially in the areas of sales and marketing, the development
of future communities, and the expansion of its Web site design and development
business, and, as a result, VCI will need to increase its revenue substantially
to become profitable. If VCI's revenue does not grow as expected or increases
in VCI's expenses are not in line with its forecasts, we will continue to incur
net losses following the completion of the merger.
VCI's quarter-to-quarter results may fluctuate significantly which may
adversely effect the market price of our shares.
VCI's operating results have fluctuated in the past and will likely continue
to do so in the future. Some of the factors that cause VCI's operating results
to fluctuate are:
. the demand for the services and products offered on or through its Web
sites and its ability to meet the demand in a timely manner;
. consumers' receptiveness to the content VCI publishes on its Web sites
and the e-commerce offerings available through its strategic partners'
Web sites;
. timely availability of content suitable for publishing on VCI's Web
sites, and its existing and future content partners' interest in
publishing suitable content on VCI's Web sites;
. developments relating to advertising and e-commerce on the Web;
. new services and products offered by VCI's competitors that affect the
traffic on VCI's Web sites and the number of users and registrants of its
Web sites;
. VCI's ability to predict demand for products and services it offers,
identify markets for future communities and create or find suitable
content for its existing and future Web sites;
. the sales and marketing costs and other operating expenses necessary to
maintain and attract new advertisers, users, registrants, and content and
e-commerce partners;
. the loss of key business relationships or personnel;
. seasonal fluctuations in revenues from, and traffic on, VCI's Web sites;
. changes in Internet industry trends regarding Web-based e-commerce and
advertising;
. the costs of acquiring technology or businesses and VCI's ability to
integrate them into its operations; and
. economic conditions generally, as well as those specific to the Internet
and related industries.
To respond to these and other factors, VCI may need to make business
decisions that could have a material adverse effect on its quarterly operating
results.
In addition, most of our revenue following the merger will come from VCI's
Web site operations and a majority of that 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 VCI will attract and/or retain within the quarter and
its ability to adjust spending in light of any revenue shortfalls. To date, the
advertising revenue from VCI's Web sites comes from a small group of customers
whose composition periodically changes. For example, during the year ended
December 31, 1998, the five largest advertisers accounted for approximately 51%
of the total advertising revenue. As a result, the cancellation of even a small
number of these advertising contracts could affect VCI's operating results.
9
Advertising revenue is also linked to the level of traffic on VCI's Web
sites, so if traffic is less than the level expected by its advertising
customers, VCI's advertising revenue could be adversely affected. Under most
advertising contracts, VCI guarantees its advertisers a minimum number of
impressions on its Web sites. Reduced traffic on these Web sites would cause
VCI to fall short in meeting this minimum requirement and, as a result, VCI may
be required to extend the length of time that an advertiser may advertise on
VCI's 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.
Moreover, the Internet has not been available for a sufficient period of
time to gauge its effectiveness as an advertising medium when compared with
traditional media and there is intense competition among sellers of advertising
space on the Web. This makes it difficult to project pricing models or to
anticipate whether VCI will be successful in selling advertising space and
relying on advertising as a substantial source of revenue.
Due to the foregoing factors, we believe that period-to-period comparisons
of VCI's operating results are not necessarily meaningful, and we do not think
they are reliable indicators of VCI's future performance. Regardless, if,
following the merger, VCI's operating results in any period fall below the
expectations of securities analysts and investors, the market price of our
shares would likely decline.
Following the merger, if our capital is insufficient to promote VCI's business
and we cannot obtain needed financing, we will not be able to promote VCI's Web
sites, exploit acquisition opportunities and remain competitive.
Since VCI's current revenues are insufficient to pay for its current
operating expenses, following the merger, we will depend on additional
investments to fund VCI's existing and future operations as well as to execute
its acquisition and business plans, launch additional Web sites and expand its
marketing and sales efforts. We think that our available cash, together with
the proceeds from VCI's series B preferred stock offering prior to the merger,
will be sufficient to support our current operations through December 31, 1999.
Notwithstanding, we will need to raise additional funds to maintain and develop
VCI's position in the marketplace. 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 VCI's business plans and may be forced to
liquidate our assets or file for bankruptcy.
VCI's independent auditors expressed doubt over VCI's ability to continue as a
going concern.
The report of independent public accountants on VCI's 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 VCI's ability to continue as a going concern. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Because VCI's business model is unproven, we do not know whether its business
will ultimately be profitable.
VCI's business model relies on using its existing Web sites and future Web
sites to retain, attract and expand its user and registrant base in order to
generate revenues from different sources. To be profitable, VCI will need to
provide content, goods and services that are attractive to its existing and
future users, registrants, advertisers, content partners and vendors. VCI
relies on its content partners to develop, supply and maintain substantial
portions of its Web sites. A decline in the creative development or interest of
VCI's existing or future content partners to supply content to its Web sites
could make these Web sites less attractive. VCI cannot be sure that Internet
users will continue to be interested in communities on the Web, in general, or
in its Web sites specifically, and any lack of interest could have a material
adverse effect on VCI's ability to generate revenue.
10
VCI's business model also relies on its ability to identify and acquire or
license additional Web sites, Internet technologies and Internet related
companies. In order for any acquisitions or licenses to be profitable, VCI will
need to successfully assimilate the personnel, operations, technology or
software of these acquisitions or licenses. If key personnel from these
acquisitions decide not to work for VCI or VCI cannot successfully integrate
these operations, technologies or software, or VCI cannot sublicense these
technologies or software as needed, then VCI may experience a material adverse
effect on its ability to grow its business.
VCI's business model also relies on its future plans to develop and
effectuate c-commerce through its existing and future Web sites. VCI's ability
to develop e-commerce systems and generate e-commerce revenue will depend upon
its ability to:
. generate or raise sufficient capital to develop e-commerce systems;
. acquire or develop technologies to competitively operate and improve
these systems;
. address its users' and registrants' security and privacy concerns; and
. gain the acceptance and confidence of its users and registrants, content
partners, advertisers and vendors so that it may successfully provide
large scale e-commerce systems on its Web sites.
VCI's business model also relies on its ability to identify and enter into
strategic and joint venture relationships with other online information and
service providers. VCI depends upon these relationships for the volume and
quality of the content on its Web sites. In some cases, VCI also depends on
exclusive agreements underlying these relationships to develop and maintain
content that is unique to its Web sites. VCI's inability to identify, attract
and maintain these relationships, or enter into these exclusive agreements may
have a material adverse effect on its ability to increase traffic on its Web
sites.
VCI's future success also depends on the continued growth in the use of the
Internet and the Web. Use of the Internet for entertainment, information
gathering, advertising and retail transactions is a recent development, and the
continued demand and growth of a market for services and products via the
Internet is uncertain. For the year ended December 31, 1998, advertising and e-
commerce referral revenue was the source of approximately 67% of VCI's total
revenue. The Internet may ultimately prove not to be a viable commercial
marketplace for a number of reasons, including:
. unwillingness of individuals and entities to advertise, market and sell
their products and services online;
. unwillingness of consumers to shift their purchasing from traditional
retailers to online purchases;
. lack of acceptable security for data and concern for privacy of personal
information;
. limitations on access and ease of use;
. inadequate development of Web infrastructure to keep pace with increased
levels of use leading to delayed or extended response times;
. increased or excessive government regulation; and
. problems regarding intellectual property ownership.
Because of these factors, we do not know whether VCI's business model will
ultimately be profitable.
VCI is substantially dependent on the virtualjerusalem.com Web site for its
revenues.
While VCI currently operates four Web sites (virtualjerusalem.com,
virtualholyland.com, virtualireland.com, and virtualitaly.com), approximately
99% of its revenues are generated directly or indirectly from
virtualjerusalem.com. Although VCI plans to market and develop
virtualholyland.com, virtualireland.com, and virtualitaly.com and launch or
acquire additional Web site communities, we cannot assure you that VCI will
successfully complete these plans, or if it completes these plans, that these
Web sites will generate significant revenues. VCI's inability to complete these
plans or generate substantial revenue from other sources would have a material
adverse effect on VCI's ability to generate revenue.
11
The political and economic stability of the State of Israel and VCI's plans to
create or acquire additional Web sites with international community content are
subject to risks that could adversely effect VCI's ability to operate its
business and expand internationally.
Two of VCI's subsidiary companies, Virtual Communities Israel Ltd. and
V.C.I. Internet Properties Ltd., which are integral to its success, are located
in the State of Israel. In addition, a significant number of VCI's content
partners and certain of its advertisers are based in Israel. Accordingly, VCI
is 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 its present trading partners or a significant downturn
in the economy or financial conditions in Israel could have a material adverse
effect on VCI's ability to operate its 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 VCI's 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 and
Israel and certain Arab countries. Although Israel entered into various
agreements with certain 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, VCI 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 VCI's employees, are obligated
to perform military reserve duty and are subject to being called into active
duty under emergency circumstances. While VCI operated despite these conditions
in the past, VCI cannot predict the likelihood of emergency circumstances
occurring in the future or the impact of these conditions on its operations in
the future.
In addition, VCI's plans to create or acquire additional Web sites with
international community content, and its plans to form strategic and joint
venture relationships in other parts of the world, will increase its 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
VCI's ability to expand its business into international markets. In addition,
even if VCI's future plans are successful, it cannot be certain that its
investment in establishing operations in other countries will produce the
desired levels of revenue.
Any failure of VCI's network infrastructure could adversely effect its
operations.
VCI's success depends upon the capacity, reliability and security of its
networking hardware and software infrastructure. VCI developed a hardware and
software system that is designed for reliability. The system
12
integrates Web site management, network monitoring, quality assurance,
transaction processing and fulfillment services. In addition, the VCI system,
which includes all of VCI's Web sites and its servers in Israel and the United
States, emphasizes extensive automation and a high degree of redundancy. The
system is designed to minimize single points of failure.
The VCI system, when completed in November 1999, will have 500 gigabytes of
disk space, which should support over 70 million Web page views per month. VCI
is continuing to expand and adapt its system infrastructure to keep pace with
the increase in the number of users and registrants who use the free Internet
services VCI provides. Demands on VCI's infrastructure that exceed its current
forecasts could result in technical operating difficulties with its Web sites.
Any system failure that interferes with the access to VCI's Web sites, and the
use by its users and registrants of the free Internet services that VCI
provides, could diminish the level of traffic on VCI's Web sites. Continuing or
repeated system failures could impair VCI's reputation and brand name and
reduce its e-commerce referral and advertising revenue. At present, VCI does
not know that it will be able to scale its systems to handle a larger amount of
traffic at higher transmission speeds. Further, any expansion of VCI's network
infrastructure will require substantial financial, operational and management
resources, all of which could affect the results of VCI's operations by
diverting these resources from other areas of VCI's business that it may seek
to develop.
User access to, and the functionality of, VCI's Web sites are highly dependent
on third parties, including Frontier Global Services, Inc. and Netvision Ltd.,
and other factors beyond the control of VCI.
VCI uses its own network servers that are housed at Frontier Global
Services, Inc.'s ("Global Center") facilities in Virginia and New York, and at
VCI's facility in Israel. VCI's Web sites are connected to the Internet by
Global Center in the United States and by Netvision Ltd. ("Netvision") in
Israel via multiple DS-3, OC-3, and 128Kbs links on a continuous basis. Global
Center is responsible for ensuring that all of VCI's servers have power and
connectivity to the Internet. VCI manages and monitors its servers and network
remotely from VCI's facility in Israel and, in addition, Global Center monitors
VCI's Web sites on a continuous basis.
Although the agreements VCI has with Global Center and Netvision provide VCI
with remedies for service interruptions, VCI cannot assure you that it will
have uninterrupted access to the Internet for its Web sites, or that its users
and registrants will be able to access its Web sites.
Any disruption in the Internet access provided to VCI 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 VCI's Web sites could have a
material adverse effect on VCI's business, results of operations and financial
condition by reducing the level of traffic on VCI's Web sites.
Despite precautions taken by VCI and by Global Center and Netvision, VCI's
system is susceptible to natural and man-made disasters such as earthquakes,
fires, floods, power loss and sabotage.
VCI's system is also vulnerable to disruptions from computer viruses and
attempts by hackers to penetrate VCI's network security. Hackers have succeeded
in penetrating VCI's network security in the past, and VCI expects these
attempts to continue from time to time. Breaches of VCI's network security
could also disrupt the operation of VCI's Web sites and jeopardize the security
of confidential information stored in its servers. VCI has recently started
implementing "Firewall" network security in its Israel facility and at Global
Center's United States facilities. "Firewall" is an industry standard product,
manufactured by CheckPoint and installed for VCI by industry experts, that is
designed to prevent unauthorized entry into network security systems. Although
VCI believes that Firewall will prevent unauthorized entry to its network
security in most instances, VCI cannot assure you that computer viruses and
hackers will not penetrate its systems in the future.
Any of the events listed above could cause VCI interference, delays, or
service interruptions and adversely affect its business and results of
operations. The success of VCI is dependent upon, among other things, its
ability to deliver uninterrupted Web site service to the users and registrants
of the VCI Web sites. As a result,
13
VCI must protect its computer equipment and the information stored in its
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 the control of VCI. In addition, VCI cannot assure you that
errors will not be found in the software underlying VCI's Web sites or a Web
site developed by VCI 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 a Web site or other project. 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 VCI
or to pay for damages caused by the delay or defect.
VCI depends on its content partners and suppliers to attract users and
registrants to its Web sites.
VCI's future success depends largely on its ability to attract and maintain
a large base of users and registrants because the larger its base the more
likely commercial enterprises are willing to advertise and sell their products
and services on VCI's Web sites. Moreover, certain advertisers pay VCI based
upon the number of times a registrant views a particular advertisement. The
volume of users who view VCI's Web sites and the size of its registrant base
depends largely on the ability of VCI's current and future content partners,
who supply content to its Web sites, to attract and retain users and
registrants. While no single content partner is material to VCI's operations,
VCI may not be able to maintain or expand its base of content partners. If VCI
is unable to obtain content from content partners, VCI would be unable to
create significant content to attract and maintain its users and registrants
and would likely lose significant advertising and other revenue.
VCI depends on a variety of third parties for the Internet services it provides
to its registrants to encourage these registrants to visit and use its Web
sites, and for the services it requires to operate its Web sites.
VCI relies on the following companies for certain of the Internet services
it provides to its 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
If VCI's relationship with any of these companies were to terminate without
sufficient advance notice, and VCI were unable to establish relationships with
comparable service providers, VCI's ability to provide Internet services to its
registrants, and to operate its own Web sites, 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 effect VCI's ability to manage and grow its businesses.
VCI's success depends to a significant degree upon the continued
contributions of its executive management team, most of whom have worked
together only for a short time. VCI does not carry key man life
14
insurance on the lives of any of its employees except for Avi Moskowitz, VCI's
Chairman of the Board, Chief Executive Officer and President. VCI's success
will also depend upon the continued service of its management team as well as
technical, marketing and sales personnel, graphic artists and editorial staff.
Although VCI has entered into employment contracts with certain members of its
management team, including Mr. Moskowitz, all of VCI's employees may
voluntarily terminate their employment at any time. VCI's success also depends
upon its 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 VCI's 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 VCI's ability to manage and grow its
businesses.
VCI's operations could be adversely affected if its investments in its Web
sites do not generate a corresponding increase in net revenue.
As the number of Web sites grow, brand and site recognition will play an
increasingly important role. Establishing, developing and promoting VCI's Web
sites in the face of pressures from its competitors will be critical to
developing its registered user base, content and strategic partners and
commercial relationships. VCI will be required to continue to devote
substantial financial and other resources to maintaining the unique content of
its Web sites 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 VCI's operations could be adversely affected if its
investment of financial and other resources in developing and promoting its Web
sites does not generate a corresponding increase in net revenue, or if the
expense of promoting its Web sites becomes excessive. Changes in the quality
and type of services VCI offers and the character of VCI as perceived by its
registered users could make its Web sites less attractive to its users,
registrants, advertisers, content and strategic partners, all of which would
have a material adverse effect on VCI's ability to increase its registered user
base and to generate revenue.
VCI may not be able to earn enough advertising revenue to support its planned
expenditures.
Historically, VCI derived a material portion of its revenue from the sale of
advertisements on its Web sites. For the year ended December 31, 1998,
advertising revenue represented 62% of VCI's total revenue. During the same
period, VCI's five largest advertising customers accounted for approximately 51
% of advertising revenue (or approximately 32% of VCI's total revenue). VCI
intends to continue relying on advertising as a significant source of revenue
in the future.
It is uncertain whether Web advertising will continue to grow at a rate that
will support VCI's revenue projections. The Internet as a marketing and
advertising medium has not been available for a sufficient period of time to
gauge its effectiveness as compared with traditional media. Many of VCI's
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.
It is also possible that in the future certain Internet access providers
will act to block or limit the use of advertisements. Moreover, "filter"
software programs that limit or remove advertising from a Web user's desktop
are currently available. If these programs become popular, there could be a
material adverse effect upon the viability of advertising on the Web and on
VCI's ability to generate sufficient advertising revenue to support its planned
expenditures.
15
Part of VCI's business depends on the growing demand for Web site design and
development services.
Because VCI is in the business of providing Web site design and development
services, its 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 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 its 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 VCI's Web site design and development services.
Because competition in the online community and Web site design and development
businesses is intense, and many of VCI's competitors have greater resources
than VCI, VCI's ability to maintain or improve its position in these markets
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 VCI competes 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), Shema Yisrael (www.shemayisrael.co.il; a non-profit ultra
Orthodox Web site), 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; and
. 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).
VCI also faces 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 VCI 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 it than VCI could otherwise establish or obtain.
Substantially all of VCI's current advertising customers and content
partners also have established collaborative relationships with some of VCI's
competitors or other Web sites. VCI's 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, VCI may be unable to maintain the
traffic on its Web sites or sustain or increase the size of its registered user
base, which would make VCI's Web sites less attractive than those of its
competitors. Any of these factors could adversely affect VCI's ability to
maintain or improve its competitive position.
16
VCI recently started offering third parties, other than its content
partners, Web site design and development services that focus on Web site
content management. The market for these services is relatively new, intensely
competitive and subject to rapid technological change. VCI expects competition
not only to persist, but to increase. Increased competition may result in price
reductions, reduced margins and loss of market share. VCI's 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 VCI's
potential clients. These competitors include Vignette Ltd., Interwoven, Inc.
and Futuretense, Inc.
The barriers to entry for Web site design 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, VCI expects
to face additional competition from new market entrants in these businesses in
the future. Since the market for these services is rapidly evolving, VCI's
competitors may be better positioned to service clients. VCI competes 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 VCI's control, therefore, existing or future
competitors may develop or offer services that provide significant advantages
over the services offered by VCI.
