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 September 30, 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 |_|
State the number of shares outstanding of each of the issuer's common equity as
of September 30, 2000: 17,118,456 shares of Common Stock, $.01 par value.
<PAGE>
INDEX
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Balance Sheets - September 30, 2000..................... 5
Condensed Statements of Operations - Nine Months ended
September 30, 2000 and 1999............................. 6
Condensed Statements of Cash Flows - Nine Months ended
September 30, 2000 and 1999............................. 8
Notes to Financial Statements..................................... 9
Item 2. Management's Discussion and Analysis
Of Financial Condition and Results of Operations.................. 15
Part II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds......................... 23
Item 5. Other Information................................................. 23
Item 6. Exhibits and Reports.............................................. 23
SIGNATURES................................................................... 24
Part 1. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
2
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VIRTUAL COMMUNITIES, INC.
CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
as of September 30, 2000
(In U.S. dollars)
(Unaudited)
3
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VIRTUAL COMMUNITIES, INC.
CONDENSED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
AS OF SEPTEMBER 30, 2000
Contents
Page
----
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheet 5
Consolidated Statements of Operations 6
Consolidated Statements of Shareholders' Deficiency 7
Consolidated Statements of Cash Flows 8
Notes to the Consolidated Financial Statements 8 - 14
# # # # # # #
4
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VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(U.S. Dollars in thousands except per share data)
<TABLE>
<CAPTION>
September 30
2000
-----------
(Unaudited)
-----------
<S> <C>
ASSETS
Current Assets
Cash and cash equivalents $ 430
Trade receivables 16
Other receivables 55
Assets of discontinued operations 224
--------
Total current assets 725
Property and Equipment, net of depreciation and amortization of $ 632 1,878
Severance Pay Deposits 168
Other assets 1,170
--------
Total assets $ 3,941
========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
Current Liabilities
Short-term bank borrowings and current maturities of long-term loan $ 683
Payables and accrued expenses 3,488
--------
Total current liabilities 4,171
--------
Long-Term Liabilities
Convertible Loan 1,271
Long-term loan 266
Accrued severance pay 532
--------
Total long-term liabilities 2,069
--------
Total liabilities 6,240
--------
Minority Interest 103
--------
Shareholders' Deficiency
Share capital
Shares of $0. 01 par value --
Preferred stock of $0.01 par value
Authorized - 5,000,000 shares; none issued and outstanding
Series C authorized -5,750 shares; issued and outstanding -2,010 shares --
Common stock of $0.01 par value
Authorized - 45,000,000 shares; issued and outstanding -
16,985,443 shares 171
Additional paid-in capital 16,991
Accumulated deficit (19,414)
--------
(2,252)
Treasury stock 149,900 shares at cost (150)
--------
Total shareholders' deficiency (2,402)
--------
Total liabilities and shareholders' deficiency $ 3,941
========
</TABLE>
The accompanying notes form an integral part of the financial statements.
5
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VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(U.S. Dollars in thousands except share and per share data )
<TABLE>
<CAPTION>
For the three For the nine
months ended months ended
September 30 September 30
--------------------------- ---------------------------
2000 1999 2000 1999
------------ ----------- ------------ -----------
(Unaudited) (Unaudited)
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
REVENUES $ 295 $ 96 $ 922 $ 96
------------ ----------- ------------ -----------
COST AND EXPENSES
Cost of revenues 338 104 1,654 104
Research and development 877 -- 1,542 --
Selling and marketing expenses 464 51 1,191 51
General and administrative expenses 666 371 2,468 1,176
Expenses of merger -- 188 -- 429
------------ ----------- ------------ -----------
Total operating costs and
expenses 2,345 714 6,855 1,760
------------ ----------- ------------ -----------
Operating loss (2,050) (618) (5,933) (1,664)
Financing expenses, net (67) (16) (151) (74)
Capital loss (62) -- (62) --
Minority interest in loss of subsidiary 72 -- 191 --
------------ ----------- ------------ -----------
Loss from continuing operations (2,107) (634) (5,955) (1,738)
Loss from discontinued operations 756 505 3,475 1,240
------------ ----------- ------------ -----------
Net loss (2,863) (1,139) (9,430) (2,978)
============ =========== ============ ===========
Dividend related to convertible
preferred stock (1,128) -- (1,128) --
============ =========== ============ ===========
Net loss attributable to common
shareholders $ (3,991) $ (1,139) $ (10,558) $ (2,978)
============ =========== ============ ===========
NET LOSS PER SHARE, BASIC
AND DILUTED:
Continuing operations (0.19) (0.07) (0.43) (0.20)
Discontinued operations (0.04) (0.06) (0.22) (0.15)
------------ ----------- ------------ -----------
Net loss per share $(0.23) $(0.13) $(0.65) $(0.35)
============ =========== ============ ===========
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING, BASIC AND
DILUTED 17,078,594 8,538,276 16,355,417 8,523,409
============ =========== ============ ===========
</TABLE>
The accompanying notes form an integral part of the financial statements.
