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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998
Commission File Number: 0-27862
REALITY INTERACTIVE, INC.
MINNESOTA 41-1781991
State of Incorporation I.R.S. Employer Identification Number
Suite 115
6121 Baker Road
Minnetonka, MN 55345
(612) 253-4700
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $.01 PAR VALUE
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes X No
----- -----
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulations S-B contained herein, and no disclosure will be contained, to
the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.
/X/
The Company's revenues for the Fiscal Year Ended December 31, 1998 totaled
$744,221.
As of February 26, 1999, the Company had 4,677,407 shares of Common Stock
outstanding. The aggregate market value of the 2,826,282 shares of Common
Stock held by non-affiliates of the Company was $310,891, based on the
closing bid price on February 26, 1999 on the Over The Counter Bulletin Board.
Transitional small business disclosure format: Yes No X
----- -----
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Company's Proxy
Statement for the Annual Meeting of Shareholders for the year ended
December 31, 1998 are incorporated by reference in Part III.
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FORM 10-KSB INDEX
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<S> <C>
PART I
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Item 1. Description of Business........................................... 3
Item 2. Description of Property........................................... 9
Item 3. Legal Proceedings................................................. 9
Item 4. Submission of Matters to a Vote of Security Holders............... 9
PART II
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Item 5. Market for Common Equity and Related Stockholder Matters.......... 10
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operation.......................................... 10
Item 7. Financial Statements Index........................................ 12
Item 8. Changes and Disagreements with Accountants on Accounting
and Financial Disclosure.......................................... 12
PART III
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Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act................. 13
Item 10. Executive Compensation............................................ 13
Item 11. Security Ownership of Certain Beneficial Owners and Management.... 13
Item 12. Certain Relationships and Related Transactions.................... 13
Item 13. Exhibits and Reports on Form 8-K.................................. 13
SIGNATURES.................................................................. 16
EXHIBIT INDEX............................................................... 17
FINANCIAL STATEMENTS........................................................ F-1
</TABLE>
SAFE HARBOR STATEMENT UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-KSB contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements involve risks and uncertainties that may cause the
Company's actual results to differ materially from the results discussed in
the forward-looking statements. Factors that might cause such differences
include, but are not limited to, doubt as to the Company's ability to
continue as a going concern, the uncertainty in growth of the Company's
revenues; limited growth of the market for multimedia education and training
products; lack of market acceptance of the Company's products; inability of
the Company to expand its marketing capability; inability of the Company to
diversify its product offerings; failure of the Company to respond to
evolving industry standards and technological changes; inability of the
Company to meet its future additional capital requirements; inability of the
Company to compete in the business education and training industry; loss of
key management personnel; inability to retain subject matter experts; failure
of the Company to secure adequate protection for the Company's intellectual
property rights; and the Company's exposure to product liability claims. The
forward-looking statements are qualified in their entirety by the cautions
and risk factors set forth in Exhibit 99.1, under the caption "Cautionary
Statement," to this Annual Report on Form 10-KSB for the year ended
December 31, 1998.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Reality Interactive, Inc. (the "Company") was incorporated on May
24, 1994 for the purpose of developing technology-based knowledge solutions
for the industrial marketplace. Since inception, the Company has developed
several off-the-shelf multimedia training products within the areas of
international quality and environmental management standards. To better align
with the needs of the marketplace, the Company recently began offering
multimedia and web development services to help customers improve business
performance through technology-assisted knowledge transfer. The Company
consults with its customers to identify initiatives and corporate best
practices that are key to improving productivity, quality, cost reduction and
time to market. The Company then uses its expertise with interactive
technologies, such as the Web and multimedia, to develop solutions that
foster enterprise-wide learning and culture change. The main markets for the
Company's products and services are the United States and Western Europe.
The Company has incurred operating losses in each period since
inception, and has an accumulated deficit of $14,807,494. To continue as a
going concern, the Company must significantly increase revenues and continue
to control expenses. Future operating results will depend upon many factors,
including the rate at which industry adopts interactive multimedia and Web
technology for education, training and knowledge transfer, the level of
product and price competition, the Company's success in maturing its direct
and indirect sales channels and the ability of the Company to manage its
expenses in relation to sales. There is no assurance that the Company will be
profitable in the future or that the previously mentioned increase in
revenues and expense control will materialize.
MARKET BACKGROUND
Historically, organizations have provided training products and
services to their employees primarily through videos, audio tapes, books and
instructor-led seminars. Such training often requires employees to be away
from their jobs for extended periods of time, and in some cases, to travel
off-site for their training. Advances in computer and communications
technology have caused organizations to rethink the way that training
products and services are delivered. Currently, many organizations are
beginning to utilize interactive multimedia training, such as CD-ROM and
distance learning media (e.g., corporate intranets and the Internet), to
overcome many of the cost and time constraints associated with traditional
training methods. The Company believes that organizations increasingly are
using technology-based learning solutions to accomplish the following
training objectives: (i) to allow employees to obtain training "on demand"
without leaving their offices, thus lowering the costs associated with
off-site training; (ii) to control the learning environment, thus ensuring
that training content is consistently delivered; (iii) to improve memory
retention of critical work skills, thus improving employee productivity and
maximizing the return on training investment; and (iv) to improve the
measurement and tracking of employee learning progress. Although
technology-based learning solutions promise to improve organizational and
employee performance, instructor-led training and consultants are currently
the primary means of training delivery in the corporate marketplace. The
Company believes, however, that technology-based delivery of training will be
used to supplement, and in some cases, replace instructor-led training and
consultants.
BUSINESS STRATEGY
The Company's business strategy is to provide its customers with
custom and off-the-shelf technology-based knowledge solutions to improve
organizational and employee performance. The Company seeks to provide its
customers with a broad range of product and service solutions to improve
organizational and employee performance.
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Such solutions will address the following customer needs:
TECHNOLOGY-ASSISTED KNOWLEDGE TRANSFER: The Company works closely with
its customers to perform a thorough needs analysis, and then creates
Web and multimedia solutions that become delivery vehicles for
education, training and knowledge transfer. The Company's approach is
multifaceted, combining instruction, print materials, online
documentation and applications, and web-based collaboration tools to
harness expert knowledge.
IMPLEMENTATION SUPPORT FOR BEST PRACTICES: The Company offers several
packaged solutions in Web and CD-ROM format that capture the knowledge
of subject matter experts in topics such as quality management (ISO
9000, QS-9000) and environmental management (ISO 14000 and Pollution
Prevention). These packages can be tailored to reflect specific
customer needs, programs and practices, and are supported by skilled
implementation consultants from the Company's Professional Services
Partners Program.
PERFORMANCE IMPROVEMENT SOFTWARE TOOLS: The Company's solutions bridge
the gap between learning and doing by including software tools that
model best practices, generate project documents, and assist in process
analysis and enhancement.
KNOWLEDGE MANAGEMENT SOFTWARE TOOLS: The Company offers tools for
creating dynamic knowledge bases that allows information associated
with projects, processes and best practices to be collected and
retained in a set of linked databases, organized to support key
corporate initiatives.
GLOBAL SOLUTIONS IN MULTIPLE LANGUAGES: A core competency of the
Company is its ability to create solutions in multiple languages. The
Company works with industry experts and context checkers within each
country to ensure that the result reflects the cultural assumptions and
business practices of that region. Several of the Company's products
are available in international versions, including German, French and
Spanish.
PRODUCTS
The Company has developed off-the-shelf product solutions for both
intranet and CD-ROM delivery. These products can be tailored at multiple
levels to reflect specific corporate policies and procedures.
WEB-BASED: These products use the corporate intranet as a platform for
learning and culture change around corporate initiatives, with links
from training to online policies, procedures and resources.
