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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark one)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE FISCAL YEAR ENDED JANUARY 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934. (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM __________ TO _________
Commission file number: 00025397
VIRTUAL TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1639011
(State or other jurisdiction (IRS Employer Identification Number)
of incorporation)
3100 WEST LAKE STREET
SUITE 400
MINNEAPOLIS, MN 55416
(Address of Principal Executive Offices)
(612) 915-1122
(Registrant's Telephone Number, Including Area Code)
Securities to be registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par
value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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 [ ] No [ X ]
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss. 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]
At April 30, 1999, the last practicable date, the aggregate market value of the
voting and non-voting common equity held by non-affiliates of the registrant
was: $42,460,074
At April 30, 1999, the number of shares outstanding of each of the registrant's
classes of common stock was: 27,860,304
Documents incorporated by reference
(1) Not Applicable
(2) Not Applicable
(3) Not Applicable
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for certain forward-looking statements. This Registration Statement on Form 10-K
contains forward-looking statements, which reflect the Company's views with
respect to future events and financial performance. These forward-looking
statements are subject to certain risks and uncertainties, including those
identified below, which could cause actual results to differ materially from
historical results or those anticipated. The words "aim," "believe," "expect,"
"anticipate," "intend," "estimate" and other expressions which indicate future
events and trends identify forward-looking statements. Actual future results and
trends may differ materially from historical results or those anticipated
depending upon a variety of factors, including, but not limited to: the
Company's ability to successfully and profitably integrate GTI into the
Company's business operations, competition in the Internet resale of computer
products, the Company's vendor relationships, the Company's ability to obtain
additional equity or debt financing on acceptable terms in order to finance its
planned growth and to retire the debt incurred in connection with the GTI
acquisition and the impact of Year 2000 issues on the Company and its
operations.
PART I
ITEM 1. BUSINESS.
(A) GENERAL DEVELOPMENT OF BUSINESS
In June 1996, International Gold Marketing, Inc., ("IGM"), a Minnesota
corporation, acquired all the outstanding shares of Network Storage Corporation
("NSC"), a Minnesota corporation formed in February 1996 and changed its name to
Virtual Technology Corporation ("VTC" "Virtual-World", "VW" or the "Company").
IGM was a publicly traded company listed on the OTC Bulletin Board and was
originally incorporated in March 1966 as MarSan Inc. Since the acquisition and
name change, the Company has traded on the OTC Bulletin Board under the symbol
VTCO.
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At the time of the NSC acquisition, IGM was a non-operating entity. NSC
was in the business of providing an online data storage system via the Internet
with a software product known as Virtual Storage.
In October 1996, VTC acquired Ashmount Research Ltd. ("ARL"), a private
London-based software firm. VTC then launched a web site for commercial
marketing of Ashmount's Virtual Access email and newsgroup software. Although
the Virtual Access marketing campaign was not economically successful,
management generated up to 1 million "hits" of traffic to its Internet site.
Realizing that VTC had gained experience at learning which internet advertising
sites could drive traffic to VTC's own web site, management refocused the
Company's business on electronic commerce ("e-commerce" or "E-Comm" ).
Specifically, VTC's internal customer research indicated a symbiosis between the
buyers visiting the Company's web site for software products and the type of
technology those buyers were interested in.
Concluding that sophisticated computer users seek speed, power, and
graphics in their latest technology and upgrades, VTC identified sources for
such products and enhanced and launched its E-Comm site, virtual-world.com, in
October 1997. Consistent with its change of business strategy, VTC sold the
Virtual Access software source code, rights and licenses in July 1998 to
Atlantic Coast, a British company, for approximately $15,000.
In January 1999, as part of the Company's efforts to expand both its
product offerings through its e-commerce operations and to diversify its
operations, the Company, through a wholly-owned subsidiary, acquired
substantially all of the assets and assumed certain liabilities of Herold
Marketing Associates, Inc., dba Graphics Technologies, Inc. ("GTI"). Greg
Appelhof, VTC's President and Chief Executive Officer, formerly was with GTI for
11 years, most recently as Vice President of Sales.
The purchase price was $10.1 million (subject to certain post-closing
adjustments), paid as follows: $1.0 million at closing, $1.6 million payable by
the issuance of 228,571 shares of the Company's restricted Common Stock, subject
to resale under Rule 144 of the Securities Act of 1933, as amended (the "Act");
$4.0 million payable by a non-interest bearing promissory note of GTI due
February 27, 1999; $3.3 million payable by a non-interest bearing promissory
note from the Company due April 28, 1999 and $200,000 placed into escrow to be
held for three years to secure certain post-closing purchase price adjustments
and indemnification obligations. The Company simultaneously entered into a
three-year consulting agreement with Stephan Herold, GTI's Chairman and founder,
in consideration of 145,000 shares of the Company's Common Stock valued at $1.0
million. The Company has agreed to register the resale of such shares under the
Act as soon as practicable. Mr. Herold has agreed not to compete against the
Company for three years. The Company has repaid the $4.0 million promissory
note and $2.7 million of the $3.3 million promissory note, deducting certain
anticipated post-closing adjustments which the Company believes will be
finalized shortly.
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(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company operated in only one business segment through the end of fiscal
1999. As a result of the GTI acquisition, the Company will operate in two
business segments in fiscal 2000 and beyond.
(C) NARRATIVE DESCRIPTION OF BUSINESS
VTC is the parent of two complimentary business units: Virtual-World.com
and GTI. Both units provide computer manufacturers with channels to deliver
their products to the end consumer. Virtual-World provides products to the end
user by purchasing products directly from manufacturers or from distribution
partners. GTI provides manufacturers with a distribution channel to sell their
products to dealers, resellers,value-added resellers ("VARs") and integrators
who then sell them to the end user. Virtual-World management directs the overall
business and provides integration and leadership to the two business units.
BUSINESS OVERVIEW
Virtual-World is an Internet retailer of high performance computer
hardware, software and peripheral products to sophisticated computer and
Internet users. Through its E-Commerce web site at www.virtual-world.com, the
Company offers more than 42,000 units of selective high-performance, brand name
computer equipment. Such web site and its contents are expressly not
incorporated by reference into this Form 10-K. Virtual-World offers an online
specialized store that is intended to provide one-stop shopping for its targeted
domestic and international customers, 24 hours a day, seven days a week.
Virtual-World's online store features a fun, easy-to-navigate interface,
competitive pricing, extensive product information and powerful search
capabilities.
GTI is a leading distributor of computer peripheral equipment to wholesale
and retail outlets throughout the United States and Canada. GTI specializes in
high performance computer equipment, computer integrated systems design and the
assembly and sale of complete computer systems. GTI purchases products directly
from more than 45 manufacturers of computer related products, and maintains a
stocking inventory of approximately 1,600 products.
GTI also has built an active base of over 1,000 customers. GTI's customers
are primarily focused in four areas: corporate resellers, government sales to
state and federal agencies, VARs and integrators which concentrate on complete
desktop solutions. GTI provides its customers with computer peripheral equipment
from industry leaders, such as Hitachi, Matrox, Viewsonic, Mitsubishi, ATI,
Phillips, Cornerstone, Oki Data, InFocus, Mag and Mag Portables, Pioneer, NANAO,
CTX, Ezol and Panasonic. The products distributed by GTI include monitors,
printers, scanners, portables, CD-ROM drives, power protection, video
accelerators, graphic controllers, UPS back-up, projectors, digital cameras and
miscellaneous peripherals and software.
Complementing its distribution business, GTI also offers its customers
value-added services, such as consultative and solution oriented selling,
compatibility testing, integration and configuration services and post-sales
support. GTI believes it differentiates itself from many competitors by
promoting GTI's value-added services through
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competitive pricing and face-to-face selling.
INDUSTRY
VIRTUAL-WORLD AND THE E-COMMERCE INDUSTRY
The Internet is an increasingly significant global medium for
communication, information and commerce. VW believes that growth in Internet
usage and web commerce has been fueled by a number of factors, including (i) a
large and growing installed base of PCs in the workplace and home, (ii) advances
in the performance and speed of PCs and modems, (iii) improvements in network
infrastructure, (iv) easier and cheaper access to the Internet and (v) increased
awareness of the Internet. International Data Corporation ("IDC"), a market
research firm, has estimated that there were 69 million web users worldwide at
the end of 1997 and anticipates that number will grow to approximately 320
million by the end of 2002. In addition, IDC estimates that the total value of
goods and services purchased over the Internet will grow from $12 billion in
1997 to approximately $425 billion by the end of 2002.
VW believes that its target market represents an attractive and rapidly
growing segment of the E-Commerce industry. According to Jupiter, a market
research firm, domestic online consumer purchases of goods and services
(excluding cars and real estate) are expected to grow from an estimated $2.6
billion in 1997 to approximately $37.5 billion by 2002. Jupiter also estimates
that the single largest web retail opportunity for the consumer and small
office/home office market is online sales of computer products (including
hardware, software and consumer electronics). By 2002, the online market for
computer products is estimated to reach approximately $10.5 billion in the
United States alone, which compares to an estimated domestic online market for
travel, books and music of $8.6 billion, $2.2 billion and $1.2 billion,
respectively. IDC estimates the worldwide consumer and small office/home office
end market for computer hardware alone (excluding peripherals) will grow from
approximately $50 billion in 1997 to approximately $80 billion in 2001.
GTI AND THE COMPUTER WHOLESALE DISTRIBUTION INDUSTRY
Wholesale distribution has proven to be well-suited for manufacturers
of computer products. The large number and diversity of resellers makes it cost
efficient for manufacturers to rely on wholesale distributors to assume
responsibility for at least some portion of their distribution, credit,
marketing and support requirements. Similarly, due to the large number of
computer product manufacturers, VARs (which integrate proprietary software with
products provided by manufacturers and distributors), computer resellers,
traditional resellers and integrators often cannot establish direct purchasing
relationships. Instead they rely on wholesale distributors, such as GTI, to
satisfy a significant portion of their product and marketing needs.
Management believes that the growth of the wholesale distribution
segment of the computer industry has been driven by four principal factors.
First, as a result of the use of open systems and off-the-shelf components,
hardware products are increasingly viewed as commodities. The resulting price
competition, coupled with
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rising selling costs and shorter product life cycles, make it difficult for
manufacturers to efficiently sell directly to resellers and has prompted them to
rely on more cost-efficient methods of distribution. Second, customers are
increasingly relying on wholesale distributors, such as GTI, for inventory
management and flexible customer financing, rather than stocking large
inventories themselves and maintaining credit lines to finance working capital
needs. Third, restrictions by certain major manufacturers on sales through
wholesale distributors were gradually eased, commencing in 1991. Since the
beginning of 1995, GTI has been able to sell certain products of those
manufacturers under more competitive terms and conditions ("open-sourcing").
Management believes that this has substantially reduced the advantage that
certain aggregators had over distributors such as GTI. Open-sourcing has also
contributed to price competition and margin decline in the industry. Fourth,
consolidation in the wholesale distribution industry continues as access to
financial resources and economies of scale become more critical.
STRATEGY
VW STRATEGY
VW's objective is to operate the premier Internet web site for speed,
power and graphics through its innovative and focused marketing strategy, depth
of product selection, competitive pricing and high quality content. VW's niche
market focus is based upon the premise that consumers are generally overwhelmed
by the information available to them through different media, including the
Internet. Research conducted by IDC has found that people searching for
information about computer hardware and software generally have a very difficult
time even getting close to articles about the products they care about. By
offering consumers an array of selective, high-performance brand name computing
equipment, easy navigation, around the clock shopping convenience and
competitive pricing, VW believes it can achieve a preeminent niche position
among computer retailers. Key elements of VW's strategy include the following:
- - Niche-Oriented Strategy. A number of traditional computer retailers and
manufacturers have created web sites to sell various computer equipment
over the Internet. However, most of these sites are targeted towards the
mass market, much like the phenomenon observed in the physical retail
world. VW's strategy is to target sophisticated computer and Internet
users who demand high performance from their systems and are
constantly seeking upgrades for their equipment.
- - Product Availability. VW believes that its targeted customers
have varied and unique needs for computer hardware and software products.
Through VW's affiliation with Ingram, Tech Data and other suppliers, VW
offers what management believes to be a
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broad product mix. By its acquisition of GTI, the Company intends to
further leverage its buying power to increase the number of available
products.
- - Favored Demographics. VW's initial target market is comprised of
individuals who are 26 years of age or older, predominately male, well
educated and are proficient with computers and the Internet. According to
New Century Network's reader survey, over 55% of these Internet users have
an annual household income of over $50,000 and are twice as likely to
purchase over the Internet than the average Internet user.
- - Web-Based and Traditional Advertising. VW utilizes aggressive
online advertising to promote both its brand name and specific
merchandising opportunities on a wide variety of web sites, including major
content and service providers, targeted computer-related sites and niche,
special interest sites. As VW grows, it also intends to advertise in trade
journals and magazines that are typically read by its targeted customers.
- - Linking and Affiliate Programs. To direct traffic to its web site, VW
has created inbound links that connect directly to virtual-world.com from
other sites on the web. These links allow potential customers to simply
click on the link to become connected to VW's web site. In addition, VW is
developing private web sites for various user groups. For example, VW has
entered into arrangements with the University of Minnesota and with the
Minnesota Service Cooperatives, a group comprising all of Minnesota's
elementary schools, to develop proprietary web sites offering hardware and
software products at special pricing for school students and faculty.
GTI STRATEGY
To maintain and expand its position in wholesale distribution, GTI's
business strategy includes the following main elements:
- - Expand Customer Focus. GTI has historically focused its marketing on
corporate resellers, government sales, VARs and integrators and intends to
expand its customer base. GTI considers the corporate reseller market
particularly attractive because its customers source products almost
exclusively from distributors and is believed to be one of the fastest
growing segments of the computer industry. Moreover, management believes
that this will remain one of the fastest growing segments of the industry
as businesses of all sizes increasingly rely on corporate resellers.
GTI also seeks to increase its market share with fast growing retailers and
computer superstores, as well as with VARs and integrators. In particular,
GTI is aware of the growing integration industry and that industry's need
for a variety of computer peripheral products. Management believes that
supplying its existing integration customers with all of their computer
products will enable it to increase its market share through expanded sales
to its existing customer base. In addition, GTI seeks to attract new
integration customers through its competitive pricing, high performance and
efficient delivery.
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- - Expand Relationships with Existing Customers. GTI credits its strong
customer relationships to its continued focus on providing its customers
with knowledgeable account executives who meet directly with the customer,
competitive pricing, a broad range of computer related products, efficient
product delivery and on-going customer support. Currently GTI is seeking to
expand its relationships with existing customers through program-selling:
i.e., determining what its clients want and need and then working in
conjunction with various manufacturers to design a program which meets the
needs of each individual client. In addition, GTI seeks to expand its
existing customer relationship by introducing more of its products to its
customers who currently purchase only a portion of their computer products
from GTI. Through marketing its product line as well as its value-added
services to its current customer base, GTI believes it will be able to
enhance and develop its existing customer relationships. This has the
advantage of enabling GTI to increase its revenues without having to incur
significant advertising and marketing expenses, as well as avoiding the
need to employ additional account executives to solicit new customers.
- - Expand In-House Integration. GTI is aware of the growing importance of
integrators in the computer industry and intends to expand its in-house
integration department. Currently GTI's integration service is limited to
one integration center in Phoenix, Arizona which configures selected
computer products to meet the client's individual needs. GTI also intends
to develop relationships with resellers who can purchase GTI's integrated
product for final sale to their customers. Moreover, GTI plans on expanding
its integration work through its existing customer base by taking advantage
of outsourcing opportunities. The expansion of these opportunities will be
a direct result of developing key relationships with key resellers that
provide contact opportunities for ongoing business and developing
integration products for targeted niche markets.
- - Broaden Product Mix. GTI offers its customers a broad assortment of
leading technology products. Currently GTI offers over 1,600 products from
more than 45 vendors. By offering an even broader product assortment, GTI
believes it can benefit from its customers' increasing desire to more
efficiently procure product from a reduced number of direct vendor
relationships.
- - Expand Market Share and Geographic Growth. GTI's plan is to utilize its
financial and industry positions to continue to expand its business
internally and through possible acquisitions, by adding new product lines,
increasing market share through
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competitive pricing, providing additional value-added services and
expanding internationally.
TECHNOLOGY
The Company has implemented a broad array of site management, search,
customer interaction, transaction-processing and fulfillment services systems
using a combination of its own proprietary technologies and commercially
available, licensed technologies. The Company's current strategy is to license
commercially available technology whenever possible rather than seek internally
developed solutions. VW intends to focus its efforts primarily in enhancing and
promoting its web site.
VW hosts its web site in an Exodus facility, located in Sterling, VA.
VW currently employs four individuals to design and maintain its
virtual-world.com web site. In addition, VW uses Exodus' National Network for
its web site back-up.
Exodus provides VW access to high-capacity, dynamic and dedicated
Internet connectivity through a complete range of commercial strength bandwidths
on Exodus' high-performance national network. Management believes that Exodus'
high performance national network is fast, reliable and scalable. It combines
key components that are critical to the operation of a state-of-the-art Internet
service: a high capacity national backbone, a 24 hour Network Operating Center
(NOC) and superior engineering support services including proactive monitoring
to isolate and identify problems before they affect the network of hosting
systems. The national network of Fiber-optic OC-3 and DS-3 connections link key
public and private points including MAE-East, MAE-West among many others from
New York to Seattle.
In January 1999, VW and Ingram, a major supplier to VW, jointly developed
and implemented a system to fully integrate the front and back office functions
of the two companies. The system is intended to provide for a seamless
throughput of customers' orders, credit authorization, posting of the sale in
the accounting system and placing the order with the "least-cost" supplier, all
within 30 seconds of each sale. This system utilizes Secure Socket Layer (SSL)
technology of the HTTP protocol for all transactions involving credit card
information. Utilizing this standard and CyberSource IVS technology, VW protects
against fraudulent transactions. The system is designed to enable real-time
price and availability from the least cost vendor and to facilitate "one-click"
ordering, processing and fulfillment.
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VW PRODUCTS AND SERVICES
Because most of VW's "shelf space" is low-cost and essentially unlimited,
VW offers a broad selection that would be economically or physically impractical
to stock in a store or to include in a typical mail-order catalog. VW currently
offers more than 42,000 hardware, software and peripheral SKUs. VW's product
selection includes computer hardware such as PC desktops and laptops, personal
digital assistants ("PDAs"), printers, modems, memory and accessories, packaged
software for both home and office use, games and utilities. These products are
produced by a wide variety of manufacturers that include IBM, Toshiba, Hewlett
Packard, 3Com, Connectix, Intel, Symantec, Epson, Electronic Arts, Acer, Compaq
and Broderbund.
VW offers its customers on-site service for most products in the United
States. For a nominal fee based upon the amount of purchase, the consumer may
extend the manufacturer's warranty to provide on-site service at the customer's
home or office location. VW contracts with several third party vendors to
provide such service. VW generally guarantees a service call within 24 hours in
most metropolitan areas.
VW believes its web site is attractive, easy to navigate and offers
distinctive competitive advantages. The user interface is simple, yet
professional and straightforward, designed to cater to the knowledgeable
technology consumer. Consumers may browse the vast database of over 42,000 items
or may selectively search and view technical "notes" or product specifications
as desired prior to purchasing online. Once a product has been selected, the
consumer may simply click on the item, which then goes into a "shopping cart" to
be added to other items until the consumer's shopping trip is complete. All of
VW's products may be reviewed and purchased "online" without having to go to a
retail location. VW provides graphic detail of products along with manufacturer
specifications.
VW has embarked on an initiative to implement "one click" purchasing.
Management believes that this initiative will enable increased sales due to
minimizing the information the consumer will have to key in to make a purchase.
Under the "one click" system, once a product is selected, a credit card holder
may only have to input their four-digit access number or a password in order to
provide VW with all of the pertinent purchasing information. The "one click"
system will directly interface with VW's e-commerce system to perform all the
processes in the background, transparent to the consumer, to place an order.
VW enters into special agreements from time to time directly with
manufacturers to provide value added packages or special bargains. VW is
currently working with manufacturers to establish cooperative marketing
agreements whereby VW would receive funds from the manufacturers to reimburse VW
for some marketing costs.
VW offers a free shipping program for the domestic USA that it believes has
been favorably received. Overseas orders are shipped and fulfilled via Ingram,
which acts as VW's customs agent and processor. Overseas orders are handled the
same as domestic orders, and the process of delivery is transparent to the
customer as well as VW. Invoices and packing slips reflect VW's name so the
customer can immediately identify VW as the shipper.
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Currently, VW encourages customers to phone in and use VW's inbound
call center Monday through Friday from 7:30 a.m. - 7:30 p.m. and Saturday from
9:00 a.m. to 2:00 p.m, Central Time. VW believes that having the opportunity to
speak with a customer enhances the likelihood that the customer will increase
the size of the order and that the price point of the average sale will also
increase. VW, by design, does not have an automated inbound call system. VW's
philosophy is that consumers have the ability to buy online or via an automated
transaction at any time. The assumption is that, once the customer has called,
he or she has made the decision to speak with someone directly at VW for
support. VW's objective is to expedite that request and not subject the consumer
to further automation or digital routing systems. VW augments its customer
service systems with various tracking software and contextual reference
databases. Customers may track shipments via Federal Express or United Parcel
Service directly through VW's web site or via hot links to the respective
shippers' sites.
VW's does not consider its backlog of orders material to an
understanding of its business. No single customer accounted for 10% or more of
VW's net sales during fiscal 1999, 1998 or 1997.
GTI PRODUCTS AND SERVICES
GTI sells more than 1,600 computer products in systems and peripherals
purchased directly from manufacturers in large quantities for sale to an active
customer base of more than 1,000 corporate resellers, VARs, integrators and
resellers. GTI pursues a strategy of expanding its product line to offer its
customers a broad assortment of products.
GTI's VAR customers typically do not have the resources to establish a
large number of direct purchasing relationships or stock significant product
inventories. These resellers generally rely on distributors as their principal
source of computer products and financing. Corporate resellers and resellers, on
the other hand, often establish direct relationships with manufacturers for
their more popular products, but utilize distributors for slower-moving products
from numerous smaller manufacturers and for fill-in orders of fast moving
products. GTI does not consider its backlog of orders material to an
understanding of its business. No single customer accounted for 10% or more of
GTI's net sales during 1998, 1997 or 1996, except Entex, a large VAR, who
accounted for 24%, 33% and 20% of GTI's net sales, respectively in 1998, 1997
and 1996.
DISTRIBUTION
VW DISTRIBUTION
VW uses alliances with Ingram Micro, Inc. ("Ingram") and Tech Data
Corporation ("Tech Data") to provide the Company with a "virtual inventory" of
hardware and software products for its site. The Company also sources products
through GTI. As a result, except for its relationship with GTI, VW carries no
inventory of products and relies on its suppliers to fulfill customers'
orders. In addition to providing a "virtual inventory" and order fulfillment for
VW, GTI, Ingram and Tech Data also provide VW with shipping and post-sale
customer support.
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VW utilizes a secure server to process all customer orders. After a
customer enters an order, an email is sent to the customer confirming the
purchase. Once the credit card information is authenticated, the order is
forwarded to one of VW's suppliers. In stock orders that are placed before 5:00
p.m. (Pacific Time) are generally shipped within 24 hours. An email confirmation
is sent to the customer immediately following the shipment of the products.
Customers may check the shipping status and the inventory availability directly
through the web site. VW's transaction-processing system is integrated with its
accounting and financial system through a common Microsoft Access-based
database. The integrated system allows management to more effectively manage its
operations.
GTI DISTRIBUTION
GTI delivers products throughout the United States and Canada from its
four distribution centers in Minneapolis, Minnesota, Boston, Massachusetts, San
Francisco, California and Phoenix, Arizona. The distribution network will expand
to meet the demand from key customers and to ensure the cost competitiveness of
GTI.
VENDOR RELATIONS
VW VENDORS
VW has formed alliances with Ingram, Tech Data and GTI to provide VW
with a "virtual inventory" of hardware and software products. These three
entities provide order fulfillment, shipping, and post sale customer support.
Ingram is a leading wholesale distributor of computer-based technology
products and services worldwide. Ingram markets computer hardware, networking
equipment, and software products to more than 100,000 reseller customers in more
than 120 countries. As a wholesale distributor, Ingram markets its products to
resellers as opposed to marketing directly to end-user customers. Ingram offers
one-stop shopping to VW by providing a comprehensive inventory, which in the
aggregate on a global basis, consists of more than 145,000 products (as measured
by distinct manufacturer's part numbers) from over 1,400 suppliers, including
most of the computer industry's leading hardware manufacturers, networking
equipment suppliers and software publishers. Ingram's broad product offerings
include: desktop and notebook PCs, servers, and workstations; mass storage
devices; CD-ROM drives; monitors; printers; scanners; modems; networking hubs,
routers, and switches; network interface cards; business application software;
entertainment software; and computer supplies.
Tech Data is the world's second largest distributor of computer
hardware and software products to VARs, corporate resellers, retailers and
direct
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marketers. Tech Data distributes products throughout the United States, Canada,
Latin America, Germany, France, Switzerland and Austria. Tech Data purchases its
products directly from more than 900 manufactures of computer hardware and
publishers of software in large quantities, maintains a stocking inventory of
more than 45,000 products and sells to an active base of over 70,000 customers.
Tech Data provides VW with leading products including systems,
peripherals, networking, and software. Tech Data offers products from
manufacturers and publishers such as Bay Networks, Cisco, Compaq, Corel,
Creative Labs, Digital Equipment, Epson, Hewlett-Packard, IBM, Intel, Microsoft,
Novell, Okidata, Seagate, Symantec, 3Com, Toshiba, Viewsonic and Western
Digital. Tech Data generally ships products the same day the orders are received
from regionally located distribution centers.
GTI VENDORS
Due to the proliferation of relatively small VARs and computer dealers
which purchase a limited volume of products from any single manufacturer, it is
more cost efficient for most manufacturers to rely upon distributors, such as
GTI, rather than to maintain their own sales forces to market, distribute and
support products. GTI's industry position has enabled it to obtain contracts
with most leading manufacturers. In addition, the advent of open-sourcing has
enabled GTI to cost effectively sell the products of certain major manufacturers
to customers which it had previously been restricted from servicing.
GTI purchases products directly from more than 45 manufacturers,
generally on a nonexclusive basis. Management believes that GTI's vendor
agreements are in the form customarily used by each manufacturer and typically
contain provisions which allow termination by either party upon 60 days notice.
Such agreements generally contain stock rotation and price protection provisions
which reduce, in part, GTI's risk of loss due to slow-moving inventory, vendor
price reductions, product updates or obsolescence. Virtually none of GTI's
supplier agreements require it to sell a specified quantity of products or
restrict GTI from selling similar products manufactured by competitors.
Consequently, GTI has the flexibility to terminate or curtail sales of one
product line in favor of another product line as a result of technological
change, pricing considerations, product availability, customer demand and vendor
distribution policies.
From time to time, the demand for certain products sold by GTI exceeds
the supply available from the manufacturer. GTI then receives an allocation of
the products available. Management believes that GTI's ability to compete is not
adversely affected by these periodic shortages and the resulting allocations.
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TRADEMARKS AND PROPRIETARY RIGHTS
The Company does not have federal or state trademark registration of
its corporate or web site name or its "V" logo. There are many companies
throughout the United States that use the words "virtual technology" in their
name. In addition, the Company recently received correspondence challenging the
Company's right to use its "V" logo. In light of these potential conflicts, the
Company is considering a change in its corporate name and logo. Any change will
cause the Company to incur substantial expense and goodwill in promoting a new
name and logo and in abandoning the use of its old name and logo. Even if the
Company selects a new name and logo, there can be no assurance that the steps
taken by the Company to protect its proprietary rights will be copyrights,
trademarks, trade dress and similar proprietary rights. In addition, there can
be no assurance that other parties will not assert infringement claims against
the Company.
COMPETITION
VW COMPETITION
The online commerce market is new, rapidly evolving and intensely
competitive. Current and new competitors can launch new sites at a relatively
low cost. In addition, the computer products retail industry is intensely
competitive. VW currently or potentially competes with a variety of other
companies.
These competitors include:
(i) various traditional computer retailers, including CompUSA and
MicroCenter;
(ii) various mail-order retailers, including CDW, MicroWarehouse,
Insight, PC Connection, and Creative Computers;
(iii) various Internet-focused computer retailers, including
Egghead.com, software.net Corporation, NECX Direct, and Cyberian
Outpost;
(iv) various manufacturers that sell directly over the Internet,
including Dell, Gateway, Apple and many software companies;
(v) a number of online service providers, including America Online
and the Microsoft Network that offer computer products directly
or in partnership with other retailers;
(vi) some non-computer retailers, such as Wal-Mart, that sell a
limited selection of computer products in their stores;
(vii) computer product distributors that may develop direct channels to
the consumer market; and
(viii) various resellers in the business to business segment.