6
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VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' DEFICIENCY
(U.S. Dollars in thousands except share data)
(Unaudited )
<TABLE>
<CAPTION>
Series C
Preferred stock Common stock
----------------------- ----------------------- Additional Accumulated Treasury Total
Shares Amount Shares Amount paid-in deficit stock
capital
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <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 -- -- 1,499,664 14 5,120 -- -- 5,134
Common stock issued
upon exercise of
warrants and
options -- -- 690,896 8 317 -- -- 325
Common stock issued
upon conversion of
loans -- -- 297,672 3 147 -- -- 150
Series C preferred
stock issued, net 2,010 -- -- -- 1,943 -- -- 1,943
Dividend related to
convertible
preferred stock -- -- -- -- 1,128 (1,128) -- --
Net loss -- -- -- -- -- (9,430) -- (9,430)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Balance as of
September 30, 2000
(unaudited) 2,010 $ -- 17,118,456 $ 171 $ 16,991 $ (19,414) $ (150) $ (2,402)
========== ========== ========== ========== ========== ========== ========== ==========
</TABLE>
The accompanying notes form an integral part of the financial statements.
7
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VIRTUAL COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. Dollars in thousands )
<TABLE>
<CAPTION>
For the nine months ended
September 30
-------------------------
2000 1999
---------- -----------
(Unaudited)
-------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss (9,430) (2,978)
Adjustments to reconcile net loss to net cash used in
operating activities (see below) 2,748 811
------ ------
Net cash used in operating activities (6,682) (2,167)
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CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of fixed assets (1,382) (513)
Investment in other assets (540) --
Investment in subsidiary 23 --
------ ------
Net cash used in investing activities (1,899) (513)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES
Short-term bank borrowing, net (49) 295
Receipt of shareholders' loans -- 150
Repayment of shareholders' loans (181) (200)
Receipt of long-term loan 99 250
Receipt (repayment) of convertible loans 1,271 (75)
Issuance of common stock 5,459 148
Issuance of preferred stock 1,943 1,640
------ ------
Net cash provided by financing activities 8,542 2,208
------ ------
DECREASE IN CASH AND CASH EQUIVALENTS (39) (472)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 469 574
------ ------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD 430 102
====== ======
ADJUSTMENT TO RECONCILE NET LOSS TO NET
CASH USED IN OPERATING ACTIVITIES:
Items not involving operating cash flows:
Depreciation 656 108
Capital loss 182 --
Accrued severance pay, net 72 37
Minority interest in loss of subsidiary (191) --
Changes in operating assets and liabilities
Increase in receivables (21) (170)
Decrease in other receivables 218 --
Increase in payable and accrued expenses 1,832 836
------ ------
2,748 811
====== ======
PURCHASE OF SUBSIDIARY
Fair value of assets acquired (318) --
Liabilities assumed and minority interest 341
------ ------
23 --
====== ======
NONCASH TRANSACTIONS
Issuance of preferred stock, Series A upon conversion of loans -- 500
====== ======
Investment in other assets on credit 93 --
====== ======
Issuance of common stock upon conversion of loans 150 --
====== ======
Dividend on convertible preferred stock 1,128 --
====== ======
</TABLE>
The accompanying notes form an integral part of the financial statements.
8
<PAGE>
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
(U.S. dollars in thousands)
(Unaudited)
Note 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles 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 and the nine month period ended September 30, 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.
The Company incurred substantial losses to date and anticipates that it
will continue to incur losses. In November 2000, as a result of its
inability to secure new financing following the completion of the Secured
Loan (see Note 3), the Company significantly curtailed its operations and
effectuated a layoff of almost all of the Company's employees in its New
York City office and most of the employees at the Company's VCIL software
development subsidiary in Jerusalem. In addition, the Company has been
unable to meet its current outstanding financial obligations and payables
and has ceased operating payments to Cortext Ltd. The Company is
attempting to raise funds to satisfy its obligations by selling its
assets, including its online communities and its Cortra Site Studio
software. Management is also exploring the possibility of selling the
Company to a party that will assume the Company's liabilities.
