<PAGE> 1
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES EXCHANGE ACT OF 1934
(AMENDMENT NO. )
Filed by the Registrant [x]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[X] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only
(as permitted by Rule 14a-b(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to ss. 240.14a-11( c ) or ss. 240.14a-12
VSI ENTERPRISES, INC.
(Name of Registrant as Specified in its Charter)
NOT APPLICABLE
(Name of Person(s) Filing Proxy Statement if other than Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
1) Title of each class of securities to which transaction applies:________
2) Aggregate number of securities to which transaction applies:___________
3) Per unit price of other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11:1 __________________________________
4) Proposed maximum aggregate value of transaction: ______________________
5) Total fee paid: _______________________________________________________
[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
of the Form or Schedule and the date of its filing.
1) Amount Previously Paid: _______________________________________________
2) Form, Schedule or Registration No.: ___________________________________
3) Filing Party: _________________________________________________________
4) Date Filed: ___________________________________________________________
================================================================================
1 Set forth amount on which the filing fee is calculated and state how it
was determined
<PAGE> 2
May 10, 1999
Dear Shareholders:
Following this letter you will find the proxy statement for the 1999 Annual
Meeting of Shareholders of VSI Enterprises, Inc. Please carefully read the
entire proxy statement and accompanying Annual Report, and vote your shares
either on the enclosed proxy card, via the Internet or by telephone, as detailed
in the instructions on the card.
I ask that you pay special attention to proxy agenda items 2 and 3, in which we
are requesting an amendment to the Company's Certificate of Incorporation for
the purpose of increasing the number of authorized shares of common stock.
Approval of agenda item 2 will provide the Company with 8,000,000 additional
shares of common stock, which will be sufficient to permit the Company to
complete, subject to certain conditions, a restructuring of its outstanding
indebtedness. Approval of agenda item 3 will provide the Company with 25,000,000
additional shares of common stock, which, after giving effect to the shares
proposed to be issued in the debt restructuring, will provide the Company with
17,000,000 additional shares of common stock to pursue acquisitions, financings
and other corporate transactions. THE BOARD OF DIRECTORS AND SENIOR MANAGEMENT
OF THE COMPANY BELIEVE IT IS ESSENTIAL, FOR THE SURVIVAL AND PROSPERITY OF THE
COMPANY, THAT BOTH OF THESE AGENDA ITEMS BE APPROVED BY SHAREHOLDERS.
REGARDING AGENDA ITEM 2
The Company has undertaken a restructuring of its business operations and
balance sheet which, when fully implemented, are intended to achieve profitable
operations, generate positive cash flows and improve prospects for raising
additional equity capital, all of which are essential for increasing the value
of your shares. Thus far, under the leadership of President & CEO Judi North,
VSI has closed an unprofitable subsidiary, drastically reduced operating
expenses, written off impaired and under-performing assets and improved
marketing efforts and sales management. Perhaps most importantly, VSI has
developed an entrepreneurial persona, which makes the Company more realistic
about its current situation and opportunistic with respect to its core
capabilities.
As announced on April 22, 1999 (and as is detailed under "Agenda Item Two" in
the accompanying proxy statement), the Company has entered into an agreement
with the holder of its $900,000 term note due May 16, 1999, that, if
consummated, will enable the Company to retire this debt and to regain control
of its patents, which are being held as collateral for the note. The agreement
replaces the existing debt with cash and equity, the latter in the form of new
shares of VSI common stock. The agreement is conditioned upon, among other
things, the conversion of at least $1 million in VSI's other long-term debt to
new shares of VSI common stock, and the completion of a $1 million private
placement of VSI common stock. Warrants to purchase shares of VSI common stock
will also be issued to all participants in the debt restructuring.
These shares will not be eligible for resale for 12 months, unless the share
price of the Company's stock reaches $1.25 before that time. Also, at no time
can more than 10% of the issued shares be sold in a 30-day period. Thus, while
the number of outstanding shares of VSI common stock will increase if these
transactions are completed, we have attempted to minimize any short-term
disruption in the market for the Company's common stock. We believe this
protects existing shareholders without placing an unreasonable burden on the
participants in the debt restructuring.
By closing the transactions described above, VSI will realize two extremely
important accomplishments. First, VSI can meet its financial obligations and
avoid having to seek protection under federal bankruptcy laws. Second, VSI will
regain control of the patented technology underlying its Omega(TM) product line.
Should VSI default on the $900,000 term note, the note holder will have the
right to sell these patents. There can be no assurance that any subsequent owner
of these patents would license this technology to VSI, thus rendering the
Company unable to sell and service its videoconferencing products.
(OVER)
<PAGE> 3
To Shareholders (continued):
In summary, VSI MUST CLOSE THESE RESTRUCTURING TRANSACTIONS IN ORDER TO SURVIVE
AND PROSPER, AND THEREFORE MUST RECEIVE SHAREHOLDER APPROVAL AUTHORIZING THE
INCREASE IN COMMON SHARES, AS PROPOSED IN AGENDA ITEM 2.
REGARDING AGENDA ITEM 3
As stated above, the Board of Directors and VSI's management team have worked
diligently to develop a business strategy that is both realistic and
opportunistic. VSI's core competency is solving for its customers complex
telecommunications problems, not manufacturing and selling "in-a-box"
videoconferencing systems, a strategy VSI previously pursued. Because VSI
depends, in part, on technology purchased from its competitors, the Company
cannot be competitive at the same gross margin unless the application is
sufficiently complex so as to require significant customization. The Omega(TM)
software enables VSI to integrate complex, multimedia conferencing technologies
at a lower cost and with better results than can the competition.
VSI is focusing on high-end applications and exploring alternative uses of its
core technology capabilities. Additionally, more attention is being placed on
other appropriate opportunities, including possible future acquisitions that
would be accretive to earnings per share.
Which brings me to my point: VSI cannot capitalize on its core strengths if its
hands are tied due to financing constraints. VSI must be able to make
appropriate acquisitions, raise working capital and attract new management team
members by issuing additional shares. Accordingly, agenda item 3 seeks
shareholder approval to increase the number of authorized common shares beyond
those required under agenda item 2. This authorization will allow the Company to
complete the restructuring transactions described under agenda item 2 and give
VSI the flexibility to pursue such other opportunities in a timely and efficient
fashion, without having to call a special shareholders' meeting.
Now is not the time for this Company to fail. Our customer base includes many
sophisticated, satisfied clients who are planning to add to their
videoconferencing networks, and our pipeline of qualified prospects is larger
than ever. Our Omega(TM) architecture continues to be the standard of excellence
in the high-end market, and we are aggressively evaluating other applications
and opportunities to utilize or license Omega's(TM) underlying technology. While
we have a long way to go, we believe that with the steps that have and are being
taken, the Company can become profitable at some point in 1999, for the first
time in five years.
As your new Chairman, I believe there is a future for this Company and an
opportunity to increase its value to you, our shareholders. I am committed to
bringing together and maintaining the right team of management, employees,
directors and advisors necessary to make this happen.
I ASK YOUR HELP IN ACHIEVING THESE GOALS BY VOTING IN FAVOR OF ALL AGENDA ITEMS
ON THE ENCLOSED PROXY. I also encourage you to attend our Annual Meeting of
Shareholders, on Friday, June 11, 1999.
Very truly yours,
Larry M. Carr
Chairman of the Board -- VSI Enterprises, Inc.
<PAGE> 4
VSI ENTERPRISES, INC.
5801 GOSHEN SPRINGS ROAD
NORCROSS, GEORGIA 30071
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD JUNE 11, 1999
The annual meeting of shareholders of VSI Enterprises, Inc. (the
"Company") will be held on Friday, June 11, 1999 at 10:00 a.m., at the Company's
offices, 5801 Goshen Springs Road, Norcross, Georgia 30071, for the following
purposes:
(1) To elect four (4) directors to constitute the Board of
Directors, to serve for a term of one year and until their
successors are elected and qualified;
(2) To approve an amendment to the Company's Certificate of
Incorporation to increase the number of authorized shares of
common stock from 15,000,000 shares to 23,000,000 shares,
which will allow the Company to complete the debt
restructuring transactions described in the accompanying
Proxy Statement;
(3) To approve an amendment to the Company's Certificate of
Incorporation to increase the number of authorized shares of
common stock from 15,000,000 shares to 40,000,000 shares,
which will allow the Company to complete the debt
restructuring transactions described in the accompanying
Proxy Statement and would result in approximately
17,000,000 additional shares of common stock being available
for future issuance by the Company; and
(4) To transact such other business as may properly come before
the meeting or any adjournments or postponements thereof.
Only shareholders of record at the close of business on April 15, 1999
will be entitled to notice of and to vote at the meeting or any adjournments or
postponements thereof.
