<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended: April 30, 1999
or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
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
of Incorporation) Identification Number)
3100 WEST LAKE STREET
SUITE 400
MINNEAPOLIS, MN 55416
(Address of Principal Executive Offices)
(612) 915-1122
(Registrant's Telephone Number, Including Area Code)
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 that the registrant was required to file
such reports), and (2) has shorter period been subject to such filing
requirements for the past 90 days.
Yes....... No X
<PAGE> 2
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of, June 11, 1999, the latest practicable date:
29,017,880
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ITEM PAGE
- ---- ----
<S> <C>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS....................................................................... F-1
Condensed Consolidated Balance Sheets (unaudited) at April 30, 1999
and January 31, 1999............................................................................. F-1
Condensed Consolidated Statement of Operations (unaudited) for the three months ended April 30,
1999 and 1998.................................................................................... F-2
Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended April 30,
1999 and 1998.................................................................................... F-3
Notes to Condensed Consolidated Financial Statements............................................ F-4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................................................ 2
Part II
Other Information
ITEM 1. LEGAL PROCEEDINGS.......................................................................... 10
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.................................................. 10
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................................................... 10
</TABLE>
1
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
<TABLE>
<CAPTION>
April 30, January 31,
ASSETS 1999 1999
----------------- ----------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 2,293,189 $ 125,993
Accounts receivable, net 6,932,209 4,497,292
Stock subscription, subsequently collected - 2,676,436
Loan from related party 123,750 -
Inventories, net 3,731,079 5,236,292
Other current assets 6,569,760 2,761,670
------------ ------------
TOTAL CURRENT ASSETS 19,649,987 15,297,683
------------ ------------
FURNITURE AND EQUIPMENT 417,274 381,662
------------ ------------
OTHER ASSETS
Goodwill 8,240,979 8,345,295
Covenant not to compete 458,333 500,000
Consulting agreement 955,272 1,042,115
Prepaid investor relation services 96,200 103,600
Loan fees 3,054,588 50,250
Deposits 18,484 21,973
------------ ------------
$ 32,891,117 $ 25,742,578
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 7,530,603 $ 7,163,358
Accrued expenses and other current liabilities 1,274,044 1,884,983
Notes payable 3,300,000 7,295,673
Line of credit 4,040,209 -
Current amount of capital lease obligations 11,072 10,628
Loans from related parties - 45,000
------------ ------------
TOTAL CURRENT LIABILITIES 16,155,928 16,399,642
------------ ------------
OTHER LIABILITIES
Loans from related parties 199,000 371,543
Capital lease obligations, net of current amount 46,327 49,267
------------ ------------
245,327 420,810
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock - 5,000,000 share authorized;
none issued - -
Common stock - no par value; 50,000,000 shares
authorized; shares issued and outstanding -
27,860,304 and 25,345,963, respectively 33,589,346 17,572,796
Stock subscription receivable (925,000) (925,000)
Accumulated deficit (16,174,484) (7,725,670)
------------ ------------
16,489,862 8,922,126
------------ ------------
$ 32,891,117 $ 25,742,578
============ ============
</TABLE>
F-1
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VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
April 30, 1999 April 30, 1998
--------------- --------------
<S> <C> <C>
NET SALES $ 17,382,763 $ 589,978
COST OF GOODS SOLD 16,170,002 710,040
------------ ------------
Gross profit (loss) 1,212,761 (120,062)
------------ ------------
OPERATING EXPENSES
Sales and marketing 1,316,802 148,588
General and administrative 1,393,165 182,331
Consulting services 2,504,789 -
Amortization of intangibles 232,826 -
------------ ------------
5,447,582 330,919
------------ ------------
LOSS FROM OPERATIONS (4,234,821) (450,981)
------------ ------------
OTHER INCOME (EXPENSE)
Warrant in lieu of stock registration (3,705,000) -
Amortization of loan fees (277,690) -
Interest expense (178,338) -
Other expense (52,965) (19,833)
------------ ------------
(4,213,993) (19,833)
------------ ------------