Increased competition from these and other sources could require VW to
respond to competitive pressures by establishing pricing, marketing and other
programs or seeking out additional strategic alliances or acquisitions, any of
which could have a material adverse effect on the business, prospects, financial
condition and results of operations of the Company.
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VW believes that the principal competitive factors in its market are
brand recognition, selection, price, variety of value-added services, ease of
use, site content, fulfillment, reliability, quality of search tools, customer
service and technical expertise. Many of VW's current and potential competitors
have longer operating histories, larger customer bases, greater brand
recognition and significantly greater financial, marketing and other resources
than VW. In addition, online retailers may be acquired by, receive investments
from or enter into other commercial relationships with larger, well-established
and well-financed companies as use of the Internet and other online services
increases. VW is aware that certain of its competitors have and may continue to
adopt aggressive pricing or inventory availability policies and devote
substantially more resources to web site and systems development than VW.
Increased competition may result in reduced operating margins, loss of market
share and a diminished brand franchise, any of which would have a material
adverse effect on VW. Moreover, companies that control access to transactions
through network access or web browsers currently promote, and will likely
continue to promote, competitors of VW. There can be no assurance that the
Company will be able to respond effectively to increasing competitive pressures
or to compete successfully with current and future competitors.
GTI COMPETITION
GTI operates in a market characterized by intense competition.
Competition within the industry is based on product availability, price, credit
availability, delivery and various services and support provided by the
distributor to the reseller. Major competitors include Tech Data, Ingram,
Merisel, Inc. and a variety of other distributors of computer related
products. Many of GTI's competitors are larger and have greater resources than
GTI. GTI also faces competition directly from manufacturers. GTI nevertheless
believes that in the majority of cases, manufacturers choose to sell products
through distributors because of the relatively small volume and high selling
costs associated with numerous small orders. Management also believes that GTI's
prompt delivery of products and efficient handling, of returns provide an
important competitive advantage over manufacturers' efforts to market their
products directly.
SALES AND MARKETING
VW markets its products and services exclusively through its
virtual-world.com website and through offering teleservice support. GTI markets
its products and services primarily through a sales force that includes field
account executives and in-house sales representatives. GTI also advertises in
major industry publications and uses direct marketing and various other
promotions to increase business opportunities.
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EMPLOYEES
As of April 30, 1999, the Company, including subsidiaries, employed 65
full-time employees.
FINANCING MATTERS
In February 1999, the Company and GTI entered into a Loan and Security
Agreement with Coast Business Credit ("CBC"), a division of Southern Pacific
Bank (the "Coast Agreement"). Under the Coast Agreement, the Company and GTI may
borrow up to $10.0 million based upon eligible receivables and inventory at an
interest rate equal to 1.5% in excess of the bank's reference rate. As part of
the overall credit facility, the Company and GTI may borrow up to $250,000 for
capital expenditure purchases at an interest rate equal to 2% in excess to the
bank's reference rate, not subject to eligible receivables and inventory.
Further, the Company and GTI may borrow up to $500,000 at an interest rate equal
to 2% in excess of the bank's reference rate, payable in 24 equal monthly
installments, also not based on eligible receivables and inventory. As of April
30, 1999, the Company and GTI owed $4.0 million under the Coast Agreement. In
consideration of the Coast Agreement, the Company has granted CBC a three-year
warrant to purchase 500,000 shares of the Company's Common Stock at an exercise
price of $6.29. The Company has agreed to register under the Act the resale of
the shares underlying the warrant upon CBC's demand and upon filing of certain
after registration statements under the Act.
RISK FACTORS
In addition to the other information provided in this report, the
following risk factors should be considered carefully in evaluating the Company
and its business.
LIMITED OPERATING HISTORY; ACCUMULATED DEFICIT; ANTICIPATED LOSSES. The Company
had no business operations prior to February 1996. Accordingly, the Company has
a limited operating history on which to base an evaluation of its business and
prospects. For the fiscal year ended January 31, 1999, the Company incurred a
net loss of $(4.4 million) and as of January 31, 1999, had an accumulated
deficit of $(7.7 million). The Company expects to continue to incur substantial
losses during fiscal 2000. The Company's prospects must be considered in light
of the risks, expenses and difficulties frequently encountered by companies in
their early stage of development, particularly companies in new and rapidly
evolving markets such as online commerce. Such risks for the Company include,
but are not limited to, an evolving and unpredictable business model and the
management of growth. To address these risks, the Company must, among other
things, maintain and increase its customer base, implement and successfully
execute its business and marketing strategy, continue to develop and upgrade its
technology and transaction-processing systems, improve its Web site, provide
superior customer service and order fulfillment, respond to competitive
developments, and attract, retain and motivate qualified personnel. There can be
no assurance that the Company will be successful in addressing such risks, and
the failure to do so
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could have a material adverse effect on the Company's business, prospects,
financial condition and results of operations.
NEED FOR ADDITIONAL CAPITAL. Based upon management's current plans, the Company,
as consolidated with GTI, believes that its existing cash, borrowing capacity
under the Coast Agreement and cash generated from operations will be adequate to
support the Company's operations through the end of fiscal 2000. However, if the
Company does not achieve its planned operating results, if the Company is unable
to utilize its borrowing capacity under the Coast Agreement as planned or if
management's plans change materially, the Company may be required to raise
additional equity or debt financing to support continued operations and growth.
In this case, there is no assurance that such funds will be available to the
Company at terms acceptable to it, or at all.
UNPREDICTABILITY OF FUTURE REVENUES; POTENTIAL FLUCTUATIONS IN QUARTERLY
OPERATING RESULTS. As a result of the Company's limited operating history and
the emerging nature of the markets in which it competes, the Company is unable
to accurately forecast its revenues. The Company's current and future expense
levels are based largely on its investment plans and estimates of future
revenues and are to a large extent fixed. Sales and operating results generally
depend on the volume of, timing of and ability to fulfill orders received, which
are difficult to forecast. The Company may be unable to adjust spending in a
timely manner to compensate for any unexpected revenue shortfall. Accordingly,
any significant shortfall in revenues in relation to the Company's planned
expenditures would have an immediate adverse effect on the Company's business,
prospects, financial condition and results of operations. Further, as a
strategic response to changes in the competitive environment, the Company may
from time to time make certain pricing, service or marketing decisions that
could have a material adverse effect on its business, prospects, financial
condition and results of operations.
The Company expects to experience significant fluctuations in its
future quarterly operating results due to a variety of factors, many of which
are outside the Company's control. Factors that may adversely affect the
Company's quarterly operating results include (i) the Company's ability to
retain existing customers, attract new customers at a steady rate and maintain
customer satisfaction, (ii) the announcement or introduction of new sites,
services and products by the Company and its competitors, (iii) price
competition or higher wholesale prices in the industry, (iv) failure of the
level of use of the Internet and online services and consumer acceptance of the
Internet and other online services for the purchase of consumer products such as
those offered by the Company to increase at the rate anticipated, (v) the
Company's ability to upgrade and develop its systems and infrastructure and
attract new personnel in a timely and effective manner, (vi) the level of
traffic on the Company's Web site, (vii) technical difficulties, system downtime
or Internet brownouts, (viii) the amount and timing of operating costs and
capital expenditures relating to expansion of the Company's business, operations
and infrastructure, (ix) technological advancement of personal computing
products, (x) the level of merchandise returns experienced by the Company, (xi)
governmental regulation, and (xii) general economic conditions and economic
conditions specific to the Internet, online commerce and the computer industry.
SUBSTANTIAL NON-CASH EXPENSES. In fiscal 1999, the Company incurred
approximately $1.3 million of non-cash compensation and consulting service
charges. The Company expects to report similar non-cash charges in the amount
of $12.0 million during fiscal 2000 as a result of commitments made prior to
and after January 31, 1999. There may be substantial additional charges if the
Company makes additional commitments. These non-cash charges will likely
require the Company to report net losses for fiscal 2000 regardless of the
Company's other operating results. Such losses could adversely affect the
limited trading market for the Company's Common Stock or efforts to raise
additional financing.
COMPETITION. The online commerce market, particularly over the Internet, is new,
rapidly evolving and intensely competitive, which competition the Company
expects to intensify in the future. Barriers to entry are minimal, and current
and new competitors can launch new sites at a relatively low cost. In addition,
the hardware and software retail industry is intensely competitive.
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The Company currently or potentially competes with a variety of other companies.
These competitors include (i) various online computer equipment and software
resellers and wholesalers and distributors and vendors of other
information-based products and (ii) a number of indirect competitors that
specialize in online commerce or derive a substantial portion of their revenues
from online commerce, including America Online, Inc. ("AOL") and Microsoft
Corporation, through which other computer equipment resellers may offer
products. Competitive pressures created by any one of these companies, or by the
Company's competitors collectively, could have a material adverse effect on the
Company's business, prospects, financial condition and results of operations.
Many of the Company's current and potential competitors have longer
operating histories, larger customer bases, greater brand recognition and
significantly greater financial, marketing and other resources than the Company.
In addition, online retailers may be acquired by, receive investments from or
enter into other commercial relationships with larger, well-established and
well-financed companies as use of the Internet and other online services
increases. Certain of the Company's competitors may be able to secure
merchandise from vendors on more favorable terms, devote greater resources to
marketing and promotional campaigns, adopt more aggressive pricing or inventory
availability policies and devote substantially more resources to Web site and
systems development than the Company. Increased competition may result in
reduced operating margins, loss of market share and a diminished brand
franchise. There can be no assurance that the Company will be able to compete
successfully against current and future competitors, and competitive pressures
faced by the Company may have a material adverse effect on the Company's
business, prospects, financial condition and results of operations. Further, as
a strategic response to changes in the competitive environment, the Company may
from time to time make certain pricing, service or marketing decisions or
acquisitions that could have a material adverse effect on its business,
prospects, financial condition and results of operations. New technologies and
the expansion of existing technologies may increase the competitive pressures on
the Company. In addition, companies that control access to transactions through
network access or Web browsers could promote the Company's competitors or charge
the Company a substantial fee for inclusion.
In addition, the Company's GTI subsidiary incurs substantial
competition in the wholesale distribution of computer products and peripherals.
In addition to competitive risks similar to those generally applicable to the
Company described above, many of GTI's competitors are larger, better financed,
have more efficient distribution systems and have a greater number of customers.
RISK OF CAPACITY CONSTRAINTS; RELIANCE ON INTERNALLY DEVELOPED SYSTEMS; SYSTEM
DEVELOPMENT RISKS. A key element of the Company's strategy is to generate a high
volume of traffic on, and use of, its Web site. Accordingly, the satisfactory
performance, reliability and availability of the Company's Web site,
transaction-processing systems and network infrastructure are critical to the
Company's reputation and its ability to attract and retain customers and
maintain adequate customer service levels. The Company's revenues depend on the
number of visitors who shop on its Web site and the volume of orders it
fulfills. Any system interruptions that result in the unavailability of the
Company's Web site or reduced order fulfillment performance would reduce
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the volume of goods sold and the attractiveness of the Company's product and
service offerings. Any substantial increase in the volume of traffic on the
Company's Web site or the number of orders placed by customers may require the
Company to further expand and upgrade its technology, transaction-processing
systems and network infrastructure. There can be no assurance that the Company
will be able to accurately project the rate or timing of increases, if any, in
the use of its Web site or timely expand and upgrade its systems and
infrastructure to accommodate such increases.
RISK OF SYSTEM FAILURE, SINGLE SITE AND ORDER INTERFACE. The Company's success,
in particular its ability to successfully receive and fulfill orders and provide
high-quality customer service, largely depends on the efficient and
uninterrupted operation of its computer and communications hardware systems. The
Company's Internet servers are hosted off site by Exodus, a major Internet
service provider. Although the Company's systems and operations are protected,
they are still vulnerable to damage or interruption from fire, flood, power
loss, telecommunications failure, break-ins and similar events.
The Company does not carry sufficient business interruption insurance
to compensate it for losses that may occur if its Internet services are
significantly disrupted. Despite the implementation of network security measures
by the Company, its servers are vulnerable to computer viruses, physical or
electronic break-ins and similar disruptions, which could lead to interruptions,
delays, loss of data or the inability to accept and fulfill customer orders. In
the event of a major loss, the Company's disaster plan calls for full recovery
of all operations within 24 hours, but such recovery cannot be assured. Further,
in spite of this protection, the occurrence of any of the foregoing risks could
have a material adverse effect on the Company's business, prospects, financial
condition and results of operations.
DEPENDENCE ON CONTINUED GROWTH OF ONLINE COMMERCE. The Company's future revenues
and any future profits are substantially dependent upon the widespread
acceptance and use of the Internet and other online services as an effective
medium of commerce by consumers. Rapid growth in the use of and interest in the
Web, the Internet and other online services is a recent phenomenon, and there
can be no assurance that acceptance and use will continue to develop or that a
sufficiently broad base of consumers will adopt, and continue to use, the
Internet and other online services as a medium of commerce. Demand and market
acceptance for recently introduced services and products over the Internet are
subject to a high level of uncertainty and there exist few proven services and
products. The Company relies on consumers who have historically used traditional
means of commerce to purchase merchandise. For the Company to be successful,
these consumers must accept and utilize novel ways of conducting business and
exchanging information.
In addition, the Internet and other online services may not be accepted
as a viable commercial marketplace for a number of reasons, including
potentially inadequate development of the necessary network infrastructure or
delayed development of enabling technologies and performance improvements. To
the extent that the Internet and other online services continue to experience
significant growth in the number of users, their frequency of use or an increase
in their bandwidth requirements, there can be no assurance that the
infrastructure for the Internet and other online services will be able to
support the demands placed upon them. In addition, the Internet or other online
services could lose their viability due to delays in the development or adoption
of new
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standards and protocols required to handle increased levels of Internet or other
online service activity, or due to increased governmental regulation.
Changes in or insufficient availability of telecommunications services
to support the Internet or other online services also could result in slower
response times and adversely affect usage of the Internet and other online
services generally and the Company's web site in particular. If use of the
Internet and other online services does not continue to grow or grows more
slowly than expected, if the infrastructure for the Internet and other online
services does not effectively support growth that may occur, or if the Internet
and other online services do not become a viable commercial marketplace, the
Company's business, prospects, financial condition and results of operations
would be materially adversely affected.
RAPID TECHNOLOGICAL CHANGE. To remain competitive, the Company must continue to
enhance and improve the responsiveness, functionality and features of its online
store. The Internet and the online commerce industry are characterized by rapid
technological change, changes in user and customer requirements and preferences,
frequent new product and service introductions embodying new technologies and
the emergence of new industry standards and practices that could render the
Company's existing Web site and proprietary technology and systems obsolete. The
Company's success will depend, in part, on its ability to license leading
technologies useful in its business, enhance its existing services, develop new
services and technology that address the increasingly sophisticated and varied
needs of its prospective customers, and respond to technological advances and
emerging industry standards and practices on a cost-effective and timely basis.
The development of Web site and other proprietary technology entails significant
technical and business risks. There can be no assurance that the Company will
successfully use new technologies effectively or adapt its Web site, proprietary
technology and transaction-processing systems to customer requirements or
emerging industry standards. If the Company is unable, for technical, legal,
financial or other reasons, to adapt in a timely manner in response to changing
market conditions or customer requirements, its business, prospects, financial
condition and results of operations would be materially adversely affected.
DEPENDENCE ON KEY PERSONNEL. The Company is dependent upon the management
services of Kenneth Israel, Chairman, Greg Appelhof, President and Chief
Executive Officer and John Harvatine, Chief Financial Officer. The loss of the
services of any of such persons could have a material adverse effect on the
Company's business, prospects, financial condition and results of operations. In
the event that any of Messrs. Israel, Appelhof or Harvatine are unable to
continue working for the Company or terminate their employment, there is no
assurance that the Company would be able to employ qualified persons to replace
such individuals. In June 1998, Mr. Israel was diagnosed with large cell B
lymphoma. He received chemotherapy treatments between June 1998 and January
1999. Although to date, Mr. Israel's cancer has not materially affected his
ability to perform his duties for the Company, there can be no assurance that
Mr. Israel's illness will not affect the Company in the future. As of April
30, 1999, Mr. Israel's cancer is currently in remission although there can be
no assurance it will not reoccur at some future date. The Company does
not presently maintain key person insurance on the life of any of Messrs.
Israel, Appelhof or Harvatine.
ONLINE COMMERCE SECURITY RISKS. A significant barrier to online commerce and
communications is the secure transmission of confidential information over
public networks. The Company relies on encryption and authentication technology
licensed from third parties to provide the security and
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authentication necessary to effect secure transmission of confidential
information, such as customer credit card numbers. There can be no assurance
that advances in computer capabilities, new discoveries in the field of
cryptography, or other events or developments will not result in a compromise or
breach of the algorithms used by the Company to protect customer transaction
data. If any such compromise of the Company's security were to occur, it could
have a material adverse effect on the Company's reputation, business, prospects,
financial condition and results of operations. A party who is able to circumvent
the Company's security measures could misappropriate proprietary information or
cause interruptions in the Company's operations. The Company may be required to
expend significant capital and other resources to protect against such security
breaches or to alleviate problems caused by such breaches. Concerns over the
security of transactions conducted on the Internet and other online services and
the privacy of users may also inhibit the growth of the Internet and other
online services generally, and the Web in particular, especially as a means of
conducting commercial transactions. To the extent that activities of the Company
or third-party contractors involve the storage and transmission of proprietary
information, such as credit card numbers, security breaches could damage the
Company's reputation and expose the Company to a risk of loss or litigation and
possible liability. There can be no assurance that the Company's security
measures will prevent security breaches or that failure to prevent such security
breaches will not have a material adverse effect on the Company's business,
prospects, financial condition and results of operations.
RELIANCE ON CERTAIN SUPPLIERS. VW purchases a substantial majority of its
products from two major vendors, Ingram and Tech Data as well as its subsidiary,
GTI. VW carries no inventory other than that maintained by GTI, and relies to a
large extent on rapid fulfillment from these and other vendors. VW has no
long-term contracts or arrangements with any of its vendors, other than GTI,
that guarantee the availability of merchandise, the continuation of particular
payment terms or the extension of credit limits. GTI relied on 3 vendors for 77%
of its purchases in fiscal 1999. There can be no assurance that the Company's
current vendors will continue to sell merchandise to the Company on current
terms or that the Company will be able to establish new or extend current vendor
relationships to ensure acquisition of merchandise in a timely and efficient
manner and on acceptable commercial terms. If the Company were unable to develop
and maintain relationships with vendors that would allow it to obtain sufficient
quantities of merchandise on acceptable commercial terms, its business,
prospects, financial condition and results of operations would be materially
adversely affected.
INTEGRATION OF GTI; FUTURE POTENTIAL ACQUISITIONS. Successfully integrating the
operations of GTI with those of the Company may divert a significant portion of
management's time and the Company's resources from its Internet business and
there is no assurance that the Company can successfully complete its integration
plans. The inability of the Company to successfully integrate the GTI operations
would have a material adverse affect on the Company's operations, financial
condition and business. In addition, the Company regularly considers additional
acquisitions (although it has no agreements as of the date hereof to acquire
any additional businesses), which activities would require management attention
and the diversion of resources which otherwise would be available for conduct
of existing operations.
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COMPANY HIGHLY LEVERAGED. In connection with the acquisition of GTI's assets,
the Company and GTI entered into a Loan and Security Agreement with CBC, under
which the Company may borrow up to $10.0 million, subject to borrowing base
limitations. As of April 30, 1999, the Company owed $4.0 million to CBC. CBC has
a security interest in the Company's assets and could foreclose on such assets
if the Company were unable to service its debt.
RISKS ASSOCIATED WITH ENTRY INTO NEW BUSINESS AREAS. The Company may choose to
expand its operations by developing new Web sites, promoting new or
complementary products or sales formats, expanding the breadth and depth of
products and services offered or expanding its market presence through
relationships with third parties. In addition, the Company may pursue the
acquisition of new or complementary businesses, products or technologies,
although it has no present understandings, commitments or agreements with
respect to any material acquisitions or investments. There can be no assurance
that the Company would be able to expand its efforts and operations in a
cost-effective or timely manner or that any such efforts would increase overall
market acceptance. Furthermore, any new business or Web site launched by the
Company that is not favorably received by consumers could damage the Company's
reputation or its current web site brand. Expansion of the Company's operations
in this manner would also require significant additional expenses and
development, operations and editorial resources and would strain the Company's
management, financial and operational resources. The lack of market acceptance
of such efforts or the Company's inability to generate satisfactory revenues
from such expanded services or products to offset their cost could have a
material adverse effect on the Company's business, prospects, financial
condition and results of operations.
YEAR 2000 COMPLIANCE. In connection with the approach of the Year 2000, industry
experts have predicted a variety of adverse consequences, including catastrophic
system failures, that may result from organizations' computer systems having
been programmed to record and process year dates by two, rather than four,
digits. Although the Company believes that its computer and communications
systems will be compliant by the year 2000, there can be no such assurance.
Further, the Company cannot predict whether its suppliers, customers and other
organizations with whom the Company conducts business will in a timely fashion
bring their computer systems or product offerings into Year 2000 compliance. If
the Company's suppliers or customers fail to complete any required Year 2000
remediation of their computer systems or product offerings, the Company could
suffer delays in product delivery or in processing of payments owed to the
Company. In addition, if any products sold by the Company to its customers were
to fail, the Company could be liable to its customers for damages and costs to
the extent that the Company's suppliers do not cover such liability. Any such
Year 2000 failures could have a material adverse effect on the Company's
business, operating results or financial condition.
GTI's internal information systems, including sales and purchase order
processing, inventory management, accounts payable and receivable and general
ledger, are not Year 2000 compliant. The Company has tested the potential of
using VW's software platform for GTI's business operations and does not believe
that an appropriate conversion can be timely effected. Accordingly, the Company
now plans, at an estimated cost of up to $250,000, to implement a newer version
of GTI's existing software. Although the software manufacturer has represented
the Year 2000 compliance of its newer version, GTI has not tested the software
and cannot assure its Year 2000 compliance or timely installation.
TRADEMARKS AND PROPRIETARY RIGHTS. The Company does not have federal or state
trademark registration of its corporate or web site name or its "V" logo. There
are many companies throughout the United States that use the words "virtual
technology" in their name. In addition, the Company recently received
correspondence challenging the Company's right to use its "V" logo. In light of
these potential conflicts, the Company is considering a change in its corporate
name and logo. Any change will cause the Company to incur substantial expense
and goodwill in
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promoting a new name and logo and in abandoning the use of its old name and
logo. Even if the Company selects a new name and logo, there can be no assurance
that the steps taken by the Company to protect its proprietary rights will be
adequate or that third parties will not infringe or misappropriate the Company's
copyrights, trademarks, trade dress and similar proprietary rights. In addition,
there can be no assurance that other parties will not assert infringement claims
against the Company.
SALES OF UNREGISTERED SECURITIES; SHARES AVAILABLE FOR PUBLIC RESALE During
fiscal 1999, the Company issued 16,856,026 shares of the Common Stock for an
aggregate consideration of $12.6 million. During the fiscal 1998, the Company
issued 1,697,839 shares of its Common Stock for an aggregate consideration of
$343,000. During fiscal 1997, the Company issued 3,579,090 shares of its Common
Stock for an aggregate consideration of $520,000. The sales of these securities
were not registered under the Act or applicable state laws and such sales were
made by the Company in reliance upon certain exemptions from such registration
requirements. Accordingly, if it were determined that such sales were not
exempt, the Company may be required to offer to rescind such sales and
repurchase such securities for the price originally paid for such securities,
together with interest from the date of such sales, and possibly, certain
attorneys' fees. If the Company is required to make any such repurchases, it
could have a material adverse effect on the Company's business, prospects,
financial condition and results of operations.
As of April 30, 1999, the Company had 27,860,304 shares of Common Stock
outstanding. Of such shares, 15,262,560 are available for public resale under
Rule 144 under the Act. In addition, 11,083,403 and 1,514,341 of such shares
will become eligible for public resale under Rule 144 under the Act in fiscal
2000 and 2001, respectively. Further, the Company is contractually obliged to
file a registration statement under the Act to register the public resale of
145,000 of the shares not currently available for public resale and 2,525,000 of
the shares that may be issued upon exercise of outstanding options and warrants.
The Company intends to file such registration statement as soon as practicable.
The availability for public resale, or the actual public resale, of such shares
may depress the limited trading market existing for such shares.
GOVERNMENTAL REGULATION AND LEGAL UNCERTAINTIES. The Company is not currently
subject to direct regulation by any domestic or foreign governmental agency,
other than regulations applicable to businesses generally, and laws or
regulations directly applicable to access to online commerce. However, due to
the increasing popularity and use of the Internet and other online services, it
is possible that a number of laws and regulations may be adopted with respect to
the Internet or other online services covering issues such as user privacy,
pricing, content, copyrights, distribution and characteristics and quality of
products and services. Furthermore, the growth and development of the market for
online commerce may prompt calls for more stringent consumer protection laws
that may impose additional burdens on those companies conducting business
online. The adoption of any additional laws or regulations may decrease the
growth of the Internet or other online services, which could, in turn, decrease
the demand for the Company's products and services and increase the Company's
cost of doing business, or otherwise have an adverse effect on the Company's
business, prospects, financial condition and results of operations. Moreover,
the
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applicability to the Internet and other online services of existing laws in
various jurisdictions governing issues such as property ownership, sales and
other taxes, libel and personal privacy is uncertain and may take years to
resolve. Any such new legislation or regulation, the application of laws and
regulations from jurisdictions whose laws do not currently apply to the
Company's business, or the application of existing laws and regulations to the
Internet and other online services could have a material adverse effect on the
Company's business, prospects, financial condition and results of operations.
SALES AND OTHER TAXES. The Company does not currently collect sales or other
similar taxes in respect of shipments of goods into states other than Minnesota,
California, Florida, Arizona, Missouri, Massachusetts, Michigan and Texas.
However, one or more states may seek to impose sales tax collection obligations
on out-of-state companies such as the Company which engage in online commerce.
In addition, any new operation in other states could subject shipments into such
states to state sales taxes under current or future laws. A successful assertion
by one or more states or any foreign country that the Company should collect
sales or other taxes on the sale of merchandise could have a material adverse
effect on the Company's business, prospects, financial condition and results of
operations.
LIMITED PUBLIC MARKET. There is presently a limited public market for the
Company's Common Stock, and there can be no assurance that a more significant
trading market will develop or that investors will be able to resell their
shares at the price quoted on the OTC Bulletin Board, or at all. In addition, if
the Company's Common Stock trades at a price under $5.00 per share, brokers and
dealers trading in the Company's Common Stock are subject to "penny stock"
disclosure rules under the Securities and Exchange Act of 1934, as amended. The
rules relating to the sale of penny stocks require brokers and dealers to
provide investors with information relating to the risks and dangers associated
with investing in penny stocks. The disclosure of such information could have a
material adverse effect on the price of the Company's Common Stock traded on the
OTC Bulletin Board. It is the Company's intention to file for listing with the
Nasdaq Small-Cap or National Market system as soon as possible. However, there
is no assurance that listing on Nasdaq will be granted.
POTENTIAL ADVERSE EFFECTS OF UNDESIGNATED PREFERRED STOCK. The authorized and
unissued capital stock of the Company includes undesignated preferred shares.
The Board, without any action by the Company's shareholders, is authorized to
designate and issue the undesignated preferred shares in such classes or series
as it deems appropriate, and to establish the rights, preferences and privileges
of such shares, including dividend, liquidation and voting rights. No shares of
preferred stock or other senior equity securities are currently designated, and
there is no current plan to designate or issue any such securities. However, the
ability of the Board to designate and issue any such undesignated shares could
impede or deter an unsolicited tender offer or takeover proposal regarding the
Company, and the issuance of additional shares having preferential rights could
adversely affect the voting power and other rights of holders of Common Stock.
ABSENCE OF DIVIDENDS. The Company does not anticipate the payment of cash
dividends on its Common Stock in the foreseeable future. Investors who
anticipate a need for immediate income from their investment should not purchase
shares of the Company's Common Stock.
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FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS. This Form 10-K contains
forward-looking statements regarding, among other things, the Company's growth
strategy and anticipated trends in the Company's business. These forward-looking
statements are based largely on the Company's expectations and are subject to a
number of risk and uncertainties, certain of which are beyond the Company's
control. Actual results could differ materially from these forward-looking
statements as a result of the factors described under "Risk Factors" and
elsewhere herein, including, among others, regulatory or economic influences. In
light of these risks and uncertainties, there can be no assurance that the
forward-looking information contained in this Form 10-K will in fact transpire
or prove to be accurate.