The Company may be obliged to cease operations if immediate financing
cannot be obtained. There can be no assurance that the Company will sell
these assets or obtain the financing necessary for its operations. These
matters raise substantial doubt about the Company's ability to continue as
a going concern. The accompanying consolidated financial statements do not
include any adjustments that might be necessary should the Company be
unable to continue as a going concern.
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
approximately 60% interest in the equity of Cortext. Cortext is engaged in
the development and licensing of content management software for web
developers.
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 approximately $425.
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 $456 was allocated to intellectual property, of
which the unamortized portion of $398 is included in other assets.
9
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VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (Cont.)
(U.S. dollars in thousands)
(Unaudited)
Note 2 - ACQUISITION OF CORTEXT LTD. (Cont.)
In July 2000, VCI entered into an Amendment to the SPA whereby it agreed
to fund further development of Cortext's Object Server software included
in VCI's Cortra Site Studio software. VCI agreed to make payments totaling
$600 according to pre-defined delivery dates from July through December
2000 for certain added functionality of the software and in consideration
for the issuance of approximately 3.5% additional equity in Cortext. In
addition, in July 2000, VCI entered into an agreement with the two
founders of Cortext Ltd. who are the CEO and CTO of Cortext, respectively,
to acquire an additional 20% of the outstanding equity of Cortext from
such individuals in consideration of an aggregate $900 payable to them
between August and December 2000. No payments have been made by VCI to
date.
Note 3 - CONVERTIBLE LOAN
During the third quarter the Company borrowed $1,271 from Gilston Corp.
Subsequent to balance sheet date, the Company borrowed an additional $474.
The loans bear interest at the rate of 12% per annum. The loans and
interest thereon are due on November 16, 2000 but may be converted at the
option of the lender into securities of the Company assuming the
completion of a proposed financing by the Company. If the closing for such
financing does not occur the Company shall issue, warrants exercisable
into 100,000 shares of common stock at an exercise price equal to 100% of
the closing bid price of the common stock.
Subsequent to balance sheet date, the Company entered into a Secured
Convertible Notes Purchase Agreement which replace the above loan
agreement. The secured loan is for three years, bears interest at a rate
of 10% per annum and is secured by all of the shares of Cortext Ltd. held
by the Company, which currently represents 60% of the outstanding shares
of Cortext Ltd. The secured loan is convertible at any time at the option
of the lenders into common stock of the Company at the lesser of a fixed
conversion rate which is between 110% and 120% of the closing bid price of
the common stock on the date of the closing and a floating conversion rate
which is 90% of the average closing bid price of the common stock for 20
days prior to the conversion of the loan. The Company may prepay the loan
by paying a prepayments penalty of 10% to 20% depending on the date of
prepayment; however, the lenders have five days to convert the loan upon
the Company's notice to them of its intent to prepay the secured loan.
10
<PAGE>
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (Cont.)
(U.S. dollars in thousands)
(Unaudited)
Note 4 - 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 that 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.
In June 2000, the Company entered into a finance lease agreement
with Syscap Computer Rentals PLC, a U.K. entity to obtain certain
equipment required by the Company in the U.K. The Company entered
into a 24 month lease for approximately $420 of computer and
Internet equipment and can acquire such equipment in consideration
for an additional monthly payment. The lease is secured by the
equipment.
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
are approximately $165 per year. Subsequent to balance sheet date
the Company sublet this space for a period of nine months to an
unaffiliated party.
Note 5 - SHARE CAPITAL
A. During the first quarter of 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 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.
11
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VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (Cont.)
(U.S. dollars in thousands)
(Unaudited)
Note 5 - SHARE CAPITAL (Cont.)
B. During the period, warrants exercisable into 457,616 shares of
common stock were converted.
C. During the second quarter of 2000, the Company issued 517,800 shares
of common stock at $5.80 per share to four institutional investors
in a private placement arranged by Josephthal & Company and
Intercoastal Financial Services Corp. ("Intercoastal") for an
aggregate gross proceeds of approximately $3,000 (the "IFSC
Financing"). 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 c)
36,246 warrants exercisable for three years at $5.80 per share to
Josephthal & Company and d) 2,000,000 one year callable warrants
exercisable at a price ranging from $18.00 to $27.00 per share which
were cancelled in July 2000.
D. During the second quarter, a short-term loan in the amount of $150
was converted into 297,672 shares of common stock.