CD-ROM: These products combine interactive multimedia instruction with
hundreds of pages of print materials, including sample manuals,
presentation overheads, project leader guides and checklists. CD-ROMs
provide performance support in the form of online software tools for
generating key business documents, including draft budgets, project
plans and documented procedures.
The Company has developed four products within the areas of
international quality and environmental management standards, which are
discussed below in more detail:
QUALITY MANAGEMENT SOLUTIONS
The Company's family of quality management products provide
training, software tools and online documents, all of which have been
designed to follow a business process approach to quality system
implementation. Consulting implementation support can be provided to
customers through the Company's Professional Services Partner Program.
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ISO 9000 IN THE WORKPLACE (WEB)
Uses the corporate intranet as a platform for education and training on
the ISO 9000 international quality management standards and their
impact on an organization. Intended for general employee and management
awareness to facilitate culture change.
ISO 9000 REGISTRATION SERIES (CD-ROM)
A five-part multimedia performance support system that provides expert
knowledge and software tools on the ISO 9000 quality process. It
includes training for management, the project team and internal
auditors, as well as software tools for generating project
documentation.
QS-9000 COMPLIANCE SERIES (CD-ROM)
A four-part multimedia performance support system that guides companies
through each step of these automotive quality requirements. It includes
training for management, the project team and internal auditors, as
well as software tools for generating project documentation.
ENVIRONMENTAL MANAGEMENT SOLUTIONS
Around the globe, organizations are adopting a new approach to
environmental issues--a shift from reactive, end-of-pipe approaches for
controlling environmental impact to more proactive approaches that
incorporate environmental management into the entire business system. The
Company has developed both Web and CD-ROM products that support the
implementation of the ISO 14000 international environmental management system
standards and Pollution Prevention programs. These products can optionally be
supported by expert consultants from the Company's Professional Services
Partner Program.
ISO 14000 IN THE WORKPLACE (WEB)
This product uses the corporate intranet as a platform for education
and training on the ISO 14000 international environmental management
standards and their impact on an organization. Intended for general
employee and management awareness to facilitate culture change.
ISO 14000 EMS CONFORMANCE SERIES (CD-ROM)
A five-part multimedia performance support system that guides companies
through the development, implementation and management of an
environmental management system in accordance with this international
environmental management standard. It includes training for management,
the project team and internal auditors, as well as software tools for
generating project documentation.
POLLUTION PREVENTION (CD-ROM)
A CD-ROM/Internet hybrid product that provides performance support
tools for analyzing pollution reduction options. It also includes
executive-level education on the business rationale for proactive
pollution prevention, with an emphasis on source reduction. Users can
link directly from within the product to a Company-maintained website
that references national and regional pollution prevention resources on
the Internet.
Each individual CD-ROM title generally sells for a price of $795 to
$995, with discounts being offered for increasing levels of purchase
commitments. Each web-based product is generally priced to sell at a fixed
price per company employee, with discounts being offered based on the number
of employees who access the program.
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INTERNATIONAL PRODUCT VERSIONS
Localizing multimedia content for non-U.S. markets is far more
challenging than conventional software localization because of differences in
culture and business practices, which affect images, audio, video and
instructional approach. The Company's localized products are not merely
translations, but completely new products that are reviewed and validated by
industry experts within the target country.
Current localized products:
/ / ISO 14000 IN THE WORKPLACE Web-based training in Spanish, French and German
/ / QS-9000 REGISTRATION SERIES CD-ROMs in German
ENTERPRISE KNOWLEDGE MANAGEMENT PRODUCTS
The Company has developed a new line of products focused
specifically on Enterprise Knowledge Management (EKM-TM-). This evolving
family of products uses the corporate intranet to facilitate the capture,
collection, amplification and dissemination of corporate information and
knowledge. As each new EKM product module is conceptualized and developed, it
will be linked with the other modules to create a common, multifaceted
network of tools to affect knowledge transfer in support of business process
improvement.
Initial EKM products include the following:
EKM:EXPERTLINK-TM-
This product creates an online knowledge base via question/answer
exchange. Employees seeking answers to questions can search and query
the existing Q&A knowledge base. If the answer is not found, a question
can be submitted to one or more qualified experts. Experts edit and
respond to question/answer pairs in a secure area of a corporate
intranet, and can provide links to additional resources on the Web.
Once the answer is added to the knowledge base, an email notification
is pushed to the questioner automatically.
With respect to the development of additional off-the-shelf
multimedia training and knowledge management products, the Company intends to
let market demand determine the direction of its product development
strategy. The Company believes that such product development strategy may
mature in the area of web-based performance improvement tools that can be
adapted to a broad range of corporate needs.
SERVICES
The Company consults with customers on key best practice initiatives
that enable them to gain access to new markets, improve organizational
performance, comply with customer and regulatory mandates or realize a
significant competitive advantage. These initiatives require intensive
process analysis and realignment of procedures. The Company's consulting
staff performs an extensive analysis of the training and knowledge needs for
each initiative, and then develops customized learning and performance
support solutions that deliver the training and knowledge to employees across
the enterprise. These solutions can be delivered via the Web or CD-ROM.
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SALES AND MARKETING
As discussed below, the Company uses several channels of marketing and
distribution.
DIRECT SALES. Direct sales focuses on selling to Fortune 2000
companies. Sales cycles for this channel generally range from six
to twelve months.
INDEPENDENT SALES AGENTS. The Company's independent sales agent program
is primarily comprised of small to medium-sized companies that
specialize in selling multimedia training or technology business
solutions, or have demonstrated competencies in the area of
international management standards.
CHANNEL RESELLERS. Channel resellers warehouse, market and distribute
the Company's products. The Company has an agreement with the American
Society for Quality ("ASQ") to warehouse, market and distribute its ISO
9000 and QS-9000 products. In addition, the Company has established a
relationship with the Automotive Industry Action Group ("AIAG") to
distribute the Company's QS-9000 products.
INTERNATIONAL DISTRIBUTORS. Currently, the Company is primarily
focusing its international sales efforts on the Western European
market. The Company also is represented in Asia Pacific markets.
MARKETING PARTNERS. The Company has developed relationships with
certain organizations to act as promoters of the Company's products.
Currently, the Company has relationships with the American National
Standards Institute ("ANSI") and the Global Environment & Technology
Foundation ("GETF") to market and promote the Company's ISO 14000
product.
PROFESSIONAL SERVICES PARTNER PROGRAM. The Company has developed a
network of independent consultants who are trained in using the
Company's digital tools as part of their solution set for customers.
These consulting partners provide gap analysis, management consulting,
documentation generation, project support and internal auditor
training.
CLIENTS
The Company seeks to establish long-term relationships with
companies desiring technology-based training and knowledge solutions. The
Company has developed sales relationships with numerous companies, primarily
through sales of its off-the-shelf CD-ROM products. The Company will attempt
to further develop these relationships to involve the delivery of custom
development services. Following is a partial list of new or repeat customers
during 1997:
Hasbro General Motors Corporation + Boeing Corporation
Sundstrand Corporation + Synergie Gmbh + * G & K Services
+ Represents customers who, on a combined basis, accounted for 58% of
the Company's revenue during 1998.
* Synergie Gmbh is the Company's German distributor.
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COMPETITION
The market for resources that prepare companies for compliance to
international management standards, such as ISO 9000, QS-9000 and ISO 14000,
is highly fragmented. No single company has a dominant market share, and the
Company generally competes with a variety of competitors, depending on
factors such as the size of the customer, specific business requirements,
geographic location and the level of investment anticipated by the customer.
The international standards market has traditionally been served by
consultants, instructor-led training and companies that market books,
manuals, tapes and similar technology solutions. Companies providing
consulting services, who may also provide training services, on ISO 9000,
QS-9000 and ISO 14000, such as Andersen Consulting, Ernst & Young and Grant
Thornton, enjoy a high level of customer loyalty with respect to the
implementation of enterprise-wide business practices. Companies providing
technology solutions similar to the Company's product offerings include
Powerway, Inc. and SystemCorp. The Company can offer no assurance that it
will be ultimately successful in competing with such companies.