ITEM 2. PROPERTIES.
FACILITIES
The Company leases approximately 1,500 square feet of office space at
3100 West Lake Street, Suite 400, Minneapolis, Minnesota pursuant to a 5-year
lease with payments of approximately $2,500 per month expiring in July 2001. In
addition, the Company leases approximately 3,900 square feet of office space at
1422 West Lake Street, Minneapolis, Minnesota pursuant to a month-to-month lease
with payments of approximately $6,200 per month.
GTI's executive offices and principal warehouse space is located at
7615 Golden Triangle Drive, Suite G, Eden Prairie, Minnesota. Additional GTI's
facilities are located at 4685 S Ashe Ave., Tempe, Arizona, and 233 Needham
Street, Newton, Massachusetts.
GTI leases approximately 11,000 square feet of space in Minnesota with
payments of approximately $8,600 per month. GTI's facility in Arizona is also
approximately 11,000 square feet with payments of approximately $8,600 per
month. The facility in Massachusetts is approximately 3,000 square feet with
payments of approximately $3,300 per month. All of these GTI leases have
expiration dates of within 10 months from April 30, 1999. GTI also utilizes
certain warehouse space of a vendor without charge in San Francisco, California.
The Company is currently investigating its options with respect to
integrating its facilities in Minneapolis.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Company may be involved in litigation relating
to claims arising out of its ordinary course of business. The Company presently
is not subject to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no matters submitted to a vote of security holders
during the last quarter of the fiscal year ended January 31, 1999.
PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is currently traded on the OTC Bulletin
Board under the symbol VTCO.
The following table sets forth, for the period indicated, the range of
high and low bid prices of the Company's Common Stock as provided by
quotecentral.com. The prices represent quotations between dealers without
adjustment for retail markups, markdowns, or commissions and may not represent
actual transactions.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JANUARY 31, 1999
----------------------------------
High Low
---- ----
<S> <C> <C>
FIRST QUARTER (END APRIL) 1-9/32 1/2
SECOND QUARTER (END JULY) 2-7/32 13/32
THIRD QUARTER (END OCTOBER) 1-31/32 13/16
FOURTH QUARTER (END JANUARY) 10 13/16
</TABLE>
For the fiscal year ended January 31, 1998, the Company is unable to
obtain reliable information on the range of high and low bid prices of the
Company's Common Stock due to the limited market for the Company's Common Stock
prior to February 1, 1999.
The Company has never paid a cash dividend on its capital stock and
does not expect to pay a cash dividend in the foreseeable future.
As of April 30, 1999, the Company had 476 shareholders of record.
RECENT SALES OF UNREGISTERED SECURITIES
A. Sales for cash consideration to accredited investors only pursuant
to Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933,
as amended (the "Act"):
In fiscal 1997, the Company issued 3,085,590 shares of its Common Stock
for $405,377 to 12 investors and $135,000 of convertible debentures to two
investors.
In fiscal 1998, the Company issued 1,553,800 shares of its Common Stock
for $243,250 to ten investors and $237,000 of convertible debentures to five
investors.
In fiscal 1999, the Company issued 13,299,832 shares of its Common
Stock for $8,554,549 to 39 investors.
Between February 1 and May 3, 1999, the Company issued 1,514,341
shares of its Common Stock for $3,104,500 to seven investors.
B. In October 1996, the Company issued 427,500 shares pursuant to
Regulation S to four individuals in connection with the acquisition of ARL.
C. In January 1999, the Company issued 373,571 shares to two
accredited investors in connection with the acquisition of GTI's assets and
certain related consulting services. The issuance of such shares was exempt
pursuant to Rule 506 of Regulation D and/or Section 4(2) of the Act.
D. In fiscal 1999, the holders of the convertible debentures as
described in (A) above converted such debentures into 1,173,091 shares of
Common Stock in reliance upon the exemption contained in Section 3(a)(9)
of the Act.
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E. Sales made solely in exchange for services rendered pursuant to Rule
504 of Regulation D and/or Section 4(2) of the Act:
In fiscal 1997, the Company issued 66,000 shares of its Common Stock
to five individuals (three of whom were accredited investors) in exchange for
$132,000 of services rendered to the Company.
In fiscal 1998, the Company issued 144,039 shares of its Common Stock
to seven individuals and entities (two of whom were accredited investors) in
exchange for $99,746 of services rendered to the Company.
In fiscal 1999, the Company issued 2,069,532 shares of its Common
Stock to thirty individuals and entities (eleven of whom were accredited
investors) in exchange for $961,625 of services rendered to the Company.
C. Issuance of options and warrants involving no sale of securities:
In fiscal 1997, the Company granted to ten individuals or entities an
aggregate of 1,341,000 options and warrants to purchase shares of the Company's
Common Stock, exercisable at prices ranging between $.25 and $7.50 per share.
In fiscal 1998, the Company granted to thirteen individuals or entities
an aggregate of 590,100 options and warrants to purchase shares of the Company's
Common Stock, exercisable at prices ranging between $1.00 and $5.00 per share.
In fiscal 1999, the Company granted to fifteen individuals or entities
an aggregate of 6,018,885 options and warrants to purchase shares of the
Company's Common Stock, exercisable at prices ranging between $.25 and $3.75
per share.
Between February 1 and May 3, 1999, the Company granted to five
entities an aggregate of 1,475,000 warrants to purchase shares of the Company's
Common Stock, exercisable at prices ranging between $1.00 and $6.29 per share.
During fiscal 1999, the Company paid the following firms cash
commissions in connection with certain fiscal 1999 sales of Common Stock as
described above: Waterford Financial, Inc.: $50,000; Trautman Kramer & Co.,
Inc.: $98,564; and Janda & Garrington, LLC: $165,000. In addition, Waterford
Financial was granted a five-year warrant to purchase 50,000 shares at $1.50
per share, and Trautman Kramer was granted a three-year warrant to purchase
125,000 shares at $3.00 per share, as additional consideration for effecting
the sale transactions. The issuance of such warrants is described as part of
the above transactions.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth certain selected financial data of VTC
as of and for each of the three years in the period ended January 31, 1999. The
selected historical financial data as of January 31, 1999 and 1998 and for each
of the two years in the period ended January 31, 1999 have been derived from the
historical consolidated financial statements of VTC, audited by Lurie, Besikof,
Lapidus & Co., LLP, independent accountants, and included elsewhere in this Form
10-K. The selected historical financial data as of and for the period ended
January 31, 1997 have been derived from the historical financial statements of
VTC, audited by Copeland Buhl & Company P.L.L.P. The information contained in
the following table should also be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the historical financial statements and related notes included elsewhere in this
Form 10-K. The table contains no selected financial data for the periods ended
January 31, 1996 and 1995, as the Company did not conduct any operations in
those periods.
<TABLE>
<CAPTION>
FY99 FY98 FY97
<S> <C> <C> <C>
Net Sales....................... $ 4,945,907 $ 174,669 $ 0
Net Loss ....................... (4,357,088) (2,539,161) (829,421)
Net Loss Per Common Share....... (0.26) (0.36) (0.13)
Total Assets.................... 25,742,578 59,409 1,023,828
Long Term Liabilities........... 420,810 715,342 138,102
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
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THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH
"SELECTED FINANCIAL DATA" AND THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS
AND NOTES THERETO INCLUDED ELSEWHERE IN THIS REPORT. EXCEPT FOR THE HISTORICAL
INFORMATION CONTAINED HEREIN, THE DISCUSSION IN THIS REPORT CONTAINS CERTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, SUCH AS
STATEMENTS OF THE COMPANY'S PLANS, OBJECTIVES, EXPECTATIONS AND INTENTIONS.
THESE FORWARD-LOOKING STATEMENTS ARE BASED ON THE CURRENT EXPECTATIONS OF THE
COMPANY, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE THIS INFORMATION. THE
CAUTIONARY STATEMENTS MADE IN THIS REPORT SHOULD BE READ AS BEING APPLICABLE TO
ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS REPORT. THE
COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED HERE.
VW OVERVIEW
VW is an Internet retailer of high performance computer hardware,
software and peripheral products to sophisticated computer and Internet users.
Through its E-Commerce web site at www.virtual-world.com, VW offers more than
42,000 units of selective high-performance, brand name computer equipment. VW
offers an online specialized store that is intended to provide one-stop shopping
for its targeted domestic and international customers, 24 hours a day, seven
days a week. VW's online store features a fun, easy to navigate interface,
competitive pricing, extensive product information and powerful search
capabilities.
VW began online marketing of a proprietary email and newsgroup software
in January 1997. In October 1997, VW launched its E-Commerce site offering a
range of selective high-performance brand names for computer equipment and
software programs. To facilitate its expansion, VW formed alliances with GTI,
Ingram and Tech Data to provide the Company with a "virtual inventory" of
hardware and software products. These three entities provide order fulfillment,
shipping, and post sale customer support.
VW derives its revenue primarily from sales of third-party computer
hardware, software and accessories. Revenues from the sale of computer products,
net of estimated returns, are recognized upon shipment of the physical product
to the end-user. The amount payable to the supplier is reported as cost of
sales. VW bears full credit risk with respect to substantially all sales. VW,
through GTI, maintains a supply of certain computer products to meet the
delivery requirements of its customers.
In January 1999, the Company acquired substantially all of GTI's
assets. The Company plans to leverage GTI's buying power to improve gross
margins in the sale of computer products on VW's website, but there is no
assurance that such operating efficiencies can or will be achieved.
The Company has a limited operating history upon which investors may
evaluate its business and prospects. At February 7, 1996, VW was essentially
a shell corporation without any products or revenues. Since such date, the
Company has incurred significant losses, and as of January 31, 1999 had an
accumulated deficit of approximately $(7.7 million). The Company
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intends to continue to expend significant financial and management resources on
the development of additional services, sales and marketing, improved
technology, acquisitions and expanded operations. As a result, the Company
expects to incur substantial additional losses and continued negative cash flow
from operations for the foreseeable future, and management anticipates that such
losses will increase substantially from current levels. There can be no
assurance that the Company's sales will increase or even continue at their
current level or that the Company will achieve or maintain profitability or
generate cash from operations in future periods. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in their early stages of development, particularly
companies in new and rapidly evolving markets such as electronic commerce. To
address these risks, the Company must, among other things, maintain existing and
develop new relationships with hardware, software and accessories manufacturers,
implement and successfully execute its business and marketing strategy, continue
to develop and upgrade its technology, provide superior customer service and
order fulfillment, respond to competitive developments, and attract, retain and
motivate qualified personnel. There can be no assurance that the Company will be
successful in addressing such risks, and the failure to do so would have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company's current and future expense levels are based
largely on its planned operations and estimates of future sales. Sales and
operating results generally depend on the volume and timing of orders received,
which are difficult to forecast. The Company may be unable to adjust spending in
a timely manner to compensate for any unexpected revenue shortfall. Accordingly,
any significant shortfall in sales would immediately and adversely affect the
Company's business, financial condition and results of operations. In view of
the rapidly evolving nature of the Company's business and its limited operating
history, the Company is unable to accurately forecast its sales and believes
that period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
RESULTS OF OPERATIONS
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<PAGE> 30
During fiscal 1998 and 1997, the Company had insignificant net sales
and cost of goods sold. Accordingly, management believes that comparisons of the
Company's net sales, cost of goods sold and expenses, as expressed as a
percentage of net sales, over such fiscal years are not meaningful.
NET SALES. The Company derives its revenue primarily from sales of
third-party computer hardware, software and accessories. The Company recognizes
revenue from the sale of computer products upon shipment of the physical product
to the end-user. Net sales are comprised of the gross selling price of products
sold by the Company, net of estimated returns. The Company bears credit risk
with respect to substantially all sales. The Company's net sales increased to
$4.9 million for fiscal 1999, from $175,000 for fiscal 1998 and $0 for fiscal
1997. The sales increases in fiscal 1999 were primarily a result of a shift in
Company strategy to e-commerce from software development and sales. The sales
increases in fiscal 1998 were primarily a result of limited marketing
activities.
COST OF GOODS SOLD. Cost of goods sold consists primarily of the
amounts payable to computer manufacturers for products sold to the end-user and
related shipping and distribution costs. Cost of goods sold during fiscal 1999
was $4.8 million, or 96.4% of net sales. During fiscal 1998 and 1997, the
Company had no product sales and thus did not record any cost of goods sold.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of personnel, advertising and promotional expenses. Sales and
marketing expenses increased to $1.8 million in fiscal 1999 from $551,000 and
$155,000 for fiscal 1998 and 1997, respectively. The primary component of the
increase in fiscal 1999 from 1998 was an increase in advertising and promotion
expenditures of $1.3 million. As a percentage of net sales, sales and marketing
expenses were 36.2% in fiscal 1999. The primary component of the increase in
fiscal 1998 from 1997 was an increase in advertising and promotion expenditures
of $218,000. The Company expects that sales and marketing
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<PAGE> 31
expenses will continue to increase in absolute dollars as the Company continues
to build its sales and marketing infrastructure and to develop marketing
programs.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses consist principally of executive, accounting and administrative
personnel expenses, legal, consulting and accounting expenses, and bad debt
expense. General and administrative expenses increased to $2.7 million for
fiscal 1999 from $1.1 million and $390,000 for fiscal 1998 and 1997,
respectively. The fiscal 1999 increase over the prior year was primarily due to
an increase in professional and consulting fees of $1.0 million. The fiscal 1998
increase over the prior year was primarily attributable to operating expenses of
ARL. As a percentage of net sales, general and administrative expenses were
55.2% in fiscal 1999. In fiscal 1999, the Company incurred approximately $1.3
million of non-cash compensation and consulting service charges. The Company
expects to report similar non-cash charges in the amount of $12.0 million during
fiscal 2000 as a result of commitments made prior to and after January 31, 1999.
There may be substantial additional charges if the Company makes additional
commitments.
INCOME TAXES. The Company has incurred a net loss for each period since
inception. As of January 31, 1999 the Company had approximately $5.6 million of
net operating loss carryforwards for federal income tax purposes, which expire
beginning in 2012. Due to the uncertainty of future profitability, a valuation
allowance equal to the deferred tax asset has been recorded. Certain changes in
ownership resulting from the sales of Common Stock could limit the future annual
realization of the tax net operating loss carryforwards to a specified
percentage under Section 382 of the Internal Revenue Code. The Company paid no
income taxes in fiscal 1999, 1998 and 1997.
WRITE OFF OF VIRTUAL TECHNOLOGY (UK) LIMITED. In fiscal 1998, the
Company recorded $925,000 of non-recurring expense related to the write-off of
the Virtual Technology (UK) Limited (formerly known as ARL) operations.
GTI OVERVIEW
GTI is a leading distributor of computer peripheral equipment to
wholesale and retail outlets throughout the United States and Canada. The
Company specializes in high performance computer equipment, computer integrated
systems design and the assembly and sale of complete computer systems. The
Company purchases products directly from more than 45 manufacturers of computer
related products, and maintains a stocking inventory of approximately 1,600
products.
GTI derives its revenue primarily from sales of third-party computer
hardware and accessories. Revenues from the sale of computer products, net of
estimated returns, are recognized upon shipment of the physical product to the
end-user. The amount payable to the supplier is reported as cost of sales. The
Company bears full credit risk with respect to substantially all sales.
For the three years prior to the Company's acquisition of GTI's assets
in January 1999, GTI was an S corporation for federal and state income tax
purposes. Accordingly, GTI did not pay federal or state income taxes during such
fiscal years. As a subsidiary of the Company, management anticipates that GTI's
future income or losses will be consolidated with the Company's future income or
losses for federal and state income tax purposes.
RESULTS OF OPERATIONS
The following table sets forth statement of operations data for the
periods indicated as a percentage of revenues:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------------------------------------------------
<S> <C> <C> <C>
Sales............................................. 100.0% 100.0% 100.0%
Cost of sales..................................... 90.5 89.8 91.2
Gross profit............................. 9.5 10.2 8.8
Operating expenses................................ 8.2 9.0 7.7
Income from operations............................ 1.3 1.2 1.1
Net income........................................ 1.3 1.3 1.2
</TABLE>
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<PAGE> 32
SALES. GTI derives its revenue primarily from sales of computer
hardware and accessories. GTI recognizes revenue from the sale of computer
hardware upon shipment of the physical product to the reseller. Sales are
comprised of the gross selling price of products sold, net of returns, plus any
outbound shipping and handling charges. GTI bears credit risk with respect to
substantially all sales. GTI's sales decreased to $65.2 million for 1998 from
$83.8 million for 1997. The sales decrease in 1998 was primarily a result of
decreases in per unit sales prices. GTI's sales decreased to $83.8 million for
1997 from $87.8 million for 1996. This decline resulted primarily from a change
in customer mix.
COST OF SALES. Cost of sales consists primarily of the amount payable
to the computer manufacturers for products sold to the reseller. As a percentage
of sales, cost of sales increased to 90.5% in 1998 from 89.8% in 1997, primarily
as a result of increased price competition in the industry that forced GTI to
reduce its sales prices to its customers. Cost of sales as a percentage of sales
declined in 1997 from 91.2% in 1996 primarily as a result of favorable prices
without a commensurate reduction in selling prices.
OPERATING EXPENSES. Operating expenses consist primarily of
compensation and employee benefits, rent and legal and professional fees.
Operating expenses declined to $5.4 million, or 8.2% of sales, in 1998 from $7.5
million, or 9.0% of sales, in 1997, primarily as a result of a reduction in
owner's compensation. Operating expenses were $6.7 million or 7.7% of sales, in
1996. The increase in operating expenses for 1997 over 1996 in absolute dollars
and as a percentage of sales is primarily attributable to an increase in owner's
compensation.
LIQUIDITY AND CAPITAL RESOURCES.
The Company historically has financed its operations primarily through
the private placement of equity and debt securities, which have yielded net
proceeds of $4.9 million, $480,000 and $355,000 for fiscal 1999, 1998 and 1997,
respectively. GTI historically has financed its operating activities primarily
through cash provided from operations.
Net cash used by operating activities for the Company in fiscal 1999,
1998 and 1997 was $3.6 million, $787,000 and $255,000, respectively. Net cash
used by operating activities for the Company in fiscal 1999 was primarily the
result of net operating losses and increases in accounts receivables, offset in
part by increases in accrued expenses and non-cash expenses. For fiscal 1998 and
1997, net cash used by operating activities for the Company was primarily a
result of net losses, offset by non-cash expenses and increases in accounts
payable and accrued expenses. Net cash provided by operations for GTI during
1998, 1997 and 1996 was used primarily for shareholder distributions.
In fiscal 1999, the Company used approximately $950,000 of its net cash
to acquire GTI'S assets.
In 1996 and 1997, GTI advanced $571,000 and $14,000, respectively, on
loans collected in 1998 primarily from a related party.
On January 28, 1999, the Company acquired substantially all of the
assets of GTI and assumed certain of GTI's liabilities. The purchase price was
$10.1 million, $1.0 million of which the Company paid at closing primarily out
of funds generated from the sale during fiscal 1999 of its equity securities.
Under the terms of the acquisition agreement, the Company paid an additional
$4.0 million of the purchase price in February 1999 by repayment of a promissory
note. The Company acquired the funds to retire such note from borrowings under
the Coast Agreement. See "Business -- Financing Matters." In May 1999, the
Company paid an additional $2.7 million of the remaining $3.3 million promissory
note under the acquisition agreement. The payment shortage is due to certain
post-closing adjustments still under negotiation between the Company and Herold
Marketing Associates, Inc. The Company believes these post-closing adjustments
will be finalized shortly. The Company made the payment on such note out of cash
from the private placement of the Company's securities and from additional
advances under the Coast Agreement.
Although the Company, as consolidated with GTI, has no material
commitments for capital expenditures, the Company anticipates that it will
expend approximately $500,000 during fiscal 2000 on additional computer hardware
resources, including commerce servers and expansion of the Company's principal
executive offices. The Company's capital expenditures could be materially
different if the Company's operating plans are altered.
As of April 30, 1999, the Company, as consolidated with GTI, had cash
of approximately $2.0 million. At such date, the Company owed $4.0 million under
the Coast Agreement and estimates that it had additional borrowing capacity
thereunder of approximately $3.3 million. Based upon management's current plans,
the Company, as consolidated with GTI, believes that its existing cash,
borrowing capacity under the Coast Agreement and cash generated from operations
will be adequate to support the Company's operations through the end of fiscal
2000. However, if the Company does not achieve its planned operating results, if
the Company is unable to utilize its borrowing capacity under the Coast
Agreement as planned or if management's plans change materially, the Company may
be required to raise additional equity or debt financing to support continued
operations and growth. In this case, there is no assurance that such funds will
be available to the Company at terms acceptable to it, or at all.
YEAR 2000 COMPLIANCE.
Like many other companies, the Company and GTI face risks associated
with Year 2000 computer issues. If the Company's internal management information
systems and external electronic commerce information systems do not correctly
recognize and process date information beyond the year 1999, it could have a
significant adverse impact on the Company's ability to process client and
end-user transactions, which could create significant potential liability for
the Company. To address potential Year 2000 issues with its internal and
external systems, the Company has evaluated such systems. Remediation is
proceeding, and the Company currently plans to have changes to these systems
completed and tested by September 30, 1999. These activities are intended to
encompass all major categories of systems used by the Company, including
electronic commerce, sales processing, sales and financial systems. The initial
assessment indicated that certain internal systems should be upgraded or
replaced as part of a solution to the Year 2000 problem. Specifically, GTI's
internal information systems, including sales and purchase order processing,
inventory management, accounts payable and receivable and general ledger, are
not Year 2000 Compliant. The Company has tested the potential of using VW's
software platform for GTI's business operations and does not believe that an
appropriate conversion can be timely effected. Accordingly, the Company now
plans, to implement a newer version of GTI's existing software. Although the
software manufacturer has represented the Year 2000 compliance of its newer
version, GTI has not tested the software and cannot assure its Year 2000
compliance or timely installation. These estimates do not include potential
costs related to any customer or other claims or the cost of internal software
and hardware replaced in the normal course of business. These estimates are
based on management's current assessment of its year 2000 projects and is
subject to change as the projects progress.
The Company is also working with key suppliers of products and services
to determine that their operations and products are Year 2000 compliant or to
monitor their progress toward Year 2000 compliance, as appropriate. The failure
of a major supplier to become Year 2000 compliant on a timely basis, or any
system conversion by a supplier that is incompatible with the Company's systems,
could have a material adverse effect on the Company's business, financial
condition and operating results. In addition, the Company's business, financial
condition and operating results may be materially adversely affected to the
extent that its end-users are unable to use their credit cards due to the Year
2000 issues that are not rectified by their credit card vendors.
In addition, the Company has begun internal discussions concerning
contingency planning to address potential problem areas with internal systems
and with suppliers and other third parties. Management expects that assessment,
remediation and contingency planning activities will be on-going throughout
calendar year 1999 with the goal of appropriately resolving all material
internal and external systems and third party issues. In the event of a Year
2000 failure of GTI's internal systems, management believes that GTI could
temporarily continue operations by manually processing transactions, although on
a less efficient and more costly basis.
As used by the Company, "Year 2000 Compliant" means software that
can individually, and in combination and in conjunction with all other systems,
products or processes with which they are required or designed to interface,
continue to be used normally and to operate successfully (both in functionality
and performance in all material respects) over the transition into the
twenty-first century when used in accordance with the documentation relating to
such software, including being able to, before, on and after January 1, 2000
substantially conform to the following: (i) use logic pertaining to dates which
allow users to identify and/or use the century portion of any date fields
without special processing; (ii) respond to all date elements and date input so
as to resolve any ambiguity as to century in a disclosed, defined and
pre-determined manner; and (iii) provide date information in ways which are
unambiguous as to century. This may be achieved by permitting or requiring the
century to be specified or where the data element is represented without a
century, the correct century is unambiguous for all manipulations involving that
element.
32
<PAGE> 33
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company does not enter into financial instruments for trading or
speculative purposes and does not currently utilize derivative financial
instruments. The operations of the Company are conducted primarily in the United
States and as such are not subject to material foreign currency exchange rate
risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Index to Financial Statements
Independent Auditor's Report............................................ F-1
Report of Independent Public Accountants................................ F-2
Consolidated Balance Sheets at January 31, 1999 and 1998................ F-3
Consolidated Statements of Operations for the years ended January 31,
1999 and 1998 and for the period February 7, 1996 to
January 31, 1997........................................................ F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended January 31, 1999 and 1998 and the period
February 7, 1996 to January 31, 1997.................................... F-5
Consolidated Statements of Cash Flows for the years ended January 31,
1999 and 1998 and the period February 7, 1996 to January 31, 1997....... F-11
Notes to Consolidated Financial Statements for the years ended
January 31, 1999 and 1998 and the period February 7, 1996 to
January 31, 1997........................................................ F-12
Accountants' Report..................................................... F-24
Balance Sheets as of December 31, 1998 and 1997......................... F-26
Statement of Income for the years ended December 31, 1998 and 1997...... F-28
Statement of Retained Earnings for the year ended December 31, 1998
and 1997................................................................ F-29
Statement of Cash Flows for the years ended December 31, 1998 and 1997.. F-30
Notes to Financial Statements for the years ended December 31, 1998
and 1997................................................................ F-32
Independent Auditor's Report............................................ F-37
Balance Sheet as of December 31, 1996................................... F-39
Statement of Income for the year ended December 31, 1996................ F-41
Statement of Retained Earnings for the year ended December 31, 1996..... F-42
Statement of Cash Flows for the year ended December 31, 1996............ F-43
Notes to Financial Statements for the year ended December 31, 1996...... F-45
Independent Auditor's Report............................................ F-50
Financial Statement Schedule............................................ F-51
33
<PAGE> 34
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
Virtual Technology Corporation and Subsidiaries
Minneapolis, Minnesota
We have audited the accompanying consolidated balance sheets of VIRTUAL
TECHNOLOGY CORPORATION AND SUBSIDIARIES as of January 31, 1998 and 1999, and the
related consolidated statements of operations, change in stockholders' equity
(deficit), and cash flows for each of the two years in the period ended January
31, 1999. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of VIRTUAL TECHNOLOGY
CORPORATION AND SUBSIDIARIES as of January 31, 1998 and 1999, and the results of
their operations and their cash flows for each of the two years in the period
ended January 31, 1999, in conformity with generally accepted accounting
principles.
/s/ LURIE, BESIKOF, LAPIDUS & CO., LLP
Minneapolis, Minnesota
April 23, 1999
F-1
<PAGE> 35
Report of Independent Certified Public Accountants
--------------------------------------------------
Board of Directors and Stockholders
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
Minneapolis, Minnesota
We have audited the accompanying consolidated statements of operations,
stockholders' equity and cash flows of Virtual Technology Corporation and
Subsidiaries (A Development Stage Enterprise) for the period from inception
(February 7, 1996) to January 31, 1997. These financial statements are the
responsibility of the Companies' management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Virtual
Technology Corporation and Subsidiaries for the period from inception
(February 7, 1996) to January 31, 1997, in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Companies will continue as a going concern. As discussed in Note A to the
financial statements, the Companies require additional financing to support
operations and have accumulated a deficit during the development stage. These
matters raise substantial doubt about the Companies' ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note A. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Copeland Buhl & Company P.L.L.P.
COPELAND BUHL & COMPANY P.L.L.P.