E. In July 2000, the Company entered into a follow-on financing
agreement with several institutional investors in the IFSC
Financing. Pursuant to the financing agreement, the Company sold
2,010 shares of Series C preferred stock in two tranches through
August 31, 2000 for an aggregate of $2,010. The first tranche,
consisted of the conversion of the $1,000 loan made in June 2000 by
one of the IFSC Financing investors and $500 in cash from a second
investor. A second tranche of $500 from two investor closed on
August 8, 2000. The Series C preferred stock is convertible for a
period of three years into shares of common stock at conversion
prices as defined in the agreement. The Company also issued to the
IFSC investors up to 977,777 three-year warrants exercisable into
common stock at $2.25 per share.
In connection with the follow-on financing, the Company and
Intercoastal entered into an agreement canceling the 2,000,000
warrants issued as part of IFSC Financing.
12
<PAGE>
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS (Cont.)
(U.S. dollars in thousands)
(Unaudited)
Note 5 - SHARE CAPITAL (Cont.)
E. (Cont.)
The Company has recorded a preferred stock dividend of $1,128
representing the value of the beneficial conversion feature on the
issuance of the Series C convertible preferred stock in July 2000.
The beneficial conversion feature was calculated at the issuance
date based on 10% discount on the closing bid price of the common
stock on the date of the closing.
F. During the period, 1,759,600 stock options were granted under VCI
Stock Option Plans, 233,280 options were exercised into shares of
common stock and 1,114,933 options were forfeited. Subsequent to
balance sheet date additional 195,892 options were forfeited.
G. 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. In September 2000 the
shareholders of the Company ratified an increase of 1,000,000
authorized shares under the plan for a total of 2,000,000 shares,
including the 500,000 approved by the Directors in March 2000.
Note 6 - DISCONTINUED OPERATION
In July 2000, the Company implemented a restructuring of its business
activities to focus primarily on developing and marketing software for Web
development and site management. In line with this new strategy, the
Company announced its intention to sell its portfolio of online
communities. The Company is currently seeking to enter into a transaction
that would transfer partial or complete ownership of its online
communities. It has also restructured its Internet technologies division
to focus on further development of Cortext software. As a result of this
restructuring, the Company reduced its editorial staff located in the
Company's New York and Jerusalem offices by approximately 50%. The Company
also terminated most of its marketing agreements related to the
communities and eliminated several technical, marketing and administrative
staff positions that supported the communities and other operations in New
York and Israel and shifted certain technical and administrative functions
to its Israeli subsidiary to achieve efficiencies.
13
<PAGE>
VIRTUAL COMMUNITIES, INC.
NOTES TO THE CONDENSED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
(U.S. dollars in thousands)
(Unaudited)
Note 6 - DISCONTINUED OPERATION (Cont.)
Accordingly, the online communities division has been accounted for as a
discontinued operation. The accompanying financial statements have been
restated to separately report the assets and operating results of these
discontinued operations. The loss from discontinued operations includes
estimated termination costs of approximately $365.
In connection with the restructuring and the discontinue of the online
communities division, the Company established a VCIX 2000 Corporate
Reorganization Severance Plan (the "Severance Plan"), effective as of July
24, 2000. The Plan was established to offer eligible employees of the
Company who suffer an involuntary termination of employment as a result of
the restructuring, the option to elect to receive severance pay and
additional benefits. The Plan is intended to constitute an "employee
welfare benefit plan" under Section 3(1) of the Employee Retirement Income
Security Act of 1974, as amended.
In addition, the Company enacted a Retention Plan to retain members of the
editorial staff of the communities for the purpose of ensuring that the
communities continue to be operated in an effective manner until such time
as the Company sells them or until operations are terminated. Employees
who receive the bonus are not eligible to receive severance payments under
the Severance Plan.
As a result of the restructuring and the discontinuation of the online
communities division, the Company will operate under one business segment.
Note 7 - SUBSEQUENT EVENTS
In November 2000, non-executive directors David Morris, Peter Jacobs
and Allan Dalfen resigned from the Company's Board of Directors.
14
<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 of content management
and Web publishing software and a publisher of ethnic communities targeted to
ethnic communities. Through its proprietary Community Management Solution (CMS),
the Company has also designed and developed for third parties web-based
communities CMS provides a 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.
The Company, a Delaware corporation formerly known as Heuristic
Development
15
<PAGE>
Group, Inc. ("HDG"), consummated a merger (the "Merger") with Virtual
Communities, Inc. ("VCI"), also a Delaware corporation, in October 1999. Prior
to the Merger, HDG was a development stage company organized to develop, design
and market fitness-related products. In 1999, HDG 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, the publishing of our own online communities and the licensing of
Cortext software. In March 2000, we merged this wholly owned subsidiary into the
parent company.