A Proxy Statement and a proxy solicited by the Board of Directors are
enclosed. Please sign, date and return the proxy promptly; you may also vote by
telephone according to the directions on the proxy card. If you attend the
meeting, you may, if you wish, withdraw your proxy and vote in person.
By Order of the Board of Directors,
Larry M. Carr, Chairman of the Board
Norcross, Georgia
May 10, 1999
PLEASE COMPLETE AND RETURN THE ENCLOSED PROXY PROMPTLY SO THAT YOUR VOTE MAY BE
RECORDED AT THE MEETING IF YOU DO NOT ATTEND PERSONALLY.
<PAGE> 5
VSI ENTERPRISES, INC.
5801 GOSHEN SPRINGS ROAD
NORCROSS, GEORGIA 30071
ANNUAL MEETING OF SHAREHOLDERS
JUNE 11, 1999
-----------------------
PROXY STATEMENT
-----------------------
This Proxy Statement is furnished in connection with the solicitation
of proxies by the Board of Directors of VSI Enterprises, Inc. (the "Company")
for the Annual Meeting of Shareholders to be held on Friday, June 11, 1999, and
any adjournments or postponements thereof, at the time and place and for the
purposes set forth in the accompanying notice of the meeting. The expense of
this solicitation, including the cost of preparing and mailing this Proxy
Statement, will be paid by the Company. In addition to solicitations by mail,
officers and regular employees of the Company, at no additional compensation,
may assist in soliciting proxies by telephone. The Company may also use the
services of a proxy solicitation firm in connection with the solicitation of
proxies. Although the exact cost of these services is not known at this time, it
is anticipated that the cost will not exceed $5,000. This Proxy Statement and
the accompanying proxy are first being mailed to shareholders on or about May
10, 1999. The address of the principal executive offices of the Company is 5801
Goshen Springs Road, Norcross, Georgia 30071.
Any proxy given pursuant to this solicitation may be revoked by any
shareholder who attends the meeting and gives oral notice of his election to
vote in person, without compliance with any other formalities. In addition, any
proxy given pursuant to this solicitation may be revoked prior to the meeting by
delivering to the Secretary of the Company an instrument revoking it or a duly
executed proxy for the same shares bearing a later date. Proxies which are
returned properly executed and not revoked will be voted and will be voted in
accordance with the shareholder's directions specified thereon. Where no
direction is specified, proxies will be voted for the election of the nominees
named below to constitute the entire Board of Directors and for adoption of both
proposals to increase in the number of authorized shares of Common Stock.
Abstentions and broker non-votes will be counted as shares present for purposes
of determining the presence of a quorum but will not be counted as votes cast
for purposes of determining whether the proposals to amend the Certificate of
Incorporation have received sufficient votes for adoption. Since approval of an
amendment to the Certificate of Incorporation requires the affirmative vote of
holders of a majority of shares outstanding, a shareholder who fails to return a
proxy or who abstains from voting on the proposals in his proxy will have
functionally voted against the proposals.
The record of shareholders entitled to vote at the annual meeting was
taken on April 15, 1999. On that date the Company had outstanding and entitled
to vote 12,300,144 shares of common stock, par value $.001 per share (the
"Common Stock"), with each share of Common Stock entitled to one vote.
All share and per share amounts included in this proxy statement have
been adjusted to reflect the effects of a 1-for-4 reverse split of the Company's
Common Stock, effected on January 15, 1999.
<PAGE> 6
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of the Company's Common Stock as of April 15, 1999 by (i)
each person known by the Company to be the beneficial owner of more than five
percent (5%) of the outstanding Common Stock; (ii) each director of the Company;
(iii) the Named Executive Officers (as defined herein); and (iv) all directors
and executive officers of the Company as a group.
<TABLE>
<CAPTION>
Shares
Name of Beneficially Percent
Beneficial Owner Owned(1) of Class
- ---------------- -------- --------
<S> <C> <C>
Larry M. Carr 550,869(2) 4.5%
Julia B. North 78,750(3) *
Harlan D. Platt, Ph.D 29,237(4) *
Edward S. Redstone 913,610(5) 7.4%
Richard W. Egan 6,574(6) *
E. Anthony Godfrey -0-(7) *
All Directors and Executive Officers 1,596,336 12.8%
as a Group (7 persons)
</TABLE>
- ----------
* Less than 1% of outstanding shares.
(1) "Beneficial Ownership" includes shares for which an individual,
directly or indirectly, has or shares voting or investment power or
both and also includes options which are exercisable within sixty days
of the date of this Proxy Statement. All of the listed persons have
sole voting and investment power over the shares listed opposite their
names unless otherwise indicated in the notes below. Beneficial
ownership as reported in the above table has been determined in
accordance with Rule 13d-3 of the Securities Exchange Act of 1934. The
percentages are based upon 12,300,144 shares outstanding, except for
certain parties who hold options to purchase shares which are
exercisable within the next sixty days. The percentages for those
parties who hold presently exercisable options are based upon the sum
of 12,300,144 shares plus the number of options held by them which are
exercisable within the next sixty days, as indicated in the following
notes.
(2) Includes 23,750 shares of Common Stock subject to stock options which
are exercisable within the next sixty days and 62,500 shares of Common
Stock subject to presently exercisable Common Stock Purchase Warrants.
(3) Includes 75,000 shares of Common Stock subject to stock options which
are exercisable within the next sixty days.
(4) Includes 25,000 shares of Common Stock subject to stock options which
are exercisable within the next sixty days, and 1,575 shares of Common
Stock jointly owned by Dr. Platt's spouse.
2
<PAGE> 7
(5) Includes 16,250 shares of Common Stock subject to stock options which
are exercisable within the next sixty days, and 625 shares owned by Mr.
Redstone's spouse. Mr. Redstone's address is 222 Merrimack Street,
Suite 210, Lowell, Massachusetts 01852.
(6) Includes 4,074 shares of Common Stock subject to stock options which
are exercisable within the next sixty days.
(7) Mr. Godfrey resigned from his positions as Chief Financial Officer &
Secretary on January 5, 1999. All options held by Mr. Godfrey expired
on or before April 5, 1999 without being exercised.
AGENDA ITEM ONE
ELECTION OF DIRECTORS
The Board of Directors of the Company consists of four directors. The
Company's By-Laws provide that the Board of Directors shall consist of not less
than three nor more than seven members, the precise number to be determined from
time to time by the Board of Directors. The number of directors has been set at
four by the Board. The Board of Directors recommends the election of the four
nominees listed below.
Each of the nominees has consented to being named in this Proxy
Statement and to serve as a director of the Company if elected. In the event
that any nominee withdraws or for any reason is not able to serve as a director,
the proxy will be voted for such other person as may be designated by the Board
of Directors, but in no event will the proxy be voted for more than four
nominees. The affirmative vote of a plurality of all votes cast at the meeting
by the holders of the Common Stock is required for the election of the four
nominees standing for election. Management of the Company has no reason to
believe that any nominee will not serve if elected.
Each of the following persons has been nominated by management for
election to the Board of Directors to succeed themselves for a term of one year
and until their successors are elected and qualified:
Larry M. Carr. Mr. Carr, age 55, has been a director of the Company
since June 1994. Mr. Carr founded Nursefinders, Inc., a temporary services
company in the healthcare industry, in 1974. Although Mr. Carr's interest in
this company was acquired by Adia Services, Inc., Mr. Carr still owns and
operates numerous Nursefinders franchises and assists in the administration and
management of several other franchises through an entity known as Management
Services, Inc. Mr. Carr is Chairman of the Board of Northwest National Bank,
located in Arlington, Texas, and is a director of several privately held
companies, including OHA Financial, Inc., Trinity Airweights, LLC and
Computerized Healthcare, Inc.
Julia B. North. Ms. North, age 51, has served as President and Chief
Executive Officer and as a director of the Company since October 1997. Ms. North
served in various capacities with BellSouth Corporation from 1972 to October
1997, including most recently as President of its Consumer Services Division.
Ms. North is a director of Winn-Dixie Stores, Inc., a food retailer,
ChoicePoint, Inc., a provider of risk management services, and Wisconsin Energy
Corp., a holding company with subsidiaries in utility and non-utility
businesses.
Harlan D. Platt, Ph.D. Dr. Platt, age 48, has been a Professor of
Finance in the College of Business Administration at Northeastern University in
Boston since 1981. His research interests are in the areas of corporate renewal
and turnaround management. Dr. Platt is the author of three books, with
3
<PAGE> 8
the most recent Principles of Corporate Renewal published in April 1998 by the
University of Michigan Press. Dr. Platt serves on the Board of Directors of
Prospect Street High Income Portfolio, Inc., and is the president of 911RISK
Inc., which develops predictive models of corporate distress. He is also the
faculty dean of the Turnaround Management Association.