Minneapolis, Minnesota
April 11, 1997
F-2
<PAGE> 36
- 3 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
January 31,
----------------------------
ASSETS 1998 1999
------------ ------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 3,649 $ 125,993
Receivables:
Accounts (net of allowance for doubtful accounts of
$-0- and $263,000) 672 4,364,905
Credit cards - 132,387
Stock subscription, subsequently collected - 2,676,436
Inventories 8,287 5,236,292
Other current assets 3,906 2,761,670
------------ ------------
TOTAL CURRENT ASSETS 16,514 15,297,683
------------ ------------
FURNITURE AND EQUIPMENT, net of accumulated depreciation
of $32,303 and $38,612, respectively 42,895 381,662
------------ ------------
OTHER ASSETS
Goodwill - 8,345,295
Covenant not to compete - 500,000
Consulting agreement - 1,042,115
Prepaid investor relation services - 103,600
Loan fees - 50,250
Deposits - 21,973
------------ ------------
- 10,063,233
------------ ------------
$ 59,409 $ 25,742,578
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable - trade $ 256,637 $ 4,950,358
Accounts payable - customers - 2,213,000
Accrued expenses and other current liabilities 479,797 1,884,983
Notes payable - 7,295,673
Current amount of capital lease obligations 1,202 10,628
Loans from related parties - 45,000
------------ ------------
TOTAL CURRENT LIABILITIES 737,636 16,399,642
------------ ------------
OTHER LIABILITIES
Loans from related parties 341,543 371,543
Convertible debentures 372,000 -
Capital lease obligations, net of current amount 1,799 49,267
------------ ------------
715,342 420,810
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock - 5,000,000 shares authorized; none issued - -
Common stock - no par value; 50,000,000 shares authorized;
shares issued and outstanding - 8,489,937 and
25,345,963 respectively 1,975,013 17,572,796
Stock subscription receivable - (925,000)
Accumulated deficit (3,368,582) (7,725,670)
------------ ------------
(1,393,569) 8,922,126
------------ ------------
$ 59,409 $ 25,742,578
============ ============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 37
- 4 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
February 7,
1996 Years Ended
(Inception) to January 31,
January 31, ----------------------------
1997 1998 1999
-------------- ------------ ------------
<S> <C> <C> <C>
NET SALES $ - $ 174,669 $ 4,945,907
COST OF GOODS SOLD - - 4,769,313
------------ ------------ ------------
GROSS PROFIT - 174,669 176,594
------------ ------------ ------------
OPERATING EXPENSES
Sales and marketing 154,887 550,802 1,792,238
General and administrative 389,878 1,148,067 2,727,937
Write-off of Virtual Technology (UK) Limited - 925,000 -
Purchased research and development costs 284,576 - -
------------ ------------ ------------
829,341 2,623,869 4,520,175
------------ ------------ ------------
LOSS FROM OPERATIONS (829,341) (2,449,200) (4,343,581)
------------ ------------ ------------
OTHER INCOME (EXPENSE)
Interest expense (1,699) (58,254) (79,618)
Other 1,619 (31,707) 66,111
------------ ------------ ------------
(80) (89,961) (13,507)
------------ ------------ ------------
NET LOSS ($829,421) ($2,539,161) ($4,357,088)
============ ============ ============
NET LOSS PER COMMON SHARE -
BASIC AND DILUTED ($0.13) ($0.36) ($0.26)
============ ============ ============
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING - BASIC
AND DILUTED 6,380,084 7,068,687 16,958,284
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 38
- 5 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Common Stock
- Subsidiaries Common Stock - Parent
-------------------------- --------------------------- Accumulated
Shares Amount Shares Amount Deficit
----------- ---------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance - February 7, 1996, prior to
acquisition of subsidiary - $ - 3,213,008 $ 1,112,286 ($1,112,286)
February 7, 1996:
Initial issuance of stock for cash, fair value
of investments, and reimbursement of
expenses - $.01 to $.167 per share 3,014,030 226,500 - - -
May 4, 1996:
Stock issued in private placement for cash -
$2.46 to $2.50 per share 27,560 68,877 - - -
Acquisition of Network Storage, Inc.
on June 17, 1996 (3,041,590) (295,377) 3,041,590 295,377 -
Reorganization of Virtual Technology
Corporation upon acquisition of subsidiary - - - (1,112,286) 1,112,286
August 27, 1996 to January 18, 1997:
Stock issued in private placement:
Stock issued for cash - $2.50 per share - - 44,000 110,000 -
Stock issued for services - $2.00 per
share - - 66,000 132,000 -
Acquisition of VTL on October 31, 1996 -
$2.56 per share - - 427,500 1,094,640 -
Compensation expense - - - - -
Net loss - - - - (829,421)
----------- ---------- --------- ----------- -------------
Balance - January 31, 1997 - $ - 6,792,098 $ 1,632,017 ($829,421)
=========== ========== ========= =========== =============
</TABLE>
<TABLE>
<CAPTION>
Stock Stockholders'
Unearned Subscription Equity
Compensation Receivable (Deficit)
-------------- ------------- ------------
<S> <C> <C> <C>
Balance - February 7, 1996, prior to
acquisition of subsidiary $ - $ - $ -
February 7, 1996:
Initial issuance of stock for cash, fair value
of investments, and reimbursement of
expenses - $.01 to $.167 per share (100,000) - 126,500
May 4, 1996:
Stock issued in private placement for cash -
$2.46 to $2.50 per share - - 68,877
Acquisition of Network Storage, Inc.
on June 17, 1996 - - -
Reorganization of Virtual Technology
Corporation upon acquisition of subsidiary - - -
August 27, 1996 to January 18, 1997:
Stock issued in private placement:
Stock issued for cash - $2.50 per share - - 110,000
Stock issued for services - $2.00 per
share - - 132,000
Acquisition of VTL on October 31, 1996 -
$2.56 per share - - 1,094,640
Compensation expense 65,278 - 65,278
Net loss - - (829,421)
-------------- ------------- -------------
Balance - January 31, 1997 ($34,722) $ - $ 767,874
============== ============= =============
</TABLE>
(continued)
See notes to consolidated financial statements.
F-5
<PAGE> 39
- 6 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
<TABLE>
<CAPTION>
Common Stock
- Subsidiaries Common Stock - Parent
-------------------------- --------------------------- Accumulated
Shares Amount Shares Amount Deficit
----------- ---------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance - January 31, 1997 - $ - 6,792,098 $ 1,632,017 ($829,421)
March 21, 1997 to May 5, 1997:
Stock issued for cash - $2.50 per share - - 18,800 47,000 -
May 8, 1997 to June 17, 1997:
Stock issued for services - $1.25 per share - - 36,539 45,674 -
September 25, 1997:
Stock issued for cash - $.40 per share - - 25,000 10,000 -
Stock issued for cash - $.25 per share - - 200,000 50,000 -
Stock issued for services - $1.50 per share - - 15,000 22,500 -
November 12, 1997:
Stock issued for cash - $.125 per share - - 50,000 6,250 -
December 3, 1997 to December 19, 1997:
Stock issued for cash - $.10 per share - - 900,000 90,000 -
Stock issued for services - $.50 per share - - 25,000 12,500 -
Stock issued for services - $.375 per share - - 50,000 18,750 -
December 19, 1997:
Stock issued for cash - $.50 per share - - 10,000 5,000 -
January 26, 1998:
Stock issued for cash - $.10 per share - - 350,000 35,000 -
Stock issued for services - $.018 per share - - 17,500 322 -
Compensation expense - - - - -
Net loss - - - - (2,539,161)
----------- ---------- --------- ----------- ------------
Balance - January 31, 1998 - $ - 8,489,937 $ 1,975,013 ($ 3,368,582)
=========== ========== ========= =========== ============
</TABLE>
<TABLE>
<CAPTION>
Stock Stockholders'
Unearned Subscription Equity
Compensation Receivable (Deficit)
------------- ------------- ------------
<S> <C> <C> <C>
Balance - January 31, 1997 ($34,722) $ - $ 767,874
March 21, 1997 to May 5, 1997:
Stock issued for cash - $2.50 per share - - 47,000
May 8, 1997 to June 17, 1997:
Stock issued for services - $1.25 per share - - 45,674
September 25, 1997:
Stock issued for cash - $.40 per share - - 10,000
Stock issued for cash - $.25 per share - - 50,000
Stock issued for services - $1.50 per share - - 22,500
November 12, 1997:
Stock issued for cash - $.125 per share - - 6,250
December 3, 1997 to December 19, 1997:
Stock issued for cash - $.10 per share - - 90,000
Stock issued for services - $.50 per share - - 12,500
Stock issued for services - $.375 per share - - 18,750
December 19, 1997:
Stock issued for cash - $.50 per share - - 5,000
January 26, 1998:
Stock issued for cash - $.10 per share - - 35,000
Stock issued for services - $.018 per share - - 322
Compensation expense 34,722 - 34,722
Net loss - - (2,539,161)
---------- ------------- -----------
Balance - January 31, 1998 $ - $ - ($1,393,569)
========== ============= ============
</TABLE>
(continued)
See notes to consolidated financial statements.
F-6
<PAGE> 40
- 7 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
<TABLE>
<CAPTION>
Common Stock
- Subsidiaries Common Stock - Parent
-------------------------- --------------------------- Accumulated
Shares Amount Shares Amount Deficit
----------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance - January 31, 1998 - $ - 8,489,937 $ 1,975,013 ($3,368,582)
Correction to shares beginning of year - - (60,000) - -
February 25 to March 10, 1998:
Stock issued for cash - $.10 per share - - 250,000 25,000 -
Stock issued for services - $.10 per share - - 240,000 24,000 -
March 10, 1998:
Stock issued for cash - $.25 per share - - 30,000 7,500 -
March 18 to March 23, 1998:
Stock issued for cash - $.08 per share - - 1,250,000 100,000 -
Stock issued for services - $.10 per share - - 70,000 7,000 -
March 23, 1998:
Stock issued for services - $.25 per share - - 600,000 150,000 -
April 2 to April 27, 1998:
Stock issued for cash - $.10 per share - - 1,690,000 169,000 -
Stock issued for services - $.10 per share - - 85,000 8,500 -
April 29, 1998:
Stock issued for services - $.10 per share - - 50,000 5,000 -
</TABLE>
<TABLE>
<CAPTION>
Stock Stockholders'
Unearned Subscription Equity
Compensation Receivable (Deficit)
------------ ------------- ------------
<S> <C> <C> <C>
Balance - January 31, 1998 $ - $ - ($1,393,569)
Correction to shares beginning of year - - -
February 25 to March 10, 1998:
Stock issued for cash - $.10 per share - - 25,000
Stock issued for services - $.10 per share - - 24,000
March 10, 1998:
Stock issued for cash - $.25 per share - - 7,500
March 18 to March 23, 1998:
Stock issued for cash - $.08 per share - - 100,000
Stock issued for services - $.10 per share - - 7,000
March 23, 1998:
Stock issued for services - $.25 per share - - 150,000
April 2 to April 27, 1998:
Stock issued for cash - $.10 per share - - 169,000
Stock issued for services - $.10 per share - - 8,500
April 29, 1998:
Stock issued for services - $.10 per share - - 5,000
</TABLE>
(continued)
See notes to consolidated financial statements.
F-7
<PAGE> 41
- 8 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
<TABLE>
<CAPTION>
Common Stock
- Subsidiaries Common Stock - Parent
-------------------------- --------------------------- Accumulated
Shares Amount Shares Amount Deficit
----------- ---------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
May 12, 1998:
Stock issued for conversion of
debentures - $.25 per share - $ - 694,000 $ 173,500 $ -
May 14 to May 15, 1998:
Stock issued for cash - $.10 per share - - 660,000 66,000 -
May 18, 1998:
Stock issued for cash - $.25 per share - - 100,000 25,000 -
May 19 to May 21, 1998:
Stock issued for cash - $.10 per share - - 50,000 5,000 -
Stock issued for services - $.10 per share - - 50,000 5,000 -
May 23, 1998:
Stock issued for cash - $.08 per share - - 1,250,000 100,000 -
June 22, 1998:
Stock issued for cash - $.08 per share - - 625,000 50,000 -
July 3, 1998:
Stock issued for cash - $.125 per share - - 200,000 25,000 -
July 6, 1998:
Stock issued for cash - $.08 per share - - 1,250,000 100,000 -
July 14, 1998:
Stock issued for services - $.10 per share - - 50,000 5,000 -
</TABLE>
<TABLE>
<CAPTION>
Stock Stockholders'
Unearned Subscription Equity
Compensation Receivable (Deficit)
------------ ------------ -------------
<S> <C> <C> <C>
May 12, 1998:
Stock issued for conversion of
debentures - $.25 per share $ - $ - $ 173,500
May 14 to May 15, 1998:
Stock issued for cash - $.10 per share - - 66,000
May 18, 1998:
Stock issued for cash - $.25 per share - - 25,000
May 19 to May 21, 1998:
Stock issued for cash - $.10 per share - - 5,000
Stock issued for services - $.10 per share - - 5,000
May 23, 1998:
Stock issued for cash - $.08 per share - - 100,000
June 22, 1998:
Stock issued for cash - $.08 per share - - 50,000
July 3, 1998:
Stock issued for cash - $.125 per share - - 25,000
July 6, 1998:
Stock issued for cash - $.08 per share - - 100,000
July 14, 1998:
Stock issued for services - $.10 per share - - 5,000
</TABLE>
(continued)
See notes to consolidated financial statements.
F-8
<PAGE> 42
- 9 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
<TABLE>
<CAPTION>
Common Stock
- Subsidiaries Common Stock - Parent
-------------------------- --------------------------- Accumulated
Shares Amount Shares Amount Deficit
----------- ---------- ---------- ----------- ------------
<S> <C> <C> <C> <C> <C>
July 9 to July 20, 1998:
Stock issued for cash - $.125 per share - $ - 50,000 $ 6,250 $ -
Stock issued for cash - $.375 per share - - 705,500 264,562 -
Stock issued for conversion of
debentures - $.25 per share - - 126,000 31,500 -
Stock issued for services - $.375 per share - - 5,000 1,875 -
July 29 to July 31, 1998:
Stock issued for cash - $.80 per share - - 56,000 44,800 -
Stock issued for conversion of
debentures - $.25 per share - - 175,648 43,912 -
July 31 to October 31, 1998:
Stock issued for cash - $.375 per share - - 1,386,666 520,000 -
Stock issued for services - $.375 per share - - 580,000 217,500 -
November 11 to December 12, 1998:
Stock issued for cash - $1.00 per share - - 500,000 500,000 -
Stock issued for services - $.99 per share - - 225,000 222,750 -
December 22, 1998 to January 26, 1999:
Stock issued for cash - $1.50 per share,
less commission of $50,000 - - 333,333 450,000 -
Stock issued for cash - $1.50 per share,
less commissions of $165,000 - - 1,000,000 1,335,000 -
Stock issued for services - $2.75 per share - - 114,532 315,000 -
Stock issued for exercise of warrants - $0.75
per share - - 213,333 160,000 -
</TABLE>
<TABLE>
<CAPTION>
Stock Stockholders'
Unearned Subscription Equity
Compensation Receivable (Deficit)
------------- ------------- ------------
<S> <C> <C> <C>
July 9 to July 20, 1998:
Stock issued for cash - $.125 per share $ - $ - $ 6,250
Stock issued for cash - $.375 per share - - 264,562
Stock issued for conversion of
debentures - $.25 per share - - 31,500
Stock issued for services - $.375 per share - - 1,875
July 29 to July 31, 1998:
Stock issued for cash - $.80 per share - - 44,800
Stock issued for conversion of
debentures - $.25 per share - - 43,912
July 31 to October 31, 1998:
Stock issued for cash - $.375 per share - - 520,000
Stock issued for services - $.375 per share - - 217,500
November 11 to December 12, 1998:
Stock issued for cash - $1.00 per share - - 500,000
Stock issued for services - $.99 per share - - 222,750
December 22, 1998 to January 26, 1999:
Stock issued for cash - $1.50 per share,
less commission of $50,000 - - 450,000
Stock issued for cash - $1.50 per share,
less commissions of $165,000 - - 1,335,000
Stock issued for services - $2.75 per share - - 315,000
Stock issued for exercise of warrants - $0.75
per share - - 160,000
</TABLE>
(continued)
See notes to consolidated financial statements.
F-9
<PAGE> 43
- 10 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
<TABLE>
<CAPTION>
Common Stock
- Subsidiaries Common Stock - Parent
-------------------------- --------------------------- Accumulated
Shares Amount Shares Amount Deficit
----------- ---------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
January 15, 1999:
Stock issued for conversion of debentures -
$1.00 per share - $ - 177,443 $ 177,443 $ -
January 25 to January 29, 1999:
Subscription agreement to purchase stock
for cash at $5.2857 per share less
commissions of $98,564 - - 700,000 3,601,436 -
Stock issued in purchase of GTI - $7.187
per share - - 228,571 1,642,740 -
Stock issued for consulting agreement in
connection with purchase of GTI -
$7.187 per share - - 145,000 1,042,115 -
Stock issued for exercise of warrants -
$1.00 per share - - 1,000,000 1,000,000 -
Value of warrants and options issued for
services - - - 2,970,400 -
Net loss - - - - (4,357,088)
----------- ---------- ---------- ------------ -------------
Balance - January 31, 1999 - $ - 25,345,963 $ 17,572,796 ($7,725,670)
=========== ========== ========== ============ =============
</TABLE>
<TABLE>
<CAPTION>
Stock Stockholders'
Unearned Subscription Equity
Compensation Receivable (Deficit)
------------ ------------- ------------
<S> <C> <C> <C>
January 15, 1999:
Stock issued for conversion of debentures -
$1.00 per share $ - $ - $ 177,443
January 25 to January 29, 1999:
Subscription agreement to purchase stock
for cash at $5.285 per share less
commissions of $98,064 - (925,000) 2,676,436
Stock issued in purchase of GTI - $7.187
per share - - 1,642,740
Stock issued for consulting agreement in
connection with purchase of GTI -
$7.187 per share - - 1,042,115
Stock issued for exercise of warrants -
$1.00 per share - - 1,000,000
Value of warrants and options issued for
services - - 2,970,400
Net loss - - (4,357,088)
----------- ------------- ------------
Balance - January 31, 1999 $ - ($925,000) $ 8,922,126
=========== ============= ============
</TABLE>
See notes to consolidated financial statements.
F-10
<PAGE> 44
- 11 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
February 7,
1996
(Inception) to Year Ended January 31,
January 31, -------------------------------
1997 1998 1999
------------- ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss ($829,421) ($2,539,161) ($4,357,088)
Adjustments to reconcile net loss to net cash
used by operating activities:
Stock issued for compensation and services 232,778 134,468 1,322,360
Purchased research and development 284,576 - -
Depreciation 2,599 19,649 28,357
Loss on disposal of equipment - 10,054 -
Amortization of intangible assets 35,000 - -
Write-off of VTL - 925,000 -
Gain on sale of investments (202) - -
Changes in operating assets and liabilities:
Accounts and credit card receivables - 11,092 (1,139,854)
Inventories - (8,287) 21,736
Other current assets - 2,756 (164,519)
Deposits - - (9,631)
Accounts payable 17,981 223,823 (102,436)
Accrued expenses and other current liabilities 1,350 433,744 821,779
--------- ----------- -----------
Net cash used by operating activities (255,339) (786,862) (3,579,296)
--------- ----------- -----------
INVESTING ACTIVITIES
Purchases of furniture and equipment (29,248) (19,061) (230,706)
Proceeds from sale of investments 50,202 - -
Purchase of subsidiaries, net of cash acquired (15,787) - (950,147)
Advances to subsidiary (77,000) - -
Other - (122) -
--------- ----------- -----------
Net cash used by investing activities (71,833) (19,183) (1,180,853)
--------- ----------- -----------
FINANCING ACTIVITIES
Loan fees - - (50,250)
Proceeds from issuance of common stock 219,877 243,251 4,912,551
Payments on capital lease obligations (719) (1,121) (4,524)
Payments on notes payable and convertible debentures - (37,965) (50,284)
Loans from related parties - 341,543 75,000
Proceeds from convertible debentures 135,000 237,000 -
--------- ----------- -----------
Net cash provided by financing activities 354,158 782,708 4,882,493
--------- ----------- -----------
NET INCREASE (DECREASE) IN CASH 26,986 (23,337) 122,344
CASH
Beginning of period - 26,986 3,649
--------- ----------- -----------
End of period $ 26,986 $ 3,649 $ 125,993
========= =========== ===========
</TABLE>
See notes to consolidated financial statements.
F-11
<PAGE> 45
- 12 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company and Summary of Significant Accounting Policies -
The Company
Virtual Technology Corporation (VTC) is an internet retailer of high
performance computer hardware, software and peripheral products to
sophisticated computer and internet users. GTI Acquisition Corporation
(GAC), a wholly-owned subsidiary, is a leading distributor of computer
peripheral equipment to wholesale and retail outlets throughout the
United States and Canada.
Virtual Technology (UK) Limited (VTL), formerly known as Ashmount
Research Ltd., is a wholly-owned subsidiary located in the United
Kingdom. VTL was dormant during fiscal 1999 but is expected to begin new
operations as a European electronic commerce business.
During fiscal 1999, the Company commenced operations and therefore the
consolidated financial statements no longer reflect those of a
developmental stage company.
In prior years, the auditor's report stated there was substantial doubt
about the Company's ability to continue as a going concern since the
Company had not commenced its planned principal operations, and therefore
had not generated revenues to support operations, had an accumulated
deficit, and required additional financing. During fiscal 1999, the
Company commenced operations and raised $4,912,551 of cash through the
issuance of common stock and raised additional proceeds of approximately
$2,250,000 subsequent to January 31, 1999. The Company also acquired
Herold Marketing Associates, Inc. (Note 2) which had profitable
operations and obtained a $10,000,000 credit agreement in February 1999
(Note 17).
The Company now believes that existing cash and cash equivalents,
available borrowing capacity and cash generated from operations will be
adequate to meet its operating cash needs through the end of fiscal
2000, although the Company may seek to raise additional capital during
that period.
Principles of Consolidation
The consolidated financial statements include the accounts of Virtual
Technology Corporation and its wholly-owned subsidiaries, GTI Acquisition
Corporation (formed to acquire the assets of Herold Marketing Associates,
Inc. on January 28, 1999 and is included in the consolidated statements
of operations and cash flows for three days in fiscal 1999) and Virtual
Technology (UK) Limited. VTL was a nonoperating entity during fiscal
1999. All significant intercompany accounts and transactions have been
eliminated.
VTL has an October 31 fiscal year and is included in the 1998
consolidated financial statements for the fifteen months ended January
31, 1998 and in the 1997 consolidated financial statements for the year
ended October 31, 1997. The results of operations of VTL for the period
November 1, 1997 to January 31, 1998, are not significant.
(continued)
F-12
<PAGE> 46
- 13 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company and Summary of Significant Accounting Policies - (continued)
Use of Estimates
The preparation of these consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts and disclosures in
the financial statements and accompanying notes. Actual results could
differ from these estimates.
Revenue Recognition
The Company recognizes revenue upon the shipment of the product.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market.
Furniture and Equipment
Furniture and equipment are recorded at cost. Depreciation is provided in
amounts sufficient to relate the cost to operations over their estimated
service lives, generally 3 to 7 years. The straight-line method of
depreciation is used for financial reporting.
Financial Instruments
The carrying values of cash, receivables, notes payable, accounts
payable, and other financial instruments approximate their fair values
principally because of their short-term nature. The carrying value of
long-term debt does not differ significantly from its fair value. It is
not practicable to determine the fair value of loans from related parties
as the relationship influences the terms, and similar instruments are not
generally available.
Advertising Costs
Advertising costs are expensed when incurred and totalled approximately
$4,800, $222,600, and $1,530,900, for the periods ended January 31, 1997,
1998, and 1999, respectively.
(continued)
F-13
<PAGE> 47
- 14 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company and Summary of Significant Accounting Policies - (continued)
Intangible Assets
Amortization of intangible assets is recognized on the straight-line
method over the following estimated lives:
<TABLE>
<CAPTION>
Description Years
----------------------- -----
<S> <C>
Goodwill 20
Covenant not to compete 3
Consulting agreement 3
Loan fees 3
</TABLE>
Goodwill and the covenant not to compete result from the acquisition
of Herold Marketing Associates, Inc. and will begin to be amortized
February 1, 1999. There was no accumulated amortization on any intangible
assets at January 31, 1999.
Net Loss Per Common Share
Basic net loss per common share is computed by dividing the net loss by
the weighted average number of common shares outstanding during the
period. Diluted net loss per common share is the same as basic as stock
options, warrants, and convertible debt are antidulutive.
Accounting for Stock-Based Compensation
The Company accounts for employee stock options under the method
prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and provides the pro forma disclosures
required by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock- Based Compensation."
Derivative Instruments, Hedging Activities and Other Comprehensive Income
The Company holds no derivative instruments, engages in no hedging
activities and has no significant items of other comprehensive income.
Recently Issued Accounting Standards
Accounting Standards Executive Committee Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" (SOP 98-1), issued in March 1998 and effective for fiscal
years beginning after December 15, 1998, provides guidance on accounting
for the costs of computer software developed or obtained for internal
use. SOP 98-1 requires all costs related to the development of
internal-use software other than those incurred during the application
development stage to be expensed as incurred. Costs incurred during the
application development stage are required to be capitalized and
amortized over the estimated useful life of the software. The Company
plans to adopt SOP 98-1 effective with the first quarter of fiscal 2000.
Adoption is not expected to have a material effect on the Company's
financial position or results of operations.
Accounting Standards Executive Committee Statement of Position 98-5,
"Reporting on the Costs of Start- Up Activities" (SOP 98-5), issued in
April 1998 and effective for fiscal years beginning after December 15,
1998, requires an entity to expense all start-up activities as incurred.
The Company is currently in compliance with the provisions of SOP 98-5
and, accordingly, the adoption of SOP 98-5 will not impact the Company's
financial position or results of operations.
F-14
<PAGE> 48
- 15 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Acquisitions -
On June 17, 1996, the stockholders of International Gold Marketing, Inc.
(IGM) approved the acquisition of Network Storage, Inc. (NSI). IGM, a
nonoperating entity, exchanged its common stock for all the common stock
of NSI and subsequently changed its name to Virtual Technology
Corporation (VTC). The merger was accounted for as a
pooling-of-interests. Combined and separate operations of NSI and IGM
during the periods preceding the merger are not disclosed as NSI was not
incorporated until 1996 and previous operations of IGM are unrelated to
current operations and immaterial. In conjunction with the acquisition,
VTC adopted fresh-start reporting. Accordingly, the deficit accumulated
from previous nonrelated operations was offset against the remaining
equity. No gain or loss resulted from the reorganization.
On October 31, 1996, VTC acquired all the outstanding common stock of
Virtual Technology (UK) Limited (VTL) for $18,000 in cash and 427,500
shares of common stock. The acquisition was accounted for using the
purchase method of accounting. Accordingly, the purchase price was
allocated to the net assets acquired based on their estimated fair
values. The balance of the purchase price was allocated to software
development costs ($600,000), trademarks, patents and copyrights
($250,000), and goodwill ($50,000). Also, certain research and
development projects totaling $284,576 were determined to have no
alternative future use and were charged to operations. In fiscal 1998,
the Company wrote off $925,000 of intangible assets and advances due to
the termination of the VTL operations.
On January 28, 1999, VTC acquired through its wholly-owned subsidiary,
GTI Acquisition Corporation, substantially all the assets and incurred
certain liabilities of Herold Marketing Associates, Inc. dba Graphics
Technology, Inc. (GTI) and entered into a three year covenant not to
compete agreement with the chairman and founder of GTI for $1,000,000 in
cash, $7,300,000 in notes (discounted to $7,188,600 due to imputed
interest), $200,000 to be placed into escrow for three years (included in
other current liabilities at January 31, 1999) and 228,571 shares of VTC
stock valued at $1,642,740. In addition, the chairman and founder
received 145,000 shares of VTC stock valued at $1,042,115 for a three
year consulting agreement. The acquisition was accounted for using the
purchase method of accounting. Accordingly, the purchase price was
allocated to the net assets acquired based upon their estimated fair
values. The purchase price was allocated as follows:
<TABLE>
<CAPTION>
<S> <C>
Inventories $ 3,693,283
Other current assets 181,761
Accounts receivable 3,360,637
Goodwill 8,345,295
Covenant not to compete 500,000
Accounts payable (5,358,497)
Other liabilities (691,139)
</TABLE>
(continued)
F-15
<PAGE> 49
- 16 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Acquisitions - (continued)
The purchase agreement provides for a post-closing adjustment to the
purchase price (dollar for dollar reduction to the extent GTI's
stockholders' equity at closing is less than $2.1 million and GTI's
funded debt exceeds $1.7 million). The determination of the closing
stockholders' equity was audited by GTI's auditors and, under the
purchase agreement, is subject to approval by the Company. The Company
has not completed its review of the closing GTI audit and therefore the
final purchase price is subject to change. The Company believes that a
post-closing adjustment, if any, will result in a decrease to the
purchase price as currently recorded in the consolidated financial
statements.
The following unaudited pro forma financial information gives effect to
the GTI acquisition as if it had occurred at the beginning of each of the
years ended January 31, 1998 and 1999. The pro forma results were
prepared for comparative purposes only and do not purport to be
indicative of the results of operations which actually would result had
the acquisition occurred on the date indicated, or which may result in
the future.
<TABLE>
<CAPTION>
Year Ended January 31,
------------------------------
1998 1999
------------ ------------
<S> <C> <C>
Net sales $ 89,944,000 $ 69,180,200
Net loss (2,334,800) (4,387,900)
Net loss per common share -
basic and diluted (0.29) (0.24)
Weighted average common shares
outstanding -
basic and diluted 8,108,925 17,987,122
</TABLE>
3. Inventories -
Inventories consist of the following:
<TABLE>
<CAPTION>
January 31,
-------------------------
1998 1999
---------- ----------
<S> <C> <C>
Inventory $ 8,287 $3,536,292
Inventory - returned goods - 1,700,000
---------- ----------
$ 8,287 $5,236,292
========== ==========
</TABLE>
Inventory at January 31, 1999, includes a reserve for obsolescence of
$350,000. Returned goods represent GAC inventory returned to the Company
subsequent to January 31, 1999.