With respect to custom multimedia development services, the
technology training industry is highly competitive, and the Company expects
the intensity of competition to increase. The Company competes with numerous
privately-held companies that provide custom multimedia development services,
many of which have stronger client relationships, a better established market
presence and a greater capacity to provide custom development services than
the Company. The Company can offer no assurance that it will be ultimately
successful in competing with such companies.
INTELLECTUAL PROPERTY RIGHTS
The Company regards its multimedia products as proprietary and
relies primarily on a combination of statutory and common law copyright,
trademark and trade secret laws, customer licensing agreements, employee and
third-party non-disclosure agreements and other methods to protect its
proprietary rights.
The Company's products are licensed to end-users under a perpetual,
non-transferable, non-exclusive license. The Company relies primarily on a
"shrink-wrap" license for protection, which is included inside the product
packaging. Such a license sets forth the terms and conditions under which the
customer may use the product and binds the purchaser upon purchase and use of
the product. The Company does not require its shrink wrap licenses to be
signed by the licensee and therefore may be unenforceable under the laws of
certain jurisdictions.
The Company has made applications for registration of certain
trademarks in the United States and other parts of the world where its
products are actively marketed. Currently, the Company has received
registration for the mark "Reality Interactive (and Logo Design)" in the
United States, Switzerland, Benelux, France and Germany. The Company also has
received registration for the mark "Real Tools for Accelerated Learning" in
the United States. The Company has applied for trademark registration for the
marks "Enterprise Knowledge Management," "EKM" and "EKM:ExpertLink" related
to its product strategy in the area of knowledge management.
RESEARCH AND DEVELOPMENT
The Company's research and development expenditures are primarily
comprised of direct employee costs. The Company also incurs outside product
development costs related to subject matter content expertise, video and
audio production and specialized computer programs.
For 1998, 1997 and 1996, the Company incurred research and
development expenditures of $545,192, $1,351,658 and $2,355,922,
respectively.
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EMPLOYEES
As of February 26, 1999, the Company had 11 full-time employees and
1 independent contractor, including 3 in sales and marketing, 3 in
administration and finance and 6 in research and development. This represents
a 50% decrease in personnel since February 28, 1998. The Company's employees
are not represented by any collective bargaining organization and the Company
has never experienced a work stoppage. The Company believes its employee
relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's executive office is located in Minnetonka, Minnesota,
where it leases approximately 10,000 square feet under a sublease that
expires in July 2003. Under the sublease, the Company is obligated to pay an
annual rent of approximately $145,000.
The Company considers its leased real property adequate for its
current and foreseeable future, and in the opinion of management, is
adequately covered by insurance.
ITEM 3. LEGAL PROCEEDINGS
NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
A. MARKET PRICE OF COMMON STOCK
The Company's common stock trades on the Over The Counter Bulletin
Board (OTC BB) under the symbol RINT. The following table sets forth the high
and low prices of the Company's Common Stock for each calendar quarter for
the past two years.
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YEAR ENDED DECEMBER 31, 1998 YEAR ENDED DECEMBER 31, 1997
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QUARTER HIGH LOW QUARTER HIGH LOW
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First $0.69 $0.28 First $1.50 $0.63
Second $0.78 $0.09 Second $1.25 $0.50
Third $0.28 $0.06 Third $1.14 $0.50
Fourth $0.17 $0.04 Fourth $0.86 $0.25
</TABLE>
As of March 26, 1999, the Company had 96 shareholders of record of
the Company's Common Stock. The Company has never paid cash dividends on its
common stock and does not anticipate paying cash dividends in the foreseeable
future.
B. CHANGES IN SECURITIES (USE OF PROCEEDS FROM PUBLIC OFFERING)
NONE
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION.
The following presentation of management's discussion and analysis
of the Company's financial condition and results of operation should be read
in conjunction with the Company's financial statements and notes contained
herein for the years ended December 31, 1998 and 1997.
RESULTS OF OPERATIONS
REVENUES. Revenues were $744,221 for 1998, compared to revenues of
$1,220,023 for 1997, a 39% decrease. This decrease was due primarily to a
decrease in sales of the Company's CD-ROM products from $906,918 for 1997 to
$384,637 for 1998. This sales decrease was attributed to a decrease in the
Company's emphasis on its CD-ROM products because the market for training on
international management standards never materialized.
Product and service revenues from clients that individually exceeded
10% of the Company's total revenues included three clients at 26%, 20% and
12% for the year ended December 31, 1998. For 1997, the Company generated
revenue of approximately $689,000 from certain affiliates and divisions of
General Motors Corporation. This revenue was the result of sales from the
Company's QS-9000 COMPLIANCE SERIES and custom intranet development services.
No other customers of the Company accounted for more than 10% of its revenue.
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COST OF REVENUES. Cost of revenues were $346,743 for 1998, compared
to $399,144 for 1997. The decrease in cost of revenues was primarily due to
the decrease in product sales, although the Company experienced an increase
in costs related to the completion of service contracts.
OPERATING EXPENSES. The Company's operating expenses for 1998 were
$2,229,350, a 47% decrease over operating expenses of $4,231,268 for 1997.
This decrease in operating expenses between 1998 and 1997 was due primarily
to expense control measures that were implemented in response to lower
revenues, and is further detailed in the following discussion:
(a) SALES AND MARKETING. Sales and marketing expenses were $493,908
for 1998, compared to $1,112,846 for 1997, a 56% decrease. This
decrease between periods was due primarily to lower staffing,
travel and general selling expenses as the Company focused its
resources on sales opportunities in its local market. The Company
also continued its cutbacks in direct product marketing
initiatives, such as tradeshow and literature expenses.
The Company expects that sales and marketing expenses for 1999
will decrease from 1998 levels.
(b) RESEARCH AND DEVELOPMENT. Research and development expenses were
$545,192 for 1998, compared to $1,351,658 for 1997, a 60%
decrease. This decrease is primarily attributable to a decrease in
development staff and a shift towards developing customer-specific
products. Such customer-specific development costs are classified
as cost of revenues when related project revenues are recognized.
For 1999, the Company expects that research and development
expenses will decrease from 1998 levels.
(c) GENERAL AND ADMINISTRATIVE. General and administrative expenses
were $1,190,250 for 1998, compared to $1,766,764 for 1997, a 33%
decrease. This decrease was due primarily to a decrease in office
rent, operating leases and professional fees associated with being
a smaller company.
The Company expects that its general and administrative expenses
for 1999 will decrease over 1998 levels.
OTHER INCOME (EXPENSE). The Company's net other income was $54,444
for 1998, compared to net other income of $175,467 for 1997. For 1998 and
1997, net other income consisted entirely of interest earned on short-term
investments, with the decrease between years being attributed to declining
cash reserves.
NET LOSS. Net loss was $1,777,428 for 1998, compared to a net loss
of $3,234,922 for 1997. The Company expects to continue to experience losses
for the foreseeable future in 1999 as its projected revenues will fall below
its base operating expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents, and short-term investments
were $291,697 as of December 31, 1998, compared to $2,018,539 as of
December 31, 1997. This decrease in cash, cash equivalents and short-term
investments was due primarily to the net loss from operations for the year
ended December 31, 1998.
The Company expects that its current cash balance, along with
collections from its existing accounts receivable and future revenue sources,
will allow the Company to meet its obligations at least through May 31, 1999.
See "Doubt as to the Company's Ability to Continue as a Going Concern".