Edward S. Redstone. Mr. Redstone, age 70, has been a director of the
Company since July 1996. Mr. Redstone has been a private investor since 1994.
From 1984 to 1994, he served as Chairman of the Board of Martha's Vineyard
National Bank.
There are no family relationships between any director or executive
officer and any other director or executive officer of the Company.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's directors, executive officers and persons who own more than 10% of the
outstanding Common Stock of the Company to file with the Securities and Exchange
Commission reports of changes in ownership of the Common Stock of the Company
held by such persons. Officers, directors and greater than 10% shareholders are
also required to furnish the Company with copies of all forms they file under
this regulation. To the Company's knowledge, based solely on a review of the
copies of such reports furnished to the Company and representations that no
other reports were required, during the year ended December 31, 1998, all
Section 16(a) filing requirements applicable to its officers, directors and
greater than 10% shareholders were complied with, except that Richard W. Egan
and Richard C. Mays each failed to timely file their respective Initial
Statement of Beneficial Ownership (Form 3).
Although it is not the Company's obligation to make filings pursuant to
Section 16 of the Securities Exchange Act of 1934, the Company has adopted a
policy requiring all Section 16 reporting persons to report monthly to the Chief
Financial Officer of the Company as to whether any transactions in the Company's
securities occurred during the previous month.
MEETINGS OF THE BOARD OF DIRECTORS
AND COMMITTEES OF THE BOARD
The Board of Directors held 14 meetings during the year ended December
31, 1998. Each director attended at least 75% or more of the aggregate number of
meetings held by the Board of Directors and the committees on which he or she
served. The Company's Board of Directors has four standing committees -- the
Executive Committee, the Audit Committee, the Compensation Committee and the
Stock Option Committee. The Board of Directors does not have a standing
nominating committee, such function being reserved to the full Board of
Directors.
The Executive Committee presently consists of Larry M. Carr and Edward
S. Redstone. The Executive Committee exercises the authority of the Board of
Directors in accordance with the By-Laws of the Company between meetings of the
Board. The Executive Committee did not meet during the year ended December 31,
1998.
4
<PAGE> 9
The Audit Committee presently consists of Harlan D. Platt, Ph.D.
(Chairman), Larry M. Carr and Edward S. Redstone. The Audit Committee has been
assigned the principal functions of: (i) recommending the independent auditors;
(ii) reviewing and approving the annual report of the independent auditors;
(iii) approving the annual financial statements; and (iv) reviewing and
approving summary reports of the auditors' findings and recommendations. The
Audit Committee held one meeting during the year ended December 31, 1998.
The Compensation Committee presently consists of Larry M. Carr
(Chairman), Edward S. Redstone and Julia B. North. The Compensation Committee
has been assigned the functions of approving and monitoring the remuneration
arrangements for senior management and establishing the targets that determine
awards payable under the Company's incentive compensation plan. The Compensation
Committee held one meeting during the year ended December 31, 1998.
The Stock Option Committee presently consists of Edward S. Redstone
(Chairman) and Larry M. Carr. The Stock Option Committee has been assigned the
functions of administering the Company's Stock Option Plans and Employee Stock
Purchase Plan and granting options thereunder. The Stock Option Committee held
three meetings during the year ended December 31, 1998.
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION HELD
---- --- -------------
<S> <C> <C>
Julia B. North 51 President and Chief Executive Officer
Richard W. Egan 33 Executive Vice President - Global Sales
Richard C. Mays 42 Vice President and Chief Technical Officer
Emmett H. Reed 48 Vice President - Operations and Service
</TABLE>
Executive officers are chosen by and serve at the discretion of the
Board of Directors of the Company. Executive officers will devote their full
time to the affairs of the Company. See "Election of Directors" for information
with respect to Julia B.
North.
Richard W. Egan. Mr. Egan joined the Company in June 1995 and, since
February 1, 1998, has served as Executive Vice President - Global Sales. From
July 1996 until February 1998 he served as National Account Manager, and from
June 1995 until July 1996 as Regional Sales Director. He was previously employed
as Eastern Region Sales Manager for DBA Software and as Account Manager for
Training America/Goal Systems.
Richard C. Mays. Mr. Mays joined the Company in April 1993 and, since
February 1, 1998, has served as Vice President and Chief Technical Officer. From
April 1993 until September 1994, he served as Lead Software Engineer, and from
September 1994 until April 1996 as Software Development Manager.
Emmett H. Reed. Mr. Reed joined the Company in September 1989 and,
since August 1998, has served as Vice President - Operations and Service. He
served as Director of Service from April 1997 until August 1998. Previously, Mr.
Reed had worked in a variety of capacities for the Company, including Senior
Network Engineer, Sales Engineer, Installation Manager, Customer Service Manager
and Test Technician.
5
<PAGE> 10
EXECUTIVE COMPENSATION
The following table provides certain summary information for the fiscal
years ended December 31, 1998, 1997 and 1996 concerning compensation paid or
accrued by the Company to or on behalf of the Company's Chief Executive Officer
and the other executive officers of the Company whose total annual salary and
bonus exceeded $100,000 during the year ended December 31, 1998 (the "Named
Executive Officers").
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE LONG TERM
ANNUAL COMPENSATION COMPENSATION
--------------------------------------------------- ------------
OTHER NUMBER OF
NAME AND ANNUAL OPTIONS
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDED
- ------------------ ---- ------ ----- ------------ -------
<S> <C> <C> <C> <C> <C>
Julia B. North ............ 1998 $161,539 $ -- $1,538 12,500
President and Chief 1997(1) 32,000 -- -- 112,500
Executive Officer
Richard W. Egan ........... 1998(2) $132,553(3) -- $ 769 25,000
Executive Vice President
-- Global Sales
E. Anthony Godfrey ........ 1998(4) $101,538 $5,850 $1,106 12,500
Chief Financial Officer & 1997 62,731 4,433 963 --
Secretary
</TABLE>
- ----------
(1) Ms. North joined the Company in October 1997.
(2) Mr. Egan was named Executive Vice President - Global Sales on January
31, 1998.
(3) Includes sales commissions of $53,995.
(4) Mr. Godfrey served as Chief Financial Officer and Secretary of the
Company from November 1997 until January 5, 1999, when he resigned
those positions.
DIRECTORS' FEES
The Company's present policy is not to pay any cash compensation to
directors who are also employees of the Company for their services as directors.
Each non-employee director of the Company receives an automatic grant of options
to purchase 3,750 shares of Common Stock on each January 5. Each non-employee
director of the Company also receives $500 for each Board meeting attended, plus
reimbursement of travel and other expenses incurred in connection with the
performance of their duties.
In addition, all new non-employee directors of the Company receive a
one-time grant of an option to purchase 5,000 shares of Common Stock at an
exercise price equal to the fair market value of such stock on the date of
grant. Such options expire, unless previously exercised or terminated, ten years
from the date of grant.
6
<PAGE> 11
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee of the Board of Directors is currently
comprised of Larry M. Carr, Edward S. Redstone and Julia B. North. With the
exception of Ms. North, who serves as President & Chief Executive Officer of the
Company, none of the members of the Compensation Committee served as an officer
or employee of the Company or any of its subsidiaries during fiscal 1998. Except
as set forth below, there were no material transactions between the Company and
any of the members of the Compensation Committee during fiscal 1998.
On February 18, 1998, Edward S. Redstone, a director of the Company,
loaned $500,000 to the Company in order to provide the Company with short-term
liquidity. This loan was repaid in full on February 27, 1998, including accrued
interest of $1,045.
In connection with private placement transactions by the Company in
1998, Messrs. Carr and Redstone purchased 18-month term notes on October 1, 1998
in the amount of $400,000 and $200,000, respectively. Interest accrues on the
outstanding principal indebtedness at a rate per annum equal to three percent in
excess of the prime rate. In addition, Messrs. Carr and Redstone were granted
50,000 and 25,000 warrants, respectively, to purchase shares of Common Stock of
the Company. The warrants will have a term of five years, expiring on October 1,
2003, and will become exercisable on April 1, 2000 at an exercise price of $1.68
per share. The term notes were purchased and warrants received by these
directors on the same terms as were offered to other investors.
STOCK OPTION PLAN
The Company, by action of its Board of Directors, adopted the 1991
Stock Option Plan (the "1991 Plan") for officers, directors and employees of the
Company or of a wholly-owned subsidiary of the Company. The 1991 Plan was
approved by the shareholders of the Company on October 10, 1991. In July 1992,
the 1991 Plan was amended to, among other things, provide for the automatic
grant of options to the Company's non-employee directors, to increase the number
of shares of Common Stock available for grant thereunder and to expand the class
of persons eligible to receive options under the 1991 Plan to include employees
of majority-owned subsidiaries of the Company. In November 1993, the 1991 Plan
was further amended to expand the class of persons eligible to receive options
under the 1991 Plan and to increase the number of shares of Common Stock
available for grant thereunder. The 1991 Plan, as amended by the shareholders of
the Company on May 19, 1998, provides for the grant of options to purchase up to
an aggregate of 915,514 shares of the Company's Common Stock. Under the terms of
the 1991 Plan, the Stock Option Committee of the Board of Directors may grant
options to purchase shares of Common Stock to officers, directors and employees
of the Company or of a subsidiary of the Company.