Many of VCI's 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 VCI's markets in the future, and that many of these
competitors will have substantially greater resources than VCI. VCI cannot
assure you that it will be able to compete successfully in any of its current
markets.
VCI could be liable for legal proceedings that would injure its business
reputation or result in substantial damages against it.
Certain of VCI's engagements involve the design and development of Web sites
that are important to their clients' businesses. VCI's failure or inability to
meet a client's expectations in the performance of services could injure either
VCI's or the client's business reputation or result in a claim for substantial
damages regardless of VCI's responsibility for such failure. In addition, the
services VCI provides to its clients may include access to confidential or
proprietary client information. Although VCI has implemented policies to
prevent such client information from being disclosed to unauthorized parties or
used inappropriately, any such unauthorized disclosure or use could result in a
claim against VCI for substantial damages. VCI's contractual provisions
attempting to limit such damages may not be enforceable in all instances or may
otherwise fail to protect it from liability for damages. Moreover, VCI does not
currently have errors and omissions insurance.
If VCI cannot integrate future acquisitions into its existing operations, then
VCI may be unable to manage its operations and expand its business.
VCI has been approached from time to time to consider and evaluate potential
business combinations, both involving its acquisition of other companies and
potential investments in VCI or other business combinations. VCI may engage in
discussions relating to similar transactions in the future. Although
VCI expects to grow, in part, through business combinations, it is uncertain
whether VCI will decide to enter into any transaction. If VCI does enter into a
transaction, VCI cannot be certain what the terms of the transaction or its
timing will be.
Acquiring complementary businesses, products and technologies is an integral
part of VCI's 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 VCI's operations while preserving the goodwill of
the acquired entity;
. the additional financial resources that may be needed to fund the
operations of acquired companies;
17
. the potential disruption of VCI's business;
. VCI management's ability to maximize its 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 VCI from realizing significant benefits
from its acquisitions. In addition, following the merger, the issuance of our
common stock, options or other securities in acquisitions will dilute our
stockholders' interests, while the use of cash will deplete our cash reserves.
Finally, if VCI is unable to account for its acquisitions under the "pooling of
interests" method of accounting, VCI may incur significant, one-time write-offs
and amortization charges. These write-offs and charges could decrease
VCI's future earnings or increase its future losses.
If VCI's important strategic relationships are discontinued for any reason, our
ability to generate revenue from advertising and e-commerce referrals would be
adversely effected.
Although VCI's strategic relationships with its content partners and
Internet services providers are a key factor in VCI's overall business
strategy, its strategic partners may not view their relationships with VCI as
significant to their own business. There is a risk that parties with whom VCI
has strategic alliance agreements may not perform their obligations as agreed.
VCI's arrangements with strategic partners generally do not establish minimum
performance requirements but instead rely on the voluntary efforts of its
partners. In addition, most of VCI's agreements with strategic partners may be
terminated by either party with little notice. If important strategic
relationships are discontinued for any reason, VCI's ability to generate
revenue from advertising and e-commerce referral revenues may be adversely
affected.
Risks Typical of the Internet Industry
Privacy concerns, government regulation and legal uncertainties could adversely
effect activity on the Internet, including VCI's 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 its 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 VCI's Web sites, or
give rise to claims by VCI's clients for whom it develops or designs 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 VCI's ability to generate e-commerce
referral revenue.
The Federal Communications Commission is currently reviewing its regulatory
positions on data transmissions over telecommunications networks and could seek
to impose some form of telecommunications 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 VCI's business and results of operations.
18
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 VCI's
advertising or e-commerce revenue.
Imposition of sales or other taxes on sales of merchandise purchased by
users of VCI's Web sites from its 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 VCI receives 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 VCI's advertising or e-commerce
revenue.
VCI could be liable for online content not covered by VCI's insurance.
The nature and breadth of information disseminated on VCI's Web sites could
expose it 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 its Web sites via links
to its 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
VCI offers; and
.product information and reviews that VCI offers.
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 VCI would result in VCI incurring substantial costs and would
also be a drain on its financial and other resources. If there were a
sufficient number or several severe claims of this nature, VCI would need to
implement measures to reduce its exposure and potential liability. In addition
to being a drain on VCI's resources, this may also require taking measures that
could make VCI's Web sites or services less attractive to its registrants and
users. This in turn could reduce traffic on VCI's Web sites, negatively impact
the size of its registered user base, and reduce its advertising and e-commerce
revenues. VCI carries 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 VCI. To the extent VCI's insurance coverage does not
cover liability or expenses it incurs, VCI's financial and other resources
could be strained.
VCI's inability to protect its intellectual property rights could adversely
effect VCI's ability to operate its businesses.
VCI considers its names, logos and designs as proprietary and tries to
protect them under existing United States and international laws relating to
protection of intellectual property. VCI also developed internal procedures to
control access and dissemination of proprietary information. Despite VCI's
precautions, third parties may succeed in misappropriating its intellectual
property or independently developing similar intellectual property. Protecting
VCI's intellectual property against infringement could result in substantial
legal and other costs and could divert VCI's limited management resources and
attention from its business plans.
Some of the technology incorporated in VCI's Web sites, and offered to VCI's
content partners and clients of its Web site design and development services,
is based on technology licensed from third parties. As VCI continues to
introduce new services, VCI may need to license additional technology. If VCI
is unable to timely license needed technology on commercially reasonable terms,
it could experience delays and reductions in the quality of its services, all
of which could adversely affect its business and results of operations. VCI's
reputation and the value of its proprietary information could also be adversely
affected by actions of third
19
parties to whom VCI licenses its proprietary information and intellectual
property. If someone asserts a claim relating to proprietary information
against VCI, VCI may seek licenses to this intellectual property. VCI 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 VCI's ability to develop its Web sites.
Although VCI does not believe it infringes the proprietary rights of any
third parties, VCI may be subject to claims from third parties in the future.
These claims, whether or not meritorious, could result in litigation and become
a drain on VCI's management and financial resources. If successful, claims of
this nature could subject VCI to liability, injunctive relief restricting its
use of intellectual property important to its operations, and could ultimately
cause VCI to lose rights to some of its intellectual property.
VCI's inability to incorporate certain content management software from a third
party into its own Web sites and the Web sites of its Web site design and
development clients, could adversely effect VCI's ability to develop content on
its own Web sites and to expand its Web site design and development business.
In July 1999, VCI acquired a license to certain content management software
for use by VCI in maintaining content on its own Web sites. VCI is also
intending to use this software in the design and development of the Web sites
of its clients. VCI cannot assure you that it will be able to successfully
integrate this software into its own Web sites and the Web sites of its
clients. If VCI is unable to integrate the software into its own, and its
clients' Web sites, VCI's ability to develop content on its own Web sites and
to expand its Web site design and development business could be adversely
affected.
Year 2000 issues could negatively affect VCI's business.
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 VCI's Web sites or engage in other business activities.
VCI's applications operate in complex network environments and directly and
indirectly interact with a number of other hardware and software systems. VCI
is unable to predict to what extent its business may be affected if its systems
or the systems that operate in conjunction with its systems experience a
material Year 2000 failure. VCI is also subject to the Year 2000 risks
affecting the Internet as a whole.
Known or unknown errors or defects that affect the operation of VCI's
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 VCI's reputation, increased service and warranty costs,
and litigation costs, any of which could adversely affect VCI's business,
financial condition and results of operations.
One of the most likely worst case scenarios for VCI due to a Year 2000
failure is that access to VCI's Web sites through the Internet would be limited
or impossible due to a telecommunications problem beyond VCI's control. In such
a scenario, VCI would be dependent on third party telecommunications providers
to remedy the problem.
Another likely worst case scenario for VCI is the failure of a VCI server to
function properly due to a Year 2000 issue. VCI believes that such a failure
could be remedied within 24 hours by its staff or the staff of its service
providers.
20
Risks Relating to Your Investment in HDG
Our stock price has been and may continue to be volatile following the merger.
The trading price of our common stock has been, and following the merger 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 VCI or its 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;
. sales of common stock or the exercise of our outstanding options,
warrants, class A or B warrants, unit purchase options or escrowed shares
or options; and
.other events or factors beyond our control.
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. The trading prices of many Internet
companies' stocks were recently at or near historical highs and these trading
prices and price to earnings multiples are substantially above historical
levels. These trading prices and multiples may not be sustainable. 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. In the past, following periods of volatility in the
market price of a company's securities, securities class action litigation
often has been instituted against that company. Similar litigation, if
instituted against us, could result in substantial costs and a diversion of our
management's attention and resources.
Your investment in our stock may become illiquid and you may lose your entire
investment.
Moreover, under the Nasdaq Stock Market Marketplace Rules, Nasdaq requires
Nasdaq SmallCap Market issuers to comply with applicable requirements for
initial inclusion (versus continued listing) where such issuer merges with a
non-Nasdaq entity which results in a change of control and a change in the
business of such issuer. Accordingly, following the merger we are subject to
Nasdaq's initial inclusion requirements which require us to meet all of the
following requirements upon completion of the merger:
. we have net tangible assets (total assets, excluding goodwill, minus
total liabilities) of at least $4 million, or
.a market capitalization exceeding $50 million, or
.net income (in the latest fiscal year or two of the last three fiscal
years) exceeding $750,000;
. we have a public float of at least 1 million shares (not including shares
held directly or indirectly by any of our officers or directors or by any
other person who beneficially owns more than ten percent of our total
outstanding shares);
.the market value of our public float is at least $5 million;
.the minimum bid price of our common stock is $4 per share;
21
.we have at least three market makers for our common stock;
. we have at least 300 shareholders of our common stock (each of which hold
at least 100 shares of common stock);
.we have an operating history of at least one year; and
.we meet certain corporate governance tests promulgated by Nasdaq.
We cannot assure you that we will meet all of these requirements following
the completion of the merger, and even if we do, Nasdaq may, in its sole
discretion, still deny inclusion of any of our securities on the Nasdaq
SmallCap Market or apply additional or more stringent criteria for the
inclusion of any of our securities on the Nasdaq SmallCap Market. Accordingly,
we cannot assure you that our securities will retain their current Nasdaq
SmallCap listings. Regardless if our listings are maintained, we cannot assure
you that any trading market for our securities will exist. Consequently, you
may not be able to liquidate your investment in the future, if at all, and as a
result may lose a significant portion, or all, of your investment.
Penny stock regulations may affect your ability to sell our securities.
As part of the merger, we must apply for listing of our securities,
including our common stock, on the Nasdaq SmallCap Market. 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.
The SEC has adopted regulations that generally define a penny stock to be
any equity security that has a market price of less than $5.00 per share,
subject to certain exceptions. These exceptions include an equity security
listed on the Nasdaq SmallCap Market, and an equity security issued by an
issuer that has (i) net tangible assets of at least $2,000,000, if the issuer
has been in continuous operation for three years, (ii) net tangible assets of
at least $5,000,000, if the issuer has been in continuous operation for less
than three years, or (iii) average revenue of at least $6,000,000 for the
preceding three years. Unless an exception is available, the regulations
require the delivery, prior to any transaction involving a penny stock, of a
disclosure schedule explaining the penny stock market and the associated risks.
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.
Anti-takeover provisions in our post-merger charter could negatively impact our
stock's trading price.
Following the merger, our board of directors will have 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. The holder of our common stock could be
adversely affected by the issuance of 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.
22
Approximately 11,999,293 million, or 70%, of our total outstanding shares will
be restricted from immediate resale following the merger, 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.
Upon completion of the merger, we will have outstanding approximately
17,133,219 shares of common stock, based on shares outstanding as of June 30,
1999 and assuming (which assumptions shall apply to the entire discussion under
this risk factor):
1. a conversion ratio of 1.361 (the calculation of the exchange ratio of
1.361 was made on the assumption that HDG will have a cash value of
$2,499,000 at the time of the merger);
2. the conversion of all of VCI's series A preferred stock and series B
preferred stock into VCI common stock concurrent with the merger;
3. the exchange of all outstanding VCI common stock into our common stock
upon completion of the merger;
4. no exercise of any of the outstanding options to purchase approximately
2,170,667 shares of VCI common stock, the outstanding warrants to
purchase approximately 1,558,936 shares of VCI common stock (not
including warrants to be issued to Jesup & Lamont in connection with the
merger), or the outstanding options to purchase approximately 215,674
shares of our common stock, or the outstanding class A or class B
warrants or unit purchase options to purchase approximately
5,620,000 shares of our common stock;
5. no conversion of the $150,000 loan made to VCI which is convertible into
approximately 258,621 shares of VCI common stock; and
6. the holders of 75% of the escrowed shares and options (see ["Share
Ownership of Management and Certain Stockholders--Escrowed Shares and
Options"] for a more detailed description of the Escrowed Shares and
Options) convert such shares into three year warrants to purchase shares
of our common stock.
Of these 17,133,219 shares that will be outstanding, approximately 5,133,926
shares, or 30%, will be freely tradable without restriction under the
Securities Act.
Of the remaining 11,999,293 shares that will be outstanding, these shares
will become available for resale in the public market as described below.
Approximately 11,111,726 of these shares are subject to tiered lock-up
agreements that the shareholders signed with VCI and HDG prior to the merger.
These lock-up agreements generally prohibit the sale of these shares as
follows:
Number of
months
following
merger 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 887,567 restricted shares of our common stock
will be subject to lock-up agreements which generally prohibit the sale of
these shares for six months following the completion of the merger.
Upon the expiration 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.
23
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 holders of VCI warrants exercisable, upon completion of the
merger, into approximately 1,126,429 shares of our common stock are subject to
the tiered lock-up agreements described above. However, all of these warrant
holders may exercise their warrants prior to the completion of the merger, and
in exchange would receive registered shares of our common stock not subject to
such lock-up agreements.
In addition, following the merger, we plan to register VCI's options which
would be exercisable into approximately 2,954,277 shares of our common stock
after the completion of the merger. These options were issued under VCI stock
plans that we will assume in the merger. This registration will permit these
option holders to freely trade our common stock which 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 holding 100% of these options signed lock-up agreements which
generally prohibit the sale of the underlying shares for six months following
the completion of the merger.
In September 1999, we 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 September 10, 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 following the effectiveness of the
registration statement from time to time subject to becoming exercisable and
the expiration of the lockup agreements following the consummation of the
merger, out of a total of 250,000 shares of common stock reserved for issuance
under the 1996 Stock Option Plan.
Following the merger, we may not receive all of the tax benefits from our
accumulated net operating losses.
As a result of the merger, the combined company may be required to pay
federal income taxes because of limitations on the use of net operating loss
carryforwards. Currently, HDG has approximately $4.2 million in loss
carryforwards, of which it may use approximately $210,000 each year as
associated with approximately $1.7 million of such loss carryforwards and of
which it may use approximately $2.5 million of the remaining loss carryforwards
each year subject to certain other limitations, with any unused portion being
carried forward to the next year. The merger will result in an ownership change
of HDG for purposes of the Internal Revenue Code and the combined company's use
of HDG net operating loss carryforwards may be limited to approximately
$242,000 each year with any unused portion carried forward.
No dividends will be paid in the near future.
Neither we nor VCI has ever paid dividends on its common stock. Following
the merger, we do not anticipate paying dividends in the future. We intend to
reinvest any funds that might otherwise be available for the payment of
dividends in further development of our business following the merger.
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.
24
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.
The merger may not be consummated.
The consummation of the merger is subject to various conditions, including
the approval by the stockholders of each of HDG and VCI. Many of the conditions
are outside of the control of HDG and VCI. In the event the merger is not
consummated, HDG would be forced to seek alternative investment or acquisition
options. There can be no guarantee that such alternative investments or
acquisitions would be available or, if available, that such alternative
investments or acquisitions would be profitable.
25
THE OFFERING
Shares to be issued to VCI warrant holders
After consummation of the merger holders of outstanding warrants to purchase
shares of VCI common stock will be 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 VCI common stock underlying their warrants were
held by them at the effective time of the merger. Accordingly, the number of
shares of our common stock that we may issue to holders of the VCI warrants
will be determined by multiplying 1,558,936 (the number of shares of VCI common
stock issuable on exercise of such warrants) times the conversion ratio
determined in accordance with the merger agreement.
The merger agreement provides that such conversion ratio is determined by
the following formula:
"VCI Valuation"/VCI common shares outstanding
----------------------------------------------------
(HDG "Cash Value" x a "multiplier")/HDG common shares outstanding
The "VCI Valuation" amount equals $22,000,000 plus any gross proceeds raised
by VCI from the sale of stock between June 2, 1999 (the date as of which the
merger agreement was signed) and the date the merger is completed. We
anticipate that the VCI Valuation will be between $23,032,500 and $24,100,000
and the number of shares of VCI common stock outstanding immediately prior to
the merger will be between 10,836,947 and 11,345,280 shares. (VCI's outstanding
shares give effect to the conversion of its outstanding preferred stock into
common stock.)
HDG's "Cash Value" is the total amount of our cash and cash equivalent
assets (with certain defined adjustments) at the effective time of the merger.
The "multiplier" will depend on the amount of our Cash Value as described
below:
If our Cash Value equals: then the multiplier will be:
------------------------- ----------------------------
$2,500,000 or more............................ 1.15
less than $2,500,000.......................... 1.00
We anticipate that our Cash Value will be between $2.5 million and
$2.7 million.
For Example
. If at the effective time of the merger, the VCI valuation is $23,032,500
(based on $1,032,500 of equity capital raised by VCI since the date of
the merger agreement), there are 10,836,947 shares of VCI common stock
outstanding, HDG's cash value is $2,700,000, the multiplier is 1.15, and
there are 1,602,056 shares of HDG common stock outstanding, the
conversion ratio will be 1.097. Accordingly, each outstanding warrant to
purchase a share of VCI common stock would entitle the holder to receive
1.097 shares of our common stock upon exercise of such warrant after the
consummation of the merger.
. Applying the same formula, if at the effective time of the merger, the
VCI valuation is $24,100,000 (based on $2,100,000 of equity capital
raised by VCI since the date of the merger agreement), there are
11,345,280 shares of VCI common stock outstanding, HDG's cash value is
$2,499,000, the multiplier is 1.00, and there are 1,602,056 shares of
HDG common stock outstanding, the conversion ratio will be 1.361.
Accordingly, each outstanding warrant to purchase a share of VCI common
stock would entitle the holder to receive 1.361 shares of our common
stock upon exercise of such warrant after the consummation of the
merger.
26
These examples are provided for explanatory purposes only, as the actual
calculation of the conversion ratio cannot be determined in advance of the
effective date of the merger.
We anticipate that the conversion ratio will be between 1.097 and 1.361.
This means that we anticipate issuing between 1,710,153 and 2,121,712 shares of
our common stock to the holders of the VCI warrants, assuming the exercise of
all the outstanding VCI warrants.