Based upon its experience in designing and developing online communities,
from Q3 1999 until recently the Company offered its Community Management
Solution ("CMS") Web site design and development services to third parties on a
fee for services basis. The Company sold four CMS Systems VCI also publishes
proprietary online communities: virtualjerusalem.com, virtualholyland.com,
virtualireland.com, www.virtualitaly.com and virtualindia.com, which were
developed by the Company between 1996 and 1999 and are designed to create a
comprehensive Web environment targeted to specific demographic profiles.
In July 2000, the Company implemented a restructuring of its business activities
to focus primarily on developing and marketing software for Web development and
site management. In line with this new strategy, the Company announced its
intention to sell its online communities. It also restructured its Internet
technologies division to focus on further development of Cortext software. As a
result of this restructuring, the Company reduced its editorial staff located in
its New York and Jerusalem offices by 50%.
In connection with the restructuring of its operations the Company
established a VCIX 2000 Corporate Reorganization Severance Plan (the "Plan"),
effective as of July 24, 2000. The Plan was established to offer eligible
employees of the Company who suffer an involuntary termination of employment, as
a result of the restructuring, the option to elect to receive severance pay and
additional benefits. The Plan is intended to constitute an "employee welfare
benefit plan" under Section 3(1) of the Employee Retirement Income Security Act
of 1974, as amended.
In connection with the restructuring, the Company also enacted a Retention
Plan to retain members of the editorial staff of the communities for the purpose
16
<PAGE>
of ensuring that the communities continue to be operated in an effective manner
until such time as the Company sells them or until such time as operations are
terminated.
Since November 2000, the Company has been unable to secure additional financing
and as a result, it has been unable to meet its outstanding financial
obligations and payables and those obligations of its VCIL Israeli operating
subsidiary. In an effort to reduce losses, it has curtailed its operations,
terminated almost all of its employees in its New York City offices and the
majority of employees at its Israeli operating facility. It has also ceased
operating payments to Cortext Ltd., a majority owned software developer in
Israel. The Company is currently engaged in attempting to sell its assets,
including its online communities and Cortra Site Studio software. The Company
has received offers for one of its online communities but there is no assurance
that it will reach agreement for the sale of the same nor whether proceeds of
the same will have a significant impact on the Company's and its VCIL
subsidiary's outstanding liabilities. Management, together with its secured
lenders, is also exploring the possibility of negotiating the sale of the
Company to a party that will assume the Company's liabilities. There is no
assurance that the Company will be successful in selling its assets or finding a
buyer prepared to assume such liabilities, and if not, the Company may be
required to cease operations. These matters raise substantial doubt about the
Company's ability to continue as a going concern.
Historical Results of Operations
Historical Comparison of Nine Months Ended September 30, 2000 and 1999
Revenues
Total revenues for the nine months ended September 30, 1999 and September
31, 2000 were $96,000 and $922,000, respectively. Revenues during the first nine
months of 1999 were generated primarily from our Online Communities and are
reflected in Discontinued Operations. CMS Services revenues commenced in the
third quarter of 1999. For the nine months ended September 30, 2000, all
revenues were generated from CMS Services. VCI entered into four CMS agreements.
CMS Services are considered, for accounting purposes, software products
and technology, and therefore, revenue from the sale of CMS Services 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.
Cost of Revenues
Cost of revenues consists primarily of salaries of the CMS and CSS support
teams and licensing fees for software licensed by the Company for use in the CMS
system. Costs of Revenues for the nine months ended September 30, 1999 and
September 30, 2000 were $104,000 and $1,654,000, respectively, as we entered the
CMS and CSS business toward the end of the third quarter of 1999..
Research and Development
During the nine months ended September 30, 2000, the Company recorded
$1,542,000 in research and development expenses in conjunction with the
Company's development of CSS for use by the Company as the central component of
its CMS system and in licensing to third parties. No Research and Development
expenses were incurred during the nine months ended September 30, 1999.
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Selling and Marketing
Selling and marketing expenses consist of salaries, travel expenses for
sales and marketing staff and marketing expenses incurred in promoting CMS
Services and CSS. Selling and Marketing expenses incurred during the nine months
ended September 30, 1999 and September 30, 2000, respectively, amounted to
$51,000 and $1,191,000, as the CMS sales activities were initiated toward the
end of the third quarter 1999.
General and Administrative
General and administrative expenses consist primarily of salaries and
legal and professional services. In addition, our rent, utilities and
administrative employee benefits are included in general and administrative
expenses. General and administrative expenses amounted to $1,176,000 and
$2,468,000 for the nine months ended September 30, 1999 and 2000, respectively.
