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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended March 31, 2001
Commission File Number 0-22619
VALUESTAR CORPORATION
(Exact name of small business issuer as specified in its charter)
Colorado 84-1202005
-------- ----------
(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
360-22nd Street, #400, Oakland, California 94612
------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(510) 808-1300
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
YES X NO
----- -----
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Common Stock, $.00025 par value 16,022,219
- ------------------------------- ----------
(Class) (Outstanding at May 15, 2001)
Transitional Small Business Disclosure Format (check one): YES NO X
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VALUESTAR CORPORATION
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of March 31, 2001 and
June 30, 2000 3
Consolidated Statements of Operations for the three and nine
months ended March 31, 2001 and 2000 4
Consolidated Statements of Cash Flows for the nine
months ended March 31, 2001 and 2000 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis or Plan
of Operation
12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
2
VALUESTAR CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
March 31, June 30,
2001 2000
---------------------- ----------------
CURRENT ASSETS
Cash $ 11,566 $ 5,287,385
Receivables 149,107 454,233
Inventory 4,517 16,898
Prepaid expenses 1,119,155 416,573
---------------------- ----------------
Total current assets 1,284,345 6,175,089
PROPERTY AND EQUIPMENT 6,214,604 5,415,358
RESTRICTED CASH 296,000 296,000
DEFERRED COSTS - 23,949
OTHER ASSETS 88,747 89,489
---------------------- ----------------
Total assets $ 7,883,696 $ 11,999,885
====================== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,808,372 $ 1,665,030
Accrued liabilities and other payables 830,126 1,254,035
Demand notes payable 68,750 -
Bridge note advances 1,180,000 -
Deferred revenues 400,812 137,520
Current portion of capitalized leases 305,268 285,458
Current portion of long-term debt 590,313 450,503
---------------------- ----------------
Total current liabilities 5,183,641 3,792,546
CAPITAL LEASE OBLIGATIONS, net of current portion 177,613 408,492
LONG-TERM DEBT, net of current portion 960,776 853,997
---------------------- ----------------
Total liabilities 6,322,030 5,055,035
---------------------- ----------------
STOCKHOLDERS' EQUITY
Preferred stock, $.00025 par value; 5,000,000 shares authorized:
500,000 shares designated Series A Convertible, with
225,000 shares issued and outstanding 56 56
800,000 shares designated Series B Convertible, with
688,586 shares issued and outstanding 172 172
1,333,333 shares designated Series C Convertible, with
0 shares issued and outstanding at March 31, 2001 - -
500,000 shares designated Series CC Convertible, with
192,739 amd 0 shares issued and outstanding respectively 48 -
Common stock, $.00025 par value; 50,000,000 shares
authorized, 15,674,990 and 15,587,543 shares issued
and outstanding respectively 3,919 3,897
Additional paid-in capital 41,170,068 32,162,473
Accumulated deficit (39,612,597) (25,221,748)
---------------------- ----------------
Total stockholders' equity 1,561,666 6,944,850
---------------------- ----------------
Total liabilities and stockholders' equity $ 7,883,696 $ 11,999,885
====================== ================
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
3
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
March 31, March 31,
2001 2000 2001 2000
-------------- -------------- --------------- --------------
REVENUES $ 257,198 $ 478,750 $ 765,436 $ 1,670,878
-------------- -------------- --------------- --------------
OPERATING EXPENSES
Buyer benefits 39,066 80,912 144,589 126,128
Ratings and content 64,600 170,000 388,418 952,423
Sales and marketing 1,118,136 2,065,893 5,205,758 4,114,006
Product and content development 1,111,294 1,664,051 5,219,924 2,845,531
General and administrative 512,187 448,927 1,873,939 1,212,634
Depreciation and amortization 685,935 343,086 1,862,660 481,874
-------------- -------------- --------------- --------------
3,531,218 4,772,869 14,695,288 9,732,596
-------------- -------------- --------------- --------------
LOSS FROM OPERATIONS (3,274,020) (4,294,119) (13,929,852) (8,061,718)
-------------- -------------- --------------- --------------
OTHER INCOME (EXPENSE)
Interest Income 1,018 118,900 76,254 144,234
Interest expense (91,797) (856,773) (283,919) (1,790,623)
Miscellaneous - (3,578) 377 (4,378)
-------------- -------------- --------------- --------------
(90,779) (741,451) (207,288) (1,650,767)
-------------- -------------- --------------- --------------
NET LOSS $ (3,364,799) $ (5,035,570) $ (14,137,140) $ (9,712,485)
============== ============== =============== ==============
NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS $ (7,129,371) $ (8,080,578) $ (21,434,241) $(21,485,617)
============== ============== =============== ==============
LOSS PER COMMON SHARE $ (0.45) $ (0.68) $ (1.37) $ (2.07)
============== ============== =============== ==============
WEIGHTED AVERAGE OF COMMON SHARES
OUTSTANDING 15,674,990 11,873,812 15,658,641 10,380,824
============== ============== =============== ==============
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
4
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31,
2001 2000
------------------ ----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (14,137,140) $ (9,712,485)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation 1,861,918 307,798
Amortization of intangible assets 742 174,076
Amortization of bond discount 29,490 1,491,936
Change in allowance for doubtful accounts 42,686 (3,783)
Accrued interest included in long-term debt - 12,224
Warrants, options & stock issued for services 252,131 142,083
Gain on disposal of assets (4,136) -
Changes in:
Receivables 262,440 24,745
Inventory 12,381 (18,763)
Prepaid expenses (213,191) (154,457)
Deferred costs 23,949 40,406
Other assets - (64,482)
Accounts payable 143,342 534,751
Accrued liabilities and other payables 824,841 66,435
Deferred revenues 263,292 27,730
------------------ ----------------
Net cash used by operating activities (10,637,255) (7,131,786)
------------------ ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Property and equipment acquisitions, net of dispositions (1,792,850) (2,198,634)
------------------ ----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of preferred stock 7,098,458 12,935,255
Proceeds from sale of common stock 50,001 5,645,635
Proceeds from subscribed common stock - 837,150
Payments due on conversion of C to CC (203) -
Proceeds from debt 732,796 250,000
Payments on capital leases (211,070) (30,427)
Payments on debt (515,696) (43,856)
------------------ ----------------
Net cash provided by financing activities 7,154,286 19,593,757
------------------ ----------------
NET INCREASE (DECREASE) IN CASH (5,275,819) 10,263,337
CASH, beginning of period 5,287,385 270,149
------------------ ----------------
CASH, end of period $ 11,566 $ 10,533,486
================== ================
SUPPLEMENTAL CASH-FLOW INFORMATION Cash paid during the period for:
Interest $ 254,431 $ 214,739
Non-cash investing and financing activities:
Series CC Stock issued for capitalized development
costs, services and prepaid costs 1,500,000 -
Accrued dividends on Series A Preferred Stock 144,564 122,877
Accrued dividends on Series CC Preferred Stock 109,145 -
Warrants issued in connection with Series B preferred stock - 400,000
Equipment acquired under capital leases - 30,000
8% Secured Notes converted to Series B Stock - 1,000,000
Shareholder advances converted to Series B Stock - 250,000
12% notes converted upon warrant exercise - 625,000
6% Convertible Notes and interest converted to equity - 546,274
8% Secured Notes converted upon warrant exercise - 1,450,000
12% subordinated notes converted upon warrant exercise - 31,250
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
5
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2001
1. OPERATIONS
The Company, a Colorado corporation, conducts its operations through ValueStar,
Inc., a wholly owned subsidiary. ValueStar, Inc. was incorporated in California
in 1991, and is a provider of branded ratings on local service businesses. The
Company generates revenues from research and rating fees and is launching a new
program to collect transaction commissions from connecting member service
businesses with member buyers.
