<PAGE>
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
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(X) Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended March 31, 2000
( ) Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the transition period from _______ to _______
Commission file number 001-12637
VIRTUAL COMMUNITIES, INC.
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(Exact name of small business issuer in its charter)
DELAWARE 11-3383125
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
589 EIGHTH AVENUE 7th FLOOR, NEW YORK, NEW YORK 10018
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(Address of Principal Executive Offices) (Zip Code)
(212) 931-8600
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(Issuer's Telephone Number, Including Area Code)
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(Former name or former address, if changed since last report)
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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 shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES X NO
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State the number of shares outstanding of each of the issuer's common equity
as of May 4, 2000: 16,500,244 shares of Common Stock, $.01 par value.
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INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Balance Sheets - March 31, 2000......................
Condensed Statements of Operations - Three Months ended March 31,
2000 and 1999..................................................
Condensed Statements of Cash Flows - Three Months ended March 31,
2000 and 1999..................................................
Notes to Financial Statements..................................
Item 2. Management's Discussion and Analysis
Of Financial Condition and Results of Operations...............
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports ..........................................
SIGNATURES................................................................
Part 1. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
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VIRTUAL COMMUNITIES, INC.
AND SUBSIDIARIES
CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
as of March 31, 2000
--------------------
(In U.S. dollars)
(Unaudited)
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VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
CONDENSED INTERIM CONSOLIDATED BALANCE SHEET
(U.S. Dollars in thousands except per share data)
March 31
2000
-----------
(Unaudited)
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ASSETS
Current Assets
Cash and cash equivalents $ 156
Trade receivables, net of allowance for doubtful
debts of $15 344
Other receivables 184
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Total current assets 684
Property and Equipment, net of accumulated depreciation and
amortization 1,682
Severance Pay Deposits 112
Other Assets 1,109
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Total Assets $ 3,587
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LIABILITIES AND SHAREHOLDERS' DEFICIENCY
Current Liabilities
Short-term bank borrowings and current maturities of
long-term loan $ 641
Shareholders' loans 175
Accounts payables and accrued expenses 2,520
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Total current liabilities 3,336
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Long-Term Liabilities
Long-term loan 253
Accrued severance pay 405
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Total long-term liabilities 658
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Total liabilities 3,994
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Minority Interest 154
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Shareholders' Deficiency
Preferred stock of $0.01 par value
Authorized - 5,000,000 shares; none issued and outstanding -
Common stock of $0.01 par value
Authorized - 45,000,000 shares; issued and outstanding -
15,859,947 shares 158
Additional paid-in capital 10,957
Accumulated deficit (11,526)
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(411)
Treasury stock 149,900 shares at cost (150)
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Total shareholders' deficiency (561)
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Total liabilities and shareholders' deficiency $ 3,587
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The accompanying notes form an integral part of the financial statements.
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VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
CONDENSED INTERIM CONSOLIDATED
STATEMENTS OF OPERATIONS
(U.S. Dollars in thousands except per share data)
For the three months
ended March 31
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2000 1999
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(Unaudited)
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REVENUES $ 453 $ 172
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OPERATING COST AND EXPENSES
Cost of revenues 909 237
Research and development 220 -
Selling and marketing expenses 911 202
General and administrative expenses 1,118 359
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Total operating costs and expenses 3,158 798
Operating loss (2,705) (626)
Financing expenses, net (21) (46)
Minority interest in loss of subsidiary 56 -
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Net loss $ (2,670) $ (672)
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NET LOSS PER SHARE, BASIC AND DILUTED $(0.18) $(0.09)
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WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING,
BASIC AND DILUTED 15,177,587 7,320,605
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The accompanying notes form an integral part of the financial statements.
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VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
CONDENSED INTERIM CONSOLIDATED STATEMENT OF CHANGES
IN SHAREHOLDERS' DEFICIENCY
(U.S. Dollars in thousands except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Common stock Additional Accumulated Treasury Total
Shares Amount paid-in deficit stock
capital
------ ------ ------- ------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Balance as of
January 1, 2000 14,630,224 $ 146 $ 8,336 $ (8,856) $ (150) $ (524)
Common stock issued 981,864 9 2,470 - - 2,479
Common stock issued
upon exercise of
warrants and options 247,859 3 151 - - 154
Net loss - - - (2,670) - (2,670)
---------- ----- ------- -------- ------- -------
15,859,947 $ 158 $10,957 $(11,526) $ (150) $ (561)
========== ===== ======= ======== ======= =======
</TABLE>
The accompanying notes form an integral part of the financial statements.
