U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 31, 2000
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 NO.: 000-30326
VSOURCE, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 77-0557617
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
5740 RALSTON STREET, SUITE 110
VENTURA, CALIFORNIA 93003
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (805) 677-6720
Indicate by check mark whether the registrant (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
--- ---
Number of shares of Common Stock, par value $.01, outstanding as of December 4,
2000 16,237,964
Number of shares of Series 1-A Convertible Preferred Stock, par value $.01
outstanding as of December 4, 2000 2,686,848
Number of shares of Series 2-A Convertible Preferred Stock, par value $.01
outstanding as of December 4, 2000 1,672,328
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
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TABLE OF CONTENTS
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Page
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PART I - FINANCIAL INFORMATION
<S> <C> <C>
Item 1. FINANCIAL STATEMENTS 1
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 24
Item 2. CHANGES IN SECURITIES 24
Item 3. DEFAULTS UPON SENIOR SECURITIES 25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 25
Item 5. OTHER INFORMATION 25
Item 6. EXHIBITS, REPORTS ON FORM 8-K 25
SIGNATURES 27
EXHIBIT INDEX 28
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<TABLE>
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PART I - FINANCIAL INFORMATION
VSOURCE, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
October 31, 2000 January 31, 2000
(unaudited)
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<S> <C> <C>
Current assets:
Cash in bank $ 8,154,474 $ 5,124,399
Restricted cash 108,694 82,768
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Total cash 8,263,168 5,207,167
Accounts receivable 191,500 --
Notes receivable - officers and other 183,367 --
Prepaid expenses 148,383 --
------------------ ------------------
Total current assets 8,786,418 5,207,167
Property and equipment
Fixed assets 819,017 240,208
Less: accumulated depreciation (121,564) (17,708)
------------------ ------------------
Property and equipment, net 697,453 222,500
Notes receivable - officers and other, non-current 50,755 110,728
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$ 9,534,626 $ 5,540,395
================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT)
Current liabilities:
Accounts payable $ 366,818 $ 247,472
Accrued liabilities 79,087 100,937
Convertible notes payable 150,000 150,000
Liabilities related to private placement of preferred stock -- 6,002,500
------------------ ------------------
Total current liabilities 595,905 6,500,909
Shareholders' equity (deficit)
Preferred stock Series 1-A ($0.01 par value, 2,900,000 shares
authorized: 2,725,232 issued and outstanding;
aggregate liquidation value is $6,813,080) 27,252 --
Preferred stock Series 2-A ($0.01 par value, 2,100,000 shares
authorized: 1,672,328 issued and outstanding;
aggregate liquidation value is $10,719,622) 16,723 --
Common stock ($0.01 par value, 50,000,000 shares
authorized: 16,101,523 issued and outstanding) 161,015 158,071
Additional paid-in capital 63,955,951 10,645,934
Deferred compensation (12,953,649) (1,780,817)
Accumulated equity (deficit) (41,841,773) (9,804,904)
Less: Notes receivable from the sale of stock (426,798) (178,798)
------------------ ------------------
Total shareholders' equity (deficit) 8,938,721 (960,514)
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$ 9,534,626 $ 5,540,395
================== ==================
The accompanying notes are an integral part of these statements.
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VSOURCE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the three months ended
October 31, 2000 October 31, 1999
------------------ ------------------
Revenue $ 151,500 $ 2,230
Expenses
General and administrative (including
1,168,952 of stock based compensation for
the three month period ended October 31, 2000) 2,017,562 226,745
Research and development (including
1,210,201 of stock based compensation for
the three month period ended October 31, 2000) 4,004,459 1,034,021
------------------ ------------------
6,022,021 1,260,766
------------------ ------------------
Loss from operations (5,870,521) (1,258,536)
Other income/(expense)
Interest income 36,023 --
Other income -- --
Interest expense (3,698) --
------------------ ------------------
Loss before income taxes (5,838,196) (1,258,536)
Provision for income taxes -- --
------------------ ------------------
Net loss $ (5,838,196) $ (1,258,536)
================== ==================
Basic loss available to
common stockholders $ (12,468,976) $ (1,258,536)
================== ==================
Basic weighted average number of
common shares outstanding: 15,969,038 14,339,164
================== ==================
Net loss per share available to common stockholders
Basic $ (0.78) $ (0.09)
================== ==================
Diluted $ (0.78) $ (0.09)
================== ==================
The accompanying notes are an integral part of these statements.
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VSOURCE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the nine months ended
October 31, 2000 October 31, 1999
------------------ ------------------
Revenue $ 214,000 $ 10,215
Expenses
General and administrative (including
6,617,357 of stock based compensation for
the nine month period ended October 31, 2000) 9,746,801 803,742
Research and development (including
3,031,209 of stock based compensation for
the nine month period ended October 31, 2000) 9,087,797 2,154,073
------------------ ------------------
18,834,598 2,957,815
------------------ ------------------
Loss from operations (18,620,598) (2,947,600)
Other income/(expense)
Interest income 91,584 --
Other income 4,019 --
Interest expense (11,096) --
------------------ ------------------
Loss before income taxes (18,536,091) (2,947,600)
Provision for income taxes 1,600 --
------------------ ------------------
Net loss $ (18,537,691) $ (2,947,600)
================== ==================
Basic loss available to
common stockholders $ (32,036,868) $ (2,947,600)
================== ==================
Basic weighted average number of
common shares outstanding: 15,869,895 13,296,009
================== ==================
Net loss per share available to common stockholders
Basic $ (2.02) $ (0.22)
================== ==================
Diluted $ (2.02) $ (0.22)
================== ==================
The accompanying notes are an integral part of these statements.
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VSOURCE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the nine months ended
October 31, 2000 October 31, 1999
------------------ ------------------
Cash flows from operating activities:
Net loss $ (18,537,691) $ (2,947,600)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 104,517 322,090
Compensation expense for stock option grants 3,775,099 --
Compensation expense for warrant grants 5,708,810 --
Compensation expense for stock issued 164,656 --
Beneficial conversion feature -- 241,753
Issuance of stock and debt for services, expense
reimbursements and accrued interest -- 647,839
Changes in assets and liabilities:
(Increase)/decrease in accounts receivable (191,500) 3,590
(Increase)/decrease in note receivables-officer and other (183,367) --
(Increase)/decrease in prepaid expenses (148,383) 33,750
(Increase)/decrease in note receivable
-officers and other, non-current 59,312 281
Increase/(decrease) in accounts payable 119,345 250,953
Increase/(decrease) in deferred revenue -- (3,250)
Increase/(decrease) in accrued expenses (21,850) (27,034)
------------------ ------------------
Net cash used in operating activities (9,151,052) (1,477,628)
Cash flows from investing activities:
Purchase of property and equipment (463,269) (151,088)
Purchase of capitalized software (115,540) --
Advances to related parties (248,000) (52,833)
------------------ ------------------
Net cash used in investing activities (826,809) (203,921)
Cash flows from financing activities:
Proceeds from issuance of common stock 2,144,034 1,749,942
Proceeds from issuance of preferred stock 10,889,828 --
Proceeds from borrowings -- 29,700
------------------ ------------------
Net cash provided by financing activities 13,033,862 1,779,642
------------------ ------------------
Net increase in cash 3,056,001 98,093
------------------ ------------------
Cash at beginning of period 5,207,167 59,937
------------------ ------------------
Cash at end of period $ 8,263,168 $ 158,030
================== ==================
Supplemental disclosure:
Reclassification of liability to equity $ 6,002,500 $ --
Interest Paid $ -- $ --
Income Taxes $ 1,600 $ 1,600
The accompanying notes are an integral part of these statements.
</TABLE>
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VSOURCE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31,2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES
The interim consolidated financial statements as of October 31, 2000 have
been prepared by Vsource, Inc. (the "Company") pursuant to the rules and
regulations of the Securities and Exchange Commission (the "SEC") for interim
financial reporting. These consolidated statements are unaudited and, in the
opinion of management, include all adjustments (consisting of normal recurring
adjustments and accruals) necessary to present fairly the consolidated balance
sheets, consolidated operating results, and consolidated cash flows for the
period presented in accordance with accounting principles generally accepted in
the United States of America ("US GAAP"). The consolidated balance sheet at
January 31, 2000 has been derived from the audited consolidated financial
statements at that date. Operating results for the interim periods presented are
not necessarily indicative of the results that may be expected for the year
ending January 31, 2001. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with US GAAP have been
omitted in accordance with the rules and regulations of the SEC. These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements, and accompanying notes, included in the
Company's Registration Statement on Form 10-SB (formerly Interactive Buyers
Network International, Ltd.) and Annual Report on Form 10-KSB for the fiscal
year ended January 31, 2000 (File No. 000-030326).
USE OF ESTIMATES IN PREPARATION OF CONSOLIDATED FINANCIAL STATEMENTS
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets, liabilities, revenue, expenses and
disclosure of contingent assets and liabilities to prepare these financial
statements in accordance with US GAAP. Accordingly, actual results may differ
from those estimates.
LOSS PER SHARE
Basic and diluted loss per share of common stock is computed by dividing
the loss available to common shareholders by the weighted average number of
common shares outstanding during the period shown. Common stock equivalents are
not included in the determination of diluted loss per share, as their inclusion
would be antidilutive. See notes to consolidated financial statements as of
January 31, 2000 and Notes 5 and 6.
REVENUE RECOGNITION
Revenue is recognized for time and materials-based arrangements as services
are performed and fixed fee arrangements on the percentage-of-completion method.
Under this approach, revenues and gross profit are recognized as the work is
performed, based on the ratio of costs incurred to total estimated costs,
commencing when progress reaches a point where experience is sufficient to
estimate final results with reasonable accuracy. Provisions for estimated
losses on uncompleted contracts are made in the period in which such losses are
determined. Customer deposits represent the amount of customer payments
received in advance Of services being performed. Transaction revenue, which the
company has not yet begun to receive, will be accounted for in the period
earned.
STOCK BASED COMPENSATION
The Company accounts for stock based compensation using the intrinsic value
based method in accordance with Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation," ("SFAS 123"), which allows
companies to continue to recognize compensation expense pursuant to Accounting
Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to
Employees" but requires companies to disclose the effect on earnings of
compensation expense for stock options based on the fair value of the options at
the grant date. Accordingly, employee compensation cost for stock options is
measured as the excess of the fair market value over the exercise price at the
measurement date.