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DOUBT AS TO THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN
The Company has incurred operating losses in each period since
inception, and anticipates that it will continue to experience operating
losses and negative cash flow from operations for the foreseeable future in
1999. The Company believes that its current cash and accounts receivable
balance, along with expected revenues over the foreseeable future, will not
be sufficient to meet its working capital and capital expenditure
requirements for all of 1999. Therefore, if the Company is to remain in
business through December 1999, or future years, the Company will need to
raise additional funds to finance its operations. In the event the Company
requires additional financing, there can be no assurance that debt or equity
financing will be available to the Company on favorable terms or at all.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Some
computer programs that have date-sensitive software may recognize a date
using "00" as the year 1900 rather than the year 2000. All of the software
produced by the Company has been analyzed and the Company is not aware of any
potential for date recognition problems in its products. The Company also
uses off-the-shelf software ("Administrative Software") produced by third
parties for use in administrative functions such as word processing, billing
and record keeping. The vendors of the Company's Administrative Software
products have indicated that such products are Year 2000 compliant. In the
event that any of these programs are susceptible to date recognition
problems, this could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process critical business transactions. In the event that the
Company experiences Year 2000 problems, the Company believes the cost to
remedy such problems will be immaterial.
ITEM 7. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
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Report of Independent Accountants.......................... F-2
Balance Sheet.............................................. F-3
Statement of Operations.................................... F-4
Statement of Stockholders' Equity.......................... F-5
Statement of Cash Flows.................................... F-6
Notes to Financial Statements.............................. F-7 to F-13
</TABLE>
ITEM 8. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
A report dated January 11, 1999 on Form 8-K was filed regarding a
change in the Company's auditor for the year ending December 31, 1998.
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PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The information under the captions "Election of Directors,"
"Executive Officers" and "Section 16(a) Beneficial Ownership Reporting
Compliance," are contained in the Company's Proxy Statement relating to the
Annual Meeting of Shareholders for the year ended December 31, 1998, and is
incorporated herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
The information contained under the caption "Executive Compensation"
in the Company's Proxy Statement relating to the Annual Meeting of
Shareholders for the year ended December 31, 1998 is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained under the caption "Principal Shareholders"
in the Company's Proxy Statement relating to the Annual Meeting of
Shareholders for the year ended December 31, 1998 is incorporated herein by
reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained under the caption "Certain Relationships
and Related Transactions" in the Company's Proxy Statement relating to the
Annual Meeting of Shareholders for the year ended December 31, 1998 is
incorporated herein by reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index of Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description
- -------- ------------------------------------------------------------------
<S> <C>
3.1(1) Articles of Incorporation of the Company
3.2(1) Amended and Restated Articles of Incorporation of the Company
3.3(1) Bylaws of the Company
3.4(1) Amended Bylaws of the Company
4.1(1) Specimen form of the Company's Common Stock Certificate
4.2(1) Warrant Agreement (including Form of Redeemable Warrant)
4.3(1) Form of Bridge Loan Agreement, dated January 19, 1996,
between the Company and various investors (including form
of Bridge Note and Bridge Warrant)
4.4(1) Canceled Promissory Note in favor of Brightstone Fund VI in the amount of $200,000
4.5(1) Canceled Promissory Note in favor of Wyncrest Capital, Inc. in the amount of $120,000
4.6(1) Warrant in favor of Brightstone Fund VI for 43,109 shares
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
- -------- ------------------------------------------------------------------
<S> <C>
4.7(1) Warrant in favor of Wyncrest Capital, Inc. for 25,188 shares
10.1(1) ISO 9000 Content Agreement between Reality Interactive, Inc. and Process
Management International, dated August 4, 1994
10.2(1) Joint Marketing and Distribution Agreement between Reality Interactive, Inc.
and American Society for Quality Control, Inc., dated May 10, 1995
10.3(1) Agreement for Consulting Services between Reality Interactive, Inc. and
Steven W. McClernon, dated January 15, 1996
10.4(1) Sublease Agreement between Reality Interactive, Inc. and Collopy Saunders
Real Estate, Inc., dated December 15, 1994
10.5(1) Subject Matter Expert Agreement between Reality Interactive, Inc. and The Third
Generation, Inc., dated January 6, 1996
10.6(1) Subject Matter Expert Agreement between Reality Interactive, Inc. and WRITAR,
dated February 1, 1996
10.7(1) Reality Systems, Inc. 1994 Stock Incentive Plan, as amended (including form of
Stock Option Agreement)
10.8(1) Form of Non-Statutory Directors' Option Agreement (issued to certain non-employee
directors or affiliates of non-employee directors in 1994 and 1995)
10.9(1) Reality Interactive, Inc. 1996 Directors Stock Option Plan (including form of
Directors Stock Option Agreement)
10.10(1) Form of Shrink-Wrap License Agreement
10.11(1) Form of Enterprise License Agreement
10.12(1) Form of Volume Discount Agreement
10.13(1) ISO 9000/QS-9000 Addendum, dated March 13, 1996, between the Company and Process
Management Institute, Inc., amending the agreement dated August 4, 1994
10.14(1) Form of Lock-Up Agreement
10.15(1) Independent Software Vendor Agreement between the Company and Hewlett Packard
10.16(1) Master Equipment Lease Agreement, dated June 15, 1995, and Amendment No. 1 to
Master Equipment Lease Agreement, dated July 1995, each between the Company
and Carlton Financial Corporation 10.17(1) Lease Agreement, dated
January 30, 1996, between the Company and Lease Finance Group, Inc.
10.18(1) Irrevocable Letters of Credit, dated June 20, 1995 and August 1, 1995,
from BankWindsor in favor of Carlton Financial Corp. and Irrevocable Letter of Credit,
dated December 27, 1995, in favor of Lease Finance Group, Inc.
10.19(2) First Amendment to Joint Marketing and Distribution Agreement between Reality Interactive,
Inc. and American Society for Quality Control, Inc., dated May 1, 1996
10.20(2) Joint Marketing and Distribution Agreement between Reality Interactive, Inc. and American
Society for Quality Control, Inc., dated May 17, 1996
10.21(3) Equipment Lease between Reality Interactive, Inc. and Dexxon Capital Corporation
Dated June 3, 1996
10.22(4) Copyright License Agreement between Reality Interactive, Inc. and the American National
Standards Institute dated August 30, 1996, including Modifying Agreement
10.23(4) ISO 14000 Marketing and Promotion Agreement between Reality Interactive, Inc. and the
American National Standards Institute dated September 20, 1996
10.24(4) ISO 14000 Marketing and Promotion Agreement between Reality Interactive, Inc. and the
Global Environment and Technology Foundation dated September 6, 1996
10.25(4) Distribution Agreement between Reality Interactive, Inc. and Futuremedia PLC dated
July 12, 1996
10.26(5) Sublease Agreement between Reality Interactive, Inc. and IVI Publishing, Inc., dated
September 17, 1996
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description
- -------- ------------------------------------------------------------------
<S> <C>
10.27(5) Distribution Agreement between Reality Interactive, Inc. and Lasermedia
(Deutschland) GMBH, dated October 9, 1996
10.28(5) Amendment No. 2, dated December 9, 1996, to Master Equipment Lease Agreement,
dated July 1995, each between the Reality Interactive, Inc. and Carlton Financial
Corporation
10.29(5) Irrevocable Letter of Credit, dated December 9, 1996, from
BankWindsor in favor of Carlton Financial Corp.
10.30(6) Master Distribution Agreement between Reality Interactive, Inc. and
Interactive Media Communications, dated February 24, 1997
10.31(6) Multinational Copyright Exploitation Agreement between Reality Interactive, Inc.
and the International Organization for Standardization, dated February 17, 1997
10.32(6) Multinational Copyright Exploitation Agreement between Reality Interactive, Inc.
and the International Organization for Standardization, dated February 17, 1997
23.1 Consent of Price Waterhouse LLP
23.2 Consent of Lund Koehler Cox & Arkema LLP
27.1 Financial Data Schedule for the Year Ended December 31, 1998
99.1 Cautionary Statement
</TABLE>
(1) Incorporated by reference to Amendment No. 2 to the Company's
Registration Statement on Form SB-2 (File No. 333-01508C), as
filed with the Securities and Exchange Commission on April 9,
1996.