<PAGE>
VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
CONDENSED INTERIM CONSOLIDATED
STATEMENTS OF CASH FLOWS
(U.S. Dollars in thousands except per share data)
For the three months
ended March 31
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2000 1999
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(Unaudited)
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CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(2,670) $ (672)
Adjustments to reconcile net loss to net cash used in
operating activities (see below) 735 (110)
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Net cash used in operating activities (1,935) (782)
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CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets (659) (107)
Investment in other assets (364) -
Investment in subsidiary 23 -
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Net cash used in investing activities (1,000) (107)
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CASH FLOWS FROM FINANCING ACTIVITIES
Short-term bank borrowing, net (91) (23)
Receipt of shareholders' loans - 150
Repayment of shareholders' loans (6) (200)
Receipt of long-term loan 86 -
Receipt (repayment) of convertible loans (*) - (75)
Issuance of shares 2,633 148
Issuance of preferred stock, series A - 815
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Net cash provided by financing activities 2,622 815
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DECREASE IN CASH AND CASH EQUIVALENTS (313) (74)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 469 574
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 156 $ 500
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ADJUSTMENT TO RECONCILE NET LOSS TO
NET CASH USED IN
OPERATING ACTIVITIES:
Items not involving operating cash flows:
Depreciation $ 189 $ 31
Accrued severance pay, net 1 (3)
Minority interest in loss of subsidiary (56) -
Changes in operating assets and liabilities
Increase in receivables, net (145) (107)
Increase in other receivables (55) -
Increase (decrease) in payable and accrued expenses 801 (31)
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$ 735 $(110)
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PURCHASE OF SUBSIDIARY
Fair value of assets acquired (318) -
Liabilities assumed and minority interest 341 -
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23 -
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NONCASH TRANSACTIONS
Issuance of preferred stock,
Series A upon conversions of loans (*) $ - $ 500
Investment in other assets on credit $ 155 $ -
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The accompanying notes form an integral part of the financial statements.
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VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
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
three month period ended March 31, 2000, are not necessarily
indicative of the results that may be expected for the year ending
December 31, 2000. For further information, refer to the financial
statements and notes for the year ended December 31, 1999.
Note 2 - ACQUISITION OF CORTEXT LTD.
In February 2000, VCI entered into a Share Purchase Agreement
("SPA") with Cortext Ltd. ("Cortext"), a corporation registered
under the laws of the State of Israel, and the principal
shareholders of Cortext, to acquire a majority interest in the
equity of Cortext. Cortext was established in 1999 and is engaged in
the development and licensing of content management software for web
publishers. VCI currently utilizes Cortext's Magazine Software
pursuant to a License Agreement with Cortext dated July 18, 1999 to
manage content on several of the ethnic communities published by VCI
and as a central component of its CMS turnkey solution which it
markets and licenses to third party web publishers.
Pursuant to the terms of the SPA, VCI was issued shares of Cortext
so that it holds approximately 54% of the outstanding shares of
Cortext following the payment of certain funds to and on behalf of
Cortext. Depending upon Cortext's completion of certain software
development milestones set forth in the SPA and additional payments
by VCI, up to 60% of the equity of Cortext could be acquired by VCI
by August 2000. Purchase price for the entire transaction is
expected to be $760.
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VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (CONT.)
(U.S. Dollars in thousands except per share data)
(Unaudited)
Note 2 - ACQUISITION OF CORTEXT LTD. (Cont.)
Simultaneously with execution of the SPA, VCI and Cortext entered
into an Assignment Agreement with Planet Communications Ltd.
("Planet"), an Israel-based unaffiliated third party holder of 50%
of the rights in Cortext's Magazine Software whereby Planet agreed
to irrevocably assign all of its rights, title and interest in the
Magazine Software to Cortext in consideration of VCI's payment of a
portion of the transaction consideration on behalf of Cortext and
subject to such third party's retaining the right to sell up to ten
Magazine Software End User licenses. Cortext agreed to provide
Planet with certain upgrades and technical support services in
connection with such End User licenses if and when the same are
granted. The majority of the payments to Planet have been made and
its assignment of its rights to the Magazine Software has been
effectuated. A portion of the payments to Planet are to be paid in
installments over a period of six months from the date of the
Assignment Agreement and the SPA. Following the assignment of the
rights by Planet, Cortext holds 100% of the rights in and to the
Magazine Software.
The transaction was accounted for as a purchase. The purchase method
of accounting allocates the aggregate purchase price to the assets
acquired and liabilities assumed based upon their respective fair
values. The excess of the purchase price over the fair value of
assets and liabilities acquired of approximately $367 was allocated
to intellectual property and it is included in other assets.
<PAGE>
VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (CONT.)