NET LOSS $ (8,448,814) $ (470,814)
============ ============
NET LOSS PER COMMON SHARE - BASIC AND
DILUTED $ (0.32) $ (0.05)
============ ============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC AND DILUTED 26,650,512 9,898,308
</TABLE>
F-2
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VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
April 30, 1999 April 30, 1998
---------------- ---------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(8,448,814) $ (470,814)
Adjustments to reconcile net loss to net cash
used by operating activities
Stock issued for services 2,622,916 54,375
Amortization 510,515 -
Warrant in lieu of stock registration 3,705,000 -
Depreciation 27,687 2,540
Changes in operating assets and liabilities
Accounts and other receivables (2,434,917) (161,688)
Inventory 1,505,213 8,287
Other current assets (264,106) (47,666)
Security deposits 3,489 -
Accounts payable 367,245 341,421
Accrued liabilities (610,939) 56,133
----------- -----------
Net cash used by operating activities (3,016,711) (217,412)
----------- -----------
INVESTING ACTIVITIES
Purchases of furniture and equipment (63,299) (4,762)
Loan to related party (123,750) -
----------- -----------
Net cash used by investing activities (187,049) (4,762)
----------- -----------
FINANCING ACTIVITIES
Line of credit 4,040,209 -
Payment on note payable (3,995,673) -
Payments on capital leases (2,496) (286)
Loans from related parties (217,543) -
Loan fees (209,527) -
Proceeds from options and warrants exercised 854,500 -
Proceeds from issuance of common stock 2,225,050 244,000
Subscription Receivable 2,676,436 -
----------- -----------
Net cash provided by financing activities 5,370,956 243,714
----------- -----------
NET INCREASE IN CASH 2,167,196 21,540
CASH
Beginning of period 125,993 3,649
----------- -----------
End of period $ 2,293,189 $ 25,189
=========== ===========
</TABLE>
F-3
<PAGE> 6
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
of Virtual Technology Corporation and subsidiaries (the "Company" or
"VTC") do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair statement
of results for the periods have been included. Operating results for
the three months ended April 30, 1999 are not necessarily indicative of
the results that may be expected for the year ended January 31, 2000.
For further information, refer to the consolidated financial statements
and footnotes thereto included in the Company's Annual Report on Form
10-K for the year ended January 31, 1999.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of
Virtual Technology Corporation and its wholly owned subsidiaries, GTI
Acquisition Corporation and Virtual Technology (UK), Limited. VTL was a
nonoperating entity during the first quarter of fiscal 2000. All
significant intercompany accounts and transactions have been
eliminated.
2. 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
(GTI), 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 and the first quarter of
fiscal 2000 but is expected to begin new operations as a European
electronic commerce business during fiscal 2000.
3. Other Current Assets -
Other current assets consist of the following:
<TABLE>
<CAPTION>
April 30, January 31,
1999 1999
------------ --------------
<S> <C> <C>
Prepaid consulting and service agreements $6,303,530 $2,546,630
Credit card company holdbacks 174,000 174,000
Other 92,230 41,040
---------- ----------
$6,569,760 $2,761,670
========== ==========
</TABLE>
In the first quarter of fiscal 2000 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.
F-4
<PAGE> 7
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3. Other Current Assets -
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 quoted market price of the Company's common stock. The cost of
the agreements is being amortized over the contract service period.
4. Loan Fees -
In February 1999, the Company entered into a 3-year credit agreement
with Coast Business Credit to provide financing of up to $10,000,000,
based upon eligible receivables and inventory (See Line of Credit). In
connection with setting up the agreement the Company incurred certain
fees and expenses, paid for with a combination of cash, stock and
warrants to purchase the Company's common stock. The loan fees are
being amortized over the term of the agreement. The loan fees and
accumulated amortization are as follows:
<TABLE>
<CAPTION>
April 30, January 31,
1999 1999
--------- ---------
<S> <C> <C>
Loan fees $3,332,278 $ 50,250
Less: accumulated amortization 277,690 -
---------- ---------
$3,054,588 $ 50,250
========== =========
</TABLE>
4. Line of Credit -
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. As of April 30, 1999 the company had borrowed $4,040,209 on
the line of credit and approximately $3,300,000 of additional
borrowing was available under the agreement.