There are outstanding warrants to purchase 225,113 shares of VCI 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 VCI's placement
of Series A and B convertible Preferred Stock in early 1999. VCI also has
outstanding warrants to purchase 1,333,823 shares of its common stock, at
exercise prices ranging from $0.30 to $2.10, issued to certain directors,
shareholders, employees and vendors in consideration for certain loans granted
to VCI, waivers and deferrals of compensation, guarantees of bank lines of
credit and services rendered to VCI.
Shares and warrants to be issued to certain holders of outstanding class A
warrants
In connection with the company's initial public offering of units in
February 1997, certain investors in the company received 500,000 redeemable
class A warrants in exchange for warrants that such 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 the company 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 certain
outstanding unit purchase options granted to the underwriter and finder in
connection with the company's 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."
27
USE OF PROCEEDS
Assuming all of the VCI warrants are exercised, the company would receive
approximately $1,355,714 in proceeds, minus certain expenses.
Upon exercise of the currently outstanding warrants of the company and
warrants issuable upon exercise of such warrants, the company would receive
gross proceeds as follows (in each case minus certain expenses):
. assuming all of the outstanding class A warrants are exercised, the
company would receive $12,220,000 in proceeds;
. assuming all of the outstanding class B warrants are exercised, the
company 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, the company would receive an
additional $16,450,000 in proceeds.
In addition, the company would receive the following gross proceeds, minus
certain 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.
The company plans 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 the VCI
communities and CMS business, and general working capital.
We will not receive any proceeds from the sale of shares by warrant holders.
28
THE COMPANY
INFORMATION ABOUT HDG
Business
We are a development stage company formed in 1994 to research, develop,
design and market fitness related products. Our sole product 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, we revamped our business model in the
second half of 1997. We no longer believe that we can be successful in selling
or licensing the IntelliFit product to customers and supporting the product in
the field. We still believe, however, that the IntelliFit software may be a
viable product for a company which has complementary products or an existing
field sales organization, and plan to pursue licensing or selling the
IntelliFit system to such a buyer.
In parallel, we have been pursuing a strategy of investment in or
acquisition of an existing company, culminating in our decision to enter into
the merger agreement with VCI.
Property
HDG does not currently own or lease any property. It maintains a mailing
address at 1219 Morningside Drive, Suite 102, Manhattan Beach, California
90266.
Legal Proceedings
HDG is not a party (nor is any of its property subject) to any pending legal
proceedings. HDG is unaware of any proceedings contemplated by any governmental
authority.
Market for Common Equity and Related Stockholder Matters
HDG common stock is traded on the Nasdaq SmallCap Market under the trading
symbol "IFIT." As of September 21, 1999, HDG had approximately 530 stockholders
of record. The following table sets forth the high and low bid quotations for
HDG, 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
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
Dividends
HDG has not paid any dividends since its inception, and we do not expect
that the post-merger company will pay any dividends in the foreseeable future.
Any determination to pay dividends in the future will be at the discretion of
the HDG board of directors, and will be dependent on HDG's future results of
operations, financial conditions, capital expenditures, working capital
requirements and other relevant factors.
29
INFORMATION ABOUT VCI
Business Overview
Virtual Communities, Inc., a Delaware corporation ("VCI"), was incorporated
in August 1996 as Virtual Jerusalem Ltd. VCI 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, VCI
acquired substantially all of the assets and outstanding shares of Virtual
Jerusalem Ltd., an Israeli corporation formed by the founders of VCI, that
developed and published an Internet Web site called Virtual Jerusalem. VCI
currently operates four online communities: Virtual Jerusalem
(www.virtualjerusalem.com), Virtual HolyLand (www.virtualholyland.com), Virtual
Ireland (www.virtualireland.com) and Virtual Italy (www.virtualitaly.com).
Rather than create its own content, VCI's Web sites aggregate comprehensive
news and a variety of interactive and community-building elements selected from
existing online entities (called "content partners") with which VCI enters into
relationships, the majority of which are exclusive. VCI wraps the content it
obtains 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, VCI provides its content partners
with a variety of benefits, including links to their Web sites, a portion of
advertising revenues and interactive Web services on co-branded pages created
by VCI.
As a result of its experience in developing its three online communities and
the creation of over one hundred Web sites for its content partners, VCI began
offering its Web site design and development services to unrelated third party
Web site publishers. Although VCI had historically provided these services only
to its content partners in exchange for access to content, offering these
custom services to third parties for a fee represents a new business for VCI.
These services, which VCI offers to its content partners and other third
parties in the form of "modules," include content management technologies and
numerous interactive elements described in more detail below. VCI has entered
into one agreement with a third party to date for the provision of these
services, and is currently negotiating with another such third party to provide
these services on a fee basis and has received interest from several other
entities for similar services. (See "Web Site Design and Development".)
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"
30
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.
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.
Web site design and development
VCI's 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 its users to interact with other users, such as
chat rooms, message boards, games, free e-mail services and personal home
pages. VCI's 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 VCI's projection of the increased complexity of Web publishers'
sites, VCI believes 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,
31
content management systems and a flexible choice of interactive elements. VCI
believes 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.
VCI's Strategy
VCI's 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 VCI's 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. VCI's management now recognizes that this strategy can be
applied equally as well to Web sites for a specific business discipline,
religion, country or ethnicity.
VCI's selects its 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. VCI's 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.
VCI's strategy entails aggregating content appearing on disparate Web sites
on the Internet into well defined online communities targeted to these specific
demographic groups. VCI's management thinks that successful Web site
communities must have the following characteristics:
. a large target market with at least 2 million Internet users;
. 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 VCI
with aggregating potential from which to cull a critical mass of content.
In selecting a large target market, VCI's 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, VCI is 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 VCI would enter into agreements.
VCI's management thinks that its strategy of developing and acquiring online
communities will position it 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 VCI's 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.
32
VCI's Revenue Sources
VCI's revenues increased from $402,000 in 1997 to $819,000 in 1998, an
increase of over 104%. VCI recorded revenue of approximately $345,000 for the
first six months of 1999. While advertising revenues contributed approximately
$512,000 to revenue for 1998 (or 63% of this revenue), and 54% of first half of
1999 revenues, VCI anticipates that the majority of its revenues after 1999
will be derived from e-commerce. VCI projects that its e-commerce revenues will
grow from approximately $0.1 million in 1999 (9% of anticipated total revenues)
to approximately $1.3 million in 2000 (17% of anticipated total revenues) and
approximately $6.8 million in 2001 (25% of anticipated total revenues). In
addition, VCI anticipates that a significant portion of its revenues in the
future will be derived from its Web site design and development services. VCI
projects that its Web site design and development services revenues will grow
from approximately $500,000 in 1999 (37% of anticipated total revenues) to $2.5
million in 2000 (33% of anticipated total revenues) and $4.9 million in 2001
(18% of anticipated total revenues). Below is a more detailed description of
VCI's three projected revenue streams.
E-commerce
To generate e-commerce revenue, VCI enters into agreements with vendors that
offer online sales capabilities, and establish links from VCI's Web sites to
the vendor's Web sites. VCI has several of these agreement in place for the
sale of products on the Virtual Jerusalem Web site and the Virtual HolyLand Web
site and plans to enter into additional relationships for each of its existing
and future Web sites. VCI receives commissions, calculated as a percentage of
the total transaction amount, from its e-commerce partners every time a VCI Web
site user purchases an e-commerce partners' product or service through a VCI
Web site. VCI receives commissions ranging from 20% to 30% from its 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. VCI anticipates 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 VCI's Web site communities since each
community targets a well-defined, passionate demographic group. At the same
time, VCI's users know the desired e-commerce vendors will be attracted to
their community due to its unique content and forum. VCI intends to create
stronger e-commerce relationships with its 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.
The Company recently entered into a license agreement with Intershop
Communications, Inc. whereby VCI will create online shopping centers in its
communities and offer its content partners and CMS customers the ability to
create their own stores using software developed by Intershop. (See "Licenses,
Service Agreements and Trademarks.")
Web site design and development
In implementing its strategy as discussed above, VCI developed three online
communities of its own and has designed and developed Web sites for many of its
content partners in exchange for their content. In addition, to leverage the
know-how and technologies VCI obtained in this process, VCI is offering Web
site design and development services to third party Web publishers on a fee
basis. VCI offers 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, VCI sublicenses modules that it
previously licensed from Internet service providers with which it has formed
prior relationships, or alters programs that VCI created for its own online
communities. VCI also intends to license additional modules from entities with
whom it is currently in negotiations or from entities which produce attractive
new technologies. In order to deliver its services to its content partners and
potential third party clients using these licensed technologies, one of VCI's
33
subsidiaries, VCIL, maintains a staff of Web site designers and programmers who
create, update and maintain Web sites. In exchange for services rendered to its
content partners, VCI receives content. In exchange for services rendered to
third parties, VCI plans to charge a one time flat fee of approximately
$250,000 to $300,000, depending upon certain factors such as the number of
modules to be provided, VCI's level of participation in a particular Web site's
advertising and e-commerce revenues and VCI's access to such site's user
registration data.
In August 1999, the Company, 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 certain design,
development and maintenance services for a web site to be produced by VCI on
behalf of Tromaville. Pursuant to the agreement, VCI granted to Tromaville a
limited, non-exclusive, worldwide, perpetual royalty-free, nontransferable
license to use the Company's Community Management Solution ("CMS") which shall
be installed on the Tromaville site. VCI shall provide a variety of CMS
elements to Tromaville including registered user, sweepstakes, greeting card,
email a friend, games, polls, and statistic modules. VCI shall also provide
certain 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 Tromaville site will reside on two separate redundant
VCI servers and VCI shall submit all components of the site to appropriate
search engines and directory listings. 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, VCI will 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, VCI shall 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
VCI's management thinks that its 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. VCI
currently has agreements with a number of advertisers, including: Continental
Airlines, Econophone, Advanced Telecom Systems and Vitamin Shoppe.
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, VCI's 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.
VCI recently shifted its advertising focus by trying to gather sponsor
advertisers who would sponsor a whole page or channel. These sponsors would
enter into a year long commitment, rather than the short term advertisement
contracts currently provided by VCI. VCI's management thinks that these
sponsors should be attracted to these sponsorship offerings since they do not
have to share VCI 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 VCI's most recent
advertisers entered into six to twelve month sponsor agreements with VCI.
VCI's Marketing Efforts
VCI markets its Web sites by:
. entering into agreements with leading public relations firms and
advertising agencies that have specific knowledge of VCI's target
audiences, including A. Larry Ross & Associates, Inc., a Dallas based
public relations firm with extensive contacts in the Christian market;
34
. engaging in comprehensive advertising campaigns, including print
advertisements, radio spots and online advertising, designed to introduce
each of its Web sites to its targeted audience in the United States;
. disseminating press releases to announce the launch of its new Web sites,
additional features and the addition of new content partners; and
. contracting with its content partners to publicize their affiliation with
VCI's Web sites to their constituent organizations and members, and
encouraging these partners to link their Web sites to VCI's Web sites
(e.g., the International Christian Embassy in Jerusalem created a link to
Virtual HolyLand).
In the future, VCI intends to supplement the activities of its outside
agencies by indexing its Web sites on the Internet's major search engines and
by further encouraging its content partners to publicize VCI's Web sites in
their print and online publications through the use of stories and
advertisements prepared by VCI.
Specific marketing efforts for Virtual Jerusalem
Previously, marketing activities for the Virtual Jerusalem Web site were
limited to VCI's 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, VCI 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 third and fourth quarters of 1999. VCI is also seeking to
promote Virtual HolyLand by contacting media that target the Evangelical market
and by entering into relationships with entities that have relationships with
Evangelical ministries.
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. VCI also
sponsors 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
The marketing campaign for Virtual Italy, to be rolled out in the first
quarter of 2000, will include newspaper and other print and online
advertisements, promotions and grass roots efforts with organizations in the
Italian American community.
Web site design and development
Although VCI has not yet engaged in any formal marketing activities to offer
its Web site design and development services to Web site publishers who are not
content partners, it intends to do so in the near future.
Competition
As described below, VCI has a variety of competitors for each of its Web
sites and for each of the markets in which its businesses operate.
In addition, VCI acknowledges 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 which may compete for VCI's
potential users, registrants, content partners, advertisers, e-commerce vendors
and sponsors. However, VCI's management thinks that most of these Web sites
focus primarily on providing free
35
personal web pages to their users and do not offer the same level of a targeted
demographics and information that VCI's Web sites offer. Moreover, VCI's
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
VCI has 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 VCI's management acknowledges that each
of such entities compete with Virtual Jerusalem in particular markets, VCI's
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, VCI's 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
VCI's 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
VCI's competition for Virtual Italy 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).
Competitors to VCI's Web site design and development services
VCI faces 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, and FutureTense, Inc., a Massachusetts
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 VCI's
competitors or potential competitors have longer operating histories, longer
client relationships and significantly greater financial, management,
technological, development, sales, marketing and other resources than VCI.
Potential future competitors
In addition to current competitors, given the low barriers to entry, it is
likely that additional competitors will enter VCI's markets in the future, and
that many of such competitors will have substantially greater financial,
management, technological, sales, marketing and other resources than VCI. VCI
cannot assure you that in the future it will be able to compete successfully in
any of its current markets, and its inability to do so would have a material
adverse impact on VCI's business, financial condition and operating results.
36
VCI Currently Operates Three Web Sites
VCI currently operates three Web sites: Virtual Jerusalem, Virtual HolyLand
and Virtual Ireland. 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 VCI 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;
. 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. VCI's 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 its introduction, VCI's management
believes that Virtual Jerusalem has attracted over 350,000 unique users, of
which approximately 128,000 have registered as of September 15, 1999. According
to VCI's tracking of the number of registrants to Virtual Jerusalem, this Web
site adds approximately 6,000 new registered users each month. VCI's management
thinks that with increased
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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 VCI with a profile of
demographic information. VCI records and maintains real time statistics of its
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.
VCI's management thinks that these demographics are favored by the
advertisers, sponsors, content partners and e-commerce partners which it
solicits for revenues, content and features.
According to Nielson/IPro's monthly reports, Virtual Jerusalem's traffic has
generally grown in the number of visits per month, average length per visit and
monthly page views, as follows:
. Total visits increased 109% from 436,017 in December 1997 to 909,764 in
December 1998 and to 1,261,760 in June 1999;
. Average length per visit (in minutes) was 6:13 in December 1997, 9: 11 in
December 1998; and 8:37 in June 1999; and
. Monthly page views increased 225% from approximately 1.6 million in
December 1997 to approximately 5.2 million in December 1998 and
approximately 5.9 million in June 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;
38
. 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. VCI intends 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 VCI's requests for additional content from
Christian-related Web sites has 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 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, VCI's management estimates that there
are approximately 27 million potential users of Virtual HolyLand from this
target community alone. VCI's goal is to register 95,000 and 410,000 users on
Virtual HolyLand by the end of 1999 and 2000, respectively. As of September 15,
1999, in excess of 11,000 persons registered on the Virtual HolyLand site. In
March 1999, VCI hired a major Dallas-based public
39
relations firm that specializes in targeting the Evangelical Christian
community with the specific mission of developing and servicing the Virtual
HolyLand community and achieving this goal.
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, VCI has 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 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. VCI's management thinks
that the strong ties of Irish descents to their heritage represent a
significant potential demographic market. VCI is currently running numerous
print, radio and television media directed towards this large American Irish
population. Over 20,000 users have registered on Virtual Ireland since its
launch in March 1999. VCI recently hired an Editor for the Virtual Ireland site
who is currently hiring additional editorial staff for this site. In the
future, VCI plans 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
40
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.
VCI is 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 its 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, VCI has not collected statistics on the site. VCI 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 include newspaper and other print and online
advertisements, promotions and grass roots efforts with organizations in the
Italian American community.
Content Partners
A key component of VCI's aggregation business strategy is its relations with
its content partners. VCI leverages existing online content by developing
"supersites" that serve as anchors for its content partners. VCI's management
thinks that these content partners recognize the benefits of being anchored to
a "supersite" which include:
. exposure of their Web content to a significantly larger readership than
their Web site alone could attract;
. increased traffic on their Web sites generated by the links that the
content partners place on VCI's Web sites;
. the opportunity to earn revenues from e-commerce sales marketed on and
originated from VCI's shopping Channels or from shared advertising on co-
branded Web pages;
. the receipt of Internet services from VCI such as user profiling
technology, advertising management software, guest books, online forums
and e-mail lists that would otherwise require expensive and multiple
licenses and technology; and
. interactive Web services on co-branded pages created by VCI.
41
VCI "wraps" the content it obtains from these content partners with an array
of its own additional features and interactive services to create a cohesive
Web environment targeted to a specific demographic profile. VCI recently
acquired a license (see "Technology Acquisitions") which will allow its content
partners to quickly and easily place excerpts from their own Web sites on VCI's
Web sites. This will facilitate the continual update of VCI's Web communities
with minimal maintenance or supervision by VCI's editorial staff.
VCI's Efforts to Accumulate Registered Users
VCI encourages user registration on its Web sites in several ways. VCI
offers its content partners the ability to create interactive features, such as
guestbooks, bulletin boards and donor forms for placement on a co-branded
"partner page" which includes multiple links to select features on VCI Web
sites. These partner pages require registration in order for users to access
the select features. VCI also encourages 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. VCI
also requires registration for some of its more popular Web features, including
a user-controlled Web camera situated in Jerusalem with views of the Western
Wall and the Temple Mount, free e-mail and personal Web pages.
To encourage registration on specific Web sites, VCI undertakes various
activities. For example, to attract registrants for Virtual HolyLand, VCI has
begun to enter into agreements with publishers and ministries with extensive
contacts in the Evangelical Christian market. These agreements require VCI to
pay these parties a nominal fee for each person who registers on Virtual
HolyLand based upon such parties recommendation, as recorded by the registrant
at the time they register.
Future Communities and Projects
VCI plans to develop or acquire additional Web sites in 1999 and 2000, which
target ethnic groups with attractive demographics. Such online expatriate
communities may include members of the Indian, Asian, African and Spanish
expatriate communities residing in the United States and other English speaking
countries. VCI's plans for the themes of its 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 its own Web sites, VCI's 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. VCI's
plans support this objective by:
. providing and developing efficient methods for its content partners to
publish varied content on VCI's 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 its content partners; and
. developing attractive interactive elements for its users.
In acquiring additional Web sites, VCI's management seek opportunities where
an existing site on the Internet offers substantial content and services to a
defined, specific readership.
In September 1999, VCI 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 VCI intends on entering into
content relationships for use of their audio content on the Internet.
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The Modules
VCI's management believes that based on its existing licenses, future
licenses that it obtains from Internet service providers, certain equipment it
has acquired and VCIL's programming staff, it will be able to offer an array of
interactive modules to Web site publishers through its Community Management
Solution (CMS). Many of these modules are already used successfully by VCI on
its own online communities. The modules which VCI either currently licenses, or
is trying to secure licenses for, include:
. Site Search and Polling Engines;
. Sweepstakes Modules;
. 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 VCI.)