(U.S. Dollars in thousands except per share data)
(Unaudited)
Note 3 - COMMITMENTS
A. In March 2000, the Company entered into a finance lease agreement
with Microtech Leasing Corp., a Princeton, New Jersey company for
the lease of up to $250 of computer equipment to the Company. The
credit facility provides the Company with the ability to obtain
certain computer equipment financed by the lease which is secured by
such equipment. The Company also agreed to provide Microtech with a
UCC financing statement covering the equipment leased pursuant to
the agreement. The lease cannot be canceled by the Company during
the term of the lease of the equipment which term is set forth on a
lease schedule.
B. In January and March 2000, the Company's Israel subsidiary, Virtual
Communities Israel Ltd. ("VCIL") exercised options for additional
space in the Jerusalem Technology Park, Israel, which serves
primarily as the Company's software development, programming and
communities design center. Total leasehold costs for the new space
will equal to approximately $165 per year.
Note 4 - SHARE CAPITAL
A. During the quarter, the Company issued 981,864 shares of common
stock at prices per share ranging from $2.11 to $3.42 to 12
individuals and entities, including three existing non-U.S.
shareholders of the Company, for aggregate gross proceeds of $2,524.
In connection with the issuance of 468,098 of such shares to three
existing shareholders of the Company, the Company issued three-year
warrants to acquire a total of 46,808 shares of common stock at
exercise prices ranging from $2.11 to $2.75. The Company paid
consultant and finders fees related to this financing in the form of
three-year warrants exercisable into 108,762 shares of common stock
at exercise prices ranging between $2.11 and $3.42 per share.
B. During the quarter, warrants exercisable into 212,859 shares of
common stock were converted.
C. During the quarter, 821,500 stock options were granted under the VCI
Stock Option Plan, 35,000 options were exercised into shares of
common stock and 193,600 options were forfeited.
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VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (CONT.)
(U.S. Dollars in thousands except per share data)
(Unaudited)
Note 4 - SHARE CAPITAL (Cont.)
D. Increase in the Number of Authorized ISOP Shares.
In March 2000, the Board of Directors approved the increase in the
authorized number of shares under the HDG 1999 Stock Option Plan by
500,000 for a total of 1,500,000 shares.
Note 5 - SUBSEQUENT EVENT
A. In April 2000, the Company sold 517,800 of its shares at $5.80 per
share to four institutional investors in a private placement
arranged by Josephthal & Company and Intercoastal Financial Services
Corp. for an aggregate gross proceeds of approximately $3,000. In
connection with the sale, the Company issued 2,000,000 callable
warrants to Intercoastal (the "IFSC Warrants") exercisable for a
period of three years at an exercise price of $18.00. 1,000,000 of
these IFSC Warrants are callable by the Company at 93% of the
average price of the common stock for the five days immediately
following the call which may be made by the Company following the
effectiveness of a registration statement registering the shares
underlying the IFSC Warrants. The remaining 1,000,000 IFSC Warrants
are callable by the Company three months following the date of
effectiveness of such registration statement. The IFSC Warrants are
redeemable by the Company at $0.75 per share decreasing to $0.50 in
July 2000 and thereafter by $0.05 per month until such redemption
price reaches $0.25 per share. In connection with the private
placement, the Company issued a) 500,000 four-month warrants to the
purchasers of the shares exercisable at $14.875 per share, b)
129,450 three-year warrants to such purchasers exercisable at
$7.4375 per share which are also redeemable at the same price as the
IFSC Warrants and c) 36,246 warrants exercisable for three years at
$5.80 per share to Josephthal & Company, the company's investment
banker in connection with the transaction in partial consideration
for its introduction of IFSC to the Company.
B. Short-term loan in the amount of $150 was converted into 297,672
shares of common stock.
C. In April 2000, the Board of Directors approved the increase in the
authorized number of shares under the HDG 1999 Stock Option Plan by
an additional 500,000 for a total aggregate of 2,000,000 shares
reserved for issuance thereunder. This increase is subject to
ratification by the shareholders, which ratification has been
solicited as part of the Company's Annual Meeting of Shareholders
scheduled for June 6, 2000.
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VIRTUAL COMMUNITIES, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (CONT.)
(U.S. Dollars in thousands except per share data)
(Unaudited)
Note 6 - SEGEMENT INFOMATION
Under the provisions of SFAS No. 131 the Company's activities fall
within two main operating segments: The Online Comuunities Division
and the Content Management Solution Division. The following table
sets forth the Company's industry segment.