2. NOTES RECEIVABLE FROM THE SALE OF STOCK
The Company has notes receivable related to the sale of stock from several
officers, which totaled $426,798 as of October 31, 2000. The notes bear interest
at the annual rates shown below. The notes were granted in connection with the
purchase of stock or exercise of stock options as follows:
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Balance as of
Date granted Interest rate Shares related Date Due October 31, 2000
------------------ -------------- -------------- ------------------ -----------------
<S> <C> <C> <C> <C> <C>
Unsecured May 15, 1999 6% per annum 636,100 On demand $ 178,798
Secured September 19, 2000 8% per annum 39,002 September 15, 2003 248,000
---------------
Total $ 426,798
---------------
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3. NOTES RECEIVABLE - OFFICERS AND OTHER
In October 2000, Robert C. McShirley, the Chief Executive Officer borrowed
$400,000 from the Company in exchange for a secured ninety-day promissory note
which bears interest at a rate of 8% per annum. In late October 2000, Mr.
McShirley repaid the Company $250,000 of the original balance, leaving a balance
of $150,000 plus interest. This note receivable is included in the current
portion of Notes Receivable - officers and other. In addition, the Chief
Operating Officer borrowed $50,000 from the Company in exchange for a two-year
promissory note in such amount, which bears interest at a rate of 8% per annum.
This note receivable is including in long-term portion of notes
receivable-officers and other.
The Company has issued loans and other advances to officers and other
employees. The current Portion is $183,367 and the long-term Portion is $50,755
as of October 31, 2000. The notes are due from two to twenty-four months and
bear interest at rates up to 8% per annum.
4. CONVERTIBLE NOTES PAYABLE
In November 1999, the Company issued $150,000 of 10% convertible notes due
December 31, 2000 to certain investors. The notes are convertible into shares
of restricted common stock at a per share price of $2.50. None of these notes
had been converted as of October 31, 2000.
The Company allocated a portion of the convertible notes to the embedded
beneficial conversion feature in the convertible notes and credited paid-in
capital. The portion allocated to the beneficial conversion feature was charged
to interest expense at the date of issuance. The amount charged to interest
expense related to convertible notes issued during the nine-month period ended
October 31, 2000 was $11,096.
5. SHAREHOLDERS' EQUITY
Common Stock - On October 31, 2000, there were 16,101,523 shares of common
stock outstanding. This reflects the issuance of 294,352 shares of common stock
during the nine months ended October 31, 2000, an increase of $2,944 from the
value of common stock, $0.01 par value, on January 31, 2000.
Preferred Stock - Effective February 24, 2000, the Company had 5,000,000
shares of preferred stock authorized and had designated 2,900,000 shares of the
preferred stock "Series 1-A Convertible Preferred Stock" of which 2,802,000
shares were initially issued, with a conversion feature of $2.50 per share. The
Company allocated all of the net proceeds from the issuance of the preferred
stock to an embedded beneficial conversion feature. The recorded discount
resulting from the allocation was fully amortized through retained earnings at
issuance. In the event of any liquidation or dissolution, either voluntary or
involuntary, the holders of the Series 1-A Convertible Preferred Stock shall be
entitled to receive, prior and in preference to any distribution of any of the
assets or surplus funds, to the holders of the Common Stock by reason of their
ownership thereof, a preference amount per share consisting of the sum (A) $2.50
for each outstanding share of Series 1-A Preferred Stock, and (B) an amount
equal to declared but unpaid dividends on such shares, if any. Each share of
Series 1-A Preferred Stock shall be convertible at any time after the date of
issuance of such shares, into such number of fully paid shares of Common Stock
as is determined by dividing the Original Issue Price by the then applicable
Conversion Price, in effect on the date the certificate evidencing such share is
surrendered for conversion. Under certain circumstances, such as stock splits,
these shares are subject to stated Conversion Price Adjustments. The remaining
2,100,000 shares were designated as "Series 2-A Convertible Preferred Stock",
which will be issued with rights, preferences and privileges as designated by
the board of directors.
- 6 -
<PAGE>
Each share of Series 1-A Preferred Stock, subject to the surrendering of
the certificates of the Series 1-A Preferred Stock, shall be automatically
converted into shares of Common Stock at the then effective Conversion Price,
immediately upon closing of a public offering of the Company's Common Stock with
an aggregate gross proceeds of at least $10,000,000 and a per share price of at
least five dollars, or at the election of the holders of a majority of the
outstanding shares of Series 1-A Preferred Stock. The holder of each share of
Series 1-A Preferred Stock shall have the right to that number of votes equal to
the number of shares of common stock issued upon conversion of the Series 1-A
Preferred Stock. Holders of the Series 1-A Convertible Preferred Stock are
entitled to noncumulative dividends, if declared by the Board of directors, of
$0.20 per share annually. In the event of a liquidation or dissolution of the
Company, the holders of the Series 1-A Convertible Preferred Stock shall be
entitled to receive a preference amount for each outstanding share equal to
$2.50 plus declared but unpaid dividends. (See Note 7 - Subsequent Events for
additional information.)
In conjunction with expenses relating to the issuance of the "Series 1-A
Convertible Preferred Stock", 235,985 warrants were granted at an exercise price
of $6.00 per share and 150,706 warrants were granted at an exercise price of
$2.50 per share. During the quarter ended July 31, 2000, 120,000 warrants were
granted at an exercise price of $2.00 per share, as compensation for services
rendered. Ramin Kamfar, who subsequently was elected as a director of the
Company, is a partner in a partnership that was awarded 60,000 warrants, of the
120,000 warrants granted, at an exercise price of $2.00 per share. As of October
31, 2000, 1,376,691 warrants and 1,977,784 options had been granted and were
outstanding.
In February 2000, the Company entered into a strategic relationship with
U.S. West, Inc. (now known as Qwest Communications) of Denver, Colorado,
pursuant to which the two firms agreed to make VSN available to Qwest's business
customers. This relationship was terminated after the end of the third quarter.
(See Note 7 subsequent events).
Qwest provides telecommunications and related services, wireless services,
high-speed data and Internet services and directory services. In exchange for
services to be rendered and a nominal amount of cash, Vsource granted to Qwest
600,000 warrants with a three-year term, at an exercise price of $5.00. The
terms of the distribution and marketing agreement are automatically renewable
each year unless either party notifies the other of its intent to terminate the
agreement, in writing, sixty calendar days prior to February 14th of the
potential renewal year. When the warrants were granted, the Company's stock was
valued at $17.50 per share, resulting in a charge to the Company of $8,412,000.
In the nine months ended October 31, 2000, the Company recognized $3,154,500 of
this charge as a marketing expense. The Company plans to recognize the remaining
$5,257,500 as a marketing expense in the quarter ending January 31, 2001 due to
the cancellation of this arrangement.
During the period August 28, 2000 to September 18, 2000, the Company sold
1,672,328 shares of Series 2-A Convertible Preferred Stock to 25 accredited
investors and received $10,719,623 less offering costs. Each share of preferred
stock is convertible into one share of common stock at the election of the
holder. Each purchaser also received a warrant to purchase common stock at an
exercise price of $6.41 per share, with a five-year term. The aggregate of such
shares of common stock is 145,550. No underwriters were used and offering costs
were $531,792 including transfer agent fees, printing cost, legal fees and
commissions or finders fees. The offering was a private placement made in
accordance with Regulation D. All of the purchasers were accredited investors.
No form of general solicitation or general advertising was used for any offer or
sale. The investors represented their intention to acquire the shares for
investment purposes only, and not with a view for resale or distribution, and
appropriate restrictive legends were placed on each stock certificate issued
pursuant to this offering.
The Company is obligated to register the shares of Common Stock underlying
the Series 2-A Preferred and the warrants held by the holders of the Series 2-A
Preferred. This registration statement is a result of the Company's obligation
to the holders of the Series 2-A Preferred. If this registration statement is
not effective on or before January 16, 2001, the Company must issue to each
holder of Series 2-A Preferred an additional warrant to purchase Common Stock in
an aggregate amount equal to two percent (2%) of the registrable shares held by
such holder for each thirty day period this registration statement is not
effective by January 16, 2001. The additional warrants would have terms of five
(5) years and an exercise price of $6.41 per share.
In connection with the sales of the Series 2-A Convertible Preferred Stock,
the Company issued warrants to purchase an aggregate of 144,881 shares of common
stock at exercise prices ranging from $6.41 to $6.69 as additional finder's
fees, commissions and other services in connection with the offering. No
underwriters were used, and no commissions were paid. The warrants were issued
to two consultants and as a private placement exempt from registration under
section 4(2) of the Securities Act. The warrant holders represented their
intention to acquire the warrants for investment purposes only, and not with a
view for resale or distribution, and appropriate stop transfer instructions and
restrictive legends indicating the transfer restrictions will be place on each
warrant and each stock certificate when issued. Each investor had ample access
to the kind of information from the Company that a registration statement would
include.
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The Company allocated $6,630,780 of the net proceeds from the issuance of
the Series 2-A Preferred Stock to Common Stock as required by an embedded
beneficial conversion feature. The deemed discount resulting from the allocation
was fully amortized through retained earnings at issuance. In the event of any
liquidation or dissolution, either voluntary or involuntary, the holders of the
series 2-A Convertible Preferred Stock shall be entitled to receive, prior and
in preference to any distribution of any of the assets or surplus funds, to the
holders of the Common Stock by reason of their ownership thereof, a preference
amount per share consisting of the sum of (A) $6.41 for each outstanding share
of Series 2-A Preferred Stock, and (B) an amount equal to declared but unpaid
dividends on such shares, if any. Each share of Series 2-A Preferred Stock shall
be convertible at any time after the date of issuance of such shares, into such
number of fully paid shares of Common Stock as is determined by dividing the
Original Issue Price by the then applicable Conversion Price, in effect on the
date the certificate evidencing such share is surrendered for conversion. Under
certain circumstances, such as stock splits, these shares are subject to stated
Conversion Price Adjustments.
In September 2000, the Chief Financial Officer and the Chief Operating
Officer each purchased shares of the Company's Series 2-A Convertible Preferred
Stock for nominal cash and three-year promissory notes that bear interest at a
rate of 8% per annum and principal amounts of $124,000 each. The preferred
stock purchased was 19,501 for each officer. In connection with these
transactions, they also each received a warrant to purchase 1,697 shares of
common stock with an exercise price of $6.41 and a term of five years.
On October 31, 2000, paid-in-capital totaled $63,955,951, an increase of
$53,310,017 from $10,645,934 at January 31, 2000. This primarily reflects the
recording of the issuance of preferred stock of $30,347,529, and the related
beneficial conversion feature and deemed dividend, the recording of $9,677,123
in compensation related to stock options granted to employees in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees", the recording of the issuance of common stock of $2,154,481, and the
recording of $11,130,883 in compensation for marketing, investor relations and
referral services in accordance with Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-based Compensation." Stockholders equity is
partially offset by deferred compensation of $12,953,649 as of October 31, 2000.
6. BASIC LOSS AVAILABLE TO SHAREHOLDERS
The Company has adopted SFAS No. 128, "Earnings Per Share," which is
effective for financial statements issued after December 15, 1997. The standard
eliminates primary and fully diluted earnings per share and requires
presentation of basic and diluted earnings per share together with disclosure of
how the per share amounts were computed.
Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted average common shares
outstanding for the period.
The loss available to common shareholders for the three and nine months ended
October 31, 2000 is the net loss for the period, adjusted for deemed dividends
on preferred stock.
The following table illustrates the calculation of basic and diluted
earnings/(loss) per share:
<TABLE>
<CAPTION>
Nine months Three months
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<S> <C> <C>
Net loss $ ( 18,537,691) $ ( 5,838,196)
Less - deemed dividend to preferred shareholders ( 13,499,177) ( 6,630,780)
------------------ ----------------
Basic loss available to common shareholders $ ( 32,036,868) $ ( 12,468,976)
================== ================
</TABLE>
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Weighted average common shares outstanding for dilution purposes do not take
into account the exercise of options or warrants because to do so would be
antidilutive.
7. SUBSEQUENT EVENTS
On November 8, 200O, the Company reincorporated in Delaware. In connection
with the Company's reincorporation, the Company issued a warrant to purchase
1,500 shares of common stock at an exercise price of $13.00 as consideration for
the name change of V-Source, Inc., a Delaware corporation (a corporation
unrelated to Vsource, Inc.), to Arizon, Inc., a Delaware corporation. No
underwriters were used, and no commissions were paid. The warrant was issued as
a private placement exempt from registration under Section 4(2) of the
Securities Act.
On December 11, 2000 the Company announced that it's strategic relationship
with Qwest had ended, citing that U.S. West had been acquired by Qwest and that
their business strategy no longer met the objectives of the relationship with
Vsource. In conjunction with the ending of this relationship, the balance of
the previously Deferred warrant expense will be expensed fully in the forth
quarter of this fiscal year in the amount Of $5,257,500.
On December 14, 2000, the Company entered into an Agreement and Plan of
Merger dated as of the same date, with OTT Acquisition Corp., a California
corporation, Online Transaction Technologies, Inc., a California corporation
("OTT"), Colin P. Kruger and Michael Shirman (the "Merger Agreement"). The
closing of the transactions under the Merger Agreement are expected to occur
later in December 2000 (the "Closing"). The proposed merger is to be a tax-free
reorganization under Section 368(a) of the Internal Revenue Code.
OTT is an Application Service Provider (ASP) that develops and hosts
transaction solutions for public (many to many) and private (one to many)
exchanges. Among the solutions that OTT brings to Vsource is
LiquidMarketplace(TM), a complete suite of fully integrated transaction
solutions, including auctions, fixed-price catalogs and RFQ engines. These
solutions are identified as LiquidAuction(TM), LiquidCatalog(TM) and
LiquidRFP(TM). This suite allows public exchange clients to handle both seller-
and buyer-initiated transactions in their e-Marketplaces. OTT's private
exchange solution, LiquidStore(TM), offers private catalog and auction
functionality to LiquidMarketplace(TM) participants or stand-alone clients. In
addition to offering a complete suite, OTT has developed proprietary modules and
applications that reduce customization and deployment time and simplify
integration.
The aggregate purchase price payable at Closing is to be 1,130,950 shares
of the Company's common stock. The number of shares was calculated from the
Merger Agreement purchase price of $7,000,000, less $77,115 paid as certain
warrants and options, divided by $6.1213 per share ("Acquisition Price", as
calculated from the average closing price of a share of Company common stock for
the 30 calendar days immediately prior to execution of the Merger Agreement).
Such aggregate price shall be subject to adjustment based on reductions or
increases in the net book value of the assets of OTT since September 30, 2000.
In connection with the Closing, two key employees of OTT will enter into
mutually agreeable employment contracts with the Company providing for, among
other things, salaries of $125,000 and options to purchase 100,000 shares of the
Company's common stock which vest over 24 months and have an exercise price of
$6.41 per share.
Twenty-five percent of the equity securities comprising the aggregate
purchase price will be held for six months in an escrow (the "Escrow
Securities"). The Escrow Securities and Company shares issued to OTT management
shareholders will be the sole recourse for the Company for indemnification
against claims and losses arising from breaches by OTT of representations and
warranties or covenants made pursuant to the definitive agreements. Such
representations and warranties shall terminate over varying periods. The Escrow
Securities will be valued for purposes of any such indemnification at the
Acquisition Price. OTT shareholders may at their option pay any such indemnity
in cash in lieu of Escrow Securities.
Closing of the transaction is contingent upon several conditions,
including, without limitation, approval of OTT minority shareholders and warrant
holders. This transaction will be recorded on the Purchase method of accounting.
8. RELATED PARTY TRANSACTION
In the quarter ended October 31, 2000, a sale was made to a related party.
Ramin Kamfar is a member of the Board of directors of the Company and is also
the Chief Executive Officer of New World Coffee, one of the customers with which
a sale of $25,000.00
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of the Company's financial condition
and results of operations should be read in conjunction with the Company's
financial statements and the related notes thereto appearing elsewhere herein.
FORWARD LOOKING STATEMENTS
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This Quarterly Report on Form 10-QSB and the documents incorporated herein
by reference contain forward-looking statements based on current expectations,
estimates and projections about the Company's industry, management's beliefs and
certain assumptions made by management. All statements, trends, analyses and
other information contained in this report relative to trends in net sales,
gross margin, anticipated expense levels and liquidity and capital resources, as
well as other statements including, but not limited to, words such as
"anticipate," "believe," "plan," "estimate," "expect," "seek," "intend," and
other similar expressions, constitute forward-looking statements. These
forward-looking statements are not guarantees of future performance and are
subject to certain risks and uncertainties that are difficult to predict.
Accordingly, actual results may differ materially from those anticipated or
expressed in such statements. Potential risks and uncertainties include, among
others, those set forth in this Item 2. Particular attention should be paid to
the cautionary statements involving the Company's limited operating history, the
unpredictability of its future revenues, the Company's need for and the
availability of capital resources, the evolving nature of its business model,
the intensely competitive market for business-to-business electronic
procurement, and the risks associated with systems development, management of
growth and business expansion. Except as required by law, the Company
undertakes no obligation to update any forward-looking statement, whether as a
result of new information, future events or otherwise. Readers, however, should
carefully review the factors set forth in other reports or documents that the
Company files from time to time with the Securities and Exchange Commission
("SEC").
OVERVIEW
The Company creates and markets "pure" Internet-based applications using an
Application Service Provider (ASP) model. An ASP model is best described as
providing the ability on a rental basis for clients to access by an Internet
browser, such as Internet Explorer or Netscape Communicator, computer software
and data that reside on a remote server on the Internet, rather than the user's
computer or a server on the user's local area network. The Company intends to
generate fees by charging a small set-up fee to use its software and then
charging based upon time or transactions, depending upon the situation.
Currently, the Company offers one application, Virtual Source Network (VSN),
which may be used by corporate clients to purchase goods and services via the
Internet.
Currently all financial, technical and marketing resources of the Company
are dedicated to VSN. The Company plans to sell VSN through a direct sales
force, through independent resellers, and through strategic partnerships in
which VSN will be offered to the partner's base of customers. VSN is designed
to be sold initially through a pilot program for on-going transaction fees and
an initial set-up fee of $25,000. During the pilot program, the client is
expected to test the functionality of VSN and determine how much customization
of the system, if any, is required for a full implementation.
During 1997 and early 1998, the Company offered an earlier version of VSN,
which was a software application installed on client computers. The Company has
discontinued the sale and use of this product. The Company's Internet version
of VSN has just recently been made available for use by clients. The Company is
presently hiring a direct sales force and creating relationships with
independent resellers and strategic partners.
The Internet version of VSN is now being used on a trial basis by initial
customers. As a result, the limited operating history makes the prediction of
future operating results very difficult. In particular, the Company believes
that period-to-period comparisons of operating results should not be relied upon
as predictive of future performance. Operating results are expected to vary
significantly from quarter to quarter and are difficult or impossible to
predict. The Company's operating prospects must be considered in relationship
to the risks, expenses and difficulties encountered by any company at an early
stage of development, particularly companies in new and rapidly evolving
markets. The Company may not be successful in addressing such risks and
difficulties. For more information, please refer to "FORWARD LOOKING
STATEMENTS" and "FACTORS THAT MAY AFFECT FUTURE PERFORMANCE."
RECENT EVENTS
On October 30, 2000, the Common Stock, $0.01 par value per share, of
Vsource, Inc., a Nevada corporation began trading on the NASDAQ National Market
system under the ticker symbol "VSRC." The Company's Common Stock had
previously been trading on the OTC Bulletin Board under the ticker symbol
"VSRC.OB."
In October 2000, the Company and IBM announced an alliance to provide
eProcurement services to mid-sized companies. IBM agreed to establish a
national practice to support the alliance.
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In October 2000, the Company announced that it had agreed to acquire Online
Transaction Technologies, Inc., a web auction developer, in a stock for stock
transaction. The acquisition had not yet been completed at the quarter ended
October 31, 2000. (See Note 7 - Subsequent Events of the financial statements
for the quarter ended October 31, 2000.)
In August 2000, the Company and IBM jointly announced an agreement between
IBM Global Services and Vsource, Inc. for localization services, including
language translations. The Company is a paying client of IBM, which has
developed the training program for VSN users. Clients of the Company retain the
services of IBM in order to train their staffs to use the VSN system. In
addition, IBM and the Company have each agreed informally to make their
respective clients aware of the other firm's services, where it seems
appropriate for the client in question.
MANAGEMENT'S DISCUSSION & ANALYSIS OF RESULTS OF OPERATIONS - THREE MONTHS
ENDED OCTOBER 31, 2000, COMPARED TO THE THREE MONTHS ENDED OCTOBER 31, 1999:
REVENUE
For the three months ended October 31, 2000, revenues were $151,500
compared to $2,230 in revenues, up $149,270 or 6,694%, during the three months
ended October 31, 1999. This increase in revenues results from the Company's
implementation of the pilot phase of the revenue generating process for the new
Internet version of VSN. The Company has not yet begun to generate transaction
fees, the anticipated primary source of revenue.
GENERAL AND ADMINISTRATIVE EXPENSES
For the three months ended October 31, 2000, general and administrative
expenses were $2,017,562 (including $1,168,952 of stock-based compensation), up
$1,790,817 or 790%, from $226,745 during the three months ended October 31,
1999. This increase was caused primarily by increased expenses associated with
marketing, advertising, public relations, stock based compensation and executive
staff.
RESEARCH AND DEVELOPMENT
For the three months ended October 31, 2000, research and development
expenses were $4,004,459 (including $1,210,201 of stock-based compensation), up
$2,970,438 or 287%, from $1,034,021 during the three months ended October 31,
1999. This increase was caused primarily by implementation of a development
effort associated with the Company's Internet version of VSN. These costs
included the use of independent contractors, as well as the addition of
technical employees in the Company's Seattle office. The Company does no work
that would be considered pure research, or basic research.