(2) Incorporated by reference to the Company's Form 10-QSB for the
quarter ended March 31, 1996.
(3) Incorporated by reference to the Company's Form 10-QSB for the
quarter ended June 30, 1996.
(4) Incorporated by reference to the Company's Form 10-QSB for the
quarter ended September 30, 1996.
(5) Incorporated by reference to the Company's Form 10-KSB for the
year ended December 31, 1996.
(6) Incorporated by reference to the Company's Form 10-QSB for the
quarter ended March 31, 1997.
(b) Reports on Form 8-K
A report dated January 11, 1999 on Form 8-K was filed regarding a
change in the Company's auditor for the year ended December 31, 1998.
15
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
REALITY INTERACTIVE, INC.
Dated: March 31, 1999 By /S/ Wesley W. Winnekins
---------------------------
Wesley W. Winnekins
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/S/ Paul J. Wendorff Chairman, Chief Executive Officer,
- ------------------------ President and Director
Paul J. Wendorff (Principal Executive Officer) March 31, 1999
/S/ Wesley W. Winnekins Chief Financial Officer and
- ------------------------ Secretary (Principal Financial
Wesley W. Winnekins and Accounting Officer) March 31, 1999
16
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description Page No.
- ------- -------------------------------------------------------------------- --------
<S> <C> <C>
23.1 Consent of PricewaterhouseCoopers LLP............................... 18
23.2 Consent of Lund Koehler Cox & Arkema LLP............................ 19
27.1 Financial Data Schedule for the Year Ended December 31, 1998........
99.1 Cautionary Statement................................................ 20
</TABLE>
17
<PAGE>
EXHIBIT 23.1
CONSENT OF PRICEWATERHOUSECOOPERS LLP
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-05027) of Reality Interactive, Inc. of our
report dated February 16, 1998 appearing in this Form 10-KSB.
/S/ PricewaterhouseCoopers LLP
- -------------------------------
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
March 31, 1999
18
<PAGE>
EXHIBIT 23.2
CONSENT OF LUND KOEHLER COX & ARKEMA LLP
CONSENT OF INDEPENDENT ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in the Registration Statement on Form S-8 (No. 333-05027) of
Reality Interactive, Inc. of our report dated February 24, 1999 appearing in
this Form 10-KSB.
/S/ Lund Koehler Cox and Arkema LLP
- ------------------------------------
Lund Koehler Cox and Arkema LLP
Minneapolis, Minnesota
March 31, 1999
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 291,697
<SECURITIES> 0
<RECEIVABLES> 231,525
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 563,521
<PP&E> 453,003
<DEPRECIATION> 389,170
<TOTAL-ASSETS> 747,710
<CURRENT-LIABILITIES> 121,738
<BONDS> 0
0
0
<COMMON> 46,774
<OTHER-SE> 579,198
<TOTAL-LIABILITY-AND-EQUITY> 747,710
<SALES> 744,221
<TOTAL-REVENUES> 798,665
<CGS> 346,743
<TOTAL-COSTS> 346,743
<OTHER-EXPENSES> 2,229,350
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,777,428)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,777,428)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,777,428)
<EPS-PRIMARY> (0.38)
<EPS-DILUTED> (0.38)
</TABLE>
<PAGE>
EXHIBIT 99.1
CAUTIONARY STATEMENT
Reality Interactive, Inc. (the "Company"), or persons acting on
behalf of the Company, or outside reviewers retained by the Company making
statements on behalf of the Company, or underwriters, from time to time make,
in writing or orally, "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. When used in conjunction with an
identified forward-looking statement, this Cautionary Statement is for the
purpose of qualifying for the "safe harbor" provisions of such sections and
is intended to be a readily available written document that contains factors
which could cause results to differ materially from such forward-looking
statements. These factors are in addition to any other cautionary statements,
written or oral, which may be made or referred to in connection with any such
forward-looking statement.
The following matters, among others, may have a material adverse
effect on the business, financial condition, liquidity, results of operations
or prospects, financial or otherwise, of the Company. Reference to this
Cautionary Statement in the context of a forward-looking statement or
statements shall be deemed to be a statement that any or more of the
following factors may cause actual results to differ materially from those in
such forward-looking statement or statements:
DOUBT AS TO THE COMPANY'S ABILITY TO CONTINUE AS A GOING CONCERN.
The Company has incurred operating losses in each period since inception, and
anticipates that it will continue to experience operating losses and negative
cash flow from operations for the foreseeable future in 1999. The Company
believes that its current cash and accounts receivable balance, along with
expected revenues over the foreseeable future, will not be sufficient to meet
its working capital and capital expenditure requirements for all of 1999.
Therefore, if the Company is to remain in business through December 1999, the
Company will need to raise additional funds to finance its operations. In the
event the Company requires additional financing, there can be no assurance
that debt or equity financing will be available to the Company on favorable
terms or at all.
FUTURE ADDITIONAL CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL
WILL BE AVAILABLE. If the Company is unable to generate substantial revenues
from its operations or if the Company's expenses exceed expectations, the
Company will likely require additional funds to meet its capital
requirements. The Company does not currently have available bank financing.
The Company may be required to raise additional funds through public or
private financings, including equity financings, or through collaborative
arrangements. There can be no assurance that additional financing would be
available on favorable terms, or at all. If funding is not available when
needed or on acceptable terms, the Company may be forced to curtail its
operations significantly or cease operations and abandon its business
entirely.
DEVELOPING MARKET; MARKET ACCEPTANCE. The market for educating and
training businesses has historically been served by consultants,
instructor-led training and training publications such as books, manuals and
tapes. Currently, there is little use of multimedia and web-based education
and training products and services by businesses, and many of the Company's
potential customers do not own or have access to the necessary equipment. The
Company's future success will depend upon, among other factors, the extent to
which companies acquire equipment compatible with the Company's products and
services, and adopt and use multimedia and web-based education and training
programs. In addition, the Company's success will depend in part on its
ability to market and sell multiple copies of its products, as well as sell
its custom development services, to large corporate customers. In the event
that adoption and use of equipment compatible with the Company's products and
services do not become widespread,
20
<PAGE>
the number of potential customers of the Company will be limited. There can
be no assurance that the Company's products, the prices the Company charges
for its products or its development services will be acceptable to the market
or that the Company will be able to sell multiple copies of its products to
large corporate customers.
LIMITED MARKETING CAPABILITY. The Company currently has a small
sales and marketing staff and limited number of strategic alliances relating
to distribution of its products. There can be no assurance that the Company
will be able to build a suitable sales force or enter into satisfactory
marketing alliances with third parties, or that its sales and marketing
efforts will be successful.
DEPENDENCE ON DIVERSIFICATION OF PRODUCT OFFERINGS. The Company
currently has a limited number of product offerings, and purchasers of the
Company's products are not required to purchase additional products.
Accordingly, the Company's products represent non-recurring revenue sources,
and the success of the Company is dependent, in part, on its ability to
develop sustained demand for its current products and to develop and sell
additional products. There can be no assurance that the Company will be
successful in developing and maintaining such demand or in developing and
selling additional products.
DEPENDENCE ON EVOLVING INDUSTRY STANDARDS. The Company's initial
product offerings prepare businesses for adherence to worldwide management
standards. The failure of the Company to enhance its products in a timely
manner to changes in the standards, the lack of public acceptance of such
standards or the delay in introduction of or enhancement to such standards
would materially adversely affect the Company's operations.