For the three months
ended March 31
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2000 1999
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(Unaudited)
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Revenues:
Online communities $ 147 $ 172
Content Management Solution 292 -
Other 14 -
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Consolidated $ 453 $ 172
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Operating loss:
Online communities $(1,997) $ (626)
Content Management Solution (502) -
Other (206) -
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Consolidated $(2,705) $ (626)
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Identifiable assets:
Online communities $ 1,592 $1,095
Content Management Solution 1,387 -
Other 608 -
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Consolidated $ 3,587 $1,095
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# # # # # #
<PAGE>
Item 2. Management's Discussion and Analysis Of Financial Condition and
Results of Operations
The following description of our financial condition and results of operations
should be read in conjunction with the financial information included in this
Form 10Q Quarterly Report. The description contains forward-looking statements
that involve risks and uncertainties. Our actual results could differ
significantly from the results discussed in the forward-looking statements.
Overview
Virtual Communities, Inc. (the "Company") is a developer and publisher of
online business-to-business and business-to-consumer communities. Through its
proprietary Community Management Solution (CMS), the Company designs and
develops web-based vertical communities containing a comprehensive suite of
products and services that includes web publishing and content management
software, integrated e-commerce solutions and best-of-breed interactive
community features. The Company also provides its CMS clients with editorial and
marketing services. CMS provides a rapid, 90-day, one-stop solution for creating
an online community that contains all the web tools required for managing
content, conducting e-commerce and attracting and retaining online visitors.
<PAGE>
The Company, a Delaware corporation formerly known as Heuristic Development
Group, Inc. ("HDG"), consummated a merger (the "Merger") with Virtual
Communities, Inc. ("VCI"), also a Delaware corporation, in October 1999. Prior
to the Merger, we were a development stage company organized to develop, design
and market fitness-related products. In 1999, we decided to pursue a strategy of
acquisition of an existing company culminating in the merger with VCI. VCI was
organized in 1996 to develop and operate online communities on the Web targeted
to specific ethnic groups. After the Merger, we changed our name to Virtual
Communities, Inc., to reflect that our Company's business is now the development
and operation of online communities and related services for third parties and
the publishing of our own online communities. In March 2000, we merged this
wholly owned subsidiary into the parent company.
VCI was incorporated in August 1996 as Virtual Jerusalem Ltd., Inc. It was
founded to develop, acquire and operate online communities on the Web targeted
to members of demographic groups with interests in their historical ethnic
backgrounds and who want to share information with other members with like
interests. In June 1997, VCI acquired substantially all of the assets and
outstanding shares of Virtual Communities Israel Ltd. formerly called Virtual
Jerusalem Ltd. ("VCIL"), an Israeli corporation formed in 1996 by the founders
of VCI that developed and published an Internet Web site called Virtual
Jerusalem. VCIL currently maintains online communities published by the Company
(see below), performs certain programming, design, software development and web
maintenance services for the Company's CMS business pursuant to a Cost Plus
Agreement and certain general and administrative duties on behalf of the Company
pursuant to a Financial Services Agreement between the entities.
Based upon our expertise in designing and developing our own communities and
the Web sites of the content partners of our online communities since 1996, in
mid 1999 we began offering our Community Management Solution (CMS) Web site
design and development services to others on a fee for services basis. To date,
we have entered into four design and development agreements for the installation
of CMS and are currently negotiating the sale of additional systems to others.
Such agreements call for the creation of an online community within a 90-day
period in consideration and the licensing of multiple interactive elements and
Web services for a fee payable over such 90-day period. We typically take 50% of
our fee in the form of equity of the CMS client.
In addition, we enter into maintenance agreements with our CMS clients that
commence upon the completion of the development of their online communities and
pursuant to which we provide them with hosting, maintenance and other services.
The term of these maintenance agreements is for one year and may be extended for
additional one-year periods on agreement by the Company and the CMS client. The
Company typically charges a monthly fee for its maintenance services.
VCI also publishes its own proprietary online communities: Virtual Jerusalem
(www.virtualjerusalem.com), Virtual HolyLand (www.virtualholyland.com), Virtual
Ireland (www.virtualireland.com), Virtual Italy (www.virtualitaly.com) and
Virtual India (www.virtualindia.com). Rather than create our own content for
these properties, we aggregate content, including news and features from our
content partner Web sites. In consideration for our use of their content, we
offer our content partners a variety of benefits such as a portion of
advertising revenues, links back to their sites and interactive elements. We
supplement the content on our Web communities by adding a variety of interactive
and community-enhancing elements, such as free e-mail, weather, bulletin boards
and chat services. We obtain the rights to use these elements or "modules" by
licensing the technologies from various Internet service providers. Our
<PAGE>
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.