The following table provides certain information concerning individual
grants of stock options under the Company's 1991 Stock Option Plan made during
the year ended December 31, 1998 to the Named Executive Officers:
7
<PAGE> 12
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------------------------- POTENTIAL REALIZABLE
% OF TOTAL VALUE AT ASSUMED
OPTIONS EXERCISE ANNUAL RATES OF STOCK
GRANTED TO OR BASE PRICE APPRECIATION FOR
OPTIONS EMPLOYEES PRICE OPTION TERM(1)
GRANTED IN FISCAL ($ PER EXPIRATION ----------------------
NAME (#) YEAR SHARE) DATE 5% 10%
---- --- ---- ------ ---- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Julia B. North ... 12,500(2) 7.9 $1.000 12/21/08 $ 7,861 $19,922
Richard W. Egan .. 12,500(3) 7.9 2.876 6/16/08 22,609 57,295
12,500(4) 7.9 1.000 12/21/08 7,861 19,922
E. Anthony Godfrey 12,500(5) 7.9 2.876 6/16/08 22,609 57,295
</TABLE>
- ----------
(1) The dollar amounts under these columns represent the potential
realizable value of each grant of option assuming that the market price
of the Company's Common Stock appreciates in value from the date of
grant at the 5% and 10% annual rates prescribed by the SEC and
therefore are not intended to forecast possible future appreciation, if
any, of the price of the Company's Common Stock.
(2) Option is fully vested.
(3) Options vest as follows: 4,167, 4,167 and 4,166 shares on each of June
16, 1999, 2000 and 2001, respectively.
(4) Options vest as follows: 4,167, 4,167 and 4,166 shares on each of
December 21, 1999, 2000 and 2001, respectively.
(5) Options vest as follows: 4,167, 4167 and 4,166 shares on each of June
16, 1999, 2000 and 2001, respectively. Mr. Godfrey resigned his
positions as Chief Financial Officer and Secretary on January 5, 1999.
Accordingly, options granted to him in 1998 expired without being
exercised.
The following table provides certain information concerning the value of
unexercised options held by the Named Executive Officers under the Company's
Stock Option Plans as of December 31, 1998. No options were exercised by any of
the Named Executive Officers during 1998.
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN-THE-
OPTIONS AT FISCAL YEAR MONEY OPTIONS AT FISCAL
END YEAR END (A)
--- ------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Julia B. North ... 75,000 50,000 $ -- $ --
Richard W. Egan .. 4,074 27,168 -- --
E. Anthony Godfrey 22,916 12,500 -- --
</TABLE>
8
<PAGE> 13
- ----------
(a) Dollar values were calculated by determining the difference between the fair
market value of the underlying securities at year-end ($1.00 per share) and the
exercise price of the options.
CERTAIN TRANSACTIONS
Reference is made to "Executive Compensation - Compensation Committee
Interlocks and Insider Participation" for information regarding certain
transactions between the Company and each of Larry M. Carr and Edward S.
Redstone, directors of the Company, during fiscal 1998.
STOCKHOLDER RETURN PERFORMANCE GRAPH
Set forth below is a line graph comparing the yearly percentage change in
the cumulative total stockholder return on the Company's Common Stock against
the cumulative total return of the Nasdaq Stock Market Index and the Nasdaq
Electronics Components Stock Index for the period commencing on December 31,
1993 and ending December 31, 1998 (the "Measuring Period"). The graph assumes
that the value of the investment in the Company's Common Stock and each index
was $100 on December 31, 1993. The yearly change in cumulative total return is
measured by dividing (i) the sum of (a) the cumulative amount of dividends for
each fiscal year, assuming dividend reinvestment, and (b) the change in share
price between the beginning and end of the Measuring Period, by (ii) the share
price at the beginning of the Measuring Period. The Company has not paid any
cash dividends.
COMPARISON OF CUMULATIVE TOTAL RETURN AMONG
VSI ENTERPRISES, INC., NASDAQ STOCK MARKET INDEX AND
NASDAQ ELECTRONICS COMPONENTS STOCK INDEX
<TABLE>
<CAPTION>
NASDAQ
NASDAQ ELECT.
MEASUREMENT PERIOD STOCK MARKET COMPONENTS
(FISCAL YEAR COVERED) VSI ENTERPRISES, INC. INDEX S.I.
- --------------------- --------------------- ----- ----
<S> <C> <C> <C>
12/31/93 100 100 100
12/30/94 61 98 110
12/29/95 45 138 183
12/31/96 137 170 316
12/31/97 76 209 332
12/31/98 9 294 513
</TABLE>
ASSUMES $100 INVESTED ON DECEMBER 31, 1993 IN VSI ENTERPRISES, INC.
COMMON STOCK, NASDAQ STOCK MARKET INDEX AND
NASDAQ ELECTRONICS COMPONENTS STOCK INDEX
9
<PAGE> 14
REPORT OF COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION
During the year ended December 31, 1998, the Compensation Committee of the
Board of Directors was comprised of two non-employee members and one employee
member of the Board. The Compensation Committee is responsible for: (i) setting
the Company's compensation philosophy and policies; (ii) setting the terms and
the administration of compensation plans for officers of the Company; (iii)
review and approval of pay recommendations for the executive officers of the
Company; and (iv) initiation of all compensation actions for the Chief Executive
Officer of the Company.
The Company's compensation policies have been designed to align the
financial interests of the Company's management with those of its stockholders,
and reflect the nature of the Company by taking into account the Company's
operating environment and the expectations for growth and enhanced
profitability. Compensation for each of the Company's executive officers
consists of a base salary, discretionary performance bonus and stock options.
The Company does not currently provide executive officers with other long-term
incentive compensation other than the ability to contribute their earnings to
the Company's 401(k) Plan.
The Compensation Committee's philosophy is that the predominant portion of
an executive's compensation should be based directly upon the value of long-term
incentive compensation in the form of stock options. The Compensation Committee
believes that providing executives with the opportunities to acquire significant
stakes in the growth and prosperity of the Company (through grants of stock
options), while maintaining other elements of the Company's compensation program
at conservative levels, will enable the Company to attract and retain executives
with the outstanding management abilities and entrepreneurial spirit which are
essential to the Company's ongoing success. Furthermore, the Compensation
Committee believes that this approach to compensation motivates executives to
perform to their full potential.
At least annually, the Compensation Committee reviews salary
recommendations for the Company's executives (other than the Chief Executive
Officer) and then approves such recommendations, with any modifications it has
deemed appropriate. The annual salary recommendations are made under the
ultimate direction of the Chief Executive Officer, based on peer group and
national industry surveys of total compensation packages, as well as evaluations
of the individual executive's past and expected future performance. Similarly,
the Compensation Committee fixes the base salary of the Chief Executive Officer
based on a review of competitive compensation data, the Chief Executive
Officer's overall compensation package, and the Compensation Committee's
assessment of his or her past performance and its expectation as to his future
performance in leading the Company. Generally, such salaries have been below
levels paid to executives with comparable qualifications, experience and
responsibilities at other similarly situated companies.
The Compensation Committee also determines, based upon the recommendation
of the Chief Executive Officer, the annual bonus, if any, to be paid to
executive officers (other than the Chief Executive Officer). The amount of each
individual bonus is determined based upon an evaluation of such factors as
individual performance, increases in the Company's revenue, net income, net
income per share and market penetration, as well as improvements in operating
efficiencies. The assessment of performance achievement is considered in
relation to the maximum normal bonus opportunity, which is paid for
10
<PAGE> 15
achieving outstanding levels of performance. The Compensation Committee applies
similar criteria in setting the amount of annual bonus, if any, earned by the
Chief Executive Officer.
Stock options represent a substantial portion of compensation for the
Company's executive officers, including the Chief Executive Officer. Stock
options are granted at the prevailing market price on the date of grant, and
will only have value if the Company's stock price increases. Generally, option
grants vest in equal amounts over a period of three years (although certain
special types of grants may vest either immediately or over a shorter period)
and executives must be employed by the Company at the time of vesting in order
to exercise the options. Grants of stock options generally are based upon the
level of the executive's position with the Company and an evaluation of the
executive's past and expected future performance. The Compensation Committee
believes that dependence on stock options for a significant portion of
executives' compensation more closely aligns such executives' interests with
those of the Company's stockholders, since the ultimate value of such
compensation is linked directly to stock price.