F-5
<PAGE> 8
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5. Notes Payable -
Notes payable consist of the following:
<TABLE>
<CAPTION>
April 30 January 31,
1999 1999
------------ ---------------
<S> <C> <C>
Payable to Herald Marketing, interest imputed
at 9.75%:
Due February 27, 1999 $ - $ 3,967,936
Due April 28, 1999 3,300,000 3,220,664
8% notes payable to former stockholder of
VTL in settlement of litigation - 93,129
Other notes - 13,944
----------- -----------
$ 3,300,000 $ 7,295,673
=========== ===========
</TABLE>
6. 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. Identifiable assets and operating data as
of and for the three months ended April 30, 1999 are as follows:
<TABLE>
<CAPTION>
e-commerce Distribution
---------- ------------
<S> <C> <C>
Assets $ 13,625,414 $ 19,265,703
========== ==========
Sales $ 1,878,780 $ 15,503,983
Cost of goods sold 1,826,475 14,343,527
---------- ----------
Gross profit $ 52,305 $ 1,160,456
========== ==========
</TABLE>
7. Supplemental Disclosures of Cash Flow Information -
<TABLE>
<CAPTION>
April 30, April 30,
1999 1998
---- ----
<S> <C> <C>
Cash paid for interest $ 110,900 $ 243
</TABLE>
F-6
<PAGE> 9
VIRTUAL TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
7. Supplemental Disclosures of Cash Flow Information -
<TABLE>
<S> <C> <C>
Warrants issued for prepaid consulting
and service agreements $7,062,000 $ -
Stock issued for consulting services 5,875,000 -
Stock issued in lieu of compensation - 54,375
</TABLE>
8. Subsequent Events -
In May 1999, the Company issued 1,157,576 shares of common stock for
cash.
In May 1999, the Company issued warrants to purchase 200,000 shares of
the Company's common stock for two years at an exercise price of $9.00
per share in connection with a portion of the above issuance of common
stock.
In June 1999, Lenhoff Capital Partners, Inc., ("LCP") commenced suit
against the Company. LCP alleges that the Company failed to pay
$120,000 of a "success fee" and to issue stock purchase warrants to LCP
as consideration for introductions to Coast Business Credit. The suit
also alleges that the Company failed to pay LCP an additional fee after
the Company, without LCP's assistance, obtained private equity funding
in January 1999. LCP seeks monetary damages and of the issuance of a
stock purchase warrant. The Company intends to vigorously defend
against the suit. As of April 30, 1999, the Company has not provided
any reserves related to such lawsuit in its financial statements.
F-7
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH THE COMPANY'S UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND
NOTES THERETO INCLUDED ELSEWHERE IN THIS REPORT AND "RISK FACTORS" INCLUDED IN
THE COMPANY'S FORM 10-K FOR THE FISCAL YEAR ENDED JANUARY 31, 1999. 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, AS PERMITTED AND COVERED BY THE PRIVATE SECURITIES
LITIGATION REFORM ACT. 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.
OVERVIEW
Virtual Technology Corporation ("VTC") or ("The Company") is the parent
of two complementary business units: Virtual-world.com and Graphics
Technologies, Inc. ("GTI"). Both units provide computer manufacturers with
channels to deliver their products to the end consumer. Virtual-world.com
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. VTC's
management directs the overall business and provides integration and leadership
to the two business units.
Virtual-world.com 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 disclaims the inclusion of this web site in this Form 10-Q),
Virtual-world.com offers more than 42,000 units of selective high-performance,
brand name computer equipment. Virtual-world.com 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.com's online store features a fun, easy to navigate interface,
competitive pricing, extensive product information and powerful search
capabilities.
2
<PAGE> 11
Virtual-world.com began online marketing of a proprietary email and
newsgroup software in January 1997. In October 1997, Virtual-world.com launched
its e-commerce site offering a range of selective high-performance brand names
for computer equipment and software programs. To facilitate its expansion,
Virtual-world.com formed alliances with GTI, Ingram Micro ("Ingram") and Tech
Data Corporation ("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.