NET LOSS
For the three months ended October 31, 2000, the net loss was $5,838,196,
an increase of $4,579,660 or 364%, from the net loss of $1,258,536 during the
three months ended October 31, 1999. This increase is a result of significantly
increased marketing and advertising expenses, stock based compensation, as well
as significantly increased research and development expense.
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC AND DILUTED
For the three months ended October 31, 2000, the basic weighted average
common shares outstanding were 15,969,038, up 1,629,874 or 11.4%, from
14,339,164 for the three months ended October 31, 1999. This increase resulted
primarily from the issuance of 1,672,328 shares in return for cash invested in
the Company, shares issued upon conversion of convertible notes and accrued
interest, as well as the exercise of stock options. Weighted average common
shares outstanding for dilution purposes do not take into account the exercise
of stock options or warrants because to do so would be anti-dilutive.
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NET LOSS PER COMMON SHARE - BASIC AND DILUTED
The basic net loss per common share for the three months ended October 31,
2000 was $0.78 per share, up $0.69 per share from a net loss of $0.09 per share
for the three months ended October 31, 1999. This increase reflects the
$4,579,660 increase in the net loss, the return of equity to preferred
stockholders of $6,630,780, created by the deemed dividend to preferred
shareholders, and partially offset by the increase of 1,629,874 shares in the
basic weighted average outstanding common shares.
MANAGEMENT'S DISCUSSION & ANALYSIS OF RESULTS OF OPERATIONS - NINE MONTHS
ENDED OCTOBER 31, 2000, COMPARED TO THE NINE MONTHS ENDED OCTOBER 31, 1999:
REVENUE
For the nine months ended October 31, 2000, revenues were $214,000, up
$203,785 or 1,995% compared to $10,215 in revenues during the nine months ended
October 31, 1999. This increase in revenues results from the Company's
implementation of the pilot phase of the revenue generating process for the new
Internet version of VSN. The Company has not begun to generate transaction fees,
the anticipated primary source of revenue.
GENERAL AND ADMINISTRATIVE EXPENSES
For the nine months ended October 31, 2000, general and administrative
expenses were $9,746,801 (including $6,617,357 of stock-based compensation), up
$8,943,059, or 1,113%, from $803,742 during the nine months ended October 31,
1999. This increase was caused primarily by the increase of expenses associated
with marketing, advertising, public relations, stock based compensation and
executive staff.
RESEARCH AND DEVELOPMENT
For the nine months ended October 31, 2000, research and development
expenses were $9,087,797 (including $3,031,209 of stock-based compensation), up
$6,933,724 or 322% from $2,154,073 during the nine months ended October 31,
1999. This increase was caused primarily by implementation of a development
effort associated with the Company's Internet version of VSN. These costs
included the use of independent contractors, as well as the addition of
technical employees in the Company's Seattle office. The Company does no work
that would be considered pure research, or basic research.
NET LOSS
For the nine months ended October 31, 2000, the net loss was $18,537,691,
an increase of $15,590,091 or 529%, from the net loss of $2,947,600 during the
nine months ended October 31, 1999. This increase is a result of significantly
increased marketing and advertising expenses, stock based compensation, as well
as significantly increased research and development expense.
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - BASIC AND DILUTED
For the nine months ended October 31, 2000, the basic weighted average
common shares outstanding were 15,869,895, up 2,573,886 or 19.4%, from
13,296,009 for the nine months ended October 31, 1999. This increase resulted
primarily from the issuance of 2,118,269 shares of common stock of the Company
upon conversion of convertible notes and accrued interest, the issuance of
217,584 shares of common stock upon exercise of stock options, as well as the
issuance of 236,084 shares of common stock in return for cash invested in the
Company. Weighted average common shares outstanding for dilution purposes do
not take into account the exercise of stock options or warrants because to do so
would be anti-dilutive.
NET LOSS PER COMMON SHARE - BASIC AND DILUTED
The basic net loss per common share for the nine months ended October 31,
2000 was $2.02 per share, up $1.80 per share from a net loss of $0.22 per share
for the nine months ended October 31, 1999. This increase reflects the
$15,590,091 increase in the net loss, the return of equity to preferred
stockholders of $13,499,177, created by the deemed dividend to preferred
shareholders, and partially offset by the increase of 2,573,886 shares in the
basic weighted average outstanding common shares.
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MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION - AT OCTOBER 31, 2000,
COMPARED TO JANUARY 31, 2000:
CASH
On October 31, 2000, cash totaled $8,263,168, up $3,056,001 or 58.7%, from
$5,207,167 at January 31, 2000. This increase reflects the proceeds from the
sale of preferred stock in private transactions that closed September 18, 2000,
in the net amount of $10,171,108, and is offset by a decrease in the funds used
for operations during the nine months ended October 31, 2000.
ACCOUNTS RECEIVABLE
On October 31, 2000, accounts receivable were $191,500 and on January 31,
2000, there were no accounts receivable. This reflects that the Company is
approaching the completion of development of its main product, VSN, and has just
begun generating revenues and receivables from the product.
NOTES RECEIVABLE - OFFICERS AND OTHER
On October 31, 2000, employee and other receivables totaled $183,367, up
from no balance at January 31, 2000. This increase results from advances to
officers and employees, net of partial repayments.
PREPAID EXPENSES
On October 31, 2000, prepaid expenses totaled $148,383 as compared to no
balance at January 31, 2000. This increase primarily reflects prepaid fees of
$148,383 that will be expensed in the next twelve months.
TOTAL CURRENT ASSETS
On October 31, 2000, total current assets totaled $8,786,418, up $3,579,251
or 68.7%, from $5,207,167 at January 31, 2000. This increase reflects the net
of proceeds from the sale of preferred stock in private transactions that closed
September 18, 2000, in the net amount of $10,171,108, and is offset by a
decrease in the funds used for operations during the nine months ended October
31, 2000.
FIXED ASSETS
On October 31, 2000, fixed assets totaled $819,017, an increase of
$578,809, or 241%, from $240,208 at January 31, 2000. This increase reflects
the addition of equipment and software needed to accommodate the increase in the
development and marketing of VSN.
ACCUMULATED DEPRECIATION
On October 31, 2000, accumulated depreciation totaled $121,564, up
$103,856, or 586.5%, from $17,808 at January 31, 2000. This increase reflects
the addition of normal depreciation expense for the nine months ended October
31, 2000.
PROPERTY AND EQUIPMENT, NET
On October 31, 2000, property and equipment, net totaled $697,453, up
$474,953, or 213.5%, from $222,500 at January 31, 2000. This increase primarily
reflects the addition of equipment and software needed to accommodate the
increase in the development and marketing of VSN, net of depreciation expense
recorded for the period.
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NOTES RECEIVABLE - OFFICERS AND OTHER, NON-CURRENT
On October 31, 2000, other assets totaled $50,755, down $59,973, or 54.2%,
from $110,728 at January 31, 2000. This decrease is due to the recognition of
partial repayment on these notes receivable for the nine months ended October
31, 2000.
TOTAL ASSETS
On October 31, 2000, total assets were $9,534,626, up $3,994,231, or 72.1%,
from $5,540,395 at January 31, 2000. This change primarily reflects cash
proceeds from the private placement during the period, offset by cash used in
research and development costs, and general and administrative expenses
associated with the development and marketing of VSN.
ACCOUNTS PAYABLE
On October 31, 2000, accounts payable were $366,818, up $119,346, or 48.2%,
from $247,472 at January 31, 2000. This change is primarily a result of
increased amounts due independent contractors involved in development of the
Internet version of VSN, and also amounts due for marketing, advertising and
legal expenses.
ACCRUED LIABILITIES
On October 31, 2000, accrued liabilities were $79,087, down $21,850, or
21.6%, from $100,937 at January 31, 2000. This change resulted primarily from
the decrease in accrued wages and related compensation expenses.
CONVERTIBLE NOTES PAYABLE
On October 31, 2000, convertible notes payable were $150,000, remaining the
same as at January 31, 2000. Interest accrued on this liability is included in
accrued liabilities.
LIABILITIES RELATED TO THE PRIVATE PLACEMENT OF PREFERRED STOCK
On October 31, 2000, liabilities related to private placement of preferred
stock were zero, as compared to liabilities of $6,002,500 at January 31, 2000.
This is due to the reclassification to equity and issuance of 2,802,000 shares
of Series 1-A Preferred Stock in April 2000. As of January 31, 2000, the Company
had received $6,002,500 in cash associated with the private placement, which it
treated as a liability until the transaction was completed and the preferred
stock was issued.
TOTAL CURRENT LIABILITIES
On October 31, 2000, total current liabilities totaled $595,905, down
$5,905,004, or 90.8%, from $6,500,909 at January 31, 2000. This reduction
reflects the reclassification of liabilities related to the private placement of
preferred stock in the amount of $6,002,500 to equity as preferred stock,
partially offset by the increase in accounts payable of $119,346 and a decrease
in accrued liabilities of $21,850.
PREFERRED STOCK, $0.01 PAR VALUE
On October 31, 2000, preferred stock for Series 1-A totaled $27,252 and
stock for Series 2-A totaled $16,723 versus no preferred stock at January 31,
2000. This reflects the issuance of 2,802,000 new Series 1-A preferred shares
less 76,768 shares converted to common shares during the nine-month period and
the issuance of 1,672,828 shares of new Series 2-A preferred shares. All of the
shares were issued in exchange for cash invested in the Company.
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COMMON STOCK, $0.01 PAR VALUE
On October 31, 2000, common stock totaled $161,015, up $2,944, or 1.86%,
from $158,071 at January 31, 2000. This reflects the issuance of 294,352 shares
of common stock , $0.01 par value, during the nine months ended October 31,
2000.
ADDITIONAL PAID-IN-CAPITAL
On October 31, 2000, paid-in-capital totaled $63,955,951, up $53,310,017 or
500.8%, from $10,645,934 at January 31, 2000. This increase reflects the value
(in excess of par) of the new preferred shares issued during the period, of
which 4,398,060 preferred shares were issued in return for cash invested in the
Company, and 294,352 common shares were issued for cash and services. This
primarily reflects the recording of additional paid in capital for common
stockholders' of $13,499,177 related to the beneficial conversion feature of
preferred stock, compensation of $10,539,257 related to stock options granted to
employees in accordance with the Statement of Financial Accounting Standards No.
123, accounting for stock-based compensation, and $10,966,310 in compensation
for marketing, investor relations and referral services.
DEFERRED COMPENSATION
On October 31, 2000, deferred compensation was $12,953,649, up $11,172,832,
or 326% from $ 1,780,817 at January 31, 2000. This change was due to the
granting of stock options to employees as employment incentives and bonuses, and
compensation for marketing, investor relations and referral services. This is
amortized over a period from one to three years, in accordance with the
individual agreement terms.