In the year ended December 31, 1998, the Company granted: its Chief
Executive Officer Julia B. North options to purchase 12,500 shares of the
Company's Common Stock; its Chief Financial Officer E. Anthony Godfrey options
to purchase 12,500 shares of the Company's Common Stock; its Executive Vice
President-Global Sales Richard W. Egan options to purchase 25,000 shares of the
Company's Common Stock; its Vice President-Operations Emmett H. Reed options to
purchase 18,750 shares of the Company's Common Stock; and its Chief Technical
Officer Richard C. Mays options to purchase 12,500 shares of the Company's
Common Stock.
The Compensation Committee continually evaluates the Company's compensation
policies and procedures with respect to executives. Although the Compensation
Committee believes that current compensation policies have been successful in
aligning the financial interests of executive officers with those of the
Company's stockholders and with Company performance, it continues to examine
what modifications, if any, should be implemented to further link executive
compensation with both individual and Company performance.
Larry M. Carr, Chairman
Edward S. Redstone
Julia B. North
Notwithstanding anything to the contrary set forth in any of the Company's
previous filings under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended, that might incorporate future filings,
including this Proxy Statement, in whole or in part, the foregoing Report of
Compensation Committee on Executive Compensation and the Stockholder Return
Performance Graph shall not be incorporated by reference into any such filings.
11
<PAGE> 16
AGENDA ITEM TWO
PROPOSAL TO AMEND CERTIFICATE OF INCORPORATION
TO INCREASE AUTHORIZED COMMON STOCK TO 23,000,000 SHARES
GENERAL
On April 21, 1999, the Company entered into an agreement with Thomson
Kernaghan & Co., Ltd. ("Thomson Kernaghan") to restructure, subject to certain
conditions, a $900,000 term note held by Thomson Kernaghan. This note matures on
May 16, 1999 and is secured by the Company's patents. As of April 1, 1999,
approximately $1,007,000 was outstanding under the note, including accrued
interest and penalties. As described below, the restructuring of the note would
involve (i) the issuance of shares of common stock of the Company to Thomson
Kernaghan, (ii) the issuance of common stock purchase warrants to Thomson
Kernaghan, (iii) the similar restructuring of not less than $1.0 million of
other indebtedness of the Company through the issuance of shares of common stock
and warrants, and (iv) the receipt by the Company of not less than $1.0 million
in new equity capital, which would require the issuance of shares of common
stock and warrants. The completion of these transactions will require the
Company to issue up to 5,000,000 shares of common stock and to reserve an
additional 3,000,000 shares of common stock for subsequent issuance upon the
exercise of warrants issued in connection therewith. The actual number of shares
and warrants issued could be less, depending on the price of the Company's
common stock at the time of the closing of the transactions.
The Company currently has approximately 1,600,000 shares of common
stock available for issuance. As a consequence, in order to complete these
transactions, the Certificate of Incorporation of the Company must be amended to
increase the number of shares of common stock available for issuance.
Accordingly, the following resolution will be introduced at the Annual Meeting:
RESOLVED: That Section 5.01 of the Certificate of Incorporation, as
heretofore added to or amended by certificates filed pursuant to law, is amended
to read in its entirety as follows:
"5.01 Authorized Shares. The aggregate number of shares which
the Company shall have authority to issue is Twenty-Three
Million Eight Hundred Thousand (23,800,000). Twenty-Three
Million (23,000,000) shares shall be designated 'Common Stock'
and shall have a par value of $.001. Eight Hundred Thousand
(800,000) shares shall be designated 'Preferred Stock' and
shall have a par value of $.00025. All shares of the Company
shall be issued for such consideration, as expressed in
dollars, as the Board of Directors may from time to time
determine."
The Board of Directors recommends that shareholders approve the
proposed amendment to the Company's Certificate of Incorporation because it
considers the proposal to be in the best long-term and short-term interests of
the Company, its shareholders and its other constituencies.
BACKGROUND
On February 23, 1998, the Company issued $3.0 million of 5% convertible
debentures due February 2000 to Thomson Kernaghan. The proceeds of the
debentures were utilized by the Company
12
<PAGE> 17
for working capital purposes and to allow the Company to deliver two large
customer orders. The debentures were convertible into shares of common stock of
the Company at the option of the holder at the lesser of (i) $8.00 per share or,
(ii) 85% of the average closing bid price of the Company's common stock.
Shortly after the debentures were issued, the Company's stock price
began to decline. Management of the Company believed that this decline was due
to, among other things, a decrease in demand for the stock resulting from
uncertainty in the investment community as to the potential dilution upon
conversion of the debentures. In an attempt to eliminate the overhang presented
by the debentures, the Company redeemed $1,040,000 of the debentures in October
1998. This redemption was funded from the proceeds of a private placement of
$1.3 million of term notes to accredited investors. These notes mature on March
31, 2000 and accrue interest at an annual rate of prime plus 3%. In November
1998, the Company redeemed an additional $400,000 of the debentures and
converted the remaining debentures to a $900,000 term note.
The $900,000 term note issued to Thomson Kernaghan matures on May 16,
1999 and accrues interest at an annual rate of 14%. The note is secured by the
Company's seven patents. The Company has not paid a $300,000 installment of
principal under the note, which installment was due February 16, 1999. The
failure to make this repayment subjected the Company to a $30,000 per month
penalty until the full balance is repaid. If the Company does not repay the note
by May 16, 1999, the Company will be obligated to pay Thomson Kernaghan an
additional $30,000 on the 16th of each month until the debt is paid.
Additionally, Thomson Kernaghan may take possession of the Company's patents,
which have been pledged as collateral for this debt.
TERMS OF THE DEBT RESTRUCTURING
The restructuring of the note issued to Thomson Kernaghan involves a
cash payment by the Company of $150,000 and the issuance of up to 1,500,000
shares of common stock of the Company to Thomson Kernaghan to repay the balance
of the note. Shares to be issued to Thomson Kernaghan will be valued at the
greater of (i) the average closing price of the common stock of the Company for
the ten trading days immediately preceding closing, or (ii) $0.67 per share.
Thomson Kernaghan will also receive warrants to purchase up to 300,000 shares of
common stock, as follows: (a) a warrant to purchase one share of common stock,
exercisable for a term of five years at a price of $1.00 per share, for each
$4.00 of principal and interest retired (less the $150,000 cash payment), and
(b) a warrant to purchase one share of common stock, exercisable for a term of
five years at a price of $1.50 per share, for each $12.00 of principal and
interest retired (less the $150,000 cash payment).
The agreement with Thomson Kernaghan requires the Company to file with
the Securities and Exchange Commission, on or before the closing date, a
registration statement covering the shares of common stock to be issued to
Thomson Kernaghan in exchange for the repayment of the note, as well as shares
issuable upon exercise of the warrants granted to Thomson Kernaghan. The Company
has agreed to cause such registration statement to become effective as soon as
possible after the closing date, but in no event later than 90 days following
the closing date. Notwithstanding such registration, Thomson Kernaghan has
agreed not to sell any shares for a period of one year after the closing date
and, thereafter, Thomson Kernaghan will not, during any period of 30 consecutive
days, sell more than 10% of the shares issued to it; provided that, commencing
30 days following the closing, during any period of 30 consecutive days, sales
of no more than 10% of the shares issued to it may be made by Thomson Kernaghan
if (i) closing price for the common stock equals or exceeds $1.25 per share for
each of the five trading days immediately preceding the sale and (ii) any such
sale by Thomson Kernaghan is at a price which equals or exceeds $1.25 per share.
13
<PAGE> 18
Completion of the transactions contemplated by the agreement with
Thomson Kernaghan is subject, among other things, to
- - approval by the shareholders of the Company of an amendment to the
Certificate of Incorporation to increase the number of authorized
shares of common stock to an amount sufficient to complete the
transactions contemplated by the agreement,
- - the agreement of the holders of not less than $1.0 million of term
notes to similarly restructure their debt to the Company,
- - the receipt of not less than $1.0 million in new equity capital, and
- - closing on or before July 15, 1999.
REASONS FOR AND EFFECT OF THE DEBT RESTRUCTURING
The failure of the Company to restructure its indebtedness to Thomson
Kernaghan would result in the Company being unable to repay this debt when it
comes due on May 16, 1999. The failure of the Company to timely repay this
indebtedness may result in Thomson Kernaghan taking possession of or selling the
Company's patents, which have been pledged by the Company as collateral for this
debt. If Thomson Kernaghan takes possession of or sells the patents, the Company
no longer has any rights in the technology described therein. To continue to be
able to sell and service its videoconferencing products, which embody the
technology covered by the patents, the Company will be required to license this
technology from Thomson Kernaghan or any subsequent owner. There can be no
assurance that any such license will be granted on commercially reasonable terms
or at all. Accordingly, if the Company is unable to restructure its debt with
Thomson Kernaghan, and is unable to license the technology covered by the
patents on commercially reasonable terms, it will be unable to sell and service
its videoconferencing products, in which event, the Company may seek protection
under federal bankruptcy laws.