F-16
<PAGE> 50
- 17 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Other Current Assets -
Other current assets consist of the following:
<TABLE>
<CAPTION>
January 31,
---------------------------
1998 1999
------- -------------
<S> <C> <C>
Prepaid consulting and service agreements $ - $ 2,546,630
Credit card company holdbacks - 174,000
Other 3,906 41,040
------- -------------
$ 3,906 $ 2,761,670
======= =============
</TABLE>
In fiscal 1999, the Company entered into consulting and service
agreements whereby the Company receives, generally over a period of one
year or less as specified in the agreements, investment banking, legal,
and other services. As consideration for these agreements the Company
paid cash, issued common stock, issued warrants to purchase common stock,
or a combination thereof. The Company valued the equity consideration
based on the most recent sale price of the Company's stock for periods
prior to November 1, 1998; for periods subsequent, valuations were based
on the quoted market price of the Company's common stock. For periods
prior to November 1, 1998 the Company believes due to the stock being
thinly traded, using the quoted market price to determine the value of
the equity consideration given would overstate the value of the
consideration received. The agreements are being amortized over the
contract service period.
5. Notes Payable -
Notes payable consist of the following:
<TABLE>
<CAPTION>
January 31,
---------------------------
1998 1999
------- -------------
<S> <C> <C>
Payable to GTI, interest imputed at 9.75%:
Due February 27, 1999 $ - $ 3,967,936
Due April 28, 1999 - 3,220,664
8% notes payable to former stockholder of VTL in
settlement of litigation - 93,129
Other notes - 13,944
------- -------------
$ - $ 7,295,673
======= =============
</TABLE>
6. Loans from Related Parties -
Related party loans bear interest at 10% and are due in fiscal years 2000
and 2001. Interest expense was approximately $0, $20,300 and $36,595 in
fiscal 1997, 1998 and 1999, respectively, and is included in accrued
expenses.
F-17
<PAGE> 51
- 18 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Convertible Debentures -
During 1999, the Company repaid the 12% convertible debentures due to
stockholders and related parties, including accrued interest, for $10,000
in cash and the issuance of 1,173,091 shares of the Company's common
stock. Interest expense in fiscal 1997, 1998 and 1999 was approximately
$1,400, $35,500 and $22,800, respectively.
8. Capital Lease Obligations -
The Company leases office equipment under capital leases expiring August
2003. Equipment capitalized under these leases is as follows:
<TABLE>
<CAPTION>
January 31,
----------------------
1998 1999
-------- ---------
<S> <C> <C>
Office equipment $ 4,842 $ 66,260
Less accumulated amortization 1,614 8,724
-------- ---------
$ 3,228 $ 57,536
======== =========
</TABLE>
Amortization of equipment under capital lease is included in depreciation
expense.
A schedule of future minimum lease payments under the capital lease
together with the present value of the net minimum lease payments is as
follows:
<TABLE>
<CAPTION>
Year Ending
January 31, Amount
-------------------------------------------------------- ---------
<S> <C> <C>
2000 $ 19,766
2001 18,701
2002 18,168
2003 18,168
2004 10,598
---------
Total minimum lease payments 85,401
Less amount representing interest 25,506
---------
Present value of net minimum lease payments 59,895
Less current amount 10,628
---------
$ 49,267
=========
</TABLE>
9. Unearned Compensation -
Two directors were issued stock in lieu of salary for the 18 months from
inception. Compensation expense was $65,278 and $34,722 for fiscal 1997
and 1998, respectively.
F-18
<PAGE> 52
- 19 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Stock Options and Warrants -
Transactions related to options and warrants during the last three years
are summarized as follows:
<TABLE>
<CAPTION>
Number Weighted Average
of Shares Exercise Price
----------- ----------------
<S> <C> <C>
Balance at January 31, 1996 - $ -
Granted 1,341,000 1.47
-----------
Balance at January 31, 1997 1,341,000 1.47
Granted 590,100 1.31
-----------
Balance at January 31, 1998 1,931,100 1.42
Granted 6,018,885 1.18
Exercised (1,213,333) 0.96
Forfeited (394,500) 2.42
-----------
Balance at January 31, 1999 6,342,152 1.54
===========
</TABLE>
The weighted average fair values of options and warrants granted during
fiscal 1997, 1998 and 1999 were $0.13, $0.59 and $1.22, respectively.
The following table summarizes information about stock options and
warrants at January 31, 1999:
<TABLE>
<CAPTION>
Outstanding Exercisable
------------------------------------------------- -------------------------------------
Weighted Average
------------------------------
Remaining
Range of Options and Contractual Options and Weighted Average
Exercise Prices Warrants Life-Years Exercise Price Warrants Exercise Price
--------------- ----------- ----------- -------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$ 0.25 90,000 4.16 $ 0.25 90,000 $ 0.25
1.00 5,220,219 4.36 1.00 3,960,219 1.00
1.25 50,000 1.39 1.25 50,000 1.25
1.50 263,333 1.36 1.50 263,333 1.50
2.00 400,000 4.49 2.00 400,000 2.00
3.75 250,000 9.93 3.75 62,500 3.75
5.00 68,600 0.15 5.00 68,600 5.00
----------- ---------
6,342,152 1.54 4,894,652 1.19
=========== =========
</TABLE>
As permitted by SFAS 123, "Accounting for Stock-Based Compensation", the
Company elected to follow Accounting Principles Board Opinion No. 25 (APB
25), "Accounting for Stock Issued to Employees", to measure compensation
cost for stock options and warrants. Under APB 25, if the exercise price
of the Company's stock options and or warrants equals the market price of
the underlying stock on the date of grant, no compensation expense is
recognized.
(continued)
F-19
<PAGE> 53
- 20 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Stock Options and Warrants - (continued)
Pro forma information regarding net loss and net loss per share is
required by SFAS 123, and was determined as if the Company had accounted
for its stock options and warrants under the fair value method of that
Statement. The fair value for these options was estimated at the date of
grant using a Black-Scholes option pricing model with the following
assumptions:
<TABLE>
<CAPTION>
Period Ended January 31,
-------------------------------------------------------------------
1997 1998 1999
------------------ ------------------ --------------------
<S> <C> <C> <C>
Dividend yield 0% 0% 0%
Volatility factor 0% 0% 240% - 307%
Risk-free interest rates 5.04% - 5.64% 5.48% - 5.66% 4.46% - 5.62%
Expected lives - years 0.2 - 3.3 1.1 - 4.8 1.6 - 8.0
</TABLE>
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restriction and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's stock options and
warrants have characteristics significantly different from those of
traded options and warrants, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a
reliable measure of the fair value of its stock options and warrants.
For purposes of pro forma disclosure, the estimated fair value of the
options is amortized over the option's vesting period. The pro forma
information is as follows:
<TABLE>
<CAPTION>
Period Ended January 31,
--------------------------------------------------
1997 1998 1999
----------- ------------ -------------
<S> <C> <C> <C>
Net loss:
As reported ($829,421) ($2,539,161) ($4,357,088)
Pro forma (948,422) (2,820,496) (7,822,096)
Net loss per common share-
basic and diluted:
As reported (0.13) (0.36) (0.26)
Pro forma (0.15) (0.40) (0.46)
</TABLE>
11. Income Taxes -
The Company provides income taxes based on income reported for financial
reporting purposes. Deferred taxes are recognized for temporary
differences between the bases of assets and liabilities for financial
statement and income tax purposes. Deferred tax assets were reduced by a
valuation allowance until their realization is reasonably assured. No
income taxes are currently payable due to the net operating losses.
(continued)
F-20
<PAGE> 54
- 21 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Income Taxes - (continued)
The significant components of deferred income tax assets and liabilities,
all of which are long-term, are as follows:
<TABLE>
<CAPTION>
January 31,
-----------------------------------------------------------------------------------
1998 1999
-------------------------------------- ----------------------------------------
Total Federal State Total Federal State
----- ------- ----- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C>
Deferred tax assets:
Net operating loss
carryforwards $ 606,900 $ 471,100 $ 135,800 $2,485,000 $1,929,000 $ 556,000
Write-off of VTL 457,600 355,200 102,400 457,600 355,200 102,400
---------- --------- --------- ---------- ---------- ---------
1,064,500 826,300 238,200 2,942,600 2,284,200 658,400
Valuation allowance (983,500) (745,300) (238,200) (2,718,800) (2,060,400) (658,400)
---------- --------- --------- ---------- ---------- ---------
81,000 81,000 - 223,800 223,800 -
Deferred tax liabilities:
Other 81,000 81,000 - 223,800 223,800 -
---------- --------- --------- ---------- ---------- ---------
Net $ - $ - $ - $ - $ - $ -
========== ========= ========= ========== ========== =========
</TABLE>
Approximately $437,000, $949,000 and $4,200,000 of the net operating
losses expire in 2012, 2013 and 2017 respectively. The change in the
valuation allowance was an increase of $176,700, $806,800 and $1,735,300
in fiscal 1997, 1998, and 1999, respectively.
Certain changes in ownership resulting from the sales of common stock will
limit the future annual realization of the tax net operating loss carry
forwards to a specified percentage under Section 382 of the Internal
Revenue Code.
12. Commitments -
Leases
The Company conducts operations in leased facilities under noncancellable
operating leases. Certain leases are renewable. Rent expense for fiscal
1997, 1998 and 1999 totalled approximately $9,000, $31,300 and $58,400,
respectively.
Approximate future minimum rental commitments under all operating leases
are as follows:
<TABLE>
<CAPTION>
Year Ending
January 31, Amount
----------- -----------
<S> <C> <C>
2000 $ 190,900
2001 34,300
2002 16,400
2003 1,700
-----------
$ 243,300
===========
</TABLE>
(continued)
F-21
<PAGE> 55
- 22 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Commitments - (continued)
Consulting Agreement
The Company has an agreement with a consultant. Under the terms of the
agreement, if certain performance measures are met the consultant is
entitled to a bonus consisting of warrants to purchase 100,000 shares of
the Company's common stock for three years at an exercise price of $1.00
per share. No compensation has been recorded related to the bonus as it
is currently unknown whether the performance measures will be met.
13. Shareholder Lawsuit -
A shareholder threatened a lawsuit against the Company related to the
acquisition of VTL and certain employment matters. The threatened lawsuit
was settled in 1998 by the issuance of two notes payable for $55,000 and
$75,000.
14. Supplemental Disclosures of Cash Flow Information -
<TABLE>
<CAPTION>
Period Ended January 31,
-------------------------------------
1997 1998 1999
------ -------- -------------
<S> <C> <C> <C>
Cash paid for interest $ 349 $ 3,835 $ 74,451
Noncash Investing and Financing Activities:
Capital lease obligation incurred for equipment purchase $ - $ - $ 61,418
Note payable issued for prior year accrued expenses - - 130,000
Note payable issued for insurance - - 27,357
Stock subscriptions - - 3,601,436
Warrants issued for prepaid consulting and service
agreements - - 2,650,226
Debt converted to common stock - - 426,355
Stock issued for consulting agreement - - 1,042,115
</TABLE>
15. Economic Dependency -
Major Customer
--------------
The following summarizes GTI's customers with net sales in excess of 10%
of GTI's fiscal net sales:
<TABLE>
<CAPTION>
Customer 1997 1998 1999
-------- ---- ---- ----
<S> <C> <C> <C>
1 20% 33% 24%
</TABLE>
Vendors
-------
The following summarizes GTI's dependence on key vendors expressed as a
percentage of GTI's fiscal net sales:
<TABLE>
<CAPTION>
Vendor 1997 1998 1999
------ ---- ---- ----
<S> <C> <C> <C>
1 29% 36% 30%
2 24% 24% 28%
3 5% 15% 19%
4 12% 1% 1%
</TABLE>
F-22
<PAGE> 56
- 23 -
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. Operating Segments and Related Information -
Prior to January 28, 1999, the Company operated in one segment, internet
sales. In connection with the acquisition of GTI, the Company now
operates in two segments, internet sales and distribution sales to retail
and wholesale outlets. Since the acquisition occurred near the end of
fiscal 1999, substantially all operations for fiscal 1999 relate to
internet sales. Identifiable assets at January 31, 1999, are as follows:
<TABLE>
<CAPTION>
Segment
------------
<S> <C>
Internet $ 6,548,239
Distribution 19,257,221
--------------
$ 25,805,460
==============
</TABLE>
17. Subsequent Events -
Pursuant to a consulting agreement with a principal shareholder, the
Company issued 1,000,000 shares of common stock for services to be
performed for one year commencing February 23, 1999. The value of the
stock was $5,875,000 ($5.875 per share).
In February 1999, the Company entered into a credit agreement with Coast
Business Credit to provide financing of up to $10,000,000, based upon
eligible receivables and inventory. The loan bears interest at the prime
rate plus 1.5% and expires March 31, 2002. As part of the agreement, the
Company may also borrow up to $250,000 for capital expenditures at the
bank's reference rate plus 2.0%, not subject to eligible receivables and
inventory. In addition, the Company may borrow up to $500,000 at the
bank's reference rate plus 2%, payable in 24 equal monthly installments,
also not based on eligible receivables and inventory. The notes are
collateralized by all of the assets of the Company.
In connection with the credit agreement, three year stock warrants were
issued in February 1999 for the purchase of 500,000 shares of common
stock at $6.29 per share.
In addition to the 1,000,000 shares of common stock issued noted above,
the Company issued an additional 1,064,341 shares subsequent to January
31, 1999.
In April 1999, the Company issued warrants to purchase 750,000 shares of
the Company's common stock for three years at an exercise price of $1.00
per share to a stockholder; the warrants were exercised by the
stockholder.
F-23
<PAGE> 57
ACCOUNTANTS' REPORT
To the Board of Directors
and Stockholders of
Herold Marketing Associates, Inc.
We have audited the accompanying balance sheets of Herold Marketing
Associates, Inc., as of December 31, 1998 and 1997 and the related statements of
income, retained earnings and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Herold Marketing
Associates, Inc. as of December 31, 1998 and 1997, and the results of operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles.
/s/ SAMUEL T. KANTOS AND ASSOCIATES
February 10, 1999
F-24
<PAGE> 58
HEROLD MARKETING ASSOCIATES, INC.
FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 1998 AND 1997
F-25
<PAGE> 59
HEROLD MARKETING ASSOCIATES, INC.
BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
ASSETS
<TABLE>
<CAPTION>
1998 1997
-------- ---------
<S> <C> <C>
Current Assets
Cash $ 1,681,597 $ 1,429,583
Accounts Receivable, Net
of Allowance For Doubtful
Accounts of $ 37,000 and
$ 46,000 in 1998 and 1997 5,099,296 5,358,144
Inventory 2,535,642 4,205,896
Employee Advances 14,551 12,988
Rebates Receivable 186,330 0
Prepaid Expenses 31,911 27,342
---------- ----------
Total Current Assets 9,549,327 11,033,953
---------- ----------
Property and Equipment
Furniture and Fixtures 109,846 106,746
Leasehold Improvements 10,539 8,836
Computer Equipment 108,909 83,356
---------- ----------
Total Property and Equipment 229,294 198,938
Less Accumulated Depreciation 165,082 143,749
---------- ----------
Net Property and Equipment 64,212 55,189
---------- ----------
Other Assets
Note Receivable 0 85,000
Loan Receivable Other 0 500,000
Security Deposits 13,057 14,622
---------- ----------
Total Other Assets 13,057 599,622
---------- ----------
Total Assets $ 9,626,596 $11,688,764
========== ==========
</TABLE>
The accompanying notes and accountants' report
should be read with these financial statements.
F-26
<PAGE> 60
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
1998 1997
-------- ---------
<S> <C> <C>
Current Liabilities
Accounts Payable $ 7,506,763 $ 8,491,643
Accrued and Withheld
Payroll Taxes 1,897 2,661
Accrued Expenses 286,007 252,089
Accrued Warranty 6,035 12,020
Loan Payable, Stockholder 0 482,079
Note Payable, Line of Credit 2,028 10,780
---------- ----------
Total Current Liabilities 7,802,730 9,251,272
Long-Term Liabilities
Accrued Warranty 30,000 155,068
---------- ----------
Total Long-Term Liabilities 30,000 155,068
---------- ----------
Stockholders' Equity
Common Stock, no par Value, 2,500
Shares Authorized, 595 Shares
Issued and Outstanding 1,000 1,000
Retained Earnings 1,792,866 2,281,424
---------- -----------
Total Stockholders' Equity 1,793,866 2,282,424
Total Liabilities and
Stockholders' Equity $ 9,626,596 $11,688,764
========== ==========
</TABLE>
F-27
<PAGE> 61
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF INCOME
FOR THE YEARS ENDED
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------- ---------
<S> <C> <C>
Sales $65,155,760 $83,767,758
Cost of Sales 58,953,052 75,218,638
---------- ----------
Gross Profit on Sales 6,202,708 8,549,120
Other Operating Income
Sales Commissions 0 1,547
---------- ----------
Gross Profit 6,202,708 8,550,667
Operating Expenses 5,368,526 7,519,567
---------- ----------
Income From Operations 834,182 1,031,100
---------- ----------
Other Income
Miscellaneous 2,982 9,212
Interest 66,864 95,345
---------- ----------
Total Other Income 69,846 104,557
---------- ----------
Income Before Taxes 904,028 1,135,657
Provision for Income Taxes 8,157 5,000
---------- ----------
Net Income $ 895,871 $ 1,130,657
========== ==========
</TABLE>
The accompanying notes and accountants' report
should be read with these financial statements.
F-28
<PAGE> 62
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF RETAINED EARNINGS
FOR THE YEARS ENDED
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------- ---------
<S> <C> <C>
Retained Earnings Beginning $ 2,281,424 $ 1,875,767
Stockholder Distribution (1,384,429) (725,000)
Net Income 895,871 1,130,657
---------- -----------
Retained Earnings Ending $ 1,792,866 $ 2,281,424
========== ==========
</TABLE>
The accompanying notes and accountants' report
should be read with these financial statements.
F-29
<PAGE> 63
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------- ---------
<S> <C> <C>
Cash Flow From Operating Activities
Net Income $ 895,871 $ 1,130,657
Adjustments to Reconcile Net
Income to Net Cash Provided by
Operating Activities:
Depreciation and Amortization 21,332 19,027
(Increase) Decrease in:
Accounts Receivable 258,849 2,172,864
Inventory 1,670,254 (2,387,158)
Employee Advances (1,564) (7,454)
Rebates Receivable (186,330) 0
Prepaid Expenses (4,569) 919
Increase (Decrease) in:
Accounts Payable (984,878) (125,038)
Accrued and Withheld
Payroll Taxes (764) (1,367)
Accrued Expenses 33,918 (146,148)
Accrued Warranty (131,053) (15,855)
---------- ----------
Net Cash Provided (Used)
by Operating Activities 1,571,066 640,447
---------- ----------
Cash Flow From Investing Activities
Purchase of Property and Equipment (30,357) (21,113)
Loan Receivable Other 500,000 (13,988)
Note Receivable 85,000 0
Security Deposits 1,565 2,085
---------- ----------
Net Cash Provided (Used)
by Investing Activities 556,208 (33,016)
---------- ----------
</TABLE>
The accompanying notes and accountants' report
should be read with these financial statements.
F-30
<PAGE> 64
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------- ---------
STATEMENT OF CASH FLOWS (CONTINUED)
<S> <C> <C>
Cash Flow From Financing Activities
Proceeds From Short-Term
Borrowing $ 4,090,208 $ 2,880,917
Proceeds From Stockholder
Borrowing Short-Term 1,949,957 2,770,132
Payments on Short-Term Borrowing (4,098,940) (2,870,137)
Payments on Short-Term Stockholder
Borrowing (2,432,056) (2,564,730)
Stockholder Distribution (1,384,429) (725,000)
---------- ----------
Net Cash Provided (Used)
by Financing Activities (1,875,260) (508,818)
Net Increase
(Decrease) in Cash 252,014 98,613
Cash at Beginning of Year 1,429,583 1,330,970
Cash at End of Year $ 1,681,597 $ 1,429,583
========== ==========
<CAPTION>
Supplemental disclosures of cash flow information:
<S> <C> <C>
Cash Paid Interest $ 132,314 $ 121,672
========== ==========
Income Taxes Paid $ 8,157 $ 5,000
========== ==========
</TABLE>
The accompanying notes and accountants' report
should be read with these financial statements.
F-31
<PAGE> 65
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
Note 1 - Summary of Significant Accounting Policies
This summary of significant accounting policies of Herold
Marketing Associates, Inc. is presented to assist in understanding the
Company's financial statements. The financial statements and notes are
representations of the Company's management who are responsible for
their integrity and objectivity. These accounting policies conform to
generally accepted accounting principles and have been consistently
applied in the preparation of the financial statements.
Business Activity
The Company sells computers and computer peripheral products to
wholesale and retail outlets throughout the nation.
Cash and Cash Equivalents
For purposes of preparing the statement of cash flows,
unrestricted currency, demand deposits, and money market accounts are
considered cash and cash equivalents.
Concentration of Credit Risk
The Company grants credit to its customers during the normal
course of business. The Company performs ongoing credit evaluations and
generally requires no collateral from its customers. At times
throughout the year the Company does maintain certain bank accounts and
money market accounts in excess of the FDIC and SPIC insured limits.
Inventory
Inventory consists primarily of computer peripheral products held
for resale. Inventory is stated at the lower of cost or market on a
first in first out basis.
Property and Equipment
Property and equipment are stated at cost. Expenditures for
maintenance and repairs are charged against operations. Depreciation is
computed for financial statement purposes on a straight line basis over
the estimated useful lives of the assets and amounted to $ 21,332 and $
19,027 respectively. The cost and related accumulated depreciation of
property and equipment sold or
F-32
<PAGE> 66
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
Note 1 - Summary of Significant Accounting Policies (Continued)
otherwise disposed of are removed from the accounts and any
gain or loss is reported as current year's revenue or expense. For
Federal income tax purposes depreciation is computed using the
accelerated cost recovery system with certain assets being expensed in
the year of purchase.
Warranties
Revenues derived from warranty contracts are recognized ratably
over the terms of the contracts. Accrued warranty liabilities recognize
the estimated current and long-term future costs associated with
fulfilling the warranty contract obligations.
Income Taxes
The Company with the consent of its shareholders, has elected
under the Internal Revenue Code to be an S corporation for the year
beginning January 1, 1996. In lieu of corporation income taxes, the
shareholders of an S corporation are taxed on their proportionate share
of the Company's taxable income. Some states require a minimum tax of
corporations doing business in their state. Any minimum tax required is
included in the provision for income taxes for 1998 and 1997.
Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principals requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Advertising
The Company follows the policy of charging the net cost of
advertising to expense as incurred. Advertising expense was $ 6,238 and
$ 28,335 in 1998 and 1997 respectively.
F-33
<PAGE> 67
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
Note 2 - Note Payable Line of Credit and Stockholder
Note Payable Line of Credit
The Company's loan agreement provides the Company with a revolving
line of credit of up to $ 5,000,000. The line of credit requires
monthly payments of accrued interest at 1% over prime. The loan
agreement is reviewed annually. This loan is secured by substantially
all assets of the Company.
Note Payable Stockholder
The stockholder also advances funds when required to during the
course of business and is paid the same interest as the financial
institutions and is unsecured. Interest expense was $ 45,261 in 1998
and $ 121,672 in 1997.
Note 3 - Long-Term Liabilities
<TABLE>
<S> <C> <C>
Accrued Warranty
(see warranty in Note 1) $ 36,035 $ 155,068
========== ==========
</TABLE>
Maturities of long-term liabilities are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31, Amount
----------- ------
<S> <C> <C>
1999 30,000
----------
$ 30,000
==========
</TABLE>
Note 4 - Lease Commitments
The Company's Minnesota location is leased under a 36 month
non-cancelable operating lease commencing March 1, 1997. The lease
requires monthly base rent payments of $ 5,405 payable through February
2000. The Company leases other facilities in Arizona, Florida,
Illinois, Massachusetts and Missouri under non-cancelable operating
leases into 1998. The majority of the leases are for 1 year with
automatic renewals with minor adjustments. The total lease expense for
all facilities for 1998 and 1997 was $ 249,556 and $ 232,321
respectively.
F-34
<PAGE> 68
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
Note 4 - Lease Commitments (Continued)
In addition, the Company leases vehicles under non-cancelable
operating leases having lease terms of 36 to 48 months. The vehicle
lease expense for 1998 and 1997 was $ 17,618 and $ 32,763 respectively.
At December 31, 1998, future minimum lease payments under all
operating leases were as follows:
<TABLE>
<CAPTION>
Year Ending
December 31, Amount
------------ ------
<S> <C>
1999 160,959
2000 160,959
2001 96,099
2002 96,099
2003 96,099
----------
Total $ 610,215
==========
</TABLE>
Note 5 - Income Taxes
The provision for Federal and State income taxes consists of
the following:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Current taxes $ 8,157 $ 5,000
--------- ---------
Total provision
for income taxes $ 8,157 $ 5,000
========= =========
</TABLE>
Note 6 - Related Party Transactions
The Company has balances due from a related party, Technology
Marketing Unlimited, LLC which is owned 50% by the sole stockholder of
Herold Marketing Associates, Inc. On December 31, 1998 and 1997, the
amount of receivables from this related party were $ 0 and $ 500,000.
Also see Note 2 relating to loans from the stockholder and terms
accordingly.
F-35
<PAGE> 69
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
Note 7 - Note Receivable
This note was issued on July 16, 1996 in the amount of $ 85,000
with an interest rate of 9.25%, with a maturity date of December 31,
1996. This note was collected in 1998.
Note 8 - Contingencies
1. The Company is currently in litigation with the Commissioner of
Internal Revenue regarding the tax years 1992 and 1993. According to
the Commissioner, the Company owes additional taxes of $245,508 and
$247,829 respectively for the years mentioned. The United States Tax
Court has ruled in favor of the Company as of January 29, 1999. The
Government has 90 days to appeal the decision and as of the date of
the report has not done so.
2. The Company is currently involved in other litigation that has been
properly provided for in the accompanying financial statements.
F-36
<PAGE> 70
INDEPENDENT AUDITORS' REPORT
HEROLD MARKETING ASSOCIATES, INC.
7615 Golden Triangle Drive
Eden Prairie, Minnesota 55344
To the Board of Directors
We have audited the accompanying balance sheet of Herold Marketing
Associates, Inc. as of December 31, 1996, and the related statements of income,
retained earnings and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We have conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Herold Marketing Associates,
Inc. as of December 31, 1996 and the results of its operations and its cash
flows for the year then ended in conformity with generally accepted accounting
principles.
/s/ SAMUEL T. KANTOS & ASSOCIATES
April 23 1999
F-37
<PAGE> 71
HEROLD MARKETING ASSOCIATES, INC.
FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1996
F-38
<PAGE> 72
HEROLD MARKETING ASSOCIATES, INC.
BALANCE SHEET
AS OF DECEMBER 31, 1996
<TABLE>
<CAPTION>
ASSETS
Current Assets
<S> <C>
Cash $ 1,330,970
Accounts Receivable, Net
of Allowance For Doubtful
Accounts of $ 46,000 7,531,008
Inventory 1,818,738
Employee Advances 5,534
Prepaid Expenses 28,261
----------
Total Current Assets $10,714,511
Property and Equipment
Furniture and Fixtures 134,316
Leasehold Improvements 8,836
Computer Equipment 95,160
----------
Total Property and Equipment 238,312
Less Accumulated Depreciation 185,212
Net Property and Equipment 53,100
Other Assets
Note Receivable 85,000
Other Receivables 486,012
Security Deposits 16,707
----------
Total Other Assets 587,719
-----------
Total Assets $11,355,330
===========
</TABLE>
The accompanying notes and auditors' report should be read with
these financial statements.