TECHNOLOGICAL CHANGE. The industry in which the Company competes is
characterized by rapid technological change. The introduction of products
embodying new technology can render existing products and product formats
obsolete and unmarketable. The Company's success will depend on its ability
to anticipate changes in technology and to develop and introduce new and
enhanced products in a timely manner in response to technological changes, or
if products or product enhancements by the Company do not achieve market
acceptance, the Company's business would be materially adversely affected.
COMPETITION. The business education and training industry is highly
competitive. A large number of companies are currently developing multimedia
and web-based training, educational and instructional aids. Competitors also
include national, regional and local accounting firms engaged in industrial
consulting and instructor-led training and companies which market training
tools such as books, videos and audio tapes. Some of the Company's existing
competitors, as well as a number of potential competitors, have larger
technical staffs, more established marketing and sales organizations, and
greater financial resources than the Company. There can be no assurance the
Company will be able to compete successfully with such companies, or at all.
FLUCTUATIONS IN OPERATING RESULTS. The Company's future operating
results may vary substantially from quarter to quarter. At its current stage
of operations, the Company's quarterly revenues and results of operations may
be materially affected by the timing of the development and market acceptance
of the Company's products. Generally, operating expenses will be higher
during periods in which product development costs are incurred and marketing
efforts are commenced. Due to these and other factors, including the general
economy, stock market conditions and announcements by the Company or its
competitors, the market price of the securities offered hereby may be highly
volatile.
DEPENDENCE ON KEY PERSONNEL; LACK OF EMPLOYMENT AND NONCOMPETITION
AGREEMENTS. The success of the Company is dependent in large part upon the
ability of the Company to attract and
21
<PAGE>
retain key management and operating personnel. Qualified individuals are in
high demand and are often subject to competing offers. In the future, the
Company will need to hire additional skilled personnel in the areas of
research and development, and sales and marketing. There can be no assurance
that the Company will be able to attract and retain the qualified personnel
needed for its business. The Company has no employment or noncompetition
agreements with any of its management or other personnel.
DEPENDENCE ON ABILITY TO RETAIN SUBJECT MATTER EXPERTS. The
Company's product development strategy requires the Company to retain
third-party subject matter experts to perform research and development
functions by providing accurate and informative content for the Company's
products. There can be no assurance that the Company will be able to continue
to attract and retain qualified subject matter experts required to develop
new products and enhance existing products. The inability of the Company to
attract and retain such experts could have a material adverse effect on the
Company and its prospects.
INTELLECTUAL PROPERTY. The Company regards its multimedia products
as proprietary and relies primarily on a combination of statutory and common
law copyright, trademark and trade secret laws, customer licensing
agreements, employee and third-party nondisclosure agreements and other
methods to protect its proprietary rights. Despite these precautions, it may
be possible for a third party to copy or otherwise obtain or use the
Company's products or technology without authorization, or to develop similar
products or technology independently. If unauthorized use or copying of the
Company's product were to occur to any substantial degree, the Company's
business and results of operations could be materially adversely affected.
There can be no assurance that the Company's means of protecting its
proprietary rights will be adequate or that the Company's competitors will
not independently develop similar products.
The Company believes that developers of multimedia and web-based
products may increasingly be subject to such claims as the number of products
and competitors in the industry grows and the functionality of such products
in the industry overlaps. Any such claim, with or without merit, could result
in costly litigation and could have a material adverse effect on the Company.
LACK OF PRODUCT LIABILITY INSURANCE. The Company may face a risk of
exposure to product liability claims in the event that use of its products is
alleged to have resulted in damage to its customers. The Company does not
currently carry product liability insurance. There can be no assurance that
such insurance will be available on commercially reasonable terms, or at all,
or that such insurance, even if obtained, would adequately cover any product
liability claim. A product liability or other claim with respect to uninsured
liabilities or in excess of insured liabilities could have a material adverse
effect on the business and prospects of the Company.
22
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................. F-2
Balance Sheet............................................. F-3
Statement of Operations................................... F-4
Statement of Stockholders' Equity......................... F-5
Statement of Cash Flows................................... F-6
Notes to Financial Statements............................. F-7 to F-13
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Reality Interactive, Inc.:
We have audited the accompanying balance sheet of Reality Interactive, Inc.
as of December 31, 1998, and the related statements of operations,
stockholders' equity and cash flows for the year 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 audit. The financial statements of Reality Interactive, Inc. as of
December 31, 1997 were audited by other auditors whose report dated
February 16, 1998 expressed an unqualified opinion on those statements.
We conducted our audit 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 audit provides 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 Reality Interactive, Inc. as
of December 31, 1998, and the results of its operations and its cash flows
for the year then ended, in conformity with generally accepted accounting
principles.
The accompanying financial statements have been prepared assuming that
Reality Interactive, Inc. will continue as a going concern. As discussed in
Note 1 to the financial statements, Reality Interactive, Inc. has suffered
recurring losses from operations and has a significant accumulated deficit
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 1. The 1998 financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
Minneapolis, Minnesota
February 24, 1999
/S/ LUND KOEHLER COX & ARKEMA LLP
F-2
<PAGE>
REALITY INTERACTIVE, INC.
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1998
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 487,994 $ 291,697
Short-term investments 1,530,545 0
Accounts receivable 410,916 231,525
Inventory 71,197 0
Prepaid expenses and other current assets 52,357 40,299
------------ ------------
Total current assets 2,553,009 563,521
------------ ------------
Fixed assets, net 121,971 63,833
Restricted cash 58,500 111,000
Other assets 19,850 9,356
------------ ------------
Total assets $ 2,753,330 $ 747,710
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 36,117 $ 38,733
Accrued liabilities 130,213 31,938
Deferred revenue 181,906 49,495
Other current liabilities 1,694 1,572
------------ ------------
Total current liabilities 349,930 121,738
------------ ------------
Commitments (Note 5)
Stockholders' equity:
Common stock, $.01 par value, 25,000,000 shares
authorized 4,677,407 shares issued and outstanding
at both dates 46,774 46,774
Additional paid-in capital 15,386,692 15,386,692
Accumulated deficit (13,030,066) (14,807,494)
------------ ------------
Total stockholders' equity 2,403,400 625,972
------------ ------------
Total liabilities and stockholders' equity $ 2,753,330 $ 747,710
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to the financial statements.
F-3
<PAGE>
REALITY INTERACTIVE, INC.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997 1998
---- ----
<S> <C> <C>
Product revenues $ 906,918 $ 384,637
Service revenues 313,105 359,584
----------- -----------
Total revenues 1,220,023 744,221
----------- -----------
Cost of product revenues 203,951 81,682
Cost of service revenues 195,193 265,061
----------- -----------
Total cost of revenues 399,144 346,743
----------- -----------
Gross profit 820,879 397,478
----------- -----------
Operating expenses:
Sales and marketing 1,112,846 493,908
Research and development 1,351,658 545,192
General and administrative 1,766,764 1,190,250
----------- -----------
Total operating expenses 4,231,268 2,229,350
----------- -----------
Operating loss (3,410,389) (1,831,872)
----------- -----------
Other income (expense):
Interest income 175,467 54,444
----------- -----------
Net loss $(3,234,922) $(1,777,428)
----------- -----------
----------- -----------
Basic and Diluted Loss Per Share: $ (0.69) $ (0.38)
----------- -----------
----------- -----------
Weighted average common shares outstanding 4,677,407 4,677,407
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to the financial statements.