To create a Web site for a Web site publisher, VCI first creates 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, VCI provides Web site publishers with complete
control over the presentation of their content on the Internet.
To complete its Web design and development services, VCI's technical and
support services include system administration, programming integration of all
components of a Web site, project management and hosting of Web sites on VCI's
servers. VCI's servers are monitored continuously for connectivity and power by
Global Center pursuant to an agreement with VCI. In addition, VCI maintains
Firewall protection and other security services such as secure servers for
financial transactions.
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Community Content Server
In addition to the above, VCI plans to offer Web site publishers another
module called the Community Content Server ("CCS") (see "Technology
Acquisitions"). CCS provides Web site publishers with the tools required for
creating and maintaining a continually generated Internet Web site. CCS
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;
. creating attractive and sophisticated designs in HTML language;
. publishing a Web site as required (up to several times a day); and
. technical administration.
CCS 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. CCS manages the publication of large quantities of data from PCs to
Internet sites. The application program for CCS is written in open source code
Perl language software and uses industry standard databases. To help ensure the
longevity of CCS as a publishing tool, CCS 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 VCI.
How CCS Works
CCS 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 CCS, 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, CCS 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.
CCS 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.
VCI's database would support all of its existing modules and CCS, and would
also support the entering, modifying, searching, deleting, placement time and
archival of any content that a Web site publisher wants to publish. CCS 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.
CCS 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, VCI 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 VCI, on a worldwide, royalty
free, non-exclusive, transferable, perpetual and sublicenseable basis, certain
web publishing tool kit software developed by Cortext. The software may be used
by VCI and its subsidiaries for its online
44
communities and for web sites maintained by VCI's content partners. The
agreement also allows VCI 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 VCI for a period of six months from the completion of
certain milestones set forth in the license agreement. The Company uses such
software as part of its CCS.
Licenses, Service Agreements and Trademarks
Community Content Server
For a detailed description of CCS, see "Community Content Server," and
"Technology Acquisitions."
Weather Services
VCI has 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 VCI selected weather
forecasts, satellite images and other weather services for VCI's 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 VCI. VCI pays Accuweather
a monthly fee for such services, but is entitled to 25% of any revenues
received by Accuweather from users of VCI's Web sites who independently
subscribe for additional Accuweather services.
E-mail List Services
VCI has 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
VCI has a custom e-mail service agreement with CommTouch Software, Inc., a
California company ("CommTouch") that provides Web-based e-mail products and
services. The agreement requires CommTouch to provide VCI with a customized e-
mail service, including upgrades hosted on CommTouch servers. These services
are available for VCI's Web sites and other Web sites residing on VCI's
servers. These services allow VCI to provide users of its online communities
with free e-mail addresses and allows VCI to advertise on the e-mail messages
mailed by its users. Per the agreement, CommTouch is required to customize the
e-mail services to each of VCI's own Web sites and provide continuous customer
support service. The agreement also obligates VCI to place certain Web links
on the custom e-mails back to CommTouch's service pages, to actively promote
CommTouch's service on VCI's 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 a
quarterly fee according to certain revenue sharing arrangements. The term of
the agreement is for one year starting June 30, 1999.
Free Home Pages
In August 1999, VCI 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 VCI will create sites co-branded using technology developed by
Homestead. Homestead will provide VCI with all necessary hardware, software,
and bandwidth necessary for
45
the co-branded sites. VCI is obligated to promote such site on its communities
and email newsletters to its registered database and maintain links to the co-
branded sites from its communities. In consideration for VCI providing
Homestead with access to its registered user base and collective statistical
data on users of the cobranded sites, Homestead creates the co-branded sites
and pays VCI a portion of revenues from advertisements placed on the user
homepages. VCI may also place banners on the co-branded site pages and retain a
percentage 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, VCI entered into an agreement with FairMarket, Inc., a
Massachusetts company ("Fairmarket") that develops and operates Internet
auction sites. Pursuant to the agreement, Fairmarket provides VCI 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 VCI's communities and Fairmarket may distribute product and related
pricing information for products located on VCI's auction service throughout
Fairmarket's network of auction sites. VCI is 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, VCI pays a
monthly hosting fee to Fairmarket for each VCI community using the auction
service and a percentage of transaction and bidder bounty fees. VCI is entitled
to retain all advertising revenues received from ads placed on the auction
service page. FairMarket also provides VCI 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, VCI entered into an agreement with Reuters Limited, a
U.K. company, for the supply of Reuters' online media services for distribution
on VCI's communities. The agreement calls for Reuters to supply VCI its world
news services, including a certain 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 VCI. VCI pays
a monthly service fee for these news services. The agreement is for a period of
two years.
E-Commerce
In September 1999, VCI 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 VCI a license to software that allows VCI to design and build on-line
stores from existing templates and create on-line "malls" for each of its
communities and CMS customers. The software also allows VCI to create online
stores for its content partners, or, alternatively, provide them with the
ability to build their own e-commerce solution. Pursuant to the agreement,
Intershop provides VCI with continuous support services and software upgrades.
VCI pays 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 VCI under the terms of the agreement
survive the expiration or earlier termination of the agreement.
Chat Services
VCI has an agreement with Talk City, Inc., a California company ("Talk
City") which provides supporting software that enable Web sites to offer chat
services to their users. Per the agreement, Talk City provides VCI with all
necessary facilities, servers, connectivity, related equipment and technology
to host chat rooms on VCI's 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,
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however VCI may also sell advertising but must pay a percentage of gross
revenues collected by it to Talk City. The agreement requires VCI to pay Talk
City an annual fee for VCI's 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
VCI has a license agreement with NetGravity, Inc., a California company
("NetGravity") that provides software enabling licensees to manage advertising
on their Web sites. VCI's license is a perpetual, worldwide, non-exclusive and
non-transferable license that enables VCI to manage advertising on its own Web
sites and on Web sites of VCI's content partners as well as any other Web sites
residing on VCI's servers. In exchange for this license VCI pays 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. The license may be terminated by NetGravity upon thirty
days notice to VCI if VCI is delinquent in its payments to NetGravity.
OnLine Bulletin Boards/Forums
VCI has a perpetual, non-exclusive, worldwide license from Infopop
Corporation (formerly Madrona Park, Inc.), a Virginia internet software company
("Infopop") for a popular online discussion forum program called the "Ultimate
Bulletin Board" which VCI uses on its online communities. VCI paid Infopop a
flat fee for such license. Infopop provided source code to VCI which VCI
integrated with its user registration system. The license permits VCI to modify
the source code for its own use, however, this license may not be resold or
distributed.
Internet Camera
VCI has 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 certain panoramic images within Jerusalem. The license's term is for
one year starting September 3, 1998, for which VCI paid a flat fee excluding
annual software support and upgrades.
NT Server Licenses and Microsoft Office Software
VCI has approximately forty licenses from Microsoft for the use of its
Microsoft Office software on PCs and the PCs of its subsidiaries' employees in
the U.S. and Israel. VCI also has twenty client access licenses from Microsoft
for its Windows NT server software, required for the operation of its computer
servers on which the VCI Web sites and the Web sites of many of VCI's content
partners reside. VCI's management believes that it has acquired a sufficient
number of licenses from Microsoft for its current needs.
Maven Index and Search Engine
VCI has 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, VCI provides Maven with technical, Web site
design, hosting, marketing and e-mail services and Album, in exchange, updates
the Maven database regularly and provides certain 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 VCI to publish Maven on the
Virtual Jerusalem site while requiring Album to place Web links on Maven to
that site's homepage. VCI and Album evenly split revenues from advertisements
placed on Maven. In the event the agreement is terminated by VCI for cause, or
by Album without cause, VCI receives a non-exclusive right to use Maven. For
five years following such termination (provided that Maven remains on the
Virtual Jerusalem site), VCI is obligated to pay Album a decreasing portion of
the advertising revenues that VCI derives from Maven.
47
Classifieds Advertising
VCI has 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 VCI's server
maintenance facility on which its Teleboard Web site is located. This site
includes a database, search and virtual agent program which allows users to
access anonymous messaging services for communication between registrants on
the Teleboard Site. Registration for the Teleboard site is free. VCI provides
links to a Teleboard site which was co-branded with VCI's online communities.
VCI and CabiNet share 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
VCI has a Master Service Agreement with Global Center Inc., a California
internet service provider ("Global Center"), that provides VCI with hosting
services and connectivity to the Internet for VCI's servers on which VCI's own
Web sites and the Web sites of its content partners reside. Global Center also
provides continuous supervision of VCI 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 VCI's servers, which are
housed at Global Center's server installations in Herndon, Virginia and New
York City. For these services, VCI pays a monthly fee. Per the agreement,
Global Center is not liable for injury to VCI's business, lost revenues or
profits resulting from any negligence on their part at its 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, VCI filed five service mark applications with the Assistant
Commissioner for Trademarks in the United States for the following names and
designs used by VCI: 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 VCI's
business. VCI intends to file additional applications for other online
communities and Web properties that it may establish in the future, including
an application for vjradio.com. There is no assurance that the VCI will be
successful in obtaining approval of such applications, and if obtained, of
enforcing such service marks' VCI is 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 VCI. VCI's management cannot assure
you if and when such application will be ruled on by the U.S. Trademark Office,
or that such applications will ever be granted or enforceable.
Technology Acquisitions
VCI recently received a license from an Israeli software development company
for Web publishing software that will form the basis of VCI's Community Content
Server (CCS) module (see "Community Content Server" for a description of the
software). This module would be sublicensed by VCI to Web site publishers as
part of VCI's CMS services (see "The Modules") and used for its own online
communities.
In May 1999, VCI signed a term sheet with this entity which contemplates
that VCI would acquire 60% of this entity's equity over time. Although VCI is
still negotiating the terms of the stock purchase agreement with this entity,
employees of VCIL have already begun working with this entity's programmers to
configure and
48
integrate the licensed software for VCI's online communities and for sublicense
to third parties. VCI anticipates the stock purchase agreement could be
finalized in the fourth quarter of 1999. VCI anticipates that it will be able
to supply its CCS to Web site publishers by late 1999.
Employees and Facilities
VCI, together with its Israeli subsidiaries, Virtual Communities Israel Ltd.
("VCIL") and V.C.I. Internet Properties Ltd. ("VCIIP"), employ 56 full-time
employees, 42 of whom are located in VCIL's offices in Jerusalem, Israel, 2 of
whom are located in VCIIP's offices in Eli, Israel, and 12 of whom are based in
VCI's offices in New York, New York. Over the next several months, VCI intends
to retain an additional 15 persons for VCIL's Jerusalem office where such
personnel will be engaged in Web site production, programming, editorial
services, client services and administration. In addition, Avi Moskowitz, VCI's
Chief Executive Officer and President, relocated from Israel to the U.S. in
June 1999 and divides his time equally between VCI's U.S. and Israeli
facilities.
VCI's 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.
The offices of VCI and VCI's Israeli subsidiaries, VCIL and VCIIP, 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
VCI is not a party to any material legal proceedings.
49
DIRECTORS AND EXECUTIVE OFFICERS
Directors and Principal Officers of HDG after the Merger
In accordance with the merger agreement, all of the current members of our
board will resign immediately prior to the effective time. Immediately
following the merger, three current directors of VCI, along with four directors
nominated by VCI, including two current directors of HDG, will become the sole
members of the HDG Board. In addition, all of HDG's executive officers and
employees will resign as of the effective time, to be replaced by VCI's current
executive officers and employees.
The following table sets forth the names, ages (as of October 20, 1999) and
positions of all directors, executive officers, nominees and key personnel of
HDG after the merger.
Name Age Position
---- --- --------
Chairman of the Board, Chief Executive Officer,
Avi Moskowitz........ 35 President and Director
Michael S. Harwayne.. 29 Vice President of Business Development and Marketing
Sonja Simon ......... 65 Secretary and Director
Peter A. Jacobs ..... 55 Director
David Morris ........ 29 Director
Robert J. Levenson .. 55 Nominee for Director
Fred S. Lafer ....... 70 Nominee for Director
Jonathan W. Seybold.. 56 Nominee for Director; current director of HDG*
Allan Dalfen......... 55 Nominee for Director; current director of HDG*
David L. Kahn ....... 43 Executive Vice President--VClL
Ellen Cohl .......... 32 Vice President, Finance--VCIL
David Cavenor ....... 30 Chief Operating Officer--VCIL
- --------
* Information regarding Messrs. Seybold and Dalfen is set forth under the
heading "Information Concerning Existing Directors" at page 52.
Avi Moskowitz founded VCI 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 who will be a director of HDG after
the merger (see below).
Michael S. Harwayne joined VCI 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.
Peter A. Jacobs has been a Director of VCI 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 Engine ring in 1966 and a DMS in Management Studies in 1969 from
Aspon University, Birmingham, England.
50
Robert J. Levenson is a nominee for Director who, upon the affirmative vote
of HDG shareholders, will become a director of HDG after the merger. 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 is a nominee for Director who, upon the affirmative vote of
HDG shareholders, will become a director of HDG after the merger. 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 VCI 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.
Sonja Simon has been a Director of VCI since September 1996. Ms. Simon
intends to resign as a director following the merger. 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 VCI's
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.
David Cavenor became the Chief Operating Officer of VCIL in April 1999. From
1997 through 1999, Mr. Cavenor was the Chief Technology Officer of Electronic
Publishing for the Jerusalem Post, published by the Holinger Group in
Jerusalem. From 1995 to 1997, he was Project Manager and Software Engineer for
Quadranet International, a software development and consulting company which is
a wholly owned subsidiary of Amdahl, Inc. Mr. Cavenor received a Bachelors of
Science degree in Computer Science and Information Technology from University
of Western Australia, Perth in 1990, and a law degree (LLB) from University of
Sydney in 1993.
Ellen Cohl became the Controller of VCIL in August 1997 and Vice President,
Finance 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 VCI, VCFL and VCIIP. 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
51
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 will be elected by and serve at the direction of the Board of
Directors of HDG after the merger.
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.
Directors and Principal Officers of HDG pending consummation of the Merger
The table set forth below names each director and executive officer of HDG.
Each current director is a nominee for director nominated by HDG board of
directors to serve as directors pending consummation of the merger and in the
event that the merger is not consummated, and gives information concerning
their age as of December 31,1999, positions and offices held with HDG, their
principal occupation for at least the past five years, the date which each such
nominee became a director of HDG and other directorships held by the nominee.
In the event that the merger is not consummated, they will serve until the next
annual meeting of our stockholders or until their respective successors shall
have been elected or qualified or until their earlier resignation or removal.
First
Became an
Principal Occupation and Other HDG
Name (age) Directorships Director
---------- ------------------------------ ---------
Jonathan W. Seybold (56).. Chairman of the Board of HDG since July 1994
1994. Mr.Seybold founded Seybold
Seminars, Inc., a company which
conducts large scale, technology-based
trade shows and conferences and Seybold
Publications, a company which publishes
reports on publishing systems, desktop
publishing and digital data
applications, and served as President
of the two companies from 1981 to 1993.
Gregory L. Zink (42)...... President of HDG since 1994. In June 1994
1997, Mr. Zink assumed the title of
Acting Chief Executive Officer of HDG
and agreed to devote a portion of his
consulting time to HDG. Mr. Zink has
served as Chief Operating Officer and
Chief Financial Officer of Nautilus
Group Japan Ltd. since April 1988. Mr.
Zink has also been Vice President of
Clark Management Co. Inc., an
investment advisory company, since
January 1989.
Theodore Lanes (35)....... Chief Financial Officer of HDG since 1998
February 1997. Previously, Mr. Lanes
was Vice President of Technology for
MarketForce, Inc., a Los Angeles based
consulting firm. From 1993 to 1995, Mr.
Lanes owned and operated a software
development firm, which he sold in a
private transaction.
Brian Wasserman (33)...... Mr. Wasserman owns and operates a New 1997
York based consulting firm and for at
least 5 years prior to at, Mr.
Wasserman served as a manager of
Coopers & Lybrand and Senior Vice
President and Chief Financial Officer
of D.H. Blair Investment Banking Corp.
in New York.
52
First
Became an
Principal Occupation and Other HDG
Name (age) Directorships Director
---------- ------------------------------ ---------
William Blase (47)....... Since 1985, Dr. Blase has served as a 1995
director of California Eye Care, an
ophthalmology practice. Since November
1992, Mr. Blase has been a director of
Valley Health Systems California
District Hospital.
Kenneth W. Krugler (37).. Mr. Krugler has served as President of 1994
Transpac Software Inc. since founding it
in January 1987. From 1983 to 1987, Mr.
Krugler was a software architect at
Apply Computer, Inc.
M.Caroline Martin (58)... Since January 1986, Ms. Martin has 1996
served as Executive Vice President of
Riverside Health System, a multi-
facility integrated healthcare system.
She is currently a member of the Board
of Directors of Signet Bank.
Allan Dalfen (55)........ Since January 1995, Mr. Dalfen has 1996
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 Weider Health and Fitness. Mr. Dalfen
is currently a director of Vestro Foods,
Inc.
HDG Executive Compensation
The table below provides information concerning the annual and long-term
compensation for services rendered to HDG during the year ended December 31,
1998 by Gregory L. Zink, our President and acting Chief Executive Officer.
Annual Compensation
------------------------- Other Annual
Name and Principal Position Year Salary ($) Bonus ($) Compensation
--------------------------- ---- ---------- --------- ------------
Gregory L. Zink........................ 1998 $97,500 0 0
President and Acting Chief Executive
Officer
On September 10, 1999, Mr. Zink was granted options to purchase 30,000
shares of our common stock at the fair market value of such stock on that date
as compensation for Mr. Zink's services to HDG for the period from July 1, 1999
through consummation of the merger.
HDG Directors Compensation
We do not pay fees to our directors. Directors are entitled to receive
options pursuant to HDG's 1996 stock option plan. In April 1998, we granted
options to purchase 10,000 shares of our common stock at an exercise price of
equal to the fair market value of our common stock on the date of the grant to
each of William Blase, M. Caroline Martin, Allan Dalfen, Brian Wasserman and
Kenneth W. Krugler. Such options vest at a rate of ten percent per each quarter
that the grantee remains a member of the Board of Directors and are exercisable
for five years from the date of the grant. In February 1997, we entered into a
consulting agreement with Mr. Seybold pursuant to which he received five-year
options to purchase 5,000 shares of common stock. All of such options are
exercisable at $5.00 per share commencing one year from the date of grant.
Under the same consulting agreement, Mr. Seybold received 10,000 five year
options exercisable at the market price at February 11, 1998, for remaining
Chairman of the Board for 1998. Under the same consulting agreement,
Mr. Seybold is entitled to receive 10,000 five year options exercisable at not
less than the market price on the date the options are granted, for remaining
Chairman of the Board for the year 1999.