Our first online community, Virtual Jerusalem, was launched in May 1996 by
VCIL. Virtual Jerusalem contains content from many Jewish and Israel-related
news providers and content partners. In addition, Virtual Jerusalem contains
many interactive elements designed to encourage users to return to the site on a
regular basis, including an online radio station, and a search engine with
access to over 10,000 other Jewish related Web sites. In December 1998, we
launched our second online community, Virtual HolyLand, which is targeted to
Evangelical Christians, and in March 1999, we launched our third online
community, Virtual Ireland, which is targeted to people of Irish descent. In
October 1999, we launched Virtual Italy targeted to the Italian American
community. In November 1999, we launched Virtual India targeted to the Indian
American community.
Advertising is offered to our advertisers at rates that are based upon an
industry accepted CPM (cost per thousand page views delivered) basis. Discounts
from our standard advertising rates are offered to certain advertisers based on
several factors, including the duration and gross dollar amount of advertising
campaigns. We currently sell banner ads for six to twelve month periods,
although in many instances such contracts are cancelable by an advertiser after
a three-month period. Cancellations by advertisers have been negligible. Barter
advertising accounted for approximately 28% and 27% of our advertising revenues
for the fiscal years ended December 31, 1998 and 1999, respectively. Revenue
from barter transactions is calculated based upon the fair market value of the
goods or services received.
We project increased revenues from banner advertising sales as we solicit
advertisers which seek the types of Web sites developed by us since such sites
deliver an audience comprised of a specific demographic profile to which such
advertisers can tailor a targeted campaign.
We are also introducing e-commerce programs on our communities powered by
Intershop Software. We intend on charging a fee of $175 to $500 for each store
placed on one of our communities and receive a percentage of gross sales equal
to 10%. We expect e-commerce transactions to generate an increasing percentage
of our revenues in the future. To the extent that the number of users on our
online communities is less than anticipated, that such users do not engage in e-
commerce transactions or that we do not establish attractive e-commerce programs
on our communities, revenues generated from e-commerce will be less than
projected.
We believe that the continued expansion of our CMS operations and marketing
efforts for CMS sales and our own communities is essential to achieving our
financial goals. We therefore intend to continue to substantially increase
expenditures in all areas of our operations, resulting in continued increases in
cost of revenues and selling, general and administrative expenses. To the extent
that such expenses precede or are not subsequently followed by increased
revenues, our business, financial condition and operating results will be
materially adversely affected.
Historical Results of Operations
Historical Comparison of Three Months Ended March 31, 2000 and 1999
<PAGE>
Revenues
Total Revenues. Total revenues for the three months ended March 31, 1999 and
March 31, 2000 were $172,000 and $453,000, respectively, reflecting a 163%
increase in revenues. Revenue during the first quarter of 1999 was generated
exclusively from our Online Communities segment, where as in the first quarter
2000, revenue was derived from both the CMS Services segment and the Online
Communities segment.
CMS Services Revenues. CMS Services revenues commenced in the third quarter of
1999 and has quickly become our primary source of revenue due to the relatively
higher value of CMS agreements over advertising agreements and as the Company's
CMS marketing efforts begin to bear results. We receive both cash and equity
from a CMS client that serves to demonstrate our long-term commitment to our CMS
customers. For the three months ended March 31, 2000, CMS Services revenue
amounted to $292,000 or 64% of total revenue. This revenue was generated in its
entirety from two CMS customers. To date, VCI has entered into four CMS
agreements. Should VCI fails to secure enter into additional CMS agreements,
VCI's business, financial condition and operating results will be materially
adversely affected.
CMS Services are considered, for accounting purposes, software products and
technology, and therefore, revenue therefrom is recognized in accordance with
Statement of Position (SOP) 97-2, as amended by SOP 98-4 and SOP 98-9.
Therefore, revenue is recognized upon delivery, when collection is probable, the
fee is fixed and determinable, vendor-specific objective evidence exists to
allocate the total fee to the elements of the arrangement and persuasive
evidence of an arrangement exists. Revenue for maintenance and support services
are deferred and recognized ratably over the service period.
Online Communities Revenues. Online Communities revenues consist of banner
advertising, web site hosting and web site production services. Revenues from
banner advertising accounted for approximately $80,000 and $118,000, for the
three months ended March 31, 1999 and 2000, respectively, reflecting a 48%
increase. Banner advertising is expected to continue to rise due to an increased
sales staff and marketing efforts. In addition, most of the lengths of
advertising contracts have steadily increased. To date, we have signed banner
advertising contracts for revenues recognizable in the second to fourth quarters
of 2000 approximating $345,000.
Of the total banner advertising revenue earned from advertisements placed on
our own communities, barter advertising accounted for 1% and 30% of such
revenues for the three months ended March 31, 1999 and 2000, respectively. This
current barter advertising revenue is primarily due to a twelve-month agreement
with Continental Airlines for airline tickets, in exchange for advertising
placements on an online community for equivalent value. The Company is currently
negotiating the renewal of this agreement for an additional twelve month period
at approximately the same value. Revenue from barter transactions is calculated
based upon the fair market value of the goods or services received.