In order to avoid a default under the note issued to Thomson Kernaghan,
the Board of Directors has determined the agreement to restructure the note to
be in the best interests of the Company and its shareholders.
If consummated, the transactions contemplated by the agreement with
Thomson Kernaghan will result in a reduction of not less than $2.0 million in
the Company's current indebtedness, resulting in a stronger balance sheet and
reducing interest expense.
These transactions, however, will result in the immediate issuance of
up to 5,000,000 shares of common stock of the Company, which represent
approximately 41% of the Company's currently outstanding shares. Giving effect
to the exercise of the warrants to be issued in connection with the debt
restructuring, up to an additional 3,000,000 shares of common stock would be
issued, which would collectively represent approximately 65% of the Company's
currently outstanding shares. The issuance of these additional shares would
substantially dilute the ownership interest of the Company's existing
shareholders.
The Company has agreed to register these shares for resale and, subject
to certain restrictions described above, a portion of such shares can be sold
beginning 30 days after the effectiveness of such registration. Sales and
potential sales of substantial amounts of common stock of the Company in the
public market could adversely affect the prevailing market prices for the common
stock and impair the
14
<PAGE> 19
Company's ability to raise additional capital through the sale of equity
securities.
Even if the proposed amendment to the Certificate of Incorporation is
approved by the Company's shareholders, all of the other conditions contained in
the debt restructuring agreement with Thomson Kernaghan will need to be
satisfied. One of such conditions is the restructuring of not less than $1.0
million of other indebtedness. The Company is currently in discussions with the
holders of its term notes due March 31, 2000 regarding the restructuring of this
debt. To date, the holders of approximately $800,000 of these term notes have
indicated to the Company that they intend to agree to the debt restructuring.
There can be no assurance that the transactions contemplated by the agreement
with Thomson Kernaghan will be consummated.
If the proposed amendment to the Certificate of Incorporation is
approved by the Company's shareholders, the Company intends to immediately file
a Certificate of Amendment with the Delaware Secretary of State to effect the
increase in authorized shares. Accordingly, if the proposed debt restructuring
is not completed, these additional shares will be available for other corporate
purposes.
VOTE REQUIRED
The approval of the holders of a majority of the issued and outstanding
shares of Common Stock of the Company is required for the adoption of the
proposed amendment to the Certificate of Incorporation. THE BOARD OF DIRECTORS
RECOMMENDS THAT THE COMPANY'S SHAREHOLDERS APPROVE THE PROPOSED AMENDMENT TO THE
CERTIFICATE OF INCORPORATION.
15
<PAGE> 20
AGENDA ITEM THREE
PROPOSAL TO AMEND CERTIFICATE OF INCORPORATION
TO INCREASE AUTHORIZED COMMON STOCK TO 40,000,000 SHARES
In addition to the 8,000,000 additional shares of authorized common
stock required to complete the transactions described under "Agenda Item Two"
herein, the Board of Directors deems it advisable to have additional shares of
common stock available for issuance in connection with any possible future
transactions approved by the Board of Directors, including, among others,
acquisitions, financings and other corporate transactions. If the transactions
described under "Agenda Item Two" herein are completed, approval of the proposal
set forth in this agenda item would result in approximately 17,000,000
additional shares of common stock being available for future issuance by the
Company.
Approval of this agenda item would result in sufficient shares being
authorized so as to permit the Company to complete the transactions described
under "Agenda Item Two" herein. Accordingly, your attention is directed to the
discussion under "Agenda Item Two."
At a meeting of the Board of Directors of the Company on March 23,
1999, the directors approved an amendment to Section 5.01 of the Company's
Certificate of Incorporation, as amended (the "Certificate of Incorporation"),
to increase the number of authorized shares of Common Stock of the Company from
15,000,000 to 40,000,000 shares. In connection therewith, the following
resolution will be introduced at the Annual Meeting:
RESOLVED: That Section 5.01 of the Certificate of Incorporation, as
heretofore added to or amended by certificates filed pursuant to law, is amended
to read in its entirety as follows:
"5.01 Authorized Shares. The aggregate number of shares which
the Company shall have authority to issue is Forty Million
Eight Hundred Thousand (40,800,000). Forty Million
(40,000,000) shares shall be designated 'Common Stock' and
shall have a par value of $.001. Eight Hundred Thousand
(800,000) shares shall be designated 'Preferred Stock' and
shall have a par value of $.00025. All shares of the Company
shall be issued for such consideration, as expressed in
dollars, as the Board of Directors may from time to time
determine."
The Board of Directors recommends that shareholders approve the
proposed amendment to the Company's Certificate of Incorporation because it
considers the proposal to be in the best long-term and short-term interests of
the Company, its shareholders and its other constituencies. In addition to
permitting the completion of the transactions described under "Agenda Item Two"
herein, the proposed increase in the number of shares of authorized Common Stock
will ensure that additional shares of Common Stock will be available, if needed,
for issuance in connection with any possible future transactions approved by the
Board of Directors, including, among others, stock splits, stock dividends,
acquisitions, financings and other corporate purposes.
The Board of Directors believes that the availability of the additional
shares of Common Stock for such purposes without delay or the necessity for a
special shareholders' meeting (except as may be
16
<PAGE> 21
required by applicable law or regulatory authorities or by the rules of any
stock exchange on which the Company's securities may then be listed) will be
beneficial to the Company by providing it with the flexibility required to
consider and respond to future business opportunities and needs as they arise.
The availability of additional authorized shares of Common Stock will also
enable the Company to act promptly when the Board of Directors determines that
the issuance of additional shares of Common Stock is advisable. It is possible
that shares of Common Stock may be issued at a time and under circumstances that
may increase or decrease earnings per share and increase or decrease the book
value per share of shares presently held.
Although the Company will require additional capital or other financing
to fund its operations and continued growth, except as described under "Agenda
Item Two" herein, the Company does not have any immediate agreements,
arrangements, commitments or understandings with respect to the issuance of any
of the additional shares of Common Stock which would be authorized by the
proposal to increase the number of authorized shares.
On April 15, 1999, 12,300,144 shares of Common Stock were issued and
outstanding and an aggregate of 1,095,789 shares of Common Stock were reserved
for issuance under outstanding stock options and warrants.
It should be noted that the availability of additional shares could
render more difficult or discourage a takeover attempt. For example, additional
shares of Common Stock could be issued and sold to purchasers who oppose a
takeover bid which is not in the best long-term and short-term interests of the
Company, its shareholders and its other constituencies or could be issued to
increase the aggregate number of outstanding shares of Common Stock and thereby
dilute the interest of parties attempting to obtain control of the Company. In
connection with any issuance of shares of Common Stock, the Board of Directors
is required to determine that such issuance would be in the best long-term and
short-term interests of the Company, its shareholders and its other
constituencies. The Board of Directors is presently unaware of any specific
effort to accumulate the shares of Common Stock of the Company or obtain control
of the Company.
The approval of the holders of a majority of the issued and outstanding
shares of Common Stock of the Company is required for the adoption of the
proposed amendment to the Certificate of Incorporation. THE BOARD OF DIRECTORS
RECOMMENDS THAT THE COMPANY'S SHAREHOLDERS APPROVE THE PROPOSED AMENDMENT TO THE
CERTIFICATE OF INCORPORATION.
INDEPENDENT PUBLIC ACCOUNTANTS
Grant Thornton LLP has served as independent auditors of the Company
for the fiscal year ended December 31, 1998. The Company has not selected its
independent accountants for the fiscal year ending December 31, 1999.
Representatives of Grant Thornton LLP are expected to be present at the
shareholders' meeting and will have the opportunity to make a statement if they
desire to do so and to respond to appropriate questions.
ENGAGEMENT OF GRANT THORNTON LLP
17
<PAGE> 22
On January 5, 1999, the Company dismissed its independent auditors,
Arthur Andersen LLP, and on the same date authorized the engagement of the firm
of Grant Thornton LLP as its independent auditors for the fiscal year ending
December 31, 1998. Each of these actions was approved by the Board of Directors
of the Company.
Arthur Andersen LLP was engaged as the Company's independent auditor on
October 16, 1997 and has only reported on the consolidated financial statements
of the Company for the fiscal year ended December 31, 1997. The report of Arthur
Andersen LLP on the consolidated financial statements of the Company for the
fiscal year ended December 31, 1997 did not contain any adverse opinions or a
disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit
scope or accounting principles.