F-39
<PAGE> 73
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current Liabilities
Accounts Payable $ 8,616,681
Accrued and Withheld
Payroll Taxes 4,028
Accrued Expenses 398,237
Accrued Warranty 24,412
Note Payable Stockholder 276,674
----------
Total Current Liabilities $ 9,320,032
Long-Term Liabilities
Accrued Warranty 158,531
Total Long-Term Liabilities 158,531
Stockholders' Equity
Common Stock, no par Value, 2,500
Shares Authorized, 595 Shares
Issued and Outstanding 1,000
Retained Earnings 1,875,767
----------
Total Stockholders' Equity 1,876,767
-----------
Total Liabilities and
Stockholders' Equity $11,355,330
===========
</TABLE>
F-40
<PAGE> 74
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
Sales $87,832,805
Cost of Sales 80,101,466
-----------
Gross Profit on Sales 7,731,339
Other Operating Income
Sales Commissions 8,385
-----------
Gross Profit 7,739,724
Operating Expenses 6,749,520
-----------
Income From Operations 990,204
Other Income and (Expense)
Miscellaneous $ 3,455
Interest 112,469
Gain on Sale of Other Assets 3,148
-----------
Total Other
Income and (Expense) 119,072
-----------
Income Before Taxes 1,109,276
Provision for Income Taxes 34,000
-----------
Net Income $ 1,075,276
===========
</TABLE>
The accompanying notes and auditors' report should be read with
these financial statements.
F-41
<PAGE> 75
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
<S> <C>
Retained Earnings Beginning $ 800,491
Net Income 1,075,276
----------
Retained Earnings Ending $ 1,875,767
==========
</TABLE>
The accompanying notes and auditors' report should be read with
these financial statements.
F-42
<PAGE> 76
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
Cash Flow From Operating Activities
Net Income $ 1,075,276
Adjustments to Reconcile Net
Income to Net Cash Provided by
Operating Activities:
Depreciation and Amortization 18,094
Gain on Sale of Other Assets (3,148)
(Increase) Decrease in:
Accounts Receivable 2,774,105
Inventory (386,430)
Employee Advances 7,461
Prepaid Expenses (13,357)
Deferred Income Taxes 29,000
Increase (Decrease) in:
Accounts Payable (2,314,187)
Accrued and Withheld
Payroll Taxes 1,649
Accrued Expenses 66,003
Accrued Warranty 182,943
Income Taxes Payable (54,747)
-----------
Net Cash Provided (Used)
by Operating Activities $ 1,382,662
----------
Cash Flow From Investing Activities
Purchase of Property and Equipment (25,956)
Loan Receivable Other (486,012)
Note Receivable (85,000)
Proceeds From Sale of Other Assets 26,898
Security Deposits 6,555
-----------
Net Cash Provided (Used)
by Investing Activities (563,515)
----------
</TABLE>
The accompanying notes and auditors' report should be read with
these financial statements.
F-43
<PAGE> 77
HEROLD MARKETING ASSOCIATES, INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
STATEMENT OF CASH FLOWS (CONTINUED)
<S> <C> <C>
Cash Flow From Financing Activities
Proceeds From Short-Term
Borrowing $ 0
Proceeds From Stockholder
Borrowing Short-Term 426,233
Payments on Short-Term Borrowing (655,005)
Payments on Long-Term Stockholder
Borrowing (800,000)
-----------
Net Cash Provided (Used)
by Financing Activities $(1,028,772)
----------
Net Increase
(Decrease) in Cash (209,625)
Cash at Beginning of Year 1,540,595
----------
Cash at End of Year $ 1,330,970
==========
<CAPTION>
Supplemental disclosures of cash flow information:
<S> <C>
Cash Paid Interest $ 69,938
==========
Income Taxes Paid $ 59,747
==========
</TABLE>
The accompanying notes and auditors' report should be read with
these financial statements.
F-44
<PAGE> 78
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
Note 1 - Summary of Significant Accounting Policies
This summary of significant accounting policies of Herold
Marketing Associates, Inc. is presented to assist in understanding the
Company's financial statements. The financial statements and notes are
representations of the Company's management who are responsible for
their integrity and objectivity. These accounting policies conform to
generally accepted accounting principles and have been consistently
applied in the preparation of the financial statements.
Business Activity
The Company sells computer peripheral products to wholesale and
retail outlets throughout the nation. In 1995 the company began the
assembly and sale of complete computer systems through its current
sales outlets.
Inventory
Inventory consists primarily of computer peripheral products held
for resale. Inventory is stated at the lower of cost or market on a
first in first out basis.
Property and Equipment
Property and equipment are stated at cost. Expenditures for
maintenance and repairs are charged against operations. Depreciation is
computed for financial statement purposes on a straight-line basis over
the estimated useful lives of the assets and amounted to $ 18,094. For
Federal income tax purposes depreciation is computed using the
accelerated cost recovery system with certain assets being expensed in
the year of purchase.
Warranty Costs
The financial statements include a product warranty reserve of $
182,943 in 1996. This reserve is based on estimates of future costs
associated with fulfilling the warranty obligations on the sold
computer systems. The estimates are derived from historical industry
costs.
F-45
<PAGE> 79
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
Note 1 - Summary of Significant Accounting Policies (Continued)
Income Taxes
The Company with the consent of its shareholders has elected under
the Internal Revenue Code to be an S corporation for the year beginning
January 1, 1996. In lieu of corporation income taxes, the shareholders
of an S corporation are taxed on their proportionate share of the
Company's taxable income. Some states require a minimum tax of
corporations doing business in their state. Any minimum tax required is
included in the provision for income taxes.
Use of Estimates
The preparation of financial statements in conformity with
generally accepted accounting principals requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
Cash Equivalents
The Company considers all highly liquid debt instruments with an
original maturity of three months or less to be cash equivalents for
the purpose of determining cash flows.
Concentration of Credit Risk
The Company grants credit to its customers during the normal course of
business. The Company performs ongoing credit evaluations and generally
requires no collateral from its customers. At times throughout the year
the Company does maintain certain bank accounts in excess of the FDIC
insured limits.
Advertising
The Company follows the policy of charging the costs of advertising to
expense as incurred. Advertising expense for the year was $ 29,606.
F-46
<PAGE> 80
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
Note 2 - Note Receivable
The note receivable issued July 16, 1996 in the amount of $ 85,000
was collected during 1998 including all interest at 9.25%.
Note 3 - Other Receivables
A loan receivable from Technology Marketing Unlimited, LLC a
company owned 50% by the sole shareholder of Herold Marketing
Associates, Inc. was determined to be uncorrectable during 1998.
Note 4 - Line of Credit
The Company's loan agreement provides the Company with a revolving
line of credit of up to $ 2,000,000. The line of credit requires
monthly payments of accrued interest at 1% over prime. The loan
agreement is reviewed annually. This loan is secured by substantially
all assets of the Company. Interest expense was $ 69,938.
Note 5 - Note Payable Stockholder
The Company stockholder advances funds to the Company as needed
under a continuous note requiring interest at the same rate as the
Company's line of credit. The note is unsecured and requires no
specific payments.
Note 6 - Income Taxes
The provision for Federal and State income taxes consists of the
following:
<TABLE>
<S> <C> <C>
Current taxes $ 5,000
Deferred taxes 29,000
---------
Total provision
for income taxes $ 34,000
=========
</TABLE>
F-47
<PAGE> 81
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
Note 7 - Long-Term Liabilities
<TABLE>
<S> <C> <C>
Accrued Warranty costs $ 182,943
Rent Payable - long-term
portion of unamortized rent. 1,191
Total $ 184,134
Less Current Portion
included in Accrued
Expenses 25,603
Net Long-Term
Liabilities $ 158,531
==========
</TABLE>
Maturities of long-term liabilities are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31, Amount
------------ ------
<S> <C>
1997 $ 25,603
1998 79,266
1999 79,265
----------
$ 184,134
==========
</TABLE>
Note 8 - Lease Commitments
The Company's Minnesota location is leased under a 36-month
non-cancelable operating lease commencing March 1, 1997. The lease
requires monthly base rent payments of $ 5,405 payable through February
2000. The Company leases other facilities in Arizona, Missouri, Florida
and Massachusetts under non-cancelable operating leases through 1998.
The total lease expense for all facilities for 1996 was $ 205,008.
In addition, the Company leases vehicles under non-cancelable
operating leases having lease terms of 36 to 48 months. The vehicle
lease expense for 1996 was $ 16,988.
F-48
<PAGE> 82
\
HEROLD MARKETING ASSOCIATES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
Note 8 - Lease Commitments (Continued)
At December 31, 1996, future minimum lease payments under all operating
leases were as follows:
<TABLE>
<CAPTION>
Year Ending
December 31, Amount
------------ ------
<S> <C>
1997 $ 152,276
1998 138,632
1999 64,860
2000 10,810
---------
Total $ 366,578
==========
</TABLE>
Note 9 - Contingencies
The Company is currently in litigation with the Commissioner
of Internal Revenue regarding the tax years 1992 and 1993. According to
the Commissioner, the Company owes additional taxes of $245,508 and
$247,829 respectively for the years mentioned. The United States Tax
Court has ruled in favor of the Company as of January 29, 1999. The
Government has 90 days to appeal the decision and as of the date of the
report has not done so.
Note 10 - Related Party Transactions
The Company transactions with related parties are explained in
notes 3 and 5.
F-49
<PAGE> 83
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
Virtual Technology Corporation and Subsidiaries
Minneapolis, Minnesota
We have audited the consolidated financial statements of Virtual Technology
Corporation and Subsidiaries as of January 31, 1998 and 1999, and for each of
the two years in the period ended January 31, 1999, and have issued our report
thereon dated April 23, 1999; such financial statements and report are included
elsewhere in this Form 10-K. Our audits also included the financial statement
schedules of Virtual Technology Corporation and Subsidiaries, listed in Item 14
for each of the two years in the period ended January 31, 1999. These financial
statement schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion based on our audits. In our opinion,
such financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
/s/ LURIE, BESIKOF, LAPIDUS & CO., LLP
Minneapolis, Minnesota
April 23, 1999
F-50
<PAGE> 84
SCHEDULE II
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Column C
------------
Column A Column B Additions Column D Column E
-------- ----------- --------------------------- -------- ---------
Charged
Balance at Charged to to Other Balance at
Beginning Costs and Accounts - Deductions - End of
Description of Period Expenses Describe(1) Describe(2) Period
- ----------------------------- ----------- -------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
Year Ended January 31, 1997
Deducted from asset accounts:
Allowance for doubtful
accounts $- $ - $ - $ - $ -
Allowance for obsolete
inventory $- $ - $ - $ - $ -
Year Ended January 31, 1998
Deducted from asset accounts:
Allowance for doubtful
accounts $- $ - $ - $ - $ -
Allowance for obsolete
inventory $- $ - $ - $ - $ -
Year Ended January 31, 1999
Deducted from asset accounts:
Allowance for doubtful
accounts $- $ 157,780 $ 175,000 ($ 69,780) $ 263,000
Allowance for obsolete
inventory $- $ - $ 350,000 $ - $ 350,000
</TABLE>
(1) Allowances and reserves for receivables and inventory related to assets
acquired by GTI Acquisition Corporation.
(2) Uncollectible accounts written off, net of recoveries.
F-51
<PAGE> 85
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
In January 1998, the Company engaged Lurie, Besikof, Lapidus & Co.,
LLP as its independent public accountants to audit the financial statements as
of January 31, 1998 and for the year then ended. The decision to dismiss
Copeland, Buhl & Company, P.L.L.P and engage Lurie, Besikof, Lapidus & Co., LLP
as the Company's independent public accountants was approved by the Board of
Directors. The report of Copeland Buhl & Company P.L.L.P as of January 31, 1997
and for the year then ended does not contain an adverse opinion or a disclaimer
of opinion, but was qualified with respect to the Company's ability to continue
operations as a going concern. Such report was not otherwise qualified or
modified as to uncertainty, audit scope or accounting principles. There were no
disagreements with the former auditors on any matters of accounting principles
or practices, financial statement disclosure or auditing scope or procedures
which, if not resolved to the former auditor's satisfaction, would have caused
them to make reference to the subject matter in their report. Prior to retaining
Lurie, Besikof, Lapidus & Co., LLP, the Company did not consult with Lurie,
Besikof, Lapidus & Co., LLP regarding the application of accounting principles
to a specified transaction, the type of audit opinion that might be rendered on
the Company's financial statements or any other matter.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
EXECUTIVE OFFICERS AND DIRECTORS
KENNETH M. ISRAEL, 47. Mr. Israel has been Chairman and a director of
the Company since February 1996 and was Chief Executive Officer between February
1996 and November 1998. Between March 1989 and January 1996, Mr. Israel served
as Chairman of Exchange Resources, Inc., a company specializing in disaster
recovery services and facilities. Between 1981 and 1987, Mr. Israel was the
Regional Manager of Lanier Business Products, a company that was later acquired
by Harris Corporation, where he became Director of Research and Development.
From 1979 to 1981, Mr. Israel was the General Manager of Pi Engineering, where
he was the Project Manager for the redesigning and rebuilding of the security
and communications systems for Northern States Power nuclear plants. Prior to
1979, Mr. Israel served for five years as a Regional Service Manager with
Raytheon Data Systems with responsibility for the Southeastern United States and
Central and South America.
GREGORY A. APPELHOF, 37. Mr. Appelhof joined VTC in October 1998 as
the Company's President and a director. He was named as Chief Executive Officer
in November 1998. Prior to joining VTC, Mr. Appelhof was employed by GTI for
over 11 years until its acquisition by the Company, most recently as Vice
President of Sales. Mr. Appelhof was responsible for building GTI's sales
strategies to increase market penetration and revenues. He was instrumental in
developing and implementing GTI's sales segments, including GTI's major focus on
corporate resellers.
34
<PAGE> 86
JOHN L. HARVATINE, 48. Mr. Harvatine became Chief Financial Officer of
the Company in January 1999. Between 1997 and 1998, he served as Chief Financial
Officer of CyberStar Computer Corporation. Between 1987 and 1996, he served in a
variety of financial positions with AmeriData Technologies, Inc., most recently
as Chief Financial Officer. From 1986 to 1987, he served as Controller of Fisher
Cheese Co. From 1973 to 1986, Mr. Harvatine served in various management
positions with The Pillsbury Company, most recently as Accounting Manager -
Marketing.
JEFFREY MAYNARD, 54. Mr. Maynard has been Executive Vice President of
Technology and a director of the Company since February 1996. Mr. Maynard has
more than 30 years of experience as an information technologist. Between 1993
and 1996, Mr. Maynard was the Chief Executive Officer of Secure Backup Systems,
a company he formed to deliver public data vaulting services. Between 1990 and
1993, he was Development Director for Mercury Communications. Mr. Maynard served
as Managing Director for Mtel Corp. and SkyTel Ltd. between 1989 and 1990.
PHILIP LACERTE, 53. Mr. Lacerte has served as a director of the Company
since April 1999. Since 1982, Mr. Lacerte has been Executive Vice President of
Lacerte Software Corporation. Prior to Lacerte Software Corporation, Mr. Lacerte
held a management position with Data Processing, Inc. He has also served as the
Chairman of the Board of Crystallex, an American Stock Exchange Company, and has
worked as a consultant and advisor for various start-up companies.
35
<PAGE> 87
Item 11. Executive Compensation.
The following table summarizes the amount of compensation paid to the Company's
executive officers for the fiscal years ended January 31, 1997, 1998 and 1999.
No other executive officers had aggregate salaries and bonuses that exceeded
$100,000.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
Annual Compensation Long-Term Compensation
-----------------------------------------------------------------------------------------------------
Awards Payouts
----------------------------------------------------------------
Securities
Name and Other Restricted Underlying LTIP All Other
Principal Salary Bonus Annual Stock Options/SAR's Payouts Compensation
Position Year ($) ($) Compensation Award (#) ($) ($)
($) ($)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Greg
Appelhof, 1999 86,115 0 2,000 0 1,250,000 0 0
Chief
Executive
Officer
- ---------------------------------------------------------------------------------------------------------------------------------
Kenneth 1997 0 0 0 909.091 280,000 0 0
Israel, 1998 0 0 0 600,000 56,000 0 0
Chairman 1999 163,750 0 6,000 10,000 30,000 0 0
- ---------------------------------------------------------------------------------------------------------------------------------
John
Harvatine, 1999 8,334 0 400 0 250,000 0 0
Chief
Financial
Officer
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
36
<PAGE> 88
OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
The following table sets forth information as of January 31, 1999 regarding
outstanding options to executive officers and directors granted for the year
ended January 31, 1999:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
Potential Realizable Value at
Assumed Annual Rates of Stock
Price Appreciation for Option
Individual Grants Term
- ------------------------------------------------------------------------------------------------------------------
Percent of
Number of Total
Securities Options/
Underlying SAR's
Options/SAR's Granted to Exercise Of
Granted Employees in Base Price
Fiscal Year ($/Sh.)
1999 Expiration
Name Date 5% ($) 10% ($)
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Kenneth Israel 30,000 1.9% $ .25 3/31/03 -- --
- -----------------------------------------------------------------------------------------------------------------
Greg Appelhof 1,250,000 80% $1.00 10/8/08 657,500 1,787,500
- -----------------------------------------------------------------------------------------------------------------
John Harvatine 250,000 16% $3.75 1/4/09 589,500 1,494,250
- -----------------------------------------------------------------------------------------------------------------
Jeff Maynard 30,000 1.9% $ .25 3/31/03 -- --
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
37
<PAGE> 89
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END
OPTION/SAR VALUES
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
Number of Securities
Underlying Unexercised
Options/SAR's at Value of Unexercised
FY-End In-The-Money Options/SAR's
Shares Acquired on Value (#) At FY-End
Name Exercise Realized Exercisable/Unexercisable ($) Exercisable/Unexercisable
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Greg Appelhof 0 0 0 0
- -------------------------------------------------------------------------------------------------------------------------------
Kenneth Israel 0 0 0 0
- -------------------------------------------------------------------------------------------------------------------------------
John Harvatine 0 0 0 0
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
38
<PAGE> 90
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth information as of April 30, 1999
regarding the ownership of the Company's common stock by officers and directors
and those persons known by the Company to be beneficial owners of 5% or more of
such stock. Each shareholder has sole voting and investment power with respect
to the shares shown as beneficially owned, except as otherwise indicated in a
footnote.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
Amount and Nature of
Beneficial Ownership
(1)
Name Title of Class Percent of Class
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Kenneth Israel (2) Common 2,298,598 (3) 8.3%
- -----------------------------------------------------------------------------------------------------------------
Harry Lowell Common 8,538,429 (6) 30.6%
- -----------------------------------------------------------------------------------------------------------------
Stephen Antebi Common 2,500,000 (12) 9.0%
- -----------------------------------------------------------------------------------------------------------------
Greg Appelhof (2) Common 606,666 (7) 2.1%
- -----------------------------------------------------------------------------------------------------------------
John Harvatine (2) Common 62,500 (10) 7.2%
- -----------------------------------------------------------------------------------------------------------------
Mary Joy Stead Common 1,494,000 (5) 5.3%
- -----------------------------------------------------------------------------------------------------------------
Stephan Herold Common 2,130,570 (8) 7.6%
- -----------------------------------------------------------------------------------------------------------------
Jeff Maynard (2) Common 820,000 (4) 2.9%
- -----------------------------------------------------------------------------------------------------------------
Philip Lacerte (2) Common 1,651,041 (9) 5.9%
- -----------------------------------------------------------------------------------------------------------------
All Officers and Directors as a Common 5,813,805 (11) 19.6%
Group
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
* Denotes less than 1%
(1) Shares issuable upon the exercise of outstanding stock options and
warrants that are currently exercisable or become exercisable within 60 days
from the date hereof are considered outstanding for the purpose of calculating
the percentage of Common Stock owned by such person and owned by a group, but
not for the purpose of calculating the percentage of Common Stock owned by any
other person.
(2) The address of each of these executive officers or directors is:
c/o Virtual Technology Corporation, 3100 West Lake Street,
Suite 400, Minneapolis, Minnesota 55416.
(3) Includes options to purchase 428,000 shares of the Company's
Common Stock. Mr. Israel's wife owns 11,850 shares. Companies
under Mr. Israel's control own options to purchase 62,000 shares
of the Company's Common Stock.
(4) Includes options to purchase 310,000 shares of the Company's
Common Stock.
(5) Includes 50,000 shares owned and controlled by Jerre Stead,
Ms. Stead's spouse.
(6) Includes warrants to purchase 504,886 shares of the Company's
Common Stock. Also includes 531,800 shares, and warrants to
purchase an additional 8,800 shares of the Company's Common Stock
held by Laurel Center Management Co., a company controlled by Dr.
Lowell.
(7) Includes options to purchase 553,333 shares of the Company's
Common Stock.
(8) Includes warrants to purchase 213,333 shares of the Company's
Common Stock. Also includes 228,571 shares of the Company's
Common Stock issued to Herold Marketing Associates, Inc., of which
Mr. Herold is the sole shareholder, in connection with the
Company's acquisition of the assets of GTI. Also includes 145,000
shares issued to Mr. Herold in connection with a consulting
agreement between Mr. Herold and GTI.
39
<PAGE> 91
(9) All shares attributed to Mr. Lacerte are owned by Euro Realty
Development, Ltd., a company controlled by Mr. Lacerte.
(10) Includes options to purchase 62,500 shares of the Company's Common
Stock.
(11) Includes options to purchase 1,737,500 shares of the Company's
Common Stock.
(12) Includes 1,500,000 shares owned by Fontenelle, LLC, of which Mr.
Antebi is the sole equity owner and manager.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
GTI ACQUISITION
Greg Appelhof, VTC's President and Chief Executive Officer, formerly
was with GTI for 11 years, most recently as Vice President of Sales. The Company
acquired substantially all of the assets and assumed certain liabilities of GTI
in January 1999 for an aggregate purchase price of $10.1 million. Mr. Appelhof
owned the right to be treated as though he were a 20% owner of GTI's stock in
the event of a sale of GTI for purposes of distributing the proceeds of such
sale to GTI's stockholders. Mr. Appelhof entered into this agreement with GTI's
sole shareholder, Stephan G. Herold. As of April 30, 1999, Mr. Appelhof had
received $1.0 million of cash distributions from GTI. The Company understands
that final distribution of cash received by GTI for the sale of GTI's assets to
VTC is due to Mr. Appelhof at the time the last payment is received by GTI from
VTC.
EMPLOYMENT AGREEMENTS
Effective as of October 8, 1998, the Company and Mr. Appelhof entered
into an employment agreement whereby Mr. Appelhof will receive an annual salary
of $150,000, with a quarterly guaranteed $25,000 bonus and a quarterly
performance bonus award based upon the Company reaching certain performance
goals. Under the agreement, Mr. Appelhof is to be granted options to purchase
1,250,000 shares of the Company Common Stock at $1.00 per share. 500,000 of such
options vested in April 1999, 500,000 options vest in October 1999, 125,000
options vest in October 2000 and the remaining 125,000 options vest in October
2001, assuming Mr. Appelhof's continued employment by the Company. All vested
options granted pursuant to the employment agreement will be exercisable until
October 2008. In addition, Mr. Appelhof will be granted 30,000 options in his
role as a Director of the Company. The Company also has agreed to provide Mr.
Appelhof with a monthly vehicle allowance of $500. Under the agreement, if Mr.
Appelhof is terminated involuntarily for reasons other than cause in the first
year of employment by the Company, he will receive a severance equal to six
months of base salary. If terminated involuntarily after the first year of
employment but before the second year, he will receive severance pay equal to
one year of base salary. If Mr. Appelhof is terminated involuntarily after the
second year of employment, he will receive severance pay equal to 18 months of
base salary.
Effective as of January 4, 1999, the Company and Mr. Harvatine entered
into an employment agreement whereby Mr. Harvatine will receive an annual salary
of $100,000, with an annual $25,000 bonus awarded based upon Mr. Harvatine
reaching certain performance goals. Under the agreement, Mr. Harvatine was
granted options to purchase 250,000 shares of the Company Common Stock at $3.75
per share. 62,500 of such options vested immediately upon Mr. Harvatine's
employment, 62,500 options vest in January 2000, 62,500 vest in January 2001,
and the remaining 62,500 options vest in January 2002, assuming Mr. Harvatine's
continued employment by the Company. All vested options granted pursuant to the
employment agreement will be exercisable until January 2009. The Company also
has agreed to provide Mr. Harvatine with a monthly vehicle allowance of $400.
Under the agreement, if Mr. Harvatine is terminated involuntarily for reasons
other than cause in the first year of employment by the Company, he will receive
a severance pay equal to three months of base salary. If terminated
involuntarily after the first year of employment, he will receive a severance
pay equal to six months of base salary.
LOANS FROM RELATED PARTIES
Between March 1997 and June 1998, the Company received loans from
Kenneth Israel, its CEO, Kate Israel, his daughter and certain companies under
his control for loans in the total amount of $371,543. These loans bear interest
at 10% per annum and are due in fiscal year 2001. As of April 30, 1999, the
Company had repaid $200,000 of the amount due and then owed $190,000, including
interest. Mr. Israel and the Company have agreed that Mr. Israel may convert the
balance outstanding, including any interest, into the Company's Common Stock at
some future date, solely at Mr. Israel's option.
In October 1998, the Company issued a promissory note to Harry Lowell,
a major shareholder of the Company, in the amount of $40,000 with an interest
rate of 10%, due on November 20, 1998. The Company and Dr. Lowell agreed to
extend the due date of the note to April 14, 1999 and the Company repaid the
note, including interest of $1,552, on February 28, 1999.
LOANS TO RELATED PARTIES
Between February and April 1999, the Company received seven promissory
notes from Kenneth Israel, its Chairman of the Board, totaling $123,750. Mr.
Israel used the proceeds of the loan and $25,000 of his personal money to form
VTCO, LLC, a start-up company to compete in
40
<PAGE> 92
the direct response informercial market. On March 25, 1999, the Company
incorporated VTC TV, Inc. ("VTC TV") with the intention of acquiring the assets
of VTCO, LLC in exchange for $148,750. The Company intends to loan VTC TV the
$148,750 for this purpose.
CONSULTING AGREEMENTS WITH RELATED PARTIES
In February 1999, the Company entered into one-year a Consulting
Agreement with Fontenelle, LLC ("Fontenelle"), an affiliate of Stephan Antebi a
principal stockholder, to provide business consulting services to the Company.
In exchange for Fontenelle's services, the Company issued 1,000,000 share of its
Common Stock valued at $5.875 per share, for a total consideration of
$5,875,000. The Company registered the issuance of such shares with the SEC on
Form S-8.
On January 28, 1999, GTI entered into a three-year consulting agreement
with Stephan Herold, a principal stockholder of the Company and founder of GTI,
to provide general consulting services to GTI. In exchange for Mr. Herold's
services, the Company issued 145,000 shares of its Common Stock. The Company
agreed to register the public resale of such shares with the SEC as soon as
practicable.
In November 1998, the Company entered into an agreement with
Fontenelle to provide certain business and public relations consulting services
to the Company. In exchange for such services, the Company issued 225,000 shares
of its Common Stock valued at $.99 per share and granted 1,000,000 warrants to
purchase shares of its Common Stock, at an exercise price of $1.00 per share
with a three year term. In January 1999, Fontenelle exercised the warrants for
$1,000,000.
In February 1999, the Company agreed to register, with the SEC the
public resale of certain of Fontenelle's shares. The Company further agreed to
grant Fontenelle warrants to purchase an additional 750,000 shares in the event
the Company did not obtain effectiveness of such registration statement by June
1, 1999. In April 1999, the Company, having determined that the effectiveness of
such registration would be impossible, issued such warrants and Fontenelle
exercised them at $1.00 per share.
ADDITIONAL ISSUANCES OF COMMON STOCK
In fiscal 1999, Ken Israel and Jeff Maynard each received 10,000
shares of the Company's Common Stock as directors' compensation.
In fiscal 1999, Mr. Israel received 600,000 of the Company's Common
Stock shares in lieu of $150,000 compensation for fiscal 1998. Also in fiscal
1999, Mr. Israel received 175,648 shares of the Company's Common Stock by
converting $35,000 of debentures.
In fiscal 1999, Mr. Maynard received 200,000 shares of the Company's
Common Stock in lieu of $20,000 compensation for fiscal 1998.
In fiscal 1999, Harry Lowell received 177,443 shares of the Company's
Common Stock by converting $150,000 of debentures. In fiscal 1999, Dr. Lowell
and affiliates purchased 6,695,000 shares of the Company's Common Stock for
$592,500 cash.
In fiscal 1999, Mary Joy Stead, received 226,000 shares of the
Company's Common Stock upon conversion of a $50,000 debenture held by her
spouse, Jerre Stead. Also in fiscal 1999, Mary Joy Stead received 468,000 shares
of the Company's Common Stock by converting $100,000 of debentures.
In fiscal 1999, Phil LaCerte and affiliates purchased 1,000,000 shares
of the Company's Common Stock for $1,500,000 cash.
In fiscal 1999, Fontenelle, LLC purchased 500,000 shares of the
Company's Common Stock for $500,000 cash. Also in fiscal 1999, Fontenelle, LLC
received 1,000,000 shares of the Company's Common Stock by exercising 1,000,000
warrants.
In fiscal 1999, Greg Appelhof purchased 53,333 shares of the Company's
Common Stock for $20,000 cash. In connection, Mr. Appelhof received 53,333
warrants, at $1.00 for 2 years.