This increase was primarily due to increased hiring of personnel; expansion of
office space; and, increased use of support services related to the expansion of
CMS operations and CSS development. In addition, legal fees increased
significantly for work related to special projects, new contract formation and
the acquisition of the Cortext subsidiary in February 2000.
Discontinued Operations
We recently announced our intention to sell the Online Communities. Thus,
from the second quarter 2000, financial results reflect the Online Communities
as Discontinued Operations. The financial results of all prior periods have been
restated accordingly. Losses from Discontinued Operations were $3,475,000 and
$1,240,000 for the nine months ended September 30, 2000 and 1999, respectively.
The reported losses include revenues of $571,000 and $500,000 for the nine
months ended September 30, 2000 and 1999, respectively. The overall increase in
reported losses reflects a significant expansion in the scope of the Online
Communities. Four of the five communities were completely redesigned and
relaunched during the first half of 2000. Increased personnel costs were
incurred as the sites added functionality and features. Marketing expenses also
expanded significantly during early 2000 to coincide with the launch of the new,
expanded sites, resulting in a significant increase in registered users and
traffic to the Online Communities. The loss from Discontinued Operations for the
ninemonths ended September30, 2000 also reflects the severance and retention
costs associated with the restructuring.
Liquidity and Capital Resources
Prior to 1999, we funded our operations, working capital needs and capital
expenditures primarily through private placements of our common stock, and the
issuance of short-term convertible loans and notes.
In February 1999, we received $815,000 in net proceeds from the sale of
9,550 shares of our series A preferred stock. At the same time we issued 5,000
shares of our series A preferred stock upon the conversion of a $500,000
convertible secured promissory note issued by us on December 31, 1998. Between
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June and September 1999, we received net proceeds of $874,000 from the sale of
10,325 shares of our series B preferred stock.
On December 14, 1999, we received a total of $985,400 for the private
placement sale to accredited investors of 400,000 shares of restricted common
stock and a three-year warrant, exercisable for 40,000 shares of common stock at
a purchase price of $2.46 per share. We made the private placement offering
under Section 4(2) of the Securities Act of 1933, as amended (the "Securities
Act"). The terms of the offering provided for issuance of the restricted common
stock at a purchase price equal to 35% below the market valuation of our
publicly traded common stock and the issuance of a warrant exercisable for the
purchase of one share of common stock for each ten shares purchased. The
warrants become exercisable six months after the date of issuance.
During the first quarter of 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 existing 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 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.
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. ("Intercoastal") for an
aggregate gross proceeds of approximately $3,000,000 (the "IFSC Financing"). 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 redeemable at the price of $c) 36,246 warrants exercisable for three
years at $5.80 per share to Josephthal & Company d) and 2,000,000 callable
warrants which were cancelled in July 2000.
In July 2000, the Company entered into a follow-on financing agreement
with several institutional investors in the IFSC Financing. Pursuant to the
financing agreement, the Company sold2,010 shares of Series C preferred stock in
twotranches. The first tranche, consisting of the conversion of the $1,000,000
loan made in June 2000 by one of the IFSC Financing investors, and $500,000 in
cash from a second investor, closed on July 28, 2000. The second tranche of
$500,000 derived from two additional institutional investors closed on August 8,
2000. The preferred stock is convertible for a period of three years into shares
of common stock at conversion prices as defined in the agreement. The Company
also issued to the IFSC investors three-year warrants exercisable into common
stock at $2.25 per share.
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The Company entered into a Registration Rights agreement with the
investors and investment bankers pursuant to which it must file, within 30 days
of the closing date, and get effective, within 90 days, a registration statement
with the Securities and Exchange Commission registering the securities issued in
connection with the preferred stock financing. The investors can force the
Company to redeem the preferred stock at 130% of the purchase price in the event
the common stock convertible from the preferred stock is not registered within
90 days.
From August through October 2000, the Company borrowed an aggregate of
$1,745,000 from an unaffiliated institutional investor. The short term loan,
which was converted into a Secure Loan in November 2000, was evidenced by a
Promissory Note in such amount. The loan earned interest at the rate of 12% per
annum and was secured by shares of the Company held by Roth Trust pursuant to an
Amended and Restated Guaranty Agreement and an Amended Pledge Agreement entered
into between the lender and Roth Trust.