53
VCI Executive Compensation
The table below provides information concerning the annual and long-term
compensation for services rendered to VCI and its subsidiaries during the year
ended December 31, 1998 by Avi Moskowitz, VCI's President and Chief Executive
Officer.
Long Term
Compensation
Annual Compensation Awards
--------------------------------------- ------------
Securities
Name and Principal Other Annual Underlying
Position Year Salary($) Bonus($) Compensation($) Options(#)
- ------------------ ---- --------- -------- --------------- ------------
Avi Moskowitz(1) ......... 1998 $104,950 $ 0 $17,900(2) 382,000(3)
President and 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., a VCI subsidiary. 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, $22,197 in the form of reimbursement for vacation time not
taken since 1997.
(3) Represents 242,000 shares of VCI common stock underlying options granted,
and 140,000 shares of VCI common stock underlying warrants issued, to Mr.
Moskowitz in 1998.
VCI Option Grants
The following table provides information regarding warrants issued during
the year ended December 31, 1998 to Avi Moskowitz. VCI has never granted stock
appreciation rights.
Option Grants in Last Fiscal Year Individual Grants
-------------------------------------------------------------------
Percent of Total
Options Granted to
Number of Employees
Securities (net of forfeitures) Exercise or Base
Underlying in Fiscal Year Ended Price Per Share Expiration
Name Options Granted December 31, 1998 ($/Share) Date
---- --------------- -------------------- ---------------- -------------
Avi Moskowitz........... 100,000(1) 41.9%(2) $1.00 June 30, 2001
40,000(1) 16.7 (2) $0.65 Dec. 31, 2001
- --------
(1) These warrants were issued in consideration of Mr. Moskowitz's personal
guarantee of certain VCIL 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 238,841 warrants issued (net of forfeitures) to
employees in the year ended December 31, 1998, including warrants issued to
Avi Moskowitz.
54
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
Underlying Unexercised Value of Unexercised
Options at Fiscal Year In-the-Money Options at
End Fiscal Year End(1)
-------------------------- -------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------- ----------- -------------
Avi Moskowitz.............. 80,666(2) 161,334(2) $20,166 $40,333
140,000(3) 0(3) 0 0
- --------
(1) Assumes a market price for VCI's common stock at December 3l, 1998 of $0.65
per share.
(2) Represents 242,000 shares of VCI common stock underlying options held by
Mr. Moskowitz as of December 31, 1998.
(3) Represents 140,000 shares of VCI common stock underlying warrants held by
Mr. Moskowitz as of December 31, 1998.
VCI Director Compensation
None of VCI's 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 VCI for
travel and lodging in the amounts of $4,600 and $1,706 in April and June 1999,
respectively.
In January 1998, VCI granted to each of David Morris, Sonja Simon and Peter
A. Jacobs options to purchase 50,000 shares of VCI's 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
50,000 shares of VCI's common stock pursuant to the 1999 Stock Option Plan in
consideration for financial consulting services provided to VCI since 1997.
VCI Employment Agreement
In June 1999, VCI entered into an employment agreement with Avi Moskowitz,
VCI's President and Chief Executive Officer. The agreement is for an initial
three year term, which will extend automatically unless written notice is given
by either party 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 200,000 shares of VCI's 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 certain other benefits including the use of an automobile
and life insurance, and is entitled to participate in certain benefit plans
that may be established by VCI. During the term of his employment and for one
year thereafter, Mr. Moskowitz is prohibited from engaging in any business
competitive with VCI. The agreement also imposes certain 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 VCI is obligated to pay the premiums for any
continuation coverage for Mr. Moskowitz's immediate family
55
pursuant to the Consolidated Omnibus Budget Reconciliation Act ("COBR-X'). In
the event the agreement is terminated because Mr. Moskowitz becomes permanently
disabled, for 6 months following such termination VCI is 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, VCI is
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 VCI will be obligated to pay Mr. Moskowitz's compensation as if
Mr. Moskowitz had been terminated by VCI without cause.
Pursuant to a separate arrangement with VCI, VCI reimbursed Mr. Moskowitz
for $10,000 of the expenses he incurred in moving his family from Israel to the
New York City area.
VCI Stock Option Plans
VCI has a 1997 Stock Option Plan, 1998 Stock Option Plan and 1999 Stock
Option Plan. 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 VCI and its subsidiaries, and to offer additional inducement in
obtaining the services of such persons. The 1997, 1998, and 1999 plans were
adopted by VCI's directors on May 20, 1997, December 13, 1998, and April 28,
1999, respectively. The 1997 plan was approved by VCI's shareholders on May 20,
1997. VCI received shareholder approval for 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 VCI 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.
VCI reserved 726,000 shares of common stock for issuance under its 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 June 30, 1999, options for all
524,000 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 October
15, 1999, options for 920,667 shares were granted and outstanding, options for
79,333 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 certain 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 VCI, 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 term of each option granted pursuant to the plans is established by the
plan administrator. 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 VCI, the maximum term is five years. Options are subject to earlier
termination as provided in the plans.
56
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 VCI has terminated for any reason other than death or
disability may exercise their options (if otherwise exercisable) for 3 months
following the date of termination if the employee optionee has resigned from
VCI, or for one year following the date of termination if the employee optionee
is terminated by VCI, or the optionee is a director or consultant of VCI. If,
however, such relationship is terminated for cause or without the consent of
VCI, 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 VCI has terminated for any
reason other than death or disability may exercise their 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 shares of VCI common stock, the aggregate
number and kind of shares subject to options under the plans and the related
exercise price shall be adjusted accordingly. In the event of certain
"corporate transactions" or a "change in control" of VCI (as defined in the
plans), or upon the dissolution of VCI, 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.
If the merger is consummated, the plans and all outstanding options will be
assumed by HDG. The HDG Board of Directors or a committee thereof will become
the plan administrator for the plans, and all references to VCI in the plans
and the individual option agreements thereunder will be deemed to refer to HDG.
In connection with the signing of the merger agreement, substantially all of
the VCI optionholders signed agreements not to dispose of their VCI securities
for a period of 180 days after the consummation of the merger.
57
Share Ownership of Management and Certain Stockholders
HDG
The following table sets forth, as of October 10, 1999, information as to:
(a) the beneficial ownership of HDG common stock by (i) each person serving HDG
as a director on such date; (ii) each person who qualifies as a "named
executive officer" as defined in Item 402(a)(2) of Regulation S-B under the
Exchange Act; and (iii) all of such directors and executive officers of HDG as
a group; and (b) each person known to HDG as having beneficial ownership of
more than 5% of HDG common stock.
Name and Address of Beneficial Number of Shares Percent of Shares
Owner Beneficially Owned(l) Beneficially Owned
------------------------------ -------------------- ------------------
Nautilus Group Japan, Ltd(2)......... 366,515 18.8%
Jonathan Seybold(3).................. 157,464 8.0%
Gregory L. Zink(4)................... 433,409 21.6%
Brian Wasserman(5)................... 11,800 0.6%
Theodore Lanes(6).................... 32,500 1.6%
William Blase(7)..................... 16,140 0.8%
Kenneth W. Krugler(8)................ 38,108 1.4%
M. Caroline Martin(9)................ 9,000 0.5%
Allan Dalfen(10)..................... 9,000 0.5%
All Directors and Named Executive
Officers............................ 699,421 33.5%
- --------
(1) Includes such individuals' Escrowed Shares (see "Escrowed Shares and
Options" below) and options exercisable within 60 days. Except as
indicated in the footnotes to this table and pursuant to applicable
community property laws, the persons named in the table have sole voting
and investment power with respect to all shares of Common Stock.
(2) The address of such company is c/o Clark Management Co. Inc., P.O. Box
3090, Boynton Beach, Florida 33424.
(3) Includes 141,464 shares, 70,732 of which are Escrowed Shares, 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 Heuristic
Development Group, Inc., 1219 Morningside Drive, Suite 102, Manhattan
Beach, CA 90266.
(4) Includes 366,515 shares held by Nautilus Group Japan, Ltd., 183,258 of
which are Escrowed Shares. Mr. Zink is the Chief Operating Officer of
Nautilus Group Japan, Ltd. Mr. Zink disclaims beneficial ownership of
these shares. Also includes 6,697 Escrowed Shares and options to purchase
53,500 shares of our common stock held by Mr. Zink. The address of such
individual is c/o Clark Management Co. Inc., P.O. Box 3090, Boynton Beach,
Florida 33424.
(5) Includes options to purchase 9,000 shares of our common stock and 700 unit
purchase options obtained from the initial public offering. The address of
such individual is c/o Heuristic Development Group, Inc., 1219 Morningside
Drive, Suite 102, Manhattan Beach, CA 90266.
(6) Includes options to purchase 32,500 shares of our common stock. The
address of such individual is c/o Heuristic Development Group, Inc., 1219
Morningside Drive, Suite 102, Manhattan Beach, CA 90266.
(7) Includes 7,140 Escrowed Shares held by the Blase Family Trust, of which
Dr. Blase is Trustee, and options to purchase 9,000 shares of our common
stock held by Dr. Blase. The address of such individual is c/o California
Eye Care, 2390 East Florida Avenue, Suite 207, Hemet, CA 92544.
(8) Includes 21,108 shares of common stock, 10,554 of which are Escrowed
Shares held by Transpac Software, Inc., and options to purchase 9,000
shares of our common stock held by Mr. Krugler. Mr. Krugler is the
President of Transpac Software, Inc. The address of such company and such
individual is 467 Saratoga Avenue, Suite 550, San Jose, California 95129.
58
(9) Includes options to purchase 9,000 shares of our common stock. The address
of such individual is c/o Riverside Health System, 606 Denbigh Boulevard,
Suite 604, Newport News, Virginia 23608.
(10)Includes options to purchase 9,000 shares of our common stock. The address
of such individual is c/o Heuristic Development Group Inc., 1219 Morningside
Drive, Suite 102, Manhattan Beach, CA 90266.
Escrowed Shares and Options
In connection with our initial public offering in 1997, the holders of
349,370 shares of our common stock (the "escrowed shares") and options to
purchase 50,630 shares of our common stock were placed into escrow pursuant to
an escrow agreement. The escrowed shares and options are not transferable or
assignable except upon death, by operation of law, to family members of the
holders or to a trust for the benefit of a holder, provided that any transferee
of escrowed shares or options agrees to be bound by the escrow agreement. The
escrowed shares may be voted by their holders. Holders of escrowed options may
exercise their options prior to their release from escrow, however, the shares
issuable upon such exercise will continue to be held by the escrow agent as
escrowed shares subject to the escrow agreement. The escrowed shares and
options will be released from escrow only if one or more of the following
conditions is met:
. our net income before provision for income taxes and exclusive of any
extraordinary earnings (as audited by our independent public accountants)
for the fiscal year ending December 31, 1999 amounts to at least $4.5
million;
. such net income for the fiscal year ending December 31, 2000 amounts to
at least $5.7 million;
. the "bid price" (as defined in the escrow agreement) of the common stock
averages in excess of $16.75 per share for 30 consecutive business days
during the 18-month period commencing with the nineteenth month from
February 11, 1997.
If none of the applicable net income or bid price levels set forth above
have been met by March 31, 2001, the escrowed shares and options, together with
any dividends or distributions made with respect thereto, will be canceled and
returned to HDG's treasury stock and capital, respectively. The consummation of
the merger is conditioned upon the holders of a minimum of 75% of the aggregate
of all our outstanding escrowed shares and options agreeing to convert their
escrowed shares and options into three-year warrants, exercisable six months
after issuance, with each such warrant having the right to purchase one share
of our common stock at a price equal to the "transaction price" of the merger
(or, in the case of the warrants to be issued in respect of the escrowed
options, at an exercise price equal to 125% of the "transaction price"), as
that item is defined in the merger agreement. No escrowed options are presently
held by any officers, directors or principal stockholders of HDG.
59
VCI
The following table sets forth, as of October 20, 1999, information as to:
(a) the beneficial ownership of VCI common stock by (i) each person serving VCI
as a director on such date, (ii) each person who qualifies as a "named
executive officer" as defined in Item 402(a)(2) of Regulation S-B under the
Exchange Act, and (iii) all of such directors and executive officers of VCI as
a group; and (b) each person known to VCI as having beneficial ownership of
more than 5% of VCI common stock.
Name and Address Number of Shares Percentage of Shares
Title of Class of Beneficial Owner(2) Beneficially Owned Beneficially Owned(l)
-------------- ---------------------- ------------------ ---------------------
Common Stock............ Avi Moskowitz(3) 429,000 4.0%
Peter A. Jacobs(4) 162,483 1.5%
David Morris(5) 132,977 1.2%
Sonja Simon(6) 16,667 .2%
All Directors and Executive Officers 769,802 7.9%
Paul and Hannah Lindenblatt(7) 721,500 6.2%
Roth Trust(8) 1,721,500 16.0%
Net Results Holdings, LLC(9) 1,454,000 13.5%
Line Holdings Ltd.(10) 693,791 6.4%
Series A Preferred
Stock(11).............. Howard F. Curd(12) 1,000 6.9%
Howard R. Curd(13) 1,000 6.9%
A.F. Lehmkuhl(14) 1,000 6.9%
Series B Preferred
Stock(15).............. Steven B. Leed & Elizabeth Leed(16) 500 5.4%
Frank A. Cieri(17) 500 5.4%
Lawrence W. Cohen & Lynn L. Cohen(18) 500 5.4%
Back Bay Capital Partners, LLC(19) 500 5.4%
Robert J. Levenson & Mira Levenson(20) 1,000 10.7%
Joseph Hoenig(21) 500 5.4%
Walter E. Scott(22) 500 5.4%
Hasanain Panju(23) 1,500 16.1%
- --------
(1) Percentage of VCI common stock shares beneficially owned is based upon
10,836,947 shares of VCI common stock outstanding prior to the merger,
which number includes 8,538,276 shares of VCI common stock outstanding,
plus 1,807,004 shares of VCI common stock reserved for issuance upon
conversion of the 14,550 shares of VCI Series A Preferred Stock
outstanding, plus 491,667 shares of VCI common stock reserved for issuance
upon conversion of the 10,325 shares of VCI Series B Preferred Stock
outstanding. See Note (16).
(2) Except as otherwise provided, the address for all beneficial owners is c/o
Virtual Communities, Inc., 589 Eighth Avenue, New York, NY 100 1 8. 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 VCI common stock set forth
opposite their names.
(3) Includes options exercisable for 161,333 shares of VCI common stock
exercisable within 60 days after September 15, 1999. Also includes
warrants exercisable for 140,000 shares of VCI common stock exercisable
within 60 days after October 20, 1999. Does not include 1,721,500 shares
of VCI 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 16,667 shares of VCI common stock
exercisable and warrants exercisable for 2,841 shares of VCI common stock
within 60 days after October 20, 1999.
(5) Includes options exercisable for 16,667 shares of VCI common stock
exercisable within 60 days after October 20, 1999. Also includes warrants
exercisable for 116,310 shares of VCI common stock
60
exercisable within 60 days after October 20, 1999. Does not include
674,098 shares of VCI common stock held by Line Holdings Ltd., which is
controlled by a discretionary settlement of which Mr. Morris is a
potential beneficiary. Also does not include 248,723 shares of VCI common
stock held by Business Systems Consultants Ltd., which is controlled by a
discretionary settlement of which Mr. Morris is a potential beneficiary.
Also does not include warrants exercisable for 19,693 shares of VCI common
stock exercisable within 60 days after October 20, 1999, held by Line
Holdings Ltd., which is controlled by a discretionary settlement of which
Mr. Morris is a potential beneficiary. Also does not include warrants
exercisable for 196,700 shares of VCI common stock exercisable within 60
days after October 20, 1999, held by Business Systems Consultants Ltd.,
which is controlled by a discretionary settlement of which Mr. Morris is a
potential beneficiary. Mr. Morris disclaims beneficial ownership of the
VCI common stock held by Line Holdings Ltd. and Business Systems
Consultants Ltd., and the warrants to purchase shares of VCI common stock
held by Line Holdings Ltd. and Business Systems Consultants Ltd. The
address for Line Holdings Ltd. is 57-63 Line Wall Road, Gibraltar, and the
address for Business Systems Consultants Ltd. is 31-33 Le Pollet Street,
Peterport, Guernsey, Channel Islands GYI 4JG. Does not include warrants
exercisable for 125,595 shares of VCI common stock, exercisable 60 days
after October 20, 1999.
(6) Includes options exercisable for 16,667 shares of VCI common stock
exercisable within 60 days after October 20, 1999. Mother-in-law of Mr.
Moskowitz. Mr. Moskowitz disclaims beneficial ownership of these shares.
(7) Sister and brother-in-law of Mr. Moskowitz. Mr. Moskowitz disclaims
beneficial ownership of these shares.
(8) The address of the Roth Trust is c/o Line Holdings Ltd., 57-63 Line Wall
Road, Gibraltar.
(9) The address of Net Results Holdings, LLC is 151 West 25th Street, New
York, New York 10001.
(10) Includes warrants exercisable for 19,693 shares of VCI common stock
exercisable within 60 days after October 20, 1999, which is controlled by
a discretionary settlement.
(11) There are 14,550 shares of Series A Preferred Stock outstanding which
will automatically convert into 1,807,004 shares of VCI common stock upon
consummation of the merger.
(12) Mr. Curd's address is c/o Jesup & Lamont Securities Corp., 650 Fifth
Avenue, 3rd Floor, New York, NY 10019.
(13) Mr. Curd's address is 2 North Tamiami Trail, Suite 900, Sarasota, Florida
34228.
(14) Mr. Lehmkuhl's address is 102 Larkspur Terrace, Bellevue, Ohio 44811.
(15) There are 21,000 shares of Series B Preferred Stock authorized. VCI sold
10,325 shares of such stock in June 1999. These shares of Series B
Preferred Stock will automatically convert into 491,667 shares of VCI
common stock upon consummation of the merger.
(16) Mr. and Mrs. Leed's address is 22 William Street, Andover, MA 01845.
(17) Mr. Cieri's address is 58 Old Village Lane, North Andover, MA 01845.
(18) Mr. and Mrs. Cohen's address is 42 Fern Drive East, Jericho, NY 11753.
(19) Back Bay Capital Partners, LLC's address is 25 Holly Lane, # 1 C,
Chestnut Hill, MA 02467.
(20) Mr. and Mrs. Levenson's address is 39 Hawthorne Road, Essex Falls, NJ
07021.
(21) Mr. Hoenig's address is 287 Narragansett Avenue, Lawrence, NY 11559.
(22) Mr. Scott's address is 1343 East 62nd Street, #54, Tulsa, Oklahoma 74136.