To date, we have not derived significant revenue from e-commerce commissions.
E-commerce commission revenues accounted for 8% and 4% of total revenues for the
three-month periods ended March 31, 1999 and 2000, respectively. The decrease
reflects our winding down of relationships with individual e-commerce partners,
in anticipation of re-launching a new e-commerce program utilizing new software
licensed by the Company. In December 1999, we signed a contract with Intershop,
Inc., provider of e-commerce technologies for this software. We expect our
e-commerce revenues to increase over subsequent
<PAGE>
quarters upon implementation of this Intershop e-commerce technology on each of
our online communities.
Cost of Revenues
CMS Services Cost of Revenues. Cost of revenue for the CMS Services segment
consists primarily of salaries of the CMS support team and licensing fees for
software licensed by the Company for use in the CMS system. Cost of revenue for
the CMS Services segment, which commenced in the third quarter of 1999, amounted
to $358,000, or 123% of CMS Services revenue for the three months ended March
31, 2000.
Online Communities Cost of Revenues. Cost of revenue for the Online
Communities segment consists primarily of expenditures for technical support of
our online communities, Internet access and connectivity, Web site production,
editorial services, content development and maintenance and client services.
Cost of revenue for the Online Communities amounted to $237,000, or 138%, and
$551,000, or 375% of Online Communities revenue, for the three months ended
March 31, 1999 and 2000. This increase is primarily due to the increased hiring
of additional editorial personnel, required for building out and launching
three additional communities between the first quarter of 1999 and the first
quarter of 2000 and increased overhead and support services required to support
expanded operations.
Research and Development
For the first time in Q1 2000, the Company recorded $220,000 in research and
development expenses in conjunction with the Company's development of compatible
software for the Cortext content management and web publishing software and used
by the Company as the central component of its CMS system.
Sales and Marketing
Selling and marketing expenses consist of salaries, travel expenses for sales
staff, sales commissions, advertising revenue sharing with content partners,
marketing expenses for CMS service and online communities. Sales and marketing
amounted to $202,000, or 117% of revenue, and $911,000, or 201% of revenue, for
the three months ended March 31, 1999 and 2000, respectively. The salary expense
increased by 112% over the first quarter of 1999, as we hired additional sales
and marketing personnel and, in addition, dedicated a resource to administer our
advertisement management program. In the first quarter of 2000, marketing and
advertising expense tripled as compared to the first quarter of the previous
year, as we conducted a campaign launching the Company's CMS Services, and at
the same time, aggressively marketed our online communities in order to increase
the numbers of users and registrants on such communities.
General and Administrative
General and administrative expenses consist primarily of salaries and legal
and professional services. In addition, legal fees, our rent, utilities and
administrative employee benefits are included in general and administrative
expenses. General and administrative expenses amounted to $359,000, or 209% of
revenue, and $1,118,000, or 247% of revenue for the three months ended March 31,
1999 and 2000, respectively. This increase was primarily due to increased hiring
of personnel, overhead and support services required to support the expansion of
operations. In addition, legal fees increased significantly for work related to
<PAGE>
special projects and new contract formation.
Liquidity and Capital Resources
In January and February 2000, the Company issued 981,864 shares of common
stock at prices per share ranging from $2.11 to $3.42 to 12 individuals and
entities, including three non-U.S. shareholders of the Company, for aggregate
gross proceeds of $2,524,000. In connection with the issuance of 468,098 of
such shares to three existing shareholders of the Company, the Company issued
three-year warrants to acquire a total of 46,808 shares of common stock at
exercise prices ranging from $2.11 to $2.75. The Company paid consultant and
finders fees related to the January and February financing in the form of three-
year warrants exercisable into 108,762 shares of common stock at exercise prices
ranging between $2.11 and $3.42 per share.
In April 2000, the Company sold 517,800 of its shares at $5.80 per share to
four institutional investors in a private placement arranged by Josephthal &
Co., Inc. and Intercoastal Financial Services Corp. In connection with the sale,
the Company issued 2,000,000 callable warrants to Intercoastal (the "IFSC
Warrants") exercisable for a period of three years at an exercise price of
$18.00 per share. 1,000,000 of these IFSC Warrants are callable by the Company
at 93% of the average price of the Common Stock for the five days immediately
following the call which may be made by the Company following the effectiveness
of a registration statement registering the shares underlying the IFSC Warrants.