The Company's revenues have been primarily from rating and certification
services. Rating services consist of collection and verification of credential
information, a survey of a business' customers and the delivery of ratings
reports. Services associated with certification include an orientation and the
delivery of certification materials and manuals. Sales of marketing materials
and other services are recognized as materials are shipped or services are
rendered.
Starting in December 1999 the Company began a transition from fixed rating and
certification fees to developing a commission based program based on the value
of transactions between member service businesses and member buyers. The Company
has also changed its program to automatically rate businesses based on
transactions and to provide benefits to buyers purchasing from and rating member
businesses. The Company completed development of the systems required to rate
buyer transactions and collect commission fees from credit card and other
transactions in March 2001. The Company plans to commence the collection of fees
and incur related benefit costs, on a limited basis, during the fourth fiscal
quarter ending June 30, 2001. Benefit costs include loyalty points and customer
satisfaction guarantees. In the future the Company expects the majority of its
revenues to be derived from transaction commissions.
The Company plans to recognize commission revenues as reported and earned. On
July 1, 2000 the Company began recognizing fixed rating and certification fees
on a straight-line basis over the term of a participating business license,
generally one year. In the future some businesses will remain on a fixed fee
basis. Costs of benefits provided to buyers will be recognized as provided, with
accruals for future benefit obligations.
Because of the changes described above, certain amounts in the current period
are not comparable to the prior period and certain amounts in the consolidated
interim statements have been reclassified to conform to the fiscal 2001
presentation.
The Securities and Exchange Commission's staff (the "Staff") issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"), in December 1999, which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements of all public
companies. The provisions of SAB 101 are effective for transactions beginning in
the Company's current fiscal year. The Company believes it is recognizing
revenues within the guidance provided by SAB 101.
2. STATEMENT PRESENTATION
The accompanying unaudited interim financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. They do not include all information and footnotes required by
generally accepted accounting principles. The interim financial statements and
notes thereto should be read in conjunction with the Company's audited financial
statements and notes thereto for the year ended June 30, 2000.
The Company has experienced recurring losses and the use of cash from
operations. A portion of the losses is attributable to research and development
of the Company's new transaction system, and marketing and promotion costs
associated with increasing consumers' awareness of the meaning of ValueStar;
marketing to businesses the advantages of becoming ValueStar members; and
discounting certain fees to encourage businesses to become ValueStar members.
6
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2001
2. STATEMENT PRESENTATION (Cont'd)
It is management's plan to seek additional financing through private placements
as well as other means. The capital markets have been unpredictable in the past,
especially for early stage companies such as the Company. The ability and amount
of capital that can be raised depends on factors beyond the Company's control.
As a result there can be no guarantee that management's efforts to secure
additional financing will be successful or that the amounts raised will be
sufficient for the Company's future needs. If the Company raises additional
funds through the issuance of equity or convertible debt securities, the
percentage ownership of existing stockholders will be reduced. Stockholders may
experience extreme dilution due to the current stock price and the significant
amount of financing the Company needs to raise. New securities may have rights
senior to those of holders of preferred or common stock. See Note 11 for
information regarding the substantial dilution resulting from recent bridge
financing.
The consolidated interim financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. Cash flows from future operations
may not be sufficient to enable the Company to meet its obligations, and market
conditions and the Company's financial position may inhibit its ability to
achieve profitable operations.
In the opinion of management, the interim financial statements reflect all
adjustments of a normal recurring nature necessary for a fair statement of the
results for interim periods. Operating results for the three and nine month
periods ended March 31, 2001 are not necessarily indicative of the results that
may be expected for the year ending June 30, 2001.
3. CHANGE IN ACCOUNTING PRINCIPLES
During the second fiscal quarter, the Company adopted Emerging Issues Task Force
Issue No. 00-27, "Application of EITF Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, to Certain Convertible Instruments", which is effective for
all such instruments. This issue clarifies the accounting for instruments with
beneficial conversion features or contingently adjustable conversion ratios. The
Company has modified the previous calculation of the beneficial conversion
features associated with previously issued convertible preferred stock. Based on
further clarification, the beneficial conversion feature should be calculated by
allocating the proceeds received in each financing to the convertible instrument
and to any detachable warrants included in the transaction, and measuring the
intrinsic value based on the effective conversion price based on the allocated
proceeds. The previous calculation was based on a comparison of the stated
conversion price in the terms of the instrument to the fair value of the
issuer's common stock at the commitment date. The Company has presented the
effect of adoption as a cumulative change in accounting principles as allowed
for in EITF No. 00-27. Accordingly, the Company recognized in the second fiscal
quarter an additional $1,715,000 in imputed deemed dividends based on a discount
at issuance of previously issued convertible preferred stock. See Note 10 below.
4. RESEARCH AND DEVELOPMENT COSTS
Research and development expenses are charged to operations as incurred. Certain
internal software and web site development costs, which are related to the
Company's new revenue model, have been capitalized as prescribed by the American
Institute of Certified Public Accountant's Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," and the Emerging Issues Task Force consensus at EITF 00-2,
"Accounting for Web Site Development Costs."
5. INVENTORY
Inventory consists of promotional materials for sale to ValueStar member
businesses and direct advertising material, and is stated at the lower of cost
(first-in, first-out method) or market.