In fiscal 1999 Stephan Herold purchased 1,333,000 shares of the
Company's Common Stock for $500,000 cash. In connection with the stock purchase,
Mr. Herold received 213,333 warrants at $.75 for 2 years and 213,333 warrants at
$1.50 for 2 years. Also in fiscal 1999, Mr. Herold exercised 213,333 warrants
for $159,999 cash. In fiscal 1999, Herold Marketing Associates, Inc, of which
Mr. Herold is a principal stockholder, received 228,571 shares in connection
with the Company's acquisition of the assets of GTI. In addition, Mr. Herold
received 145,000 shares in connection with the Company's acquisition of the
assets of GTI.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
41
<PAGE> 93
(a)(1) Consolidated Financial Statements
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditor's Report............................................ F-1
Report of Independent Public Accountants................................ F-2
Consolidated Balance Sheets at January 31, 1999 and 1998................ F-3
Consolidated Statements of Operations for the years ended January 31,
1999 and 1998 and for the period February 7, 1996 to
January 31, 1997........................................................ F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended January 31, 1999 and 1998 and the period
February 7, 1996 to January 31, 1997.................................... F-5
Consolidated Statements of Cash Flows for the years ended January 31,
1999 and 1998 and the period February 7, 1996 to January 31, 1997....... F-11
Notes to Consolidated Financial Statements for the years ended
January 31, 1999 and 1998 and the period February 7, 1996 to
January 31, 1997........................................................ F-12
Accountants' Report..................................................... F-24
Balance Sheets as of December 31, 1998 and 1997......................... F-26
Statement of Income for the years ended December 31, 1998 and 1997...... F-28
Statement of Retained Earnings for the year ended December 31, 1998
and 1997................................................................ F-29
Statement of Cash Flows for the years ended December 31, 1998 and 1997.. F-30
Notes to Financial Statements for the years ended December 31, 1998
and 1997................................................................ F-32
Independent Auditor's Report............................................ F-37
Balance Sheet as of December 31, 1996................................... F-39
Statement of Income for the year ended December 31, 1996................ F-41
Statement of Retained Earnings for the year ended December 31, 1996..... F-42
Statement of Cash Flows for the year ended December 31, 1996............ F-43
Notes to Financial Statements for the year ended December 31, 1996...... F-45
Independent Auditor's Report............................................ F-50
Financial Statement Schedule............................................ F-51
</TABLE>
(a)(2) None.
(a)(3)
42
<PAGE> 94
All schedules and exhibits not included are not applicable, not
required or would contain information which is shown in the financial
statements or notes thereto.
EXHIBITS DESCRIPTION
- -------- -----------
3.1 Articles of Incorporation of the Company, as amended. Incorporated
by reference from the Company's Form 10-SB as filed with the SEC on
February 12, 1999.*
3.2 By-Laws of the Company, as amended. Incorporated by reference from the
Company's Form 10-SB as filed with the SEC on February 12, 1999.*
4.1 Form of Stock Certificate, form of Stock Purchase Warrant and Stock
Option Agreement. Incorporated by reference from the Company's Form
10-SB as filed with the SEC on February 12, 1999.*
10.1 Asset Purchase Agreement dated January 28, 1999, by and among GTI
Acquisition Corporation, Herald Marketing Associates, Incorporated,
dba Graphics Technology, Inc. and Stephan G. Herold*
10.2 Consulting Agreement dated January 28, 1999,
between GTI Acquisition Corporation and Stephan G. Herold*
10.3 Loan and Security Agreement dated February 11, 1999, by and among
Virtual Technology Corporation, GTI*
10.4 Acquisition Corporation and Coast Business Credit Fontenelle, L.L.C.
Consulting Agreement*
10.5 Consulting Agreement with Fontenelle, LLC.**
10.6 Employment Agreement with Gregory Appelhof
10.7 Employment Agreement with John Harvatine
21. The Company has only one subsidiary, GTI Acquisition Corporation, a
Minnesota Corporation, doing business as "Graphics Technology,
Incorporated" and "GTI" none of the Company's other subsidiaries is
a "significant subsidiary" as defined by Rule 1-02(w) of Regulation
S-X promulgated under the Securities Act of 1933, as amended.
23.1 Consent of Lurie, Besikof, Lapidus & Co., LLP
23.2 Consent of Copeland Buhl & Company, P.L.L.P.
23.3 Consent of Samuel T. Kuntos
24 Power of Attorney. Included in this 10-K under "Signatures."
27 Financial Data Schedule
- ------------
(b) Reports on Form 8-K. The Company did not file any current reports on Form
8-K during the fourth quarter ended January 31, 1999.
(c) See Part IV, Item 14(a)(3) and the exhibit list immediately above.
(d) None.
* Incorporated by reference from the Company's 10-SB, filed with the SEC on
February 12, 1999.
** Incorporated by reference from the Company's amended Form S-8, filed with
the SEC on April 15, 1999.
43
<PAGE> 95
(27) - Financial Data Schedule
(99) --
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
By: /s/ Gregory Appelhof
---------------------------------------------
Gregory Appelhof
Its: Chief Executive Officer and President (Principal Executive Officer)
Date: May 3, 1999
POWER OF ATTORNEY
Each person whose signature to this Annual Report on Form 10-K appears below
hereby appoints Gregory Appelhof and Kenneth Israel, or either of them, as his
attorney-in-fact to sign on his behalf individually and in the capacity stated
below and to file all amendments and post-effective amendments to this Annual
Report on Form 10-K, and any and all instruments or documents filed as part of
or in conception with this Annual Report on Form 10-K or the amendments thereto,
and the attorney-in-fact, or either of them, may make such changes and additions
to this Annual Report on Form 10-K as the attorney-in-fact, or either of them,
may deem necessary or appropriate.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
By: /s/ John Harvatine
----------------------------------------------
John Harvatine
Its: Chief Financial Officer (Principal Financial and Accounting Officer)
Date: May 3, 1999
By: /s/ Kenneth Israel
----------------------------------------------
Kenneth Israel
Its: Director
Date: May 3, 1999
44
<PAGE> 96
By: /s/ Jeff Maynard
----------------------------------------------
Jeff Maynard
Its: Director
Date: May 3, 1999
By: /s/ Philip Lacerte
----------------------------------------------
Philip Lacerte
Its: Director
Date: May 3, 1999
By: /s/ Gregory Appelhof
----------------------------------------------
Gregory Appelhof
Its: Director
Date: May 3, 1999
45
<PAGE> 1
EXHIBIT 10.6
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT dated this 29th day of April, 1999 effective as
of the 8th day of October, 1998 between VIRTUAL TECHNOLOGY CORPORATION, a
Minnesota corporation (the "Corporation") with its principal office at 3100 W.
Lake Street, Suite 400, Minneapolis, MN 55416, and GREGORY APPELHOF, an
individual residing at 219 Homedale Road, Hopkins, Minnesota 55343
("Executive").
WHEREAS, the Corporation wishes to retain the services of Executive
as President of the Corporation and Executive is willing, upon the terms and
conditions set forth herein, to serve as such.
NOW THEREFORE, in consideration of the foregoing and the agreements
contained herein and for other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties agree, intending to be
legally bound, as follows:
1. EMPLOYMENT. Subject to the terms and conditions hereinafter set
forth, the Corporation hereby employs Executive as President of the Corporation,
and Executive hereby accepts such employment.
2. TERM. The term of Executive's employment under this Agreement shall
commence as of October 8, 1998 (the "Commencement Date") and shall remain in
full force and effect unless terminated earlier pursuant to Section 6 hereof
(the "Employment Term"). On each anniversary of the Commencement Date, Executive
and the Board of Directors of the Corporation (the "Board") will mutually agree
to the compensation to be paid to Executive during the ensuing year; provided,
however, that Executive's overall compensation package (consisting of base
salary, bonuses, stock options and benefits) in any particular year shall not be
less than the amounts specified in Section 5 below.
3. DUTIES. During the Employment Term, Executive shall render his
services to the Corporation as President, such duties and authority not to be
diminished. Executive agrees to (i) faithfully and diligently perform the acts
and duties of his office and such other duties as are consistent with his
position as are reasonably assigned to him by Kenneth Israel, the current
Chairman and CEO of the Corporation or the Board, (ii) devote his full business
time (minimum of 40 hours per week), efforts and entire energy and skills to the
business of the Corporation and (iii) use his best efforts to promote the
interests of the Corporation. Executive shall have the sole authority and
discretion to hire new employees and to terminate existing employees other than
the appointment of the Chairman of the Corporation. It is the intent of the
parties that Executive shall be promoted to Chief Executive Officer of the
Corporation after the first six (6) months of this Agreement. At that time, the
parties shall discuss the appropriateness of such promotion.
4. MEMBER OF BOARD. As of the Commencement Date, the Board shall create
a new directorship and elect Executive to fill it. Thereafter, Executive's
continuing directorship shall be subject to the vote of the Corporation's
shareholders at the Corporation's annual meetings. The Corporation hereby grants
to Executive in his capacity as director of the Corporation a non-incentive
stock option to purchase an aggregate of 30,000 shares of the
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<PAGE> 2
Corporation's common stock (the "Director Option") at an exercise price of $1.00
per share. The Director Option shall vest as follows: on the first anniversary
date of this Agreement, 10,000 shares subject to said option shall vest and be
immediately exercisable, on the second anniversary date of this Agreement, an
additional 10,000 shares shall vest and be immediately exercisable, and on the
third anniversary date of this Agreement, an additional 10,000 shares shall vest
and be immediately exercisable. Upon each vesting, the Director Option shall be
exercisable for a period of 5 years. The parties shall enter into the
Corporation's standard Stock Option Agreement used for its directors as soon as
practicable but if no such agreement is entered into, this shall constitute such
agreement. Additional options shall be granted as agreed upon by the parties in
the event Executive continues as a director after three years from the date
hereof.
5. COMPENSATION AND RELATED MATTERS. The Corporation shall pay
Executive compensation and benefits as follows:
(a) BASE COMPENSATION. In full consideration of the services to be
rendered by Executive (including serving as a director), the Corporation shall
pay Executive during the Employment Term an initial annual base salary of One
Hundred Fifty Thousand ($150,000) which may be further reviewed and adjusted
periodically by the Board (the "Base Salary"). The Corporation's obligation to
pay the Base Salary shall begin to accrue on the Commencement Date and shall be
payable in equal installments in accordance with the usual payroll practices of
the Corporation which are in effect from time to time during the Employment
Term, but in no event less frequently than monthly. Executive's Base Salary
shall be subject to all applicable withholding and other taxes to the extent
required by law.
(b) BONUSES.
(1) GUARANTEED BONUS. During the Employment Term, Executive shall
be entitled to a minimum bonus of $25,000 for each fiscal quarter payable in one
lump sum in cash by the 15th day of the beginning of each such quarter (the
"Guaranteed Bonus"). The Guaranteed Bonus shall be paid irrespective of the
sales revenues achieved by the Corporation. If Executive is employed on the
first day of a new quarter, the Guaranteed Bonus shall be paid.
(2) PERFORMANCE BONUS. During the Employment Term, Executive shall
be entitled to a performance bonus (the "Performance Bonus") for each fiscal
quarter in an amount equal to a percentage of the Corporation's Net Sales as set
by the Board. The term "Net Sales" means the total amount invoiced by the
Corporation from the sale of any type of product or services (including
advertising revenues) less discounts, allowances and similar deductions and less
sales tax, duties or other similar charges computed in accordance with generally
accepted accounting principles consistently applied. The Performance Bonus shall
be computed by the controller of the Corporation as soon as practicable
following the end of the fiscal year of the Corporation and payable in one lump
sum in cash not later than 45 days from the end of such fiscal year. Any
adjustments to the Net Sales determined as a result of the Corporation's annual
audit shall be made and Executive shall be paid the remainder of the Performance
Bonus at the earlier of the time the audit is approved by the Board or May 31st.
Within thirty (30) days of the end of each fiscal year, the Corporation and the
Executive shall mutually determine the Net Sales Thresholds for calculating the
Performance Bonus for the ensuing year. In any fiscal year wherein Executive is
employed for a period less than the full fiscal year, the Performance Bonus and
all calculations
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<PAGE> 3
related thereto shall be prorated for the actual number of days
during which Executive was employed in such year. Executive shall also be
entitled to such further bonus as the Board, in its discretion, deems
appropriate.
(3) STOCK OPTION.
The Corporation hereby grants to Executive on the Commencement Date a
non-transferable, stock option under and subject to the Company's 1999 Long-Term
Incentive Plan to purchase (subject to vesting) all or any part of an aggregate
of 1,250,000 shares of the common stock of the Corporation at an exercise price
of $1.00 per share (the "Option"). The vesting schedule and the exercise price
for the shares underlying the Options is as follows:
- --------------------------------------------------------------------------------
Grant Date Quantity Strike Price Vesting Date
- --------------------------------------------------------------------------------
10/08/98 500,000 $1.00 04/08/99
- --------------------------------------------------------------------------------
10/08/98 500,000 $1.00 10/08/99
- --------------------------------------------------------------------------------
10/08/98 125,000 $1.00 10/08/01
- --------------------------------------------------------------------------------
10/08/98 125,000 $1.00 10/08/02
- --------------------------------------------------------------------------------
Upon the Vesting Date, the shares vested shall be immediately exercisable in
whole or part and shall be exercisable for a period of ten (10) years. Executive
may exercise the Option by delivering previously acquired shares of the
Corporation's common stock or by decreasing the number of shares underlying the
Option pursuant to the terms of a Stock Option Agreement for the Option in the
form of Exhibit B annexed hereto to be executed on the date hereof (the "Stock
Option Agreement"). Notwithstanding the foregoing, in the event of a change of
control or ownership of the Corporation as defined in the Stock Option
Agreement, the Option shall vest in full and be immediately exercisable for a
period of ten (10) years. The Corporation hereby covenants and agrees that it
shall register the shares underlying the Option and the Director Option with the
Securities and Exchange Commission within six months of the date of this
Agreement so that such shares are not subject to Rule 144 of the Securities and
Exchange Act of 1934. If the Corporation fails to timely comply with the such
covenant, the Corporation shall be liable to Executive for damages resulting
from Executive's failure to sell the Corporation's common stock because of Rule
144. In the event the Corporation engages in a public offering of its common
stock, upon the request of the investment banking firm underwriting such
offering, Executive agrees to sign a lock-up agreement on terms and conditions
no more or less favorable than those signed by other insiders of the
Corporation, but in no event to exceed a term of one year.
(d) BENEFITS.
(i) VACATION. Executive shall be entitled to four (4) weeks paid
vacation per fiscal year of the Corporation at times chosen by Executive but
taking into consideration the needs of the Corporation. In the event Executive
does not take all vacation to which he is entitled in any fiscal year, Executive
shall be entitled to take up to one week of such vacation in the next following
fiscal year (but not to be carried over into the second succeeding fiscal year).
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<PAGE> 4
(ii) CAR AND PHONE EXPENSE ALLOWANCE; EXPENSES. The Corporation
shall provide Executive with a $500 per month expense allowance for Executive's
automobile. Cellular phone expenses will be reimbursed as incurred by Executive
in carrying out his duties hereunder. Executive shall be entitled to receive
prompt reimbursement for all other reasonable expenses incurred by Executive in
performing services hereunder provided Executive complies with the Corporation's
policies and procedures established from time to time to document such expenses.
(iii) EMPLOYMENT BENEFIT PLAN. During the Employment Term,
Executive shall be entitled to (i) participate, subject to qualification
requirements, in medical or other insurance or hospitalization plan and policies
which are presently in effect or hereinafter instituted by the Corporation and
applicable to its executive officers generally, and (ii) participate, subject to
classification requirements and continued maintenance thereof by the
Corporation, in other employee benefit plans, such as profit sharing plans,
which are from time to time applicable to the Corporation's executive officers
generally. If the Corporation has no medical/health plan providing insurance
coverage to its employees for which Executive (including his wife and four minor
children) would be eligible to participate under, the Corporation shall timely
pay (or reimburse Executive for) the premiums for Executive's existing health
insurance with Blue Cross/Blue Shield including any COBRA payments.
(e) ADDITIONAL BENEFITS. Executive shall be entitled to such other
employment benefits as the Board may determine in its sole discretion from time
to time.
6. TERMINATION. Executive's employment hereunder may be terminated as
follows:
(a) CAUSE. The Corporation may terminate Executive's employment
immediately upon notice to Executive for "cause," which shall mean (i) a final
non-appealable adjudication in a criminal or civil preceding that Executive has
committed a fraud or a felony relating to or adversely affecting his employment,
or (ii) insubordination or other substantial willful refusal by Executive in
fulfilling his duties and obligations hereunder which Executive fails to remedy
within thirty (30) days after written demand from the Board detailing with
specificity the nature of such breach. In the event that Executive's employment
is terminated hereunder for "cause," the Corporation shall have the following
obligations to Executive in addition to those required by law (i) Base Salary
and the Bonuses pursuant to Section 5(b) earned by Executive as of the date of
termination, and (ii) Executive shall have 90 days to exercise that portion of
the Stock Option Agreement vested through the time of such termination with all
other rights thereunder being forfeited.
(b) WITHOUT CAUSE. The Corporation may terminate Executive's employment
hereunder at any time upon thirty (30) days' notice to Executive, without
"Cause" (as defined above), for any reason or no reason. Upon any such
termination of Executive, Executive shall be entitled as a severance payment to
that number of months' salary as set forth below times the then applicable Base
Salary rate (the "Severance Payment"):
(i) if the employment was less than one year (from the
Commencement Date), six months' Base Salary;
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<PAGE> 5
(ii) if the employment was more than one year (from the
Commencement Date) but less than two years, twelve months'
Base Salary; and
(iii) if the employment was more than two years (from the
Commencement Date), eighteen months' Base Salary.
Such payments shall be made in a lump sum payment on the last date of employment
whether or not the Company enforces Executive's non-compete obligations set
forth in Section 8. In addition, the Stock Option Agreement shall remain in full
force and effect with respect to that portion of the Option vested through the
time of such termination in accordance with its terms.
(c) RESIGNATION. Upon any voluntary termination of employment by
Executive, the Corporation shall have no further obligations (except as required
by law) to Executive except for Base Salary and Bonuses pursuant to Section 5(b)
earned by Executive as of the date of termination and the Stock Option Agreement
shall remain in full force and effect with respect to that portion of the Option
vested through the time of such termination in accordance with its terms.
Notwithstanding the preceding sentence, in the event Executive's resignation is
requested by the Board other than for "cause", such termination shall be deemed
a termination without cause and subject to the provisions of Section 6(b) above.
(d) DEATH OR DISABILITY. Executive's employment hereunder shall
terminate upon his death or disability. In either event, Executive or his
estate, as applicable, shall be entitled to receive the same payments Executive
would have received had Executive been terminated "without cause" pursuant to
Section 6(b) above. Executive, or his estate, as applicable shall also be
entitled to exercise that portion of the Option vested through the date of such
death or disability in accordance with the terms of the Stock Option Agreement.
Executive shall be deemed to have become permanently disabled if in any year
during the Employment Term, because of ill health, physical or mental
disability, or for other causes beyond the control of Executive, Executive has
been continuously unable or unwilling or has failed to perform Executive's
duties for 120 consecutive days, or if, during any year of the employment
period, Executive has been unable or unwilling or has failed to perform his
duties for a total of 150 days, consecutive or not. The term "any year of the
employment period" means any period of 12 consecutive months during the
Employment Term. A determination of disability shall be made upon written
agreement of the Corporation and Executive, or the legally appointed guardian of
Executive if he is incompetent. If the parties do not agree, the determination
of disability shall be made by three physicians. The Corporation shall name one
physician, Executive or legal guardian shall select one physician, and the two
physicians shall jointly select a third physician. The majority decision of the
three physicians shall be determinative in all respects. Executive agrees to
submit to a reasonable number of medical examinations for determination
purposes. If the cause of the disability appears to be primarily of a mental,
rather than a physical nature, then the physicians shall be psychiatrists or
psychologists licensed to practice within the State of Minnesota. The
Corporation shall pay the cost of examinations relating to the issue of
disability. Any period of disability shall be included in determining the
amounts payable under this Section.
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<PAGE> 6
7. CONFIDENTIALITY. Executive agrees that he will not use or disclose,
or permit others to use or disclose (other than other executives or
representatives of the Corporation), any trade secrets, confidential
information, data or records relating to the business, techniques, operations
and condition (financial or otherwise) of the Corporation which is not generally
known or available through other lawful sources. On termination of Executive's
employment for any reason, Executive shall deliver promptly to the Corporation
all such property of the Corporation in the possession or power of Executive or
directly or indirectly under the control of Executive.
8. NON-COMPETITION AND NON-SOLICITATION.
(a) NO COMPETITION. So long as Executive is employed by the
Corporation, and for a period of two (2) years after Executive's termination of
employment for any reason (the "Non-Compete Period"), Executive shall not,
directly or indirectly, throughout the world (the "Territory") whether as an
individual, independent consultant, investor, officer, director, employee,
shareholder, or other owner of any corporation, firm, partnership, trust, sole
proprietorship, limited liability company, limited liability partnership, or
other business entity, engage in a business which directly competes with the
Corporation. The provisions of this Section 8(a) shall not apply to: (i) the
ownership by Executive of the securities of any publicly traded corporation so
long as Executive is not an affiliate of such corporation; and (ii) the
ownership of securities of the Corporation.
(b) NO SOLICITATION OF EXECUTIVES. For the Non-Compete Period,
Executive shall not, whether voluntary or involuntary, directly or indirectly,
(i) solicit, induce or attempt to solicit or induce any employee or independent
consultant of the Corporation to terminate his, her or its employment or
relationship with the Corporation, or (ii) employ, engage or seek to employee or
engage, any individual or entity who is, or was, employed or engaged by the
Corporation, until the expiration of six (6) months following the termination of
such person's or entity's employment or relationship with the Corporation.
(c) CONSIDERATION FOR COVENANTS. In consideration for the covenants set
forth in Sections 8(a) and 8(b), the Corporation shall continue to pay Executive
his Base Salary and Guaranteed Bonus then in effect at the time of termination
of employment for the Non-Compete Period (the "Non-Compete Payments"). If
Executive is terminated pursuant to Section 6(a) for "cause", Executive shall be
bound by such covenants but the Corporation shall not be obligated to pay
Executive the Non-Compete Payments. The Non-Compete Payments shall be made in
accordance with the Corporation's usual payroll practice then in effect from
time to time but in no event less frequently than monthly. If Non-Compete
Payments are not made, Employee shall be free to compete without restriction.
The Non-Compete Payments are in addition to any Severance Payment pursuant to
Section 6(b) and are required to be paid regardless of whether the Non-Compete
Payments are made.
9. PROPERTY RIGHTS. Subject to the last sentence of this Paragraph 9,
the Corporation shall acquire exclusive right, title, and interest to all
inventions, discoveries, improvements, designs, ideas, know-how, technology and
the like developed, conceived, or invented by Executive, in whole or in part,
whether written or in some other form and whether
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<PAGE> 7
or not patentable or eligible for protection under any copyright law. Despite
the preceding sentence, nothing in this Paragraph 9 shall apply to an invention
for which no equipment, supplies, facility or trade secret information of the
Corporation is used and which is developed entirely on Executive's own time, and
(i) does not relate directly to the business of the Corporation or to the
Corporation's actual or demonstrably anticipated research or development, or
(ii) which does not result from any work performed by Executive for the
Corporation.
10. NOTICES. Any notice or other communication required or permitted to
be given hereunder shall be in writing and delivered by hand. Notices shall be
effective upon receipt with confirmation.
11. NO ASSIGNMENT. Neither party may assign this Agreement without the
prior written consent of the other party. This Agreement shall be binding on and
inure to the benefit of the successors and assigns of the Corporation and the
heirs, executors, personal and legal representatives of Executive.
12. LEGAL EXPENSES. The Corporation agrees to pay the legal and
advisory expenses incurred by Executive in connection with the negotiation of
this Agreement and the other agreements required hereunder upon invoice not to
exceed $7,500.
13. MISCELLANEOUS. The failure of any party to insist on the strict
performance of any of the terms, conditions, and provisions of this Agreement
shall not be construed as a waiver or relinquishment of future compliance
therewith. This Agreement constitutes the entire agreement between the parties
hereto relating to the subject matter hereof and supersedes all prior or
contemporaneous negotiations, representations, agreements and understandings
(both oral and written) of the parties relating thereto. No supplement,
modification or amendment of this Agreement or waiver of any term hereunder
shall be binding unless it is in writing and executed by the parties hereto.
This Agreement shall be governed by and construed in accordance with the laws of
the State of Minnesota.
IN WITNESS WHEREOF, this Agreement has been executed by the parties
hereto as of the date first above written.
THE CORPORATION: VIRTUAL TECHNOLOGY CORPORATION
By: /s/ Ken Israel
--------------------------------
Name: Ken Israel
Title: Chairman
/s/ Gregory Appelhof
EXECUTIVE: --------------------------------
Gregory Appelhof
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<PAGE> 1
EXHIBIT 10.7
VIRTUAL TECHNOLOGY CORPORATION
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (the "Agreement") is made and entered into by
and between Virtual Technology Corporation, a Minnesota corporation ("the
Company"), and John Harvatine (the "Employee"), effective as of the 4th day of
January, 1999.
R E C I T A L S :
WHEREAS, as of the date of this Agreement, the Company is engaged
primarily in the business of selling computer equipment; and
WHEREAS, Employee desires to become employed hereunder by the Company
in a confidential relationship wherein Employee, in the course of Employee's
employment with the Company, will continue to become familiar with and aware of
information as to the Company's business plan, acquisition candidates,
prospective customers, specific manner of doing business, including the
processes, techniques and trade secrets utilized by the Company and future plans
with respect thereto, all of which will be established and maintained at great
expense to the Company; this information is a trade secret and constitutes the
valuable goodwill of the Company.
NOW, THEREFORE, in consideration of the mutual promises, terms,
covenants and conditions set forth herein and the performance of each, the
parties hereto hereby agree as follows:
1. EMPLOYMENT AND DUTIES.
(a) The Company hereby employs Employee as Chief Financial Officer of
Virtual Technology Corporation. As such, Employee shall have responsibilities,
duties and authority reasonably accorded to and expected of such an officer of
the Company and will report directly to the President of VTC. Employee hereby
accepts this employment upon the terms and conditions herein contained and,
subject to Section 1(c) hereof, agrees to devote Employee's full business time,
attention and efforts to promote and further the business of the Company.
(b) Employee shall faithfully adhere to, execute and fulfill all
policies established by the President.
(c) Employee shall not, during the term of his employment hereunder, be
engaged in any other business activity pursued for gain, profit or other
pecuniary advantage if such activity interferes with Employee's duties and
responsibilities hereunder. The foregoing limitations shall not be construed as
prohibiting Employee from making personal investments in such form or manner as
will neither require Employee's services in the operation or affairs of the
companies or enterprises in which such investments are made nor violate the
terms of Section 4 hereof.
<PAGE> 2
2. COMPENSATION.
For all services rendered by Employee, the Company shall compensate
Employee as follows:
(a) BASE SALARY. The base salary payable to Employee shall be $100,000
per year, payable on a regular basis in accordance with the Company's standard
payroll procedures but not less than monthly. Commencing in February 2000, and
on at least an annual basis, the President of VTC and the Company and Board of
Directors of the Company will review Employee's performance and may make
increases to such base salary if, in its discretion, any such increase is
warranted. Such recommended increase would, in all likelihood, require approval
by the Board or a duly constituted committee thereof. In no event shall
Employee's base salary be reduced.
(b) INCENTIVE BONUS PLAN. For 1999, Employee shall be entitled to a
bonus of $25,000, payable in cash, upon attainment of to be determined Key
Management Objectives for the Company. The 1999 bonus shall be payable by
March 2000.
For 2000 and subsequent years, Employee and the President of VTC and
the Company and Board shall develop, as soon as practicable, a written Incentive
Bonus Plan setting forth the criteria and performance standards under which
Employee will be eligible to receive a year-end bonus award.
(c) EXECUTIVE PERQUISITES, BENEFITS AND OTHER COMPENSATION. Employee
shall be entitled to receive additional benefits and compensation from the
Company in such form and to such extent as specified below:
(i) Employee shall be eligible to participate in Company health
insurance plans in the same manner as other Company senior management.
(ii) Reimbursement for all business travel and other out-of-pocket
expenses reasonably incurred by Employee in the performance of Employee's
services pursuant to this Agreement. All reimbursable expenses shall be
appropriately documented in reasonable detail by Employee upon submission of any
request for reimbursement, and in a format and manner consistent with the
Company's expense reporting policy.