ACCUMULATED DEFICIT
On October 31, 2000, the accumulated deficit was $41,841,773 up $32,036,869
or 326% from $9,804,904 at January 31, 2000. This change resulted from a net
loss of $18,537,691 during the nine months ended October 31, 2000 and the
recognition of a deemed dividend to preferred stockholders of $13,499,177.
NOTES RECEIVABLE FROM THE SALE OF STOCK
On October 31, 2000, notes receivable from the sale of stock totaled
$426,798, up $248,000 from $178,798 at January 31, 2000. This amount is used to
offset the balance in stockholders' equity. These notes are receivable from
officers who exercised stock options during the current period, and in a prior
period. The Company's stock option program provides several alternative
methods of paying for shares acquired through exercise of stock options, and one
of those alternatives is to provide a demand note payable to the Company, in the
amount of the purchase.
TOTAL STOCKHOLDERS' EQUITY/(DEFICIT)
On October 31, 2000, total stockholders' equity was $8,938,721, up
$9,899,235, or 1,031%, from a deficit of $960,514 at January 31, 2000. This
change resulted primarily from increases in preferred stock and paid-in-capital
of $53,356,936 offset by an increase in deferred compensation of $11,172,832,
the recognition of a deemed dividend to preferred stockholders of $13,499,177,
the increase in notes receivable relating to the sale of stock of $248,000 and
the net loss of $18,537,691 during the nine months ended October 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company had $214,000 of revenue during the nine months ended October
31, 2000, in addition to small amounts of interest income, and certain
non-recurring items. While the Company expects to generate revenue in the
future, it is currently entirely dependent on investor funds. At October 31,
2000, the Company had cash balances totaling $8,263,168, primarily as a result
of its private placement of preferred stock during the first and third quarters
of 2000 offset by current operating activity. The Company is currently expending
approximately $900,000 per month of cash and cash equivalents. With anticipated
revenue from current clients only and at the current rate of expenditure,
management expects those funds to last through July 2001.
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The Company's principal sources of cash and cash equivalents were derived
from private sales of the Company's equity and debt securities. The main source
of funds for the Company from the date of inception through October 31, 2000,
other than the sale of equity and debt securities, has been from implementation
fees. $214,000 was derived from such sales made in the nine months ended
October 31, 2000. The Company has not yet begun to generate transaction fees,
the anticipated primary source of revenue.
The Company anticipates client revenues to continue increasing during the
twelve-month period from November 1, 2000 to October 31, 2001. In September
2000, the Company completed a private equity offering and received $10,719,623
less offering costs of $531,792. There can be no assurances that the Company
will continue generating additional revenue from clients. If client revenues or
future private equity offerings do not materialize, the Company has a contingent
plan of cash conservation that will allow it to operate through October 31,
2001.
The Consolidated Statements of Cash Flows for the nine months ended October
31, 2000, and nine months ended October 31, 1999 show that net losses were
$18,537,691 and $2,947,600, respectively, with the issuance of preferred stock
for cash of $10,889,828, partially offsetting the cash requirement. A non-cash
entry was made for the period ended October 31, 2000 to recognize the conversion
of liabilities related to the private placement of preferred stock in the amount
of $6,002,500 to equity as preferred stock. In addition, a non-cash accounting
entry of $20,808,006 was made to increase additional paid-in capital, with an
offsetting entry of $9,648,566 for compensation expense, and $11,159,440 to
deferred compensation. This did not offset any cash requirement directly or
indirectly, and there was no such cash or other consideration paid as
compensation in the period.
RESEARCH AND DEVELOPMENT FOR THE FISCAL YEAR ENDING JANUARY 31, 2001
During the fiscal year ending January 31, 2001, it is expected that
approximately $12,000,000, including stock based compensation, will be spent on
product development. The Company does not expect to expend any resources in
basic research. Additional work is being done to enhance the present system.
Developments will make the system more flexible, and allow additional options
for the user to modify portions of the system to better meet the unique needs of
each particular user's business. Other enhancements will add new capabilities
to the system in the future. No assurance can be given that the Company will
have the resources necessary to conduct this product development.
FACTORS THAT MAY AFFECT FUTURE PERFORMANCE:
RISKS RELATED TO THE COMPANY'S BUSINESS
NEED FOR ADDITIONAL CAPITAL: The Company has recorded substantial operating
losses and, as of October 31, 2000, has an accumulated deficit of approximately
$41.8 million. The Company anticipates sustaining its current rate of
development and operating expenditures through the fiscal year ending January
31, 2002. The Company currently has less than 10 clients under contract.
During the recent quarter, six of these clients together generated a small
amount of revenue from the initial phases of contract implementation. It is
expected that current and newly added clients will produce significantly
increased revenues during the fourth quarter, primarily from implementation fees
LIMITED OPERATING HISTORY: VSN, the Company's primary service offering,
began operations in October 1996 when the earlier version of VSN, a software
application for personal computers rather than an Internet application, was
successfully installed and used at a private company in southern California.
The Company has had a limited operating history since then, although it did
successfully install the earlier VSN version (personal computer application) for
several clients, and was paid the annual subscription rate then in effect. This
limited history makes an evaluation of the Company's future prospects very
difficult. The new Internet version of VSN is now available for evaluation and
use by customers, but does not yet have any fully operational customers. As
such, because of the limited operational history of VSN, there can be no
assurances that the product will meet the needs of potential customers or that
the product will operate correctly.
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RISKS OF EARLY STAGE COMPANY; NEW, RAPIDLY CHANGING MARKET: NEED TO ATTRACT
LARGE CORPORATIONS: The market for Internet applications and services is at an
early stage, and changing rapidly. Internet procurement is a relatively new
market. Its rate of growth and change is unpredictable, as is the nature of this
change. The Company will encounter the risks and difficulties often encountered
by early-stage companies in new and rapidly evolving markets. The Company's
initial success will depend upon attracting several large, technologically
advanced corporations to use VSN, and their favorable results from this usage.
Subsequent success will depend on the Company's ability to communicate these
early successes to the marketplace, thus attracting significant numbers of other
businesses and buying organizations. No assurance can be given that the Company
will be successful in the marketplace, or if successful, that it will attract
significant numbers of clients. There can be no assurance that an adequate
demand for, and usage of, the Company's products will develop.
COMPLEX IMPLEMENTATION AND INTEGRATION OF VIRTUAL SOURCE NETWORK MAY IMPEDE
MARKET PENETRATION: The installation of VSN, including integration with a
client's systems currently in use, can be a complex, time consuming and
expensive process. While the Company is designing a simplified version for use
by smaller organizations with limited enhancement capabilities and, as a result,
a low cost associated with its implementation, the Company anticipates that its
initial customers will be mid-sized or larger organizations that will require
that VSN undergo substantial customization to meet their needs. These firms
will also likely require that VSN be integrated with existing internal
Enterprise Resource Planning (ERP) and other operational systems. The Company's
management estimates that the installation and integration process may take up
to nine weeks or longer in some cases, depending on the size of the client, the
complexity of its operations, the configurations of its current computer
systems, and other systems projects that compete for the time and attention of
the Information Technology departments of the clients. Management also expects
that most integration projects in larger companies will involve various
integrators as outside systems consultants to the client. The Company's ability
to continually enhance the features of VSN, in response to client's widely
differing needs, is yet to be proven. The Company's ability to develop a
simplified version for smaller businesses that is inexpensive to implement is
also unproven. As a result, VSN may not achieve significant market penetration
in the near future, or ever.
LARGE OPERATING LOSSES EXPECTED TO CONTINUE: As discussed above, the
Company has accumulated substantial net losses through October 31, 2000. Since
inception, the Company has not had material revenues, and has recognized only a
small amount of revenue from the Internet version of VSN. The Company expects
to derive the majority of its revenues from VSN fees over the next five years.
In addition, provided that revenues develop more or less as expected, the
Company expects to spend a substantial portion of revenues during the next two
or three years on marketing, sales, technology development, training and
administration. There can be no assurance that the Company will be able to fund
these expenses.
FAILURE TO MAINTAIN LISTING ON MAJOR STOCK MARKET: Although the Company's
common stock began trading on the Nasdaq National Market System on October 30,
2000, there is no assurance that the Company will continually achieve the
requirements for continued listing on the Nasdaq National Market System. The
Company's common stock is currently trading below $5.00 per share. If the stock
continues to trade below $5.00 per share, the Company may be the subject of
de-listing or transfer to the Nasdaq Small-Cap. While the listing of the
Company's stock does not have a direct effect on the Company's operations, it
has an effect on the perception of the Company amongst potential investors and
can have an effect on the ability of the Company to raise additional funds. It
can also impact the dilution associated with any financing.
EFFECT OF INCREASED OPERATING EXPENSES ON OPERATIONS AND PRICE OF COMMON
STOCK: The Company plans to increase operating expenses to expand its sales and
marketing operations, establish new strategic relationships, fund additional
systems development, and increase its business and technical staff. These
planned expenses will increase operating losses during reporting periods before
significant revenues develop. These increased losses could have a negative
effect on the price of the Company's common stock.
DEPENDENCE ON VIRTUAL SOURCE NETWORK ANTICIPATED REVENUES: The Company expects
that when revenues do develop, substantially all of those revenues will come
from VSN clients. Although VSN fees are believed by management of the Company to
be below those currently charged for leading competitive systems and services,
future reductions in competitive prices could negatively impact the demand for,
or usage of, VSN. These changes may impede VSN's ability to achieve broad market
acceptance, thus negatively impacting the Company's opportunity to eventually
become profitable. There can be no assurance that broad and timely acceptance of
VSN, which is critical to the Company's future success, will be achieved.
Failure to achieve anticipated revenues would have adverse consequences for the
Company.
DEPENDENCE ON ONE PRODUCT: At the present time all of the Company's resources
are being devoted to the development and marketing of VSN. The Company expects
to depend on VSN for substantially all of the Company's revenues for the
foreseeable future. Accordingly, if VSN is not accepted by customers or
potential customers, or does not generate the demand or revenues necessary to
the Company, the Company may face serious or irreparable harm.
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DEPENDENCE ON SALES AND MARKETING RELATIONSHIPS FOR GROWTH: Our business
model includes generating sales through our alliance and affiliate programs.
Consequently, the Company will depend, in part, on sales and marketing strategic
relationships for growth. The Company has established and plans to continue to
establish sales and marketing strategic relationships with large organizations
as part of our growth strategy. Such relationships may not contribute to
increased use of the Company's services, help the Company add new clients, or
increase the Company's revenue. The Company may not be able to enter into new
relationships or renew existing relationships on favorable terms, if at all. In
addition, the Company may not be able to recover costs and the expenses
associated with the formation of these programs. In December 2000, the Company
announced that it's strategic relationship with Qwest had ended, citing that
U.S. West had been acquired by Qwest and that their business strategy no longer
met the objectives of the relationship with Vsource. Accordingly, if the
Company is unable to establish and maintain effective and long-term alliances
with other organizations, the Company may have difficulty achieving significant
market penetration.