F-4
<PAGE>
REALITY INTERACTIVE, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NUMBER ADDITIONAL TOTAL
OF SHARES COMMON PAID-IN ACCUMULATED STOCKHOLDERS'
ISSUED STOCK CAPITAL DEFICIT EQUITY
--------- -------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1996 4,677,407 46,774 15,386,692 (9,795,144) 5,638,322
Net loss - - - (3,234,922) (3,234,922)
--------- -------- ------------ ------------- ------------
Balance at December 31, 1997 4,677,407 $ 46,774 $ 15,386,692 $ (13,030,066) $ 2,403,400
Net loss - - - (1,777,428) (1,777,428)
--------- ------- ------------ ------------- ------------
Balance at December 31, 1998 4,677,407 $ 46,774 $ 15,386,692 $ (14,807,494) $ 625,972
--------- ------- ------------ ------------- ------------
--------- ------- ------------ ------------- ------------
</TABLE>
See accompanying notes to the financial statements.
F-5
<PAGE>
REALITY INTERACTIVE, INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net loss $(3,234,922) $(1,777,428)
Reconciliation of net loss to net cash used by
operating activities:
Depreciation and amortization 96,308 63,115
Changes in assets and liabilities:
Accounts receivable (313,520) 179,391
Inventory 63,656 71,197
Prepaid expenses and other assets 19,109 22,552
Accounts payable (80,272) 2,618
Accrued liabilities 11,527 (98,275)
Deferred revenue 179,209 (132,411)
Other current liabilities (7,954) (122)
----------- -----------
Net cash used by operating activities (3,266,859) (1,669,363)
----------- -----------
Cash flows from investing activities:
Purchases of fixed assets (26,343) (4,977)
Purchases of short-term investments (180,832) (32,979)
Sales of short-term investments 3,395,000 1,563,522
Cash restricted for operating leases 58,300 (52,500)
----------- -----------
Net cash used by investing activities 3,246,125 1,473,066
----------- -----------
Net cash provided (used) during period (20,734) (196,297)
Cash and cash equivalents:
Beginning of period 508,728 487,994
----------- -----------
End of period $ 487,994 $ 291,697
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to the financial statements.
F-6
<PAGE>
REALITY INTERACTIVE, INC.
NOTES TO THE FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. ORGANIZATION AND STATUS
Reality Interactive, Inc. (the Company) was incorporated on May 24, 1994
for the purpose of developing technology-based knowledge solutions for
the corporate marketplace. Since inception, the Company has developed
several off-the-shelf multimedia training products within the areas of
international quality and environmental management standards. To better
align with the needs of the marketplace, the Company recently began
offering multimedia and web development services to help customers
improve business performance through technology-assisted knowledge
transfer. The Company consults with its customers to identify initiatives
and corporate best practices that are key to improving productivity,
quality, cost reduction and time to market. The Company then uses its
expertise with interactive technologies, such as the Web and multimedia,
to develop solutions that foster enterprise-wide learning and culture
change. The main markets for the Company's products and services are the
United States and Western Europe.
The accompanying financial statements have been prepared on the basis
that the Company will continue as a going concern, which contemplates the
realization of assets and satisfaction of liabilities in the normal
course of business. The Company has incurred operating losses in each
period since inception, and has an accumulated deficit of $14,807,494.
The Company expects that its current cash balance, along with collections
from its existing accounts receivable and future revenue sources, will
allow the Company to meet its obligations at least through May 31, 1999.
To continue as a going concern, the Company must significantly increase
revenues and continue to control expenses. Future operating results will
depend upon many factors, including the rate at which industry adopts
interactive multimedia and Web technology for education, training and
knowledge transfer, the level of product and price competition, the
Company's success in maturing its sales capabilities and the ability of
the Company to manage its expenses in relation to sales. There is no
assurance that the Company will be profitable in the future or the
previously mentioned revenue increase and expense control will
materialize.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include highly liquid investments with original
maturities of less than 90 days and are generally invested in money
market funds and certificates of deposit. The Company maintains its cash
in bank deposit accounts at various financial institutions with high
credit quality. The balances, at times, may exceed federally insured
limits.
F-7
<PAGE>
SHORT-TERM INVESTMENTS
Short-term investments consisted of commercial paper held for periods
generally less than 90 days. These investments are considered available
for sale and are carried at fair value. The estimated fair value of the
investments approximates the amortized cost, and therefore, there are no
unrealized gains or losses.
REVENUE RECOGNITION
Revenue derived from product sales and licenses is recognized upon
shipment of the products. The Company has no significant obligations
after shipment. Revenue derived from multimedia and Web-based development
services is recognized on the percentage of completion method over the
life of each project, which may range from three to nine months. Project
costs include all direct labor costs and other direct costs related to
service performance, such as contract labor, supplies and equipment
costs. The Company's use of the percentage of completion method of
revenue recognition requires estimates of the degree of project
completion. To the extent these estimates prove to be inaccurate, the
revenues and gross profits, if any, reported during the periods where the
project is ongoing may not accurately reflect the final results of the
project. Provisions for any estimated losses on uncompleted contracts are
made in the period in which such losses are determinable. Revenue is
reported net of reimbursable expenses.
ACCOUNTS RECEIVABLE
The Company considers all accounts receivable to be fully collectible.
Accordingly, no allowance for uncollectible accounts has been
established. If accounts become uncollectible, they are charged to
operations when that determination has been made. The Company extends
unsecured credit to customers in the normal course of business.
INVENTORY
Inventory consisted primarily of software media, manuals and related
packaging materials. Inventory is carried at the lower of cost or market
using the first-in, first-out valuation method.
FIXED ASSETS
Fixed assets are stated at cost. Accelerated depreciation methods are
used for both book and tax purposes over the estimated useful life of the
equipment ranging from three to seven years. Leasehold improvements were
amortized over the lease term using the straight-line method.
INCOME TAXES
Income taxes are accounted for using the liability method under the
provisions of Statement of Financial Accounting Standards (SFAS)
No. 109, "Accounting for Income Taxes."
NET LOSS PER SHARE
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings Per Share" (SFAS No. 128). SFAS No. 128
applies to entities with publicly held common stock and is effective for
financial statements for both interim and annual periods ending after
December 15, 1997. After the effective date, all prior-period earnings
(loss) per share data presented were restated to conform to the
provisions of this statement. Under SFAS No. 128, the presentation of
primary earnings (loss) per share is replaced with a presentation of
basic earnings (loss) per share. SFAS No. 128 requires dual presentation
of basic and diluted earnings (loss) per share for entities with complex
capital structures. Basic earnings (loss) per share includes no dilution
and is computed by dividing net earnings (loss) available to common
stockholders by the weighted average number of common shares outstanding
for the period. Diluted earnings (loss) per share reflects the potential
dilution of securities that could share in the earnings of an entity and
is
F-8
<PAGE>
similar to the former fully diluted earnings (loss) per share
calculation. The Company has adopted SFAS No. 128 and all net earnings
(loss) per share data presented complies with this statement. For the
years ended December 31, 1998, and for all prior periods presented, basic
and diluted loss per share for the Company is the same because the
inclusion of stock options and warrants as common stock equivalents would
be antidilutive.
PRODUCT DEVELOPMENT AND RESEARCH
Expenditures for software development costs and research are expensed as
incurred. Such costs are required to be expensed until the point that
technological feasibility and proven marketability of the product is
established. Costs otherwise capitalizable after technological
feasibility is achieved are also generally expensed because they are
insignificant.
DEFINED CONTRIBUTION PLAN
The Company has established a qualified 401(k) profit sharing plan which
allows eligible employees to defer a portion of their salary. The Plan
does not require any discretionary Company contributions.
3. FIXED ASSETS
Fixed assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1998
---- ----
<S> <C> <C>
Computer equipment $ 318,821 $ 332,938
Office equipment and furniture 120,065 120,065
Leasehold improvements 9,140 0
--------- ---------
448,026 453,003
Less accumulated depreciation and amortization (326,055) (389,170)
--------- ---------
$ 121,971 $ 63,833
--------- ---------
--------- ---------
</TABLE>
4. INCOME TAXES
Significant components of the Company's deferred tax assets are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1998
---- ----
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 5,268,000 $ 5,978,000
Other 50,000 50,000
----------- -----------
Total deferred tax assets 5,318,000 6,028,000
Less valuation allowance (5,318,000) (6,028,000)
----------- -----------
Net deferred tax assets $ - $ -
----------- -----------
----------- -----------
</TABLE>
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $14,605,000 for income tax purposes. The net operating loss
carryforwards expire in 2009 through 2013 if not previously utilized.