Virtual-world.com 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. A majority of Virtual-world.com's sales are through
credit cards. Virtual-world.com uses a credit card screening service to mitigate
the risk of credit card fraud, thereby reducing the credit risk involved with
accepting credit cards. Virtual-world.com bears full credit risk on non-credit
card sales. Virtual-world.com, through its network of suppliers, 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 Virtual-world.com's website, but
there is no assurance that such buying efficiencies can or will be achieved.
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 40 manufacturers of computer related products,
and maintains an inventory stock 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
customer. The amount payable to the supplier is reported as cost of sales. GTI
bears full credit risk with respect to substantially all sales.
The Company has a limited operating history upon which investors may
evaluate its business and prospects. At February 7, 1996, the Company was
essentially a shell corporation without any products or revenues. Since such
date, the Company has incurred significant losses, and as of April 30, 1999 had
an accumulated deficit of approximately $16.2 million. The Company 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
3
<PAGE> 12
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
e-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
The following table sets forth statement of operations data for the
periods indicated as a percentage of revenues:
<TABLE>
<CAPTION>
Three Months Ended
April 30, 1999 April 30, 1998
-------------- --------------
<S> <C> <C>
Sales .................................. 100.0% 100.0%
Cost of goods sold ..................... 93.0 120.4
----- -----
Gross profit .................. 7.0 (20.4)
Operating expenses ..................... 31.3 56.1
----- -----
Loss from operations ................... (24.4) (76.4)
</TABLE>
4
<PAGE> 13
<TABLE>
<S> <C> <C>
Other expenses (net) ................... (24.2) (3.4)
----- -----
Net loss ............................... (48.6) (79.8)
===== =====
</TABLE>
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 customer. 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 a majority of its sales. The Company's net sales increased to
$17.4 million for the three months ended April 30, 1999, from $590,000 for the
three months ended April 30, 1998, reflecting an increase of $16.8 million or
2,846%. This sales increase included a $1.4 million or 234% increase for
Virtual-world.com (e-commerce) sales and a $15.9 million increase for GTI
(distribution) sales as a result of the GTI acquisition, offset by the
elimination of intercompany sales. The Virtual-world.com increase was primarily
the result of the growth of Internet sales through the Company's web-site. The
Company acquired GTI on January 28, 1999, therefore did not report net sales
prior to that date.
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 the three
months ended April 30, 1999 was $16.2 million, or 93.0% of net sales, reflecting
an increase of $15.5 million or 2,177%. The cost of goods sold increase includes
a $1.2 million or 170% increase for Virtual-world.com cost of goods sold and a
$14.7 million increase for GTI cost of goods sold as a result of the GTI
acquisition, offset by the elimination of intercompany cost of goods sold. The
Virtual-world.com increase was primarily the result of the increase in sales.
Prior to the three months ended January 31, 1999, the Company did not report
cost of goods sold for GTI.
OPERATING EXPENSES. Operating expenses consist principally of sales and
marketing, general and administrative, consulting services and amortization of
intangibles. Sales and marketing expenses, which include sales and marketing
personnel expenses and advertising and promotional expenses, increased to $1.3
million during the three months ended April 30, 1999 from $149,000 for the three
months ended April 30, 1998. The primary components of the increase were an
increase in advertising and promotion expenditures of $704,000 and an increase
in sales and marketing personnel expenses of $464,000. As a percentage of net
sales, sales and marketing expenses were 7.6% in the three months ended April
30, 1999, as compared to 25.2% in the three months ended April 30, 1998. The
Company expects that sales and marketing 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 consist principally of executive,
accounting and administrative personnel expenses, legal, and accounting
expenses, occupancy and bad
5
<PAGE> 14
debt expense. General and administrative expenses increased to $1.4 million for
the three months ended April 30, 1999 from $182,000 for the three months ended
April 30, 1998. The three months ended April 30, 1999 increase over the three
months ended April 30, 1998, was primarily due to an increase in personnel
expense of $578,000, and legal, accounting and other professional services of
$309,000. As a percentage of net sales, general and administrative expenses were
8.0% during the three months ended April 30, 1999, compared to 30.9% for the
three months ended April 30, 1998.