7
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2001
6. LONG-TERM DEBT
Long-term debt at March 31, 2001 consists of the following:
15% Equipment Note due in monthly installments of principal and interest of
$39,023 through March 2003, with a balloon payment of $191,810 due on April 1,
2003; secured by equipment; net of unamortized note discount
of $76,666 $ 869,370
15% Equipment Note due in monthly installments of principal and interest of
$22,363 through July 2003, with a balloon payment of $109,919 due on
September 1, 2003; secured by equipment 602,400
15% Equipment Note due in monthly installments of principal and interest of
$5,500 to maturity in June 2002; secured by equipment and software 30,384
15% Equipment Note due in monthly installments of principal and interest of
$2,022 to maturity in August 2003; secured by equipment and software 48,935
------------
1,551,089
Less current portion 590,313
------------
$ 960,776
============
7. STOCKHOLDERS' EQUITY
The following table summarizes equity transactions during the nine months ended
March 31, 2001:
Additional
Paid-in
Preferred Stock Common Stock Capital Accumulated
--------------------- ----------------------
Shares Amount Shares Amount Common Deficit Total
---------- --------- ------------ --------- ------------ ------------- -----------
Balance, June 30, 2000 913,586 $ 228 15,587,543 $ 3,897 $32,162,473 $ (25,221,748) $ 6,944,850
Sale of Series C Convertible
Preferred at $22.50 per
share, net of issuance
costs of $35,000 238,469 60 5,330,493 5,330,553
Sale of Series CC Convertible
Preferred at $45.00
per share, net of
issuance costs of $40,000 73,509 18 3,267,887 3,267,905
2 for 1 Exchange of Series C
Convertible Preferred to
Series CC Convertible
Preferred (119,239) (30) (173) (203)
Accrued 8% dividends on
Series A 144,564 (144,564) -
Accrued 8% dividends on
Series CC 109,145 (109,145) -
Stock issued on exercise
of options 75,001 19 49,982 50,001
Stock issued on exercise
of options in exchange
for shares 12,446 3 (3) -
Value assigned to warrants
issued for services 105,700 105,700
Net loss - - - - - (14,137,140) (14,137,140)
---------- --------- ------------ --------- ------------ ------------- -----------
Balance, March 31, 2001 1,106,325 $ 276 15,674,990 $ 3,919 $ 41,170,068 $ (39,612,597) $ 1,561,666
========== ========= ============ ========= ============ ============= ===========
During the first nine months of fiscal 2001 the Company issued 238,469 shares of
Series C Convertible Preferred Stock, par value $.00025 ("Series C Stock") for
cash of $22.50 per share. In connection with the sale of the Series C Stock, the
Company granted the purchasers warrants on an aggregate of 1,192,345 shares of
common stock ("C-Warrants"). During the third fiscal quarter all the holders of
Series C Stock and C-Warrants exchanged their securities (a two for one
exchange) for 119,230 shares of Series CC Convertible Preferred Stock, par value
$.00025 ("Series CC Stock") and warrants on 3,576,900 shares of common stock
("CC-Warrants") exercisable at $0.75 per share. At March 31, 2001 there were no
shares of Series C Stock outstanding and no C-Warrants outstanding.
8
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2001
7. STOCKHOLDERS' EQUITY (Cont'd)
During the third fiscal quarter the Company also issued 73,509 shares of Series
CC Stock for $45.00 per share for cash of $1,807,905 and an agreement with First
Data Merchant Services Corporation (FDMS), a subsidiary of First Data
Corporation ("FDC"), to perform $1,500,000 of services.
Purchasers of Series CC Stock were granted CC-Warrants to purchase 30 shares of
common stock for each share of Series CC Stock. In connection with the aggregate
of 192,739 shares of Series CC Stock issued or exchanged, the Company issued an
aggregate of 5,782,170 CC-Warrants that expire on January 5, 2004. A total of
72,669 shares of the Series CC Stock and related CC-Warrants sold and/or
exchanged were issued to entities affiliated with directors of the Company.
Cumulative dividends of 8% per annum are payable on the Series CC Stock when and
if declared by the Board of Directors or upon liquidation or conversion. The
dollar amount of Series CC Stock is convertible into shares of common stock at a
conversion price equal to $0.75 per common share, and are automatically
converted on the occurrence of certain events. The Series CC Stock has certain
antidilution and registration rights, has a liquidation preference of $45.00 per
share, plus accrued and unpaid dividends, pari passu with the Series B preferred
stock, but after payment of the preferential amount for the Series A preferred
stock. The Series CC Stock has voting rights equal to the number of common
shares into which it is convertible. In addition, as long as there are at least
100,000 shares of Series CC Stock outstanding, then the holders are entitled to
elect one member of the Company's Board of Directors.
The Company issued to a financial advisor, controlled by a director, warrants to
purchase an aggregate of 445,607 shares of common stock at an exercise price of
$0.75 per share with a five-year term in connection with the sale of the Series
CC Stock.
At March 31, 2001 the Company's Series A, B and CC convertible preferred stock
were convertible into approximately 11.7 million shares of common stock. Due to
the antidilution provisions of the preferred stock, and as a result of the
subsequent financing described in Note 11, additional shares of common stock
will be issuable to preferred holders in future periods.
8. STOCK OPTIONS AND WARRANTS
The following table summarizes option activity for the period ended March 31,
2001:
Weighted Average Weighted
Shares Exercise Price Average Life
Outstanding July 1, 2000 2,233,938 $4.19 3.75
Granted 2,506,801 $1.90
Canceled (774,058) $5.77
Exercised (90,001) $0.64
Expired (5,000) $0.50
---------
Outstanding March 31, 2001 3,871,680 $2.50 3.90
=========
Exercisable at March 31, 2001 1,804,976 $1.96 3.49
=========
In January 2001 the Company granted warrants on 500,000 shares of common stock
exercisable at $1.00 per share to a financial consulting firm, controlled by a
director, for financial advisory services. A total of 250,000 warrants vested
and were exercisable at issuance and the balance at the end of one year. The
warrants expire in January 2006. The Company valued the 250,000 warrants that
have vested at $99,000, which is being expensed over the initial one-year
service period.
In February 2001 the Company granted warrants on 150,000 shares of common stock
exercisable at $1.00 per share to a consulting firm for public relations
services. A total of 18,750 warrants vested and were exercisable at issuance and
the balance vest at the rate of 18,750 at the end of each three month period.
The warrants expire in February 2006. The Company has expensed the value of the
18,750 warrants that vested in the third quarter of $6,700.
9
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2001
8. STOCK OPTIONS AND WARRANTS (Cont'd)
At March 31, 2001 the Company had the following stock purchase warrants
outstanding each exercisable into one common share:
Number Exercise Price Expiration Date
------ -------------- ---------------
187,500 (1) $1.25 September 2002
20,000 (1) $1.25 December 2002
66,300 (2) $5.85 March 2003
64,713 (2) $5.85 April 2003
30,000 $5.85 April 2005
50,000 $10.00 April 2003
12,500 (3) $2.00 April 2003
50,000 $1.75 May 2003
350,000 (1) $1.00 December 2003
5,782,170 (4) $0.75 January 2004
152,728 (1) $1.375 March 2004
30,000 (1) $1.50 March 2004
75,000 $2.50 December 2004
33,163 (5) $4.22 April 2005
500,000 (6) $1.00 January 2006
150,000 (6) $1.00 February 2006
445,607 $0.75 March 2006
----------
7,999,681
(1) These warrants are callable at a stock price of $5.00 per share subject to
certain conditions.