F-9
<PAGE>
The Company has determined, based on the weight of available evidence at
December 31, 1998, that it is more likely than not the Company's deferred
tax assets will not be realized. Accordingly, a valuation allowance has
been established for the tax benefits of these items. Future utilization
of the available net operating loss carryforwards may be limited under
Internal Revenue Code Section 382 due to future significant changes in
ownership.
5. COMMITMENTS
LEASES
The Company leases office space, equipment and furniture under various
operating lease agreements, the last of which expires in 2003.
At December 31, 1998, future minimum lease payments under noncancelable
operating leases were as follows:
<TABLE>
<CAPTION>
OPERATING
YEAR ENDING DECEMBER 31, LEASES
------------------------ ---------
<S> <C>
1999 $ 182,859
2000 145,411
2001 144,756
2002 144,756
2003 84,441
---------
Total future minimum lease payments $ 702,223
---------
---------
</TABLE>
Rent expense was approximately $341,164 and $440,070 for the years ended
December 31, 1997 and 1998, respectively.
The Company has entered into agreements with third party content
providers and marketing partners that require royalty payments to be made
based upon the sales of the Company's products. The amount expensed under
these agreements for 1997 and 1998 totaled approximately $153,396 and
$48,402, respectively.
LETTERS OF CREDIT
The Company has outstanding a letter of credit from a bank as security
for an operating lease of office space. The Company is required to
maintain the cash as collateral at the bank which issued the letter of
credit. This amount is reflected as restricted cash at December 31, 1998.
6. STOCKHOLDERS' EQUITY
COMMON STOCK ISSUED
The holders of Common Stock are entitled to one vote for each share on
all matters submitted to a vote of stockholders. Holders of Common Stock
have no preemptive, subscription or conversion rights and there are no
redemption or sinking fund provisions applicable thereto. The outstanding
shares of Common Stock are fully paid and nonassessable.
F-10
<PAGE>
WARRANTS
A summary of the Company's warrant activity is as follows:
<TABLE>
<CAPTION>
EXERCISE
NUMBER PRICE EXPIRATION
------ -------- ----------
<S> <C> <C> <C>
Outstanding at December 31, 1996 3,365,922 $2.40-$8.00 1998-2001
1997 - No activity -
---------
Outstanding at December 31, 1997 3,365,922 $2.40-$8.00 1998-2001
Expired (7,625) $3.00 12/31/98
---------
Outstanding at December 31, 1998 3,358,297 $2.40-$8.00 1999-2001
---------
---------
</TABLE>
Such warrants were issued in connection with various financing
transactions by the Company. The holders of these warrants are not
entitled to vote, receive dividends or exercise any other rights until
such warrants have been duly exercised and payment of the purchase price
has been made.
STOCK OPTIONS
At December 31, 1998, the Company had 700,000 shares of common stock
reserved under its 1994 Stock Incentive Plan. The plan provides for
grants of incentive and nonqualified stock options to officers, employees
and independent contractors. Furthermore, the Company may grant
nonqualified options outside of this plan. These stock options generally
vest evenly over a three to four year period and are exercisable over
periods up to five years from date of grant. In addition, the Company had
400,000 shares of common stock reserved under its 1996 Directors' Stock
Option Plan. This plan provides for annual grants of options to purchase
10,000 shares of Common Stock per director per year and vests six months
from the date of grant.
The Board of Directors establishes all terms and conditions of each
grant. Stock options are granted at or above fair market value as
determined by the Board of Directors at each grant date.
Option transactions under these plans are summarized as follows:
<TABLE>
<CAPTION>
EXERCISE WEIGHTED AVERAGE
OPTIONS PRICE EXERCISE PRICE
STOCK INCENTIVE PLAN OUTSTANDING PER SHARE PER SHARE
-------------------- ----------- --------- ----------------
<S> <C> <C> <C>
Options outstanding at December 31, 1996 498,050 $1.00 - $5.25 $2.87
Granted 585,600 $0.45 - $1.00 $0.82
Canceled (600,550) $0.81 - $5.25 $2.45
--------
Options outstanding at December 31, 1997 483,100 $0.45 - $4.44 $0.90
Granted 180,000 $0.75 $0.75
Canceled (75,600) $0.50 - $4.44 $0.81
--------
Options outstanding at December 31, 1998 587,500 $0.45 - $1.80 $0.87
--------
--------
Exercisable at December 31, 1998 102,625 $0.45 - $1.80 $1.08
--------
--------
</TABLE>
F-11
<PAGE>
<TABLE>
<CAPTION>
EXERCISE WEIGHTED AVERAGE
OPTIONS PRICE EXERCISE PRICE
DIRECTOR'S STOCK OPTION PLAN OUTSTANDING PER SHARE PER SHARE
---------------------------- ----------- --------- ----------------
<S> <C> <C> <C>
Options outstanding at December 31, 1996 - - -
Granted 20,000 $1.13 $1.13
--------
Options outstanding at December 31, 1997 20,000 $1.13 $1.13
Granted 10,000 $0.25 $0.25
Canceled (30,000) $0.25 - $1.13 $0.83
--------
Options outstanding at December 31, 1998 0
--------
--------
</TABLE>
The following tables summarize stock options outstanding and exercisable
at December 31, 1998:
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
----------------------------------------------- ---------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
EXERCISE CONTRACTUAL LIFE AVERAGE AVERAGE
PRICE RANGE OPTIONS REMAINING EXERCISE PRICE OPTIONS EXERCISE PRICE
----------- ------- ---------------- -------------- ------ --------------
<S> <C> <C> <C> <C> <C>
$0.45 - $0.89 446,500 3.70 $ 0.73 44,875 $ 0.64
$1.00 111,000 3.69 1.00 27,750 1.00
$1.80 30,000 0.78 1.80 30,000 1.80
------- ---- -------- ------- ------
587,500 3.61 $ 0.87 102,625 $ 1.08
------- ---- -------- ------- ------
------- ---- -------- ------- ------
</TABLE>
The estimated weighted average grant-date fair value of stock options
granted during 1998 was $0.75 per option and $0.32 per option in 1997.
The Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation." As allowed by SFAS No. 123, the Company applies APB
Opinion No. 25 and related interpretations in accounting for its stock
option plans and, accordingly, does not recognize compensation expense
related thereto. If the Company had elected to recognize compensation
expense based on the fair value of the options granted at grant date as
prescribed by SFAS No. 123, net loss and net loss per share would have
been increased to the pro forma amounts indicated in the following table:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Net loss - as reported $ (3,234,922) $ (1,777,428)
Net loss - pro forma $ (3,323,557) $ (1,821,136)
Basic and Diluted net loss per share - as reported $ (0.69) $ (0.38)
Basic and Diluted net loss per share - pro forma $ (0.71) $ (0.39)
</TABLE>
F-12
<PAGE>
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
assumptions:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Expected dividend level 0% 0%
Expected stock price volatility 50% 50%
Risk-free interest rate 6% 5.4%
Expected life of options 4 years 4 years
</TABLE>
7. SIGNIFICANT CUSTOMERS
Product and service revenues from clients that individually exceeded 10%
of the Company's total revenues included three clients at 26%, 20% and
12% for the year ended December 31, 1998, and one client at 56% for the
year ended December 31, 1997. Accounts receivable from two of these
customers represented approximately 26% and 23% of total accounts
receivable at December 31, 1998.
F-13