Consulting services consist primarily of financial and other services
contracts paid with cash, common stock and warrants to purchase common stock or
a combination thereof. In the three months ended April 30, 1999, the Company
recognized $2.5 million of non-cash consulting services expenses from a
combination of previous agreements and new agreements, generally written for a
term of one year. There were no consulting services for the three months ended
April 30, 1998. The Company will continue to recognize the cost of existing
noncash consulting agreements over the course of fiscal 2000, with the total
charge to exceed $8 million for the entire fiscal year. There may be substantial
additional charges if the Company enters into additional agreements.
Amortization of intangibles consists of goodwill, a covenant not to
compete and a consulting agreement, all associated with the acquisition of GTI.
Amortization totaled $233,000 for the three months ended April 30, 1999,
compared with no amortization for the three months ended April 30, 1998.
OTHER EXPENSE. Other expense consists primarily of a $3.7 million
charge for warrants issued in April 1999 in lieu of the registration of certain
shares of common stock as required in a November, 1998 consulting agreement. The
Company used the Black-Scholes option model and the quoted market price of the
Company's common stock to value the warrants. Additional other expenses include
$278,000 for amortization of loan fees and interest expense of $178,000. The
loan fee expense and $74,000 of the interest expense relate to a collateralized
3 year $10 million line of credit with Coast Business Credit ("Coast"). The
balance of the interest is primarily related to a $111,000 discount on the notes
payable to Herold Marketing as a result of the acquisition of GTI.
LIQUIDITY AND CAPITAL RESOURCES
6
<PAGE> 15
The Company historically has financed its operations primarily through
the private placement of equity and debt securities. Primary uses of cash have
been to fund the operation of the Company through its development stage, the
acquisition of subsidiary businesses, and increases in inventory and accounts
receivable. If the Company is successful in achieving continued revenue growth,
its working capital requirements are likely to increase.
Cash provided by financing activities was $5.4 million for the three
months ended April 30, 1999, as compared to cash provided by financing
activities of $244,000 for the three months ended April 30, 1998. During the
three months ended April 30, 1999, the Company received $5.8 million from
issuance of equity securities and the collection of a stock subscription
receivable of $2.7 million. In addition, the Company borrowed $4.0 million under
the loan and security agreement with Coast Business Credit, a division of
Southern Pacific Bank (the "Coast Agreement"). Proceeds from these financing
activities were used to retire a $4.0 million note payable to Herold Marketing
in connection with the Company's acquisition of GTI. The Company also used the
proceeds to retire $218,000 of loans to related parties and paid $210,000 in
loan fees to establish the Coast Agreement.
Net cash used by operating activities for the Company during the three
months ended April 30, 1999, was $3.0 million versus $217,000 for the three
months ended April 30, 1998. Net cash used by operating activities for the
Company during the three months ended April 30, 1999 was primarily the result of
net operating losses and increases in accounts receivables, offset in part by
decreases in inventory and non-cash expenses. Net cash used by operating
activities for the Company during the three months ended April 30, 1998 was
primarily the result of net operating losses and increases in inventory offset
by increases in accounts payable.
For the three months ended April 30, 1999, the Company used $63,000 for
purchases of furniture and equipment and $124,000 for loans to a related party
for the development of a TV infomercial business.
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 the three months ended January 31, 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. Under the Coast Agreement, the Company 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 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 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
7
<PAGE> 16
not based on eligible receivables and inventory. 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 differential 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 up to $400,000 over the balance of fiscal 2000 on additional computer
hardware resources, including e-commerce servers, Year 2000 compliance issues
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 $2.3 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 faced 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. The evaluation determined that
the Virtual-world.com software platform is Year 2000 compliant. However, it was
also determined that 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. 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.