(2) These warrants are callable at a stock price of $5.00 per share subject to
certain conditions.
(3) These warrants are callable at a stock price of $4.50 per share subject to
certain conditions.
(4) These warrants are callable at a stock price of $3.00 per share after two
years subject to certain conditions.
(5) These warrants have certain antidilution adjustments subject to certain
conditions.
(6) A portion of these warrants are subject to future vesting.
9. INCOME TAXES
At March 31, 2001 a valuation allowance has been provided to offset the net
deferred tax assets as management has determined that it is more likely than not
that the deferred tax asset will not be realized. The Company has for federal
income tax purposes net operating loss carryforwards of approximately $26.5
million, which expire through 2020, of which certain amounts are subject to
limitations under the Internal Revenue Code, as amended. The Company has for
state income tax purposes net operating loss carryforwards of approximately $13
million, which expire through 2005, of which certain amounts are subject to
limitations under the laws of California.
10
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 2001
10. LOSS PER COMMON SHARE
Loss per common share is computed using the weighted average number of common
shares outstanding. Since a loss from operations exists, a diluted earnings per
common share number is not presented because the inclusion of common stock
equivalents in the computation would be antidilutive. Common stock equivalents
associated with warrants, stock options and preferred stock, which are
exercisable into approximately 23.6 million shares of common stock at March 31,
2001 could potentially dilute earnings per share in future periods.
The provisions of the Series A and Series CC Stock provide for cumulative 8%
dividends and provide, upon conversion, a similar accretion whether or not such
dividends have been declared by the Board of Directors. These amounts increase
the net loss available to common stockholders. Net loss attributable to common
stockholders was also increased by imputed deemed dividends from a discount
provision included in the Series C and Series CC Stock, which provided for an
effective conversion price, after allocating a fair value of the proceeds to
detachable warrants, less than the market price on the date of issuance. The
imputed non-cash dividends are not a contractual obligation on the part of the
Company to pay such dividend. Net loss available to common stockholders is
computed as follows:
Three Months Ended Nine Months Ended
March 31, March 31,
2001 2000 2001 2000
---- ---- ---- ----
Net loss $(3,364,799) $(5,035,570) $(14,137,140) $(9,712,485)
Imputed deemed dividend on Series CC Stock based on
discount at issuance (3,648,500) (3,648,500)
Imputed deemed dividend on Series C Stock based on
discount at issuance (17,013) - (1,679,892) -
Imputed deemed dividend on Series B Stock based on
discount at issuance - (3,000,008) - (11,650,255)
Accrued dividends on Series A and Series CC Stock (99,059) (45,000) (253,709) (122,877)
---------- ----------- ------------ ------------
Net loss available to common stockholders before
cumulative effect of a change in accounting principles $(7,129,371) $(8,080,578) $(19,719,241) $(21,485,617)
Cumulative effect of a change in accounting
principles (note 3) - - (1,715,000) - .
-------------- --------------- --------------------------
Net loss available to common stockholders $(7,129,371) $(8,080,578) $(21,434,241) $(21,485,617)
============ ============ ============= =============
11. SUBSEQUENT EVENTS
Subsequent to March 31, 2001 the Company entered into bridge notes aggregating
$2,460,000, of which $1,180,000 had been advanced to the Company at March 31,
2001. The bridge notes bear interest at 12% per annum and are due on April 30,
2002. For each $1.00 of principal the Company has agreed to issue five shares of
common stock or an aggregate of 12,300,000 common shares. An aggregate of
$1,262,058 of the notes are to entities affiliated with directors of the
Company. The Company anticipates, but there can be no assurance, that the bridge
notes will convert into a future round of debt or equity financing. As a result
of these issuances, the Company does not have sufficient authorized common stock
to provide for the conversion of all options, warrants and preferred stock
outstanding. While the Company has obtained waivers from its obligation to
reserve unissued shares for preferred stock holders, the Company is required to
take steps to increase the number of authorized shares of common stock.
Subsequent to March 31, 2001 the Company received notice that it was in default
on payments on approximately $1.7 million of equipment debt. The Company has
subsequently negotiated deferred payment terms on this debt and removed the
default. The Company also is working to negotiate revised payment terms on a
software lease agreement with an estimated net liability of $64,000 after
application of a restricted cash balance of $296,000. The Company has further
received notice that it is in default on occupancy payments to its landlord. The
Company has reduced the space it is occupying and is attempting to negotiate
modifications to rental payments and obligations to its landlord. Failure to
successfully resolve these obligations and commitments could have an adverse
impact on operations. Failure to successfully arrange additional financing is
likely to result in an inability to fund our operations in the long term, as
cash resources will be used to satisfy our existing liabilities.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE
COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW AND IN THE COMPANY'S ANNUAL
REPORT ON FORM 10-KSB FOR THE YEAR ENDED JUNE 30, 2000.
Overview
We are a provider of branded rating content on local service businesses. As an
infomediary we enhance online and offline commerce between buyers and sellers of
services by offering ratings enabling buyers to quickly determine the best local
service providers. Our ValueStar ratings are provided on the Internet at , on
other partner Internet sites, in our ValueStar Report and through promotions by
rated businesses. Our goal is to position ValueStar as the dominant rating
system for local service providers and operate a commission based system to
match buyers and sellers of local services. Our services are free to consumers.
Starting in December 1999 we began a transition from fixed rating and
certification fees to percentage commission fees based on the value of
transactions between member service companies and member buyers. Since December
1999 we invested over $11 million in development costs creating and testing the
systems to match and collect transaction commissions and ratings for offline
transactions. Our new systems create continuously updated customer satisfaction
ratings collected from the actual purchasers of local services. We also provide
benefits to buyers purchasing from member businesses.