(iii) A $400 per month car allowance.
(iv) Commencing in 1999, three weeks paid (at the Employee's then
current base salary rate) vacation per year, to be scheduled in increments at
such time or times as is agreeable to Employee and the Company. The Employee may
carry over unused vacation time for a period of up to six (6) months into the
following year.
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<PAGE> 3
(v) The Company shall provide Employee with other executive perquisites
as may be available to or deemed appropriate for Employee by the Board and
participation in all other Company-wide employee benefits as available from time
to time.
(vi) Employee shall be eligible to participate in the Company's Stock
Participation Program on the same terms as other Company senior management, as
defined by the Company's Board of Directors, to be implemented during the first
quarter of fiscal 2000.
3. OPTIONS.
The Company hereby grants to Employee options under and subject to the
Company's 1999 Long-Term Incentive Plan to acquire of the Company's Common
Stock, no par value pursuant to the following:
- ----------------------------------------------------------------------
Grant Date Quantity Strike Price Vesting Date
- ----------------------------------------------------------------------
4/19/99 62,500 $4.875 immediately
- ----------------------------------------------------------------------
4/19/99 62,500 $4.875 1/04/00
- ----------------------------------------------------------------------
4/19/99 62,500 $4.875 1/04/01
- ----------------------------------------------------------------------
4/19/99 62,500 $4.875 1/04/02
- ----------------------------------------------------------------------
Except as otherwise provided by the Incentive Plan or this Agreement,
Employee must continue in the employ of the Company through the applicable
vesting date (whether the vesting occurs upon the lapse or time in order to vest
in the options for such vesting date. Vested options shall be exercisable for
the shorter of (i) ninety (90) days after Employee terminates employment with
the Company or (ii) five (5) years from the date of this Agreement. To the
fullest extent possible, the options shall be treated as "incentive options"
within the meaning of Section 422 of the Internal Revenue Code of 1986, as
amended (the "Code").
Employee acknowledges that the options are not transferrable except as
provided by Section 15.4 of the Incentive Plan and that the shares of Common
Stock underlying such options have not been registered under the Securities Act
of 1933, as amended (the "Act"), or any state securities laws. Accordingly, the
shares underlying the options may not be sold or otherwise transferred without
registration under the Act or an exemption therefrom. The Company will place a
restrictive legend on any certificate representing shares acquired by Employee
upon exercise of the options, and a "stop transfer order" with any transfer
agent of the Company's securities, barring the sale or other transfer of the
Employee's shares without registration under the Act or an exemption therefrom.
This Agreement shall constitute the "Award Agreement" referred to in
Section 6.2 of the Incentive Plan.
4. NON-COMPETITION.
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(a) Employee will not, during (i) the period of Employee's employment
with the Company and (ii) conditioned upon the Company's continued payment of
Employee's base salary in effect at the time of Employee's termination of
employment, for a period of ninety (90) days immediately following the
termination of Employee's employment under this Agreement, for any reason
whatsoever, directly or indirectly, for himself or on behalf of or in
conjunction with any other person, persons, entity, company, business,
partnership, corporation, limited liability company or limited liability
partnership of whatever nature:
(i) engage, as an officer, director, shareholder, owner, partner, joint
venturer or in a managerial capacity, whether as an employee, independent
contractor, consultant or advisor or as a sales representative, in any
computer-related sales business in direct competition with the Company or any
subsidiary of the Company, within the state of Minnesota, including any
territory serviced by the Company or any of its subsidiaries (the "Territory");
(ii) call upon any person who is, at that time, within the Territory,
an employee of the Company (including the subsidiaries thereof) in a managerial
capacity for the purpose or with the intent of enticing such employee away from
or out of the employ of the Company (including the subsidiaries thereof);
(iii) call upon any person or entity which is, at that time, or which
has been, within one (1) year prior to that time, a customer of the Company
(including the respective subsidiaries thereof) within the Territory for the
purpose of soliciting or selling products or services in direct competition with
the Company or any subsidiary of the Company within the Territory; or
(iv) call upon any prospective acquisition candidate, on Employee's own
behalf or on behalf of any competitor, which candidate was, to Employee's actual
knowledge after due inquiry, either called upon by the Company (including the
respective subsidiaries thereof) or for which the Company made an acquisition
analysis, for the purpose of acquiring such entity.
Notwithstanding the above, the foregoing covenant shall not be deemed
to prohibit Employee from acquiring as a passive investment not more than two
percent (2%) of the capital stock of a competing business, whose stock is traded
on a national securities exchange or over-the-counter, or from engaging in the
sports promotion business so long as such activities do not compete with the
Company's activities.
(b) Because of the difficulty of measuring economic losses to the
Company as a result of a breach of the foregoing covenants, and because of the
immediate and irreparable damage that could be caused to the Company for which
it would have no other adequate remedy, Employee agrees that the foregoing
covenants may be enforced by the Company in the event of breach by him, by
injunctions and restraining orders.
(c) It is agreed by the parties that the foregoing covenants in this
Section 4 impose a reasonable restraint on Employee in light of the activities
and business of the Company (including the Company's subsidiaries) on the date
of the execution of this Agreement and the current plans of
-4-
<PAGE> 5
the Company (including the Company's subsidiaries); but it is also the intent of
the Company and Employee that such covenants be construed and enforced in
accordance with the changing activities, business and locations of the Company
(including the Company's subsidiaries) throughout the term of this Agreement,
whether before or after the date of termination of the employment of Employee.
For example, if, during the term of this Agreement, the Company (including the
Company's subsidiaries) engages in new and different activities, enters a new
business or establishes new locations for its current activities or business in
addition to or other than the activities or business enumerated under the
Recitals above or the locations currently established therefor, then Employee
will be precluded from soliciting the customers or employees of such new
activities or business or from such new location and from directly competing
with such new business within 250 miles of its then-established operating
location(s) through the term of this Agreement.
It is further agreed by the parties hereto that, in the event that
Employee shall cease to be employed hereunder, and shall enter into a business
or pursue other activities not in competition with the Company (including the
Company's subsidiaries), or similar activities, or business in locations the
operation of which, under such circumstances, does not violate clause (i) of
this Section 4, and in any event such new business, activities or location are
not in violation of this Section 4 or of Employee's obligations under this
Section 4, if any, Employee shall not be chargeable with a violation of this
Section 4 if the Company (including the Company's subsidiaries) shall thereafter
enter the same, similar or a competitive (i) business, (ii) course of activities
or (iii) location, as applicable.
(d) The covenants in this Section 4 are severable and separate, and the
unenforceability of any specific covenant shall not affect the provisions of any
other covenant. Moreover, in the event any court of competent jurisdiction shall
determine that the scope, time or territorial restrictions set forth are
unreasonable, then it is the intention of the parties that such restrictions be
enforced to the fullest extent which the court deems reasonable, and the
Agreement shall be reformed in accordance therewith.
(e) All of the covenants in this Section 4 shall be construed as an
agreement independent of any other provision in this Agreement, and the
existence of any claim or cause of action of Employee against the Company,
whether predicated on this Agreement or otherwise, shall not constitute a
defense to the enforcement by the Company of such covenants. It is specifically
agreed that the period of 90 days following termination of employment stated at
the beginning of this Section 4, during which the agreements and covenants of
Employee made in this Section 4 shall be effective, shall be computed by
excluding from such computation any time during which Employee is in violation
of any provision of this Section 4.
5. TERM; TERMINATION; RIGHTS ON TERMINATION.
The term of this Agreement shall begin on the date hereof and continue
for one (1) year, and, unless terminated sooner as herein provided, shall
continue thereafter on a year-to-year basis on the same terms and conditions
contained herein in effect as of the time of renewal. As used
-5-
<PAGE> 6
herein, the word "Term" shall mean (i) during the one-year period referred to
in the preceding sentence, such three-year period and (ii) during any one-year
renewal pursuant to the terms hereof, such one-year period. This Agreement and
Employee's employment may be terminated in any one of the following ways:
(a) DEATH. The death of Employee shall immediately terminate this
Agreement with no severance compensation due to Employee's estate other than
accrued base salary and any declared, but unpaid, bonuses through the date of
termination and reimbursement of expenses. Further, Employee's estate shall have
the right to exercise any options which are vested as of the date of the
Employee's death to the same extent as Employee could had he not died.
(b) DISABILITY. If, as a result of incapacity due to physical or mental
illness or injury, as reasonably determined by Employee's physician, Employee
shall have been absent from Employee's full-time duties hereunder for four (4)
consecutive months, then thirty (30) days after receiving written notice (which
notice may occur before or after the end of such four (4) month period, but
which shall not be effective earlier than the last day of such four (4) month
period), the Company may terminate Employee's employment hereunder; provided
that Employee is unable to resume Employee's full-time duties at the conclusion
of such notice period. Also, Employee may terminate Employee's employment
hereunder if his health should become impaired to an extent that makes the
continued performance of Employee's duties hereunder hazardous to Employee's
physical or mental health or life; provided that Employee shall have furnished
the Company with a written statement from a qualified doctor to such effect, and
provided further that, at the Company's request made within thirty (30) days of
the date of such written statement, Employee shall submit to an examination by a
doctor selected by the Company who is reasonably acceptable to Employee or
Employee's doctor and such doctor shall have concurred in the conclusion of
Employee's doctor. In the event this Agreement is terminated by either party as
a result of Employee's disability, Employee shall receive from the Company, in a
lump-sum payment due within ten (10) days of the effective date of termination,
the base salary at the rate then in effect for one (1) year plus payment of any
declared, but unpaid bonuses as of the date of disability and reimbursement of
expenses.
(c) CAUSE. The Corporation may terminate Executive's employment
immediately upon notice to Executive for "cause," which shall mean (i) a final
non-appealable adjudication in a criminal or civil preceding that Executive has
committed a fraud or a felony relating to or adversely affecting his employment,
or (ii) insubordination or other substantial willful refusal by Executive in
fulfilling his duties and obligations hereunder which Executive fails to remedy
within thirty (30) days after written demand from the Board detailing with
specificity the nature of such breach. In the event that Executive's employment
is terminated hereunder for "cause," the Corporation shall have the following
obligations to Executive in addition to those required by law (i) Base Salary
and the Bonuses pursuant to Section 2 earned by Executive as of the date of
termination, and (ii) Executive shall have 90 days to exercise that portion of
the Stock Option Agreement vested through the time of such termination with all
other rights thereunder being forfeited.
-6-
<PAGE> 7
(d) WITHOUT CAUSE. The Corporation may terminate Executive's employment
hereunder at any time upon thirty (30) days' notice to Executive, without
"Cause" (as defined above), for any reason or no reason. Upon any such
termination of Executive, Executive shall be entitled as a severance payment to
that number of months' salary as set forth below times the then applicable Base
Salary rate (the "Severance Payment"):
(i) if the employment was less than one year (from the
Commencement Date), three months' Base Salary;
(ii) if the employment was more than one year (from the
Commencement Date) but less than two years, six months'
Base Salary.
Such payments shall be made in a lump sum payment on the last date of employment
whether or not the Company enforces Executive's non-compete obligations set
forth in Section 4. In addition, the Stock Option Agreement shall remain in full
force and effect with respect to that portion of the Option vested through the
time of such termination in accordance with its terms.
(e) RESIGNATION. Upon any voluntary termination of employment by
Executive, the Corporation shall have no further obligations (except as required
by law) to Executive except for Base Salary and Bonuses pursuant to Section 2
earned by Executive as of the date of termination and the Stock Option Agreement
shall remain in full force and effect with respect to that portion of the Option
vested through the time of such termination in accordance with its terms.
Notwithstanding the preceding sentence, in the event Executive's resignation is
requested by the Board other than for "cause", such termination shall be deemed
a termination without cause and subject to the provisions of Section 5(d) above.
(f) CHANGE IN CONTROL OF THE COMPANY. In the event of a "Change in
Control of the Company" (as defined below) during the Term, refer to Section 12
below.
Upon termination of this Agreement for any reason provided above,
Employee shall be entitled to receive all compensation earned and all benefits
and reimbursements due through the effective date of termination. Additional
compensation subsequent to termination, if any, will be due and payable to
Employee only to the extent and in the manner expressly provided above or in
Section 13 hereof. All other rights and obligations of the Company and Employee
under this Agreement shall cease as of the effective date of termination, except
that the Company's obligations under Section 9 hereof and Employee's obligations
under Sections 4, 6, 7, 8 and 10 hereof shall survive such termination in
accordance with their terms.
If termination of Employee's employment arises out of the Company's
failure to pay Employee on a timely basis the amounts to which he is entitled
under this Agreement or as a result of any other material breach of this
Agreement by the Company (including but not limited to a material reduction in
Employee's responsibilities hereunder), as determined by a court of competent
jurisdiction or pursuant to the provisions of Section 16 below, such termination
shall be
-7-
<PAGE> 8
deemed a termination without cause, and the Company shall pay to Employee
severance compensation pursuant to the applicable provisions of Section 5(d) and
all amounts and damages to which Employee may be entitled as a result of such
breach, including interest thereon and all reasonable legal fees and expenses
and other costs incurred by Employee to enforce Employee's rights hereunder.
In the event of any termination of Employee's employment for any reason
provided above, Employee shall be under no obligation to seek other employment
and there shall be no offset against any amounts due to Employee under this
Agreement on account of any remuneration attributable to any subsequent
employment that Employee may obtain. Any amounts due under this Section 5 are in
the nature of severance payments, or liquidated damages, or both, and are not in
the nature of a penalty.
6. RETURN OF COMPANY PROPERTY.
All records, designs, tradenames and trademarks, service names and
service marks, patents, business plans, financial statements, manuals,
memoranda, customer and other lists and other property delivered to or compiled
by Employee by or on behalf of the Company, or its representatives, vendors or
customers which pertain to the business of the Company shall be and remain the
property of the Company, and be subject at all times to its discretion and
control. Likewise, all correspondence, reports, records, charts, advertising and
marketing materials and other similar data pertaining to the business,
activities or future plans of the Company which is collected by or in the
possession of Employee shall be delivered promptly to the Company without
request by it upon termination of Employee's employment.
7. INVENTIONS.
Employee shall disclose promptly to the Company any and all significant
conceptions and ideas for inventions, improvements and valuable discoveries,
whether patentable or not, which are conceived or made by Employee, solely or
jointly with another, during the period of employment, and which are directly
related to the business or activities of the Company and which Employee
conceives as a result of Employee's employment by the Company. Employee hereby
assigns and agrees to assign all of Employee's interests therein to the Company
or its nominee. Whenever requested to do so by the Company, Employee shall
execute any and all applications, assignments or other instruments that the
Company shall deem necessary to apply for and obtain Letters Patent of the
United States or any foreign country or to otherwise protect the Company's
interest therein. Nothing in this Agreement shall apply to an invention for
which no equipment, supplies, facility or trade secret information of the
Company was used and which was developed entirely on Employee's own time and (i)
which does not relate (a) directly to the business of the Company or (b) to the
Company's actual or demonstrably anticipated research or development or (ii)
which does not result from any work performed by Employee for the Company.
8. TRADE SECRETS.
-8-
<PAGE> 9
Employee agrees that he will not, other than as required by court
order, during or after the Term of this Agreement with the Company, disclose the
confidential terms of the Company's or its subsidiaries' relationships or
agreements with its significant vendors or customers or any other significant
and material trade secret of the Company or its subsidiaries, whether in
existence or proposed, to any person, firm, partnership, corporation or business
for any reason or purpose whatsoever.
9. INDEMNIFICATION.
In connection with any threatened, pending or completed claim, demand,
liability, action, suit or proceeding, whether civil, criminal, administrative
or investigative (other than an action by the Company against Employee), by
reason of the fact that Employee is or was performing services (including an
act, omission or failure to act) under this Agreement, the Company shall
indemnify and hold harmless, to the maximum extent permitted by law, Employee
against all expenses (including attorneys' fees), judgments, fines and amounts
paid in settlement, as actually and reasonably incurred by Employee in
connection therewith. In the event that both Employee and the Company are made a
party to the same third-party action, complaint, suit or proceeding, the Company
agrees to engage competent legal representation reasonably acceptable to
Employee, and Employee agrees to use the same representation; provided that if
counsel selected by the Company shall have a conflict of interest that prevents
such counsel from representing Employee, Employee may engage separate counsel
and the Company shall pay all attorneys' fees of such separate counsel. Further,
while Employee is expected at all times to use Employee's best efforts to
faithfully discharge his duties under this Agreement, Employee cannot be held
liable to the Company for errors or omissions made in good faith where Employee
has not exhibited gross, willful or wanton negligence or misconduct or performed
criminal and fraudulent acts which materially damage the business of the
Company. The Company shall pay, on behalf of Employee upon presentation of
proper invoices, all fees, costs and expenses (including attorneys' fees)
incurred in connection with any matter referenced in this Section 9.
10. NO PRIOR AGREEMENTS.
Employee hereby represents and warrants to the Company that the
execution of this Agreement by Employee and his employment by the Company and
the performance of Employee's duties hereunder will not violate or be a breach
of any agreement with a former employer, client or any other person or entity.
Further, Employee agrees to indemnify the Company for any claim, including but
not limited to attorneys' fees and expenses of investigation, by any such third
party that such third party may now have or may hereafter come to have against
the Company based upon or arising out of any noncompetition agreement, invention
or secrecy agreement between Employee and such third party which was in
existence as of the date of this Agreement.
11. ASSIGNMENT; BINDING EFFECT.
-9-
<PAGE> 10
Employee understands that he has been selected for employment by the
Company on the basis of Employee's personal qualifications, experience and
skills. Employee, therefore, shall not assign all or any portion of Employee's
performance under this Agreement. Subject to the preceding two (2) sentences and
the express provisions of Section 12 below, this Agreement shall be binding
upon, inure to the benefit of and be enforceable by the parties hereto and their
respective heirs, legal representatives, successors and assigns.
12. CHANGE IN CONTROL.
(a) Unless Employee elects to terminate this Agreement pursuant to (c)
below, Employee understands and acknowledges that the Company may be merged or
consolidated with or into another entity and that such entity shall
automatically succeed to the rights and obligations of the Company hereunder or
that the Company may undergo another type of Change in Control. In the event
such a merger or consolidation or other Change in Control is initiated prior to
the end of the Term, then the provisions of this Section 12 shall be applicable.
(b) In the event of a pending Change in Control wherein the Company and
Employee have not received written notice at least five (5) business days prior
to the anticipated closing date of the transaction giving rise to the Change in
Control from the successor to all or a substantial portion of the Company's
business and/or assets that such successor is willing as of the closing to
assume and agree to perform the Company's obligations under this Agreement in
the same manner and to the same extent that the Company is hereby required to
perform, then such Change in Control shall be deemed to be a termination of this
Agreement by the Company without cause during the Term and the applicable
portions of Section 5(d) will apply.
(c) In any Change in Control situation, Employee may elect to terminate
this Agreement by providing written notice to the Company at least five (5)
business days prior to the anticipated closing of the transaction giving rise to
the Change in Control. In such case, the applicable provisions of Section 5(d)
will apply as though the Company had terminated the Agreement without cause
during the Term
(d) For purposes of applying Section 5 hereof under the circumstances
described in (b) and (c) above, the effective date of termination will be the
closing date of the transaction giving rise to the Change in Control and all
compensation, reimbursements and lump-sum payments due Employee must be paid in
full by the Company at or prior to such closing. Further, Employee will be given
sufficient time and opportunity to elect whether to exercise all or any of
Employee's vested options to purchase the Company Common Stock, including any
options with accelerated vesting under Article 16 of the Incentive Plan, such
that Employee may convert the options to shares of the Company Common Stock at
or prior to the closing of the transaction giving rise to the Change in Control,
if Employee so desires.
(e) A "Change in Control" shall be deemed to have occurred if:
-10-
<PAGE> 11
(i) any person or entity, or group of persons or entities acting
together, other than the Company or an employee benefit plan of the Company,
acquires directly or indirectly the Beneficial Ownership (as defined in Section
13(d) of the Securities Exchange Act of 1934, as amended) of any voting security
of the Company and immediately after such acquisition such person, entity or
group is, directly or indirectly, the Beneficial Owner of voting securities
representing 33% or more of the total voting power of all of the
then-outstanding voting securities of the Company and has a larger percentage of
voting securities of the Company than any other person, entity or group holding
voting securities of the Company, unless the transaction pursuant to which such
acquisition is made is approved by at least two-thirds (2/3) of the Board;
(ii) the following individuals no longer constitute a majority of the
members of the Board: (A) the individuals who, as of the first closing date of
the Company's IPO, constitute the Board (the "Original Directors"); (B) the
individuals who thereafter are elected to the Board and whose election, or
nomination for election, to the Board was approved by a vote of at least
two-thirds (2/3) of the Original Directors then still in office (such directors
becoming "Additional Original Directors" immediately following their election);
and (C) the individuals who are elected to the Board and whose election, or
nomination for election, to the Board was approved by a vote of at least
two-thirds (2/3) of the Original Directors and Additional Original Directors
then still in office (such directors also becoming "Additional Original
Directors" immediately following their election);
(iii) the stockholders of the Company shall approve a merger,
consolidation, recapitalization or reorganization of the Company, a reverse
stock split of outstanding voting securities, or consummation of any such
transaction if stockholder approval is not obtained, other than any such
transaction which would result in at least 75% of the total voting power
represented by the voting securities of the surviving entity outstanding
immediately after such transaction being Beneficially Owned by at least 75% of
the holders of outstanding voting securities of the Company immediately prior to
the transaction, with the voting power of each such continuing holder relative
to other such continuing holders not substantially altered in the transaction;
or
(iv) the stockholders of the Company shall approve a plan of complete
liquidation of the Company or an agreement for the sale or disposition by the
Company of all or a substantial portion of the Company's assets (i.e., 50% or
more of the total assets of the Company).
However, in no event shall a "Change in Control" be deemed to have occurred,
with respect to Employee, if Employee is part of a purchasing group which
consummates the Change in Control transaction. Employee shall be deemed "part of
a purchasing group" for purposes of the preceding sentence if Employee is an
equity participant in the purchasing company or group (except for: (i) passive
ownership of less than three percent (3%) of the stock of the purchasing company
or (ii) ownership of equity participation in the purchasing company or group
which is otherwise not significant, as determined prior to the Change in Control
by a majority of the Original and Additional Original Directors). Further, no
event occuring prior to the completion of the Company's IPO shall constitute a
Change of Control hereunder.
-11-
<PAGE> 12
(f) Employee must be notified in writing by the Company at any time
that the Company or any member of its Board anticipates that a Change in Control
may take place.
(g) Employee shall be reimbursed by the Company or its successor, on a
grossed up basis, for any excise taxes that Employee incurs under Section 4999
of the Code, as a result of any Change in Control. Such amount will be due and
payable by the Company or its successor within ten (10) days after Employee
delivers a written request for reimbursement accompanied by a copy of Employee's
tax return(s) showing the excise tax actually incurred by Employee.
13. COMPLETE AGREEMENT.
This Agreement supersedes any other agreements or understandings,
written or oral, between the Company and Employee, and Employee has no oral
representations, understandings or agreements with the Company or any of its
officers, directors or representatives covering the same subject matter as this
Agreement.
This written Agreement is the final, complete and exclusive statement
and expression of the agreement between the Company and Employee and of all the
terms of this Agreement, and it cannot be varied, contradicted or supplemented
by evidence of any prior or contemporaneous oral or written agreements. This
written Agreement may not be later modified except by a written instrument
signed by a duly authorized officer of the Company and Employee, and no term of
this Agreement may be waived except by a written instrument signed by the party
waiving the benefit of such term.
14. NOTICE.
Whenever any notice is required hereunder, it shall be given in writing
addressed as follows:
To the Company: Virtual Technology Corporation
3100 West Lake Street
Suite 400
Minneapolis, MN 55416
g
To Employee: John Harvatine
Notice shall be deemed given and effective three (3) days after the deposit in
the U.S. mail of a writing addressed as above and sent first class mail,
certified, return receipt requested, or when actually received. Either party may
change the address for notice by notifying the other party of such change in
accordance with this Section 14.
15. SEVERABILITY; HEADINGS.
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<PAGE> 13
If any portion of this Agreement is held invalid or inoperative, the
other portions of this Agreement shall be deemed valid and operative and, so far
as is reasonable and possible, effect shall be given to the intent manifested by
the portion held invalid or inoperative. The Section headings herein are for
reference purposes only and are not intended in any way to describe, interpret,
define or limit the extent or intent of the Agreement or of any part hereof.
16. ARBITRATION.
Except as to matters of injunctive or equitable relief (over which the
parties agree that the federal and state courts located in Minneapolis,
Minnesota shall have exclusive jurisdiction and are deemed to be of proper venue
and convenience to the parties), any unresolved dispute or controversy arising
under or in connection with this Agreement shall be settled exclusively by
arbitration, conducted before a panel of three (3) arbitrators in Minneapolis,
Minnesota, in accordance with the rules of the American Arbitration Association
then in effect. The arbitrators shall not have the authority to add to, detract
from or modify any provision hereof nor to award punitive damages to any injured
party. The arbitrators shall have the authority to order back-pay, severance
compensation, vesting of options (or cash compensation in lieu of vesting of
options), reimbursement of costs, including those incurred to enforce this
Agreement, and interest thereon in the event the arbitrators determine that
Employee was terminated without disability or good cause, as defined in Sections
5(b) and 5(c) hereof, respectively, or that the Company has otherwise materially
breached this Agreement. A decision by a majority of the arbitration panel shall
be final and binding. Judgment may be entered on the arbitrators' award in any
court having jurisdiction. The direct expense of any arbitration proceeding
shall be borne by the Company.
17. GOVERNING LAW.
This Agreement shall in all respects be construed according to the laws
of the State of Minnesota without regard to the conflicts of laws principles of
such state.
18. COUNTERPARTS.
This Agreement may be executed simultaneously in two (2) or more
counterparts, each of which shall be deemed an original and all of which
together shall constitute but one and the same instrument.
IN WITNESS WHEREOF, the undersigned have hereunto affixed their
signatures.
VIRTUAL TECHNOLOGY CORPORATION
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<PAGE> 14
By /s/ Greg Appelhof, President & CEO
-------------------------------------
Greg Appelhof, President & CEO
/s/ John Harvatine
-------------------------------------
John Harvatine
-14-
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITOR'S CONSENT
We consent to the incorporation by reference in Registration Statement of
Virtual Technology Corporation on Amendment No. 1 to Form S-8 filed on April 15,
1999, related to the 1999 Fontenelle, LLC Consulting Plan of our report dated
April 23, 1999, appearing in this Annual Report on Form 10-K of Virtual
Technology Corporation for the year ended January 31, 1999.
/s/ LURIE, BESIKOF, LAPIDUS & CO., LLP
Minneapolis, Minnesota
May 5, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
we consent to the inclusion in this registration statement on Form 10-K of our
report dated April 11, 1997, on our audit of the financial statements of Virtual
Technology Corporation.
/s/Copeland Buhl & Company P.L.L.P.
COPELAND BUHL & COMPANY P.L.L.P.
Minnepolis, Minnesota
April 27, 1999
<PAGE> 1
EXHIBIT 23.3
[SAMUEL T. KANTOS & ASSOCIATES LETTERHEAD]
April 27, 1999
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this registration statement on Form 10-K
or our reports as follows regarding Herold Marketing Associates, Inc.:
1. December 31, 1996 Audited Financial Statements dated April 23, 1999.
2. December 31, 1997 & 1998 Audited Financial Statements dated
February 10, 1999.
in the financial statement schedules of Virtual Technology Corporation.
Sincerely,
/s/ SAMUEL T. KANTOS & ASSOCIATES
---------------------------------
Samuel T. Kantos,
Certified Public Accountant
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM HISTORICAL
ANNUAL AUDITED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED JANUARY 31,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-K.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> JAN-31-1999
<CASH> 125,993
<SECURITIES> 0
<RECEIVABLES> 4,497,292
<ALLOWANCES> 263,000
<INVENTORY> 5,236,292
<CURRENT-ASSETS> 15,297,683
<PP&E> 420,274
<DEPRECIATION> 38,612
<TOTAL-ASSETS> 25,742,578
<CURRENT-LIABILITIES> 16,399,642
<BONDS> 49,267
0
0
<COMMON> 16,647,796
<OTHER-SE> (7,725,670)
<TOTAL-LIABILITY-AND-EQUITY> 25,742,578
<SALES> 4,945,907
<TOTAL-REVENUES> 4,945,907
<CGS> 4,769,313
<TOTAL-COSTS> 4,769,313
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 157,780
<INTEREST-EXPENSE> 79,618
<INCOME-PRETAX> (4,357,088)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,357,088)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,357,088)
<EPS-PRIMARY> (.26)
<EPS-DILUTED> (.26)
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