THIRD PARTY IMPLEMENTATION/INTEGRATION OF VIRTUAL SOURCE NETWORK; NEGATIVE
IMPACT UPON REVENUE GOALS IF THIRD PARTIES UNAVAILABLE OR DO NOT PERFORM: The
Company expects to rely, to a large degree, on a number of third parties to
propose and explain VSN to prospective clients, to sell pilot projects to the
clients, and to integrate VSN with clients' existing systems, and to train users
when VSN is rolled out for general usage. The Company itself is planning to
work with clients and third-parties to implement the pilot projects. The
Company's ability to support its strategic partners, in pursuit of large numbers
of buyers and suppliers, is yet to be proven. If the Company is unable to
establish and maintain effective, long-term relationships with these third
parties, if these third parties are unable to meet the needs and expectations of
VSN clients, or if the Company cannot properly implement pilot projects, the
Company will likely have difficulty achieving its revenue goals.
UNSUCCESSFUL ACQUISITIONS COULD HARM OUR OPERATING RESULTS, BUSINESS AND
GROWTH: The Company may acquire businesses, products and technologies that
complement or augment the Company's existing businesses, services and
technologies. The inability to integrate any newly acquired entities or
technologies effectively could harm the Company's operating results, business
and growth. Integrating any newly acquired businesses or technologies may be
expensive and time consuming. To finance any acquisitions, the Company may need
to raise additional funds through public or private financings. Any equity or
debt financings, if available at all, may be on terms that are not favorable to
the Company and, in the case of equity financings, may result in dilution to the
Company's stockholders. The Company may not be able to operate any acquired
businesses profitably or otherwise implement the Company's business strategy
successfully.
LONG SALES CYCLE FOR LARGE CORPORATE ACCOUNTS COULD CAUSE DELAYS IN REVENUE
GROWTH: The Company's sales cycles for large corporate accounts may take many
months to complete and may vary from contract to contract. Further, the Company
expects that a large number of the Company's clients may be introduced to VSN
through such large accounts. Lengthy sales cycles for large corporate accounts
could cause delays in revenue growth, and result in significant fluctuations in
the Company's quarterly operating results. The length of the sales cycle may
vary depending on a number of factors over which the Company may have little or
no control, including the internal decision-making process of the potential
customer and the level of competition that the Company encounters in its selling
activities. Additionally, since the market for business-to-business e-commerce
is relatively new, the Company believes that it will have to educate many
potential customers about the use and benefits of the Company's products and
services, which can in turn prolong the sales process. The Company has provided
access to VSN on a trial basis for customer evaluation, which again may prolong
the sales process. Sales made through third parties, such as the Company's
alliance partners, can further extend sales cycles.
QUARTERLY RESULTS MAY BE SUBJECT TO SIGNIFICANT FLUCTUATIONS; EXPECTATIONS
OF INVESTORS AND ANALYSTS MAY NOT BE MET: The Company expects that its quarterly
operating results will fluctuate significantly due to many factors, many of
which are outside the control of the Company. Such factors include:
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- demand for and market acceptance of VSN
- inconsistent growth, if any, of the Company's client base
- loss of key customers or strategic partners
- timing of the recognition of revenue for large contracts
- variations in the dollar volume of transactions effected through VSN
- intense and increased competition
- introductions of new services or enhancements, or changes in pricing
policies, by the Company and it's competitors
- the Company's ability to control costs
- reliable continuity of VSN availability
The Company believes that quarterly revenues, expenses and operating
results are likely to vary significantly in the future, that period-to-period
comparisons of results of operations are not necessarily meaningful and that, as
a result, such comparisons should not be relied upon as indications of future
performance. Due to these and other factors, it is likely that the Company's
operating results will be below market analysts' expectations in some future
quarters, which would cause the market price of the Company's stock to decline.
COMPETITIVE "BUSINESS-TO-BUSINESS" INTERNET COMMERCE MARKET; EFFECT ON
MARKET SHARE AND BUSINESS: The market for VSN is very competitive, evolving and
subject to rapid technological change. Intensity of competition is likely to
increase in the future. Increased competition from new competitors is likely to
result in loss of market share, which could negatively impact the Company's
business. Competitors vary in size, and in the scope and breadth of the
products and services offered. VSN will encounter competition from Ariba,
Clarus, Commerce One, GE Information Services, i2 Technologies, Intelisys,
PurchasePro, TRADE'ex Electronic Commerce Systems and other eProcurement
competitors. VSN may also encounter competition from several major enterprise
software developers, such as Oracle, PeopleSoft and SAP who are not presently
considered to be direct competitors, but who have announced intentions to enter
into the market. In addition, because there are relatively low barriers to
entry in this market, additional competition from other established and emerging
companies may develop.
Many current and potential competitors have longer operating histories,
significantly greater financial, technical, marketing and other resources than
the Company, significantly greater name recognition, and a larger installed base
of customers. In addition, many of the competitors have well-established
relationships with the Company's clients and potential clients, and have
extensive knowledge of the industry. Current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address customer
needs. Accordingly, it is possible that new competitors, or alliances among
competitors, may emerge and rapidly acquire significant market share. Actions
taken by the Company competitors, including price cuts, new product
introductions and enhancements could have material adverse consequences for the
Company. There can be no assurance that the Company will be able to compete
with price cuts, or develop, introduce and market enhancements to its service on
a timely basis to compete successfully in this market.
VIRTUAL SOURCE NETWORK REVENUES EXPECTED FROM A LIMITED NUMBER OF CLIENTS,
MEANING INCREASED POTENTIAL IMPACT OF CUSTOMER LOSS: The Company expects that
VSN revenues, if any, during the current fiscal year will come from a small
number of clients, perhaps as few as 20 or less. The loss of customers or a
change in a client's budget could have a substantial negative impact on the
business of the Company.
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VENDORS ARE ESSENTIAL TO SUCCESS OF VIRTUAL SOURCE NETWORK; NEGATIVE IMPACT
OF VENDORS' FAILURE TO JOIN THE NETWORK: In order to operate, VSN requires that
vendors (suppliers) be able to access the network and that client buyers be able
to communicate their requirements electronically to vendors. Currently, vendors
can access VSN even if they have not joined the network, but it is far more
efficient if a vendor does join the network and sets up a catalog online. It is
necessary, furthermore, that a client's key vendors join the network in order to
achieve the full benefits of the system, such as buying from an electronic
catalog. The Company, furthermore, expects that vendors will join VSN upon
invitation from their respective buyers. Network membership is now free for any
vendor. Client buyers operating on VSN make direct requests of their key
vendors that they join. When a large corporation requests that its vendors
adapt to a new purchasing process, and that change is free, the Company believes
that there is a strong incentive for those vendors to make that change to
protect their customer relationships.
To date there has been no significant vendor resistance to joining the new
Internet version of VSN. During 1996 and 1997, however, the Company found
significant vendor resistance to joining the PC version of VSN. Vendors, at the
time, viewed VSN as increasing competitive price pressure. They also saw an
increased possibility of losing customers to lower cost vendors not previously
competing for the business. Additionally, the non-Internet version was more
difficult for vendors to operate.
Since 1997 the Company believes that important changes have occurred in the
procurement environment. Electronic commerce, and the resultant increased
competition, has become more accepted by vendors. It is management's opinion
that most vendors believe that they will eventually be required to do business
electronically, if they have not already started. The Company also believes
that the Internet version of VSN is easier for vendors to use. As a final
incentive, the Company no longer charges subscription fees to vendors. Despite
these changes, there can be no assurance that vendors will not resist
participating in VSN. Should significant new vendor resistance develop, that
could slow adoption of VSN by clients, and negatively impact potential revenues
of the Company.
ABILITY TO ENHANCE FEATURES AND FUNCTIONALITY OF PRODUCTS; CHANGE IN THE
MARKET: The success of the Company will depend on its ability to tailor VSN to
meet the requirements of its clients, not only as such requirements are
presently known and understood by the Company and its client base, but also as
such requirements evolve. Such requirements may be driven by competitive
products or the changing preferences of the Company's client base. An inability
to offer enhanced products or features that anticipate or meet such requirements
in a timely and efficient manner may result in a loss of sales and revenues and
the obsolescence of the Company's products. There can be no assurance that the
Company can make the changes and enhancements to its products necessary to meet
and satisfy the demands of its clients.
In addition, the rapid technological changes and rapidly changing industry
standards, which have characterized the Internet and companies doing business on
the Internet, may have the effect of rendering the Company, its business model
and products obsolete. Making the adjustments, changes and adaptations
necessary in this market may also require significant expenditures in equipment,
infrastructure and product development. There can be no assurance that the
Company will be able to adapt to such rapid changes.
FAILURE TO MAINTAIN ACCURATE DATABASES: The Company must update and
maintain extensive databases of the products, services and procurement network
transactions for its clients. The Company's computer systems and databases must
allow for expansion as a client's business grows without losing performance.
Database capacity constraints may result in data maintenance and accuracy
problems, which could cause a disruption in service and the Company's ability to
provide accurate information to its clients. These problems may result in a
loss of clients that could severely harm the Company's business.
DEFECTS IN SOFTWARE: VSN is complex software. Software often contains
defects, particularly when first introduced or when new versions are released.
The Company's testing procedures may not discover software defects that affect
new or current services or enhancements until after they are deployed. Such
defects could cause service interruptions, which could damage the Company's
reputation or increase its service costs, cause it to lose revenue, delay market
acceptance or divert development resources, any of which could severely harm the
Company's business.
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SYSTEM FAILURES, SERVICE DELAYS AND INTERRUPTIONS: The Company's ability to
provide acceptable levels of customer service largely depends on the efficient
and uninterrupted operation of the Company's computer and communications
hardware and procurement network systems. Any interruptions could severely harm
the Company's business and result in a loss of customers. The Company's
computer and communications systems are located in the state of Washington. The
Company does not maintain a redundant site, although is currently planning to do
so. The Company's systems and operations are vulnerable to damage or
interruption from a variety of sources including human error, sabotage, fire,
flood, earthquake, power loss, telecommunications failure and similar events.
The Company cannot give assurances that it will not experience system failures
in the future. The occurrence of any system failure or similar event could harm
the Company's business dramatically.
INCOMPLETE DISASTER RECOVERY PLAN: The Company has developed a disaster
recovery plan that is still in the implementation process. The Company has
transferred its Web site operations to a facility in Seattle, Washington. The
Bothell, Washington facility will initially serve as backup. A second phase of
the plan will include a dedicated backup facility in another state. Until the
second phase is completed there are risks of localized Internet failure, which
could affect both Seattle and Bothell. The Company is also in the process of
implementing redundancy and other improvements in its internal network
operations. Until these improvements are completed, there will be risks of
periodic network disruptions.