The remaining 1,000,000 IFSC Warrants are callable by the Company three months
<PAGE>
following the date of effectiveness of such registration statement. The IFSC
Warrants are redeemable by the Company at $0.75 per share decreasing to $0.50 in
July 2000 and thereafter by $0.05 per month until such redemption price reaches
$0.25 per share. In connection with the private placement, the Company issued
a) 500,000 four-month warrants to the purchasers of the shares exercisable at
$14.875 per share, b) 129,450 three-year warrants to such purchasers exercisable
at $7.4375 per share which are also redeemable at the same price as the IFSC
Warrants and c) 36,246 warrants exercisable for three years at $5.80 per share
to Josephthal & Company, the company's investment banker in connection with the
transaction in partial consideration for its introduction of IFSC to the
Company.
We maintain an operating line of credit with Israel General Bank in the amount
of $560,000. As of March 31, 2000, the amount outstanding on this line of credit
totaled $515,000. Israel General Bank has also provided us with a $58,000
guarantee for three months rent on the leaseholds occupied by Virtual
Communities Israel, Ltd.
In June 1999, Virtual Communities Israel, Ltd., ("VCIL"), one of our Israeli
subsidiaries, entered into a three-year lease for approximately 10,000 square
feet of office space in Jerusalem for approximately $45,000 in quarterly
leasehold costs which payments commenced in December 1999. In January and March
2000, VCIL exercised options for additional space which serves primarily as the
Company's software development, programming and communities design center. Total
leasehold costs for the new space will equal to approximately $165,000 per year.
In July 1999, we entered into a five-year lease for approximately 5,000 square
feet of office space in New York City for a rental fee of approximately $22,500
per quarter. In October 1999, we exercised our option to lease an additional
5,000 square feet of office space in the same building for a five-year time at a
monthly rental of approximately $8,250. In addition, the lessor of the new
Jerusalem premises is contributing $234,000 in build out costs that 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 our move to new premises in August 1999
and which it intends to sublet upon vacancy of the current sub-lessor in July
2000. Although VCIL believes that it will be able to continue to sublet such
space, our management cannot assure you that it will be successful in doing so,
and in the event such space cannot be sublet, we would be obligated to pay
approximately $15,000 in quarterly leasehold fees in addition to the lease costs
for our new premises until December 2001.
We anticipate that we will continue to increase our capital expenditures in
the near future due to anticipated growth in our operations, infrastructure, and
personnel. In addition to the commitments relating to the new leaseholds,
improvements to infrastructure, additional licenses for interactive elements
(including content management software) and Web site security are expected to
amount to approximately $115,000 monthly through the year 2000.
Projects anticipated during the year 2000 which will require capital
expenditure of approximately $500,000 includes the development of server parks
in New York and London in order to facilitate local technical services for CMS
customers and the opening of an office in California.
In March 2000, the Company entered into a finance lease agreement with
Microtech Leasing Corp., a Princeton, New Jersey company for the lease of up to
$250,000 of computer equipment to the Company. The credit facility provides the
<PAGE>
Company with the ability to obtain certain computer equipment financed by the
lease which is secured by such equipment.
Marketing expenditures are expected to approach approximately $50,000 per
month to promote CMS services and, on average, $73,000 per month per each of our
Web sites, by the fourth quarter of 2000, in order to reach projected levels of
CMS customers, registered users, traffic, and revenue from banner advertisements
and e-commerce transactions on online communities.
We anticipate that our existing cash balance combined with the net proceeds
which may be realized from the sale of additional shares pursuant to our private
placement offerings, the anticipated proceeds from exercise of warrants and
anticipated revenue from operations will be sufficient to meet our working
capital and capital expenditure needs through December 31, 2000. If the cash
that we generate from our operations is insufficient to satisfy our liquidity
requirements after this period, then we may need to sell additional securities.
The sale of additional equity or convertible debt securities may result in
additional dilution to our shareholders. We will need to obtain additional
capital or modify our growth strategy. We may not be able to raise any
additional capital or obtain such capital on acceptable terms.
Legal Proceedings
On April 14, 2000, a Complaint was filed against VCI in the Supreme Court of
the State of New York, County of New York, by six investors in VCI who acquired
Series B Preferred Stock of VCI pursuant to a private placement of VCI's
securities in August 1999 prior to its merger with, and into a wholly-owned
subsidiary of Heuristic Development Group, Inc. on October 29, 1999 (the
"Merger"). The plaintiffs claim that they are entitled to additional shares of
VCI Common Stock as a result of a provision in the Private placement
Memorandum, pursuant to which they acquired their securities in VCI, providing
for a reset of the conversion price of the plaintiffs' Series B Preferred Shares
into Common Stock of VCI. The original conversion price set forth in the
Memorandum was $2.10, however this conversion price was subject to a reset to
$1.45 in the event that VCI did not close the Merger by August 31, 1999, which
date was subsequently extended to September 30, 1999 by a Supplement to the
Private Placement Memorandum dated May 27th 1999. The Supplement also stated
that such date could be further extended to October 31, 1999 in the event VCI
received a letter from its outside counsel stating that the Merger closing was
delayed by the SEC for reasons beyond the Company's control. VCI received such a
letter from its outside counsel on September 29, 1999 and the Merger closed on
October 29, 1999. Plaintiffs in this action have demanded a judgment in the form
of additional shares, and, alternatively, granting money damages in favor of the
Plaintiffs computed at the highest price of VCI shares trading on NASDAQ during
the period subsequent to the merger date and attorneys fees, costs and
disbursements of the action.