(23) Mr. Panju's address is 9015 Roussin, Brossard, Quebec, Canada J4X 2K3.
61
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF HDG
Results of Operations
From its inception in 1994 through the second quarter of 1997, our efforts
had been principally devoted to research, development and design of products,
marketing activities and raising capital in connection with the IntelliFit
system. HDG has generated only nominal revenues to date from the placement of
test products and has incurred substantial operating losses.
HDG has been unsuccessful in arranging licensing agreements for the
IntelliFit system. Prior to the second quarter of 1999, HDG had believed that
licensing or entering into a joint venture for the IntelliFit software was
viable. While HDG still believes that the software has value, it does not
believe that it is likely to conclude such a transaction in the near term. As
such, HDG will continue to value the capitalized software at its estimated net
realizable value of $50,000. HDG will still pursue licensing or purchase
agreements for the IntelliFit system.
From inception through June 30, 1999, HDG sustained cumulative net losses of
approximately $5,364,000 primarily as a result of general and administrative
expenses, including salaries, marketing, and professional fees which have
aggregated $3,844,000 since inception. During the three months ended June 30,
1999, HDG incurred net losses of $382,000, while during the same six-month
period during 1998, HDG incurred net losses of $225,000. The increased net
losses during 1999 were a direct result of reduced interest income and increase
general and administrative expenses incurred in connection with the merger.
HDG has reduced current cash use to approximately $ 10,000 per month, not
including transaction expenses being incurred in connection with the merger.
HDG has interest income of approximately $10,000 per month. The ongoing
expenses are expected to remain at current levels through the consummation of
the merger, except for expenses incurred in connection with the merger.
During the six months ended June 30, 1999 and 1998, HDG recognized interest
income of $63,000 and $96,000 respectively. The reduction in 1999 interest
income is a result of lower interest rates and a reduction in our working
capital.
Plan of Operation
Based on feedback from test sites and beta customers and the disappointing
acceptance of the IntelliFit product, HDG has revamped its going forward
business model. HDG no longer believes that it can be successful in selling or
licensing the IntelliFit System to consumers and supporting the system in the
field. As such, HDG has written off capitalized software costs of $456,000
representing all but the salvage value of the IntelliFit software on our
balance sheet. We still believe that the IntelliFit software is a viable
product for a company which has complementary products or which has an existing
field sales and support organization. Accordingly, we will still entertain
discussions with respect to possible licensing or sales arrangements, or
selling or licensing the IntelliFit software to customers for incorporation
into existing or new product lines. No assurances can be given that any such
discussions will result in any agreements being reached. Additionally, because
the IntelliFit software operates on a Macintosh OS operating system, we believe
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, we are 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.
62
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF VCI
The following description of VCI's 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. VCI's 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
VCI's 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 VCI with content for such communities.
VCI currently operates four online communities: Virtual Jerusalem
(www.virtualjerusalem.com), Virtual HolyLand (www.virtualholyland.com), Virtual
Ireland (www.virtualireland.com) and Virtual Italy (www.virtualitaly.com).
Rather than create its own content, VCI aggregates content, including news and
features, from its content partner Web sites. In consideration for VCI's use of
their content, VCI offers its 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. VCI supplements the
content on its Web sites by adding a variety of interactive and community
enhancing elements, such as free e-mail, weather, bulletin boards and chat
services. VCI obtains the rights to use these elements or "modules" by
licensing the technologies from Internet service providers. VCI's 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 its expertise in designing and developing Web sites for its
content partners, VCI also recently began offering Web site design and
development services to others on a fee for services basis.
VCI's first online community, Virtual Jerusalem, was launched in May 1996 by
VCIL. Substantially all of the assets and stock of VCIL was acquired by VCI in
June 1997. Virtual Jerusalem contains content from over 100 Jewish and Israel-
related news providers and content partners, many of whom VCI 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, VCI launched its second online community, Virtual
HolyLand, which is targeted to Evangelical Christians, and in March 1999 VCI
launched its third online community, Virtual Ireland, which is targeted to
people of Irish descent and in October 1999, VCI launched Virtual Italy
targeted to the Italian American community. VCI anticipates launching one
additional online community during the fourth quarter of 1999 and additional
communities in the year 2000.
In the third quarter of 1999, VCI 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 VCI intends
on entering into content relationships for use of their audio content on the
Internet. VCI anticipates incurring additional administrative and licensing
costs related to the establishment of this site but believes that this project
will provide VCI 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 VCI's total revenue for
fiscal years ended December 31, 1997 and 1998, respectively. VCI's remaining
revenues were derived from commissions on sales of products marketed through
VCI's online communities and from Web production and hosting service fees.
Advertising is offered to VCI's advertisers at rates that are based upon an
industry accepted CPM (cost per thousand page views delivered) basis. Discounts
of up to 20% from VCI's advertising rates, are offered to certain advertisers
based on several
63
factors, including the duration and gross dollar amount of advertising
campaigns. VCI currently sells 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 VCI's 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.
VCI projects increased revenues from banner advertising sales as VCI
continues to expand its advertising sales staff, add online communities and
solicit advertisers which seek the types of Web sites developed by VCI since
such sites deliver an audience comprised of a specific demographic profile to
which such advertisers can tailor a targeted campaign.
VCI is also expanding its current e-commerce programs on the Virtual
Jerusalem and introducing similar programs for its other online communities.
VCI currently enters into agreements with online sellers of books, multimedia
products and other goods related to the theme of its online communities from
which VCI receives a percentage of gross sales ranging from 5% to 30%. VCI
provides links to these third party Web sites for which it receives a
percentage of sales from users who make purchases on those third party sites
where such users originated from VCI's sites. VCI expects e-commerce
transactions to generate a significant percentage of VCI's revenues in the
future. To the extent that the number of anticipated users on VCI's online
communities is less than anticipated, that such users do not engage in e-
commerce transactions or that VCI does not establish attractive e-commerce
programs on its communities, revenues generated from e-commerce will be less
than projected.
VCI also anticipates deriving additional significant revenue from its entry
into the fee-based Web design and development business. VCI 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 VCI has received a license from a software
developer. VCI believes 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.
VCI believes that the continued expansion of its operations and marketing
efforts is essential to achieving its financial goals. VCI therefore intends to
continue to substantially increase expenditures in all areas of its 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, VCI's business, financial
condition and operating results will be materially adversely affected.
VCI 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 VCIL. VCIL develops and maintains VCI's online communities and, in
some instances, the Web sites of VCI's content partners, pursuant to a cost
plus agreement and a financial services agreement which VCIL entered into with
VCI in July 1997 and amended in September 1999.
Historical Results of Operations
Historical Comparison of Six Months Ended June 30, 1999 and 1998
Revenue
Revenue to date has almost exclusively been generated by the Virtual
Jerusalem site. Revenues from Virtual HolyLand and Virtual Ireland are expected
to increase in the fourth quarter 1999.
Total revenues for the six months ended June 30, 1999 were $345,000, a
decrease of $169,000 or 33% from the same period in 1998. VCI's primary source
of revenue to date derives from banner advertising fees. Revenues from banner
advertising amounted to $299,000, or 58%, and $187,000, or 54%, of VCI's total
revenues for the six months ended June 30, 1998 and June 30, 1999,
respectively. To date, VCI has signed
64
banner advertising contracts for revenues expected to be recognized in the
third and fourth quarters of 1999 amounting to $332,000 and $145,000 in 2000.
Of the 26 new advertising clients that VCI retained in 1999, ten clients have
entered into annual advertising contracts.
Although quarterly banner advertising revenues have increased consistently
over the four quarters ended June 30, 1999, the decrease from the first half of
1998 resulted essentially from two sources. First, the first half of 1998 had
benefitted from a special Passover promotion, which was not repeated in the
first half of 1999. Second, almost no revenue was recorded in the first half 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, VCI signed a
barter advertising agreement with Continental Airlines in which VCI 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.
VCI also earns revenue from Web site hosting, Web links to and promotion of
its content partner's Web sites on VCI's 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
which provide for annual fees. Therefore, these revenues were fairly consistent
between the periods of comparison. Hosting, Web link and promotion revenues
accounted for 26% and 29% of total revenue for the quarters ended June 30, 1998
and 1999, respectively. Production revenue is recognized upon performance of
production services. Production revenues accounted for 12% and 9% of total
revenue for the quarters ended June 30, 1998 and 1999, respectively.
The five largest advertising clients in the first half of 1999 accounted for
22% of total revenue. Due to the relative importance of advertising revenue to
its total revenue, as well as the significance of total advertising revenue
that VCI realizes from its five largest advertising clients, VCI's success will
depend largely upon its ability to broaden and diversify its advertising base.
If VCI loses advertisers, fails to attract new advertisers or is forced to
reduce advertising rates in order to retain or attract advertising clients,
VCI's 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
VCI's online communities, Internet access and connectivity, Web site
production, content development and maintenance and client services. Cost of
revenue amounted to $327,000, or 64%, and $556,000, or 161% of revenue for the
six months ended June 30, 1998 and 1999, respectively. This increase is
primarily due to the 92% increase in the hiring of additional technical and Web
site support personnel from January 1, 1999 to June 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 VCI on its online
communities. Bartered content material expense amounted to $32,000, or 6% of
revenue, in the first half of 1998, and $29,000, or 8% of revenue, in the first
half 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 VCI's online communities, marketing materials
and promotions. Sales and marketing amounted to $177,000, or 34% of revenue,
for the six months ended June 30, 1998, and $575,000, or 167% of revenue, for
the six months ended March 31, 1999. The increase is consistent with VCI's
plan, which commenced during the first half of 1999, to market its online
communities aggressively, in order to increase the numbers of users and
encourage their registration on its online communities.
65
General and administrative expenses consist primarily of salaries and legal
and professional services. In addition, VCI's rent, utilities and
administrative employee benefits are included in general and administrative
expenses. General and administrative expenses accounted for $429,000, or 83% of
revenue, for the six months ended June 30, 1998, and $754,000, or 219% of
revenue for the six months ended June 30, 1999. This increase is primarily due
to the hiring of additional personnel between January 1, 1999 and June 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.
VCI's 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, VCI has 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. VCI expects e-commerce transactions to
generate a significant percentage of VCI's revenues in the future as e-commerce
partners are added to its online communities. VCI is currently researching the
availability of e-commerce programs to support its projected expanding e-
commerce business.
VCI also earns revenue from Web site hosting, Web links and promotion of
content partner Web sites on VCI's 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 which
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, VCI 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 its total revenues as well as
the significance of total advertising revenue that VCI realizes from its five
largest advertising clients, VCI's success will depend largely upon its ability
to broaden and diversify its advertising base. If VCI loses advertisers, fails
to attract new advertisers or is forced to reduce advertising rates in order to
retain or attract advertising clients, VCI's 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
VCI's online communities, Internet access and connectivity, Web site
production, content development and maintenance and client services. Cost of
revenue amounted to $602,000, or 150% of revenue, in 1997, $721,000, or 88% of
revenue, in 1998.
66
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 the revenue recognition policy of VCI changed 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 VCI's online communities, marketing materials
and promotions. VCI plans to market its online communities aggressively going
forward, in order to increase the numbers of users and encourage their
registration on its 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, VCI's 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
VCI 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 VCI, plus a warrant to
purchase that number of shares of VCI's 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, VCI 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,
VCI has not utilized any portion of its net operating loss carryforwards to
reduce its overall income tax liability.
Liquidity and Capital Resources
Prior to 1999, VCI funded its operations, working capital needs and capital
expenditures primarily through private placements of its common stock, cash
flow from operations and the issuance of short-term convertible loans and
notes. On February 17, 1999, VCI received $815,000 in net proceeds from the
sale of 9,550 shares of its series A preferred stock. At the same time VCI
issued 5,000 shares of its series A preferred stock upon the conversion of a
$500,000 convertible secured promissory note issued by VCI on December 31,
1998. As of December 31, 1998, VCI had cash and cash equivalents of $574,000 as
compared to total liabilities of $1,732,000.
In June 1999, VCI received net proceeds of $757,000 from the sale of 9,325
shares of its series B preferred stock. As of June 30, 1999, VCI had cash and
cash equivalents of $368,000 as compared to total liabilities of $1,544,000.
67
In June 1999, VCIL, one of VCI's 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 will
start in December 1999. In July 1999, VCI 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. Cash outlays, excluding rent and
deposits, expected prior to the pending merger with HDG, for both leaseholds,
including leasehold improvements, furniture, technical systems and professional
fees, amount to approximately $225,000. VCI also expects to apply $435,000 of
the HDG cash from the merger to complete payment of additional commitments
generated by these leaseholds. In addition, the lessor of the new Jerusalem
premises is contributing $236,500 in buildout costs which VCIL is obligated to
repay over the course of the lease term. In January 1999, VCIL entered into a
three-year lease for approximately 3,800 square feet of office space in
Jerusalem which it vacated upon its move to new premises in August 1999 and
which it intends to sublet. Although VCIL believes that it will be able to
sublet such space, VCI's management cannot assure you that it will be
successful in doing so, and in the event such space cannot be sublet, VCI would
be obligated to pay approximately $15,000 in quarterly leasehold fees in
addition to the lease costs for its new premises until December 2001.
VCI anticipates that it will continue to increase its capital expenditures
in the near future due to anticipated growth in its 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 VCI's 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.
VCI maintains an operating line of credit with Israel General Bank in the
amount of $560,000. As of September 15, 1999, the amount outstanding on this
line of credit totaled $322,000. Israel General Bank has also provided VCI with
a $58,000 guarantee for three months rent on the leaseholds occupied by VCIL.
Without accounting for cash held by HDG that will be available for use by
the combined entity following the merger, VCI anticipates that its existing
cash balance combined with the net proceeds which may be realized from the sale
of additional shares of its Series B preferred stock and anticipated revenue
from operations will be sufficient to meet VCI's working capital and capital
expenditure needs through October 31, 1999. In the event the merger with HDG is
not consummated, or if the cash that VCI generates from its operations is
insufficient to satisfy its liquidity requirements after this period, then VCI
may need to sell additional securities. The sale of additional equity or
convertible debt securities may result in additional dilution to VCI's and
HDG's shareholders. VCI will need to obtain additional capital or modify its
growth strategy. VCI may not be able to raise any additional capital or obtain
such capital on acceptable terms. In September 1999, VCI entered into a note
purchase agreement with HDG to issue up to $750,000 in 12% senior convertible
notes (the "notes") to HDG. $250,000 of such notes were issued in September
1999 and an additional $500,000 in notes were issued to HDG on October 5, 1999.
Pursuant to a security agreement between HDG and VCI, the notes are secured by
a security interest in all of VCI's assets, including all of the stock of its
three subsidiaries. All principal plus all accrued interest shall be due and
payable on the termination of the merger agreement between VCI and HDG. In the
event the merger is consummated, the notes will be deemed automatically
redeemed and the principal and accrued interest on the notes will be added to
the cash value of HDG immediately prior to closing of the merger.
In connection with the notes, VCI 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 shares are exercisable immediately at a
price of $1.45 per share subject to adjustment in the event the anticipated
merger does not close. The notes are also convertible at a rate of $1.45 per
share of common stock in VCI in the event the anticipated merger does not
close.
68
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 VCI's Web sites or engage in other business activities.
State of Readiness
The following outlines VCI's state of readiness as to the Year 2000 issue
with respect to each section of its operations.
Infrastructure. The Year 2000 problem could affect the systems, transaction
processing computer applications and devices used by VCI to operate and monitor
all major aspects of its business, including financial systems, customer
services, infrastructure and networks.
VCI believes that it has identified and has, where appropriate, modified
substantially all of the major systems, software applications and related
equipment used in connection with its internal operations that needed to be
modified or upgraded in order to minimize the possibility of a material
disruption to its business due to the Year 2000 problem.
Facility Systems. Systems such as heating, sprinklers, test equipment and
security systems at VCI's facilities also may be affected by the Year 2000
problem. VCI currently is assessing the potential effect of, and costs of
remedying, the Year 2000 problem on its facility systems. VCI estimates that
the total cost to VCI of completing any required modifications, upgrades or
replacements of these systems will not have a material adverse effect on VCI's
business or results of operations, as these facility systems are currently
being built or installed in VCI's Israel and United States facilities by
vendors with a full understanding of Year 2000 compliance.
Software. VCI is conducting an internal review of the software systems it
uses for site management, network monitoring, quality assurance and transaction
processing. VCI is also reviewing its computer infrastructure, including
network equipment and servers. VCI does not anticipate material problems with
network equipment, as its current configuration was installed within the last
three years. Similarly, VCI purchased most of its servers in 1998 and 1999.
With this relatively current equipment, VCI does 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. VCI
also internally standardized its personal computers on Windows 98, using
reasonably current service packs. VCI was advised by its vendors that these
packs are Year 2000 compliant. VCI uses 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 VCI's vendors
have advised VCI 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, VCI has developed a process to check and remedy
these applications by the end of September 1999.
Hardware. VCI has made verbal inquiries of vendors of, and has reviewed the
relevant vendor documentation for, those VCI systems that VCI believes to be
mission critical to its business with respect to the Year 2000 readiness of
such systems. VCI has received various verbal assurances of Year 2000 readiness
from certain of its vendors, and has received written assurance from both
Compaq (servers) and IBM (personal computers).
VCI is currently performing further operational tests on all hardware,
despite vendor assurances. VCI generally does not have contractual rights to
assert against its vendors should their equipment or software fail due to Year
2000 issues.
69
If any of VCI's third party equipment or software does not operate properly
with regard to the Year 2000 issue, VCI may incur unexpected expenses to remedy
any problems. These expenses could potentially include purchasing replacement
hardware and software.
Other third-parties. VCI has received assurances from Global Center and
Netvision, its United States and Israeli internet service providers
respectively, that VCI's internet services will not be disrupted due to a Year
2000 issue.
VCI has not determined the state of Year 2000 compliance of certain third-
party suppliers of services such as VCI's content partners, marketing and
advertising partners, telephone companies, long distance carriers, financial
institutions and electric companies, as each relates to VCI's business. The
failure of any of these service suppliers to timely remedy any Year 2000 issues
in a manner compatible with VCI's systems could severely disrupt VCI's ability
to carry on its business.
Costs
VCI anticipates that its review of Year 2000 issues and any remedial efforts
will continue throughout 1999. The costs incurred to date to remedy VCI's Year
2000 issues have not been material. If any Year 2000 issues are uncovered with
respect to VCI's systems, VCI believes that it will be able to resolve these
problems without material difficulty, as replacement systems should be
generally available on commercially reasonable terms. VCI presently estimates
that the total remaining cost of addressing any Year 2000 issues will not
exceed $10,000.
Risks
VCI's applications operate in complex network environments and directly and
indirectly interact with a number of other hardware and software systems. VCI
is unable to predict to what extent its business may be affected if its systems
or the systems that operate in conjunction with its systems experience a
material Year 2000 failure. VCI is also subject to the Year 2000 risks
affecting the Internet as a whole.