In November 2000, the Company entered into a Secured Convertible Notes
Purchase Agreement with lenders of an aggregate of $1,745,000 in loans made to
the Company between August and October 2000. The secured loan is for three
years, bears interest at a rate of 10% per annum and is secured by all of the
shares of Cortext Ltd. held by the Company, which currently represents 60% of
the outstanding shares of Cortext Ltd. The secured loan is convertible at any
time at the option of the lenders into common stock of the Company at the lesser
of a) a fixed conversion rate which is between 110% and 120% of the closing bid
price of the common stock on the date of the closing and a floating conversion
rate which is 90% of the average closing bid price of the common stock for 20
days prior to the conversion of the loan. The Company may prepay the loan by
paying a prepayment penalty of 10% to 20% depending on the date of prepayment;
however, the lenders have five days to convert the loan upon the Company's
notice to them of its intent to prepay the secured loan.
In connection with the secured loan the Company entered into a
Registration Rights Agreement with the lenders whereby it agreed to register
200% of the shares convertible from the loan with the Securities and Exchange
Commission pursuant to a registration statement to be filed within 45 days from
the closing date and which must be effective within 120 days from the filing of
the same, the absence of which would constitute an event of default under the
agreement. The Company is also required to obtain shareholder approval of the
secured loan and failure to secure their approval constitutes an event of
default under the terms of the Promissory Note. Other events of default include
the Cortext stock held by the lender as security representing less than 51% of
the issued and outstanding shares of Cortext; the Company's delisting from
NASDAQ or OTC Bulletin Board and the default by the Company or Cortext of over
$25,000 of indebtedness aside from trade payables. The Company has three to
seven business days to cure an event of default.
Upon the closing of the secured loan, a promissory note and an Amended and
Restated Pledge Agreement and Amended and Restated Guaranty Agreement entered
into between the lenders and Roth Trust, a shareholder of the Company which
secured the promissory note with shares held by Roth Trust, were cancelled by
the lender.
In connection with the secured loan, the Company entered into a Release
and Amendment Agreement with purchasers of Series C Convertible Preferred Stock
of the Company who acquired such securities in July and August 2000 and a
Release Agreement with Intercoastal Financial
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Securities Corporation, which acted as the placement agent in connection with
the sale of such securities releasing the purchasers and Intercoastal from any
potential claims by the Company in connection with the Series C offering. In
addition, the Series C shareholders waived any payments by the Company due as a
penalty resulting from its failure to register the shares of common stock
convertible from the Series C Preferred Stock provided that the same is done
within 30 days from the date of the Release and the Company obtains
effectiveness of such registration statement within 60 days of filing such
registration statement.
The Company maintains an operating line of credit with Investec Clali Bank
in the amount of $560,000. As of September 30, 2000, the amount outstanding on
this line of credit totaled $555,000. Investec Clali Bank has also provided us
with a $58,000 guarantee for three months rent on the leaseholds occupied by
Virtual Communities Israel, Ltd.
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, which we
subsequently returned to the landlord as of September,. 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 $39,000 in quarterly leasehold costs which payments
commenced in December 1999. In January, March and June 2000, VCIL exercised
options for additional space for which the quarterly leasehold costs are
approximately $29,000 per quarter As of October 15, 2000 the Company has
subleased this additional space for $51,000 per quarter. In addition, the lessor
of the Jerusalem premises is contributing $354,000 in build out costs that VCIL
is obligated to repay over the course of the lease term, of which $293,000 was
the outstanding balance as of September 31, 2000. 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. Although VCIL believes that it will be able to
sublet such space, our management cannot assure you that it will be successful
in doing so, and in the event such space cannot be sublet, we would be obligated
to pay approximately $15,000 in quarterly leasehold fees in addition to the
lease costs for our new premises until December 2001.
Given our recently announced change in strategic direction to focus on the
licensing of CSS technology, we anticipate that future capital expenditure
levels will be significantly less than previous expenditure levels.
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Since November 2000, the Company has been unable to secure additional
financing and as a result, it has been unable to meet its outstanding financial
obligations and payables and those obligations of its VCIL Israeli operating
subsidiary. In an effort to reduce losses, it has curtailed its operations,
terminated almost all of its employees in its New York City offices and the
majority of employees at its Israeli operating facility. It has also ceased
operating payments to Cortext Ltd., a majority owned software developer in
Israel. The Company is currently engaged in attempting to sell its assets,
including its online communities and Cortra Site Studio software. The Company
has received offers for one of its online communities but there is no assurance
that it will reach agreement for the sale of the same nor whether proceeds of
the same will have a significant impact on the Company's and its VCIL
subsidiary's outstanding liabilities. Management, together with its secured
lenders, is also exploring the possibility of negotiating the sale of the
Company to a party that will assume the Company's liabilities.