8
<PAGE> 17
The Company has tested the potential of using virtual-world.com's
software platform for GTI's business operations and does not believe that an
appropriate conversion can be timely effected. Accordingly, the Company is now
in the process of implementing the 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. Any expenditures related to ensuring
Year 2000 compliance 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.
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.
PART II-OTHER INFORMATION
9
<PAGE> 18
ITEM 1. LEGAL PROCEEDINGS
In June 1999, Lenhoff Capital Partners, Inc. ("LCP") commenced suit
against the Company in the U.S. District Court for the Northern District of
Illinois, Eastern Division. LCP alleges that the Company failed to pay $120,000
of a "success fee" and to issue stock purchase warrants to LCP as consideration
for introductions to Coast Business Credit. The suit also alleges that the
Company failed to pay LCP an additional fee after the Company, without LCP's
assistance, obtained private equity funding in January 1999. LCP seeks monetary
damages and the issuance of a stock purchase warrant. The Company intends to
vigorously defend against the suit.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) None
(b) None
(c) Recent Sales of Unregistered Securities.
(1) 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"):
Between February 1 and April 30, 1999, the Company issued 1,514,341
shares of its Common Stock for $3,079,500 to seven investors.
(2) Issuance of options and warrants involving no sale of
securities:
Between February 1 and April 30, 1999, the Company granted to 5
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.
(d) None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 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
10.1 Loan and Security Agreement dated February 11, 1999, by and
among Virtual Technology Corporation, GTI Acquisition
Corporation and Coast Business Credit*
10
<PAGE> 19
10.2 Consulting Agreement with Fontenelle, LLC.**
10.3 Employment Agreement with Gregory Appelhof***
10.4 Employment Agreement with John Harvatine***
10.5 Consulting Agreement with Donna Miller****
27 Financial Data Schedule
- ------------
(b) Reports on Form 8-K. The Company did not file any current reports on Form
8-K during the first three months ended April 30, 1999.
* Incorporated by reference from the Company's 10-SB, filed with the SEC on
February 12, 1999. SEC file #000-25397
** Incorporated by reference from the Company's amended Form S-8, filed with
the SEC on April 15, 1999. SEC file #333-78621
*** Incorporated by reference from the Company's Form 10-K, filed with the SEC
on May 6, 1999. SEC file #333-72849
**** Incorporated by reference from the Company S-8, filed with the SEC
on May 17, 1999. SEC file #333-78619
Signatures
Pursuant to the requirements 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.
Virtual Technology Corporation
(Registrant)
By: /s/ Greg Appelhof
------------------------------
Its: Chief Executive Officer
-----------------------------
Date: June 14, 1999
----------------------------
By: /s/ John Harvatine
------------------------------
Its: Chief Financial Officer
-----------------------------
Date: June 14, 1999
----------------------------
11
<PAGE> 20
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBITS DESCRIPTION
- -------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONDENSED CONSOLIDATED BALANCE SHEET AND CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS INCLUDED IN THE COMPANY'S FORM 10-Q FOR THE THREE
MONTHS ENDED APRIL 30, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FORM 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1999
<PERIOD-END> APR-30-1999
<CASH> 2293189
<SECURITIES> 0
<RECEIVABLES> 7139209
<ALLOWANCES> 207000
<INVENTORY> 3731079
<CURRENT-ASSETS> 19649987
<PP&E> 483573
<DEPRECIATION> 66299
<TOTAL-ASSETS> 32891117
<CURRENT-LIABILITIES> 16155928
<BONDS> 0
0
0
<COMMON> 33589346
<OTHER-SE> (17099484)
<TOTAL-LIABILITY-AND-EQUITY> 32891117
<SALES> 17382763
<TOTAL-REVENUES> 17382763
<CGS> 16170002
<TOTAL-COSTS> 16170002
<OTHER-EXPENSES> 4213993
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 178338
<INCOME-PRETAX> (8448814)
<INCOME-TAX> 0
<INCOME-CONTINUING> (8448814)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (8448814)
<EPS-BASIC> (.32)
<EPS-DILUTED> (.32)
</TABLE>