Known or unknown errors or defects that affect the operation of VCI's
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 VCI's reputation, increased service and warranty costs,
and litigation costs, any of which could adversely affect VCI's business,
financial condition and results of operations.
The most likely worst case scenario for VCI due to a Year 2000 failure is
that access to VCI's Web sites through the internet would be limited or
impossible due to a telecommunications problem beyond VCI's control. In such a
scenario, VCI would be dependent on third party telecommunications providers to
remedy the problem.
Another likely worst case scenario for VCI is the failure of a VCI server to
function properly due to a Year 2000 issue. VCI believes that such a failure
could be remedied within 24 hours by its staff or the staff of its service
providers.
Contingency Plans
VCI's Year 2000 analysis has been derived based on a number of assumptions,
including the assumption that it has already identified its most significant
Year 2000 issues and is already engaged in a program to remedy any issues. In
view of VCI's Year 2000 review and remediation efforts to date, the development
of its products and services within the last several years, the recent
installation of its networking equipment and servers, and the limited Year 2000
activities that remain to be completed, VCI has not engaged in contingency
planning until recently. VCI anticipated that its contingency plans will be
completed prior to October 1, 1999. However, VCI can make no assurances that
its assumptions are accurate, and actual results could differ materially from
those VCI anticipates.
70
Notwithstanding the above, VCI currently is developing contingency plans to
address the Year 2000 issues that may pose a significant risk to its on-going
operations. These plans could include accelerated replacement of affected
equipment or software, temporary use of back-up equipment or software or the
implementation of manual procedures to compensate for system deficiencies. VCI
anticipates that its contingency plans will be completed prior to October 1,
1999. However, there can be no assurance that any contingency plans implemented
by VCI would be adequate to meet VCI's needs without materially impacting its
operations, that any such plan would be successful or that VCI's results of
operations would 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 ("FASB") issued
Statement of Financial Accounting Standards ("SIAS") 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 SFAS No. 132 did not impact VCI's disclosures.
In March 1998, the American Institute of Certified Public Accountants
("AICPN") 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
VCI's 1998 financial statements. VCI's management does not expect this
statement to have significant impact on its financial statements.
In April 1998, AICPA 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 VCI's 1998 financial statements. VCI's management does not
expect this statement to have a significant impact on its financial statements.
In June 1998, the FASB issued SIAS 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 its fair value. The statement is effective for all fiscal years
beginning after June 15, 1999. As VCI currently is not a party to any
derivative financial instrument and does not anticipate becoming a party to any
derivative instruments, VCI's management does not expect this statement to have
a significant impact on its financial statements.
71
FINANCIAL STATEMENTS
HDG Financial Statements
The audited balance sheet of HDG 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 HDG as of June 30,
1999 and related statements of operations, changes in stockholders' equity and
cash flows for each of the quarterly periods ending on those dates and for the
period from July 20, 1994 through June 30, 1999, is attached to this prospectus
as Appendix B.
VCI Financial Statements
The audited consolidated balance sheet of VCI 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 VCI as of June 30, 1999 and related statements of operations,
changes in stockholders' deficiency and cash flows for each of the quarterly
periods ending on those dates is attached to this prospectus as Appendix D.
72
VIRTUAL COMMUNITIES, INC. (VCI) AND HEURISTIC
DEVELOPMENT GROUP, INC. (HDG)
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 June 30, 1999, assuming the merger has been
completed as of the balance sheet date. The pro forma statements of operations
for the year ended December 31, 1998 and for the six months ended June 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
assumptions that no VCI stockholder dissents the merger and that the minimum of
75% of HDG escrowed share and escrowed option holders, combined convert their
escrowed shares and options into warrants, and (2) adjusted to reflect pro
forma activity, with the assumptions that the maximum of 7% VCI stockholder
dissent to the merger and that maximum of 100% of HDG escrowed share and
escrowed option holders convert their escrowed shares and options into
Warrants. Should more than 7% of VCI stockholders vote against the proposed
transaction, or should less than 75% of the HDG escrowed share and escrowed
option holders not convert their escrowed shares and options into warrants, the
transaction may not be consummated.
In the proposed merger, each outstanding share of VCI common stock will be
exchanged for HDG common stock, at an exchange ratio of approximately 1.13 of a
share of HDG common stock to one share of VCI common stock. As a result of the
merger, the VCI shareholders will collectively acquire approximately 12,223,389
shares of HDG common stock or approximately 88% of the then outstanding HDG
common stock excluding escrow shares and treasury stock. The merger will be
accounted for as a capital transaction, which is equivalent to the issuance of
stock by VCI for HDG's net monetary assets of approximately $3,000,000,
accompanied by a recapitalization of VCI.
The calculation of the exchange ratio of 1.13 was made on the assumption
that HDG will have a cash value of $2,625,000 at the time of the merger. If the
cash value falls below $2,500,000 the conversion ratio would be above 1.36. As
a result, the VCI stockholders would collectively acquire at least
approximately 14,759,748 shares of HDG common stock or at least approximately
90% of the then outstanding HDG common stock. 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 1.13 assumes 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 will convert into
approximately 47.6 shares of VCI common stock. This conversion price will
automatically reset to $1.45 per share in the event that the merger is not
consummated by September 30, 1999, provided, however, that such date may be
extended to October 31, 1999 upon the receipt of a letter from VCI's outside
counsel stating that the closing has been delayed for certain reasons beyond
VCI's control. If the conversion price is reset to $1.45, the exchange ratio
would decrease.
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.
73
VIRTUAL COMMUNITIES, INC. (VCI) AND HEURISTIC
DEVELOPMENT GROUP, INC. (HDG)
PRO FORMA BALANCE SHEET
AS OF JUNE 30, 1999
(U.S. Dollars in thousands)
(Unaudited)
Additional Pro
VCI HDG Pro Forma Forma
(Unaudited) (Unaudited) Combined Adjustments Combined Adjustments Combined
----------- ----------- -------- ----------- -------- -------------- ------------
(no dissent shares (7% dissenting shares and
and 75% Escrow 100% Escrow shares
shares converted) converted)
ASSETS
------
Current Assets
Cash and cash
equivalents............. 368 2,819 3,187 (353)(c) 2,834 (1,095)(f) 1,739
Trade receivables........ 249 249 249 249
Other receivables........ 81 62 143 143 143
------ ------ ------- ------ ------------
Total current assets.... 698 2,881 3,579 3,226 2,131
------ ------ ------- ------ ------------
Fixed Assets, Net.......... 398 -- 398 398 398
------ ------ ------- ------ ------------
Severance Pay Deposits..... 57 -- 57 57 57
------ ------ ------- ------ ------------
Other Assets............... -- 50 50 50 50
------ ------ ------- ------ ------------
Total assets............ 1,153 2,931 4,084 3,731 2,636
====== ====== ======= ====== ============
LIABILITIES AND
SHAREHOLDERS' EQUITY
(DEFICIENCY)
--------------------
Current Liabilities
Short-term bank
borrowings.............. 59 -- 59 59 59
Shareholders' loans...... 150 -- 150 150 150
Payables and accrued
expenses................ 1,232 105 1,337 1,337 1,337
------ ------ ------- ------ ------------
Total current
liabilities............ 1,441 105 1,546 1,546 1,546
------ ------ ------- ------ ------------
Long-Term Liabilities
Accrued severance pay ... 103 -- 103 103 103
------ ------ ------- ------ ------------
Total long-term
liabilities............ 103 -- 103 103 103
------ ------ ------- ------ ------------
Total liabilities....... 1,544 105 1,649 1,649 1,649
------ ------ ------- ------ ------------
Shareholders' Equity
(Deficiency)
Share Capital............ 1 21 22 (3)(d) 140 (1)(e) 130
121 (a) (9)(f)
Treasury Stock........... -- (150) (150) 150 (b) -- --
Additional paid-in
capital................. 4,373 8,441 12,814 (5,607)(a) 6,866 1 (e) 5,781
(150)(b) (1,086)(f)
(194)(c)
3 (d)
Accumulated deficit...... (4,765) (5,486) (10,251) 5,486 (a) (4,924) (4,924)
(159)(c)
------ ------ ------- ------ ------------
Total shareholders'
equity (deficiency)....... (391) 2,826 2,435 2,082 987
------ ------ ------- ------ ------------
Total liabilities and
shareholders' equity
(deficiency)........... 1,153 2,931 4,084 3,731 2,636
====== ====== ======= ====== ============
74
VIRTUAL COMMUNITIES, INC. (VCI) AND HEURISTIC
DEVELOPMENT GROUP, INC. (HDG)
PRO FORMA STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1999
(U.S. Dollars in thousands, except share and per share data)
(Unaudited)
VCI HDG
For the six For the six Pro Forma Pro Forma
months ended months ended Adjustments Combined Adjustments Combined
June 30, June 30, (no dissenting (no dissenting (7% dissenting (7% dissenting
1999 1999 shares) shares) shares) shares)
------------ ------------ -------------- -------------- -------------- --------------
(Unaudited)
REVENUES................ 345 -- 345 345
------ --------- ---------- --- ----------
COST AND EXPENSES
Cost of revenues........ 556 -- 556 556
Selling, general and
administrative
expenses............... 1,329 389 1,718 1,718
Financing expenses
(income), net.......... 58 (63) (5) (5)
Expenses of merger...... 241 56 (297)(i) -- --
------ --------- ---------- --- ----------
2,184 382 2,269 2,269
------ --------- ---------- --- ----------
Net loss.............. (1,839) (382) (1,924) (1,924)
====== ========= ========== === ==========
Net Loss per share...... (0.24) (0.14) (0.15)
========= ========== === ==========
Weighted average number
of shares outstanding.. 1,602,056 13,825,445 (g) 12,969,808 (h)
========= ========== === ==========
75
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) (0.18) (0.19)
========= === ========== === ===========
Weighted average number
of shares outstanding.. 1,728,114 13,951,503 (g) 13,095,866 (h)
========= === ========== === ===========
76
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 June 30, 1999, assuming the merger has been completed as of the balance
sheet date. The pro forma statements of operations for the year ended December
31, 1998 and for the six months ended June 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
assumptions that no VCI stockholder dissents the merger and the minimum of 75%
of HDG escrowed share and escrowed option holders convert their escrowed
shares and escrowed options into warrants, and (2) adjusted to reflect pro
forma activity, with the assumptions that the maximum of 7% VCI stockholders
dissent the merger and that the maximum of 100% of HDG escrowed share and
escrowed option holders convert their escrowed shares and escrowed options
into warrants. Should more than 7% of VCI stockholders vote against the
proposed transaction, or should less than 75% of the HDG escrowed shares and
escrowed options holders not convert their escrowed shares and options into
warrants, the transaction may not be 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 June 30, 1999. The historical statements
of operations for the year ended December 31, 1998 and six months ended June
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 12,223,389 shares of HDG common
stock.
(b) Reflects the elimination of HDG's treasury stock.
(c) Reflects the payment of an estimated $194 in connection with HDG
expenses, and reflects the payment of an estimated $159 in connection
with VCI expenses for professional services and other expenses in
connection with the merger.
(d) Reflects 75% of HDG escrow shares and options converted into warrants.
(e) Reflects an additional 25% of HDG escrow shares and options converted
into warrants.
(f) 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.
77
NOTES TO PRO FORMA FINANCIAL STATEMENTS--(Continued)
(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 six months ended June 30, 1999, plus the number of HDG shares
issued to VCI upon consummation of the merger, in the estimated amount
of 12,223,389, assuming no VCI stockholder dissents the merger.
(h) 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 six months ended June 30, 1999, plus the number of HDG shares
issued to VCI upon consummation of the merger, in the estimated amount
of 12,223,389, less 855,637, the maximum number of VCI common stock
that may dissent the merger without precluding the consummation of the
merger.
(i) Reflects elimination of merger costs recorded in the period presented,
assuming the merger had occurred on the first day of the period.
78
RELATED PARTY TRANSACTIONS
In connection with the signing of the merger agreement, substantially all of
the VCI optionholders signed agreements not to dispose of their VCI securities
for a period of 180 days after the consummation of the merger.
In connection with the merger, the HDG board of directors will approve,
effective upon the merger, a new 1999 stock incentive plan for HDG which HDG
stockholders are voting on at their annual meeting.
In January 1996, VCIL purchased certain equipment, intellectual property
rights and contractual rights from Avi Moskowitz, VCI's President, Chief
Executive Officer and a director of VCI, and his wife Helen Moskowitz, in
return for an obligation to pay $100,000. In June 1997, these assets were sold
by VCIL to VCI, and VCI assumed the payment obligation. In December 1998, VCI
permitted the Moskowitz's to convert $60,000 of this obligation into 127,667
shares of VCI common stock at a rate of $.47 per share. VCI paid the remaining
$40,000 to the Moskowitz's 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 VCIL, on an
interest-free basis, an aggregate of $250,000. Harry Fox, a former director of
VCI, is a 33.6% shareholder of NRH and its Chief Executive Officer and a
director. In August 1998, VCI permitted NRH to convert the loan into 1,454,000
shares of VCI common stock at a rate of approximately $.17 per share. NRH owns
approximately 13.5% of VCI's outstanding capital stock.
In April 1997, VCI borrowed $100,000 from Business Systems Consultants
("BSC"), an entity that is affiliated with the family of David Morris, a VCI
director. In December 1998, VCI permitted BSC to convert the principal and
accrued interest of $16,900 into 248,723 shares of VCI common stock at a rate
of $.47 per share. While the original conversion rate on the loan was $.60 per
share, VCI lowered the conversion rate as an incentive to BSC to convert the
loan. In consideration of the BSC loan, VCI also issued to BSC three two-year
warrants, each expiring December 31, 2000, to acquire a total of 192,000 shares
of VCI common stock at exercise prices ranging from $.30 to $.65 per share. In
June 1997, VCI issued BSC a two-year warrant, expiring December 31, 2000, to
acquire 4,200 shares of VCI common stock at an exercise price of $.60 per
share. This warrant was issued in consideration of a 30-day loan to VCI from
BSC in the amount of $50,000, which VCI repaid in July 1997. In September 1999,
David Morris was issued two three-year warrants to acquire up to 211,905 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 VCI.
In June 1997, Peter A. Jacobs, a VCI director, loaned VCI $50,000. In
January 1998, Mr. Jacobs converted this loan into 83,333 shares of VCI common
stock at a rate of $.60 per share. In February 1998, Mr. Jacobs loaned VCI an
additional $2,706, which amount was converted in December 1998 into 6,262
shares of VCI common stock at the rate of $.47 per share. At this time, Mr.
Jacobs also purchased 53,200 shares of VCI common stock from VCI for $25,000,
or $.47 per share.
During 1997 and 1998, VCIL, a VCI subsidiary, 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. VCIL 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, VCI issued to Versaware, Ltd., a two-year warrant,
expiring February 15, 2000, to purchase 14,167 shares of VCI common stock at an
exercise price of $.66. This warrant was issued in consideration of Versaware,
Ltd.'s agreement to give VCIL a 90-day extension for the payment of
approximately $47,000 due to Versaware, Ltd. through May 15, 1998.
In August 1998, VCI issued to Versaware, Ltd. a two-year warrant, expiring
August 24, 2000, to purchase 13,358 shares of VCI common stock at an exercise
price of $.66 in consideration of Versaware, Ltd.'s
79
agreement to give VCIL a 100-day extension for the payment of approximately
$75,119 due to Versaware, Ltd. through August 24, 1998.
In December 1998, VCI issued to Versaware, Ltd. a two-year warrant, expiring
December 31, 2000, to purchase 35,519 shares of VCI common stock at an exercise
price of $.66 in consideration of Versaware, Ltd.'s agreement to give VCIL a
125-day extension for the payment of approximately $115,000 due to Versaware,
Ltd. through from September through December 1998.
As of August 31, 1999, VCIL currently owed Versaware, Ltd. a total of
$25,000.
In addition, during 1997 and 1998, VCI sublet office space and obtained
office services from NRH. Harry Fox, a former director of VCI, is a 33.6%
shareholder of NRH and its Chief Executive Officer and a director. Pursuant to
this arrangement, VCI paid NRH $9,000 during 1997, and $19,000 during 1998. As
of July 1999, VCI ceased subletting office space from NRH.
In February 1998, VCI borrowed $50,000 from George Moskowitz, the brother of
Avi Moskowitz, VCI's President, Chief Executive Officer and a director of VCI.
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,
VCI issued to George Moskowitz a two-year warrant, expiring February 2000, to
purchase 53,300 shares of VCI common stock at an exercise price of $.66 per
share. The loan, and interest thereon, was repaid by the VCI in January 1999.
In August 1998, George Moskowitz loaned VCI 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, VCI provided George Moskowitz with $4,200 of goods
and services available to VCI through VCI's barter arrangements with its
customers and agreed to issue George Moskowitz 10,000 shares of VCI common
stock for each 30-day period the loan remained outstanding following the
maturity date. In December 1998, VCI issued to George Moskowitz 36,451 shares
of VCI 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 111,383 shares of VCI
common stock at the rate of $.47 per share.
In February 1999, VCI entered into an employment agreement with Michael
Harwayne, VCI's Vice President of Business Development and Marketing. Beginning
June 1999, Mr. Harwayne's annual salary was adjusted to $125,000. Pursuant to
the agreement, VCI granted to Mr. Harwayne options to purchase 100,000 shares
of VCI's common stock with an exercise price of $0.81 per share. Such options
vest equally over three years. Mr. Harwayne is also eligible to receive an
additional 100,000 options should Mr. Harwayne meet certain performance targets
as determined by VCI's board of directors. The agreement may be terminated by
either party upon sufficient notice as provided in the agreement, except that
VCI may terminate Mr. Harwayne for cause without notice.
In August and September 1999, VCIL increased its 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 VCI. In consideration for providing the guarantee, the VCI issued
to David Morris two three-year warrants exercisable into a total of 211,905
shares of common stock of VCI at an exercise price of $2.10 per share. One
warrant, for the purchase of 78,571 shares vests quarterly so that
19,643 shares vest for each quarter the guarantee remains in effect. The other
warrant, exercisable into 133,333 shares, vests on a semi-annual basis so that
a minimum of 66,667 shares are exercisable for every half-year that the
guarantee remains in effect. VCI also agreed to pay Conrad Morris a fee equal
to two and one quarter percent (2.25%) of the amount of the line as further
consideration for his guarantee. Upon the closing of the merger, VCI has agreed
to limit Conrad Morris's guarantee of the line to no more than $100,000.
80
DESCRIPTION OF SECURITIES
As of the date of this prospectus, HDG's authorized capital stock consists
of 20,000,000 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 the HDG board
of directors out of funds legally available for payment. Upon HDG's
liquidation, dissolution or winding up, the holders of the HDG common stock may
share ratably in HDG's assets, subject to the rights and preferences of any
outstanding preferred stock.