In addition to creating proprietary rating content on America's service
companies, we are also developing strategic relationships to provide data,
process transactions and increase the distribution of ValueStar's branded
ratings. Important relationships and developments include:
o In January 2000 we entered into a strategic data agreement with
Experian, a provider of global information solutions. This alliance
provides financial and legal status on local service businesses as a
part of our content development. We provide Experian with the results
of our branded proprietary research on local service businesses for
distribution to their clients.
o In April 2000 we entered into an alliance with Netcentives to manage
our ValueStar Rating Points award program. As a part of this
relationship, we expect the four million consumer members of
Netcentives shopping network, ClickRewards(TM), will become trial
ValueStar members for opt-in activation.
o Commencing in May 2000 we began to form distribution partnerships with
Internet portals and service referral companies to broadly distribute
our ratings. Our roster of distribution partners includes home service
portal Ourhouse.com and other vertical portals such as eAttorney.com
and rentals.com.
o In June 2000 we entered into a database agreement with InfoUSA, Inc.
to receive certain raw database information.
o In September 2000 we announced a pilot program for the San Francisco
Bay area credit card holders of First National Bank of Omaha. This
program is expected to be launched in the fourth fiscal quarter ended
June 30, 2001.
o In November 2000 we announced two strategic and marketing alliance
agreements with global electronic commerce and payments leader First
Data Corp. First Data is marketing the ValueStar Customer-Rated
program to merchants through participating merchant acquiring clients,
while helping ValueStar market cardholder benefits to issuer clients.
First Data has also developed and has agreed to operate systems to
match transactions between registered buyers and licensed ValueStar
rated service businesses.
o In January 2001 we entered into a ratings distribution agreement with
BellSouth RealPages.com. ValueStar expects to be a primary third-party
content partner for RealPages.com to supplement service business
listings.
o In April and May 2001, through the assistance of First Data Resources,
we signed four letters of intent with credit card issuing banks
representing an estimated 49 million active cardholders. Our plan is
to enter into definitive contracts with these issuers and commence
providing ValueStar ratings and benefits to cardholder members while
collecting transaction commissions between these cardholders and
ValueStar member service businesses.
o Through early May 2001 we have signed marketing and or data sharing
agreements with five major acquiring merchant banks representing an
estimated 110,000 service merchants across the U.S. that are eligible
to participate in the ValueStar program. Our strategy is to market our
program to these service merchants and expand our penetration of
service businesses in selected market regions.
12
At April 30, 2001 we had approximately 730,000 service businesses rated as
either ValueStar Verified or ValueStar Customer-Rated. While this credential
information is important to consumers our strategy is to license our ValueStar
Customer-Rated program to these businesses. While we used to operate fixed fee
licensing in eight market regions, we are currently targeting licensing efforts
in the Northern California region for activation of our commission program. We
had approximately 7,500 licensed service businesses at March 31, 2001 compared
to approximately 2,000 at March 31, 2000. We expect these businesses and new
businesses being enrolled to produce limited commission revenue starting in the
fourth quarter of the current fiscal year. We also expect to license businesses
in other regions in the future. Our future business will be predicated on
creating and maintaining a growing number of member buyers and sellers
transacting commerce in local services. We expect a majority of our future
revenues to be derived from commissions from transactions between member buyers
and sellers of local services. Renewals of businesses from year to year will
impact future operations as we expend funds enrolling new businesses in our
member program.
In order to more efficiently collect commissions our strategy is to capture
automated credit card transactions through the use of third party matching
partners. We currently contract with two partners who have access to an
estimated 65% of all credit card transactions in the United States. These
matching partners can provide data on transactions which occur between member
businesses and member buyers, as permitted. We also enter into agreements with
individual banks or processors to authorize access to transaction data. Upon
receipt and matching of transaction data, we are able to calculate commission
fees and invoice or debit member businesses.
Our staffing has varied significantly in the current year as we have developed
new business credential content and systems. We have in the past and expect to
continue to use outside contractors for certain services. We reduced our
staffing from 140 in December 2000 to approximately 67 at the date of this
report in connection with the completion of rating content on the 730,000
businesses and development of our computer systems. Our future activities will
include maintenance and expansion of rating content on businesses and
maintenance and enhancement of our software and systems. The reduction in
personnel and development costs has reduced monthly operating costs by over 40%
as we streamline operations to focus our resources on our First Data strategic
relationship and the major credit card issuing banks that have expressed their
intent to incorporate our program as a benefit to their cardholders.
Future operations will be impacted by changes in cost structure and elections
regarding new product development, advertising, promotions and growth rates.
Rapid growth, due to the nature of our operations, is expected to contribute to
continued operating losses in the foreseeable future.
Revenue and Cost Recognition
During fiscal 2000 a majority of our revenues were from fixed certification fees
ranging from $995 to approximately $2,000 depending on business size. In fiscal
2000 these fees were recognized as revenue when material services or conditions
relating to the certification had been performed. Due to the change in our
product offering and the benefits to be supplied to buyers, we changed the
method of recording fixed fee revenue effective July 1, 2000. We recognize fixed
fees on a straight-line basis over the term of a participating business license,
generally one year. We will recognize commission revenues as reported and
earned. Costs of benefits provided to buyers are recognized as provided, with
accruals for any future benefit obligations.
We expect to commence collecting commission revenues, on a limited basis, in the
fourth fiscal quarter ending June 30, 2001. Due to the change in our program and
the change in recognizing fixed certification fees and until we can recognize
sufficient commission revenues, we expect comparative revenues in current
periods to be less than prior periods.
The Securities and Exchange Commission's staff (the "Staff") issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"), in December 1999, which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements of all public
companies. The provisions of SAB 101 are effective for transactions beginning in
our current fiscal year. We believe we are recognizing revenues within the
guidance provided by SAB 101.
Results of Operations
Revenues. Revenues consist of rating and certification fees from new and renewal
business applicants, sale proceeds from information materials and premium
listings in our ValueStar Report and on our Web site, and other ancillary
revenues. We
13
reported total revenues of $765,436 for the nine months ended March 31, 2001
compared to $1,670,878 for the first nine months of the prior fiscal year. The
decrease in revenues is due to the commencement in July 2000 of recognizing
fixed fee revenues on a straight-line basis over the term of the annual license
corresponding to the term we expect to provide benefits to buyers transacting
with a business. This change is due to the change in our product offering and
the change in benefits to be supplied to consumers. If the Company had
recognized revenues in the prior year's first nine months using the current
fiscal year method, we would have reported total revenues of approximately
$940,000, with the decrease due to renewing a portion of our existing service
provider base into the commission program for the Northern California market
instead of the fixed certification fee program. During the first nine months of
the current fiscal year, certification fees accounted for 53% of revenue,
compared to 75% for the prior year period. Revenues for the three months ended
March 31, 2001 were $257,198 compared to the $478,750 reported in the comparable
prior period.
We reported approximately $124,000 of revenue from premium listings in our
ValueStar Report and on our Web site, a decrease of $66,000 from the $190,000
reported in the first six months of the prior year. The decrease results from a
shift in focus from licensing merchants on a fixed fee basis to licensing
merchants into our commission based systems. We expect ValueStar Report revenues
and Web site revenues may increase in future periods when we have an active
commission-based relationship with sellers.