The Company is currently evaluating the value of its tangible and
intangible assets, which might result in a write down of assets in the
subsequent quarter.
There is no assurance that the Company will be successful in selling its
assets or finding a buyer prepared to assume such liabilities, and if not, the
Company may be required to cease operations.These matters raise substantial
doubt about the Company's ability to continue as a going concern. The Company's
auditors issued a qualified opinion in connection with the Financial Statements
as of December 31, 1999, and have advised management that if circumstances do
not improve, a qualified opinion would be issued for the current year as well.
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. 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. The Company filed a
motion to dismiss the action, which was denied by the Court in October 2000. The
Company continues to believe that the complaint is without merit and intends to
vigorously defend such action.
In August 2000, a complaint was filed in the Civil Court of the City of New York
against the Company by a placement agency claiming referral fees for the
placement of three employees in the Company's New York City offices who were
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subsequently terminated by the Company. The Company intends to defend such
action.
In July 2000, a complaint was filed in the Los Angeles Superior Court
against the Company and a placement agency retained by the Company by a former
employee of the Company claiming wrongful termination of employment and
reinstatement of his position with the Company as well as compensatory and
punitive damages. The Company believes that the complaint is without merit and
intends to vigorously defend such action.
Part II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
In November 2000, the Company converted Promissory Note made by the Company from
August through October 2000 in favor of Gilston Corporation aggregating
$1,745,000 into a three-year loan bearing interest at the rate of 10% per annum
and secured by the Company's 60% interest in Cortext Ltd. The loan is
convertible at any time at the option of the lenders into common stock of the
Company at the lesser of a) a fixed conversion rate which is equal to 110% to
120% of the closing bid price of the Common Stock on the date of the Closing and
b) a floating conversion rate which is equal to 90% of the average closing bid
price of the common stock for the 20 days prior to the conversion. Pursuant to
the loan the Company is obligated to register the shares convertible from the
loan for resale pursuant to a registration statement which must be filed within
45 days from the date of the loan and which registration statement must be
effective within 120 days from the filing thereof. The Company is entitled to
prepay the loan upon payment of a prepayment penalty equal to 10% to 20% of the
loan principal provided the lenders do not choose to convert the loan upon the
Company's notice to them of the Company's election to prepay the loan.
Item 5. Other Information
In November 2000, as a result of its inability to secure new financing following
the completion of the Secured Loan, the Company significantly curtailed its
operations and effectuated a layoff of almost all of the Company's employees in
its New York City office and most of the employees at the Company's VCIL
software development subsidiary in Jerusalem. The Company is attempting to raise
funds to satisfy its obligations by selling certain of its assets, including its
online communities and its Cortra Site Studio software. The Company may be
obliged to cease operations if immediate financing cannot be obtained. There can
be no assurance that the Company will be successful in obtaining such financing.
In addition, in November 2000, non-executive directors David Morris, Peter
Jacobs and Allan Dalfen resigned from the Company's Board of Directors. The
Company's current remaining director is Avi Moskowitz, the Company's President
and CEO.
Item 6. Exhibits and Reports on Form 8-K
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EXHIBITS
Exhibit No. Description of document
----------- -----------------------
10(52) Secured Convertible Notes Purchase Agreement by and among Virtual
Communities, Inc. and Gilston Corporation and Acqua Wellington Value Fund dated
November 3, 2000.
10(53) Registration Rights Agreement by and among Virtual Communities, Inc. and
Gilston Corporation and Acqua Wellington Value Fund dated November 3, 2000.
10(54) Pledge Agreement by and among Virtual Communities, Inc. and Gilston
Corporation and Acqua Wellington Value Fund dated November 3, 2000.
10(55) Secured Convertible Notes issued by Virtual Communities, Inc. to Gilston
Corporation and Acqua Wellington Value Fund dated November 3, 2000.
10(56) Release and Amendment Agreement by and between Virtual Communities, Inc.
and Purchasers of the Series C Convertible Preferred Stock dated November 3,
2000.
10(57) Release Agreement by and among Virtual Communities, Inc. and Intercoastal
Financial Services Corporation dated November 6, 2000.
REPORTS ON FORM 8-K
None.
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: November 20, 2000 by: /s/ Avi Moskowitz
------------------------------
Avi Moskowitz, President
(Principal Executive Officer)
Date: November 20, 2000 by: /s/ Arthur Dubroff
------------------------------
Arthur Dubroff, CFO
(Principal Financial Officer)
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