In connection with the audit of the fiscal year ended December 31, 1997
and for the unaudited interim period through January 5, 1999, there were no
disagreements with Arthur Andersen LLP on any matter of accounting principle or
practice, financial statement disclosure, or audit procedure or scope which
disagreement, if not resolved to the satisfaction of Arthur Andersen LLP, would
have caused it to make reference to the subject matter of the disagreement in
its report. Further, during the fiscal year ended December 31, 1997 and the
unaudited interim period through January 5, 1999, neither the Company nor any of
its representatives sought the advice of Grant Thornton LLP regarding the
application of accounting principles to a specific completed or contemplated
transaction or the type of audit opinion that might be rendered on the Company's
financial statements, which advice was an important factor considered by the
Company in reaching a decision as to the accounting, auditing or financial
reporting issue.
In connection with the audit of the fiscal year ended December 31,1997
and the unaudited interim period through January 5, 1999, Arthur Andersen LLP
did not advise the Company that (i) the internal controls necessary for the
Company to develop reliable financial statements did not exist; (ii) information
had come to its attention that led it to no longer be able to rely on
management's representations, or that made it unwilling to be associated with
the financial statements prepared by management; (iii) there existed a need to
expand significantly the scope of its audit, or that information had come to
Arthur Andersen LLP's attention during the fiscal periods, that if further
investigated may (a) materially impact the fairness or reliability of either: a
previously issued audit report or the underlying financial statements, or the
financial statements issued or to be issued covering the fiscal period
subsequent to the date of the most recent financial statements covered by an
audit report (including information that may prevent it from rendering an
unqualified audit report on those financial statements), or (b) cause Arthur
Andersen LLP to be unwilling to rely on management's representations or be
associated with the Company's financial statements, and due to Arthur Andersen
LLP's dismissal did not so expand the scope of its audit or conduct such further
investigation; or (iv) information had come to Arthur Andersen LLP's attention
that it concluded materially impacts the fairness or reliability of either (a) a
previously issued audit report or the underlying financial statements, or (b)
the financial statements issued or to be issued covering the fiscal period
subsequent to the date of the most recent financial statements covered by an
audit report (including information that, unless resolved to Arthur Andersen
LLP's satisfaction, would prevent it from rendering an unqualified audit report
on those financial statements), and due to Arthur Andersen LLP's dismissal, the
issue has not been resolved to Arthur Andersen LLP's satisfaction prior to its
dismissal.
ENGAGEMENT OF ARTHUR ANDERSEN LLP
On September 18, 1997, the Company dismissed its independent auditors,
Grant Thornton LLP, and on the same date authorized the engagement of the firm
of Arthur Andersen LLP as its independent auditors for the fiscal year ending
December 31, 1997. Arthur Andersen LLP was formally engaged by the
18
<PAGE> 23
Company on October 6, 1997. Each of these actions was approved by the Board
of Directors of the Company.
Except as described herein, the report of Grant Thornton LLP on the
consolidated financial statements of the Company for the fiscal years ended
December 31, 1996 and 1995 did not contain any adverse opinion or a disclaimer
of opinion, nor was qualified or modified as to uncertainty, audit scope or
accounting principles. Grant Thornton LLP previously reported on the
consolidated financial statements of the Company as of and for the year ended
December 31, 1995, prior to the restatement for the 1996 merger with Integrated
Network Services, Inc. ("INS"), which was accounted for as a pooling of
interests. Separate financial statements of INS included in the VSI Enterprises,
Inc. and subsidiaries consolidated financial statements as of and for the year
ended December 31, 1995 were audited and reported on separately by other
auditors. Grant Thornton LLP audited the combination of the Company's
consolidated financial statements as of and for the year ended December 31,
1995, after restatement for the 1996 merger with INS. Other than the reference
to the separate financial statements of INS included in VSI Enterprises, Inc.
and subsidiaries consolidated financial statements as of and for the year ended
December 31, 1995, the report of Grant Thornton LLP on the consolidated
financial statements of the Company as of and for the year ended December 31,
1995 did not contain any adverse opinion of disclaimer of opinion, nor was it
modified as to uncertainty, audit scope or accounting principles.
In connection with the audit of the fiscal years ended December 31,
1996 and 1995 and for the unaudited interim period through September 18, 1997,
there were no disagreements with Grant Thornton LLP on any matter of accounting
principle or practice, financial statement disclosure, or audit procedure or
scope which disagreement, if not resolved to the satisfaction of Grant Thornton
LLP, would have caused it to make reference to the subject matter of the
disagreement in its report. Further, during the fiscal years ended December 31,
1996 and 1995 and the unaudited interim period through September 18, 1997,
neither the Company nor any of its representatives sought the advice of Arthur
Andersen LLP regarding the application of accounting principles to a specific
completed or contemplated transaction or the type of audit opinion that might be
rendered on the Company's financial statements, which advice was an important
factor considered by the Company in reaching a decision as to the accounting,
auditing or financial reporting issue.
In connection with the audit of the fiscal years ended December 31,
1996 and 1995 and the unaudited interim period through September 18, 1997, Grant
Thornton LLP did not advise the Company that (i) the internal controls necessary
for the Company to develop reliable financial statements did not exist; (ii)
that information had come to its attention that led it to no longer be able to
rely on management's representations, or that made it unwilling to be associated
with the financial statements prepared by management; (iii) that there existed a
need to expand significantly the scope of its audit, or that information had
come to Grant Thornton LLP's attention during the fiscal periods, that if
further investigated may (a) materially impact the fairness or reliability of
either: a previously issued audit report or the underlying financial statements,
or the financial statements issued or to be issued covering the fiscal period
subsequent to the date of the most recent financial statements covered by an
audit report (including information that may prevent it from rendering an
unqualified audit report on those financial statements), or (b) cause Grant
Thornton LLP to be unwilling to rely on management's representations or be
associated with the Company's financial statements, and due to Grant Thornton
LLP's dismissal did not so expand the scope of its audit or conduct such further
investigation; or (iv) that information had come to Grant Thornton LLP's
attention that it concluded materially impacts the fairness or reliability of
either (a) a previously issued audit report or the underlying financial
statements, or (b) the financial statements issued or to be issued covering the
fiscal period subsequent to the date of the most recent financial statements
covered by an audit report (including information that, unless resolved to Grant
Thornton LLP's satisfaction, would prevent it from rendering an unqualified
audit report on those financial statements), and due to Grant
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<PAGE> 24
Thornton LLP's dismissal, the issue has not been resolved to Grant Thornton
LLP's satisfaction prior to its dismissal.
ANNUAL REPORT ON FORM 10-K
The Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1998, as filed with the Securities and Exchange Commission, is
available to shareholders who make written request therefor to the Company's
Investor Relations Department, 5801 Goshen Springs Road, Norcross, Georgia
30071. Copies of exhibits and basic documents filed with that report or
referenced therein will be furnished to shareholders of record upon request.
INCORPORATION BY REFERENCE
The following portions of the Company's Annual Report to Shareholders
for the year ended December 31, 1998, which accompanies this Proxy Statement,
are incorporated by reference herein: (i) consolidated financial statements of
the Company as of December 31, 1998 and 1997 and for the years ended December
31, 1998, 1997 and 1996; and (ii) Management's Discussion and Analysis of
Financial Condition and Results of Operations.
SHAREHOLDER PROPOSALS
Proposals of shareholders intended to be presented at the Company's
2000 annual meeting must be received at the Company's principal executive
offices by December 15, 1999 in order to be eligible for inclusion in the
Company's proxy statement and form of proxy for that meeting.
With respect to any such proposals received by the Company after March
1, 2000, the persons named in the form of proxy solicited by management in
connection with the 2000 annual meeting of shareholders of the Company will have
discretionary authority to vote on any such shareholder proposals in accordance
with their judgment of that is in the best interests of the Company.
OTHER MATTERS
The Board of Directors knows of no other matters to be brought before
the annual meeting. However, if other matters should come before the annual
meeting it is the intention of the persons named in the enclosed form of Proxy
to vote the Proxy in accordance with their judgment of what is in the best
interest of the Company.
By Order of the Board of Directors,
Larry M. Carr, Chairman of the Board
Norcross, Georgia
May 10, 1999
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<PAGE> 25
APPENDIX A
VSI ENTERPRISES, INC.
5801 Goshen Springs Road
Norcross, Georgia 30071
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS FOR THE
1999 ANNUAL MEETING OF SHAREHOLDERS.
The undersigned hereby appoints Julia B. North and J. Kendall Keatley
or either of them, with power of substitution to each, the proxies of the
undersigned to vote the Common Stock of the undersigned at the Annual Meeting of
Shareholders of VSI ENTERPRISES, INC. to be held Friday, June 11, 1999, at 10:00
a.m., at the Company's offices, 5801 Goshen Springs Road, Norcross, Georgia
30071, and any adjournments or postponements thereof.