Our revenues can vary from quarter to quarter due to (a) management's decision
on the mix of sales effort between enrolling local service providers into
commission based vs. fixed fee programs, (b) the impact of distributing the
semi-annual ValueStar Report to buyers, (c) seasonality, (d) effectiveness of
sales methods and promotions, (e) levels of expenditures targeted at prospective
businesses, (f) the numbers of licensees up for renewal, (g) renewal rates, (h)
pricing policies, (i) timing of completion of ratings, and (j) other factors,
many of which are beyond our control. The timing of implementation of our
commission based processing will materially impact future revenues. There can be
no assurance we can successfully implement this program as scheduled in the last
fiscal quarter of 2001. Unknown technical or business issues and barriers could
arise that could delay implementation or preclude us from executing our
commission program. In such an event we may be required to revert to a fixed fee
basis.
Buyer Benefits. Buyer benefits consist of direct product costs for materials
provided to buyers through the use of marketing and sales aids purchased by
service providers, customer service costs for buyers, and, in future periods,
the costs of loyalty points and customer satisfaction guarantees. These costs of
$144,589 represented 19% of sales during the nine months ended March 31, 2001.
This is an increase from $126,128 or 8% of revenues for the prior year
comparable period, although the percentage is not directly comparable due to the
change in revenue reporting outlined above. Buyer customer service costs were
$107,000 compared to $55,840 in the prior comparable period, although in the
prior period, the buyer customer service team had only been in existence for
three months as opposed to nine months in the current period.
Ratings and Content. Ratings and content costs consist primarily of the costs of
rating service businesses in the fixed fee certification program, ongoing
content and technology costs associated with maintaining our databases and
supporting our operations. In future quarters we expect to incur certain
transaction and matching fees with third parties. Rating and content costs were
$388,418, or 51% of revenues, for the nine month period ended March 31, 2001,
compared to $952,423 and 57% of revenues for the prior comparable period. The
decrease is due primarily to a reduction in fixed fee ratings and conversion to
the new program. Ratings costs totaled $64,600 for the three months ended March
31, 2001 or 25% of revenues compared to $170,000 and 36% of revenues for the
third quarter of the prior fiscal year.
Selling and Marketing Costs. Selling and marketing costs consist primarily of
personnel costs for outside sales consultants interacting with licensed sellers,
an inside customer service team for licensed sellers, direct marketing costs
including lead generation, telemarketing costs, costs associated with our
ValueStar Report, costs associated with marketing and business development
personnel and marketing, advertising and promotion expense. Sales and marketing
costs for the nine months ended March 31, 2001, were $5,205,758, compared to
$4,114,006 for the first nine months of the prior year. Sales and marketing
costs totaled $1,118,136 for the third fiscal quarter of the current year, a
decrease from the $2,065,893 reported for the prior year's third quarter.
Sales related expenses totaled $2,025,253 compared to $2,376,669 for the prior
year's comparable nine-month period. The decrease is due to corporate focus from
December 2000 onward in only Northern California as opposed to soliciting
broader new sales. This has allowed us to reduce our selling expenses in the
current year and especially in the last quarter. Selling costs totaled $395,665
for the three months ended March 31, 2001, compared to $1,107,976 for the third
quarter of the prior year. We expect selling costs will vary in future periods,
resulting from levels of future revenues, variances in renewal rates,
14
the effect of new sales promotions and costs thereof, timing of research and
rating completions, levels of fixed selling costs, the number of new market
regions opened, the mix of sales between fixed fee certifications and commission
based certifications and other factors, some beyond our control.
Marketing and promotion related expenses aggregated $3,180,505 during the first
nine months of fiscal 2001, compared to $1,737,337 for the prior period. During
the period, we expended $287,000 on paid advertising targeted at expanding
consumer awareness of ValueStar Certified. Paid advertising of $606,000 was
employed in the prior year's comparable period. Printing and distribution costs
for the ValueStar Report increased by $23,000 as we printed and distributed more
copies with additional pages. During the nine-month period, we expended $572,000
on promotions compared to $161,000 for the prior year's comparable period with
the increase due to a significant increase in the number of promotions in the
period and in the amount of promotional material provided to service providers
upon their enrollment in our program. We spent approximately $370,000 on agency
fees and market research in the current nine-month period compared to $63,000 in
the prior comparable period. Expenses related to wages and consultants in
marketing were $1,592,000 in the current nine months compared to $511,000 in the
prior year's nine month period with the large increase due to the hiring of
executives and increased staff in the marketing and business development
departments. Marketing costs totaled $722,471 for the three months ended March
31, 2001 compared to $957,917 for the third quarter of the prior year, with the
decrease due to the reduction in force occurring at the end of December 2000
with the substantial completion of the majority of our product and content
development efforts.
Marketing and promotion expenses are subject to significant variability based on
decisions regarding paid advertising, public relations and market and brand
awareness efforts. We anticipate continuing to make significant expenditures on
marketing and promotion efforts to support a growing business base but
anticipate these costs will decrease as an annual percentage of revenues as
revenues grow. However, amounts and percentages on a quarterly basis may vary
significantly.
Product and Content Development Costs. Product and content development costs
consist primarily of expenses associated with the design, development and
testing of our commission program. These costs include development of our
website and the associated back office systems, developing our new proprietary
ratings content for our website and wages in our technology department
associated with new product and content development. During the nine months
ended March 31, 2001 we expended $5,219,924 on new program development. This
compares to $2,845,531 during the same period last year. The major component of
product development costs were compensation and related costs of $3,145,000,
partner and alliance implementation costs of $474,000 and expenses related to
the gathering of new content of $173,000. During the first nine months of fiscal
2001 we allocated $1,267,000 of general and administrative costs to product and
content development to reflect the percentage of product and content development
expenses relative to overall administrative costs. This compares to $614,000
allocated in the prior fiscal year's nine-month period.
We have capitalized an additional $871,000 of product and content development
costs as website development and software that are specifically related to
internal software development. The Company capitalized $1,001,000 in the prior
fiscal year. The Company will begin depreciation of this asset upon commencement
of tracking transactions between rating partners and local service providers
over a period not to exceed three years.