In the event the Plaintiffs are successful in this action they would be entitled
to approximately 52,320 shares of Common Stock and Series B Preferred
Shareholders as a group would be entitled to approximately 175,000 additional
shares of Common Stock of the Company after adjustment for the exchange ratio of
1.151 to 1 used to calculate the number of new shares of Common Stock in the
merged Company that former VCI shareholders would be entitled to pursuant to the
Agreement and Plan of Merger. The Company and its counsel believe that this
claim is without merit. The Company intends to defend vigorously any action
which may be filed against the Company and its officers and directors in
connection with the aforementioned claim.
<PAGE>
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
EXHIBITS
Exhibit No. Description of document
- ----------- -----------------------
10(1) Share Purchase Agreement between Virtual Communities, Inc., Cortext
Ltd., Ran Eilam and Noam Ilan dated February 7, 2000, as filed with the
Commission as Exhibit 10(40) to Virtual Communities, Inc.'s Registration
Statement on Form SB-2 filed on May 5, 2000, is incorporated by reference.
10(2) Assignment Agreement between Planet Communications Ltd, Cortext Ltd., and
Virtual Communities, Inc., dated February 10, 2000, as filed with the Commission
as Exhibit 10(41) to Virtual Communities, Inc.'s Registration Statement on Form
SB-2 filed on May 5, 2000, is incorporated by reference.
REPORTS ON FORM 8-K
On February 18, 2000, the Registrant ("VCI") filed a Form 8-K related to its
February 10, 1999 Share Purchase Agreement ("SPA") with Cortext Ltd.
("Cortext"), a corporation registered under the laws of the State of Israel, and
the principal shareholders of Cortext, to acquire a majority interest in the
equity of Cortext. Cortext was established in 1996 and is engaged in the
development and licensing of content management software for web publishers. VCI
currently utilizes Cortext's Magazine Software pursuant to a License Agreement
with Cortext dated July 18, 1999 to manage content on several of the ethnic
communities published by VCI and as a central component of its Community
Management Solution (CMS) turnkey solution which it markets and licenses to
third party web publishers.
Pursuant to the terms of the SPA, VCI was issued shares of Cortext so that it
holds approximately 54% of the outstanding shares of Cortext following the
payment of certain funds to and on behalf of Cortext. VCI will acquire
additional shares so that it will hold 60% of the equity of Cortext by August
2000 depending upon Cortext's completion of certain software development
milestones set forth in the SPA and additional payments by VCI. Pursuant to the
SPA, the total amount of payments to be made by VCI to and on behalf of Cortext
(see below), including repayment of certain Cortext loans, amounts to $760,000.
Simultaneously with execution of the SPA, VCI and Cortext entered into an
Assignment Agreement with Planet Communications Ltd. ("Planet"), an Israel-based
unaffiliated third party holder of 50% of the rights in Cortext's Magazine
Software whereby Planet agreed to irrevocably assign all of its rights, title
and interest in the Magazine Software to Cortext in consideration of VCI's
payment of approximately $425,000 on behalf of Cortext and subject to such third
party's retaining the right to sell up to ten Magazine Software End User
licenses. Cortext agreed to provide Planet with certain upgrades and technical
support services in connection with such End User licenses if and when the same
are granted. The majority of the payments to Planet have been made and its
assignment of its rights to the Magazine Software has been effectuated. A
portion of the payments to such third party are to be paid in installments over
a period of six months period from the date of the Assignment Agreement and the
<PAGE>
SPA. Following the assignment of the rights by Planet, Cortext holds 100% of the
rights in and to the Magazine Software.
Concurrently with the execution of the SPA, Cortext also entered into long-term
employment agreements with its C.E.O. and C.T.O. and amended its By Laws.
Pursuant to the SPA, VCI has the right to name two members to Cortext's Board
and to name a majority of the Board upon the completion of its payments and
acquisition of shares in August 2000.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
VIRTUAL COMMUNITIES, INC.
Date: May 15, 2000 by: /s/ Avi Moskowitz
------------------------------
Avi Moskowitz, President
(Principal Executive and
Financial Officer)
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