SUBSTANTIAL COSTS OF ANY PRODUCT LIABILITY CLAIMS; NO PRODUCT LIABILITY
INSURANCE: Errors, defects or other performance problems with VSN could result
in financial or other damages to our clients. Management believes that the
contractual limits of liability, indemnification provisions and disclaimers of
warranties should minimize the exposure of the Company in the event of a product
liability claim. A product liability claim, however, even if not successful,
would likely be time consuming and costly and could seriously harm the Company.
The Company presently does not maintain product liability insurance. Although
the terms and conditions in VSN user agreements contain disclaimers of any
warranties designed to limit exposure to these claims, existing or future laws,
or unfavorable judicial decisions, could weaken or negate these provisions and
have materially adverse consequences for the Company.
LEGAL LIABILITY FOR COMMUNICATION ON PROCUREMENT NETWORK: The Company may
be subject to legal claims relating to the content in its procurement network,
or the downloading and distribution of such content. Claims could involve
matters such as fraud, defamation, invasion of privacy and copyright
infringement. Providers of Internet products and services have been sued in the
past, sometimes successfully, based on the content of material. Even if the
Company was ultimately successful in its defense of these claims, any such
litigation is costly and these claims could harm the Company's reputation and
business.
SUCCESS DEPENDS ON KEY PERSONNEL; NO "KEY MAN" LIFE INSURANCE: Future
performance depends on the continued service of key personnel, and the ability
to attract, train, and retain additional technical, marketing, customer support,
and management personnel. The loss of one or more key employees could
negatively impact the Company, and there is no "key man" life insurance in force
at this time. However, the Company does plan to obtain this insurance.
Competition for qualified personnel is intense, and there can be no assurance
that the Company will retain key employees, or attract and retain other needed
personnel.
PROTECTION OF INTELLECTUAL PROPERTY; LACK OF PATENTS; POTENTIAL PIRATING:
The Company's success depends to a large extent on its exclusive technology, and
relies on a combination of contractual provisions, confidentiality procedures,
trade secrets, copyrights and trademark protections. The Company has no patents
at this point, and the Company's technologies may not be patentable. Despite
efforts to protect its exclusive rights, unauthorized parties may attempt to
copy aspects of that technology, or to obtain and use our exclusive information.
Policing unauthorized use of this technology is difficult. While the Company
does not suspect that any of the Company's software has been subject to piracy,
there can be no assurances that such piracy will not occur. Further,
competitors may independently develop similar technology, or duplicate the
Company's services without violating intellectual property rights.
At present, the Company's technologies are owned outright by the Company.
However, the Company may in the future have to license or otherwise obtain
access to intellectual property of third parties in order to remain competitive
in the marketplace.
STRAIN ON LIMITED RESOURCES DUE TO NEED TO MANAGE GROWTH AND EXPANSION: The
Company anticipates a period of significant expansion and growth, which most
likely will place significant strain upon management, employees, systems, and
resources. Because the market is developing rapidly, furthermore, it is
difficult to project the rate of growth, if any. Failure to properly manage
growth and expansion, if and when it occurs, will jeopardize the ability of the
Company sustain its third party and customer relationships. There can be no
assurances that the Company will properly be able to manage growth, especially
if such growth is more rapid than anticipated.
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INABILITY TO ACCURATELY PREDICT USAGE RATES AND DIFFICULTY IN ADAPTING
SYSTEMS IN A TIMELY MANNER: Traffic in the Company's procurement network may
increase to the point where the Company must expand and upgrade some of its
transaction processing systems and procurement network hardware and software.
While the Company's systems are scalable and can be expanded, that flexibility
is limited. The Company may not be able to accurately predict the rate of
increase in the usage of its procurement network. This may affect the Company's
timing and ability to expand and upgrade its systems and procurement network
hardware and software capabilities to accommodate increased use of its
procurement network. If the Company does not upgrade its systems and
procurement network hardware and software in a timely fashion, the Company may
experience downgraded service, interruptions or delays that could damage its
business reputation, relationship with clients and its operating results. It
might also be forced to delay bringing additional customers onto the VSN system
until such upgrades are completed
RISKS OF INTERNATIONAL OPERATION: The Company is exploring international
markets and considering the expansion of its operations and marketing efforts to
include international markets. If the Company should elect to expand into such
markets, it would be confronted with risks including:
- increased impact of recessions in economies outside of the United States
- difficulties staffing and managing foreign operations
- political instability
- the burdens of compliance with a wide variety of foreign laws and legal
regimes
- unexpected changes in regulatory requirements
- tariffs, export controls and other barriers to trade
- potentially adverse tax consequences
- fluctuations in currency exchange rates
- longer payment cycles and difficultiesin collecting accounts receivables
- seasonal fluctuations in business activity
RISKS RELATED TO THE INTERNET AND E-COMMERCE
YEAR 2000 RISK: Management believes that its internally developed systems
and technology are Year 2000 compliant and has so far had no indications that
its products are not Y2K compliant. Nevertheless, because the Company relies on
information technology supplied by third parties, it is still possible that year
2000 problems may yet surface that could adversely affect the Company, although
none have surfaced to date. Further, the Internet itself could face serious
disruptions arising from Year 2000 problems, although none have surfaced to
date. Many potential VSN clients, furthermore, may have implemented policies
that prohibit or strongly discourage making changes or additions to their
internal computer systems until after the impact of Year 2000 has been assessed.
While the Year 2000 issue has generally been considered resolved, there can be
no assurances that the issue will not impact the rate at which VSN will be
implemented inside client organizations.
VOLATILITY IN STOCK PRICE: The stock market and especially the stock prices
of Internet related companies have been very volatile. This volatility may not
be related to the operating performance of the companies. The broad market
volatility and industry volatility may reduce the price of the Company's stock
without regard to the Company's operating performance. The market price of the
company's stock could significantly decrease at anytime due to this volatility.
The uncertainty that results from such volatility can itself depress the market
price of the company's stock.
SUBSTANTIAL COSTS OF ANY SECURITIES LITIGATION COULD DIVERT LIMITED
RESOURCES OF THE COMPANY: In the past, securities class action litigation has
often been brought against a company following periods of volatility in the
market price of its securities. The Company could become a target of similar
securities litigation based upon the volatility of its stock in the marketplace.
Litigation of this type could result in substantial costs and divert
management's attention and resources.
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SUBSTANTIAL COSTS OF ANY INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS: There
has been a substantial amount of litigation in the software industry and the
Internet industry regarding intellectual property rights. It is possible that
in the future, third parties may claim that the Company's technology may
infringe their intellectual property. Management is not aware of any
infringement or claim of infringement by a third party. It is expected,
however, that software product developers and providers of electronic commerce
solutions will increasingly be subject to infringement claims as the number of
products and competitors grows and the functionality of products in different
industry segments overlaps. Any claims, with or without merit, could be
time-consuming and result in costly litigation.
DEPENDENCE UPON, AND RISKS RELATED TO, THE INTERNET: The use of VSN and
other ASP-based products depends on the increased acceptance and use of the
Internet as a medium of commerce and communication. While management believes
that acceptance and use of the Internet will continue to increase at very rapid
rates, there can be no assurances that such increase will continue to develop,
or that use of the Internet as a means of conducting business will continue or
increase. If growth in the use of the Internet does not continue, clients may
not adopt or use these new Internet technologies at the rates or for the
purposes management has assumed. This could, in turn, adversely impact the
Company and the results of its business operations. Further, even if acceptance
and use of the Internet does increase rapidly, but the technology underlying the
Internet and other necessary technology and related infrastructure does not
effectively support that growth, the Company's future would be negatively
impacted.
POTENTIAL BREACHES OF THE COMPANY'S SECURITY SYSTEMS: A significant barrier
to electronic commerce and communications is the secure transmission of
confidential information over public networks. Advances in computer
capabilities, new discoveries in the field of cryptography or other events or
developments could result in compromises or breaches of the Company's security
systems or those of other web sites to protect the Company's exclusive
information. If any well-publicized compromises of security were to occur, it
could have the effect of substantially reducing the use of the web for commerce
and communications. Anyone who circumvents the Company's security measures
could misappropriate its exclusive information or cause interruptions in
services or operations. The Internet is a public network, and data is sent over
this network from many sources. In the past, computer viruses, software
programs that disable or impair computers, have been distributed and have
rapidly spread over the Internet. Computer viruses could theoretically be
introduced into the Company's systems, or those of our clients or vendors, which
could disrupt VSN or another ASP-based product offered by the Company, or make
it inaccessible to clients or vendors. Although language in its user agreement
places responsibility with users to protect VSN from such threats, the Company
may be required to expend significant capital and other resources to protect
against the threat of security breaches or to alleviate problems caused by
breaches. To the extent that the Company's activities may involve the storage
and transmission of exclusive information, such as credit card numbers, security
breaches could expose the Company to a risk of loss or litigation and possible
liability. Despite provisions to the contrary in its user agreements, the
Company's security measures may be inadequate to prevent security breaches, and
the Company's business could be seriously impacted if they are not prevented.
GOVERNMENT REGULATION: As Internet commerce continues to grow, the risk
that federal, state or foreign agencies will adopt regulations covering issues
such as user privacy, pricing, content and quality of products and services,
increases. It is possible that legislation could expose companies involved in
electronic commerce to liability, which could limit the growth of electronic
commerce generally. Legislation could dampen the growth in Internet usage and
decrease its acceptance as a communications and commercial medium. If enacted,
these laws, rules or regulations could limit the market for the Company's
services.
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One or more states, furthermore, may seek to impose sales tax collection
obligations on out-of-state companies like the Company that engage in or
facilitate electronic commerce throughout numerous states. These proposals, if
adopted, could substantially impair the growth of electronic commerce and could
adversely affect the Company's opportunity to derive financial benefit from
these activities.
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
On October 23, 2000, the Company filed a suit in the Superior Court of the
State of California for the County of Los Angeles for fraudulent
misrepresentation, fraudulent concealment, rescission and mutual mistake,
seeking to rescind a contract the Company purportedly entered into with Vitria
Technology, Inc. ("Vitria") in February of this year. Vitria has filed a motion
to transfer venue to Santa Clara County. Although Vitria has not as yet
responded to the substance of the Company's complaint, it is anticipated that
Vitria will deny the substantive allegations in the complaint and seek the award
of monetary damages against the Company for breach of contract. The Company
intends to pursue its claims against Vitria aggressively. However, if the
Company is unsuccessful in this litigation, damages could be awarded against the
Company in excess of $700,000 plus Vitria's legal fees and costs.