General and Administrative Expenses. General and administrative expenses consist
primarily of expenses for finance, office operations, administration and general
and executive management activities, including legal, accounting and other
professional fees. General and administrative expenses were $1,873,939 for the
nine months ended March 31, 2001, compared to $1,212,634 for the prior year
comparable period, an increase of $661,305. The major increases include a
$661,000 increase in compensation and benefits due primarily to the increased
number of executive, administrative and finance personnel added in connection
with an expansion of the employee base; a $78,000 increase in travel and
entertainment costs, a $526,000 increase in occupancy and telephone costs due to
additional personnel and expanded office facilities, a $94,000 increase in legal
and accounting expense due to expanded operations, a $30,000 increase in reserve
for doubtful accounts due to conversion of markets outside of San Francisco to
our commission based program and a $76,000 decrease in non-cash other expense in
associated with issuing warrants for services to unaffiliated entities. General
and administrative costs in the third fiscal quarter were $512,187, an increase
from $448,927 for the third quarter of the prior year. Management anticipates
that general and administrative costs will continue to exceed prior period
levels due to increased personnel added to support growth and increased general
computer, operating, occupancy and corporate costs.
Depreciation and Amortization. Depreciation and amortization expenses were
$1,862,660 for the nine months ended March 31, 2001, compared to $481,874 for
the prior year period. The large increase is due to the acquisition of
technology
15
equipment and software infrastructure to support an expanded employee base and
our new program, our web site and various internal databases.
Interest and Other Expenses. We incurred interest expense for the nine months
ended March 31, 2001 of $283,919 that included $29,489 of non-cash amortization
of bond discount. Interest for the prior comparable period was $1,790,623, of
which $1,504,160 was non-cash interest expense and amortization of bond
discount. The decrease is due to conversion of senior and subordinated debt into
equity in the prior fiscal year. The Company generated interest income of
$76,254 in the first nine months of fiscal 2001 compared to $144,234 in the
comparable prior period with the decrease due to lower average cash balances
during the current fiscal year.
Net Loss. We had a net loss of $14,137,140 for the nine months ended March 31,
2001, compared to a loss of $9,712,485 for the nine months ended March 31, 2000.
Our increased loss is attributable to (a) increased marketing costs incurred
related to increased promotions and increases in the number of marketing and
business development personnel, (b) product and content development costs
associated with developing our commission based program, (c) increased general
and administrative costs associated with additional management and support for
expanded operations and (d) increased depreciation and amortization costs
associated with a significant increase in property, equipment and software. We
anticipate we will continue to experience operating losses until we achieve a
combination of a fully functional commission program and a critical mass of
buying and selling members. Future quarterly results will be greatly impacted by
future decisions regarding new markets, advertising and promotion expenditures
and growth rates. Achievement of positive operating results will require that we
build a working commission program and that we obtain a sufficient base of
buying and selling members to support our operating and corporate costs. There
can be no assurance we can successfully build a transaction program, sustain
sufficient buyer and seller member rates or achieve a profitable base of
operations.
The net loss available to common stockholders includes an increase in the net
loss for the nine months ended March 31, 2001 due to the beneficial conversion
feature of the Series C and Series CC preferred stock issued during the period.
Net loss was increased by $5,328,392 for this one-time non-cash imputed charge
and increased by $253,709 for non-cash accrued dividends on Series A and Series
CC preferred stock. In addition, in the second quarter the Company recognized an
additional $1,715,000 in imputed deemed dividends based on a discount at
issuance of previously issued Series C preferred stock due to a change in
accounting principle related to the fair value of warrants as more fully
described in Note 3 to the interim statements above. These non-cash imputed
amounts had no effect on our financial position.
Liquidity and Capital Resources
Since we commenced operations, we have had significant negative cash flow from
operating activities. Our negative cash flow from operating activities was
$10,637,255 for the nine months ending March 31, 2001. At March 31, 2001, we had
a working capital deficit of $3,899,296 including $590,313 representing the
current portion of long-term debt and $305,268 representing the current portion
of capitalized leases. For the nine months ended March 31, 2001, our negative
cash flow from operating activities was due primarily to our continued operating
losses, selling costs associated with enrolling local service companies into our
commission based program with no immediate revenue, product and content
development costs and addition of new executive management. During this period
we also expended $2,586,669 on net property and equipment purchases.
At March 31, 2001, our net accounts receivables were $149,107, representing
approximately 53 days of revenues and an annualized turnover ratio of
approximately 6.8 times. This compares to approximately 64 days of revenues and
turnover of approximately 5.7 times at March 31, 2001. The change is due to the
change in the way we recognize revenues. We bill fixed fees in full at the time
the contract starts and extend terms throughout the contract period. Please see
our discussion of the change in revenue recognition practices under the section
Revenue and Cost Recognition above for further information. We believe that 60
to 90 days revenues in receivables is reasonable based on the nature of our
business and the terms we provide licensees. At March 31, 2001, we have not
experienced any significant accounts receivable recoverability problems.
We have financed our operations primarily through the sale of equity and debt
financing. In August 2000 we drew down the balance of $732,796 from a commitment
for $2,000,000 in equipment financing obtained in the prior fiscal year. Also
during the nine months ended March 31, 2001, we obtained $8,648,256 from the
sale of common and preferred stock, of which $1,500,000 was contributed
services. We have no commitments for future investments and there can be no
assurance that we can continue to finance our operations through these or other
sources. In the past, shareholders, including from time to time directors, have
advanced funds and at times cancelled debt for equity on terms of new forms of
financing. There can be no assurance that shareholders or directors or others
will provide us with any future financing.
16
Other than cash on hand of $11,566 at March 31, 2001, net accounts receivable of
$149,107 and subsequent bridge financing of $2,460,000, we have no material
unused sources of liquidity at this time. We are committed on lease, equipment
note and facility rental payments aggregating approximately $148,000 per month.
We are in arrears on certain of these commitments and the failure to make timely
payments or to work out revised payment arrangements could have a material
adverse impact on our operations.
We expect to incur additional operating losses in future fiscal quarters as a
result of continued operations, product development expenditures and investments
in growth. The timing and amounts of these expenditures and the extent of
operating losses will depend on many factors, some of which are beyond our
control.
We expect that we will require a minimum of $8 million of additional capital to
finance operations during the next twelve months. This estimate is based on the
third fiscal quarter level of operations, anticipated revenues and budgeted
product development and operating costs. The launch of our new commission
program may provide some of these revenues but there can be no assurance
thereof. To expand the enrollment of new member buyers and sellers or to launch
new products or services, we may require additional financing. Our actual
results could differ significantly from plan and, therefore, we may require
substantially greater operating funds.
The capital markets have been unpredictable in the past, especially for early
stage companies such as ValueStar. The ability and amount of capital that can be
raised, if any, depends on many factors beyond our control. As a result there
can be no guarantee that our efforts to secure additional financing will be
successful or that the amounts raised will be sufficient for our future needs.
If we raise additional funds through the issuance of equity or convertible debt
securities, the percentage ownership of our stockholders will be reduced.