Each holder of HDG 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.
Preferred Stock
The HDG board of directors has the power, without further vote of the
stockholders, to authorize the issuance of up to 5,000,000 shares of HDG
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 HDG 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 by the company on 30 days' written notice
at a redemption price of $.05 per class A warrant if the "closing price" of the
company's 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" shall mean 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 by the company on 30 days' written notice at a
redemption price of $.05 per class B warrants, if the closing price (as defined
above) of the company's 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 certain
exceptions.
The company has reserved from its 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.
81
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 the company could obtain additional capital may
be adversely affected. The holders of the warrants might be expected to
exercise them at a time when the company 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, the company
has the right to reduce the exercise price or extend the expiration date of the
warrants.
Unit Purchase Options
The company granted to the underwriter and a finder in connection with its
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 by the company 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 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 in certain events 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
HDG has 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 HDG's expense and
the second at the expense of the holders. HDG has also granted certain
"piggyback" registration rights to holders of the unit purchase option and
finder's unit purchase option.
INDEMNIFICATION AND INSURANCE
After the effective time of the merger, HDG will indemnify and hold harmless
each present and former officer and director of VCI and its subsidiaries
against any costs or expenses pertaining to any matter esiting or occurring
before or after the effective time of the merger to the fullest extent
permitted by Delaware law. Also, the parties have agreed that the rights of
present and former VCI and HDG directors and officers to indemnification under
the respective companies' certificate of incorporation, bylaws and similar
documents will continue in force for a period of six years after the effective
time of the merger. For a period of six years after the effective time of the
merger, post-merger HDG 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 VCI and
HDG directors and officers, on terms no less favorable than those presently
provided by the companies.
82
LEGAL MATTERS
The validity of the HDG common stock to be issued upon exercise of the
warrants will be passed upon for HDG by Christensen, Miller, Fink, Jacobs,
Glaser, Weil & Shapiro, LLP.
EXPERTS
The financial statements of HDG 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 (HDG'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 VCI 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 VCI's
ability to continue as a going concern as discussed in Note I to the financial
statements.
WHERE YOU CAN FIND MORE INFORMATION
HDG files 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 HDG files 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. HDG public filings are also available to the
public from commercial document retrieval services and at the Internet World
Wide Web site maintained by the Commission at "http://www.sec.gov." Reports,
proxy statements and other information concerning HDG also may be inspected at
the offices of the National Association of Securities Dealers, Inc., 1735 K
Street, N.W., Washington, D.C. 20006.
HDG has filed the registration statement to register with the Commission the
securities being offered by the selling securityholders. This prospectus is a
part of the registration statement and constitutes a prospectus of HDG. 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.
83
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
(Inceptionn)
Year Ended December 31, through
------------------------ 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
HEURISTIC DEVELOPMENT GROUP, INC.
FINANCIAL STATEMENTS FOR THE PERIOD ENDING JUNE 30, 1999
AND FOR THE PERIOD FROM JULY 20, 1994 THROUGH JUNE 30, 1999
(unaudited)
B-1
HEURISTIC DEVELOPMENT GROUP, INC.
(A Development Stage Company)
BALANCE SHEET
June 30, 1999
ASSETS
------
Current assets:
Cash and cash equivalents......................................... $ 2,819,000
Prepaid expenses and other current assets......................... 62,000
-----------
Total current assets............................................ 2,881,000
Captialized software costs........................................ 50,000
-----------
TOTAL......................................................... $ 2,931,000
===========
LIABILITIES
-----------
Current liabilities:
Accounts payable.................................................. $ 49,000
Accrued expenses.................................................. 56,000
-----------
Total current liabilities....................................... 105,000
-----------
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).......................................................... 21,000
Additional paid-in capital........................................ 8,441,000
(Deficit) accumulated during the development stage................ (5,486,000)
-----------
2,976,000
Treasury stock (149,900 shares)................................... (150,000)
-----------
Total stockholders' equity...................................... 2,826,000
-----------
TOTAL......................................................... $ 2,931,000
===========
B-2
HEURISTIC DEVELOPMENT GROUP, INC.
(A Development Stage Company)
STATEMENTS OF OPERATIONS
July 20,
Three Months Ended Six Months Ended 1994
June 30 June 30, (Inception)
---------------------- ---------------------- to June 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......... $ 130,000 258,000 $ 314,000 $ 432,000 3,844,000
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
Acquisition breakup
fee.................... 100,000
---------- ---------- ---------- ---------- -----------
Total costs and
expenses............... 130,000 258,000 321,000 445,000 5,060,000
---------- ---------- ---------- ---------- -----------
(Loss) from operations.. (130,000) (258,000) (321,000) (445,000) (5,060,000)
Interest expense and
amortization of debt
discount and expense... -- -- -- -- (748,000)
Interest income......... 50,000 31,000 96,000 63,000 444,000
---------- ---------- ---------- ---------- -----------
Net (loss).............. $ (80,000) (227,000) (225,000) (382,000) $(5,364,000)
========== ========== ========== ========== ===========
Net (loss) per share--
Basic and Diluted...... $ (0.05) (0.11) (0.13) (0.24)
========== ========== ========== ==========
Weighted average shares
outstanding............ 1,751,956 1,602,056 1,751,956 1,602,056
========== ========== ========== ==========
B-3
HEURISTIC DEVELOPMENT GROUP, INC.
(A Development Stage Company)
STATEMENTS OF CASH FLOWS
July 20,
Six Months Ended 1994
June 30, (Inception)
---------------------- to June 30,
1998 1999 1999
---------- ---------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss)............................... $ (225,000) (382,000) (5,364,000)
Adjustments to reconcile net (loss) to
net cash (used in) operating activities:
Depreciation and amortization............ 5,000 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
Deposit for letter of intent............. 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................ 9,000 (30,000) (101,000)
Net (decrease) increase in accounts
payable and accrued expenses............ (19,000) 76,000 100,000
---------- ---------- -----------
Net cash (used in) operating
activities............................. (223,000) (321,000) (3,444,000)
---------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposit for letter of intent............. (100,000)
Acquisition of fixed assets.............. (5,000) 0 (339,000)
Capitalized software costs............... -- (506,000)
Proceeds from sale of equipment.......... 11,000 0 24,000
---------- ---------- -----------
Net cash (used in) investing
activities............................. 6,000 0 (921,000)
---------- ---------- -----------
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............... (150,000)
---------- ---------- -----------
Net cash provided by financing
activities............................. -- 0 7,184,000
---------- ---------- -----------
NET INCREASE (DECREASE) IN CASH........... (217,000) (321,000) 2,819,000
---------- ---------- -----------
Cash--end of period....................... 3,568,000 $2,819,000 2,819,000
========== ========== ===========
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 1,084,000
Initial public offering expenses charged
to additional paid-in capital........... 198,000
Interest paid............................ 14,000 16,000
Cash--beginning of period................. 3,785,000 3,140,000
B-4
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 six-month period ended June 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:
Heuristic Development Group (the "Company") is a development stage company
formed in 1994 to research, develop, design and market fitness-related
products. The Company's sole product 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.
On June 3, 1999, the Company announced that it has executed a definitive
merger agreement to merge with Virtual Communities, Inc., a privately held
developer and publisher of Internet based communities.
Under the terms of the merger agreement, a subsidiary of HDG will merge with
VCI in an all stock transaction in which VCI's stockholders would receive
between approximately 11.8 million to 15.4 million shares of HDG common stock
(subject to adjustment), representing approximately 88% to 91% of HDG's common
stock after the merger (assuming no exercise of either company's warrants or
options). HDG's existing common stock and Class A and Class B warrants will
remain outstanding. VCI's Board of Directors and management will become the
Board of Directors and management of the merged company.
The transaction is expected to close in the third quarter of 1999, subject
to the satisfaction of certain conditions, including obtaining the approval of
HDG's and VCI's stockholders and an opinion from an investment banking firm
that the transaction is fair to HDG's stockholders.
The transaction will be considered and treated as an acquisition, however,
for accounting purposes, the transaction is a re-capitalization of the
accounting acquirer, VCI.
B-5
HEURISTIC DEVELOPMENT GROUP, INC.
(A Development Stage Company)
NOTES TO FINANCIAL STATEMENTS--(Continued)
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.
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 JUNE 30, 1999
D-1
VIRTUAL COMMUNITIES, INC.
CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
AS OF JUNE 30, 1999
Contents
Page
----
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets I-3
Consolidated Statements of Operations I-4
Consolidated Statements of Shareholders' Deficiency I-5
Consolidated Statements of Cash Flows I-6
Notes to the Consolidated Financial Statements I-7
# # # # # # #
D-2
VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. Dollars in thousands except share data)
June 30 December 31
1999 1998
----------- -----------
(Unaudited) (Audited)
----------- -----------
ASSETS
Current Assets
Cash and cash equivalents............................. 368 574
Trade receivables, net of allowance of $18 in 1999 and
$11 in 1998.......................................... 249 139
Other receivables..................................... 81 35
------ ------
Total current assets............................... 698 748
------ ------
Fixed Assets, Net...................................... 398 181
------ ------
Severance Pay Deposits................................. 57 31
------ ------
Total assets....................................... 1,153 960
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
Current Liabilities
Short-term bank borrowings............................ 59 101
Shareholders' loans................................... 150 200
Payables and accrued expenses......................... 1,232 782
------ ------
Total current liabilities.......................... 1,441 1,083
------ ------
Long-Term Liabilities
Convertible Loans..................................... -- 575
Accrued severance pay ................................ 103 74
------ ------
Total long-term liabilities........................ 103 649
------ ------
Total liabilities.................................. 1,544 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 June
30, 1999--14,550 shares and 9,325 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 June 30,
1999 and 8,425,749 shares as of December 31, 1998.. 1 1
Additional paid-in capital............................ 4,373 2,153
Accumulated deficit................................... (4,765) (2,926)
------ ------
Total shareholders' deficiency..................... (391) (772)
------ ------
Total liabilities and shareholders' deficiency..... 1,153 960
====== ======
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 six months
June 30 ended June 30
-------------------- --------------------
1999 1998 1999 1998
--------- --------- --------- ---------
(Unaudited) (Unaudited)
-------------------- --------------------
REVENUES........................... 173 182 345 514
--------- --------- --------- ---------
COST AND EXPENSES
Cost of revenues................. 319 174 556 327
Selling, general and
administrative expenses......... 768 322 1,329 606
Financing expenses, net.......... 12 34 58 48
Expenses of merger............... 241 -- 241 --
--------- --------- --------- ---------
1,340 530 2,184 981
--------- --------- --------- ---------
Net loss....................... (1,167) (348) (1,839) (467)
========= ========= ========= =========
Net loss per share................. (0.14) (0.09) (0.22) (0.12)
========= ========= ========= =========
Weighted average number of shares
outstanding....................... 8,538,276 3,891,667 8,515,975 3,891,667
========= ========= ========= =========
The accompanying notes form an integral part of the financial statements.
D-4
VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' 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.................. -- 9,325 -- -- 757 -- 757
Net loss................ -- -- -- -- -- (1,839) (1,839)
------ ----- --------- --- ----- ------ ------
Balance as of June 30,
1999................... 14,550 9,325 8,538,276 1 4,373 (4,765) (391)
====== ===== ========= === ===== ====== ======
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 six
months
ended
June 30
------------
1999 1998
------ ----
(Unaudited)
------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss....................................................... (1,839) (467)
Adjustments to reconcile net loss to net cash used in operating
activities (see below)........................................ 361 112
------ ----
Net cash used in operating activities........................ (1,478) (355)
------ ----
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets....................................... (281) (28)
------ ----
Net cash used in investing activities........................ (281) (28)
------ ----
CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in short-term bank borrowing, net..................... (42) (27)
Receipt of shareholders' loans................................. 150 --
Repayment of shareholders' loans............................... (200) --
Receipt (repayment) of convertible loans (*)................... (75) 347
Issuance of common stock....................................... 148 46
Issuance of preferred stock, Series A and B.................... 1,572 --
------ ----
Net cash provided by financing activities.................... 1,553 366
------ ----
DECREASE IN CASH AND CASH EQUIVALENTS............................ (206) (17)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD................. 574 34
------ ----
CASH AND CASH EQUIVALENTS AT END OF PERIOD....................... 368 17
====== ====
ADJUSTMENT TO RECONCILE NET LOSS TO NET CASH USED IN OPERATING
ACTIVITIES:
Items not involving operating cash flows:
Depreciation................................................. 64 17
Accrued severance pay, net................................... 3 26
Changes in operating assets and liabilities
Increase in receivables...................................... (156) (91)
Increase in payable and accrued expenses..................... 450 208
------ ----
361 160
====== ====
NONCASH TRANSACTIONS
Issuance of preferred stock, Series A upon conversions
of loans (*).................................................. 500 --
====== ====
The accompanying notes form an integral part of the financial statements.
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 six month period
ended June 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' LOAN
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 period January--June 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 costs) 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 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 mentioned 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 merger of the Company into an
existing public company.
D-7
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (CONT.)
(Unaudited)
C. In June 1999, the Company raised gross proceeds of $932,500 (before
issuance costs) through the issuance of 9,325 shares of Series B preferred
stock to 24 accredited investors. The gross proceeds from the issuance include
a sum of $182,500, which was received as a result of oversubscription. The
Company has recently received consents from its Series A preferred shareholders
to authorize the increased size of the Series B preferred shares offering.
Holders of the Series B preferred stock have the right to convert their stock
into 444,048 shares of common stock of the Company at a conversion ratio of
$2.1 per share. The Series B preferred stock has the same voting rights as the
common stock based upon its conversion into common stock.
In the event the Company's anticipated merger with HDG (see Note 4) does not
occur, the conversion ratio will be reset from $2.1 per share to $1.45 per
share so that Series B shareholders will be issued a total of 643,103 shares
upon their conversion of the Series B preferred stock into common stock.
D. Subsequent to balance sheet date, the Company issued 1,000 shares of
Series B Preferred Stock for $100,000 to an individual who has been nominated
to become a member of the Board of the Company following its proposed merger
with and into HDG. The Series B shares are convertible into 47,619 shares of
Common Stock of the Company.
Note 4--MERGER AGREEMENT
As of June 2, 1999, the Company ("VCI") signed 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. HDG's Board and management will
resign upon the completion of the merger and VCI's Board and management will
replace them. HDG will change its name to Virtual Communities, Inc.
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 which
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.
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
D-8
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (CONT.)
(Unaudited)
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--SUBSEQUENT EVENTS
In September 1999, VCI 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 have been issued to date and an additional $500,000
Notes is anticipated to be issued to HDG by October 1999 upon written demand by
VCI at any time after VCI has secured the approval of its shareholders of the
proposed Merger with HDG. In the event that VCI does not obtain shareholder
approval on or before October 8, 1999 HDG shall not be obligated to 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 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 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.
# # # # # #
D-9
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.
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 DevelopmentGroup
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.
3(1) Certificate of Incorporation of Heuristic Development Group, as
amended, as filed with the Commission as Exhibit 3.1 to Heuristic
Development Group's Registration Statement on Form SB-2 filed on
December 11, 1996 (File No. 333-17635), is incorporated by
reference.
3(2) Bylaws of Heuristic Development Group, as filed with the
Commission as Exhibit 3.2 to Heuristic Development Group's
Registration Statement on Form SB-2 filed on December 11, 1996
(File No. 333-17635), is incorporated by reference.
II-1
Exhibit No. Description of document
----------- -----------------------
3(3) Certificate of Amendment of Certificate of Incorporation for
Virtual Jerusalem, Ltd., filed with the Delaware Secretary of
State on July 2, 1997, as filed with the Commission as Exhibit
3(3) to Heuristic Development Group's Registration Statement on
Form S-4 on September 17, 1999 (File No. 333-87373), is
incorporated by reference.
3(4) Certificate of Incorporation of Virtual Jerusalem, Ltd., filed
with the Delaware Secretary of State on August 13, 1996, as filed
with the Commission as Exhibit 3(4) to Heuristic Development
Group's Registration Statement on Form S-4 on September 17, 1999
(File No. 333-87373), is incorporated by reference.
3(5) Amended and Restated Bylaws of Virtual Communities, Inc , as filed
with the Commission as Exhibit 3(5) to Heuristic Development
Group's Registration Statement on Form S-4 on September 17, 1999
(File No. 333-87373), is incorporated by reference.
5(1) Opinion of Christensen, Miller, Fink, Jacobs, Glaser, Weil &
Shapiro, LLP.*
10(1) 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.
10(2) 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(3) 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(4) 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(5) 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(6) 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(7) 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(8) 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(9) 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.
II-2
Exhibit No. Description of document
----------- -----------------------
10(10) 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(11) 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(12) 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(13) 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(14) 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.
10(15) 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(16) 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(17) 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(18) 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(19) 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(20) 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(21) 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.
II-3
Exhibit No. Description of document
----------- -----------------------
10(22) 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(23) 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(24) 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(25) 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.
10(26) 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(27) 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(28) 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(29) 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(30) 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(31) 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(32) 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(33) 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(34) 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.
II-4
Exhibit No. Description of document
----------- -----------------------
10(35) 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(36) 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.
23(1) Consent of Arthur Andersen, LLP.
23(2) Consent of Richard A. Eisner & Company, LLP.
23(3) Consent of Christensen, Miller, Fink, Jacobs, Glaser, Weil &
Shapiro, LLP (see Exhibit 5(1)).*
24(1) Certified resolutions of the Board of Directors of Heuristic
Development Group, Inc., taken at a special meeting of the Board
held September 10, 1999, appointing Gregory L. Zink as attorney in
fact for the filing of the company's Registration Statement on
Form SB-2, as filed with the Commission as Exhibit 24(1) to
Heuristic Development Group's Registration Statement on Form S-4
on September 17, 1999 (File No. 333-87373), is incorporated by
reference.
- --------
* 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.
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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 Ocean Ridge, State of Florida, on October 21, 1999.
HEURISTIC DEVELOPMENT GROUP, INC.
By: /s/ Gregory L. Zink
Name: Gregory L. Zink
Title: President and Acting Chief
Executive Officer
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/ Gregory L. Zink President, Acting Chief October 21, 1999
____________________________________ Executive Officer and
Gregory L. Zink Director
/s/ Jonathan W. Seybold Chairman of the Board and October 21, 1999
____________________________________ Director
Jonathan W. Seybold
/s/ Theodore Lanes Secretary, Chief Financial October 21, 1999
____________________________________ Officer and Director
Theodore Lanes
/s/ Allan Dalfen Director October 21, 1999
____________________________________
Allan Dalfen
/s/ Brian Wasserman Director October 21, 1999
____________________________________
Brian Wasserman
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