There are currently no other legal proceedings involving the Company, and none
threatened. However, because of the rapidly changing environment surrounding the
Internet, and the rapid pace with which new businesses enter or attempt to enter
Internet related businesses, it is possible that disagreements will develop
regarding business names, relationships, markets, technologies, and other
subjects. Any future disagreement could lead to legal action.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the period August 1, 2000 to September 18, 2000, the Company sold
1,672,328 shares of Series 2-A Convertible Preferred Stock to 25 accredited
investors for $10,719,623 less offering costs of $531,792. Each share of
preferred stock is initially convertible into one share of common stock at the
election of the holder, upon an underwritten public offering with aggregate
proceeds to the Company of at least $10 million or upon the election of a
majority of the outstanding shares of preferred stock. No underwriters were
used. Offering costs included transfer agent fees, printing costs, legal fees
and commissions or finders' fees. The offering was a private placement made in
accordance with Regulation D. All of the purchasers were accredited investors.
No form of general solicitation or general advertising was used for any offer or
sale. The investors represented their intention to acquire the shares for
investment purposes only, and not with a view to resale or distribution, and
appropriate restrictive legends were placed on each stock certificate issued
pursuant to this offering.
In connection with the sales of the Series 2-A Convertible Preferred Stock, the
Company has issued warrants to purchase an aggregate 144,881 shares of common
stock at exercise prices ranging from $6.41 to $6.69 as additional finder's fees
and commissions and for other services in connection with the offering. No
underwriters were used, and no commissions were paid. The warrants were issued,
or will be issued, to seven consultants and as a private placement exempt from
registration under Section 4(2) of the Securities Act. The warrant holders
represented their intention to acquire the warrants for investment purposes
only, and not with a view to resale or distribution, and appropriate stop
transfer instructions and restrictive legends indicating the transfer
restrictions will be placed on each warrant and each stock certificate when
issued. Each investor had ample access to the kind of information from the
Company that a registration statement would include.
Upon the Company's reincorporation in Delaware on November 8, 2000, each
share of each class of the Company's predecessor's stock was exchanged for a
substantially similar share of the Company's stock. The Company increased the
number of shares of common stock authorized for issuance to 100,000,000. The
issuance of additional shares of common stock could have the effect of delaying,
deferring or preventing a change in control of the Company, even if such change
in control would be beneficial to the Company's stockholders.
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Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
Item 5. OTHER INFORMATION
On December 14, 2000, the Company entered into an Agreement and Plan of
Merger dated as of the same date, with OTT Acquisition Corp., a California
corporation, Online Transaction Technologies, Inc., a California corporation
("OTT"), Colin P. Kruger and Michael Shirman (the "Merger Agreement"). The
closing of the transactions under the Merger Agreement are expected to occur
later in December 2000 (the "Closing"). The proposed merger is to be a tax-free
reorganization under Section 368(a) of the Internal Revenue Code.
OTT is an Application Service Provider (ASP) that develops and hosts
transaction solutions for public (many to many) and private (one to many)
exchanges. Among the solutions that OTT brings to Vsource is
LiquidMarketplace(TM), a complete suite of fully integrated transaction
solutions, including auctions, fixed-price catalogs and RFQ engines. These
solutions are identified as LiquidAuction(TM), LiquidCatalog(TM) and
LiquidRFP(TM). This suite allows public exchange clients to handle both seller-
and buyer-initiated transactions in their e-Marketplaces. OTT's private
exchange solution, LiquidStore(TM), offers private catalog and auction
functionality to LiquidMarketplace(TM) participants or stand-alone clients. In
addition to offering a complete suite, OTT has developed proprietary modules and
applications that reduce customization and deployment time and simplify
integration.
The aggregate purchase price payable at Closing is to be 1,130,950 shares
of the Company's common stock. The number of shares was calculated from the
Merger Agreement purchase price of $7,000,000, less $77,115 paid as certain
warrants and options, divided by $6.1213 per share ("Acquisition Price", as
calculated from the average closing price of a share of Company common stock for
the 30 calendar days immediately prior to execution of the Merger Agreement).
Such aggregate price shall be subject to adjustment based on reductions or
increases in the net book value of the assets of OTT since September 30, 2000.
In connection with the Closing, two key employees of OTT will enter into
mutually agreeable employment contracts with the Company providing for, among
other things, salaries of $125,000 and options to purchase 100,000 shares of the
Company's common stock which vest over 24 months and have an exercise price of
$6.41 per share.
Twenty-five percent of the equity securities comprising the aggregate
purchase price will be held for six months in an escrow (the "Escrow
Securities"). The Escrow Securities and Company shares issued to OTT management
shareholders will be the sole recourse for the Company for indemnification
against claims and losses arising from breaches by OTT of representations and
warranties or covenants made pursuant to the definitive agreements. Such
representations and warranties shall terminate over varying periods. The Escrow
Securities will be valued for purposes of any such indemnification at the
Acquisition Price. OTT shareholders may at their option pay any such indemnity
in cash in lieu of Escrow Securities.
Closing of the transaction is contingent upon several conditions,
including, without limitation, approval of OTT minority shareholders and warrant
holders.
Item 6. EXHIBIT AND REPORTS ON FORM 8-K
(a) EXHIBITS:
4.3(*) Form of Series 3 Convertible Demand Note incorporated herein by
reference to Exhibit 3.2 to Registrant's Registration Statement
on Form 10-SB filed on September 21, 1999 (SEC File No.
000-26563)
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<PAGE>
4.4(*) Form of Series 2 Convertible Demand Note incorporated herein by
reference to Exhibit 3.3 to Registrant's Registration Statement
on Form 10-SB filed on September 21, 1999 (SEC File No.
000-26563)
4.5(*) Form of Common Stock Purchase Warrant incorporated herein by
reference to Registrant's Form 8-K filed September 26, 2000 (SEC
File No. 000-30326)
10.1(*) Distribution and Marketing Agreement between Vsource, Inc. and
U.S. West Interprise America, Inc. dated February 15, 2000
incorporated herein by reference to Exhibit 10.1 to Registrant's
Form 10-KSB filed May 11, 2000 (SEC File No. 000-30326)
10.2(*) Ventura Professional Center First Amendment to Lease between
Virtual Source, Inc. and Security National Properties, LLC, dated
October 27, 1998 incorporated herein by reference to Exhibit 10.2
to Registrants Form 10-KSB filed May 11, 2000 (SEC File No.
000-30326)
10.3(*) Lease - Razore Land Company, Landlord and Interactive Buyers
Network International, Tenant, dated October 11, 1999
incorporated herein by reference to Exhibit 10.3 to Registrants
Form 10-KSB filed May 11, 2000 (SEC File No. 000-30326)
10.4 Promissory Note by Robert C. McShirley dated October 11, 2000
10.5 Pledge and Security Agreement with Robert C. McShirley dated
October 11, 2000
10.6 Promissory Note by P. Scott Turner dated October 13, 2000
10.7 Promissory Note by Sandford T. Waddell dated September 18, 2000
10.8 Pledge and Security Agreement with Sandford T. Waddell dated
September 18, 2000
10.9 Promissory Note by P. Scott Turner dated September 18, 2000
10.10 Pledge and Security Agreement with P. Scott Turner dated
September 18, 2000
10.11 Agreement and Plan of Merger dated as of December 14, 2000, among
the Company, OTT Acquisition Corp., Online Transaction
Technologies, Inc. and it's Shareholders
27.1 (**) Financial Data Schedule
99.1 (*) Vsource, Inc. 2000 Stock Option Plan incorporated herein by
reference to Exhibit 99.1 to Registrant's Form 10-QSB/A filed
September 25, 2000 (SEC File No. 000-30326)
______________
* Previously filed with Securities and Exchange Commission.
** Filed electronically via EDGAR.
(b) REPORTS ON FORM 8-K
1. Report on Form 8-K dated September 18, 2000 filed on
September 26, 2000.
2. Report on Form 8-K dated October 6, 2000 filed on October
23, 2000.
3. Report on Form 8-K dated October 30, 2000 filed on November
14, 2000.
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<PAGE>
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VSOURCE, INC.
By: /s/ Robert C. McShirley
-----------------------------
Robert C. McShirley
President and Chief Executive Officer
(Principal Executive Officer)
Date: December 15, 2000
By: /s/ Sandford T. Waddell
-----------------------------
Sandford T. Waddell
Chief Financial Officer and Secretary
(Principal Accounting Officer)
Date: December 15, 2000
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<PAGE>
EXHIBIT INDEX
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION NUMBERED PAGE
4.3(*) Form of Series 3 Convertible Demand Note incorporated herein by
reference to Exhibit 3.2 to Registrant's Registration Statement
on Form 10-SB filed on September 21, 1999 (SEC File No.
000-26563)
4.4(*) Form of Series 2 Convertible Demand Note incorporated herein by
reference to Exhibit 3.3 to Registrant's Registration Statement
on Form 10-SB filed on September 21, 1999 (SEC File No.
000-26563)
4.5(*) Form of Common Stock Purchase Warrant incorporated herein by
reference to Registrant's Form 8-K filed September 26, 2000 (SEC
File No. 000-30326)
10.1(*) Distribution and Marketing Agreement between Vsource, Inc. and
U.S. West Interprise America, Inc. dated February 15, 2000
incorporated herein by reference to Exhibit 10.1 to Registrant's
Form 10-KSB filed May 11, 2000 (SEC File No. 000-30326)
10.2(*) Ventura Professional Center First Amendment to Lease between
Virtual Source, Inc. and Security National Properties, LLC, dated
October 27, 1998 incorporated herein by reference to Exhibit 10.2
to Registrants Form 10-KSB filed May 11, 2000 (SEC File No.
000-30326)
10.3(*) Lease - Razore Land Company, Landlord and Interactive Buyers
Network International, Tenant, dated October 11, 1999
incorporated herein by reference to Exhibit 10.3 to Registrants
Form 10-KSB filed May 11, 2000 (SEC File No. 000-30326)
10.4 Promissory Note by Robert C. McShirley dated October 11, 2000
10.5 Pledge and Security Agreement with Robert C. McShirley dated
October 11, 2000
10.6 Promissory Note by P. Scott Turner dated October 13, 2000
10.7 Promissory Note by Sandford T. Waddell dated September 18, 2000
10.8 Pledge and Security Agreement with Sandford T. Waddell dated
September 18, 2000
10.9 Promissory Note by P. Scott Turner dated September 18, 2000
10.10 Pledge and Security Agreement with P. Scott Turner dated
September 18, 2000
10.11 Agreement and Plan of Merger dated as of December 14, 2000, among
the Company, OTT Acquisition Corp., Online Transaction
Technologies, Inc. and it's Shareholders
27.1 (**) Financial Data Schedule
99.1 (*) Vsource, Inc. 2000 Stock Option Plan incorporated herein by
reference to Exhibit 99.1 to Registrant's Form 10-QSB/A filed
September 25, 2000 (SEC File No. 000-30326)
___________________
(1) This exhibit is being filed electronically in the electronic format
specified by EDGAR./foot2
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<PAGE>