Stockholders may experience extreme dilution due to our current stock price and
the significant amount of financing we need to raise. New securities may have
rights senior to those of holders of our preferred or common stock. Any form of
debt financing could contain covenants restricting our operations and/or
detrimental to equity holders.
Should required and/or additional funds not be available or planned operations
not meet our expectations, we may be required to significantly curtail or scale
back staffing, advertising, marketing expenditures, product and content
development and general operations. We may also have to curtail the area in
which we operate or revert to some form of fixed fee program. If adequate funds
are not available or are not available on acceptable terms, our business,
results of operations, financial condition and continued viability will be
materially adversely affected.
Tax Loss Carryforwards
As of June 30, 2000, we had approximately $26.5 million of federal tax loss
carryforwards and $13 million in California tax loss carryforwards. These losses
create a deferred tax asset. We have recorded a valuation allowance to reduce
the net deferred tax asset to zero because, in our assessment, it is more likely
than not that the deferred tax asset will not be realized. There may also be
limitations on the utilization of tax loss carryforwards to offset any future
taxes.
Forward-Looking Statements and Business Risks
This Form 10-QSB includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. The words "anticipate," "believe,"
"expect," "plan," "intend," "project," "forecasts," "could" and similar
expressions are intended to identify forward-looking statements. All statements
other than statements of historical facts included in this Form 10-QSB regarding
our financial position, business strategy, budgets and plans and objectives of
management for future operations are forward-looking statements. Although we
believe that the expectations reflected in such forward-looking statements are
reasonable, no assurance can be given that actual results may not differ
materially from those in the forward-looking statements herein for reasons
including the effect of competition, the level of sales and renewal
certifications, marketing, product development and other expenditures, economic
conditions, the legislative and regulatory environment and the condition of the
capital and equity markets.
Readers are cautioned to consider the specific business risk factors described
in our annual report on Form 10-KSB for the fiscal year ended June 30, 2000 and
not to place undue reliance on the forward-looking statements contained herein,
which speak only as of the date hereof. We undertake no obligation to publicly
revise forward-looking statements to reflect events or circumstances that may
arise after the date hereof.
17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
(a) See description of Series CC preferred stock in (c) below.
(b) See description of Series CC preferred stock in (c) below.
(c) The following is a description of equity securities sold by the
Company during the third fiscal quarter ended March 31, 2001 that
were not registered under the Securities Act:
During the third fiscal quarter, we issued an aggregate of
192,739 shares of Series CC Convertible Preferred Stock, par
value $0.00025 ("Series C Stock"), at $45.00 per preferred
share (each share of which is initially convertible into sixty
shares of common stock). This sale was made in a private
offering. A total of 500,000 shares of preferred stock have
been authorized and designated by the Company as Series CC
Stock.
In connection with the sale in the second quarter, the Company
issued to the purchasers warrants exercisable at $0.75 per
share into an aggregate of 5,782,170 shares of common stock
("CC-Warrants"). These CC-Warrants expire on January 5, 2004
and are callable by the Company after two years if the stock
price exceeds $3.00 per share, subject to certain additional
conditions.
The purchasers of Series CC Stock and CC-Warrants included all
the holders of Series C Stock and C-Warrants who exchanged
their securities for 119,230 shares of Series CC Stock and
3,576,900 CC-Warrants. At March 31, 2001 there were no shares
of Series C Stock outstanding. The balance of 73,509 shares of
Series CC Stock was sold for $45.00 per share for cash of
$1,807,905 and an agreement First Data Merchant Services
Corporation (FDMS), a subsidiary of First Data Corporation
("FDC"), to perform $1,500,000 of services.
The Series CC Stock has a cumulative dividend of 8% per annum
payable when and if declared by the Board of Directors or upon
liquidation or conversion.
The dollar amount of the Series CC Stock is convertible at the
option of the holder into shares of common stock at an initial
conversion price, negotiated with outside unaffiliated
investors, of $0.75 per share and are automatically converted
on the occurrence of certain events.
The Series CC Stock has a liquidation preference pari passu
with the Series B Stock, after payment of the preferential
amount for the Series A Stock, of $45.00 per share of Series
CC Stock plus an additional amount accruing at the rate of 8%
per annum.
The Series CC Stock has antidilution rights for certain
issuances below the conversion price. The Series CC Stock has
voting rights equal to the number of shares of common stock on
an as-converted basis. In addition, as long as there are at
least 100,000 shares of Series CC Stock issued and
outstanding, the holders are entitled, voting as a separate
class, to elect one member of the Company's board of
directors.
In connection with the sale of Series CC Stock, the Company
entered into a Registration Rights Agreement with the Series
CC Stock investors. This agreement, as amended, provides that
by June 30, 2001 the Company will use its best efforts to
prepare and file a registration statement on Form S-3
(provided that at such time the Company is eligible to use S-3
and, if not, use its best efforts to prepare and file a
registration statement on Form S-3 at such later date as the
Company is so eligible).
While the securities were sold by the Company without an
underwriter or cash commission, the Company issued to a
financial advisor, affiliated with a director, warrants to
purchase 445,607 shares of common
18
stock at an exercise price of $0.75 per share with a five-year
term in connection with the sale of the Series CC Stock.
All of these securities were offered and sold without
registration under the Securities Act of 1933, as amended (the
"Act"), in reliance upon the exemption provided by Section
4(2) thereunder and/or Regulation D, Rule 506 and appropriate
legends were placed on the Series C Stock and Warrants and
will be placed on the shares of common stock issuable upon
conversion unless registered under the Act prior to issuance.
The descriptions of these transactions are qualified in their
entirety by the full text of the agreements attached as
exhibits to the Company's Form 8-K dated February 5, 2001.
(d) None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
4.39 Form of Stock Purchase Warrant dated January 23, 2001
issued to Hull Capital Corp. and J. Mitchell Hull for
an aggregate of 500,000 shares of common stock at an
exercise price of $1.00 per share (individual
warrants differ as to holder and number)
4.40 Form of Stock Purchase Warrant dated March 5, 2001
issued to three individual assignees of Hull Capital
Corp for an aggregate of 445,607 shares of common
stock at an exercise price of $0.75 per share
(individual warrants differ as to holder and number)
4.41 Letter Agreement dated February 20, 2001 between the
Company and The Investor Relations Group, Inc.
providing for warrants on 150,000 shares of common
stock at an exercise price of $1.00 per share
(b) Reports on Form 8-K:
On February 5, 2001 the Company filed a Form 8-K reporting on
the Series CC Stock financing.
19
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
VALUESTAR CORPORATION
Date: May 15, 2001 By: /s/ JAMES A. BARNES
--------------------
James A. Barnes
Secretary and Treasurer
(Principal Financial Officer and duly
authorized to sign on behalf of the
Registrant)