1. To elect four (4) directors for a term of one year and until their
successors are elected and have qualified
[ ] FOR all nominees listed [ ] WITHHOLD AUTHORITY to vote for
below (except as marked all nominees listed below
to the contrary below)
LARRY M. CARR, JULIA B. NORTH, HARLAN D. PLATT, PH.D., and EDWARD S.
REDSTONE
INSTRUCTION: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE
WRITE THE NOMINEE'S NAME IN THE SPACE PROVIDED BELOW.
-----------------------------------------------------------------------
- --------------------------------------------------------------------------------
2. To approve an amendment to the Company's Certificate of Incorporation
to increase the number of authorized shares of common stock from
15,000,000 shares to 23,000,000 shares, which will allow the Company to
complete the debt restructuring transactions described in the
accompanying Proxy Statement;
[ ] FOR [ ] AGAINST [ ] ABSTAIN
3. To approve an amendment to the Company's Certificate of Incorporation
to increase the number of authorized shares of common stock from
15,000,000 shares to 40,000,000 shares, which will allow the Company
to complete the debt restructuring transactions described in the
accompanying Proxy Statement and would result in approximately
17,000,000 additional shares of common stock being available for future
issuance by the Company; and
[ ] FOR [ ] AGAINST [ ] ABSTAIN
4. To vote in accordance with their best judgment with respect to any
other mattes that may properly come before the meeting or any
adjournments or postponements thereof.
THE BOARD OF DIRECTORS FAVORS A VOTE "FOR" THE ABOVE PROPOSALS AND UNLESS
INSTRUCTIONS TO THE CONTRARY ARE INDICATED IN THE SPACE PROVIDED, THIS PROXY
WILL BE SO VOTED.
- --------------------------------------------------------------------------------
Please date and sign this Proxy exactly as
name(s) appears on the mailing label.
--------------------------------------------
--------------------------------------------
--------------------------------------------
Print Name(s):
NOTE: When signing as an attorney, trustee,
executor, administrator or guardian, please
give your title as such. If a corporation or
partnership, give full name by authorized
officer. In the case of joint tenants, each
joint owner must sign.
Date: --------------------------------------
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A-1
<PAGE> 26
APPENDIX B
The following portions of the Company's Annual Report to Shareholders for the
year ended December 31, 1998 are incorporated by reference into the Company's
proxy statement relating to the 1999 annual meeting of shareholders, scheduled
to be held on June 11, 1999:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
As a result of the Company's recurring losses from operations and the
Company's ratio of current assets/current liabilities, the Company's independent
auditors for the year ended December 31, 1998 have included a paragraph in their
audit report accompanying the Company's consolidated financial statements
regarding the Company's ability to continue as a going concern.
In response to those concerns, the Company has undertaken a
restructuring of the business operations and balance sheet that, when fully
implemented, are intended to achieve profitable operations and provide positive
operating cash flows as well as to improve prospects for additional equity
capital investments. During the first quarter of 1999, the Company reviewed its
operating expenses and substantially reduced fixed management and overhead
expenses. In addition, the Company proposes to restructure certain of its
outstanding indebtedness. (See "Liquidity and Sources of Capital.")
As of December 31, 1998, the Company had an accumulated deficit of
$46,877,847, of which $16,935,972 was realized in 1998. The Company believes
that its ongoing effort to restructure and refocus the strategic direction of
the organization, and to eliminate assets that are either non-performing,
impaired or unrelated to the core business (resulting in a non-recurring charge
of approximately $10.3 million in 1998), will enable it to compete in the
domestic videoconferencing and control system market.
FINANCIAL CONDITION
During the year ended December 31, 1998, the Company's total assets
decreased approximately 52% to $10,960,965 from $22,880,459 at December 31,
1997. A large part of the decrease resulted from a $7,767,444 impairment charge
of most of the goodwill from two non-core assets. Other factors were:
- - 92% decrease in other long-term assets, primarily due to the sale and
impairment of investments in two other companies
- - 57% decrease in inventories, primarily due to an approximately $1.68
million write-down of obsolete or slow-moving videoconferencing
inventory
- - 86% decrease in rental and demonstration inventory, due to write-downs
of obsolete demonstration inventory and the closing of several sales
offices
- - 89% decrease in software development costs, net, due to impairment of
capitalized costs
Cash and cash equivalents as of December 31, 1998 increased $282,732,
or approximately 32%, to $1,134,231 from $859,684 on December 31, 1997.
Total stockholders' equity decreased $14,588,279, or approximately 94%,
from December 31, 1997, primarily because of the $16,935,972 net loss for the
year.
RESULTS OF OPERATIONS
B-1
<PAGE> 27
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
As part of an ongoing effort to restructure and refocus the strategic
direction of the Company, and to eliminate assets that are either
non-performing, impaired or unrelated to the core business, the Company took a
non-cash and non-recurring charge of approximately $10.3 million in 1998. The
charge included: the write-down of obsolete or slow-moving videoconferencing and
demonstration inventory ($1.88 million); the loss from the sale of investments
in two companies ($450,000); a write-down of capitalized software development
costs ($180,000); and the write-off of most of the goodwill from the
acquisitions of VSI n.v. in 1992 and ETI in 1996 ($7.76 million). As a result,
many of the comparisons between 1998 and 1997 financial results in several
categories have been significantly impacted by the non-recurring charges and/or
the related changes in organizational structure and strategic direction.
Also, results for 1998 and 1997 reflect the December 1998 closure of
INS. Results for years presented have been restated to reflect the
discontinuance of operations of INS.
REVENUES
Revenues for the year ended December 31, 1998 were $19.4 million, an
approximately 1% decrease over revenues for the year ended December 31, 1997. An
approximately 12% increase in videoconferencing systems revenues was more than
offset by an approximately 21% decrease in commissions from telephone network
reselling. That decrease was due to lower revenues during 1998 at ETI, the
Company's network reselling subsidiary, that resulted from lower commission
rates and higher than anticipated chargebacks for disconnections and
cancellations.
GROSS MARGIN
Gross margin as a percentage of revenues for the year ended December
31, 1998 was approximately 37%, down from 51% for the year ended December 31,
1997. The decrease was due to higher than usual sales of lower margin
videoconferencing products during the second and third quarters of 1998,
primarily from a $2.3 million order to a customer in China, and to lower
revenues during the first quarter of 1998 at ETI.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the year ended
December 31, 1998 were $13,023,732, a decrease of $479,808, or approximately 4%,
over the year ended December 31, 1997, due to improvements in parts procurement
and ongoing cost reduction programs; and an approximately 10% reduction in
workforce during 1998.
RESEARCH AND DEVELOPMENT EXPENSES
The Company charges research and development costs to expense as
incurred until technological feasibility of a software product has been
established. Software development costs incurred after technological feasibility
has been established are capitalized and amortized over the useful life of the
product. For the year ended December 31, 1998, the Company's research and
development expenses were $786,103, an approximately 24% decrease over the year
ended December 31, 1997. The decrease was due to a reduction in workforce.
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IMPAIRMENT LOSS
At December 31, 1998, an impairment loss of $7,767,444 was charged to
operations. The majority of that loss -- $6,995,211 - was charged to operations
as an impairment of the original goodwill recorded with the Company's
acquisition of ETI. Management decreased ETI's goodwill to its estimated value
based on expected future undiscounted cash flows from ETI's operations,
primarily due to a change in the commission structure initiated by ETI's major
customer. An additional $577,077 impairment loss was recorded to eliminate all
remaining goodwill related to VSI Europe, and an additional $195,156 impairment
loss was recorded to write down VSI Europe's net assets to zero. Management
recorded the impairment loss in light of VSI Europe's continuing operating
losses. See Note A-7 and A-10 to the consolidated financial statements.
OTHER EXPENSES
Other expenses, primarily finance charges, were $1,682,303 for the year
ended December 31, 1998, an increase of $1,606,134 over the year ended December
31, 1997. The increase was primarily due to amortization of debt discount costs
during the vesting period (the second and third quarters of 1998) of the
conversion feature of the Company's convertible debentures; the amortization of
debt issuance costs associated with the Company's convertible debentures; and
interest expense from the convertible debentures.
NET LOSS
Net loss for the year ended December 31, 1998 was $16,935,972, a
$11,118,606, or approximately 191%, increase over the net loss of $5,817,366 for
the year ended December 31, 1997. Net loss from continuing operations was
$16,516,999, a $11,645,395, or approximately 239%, increase over the net loss of
$4,871,604 for the year ended December 31, 1997. The increase in net loss was
due primarily to non-cash and non-recurring charges of approximately $10.3
million in 1998.
Excluding the non-recurring charges of approximately $10.3 million, the
net loss was approximately $6.6 million, an approximately $800,000 increase over
the net loss for the year ended December 31, 1997. The non-recurring charges
included: the write-down of obsolete or slow-moving videoconferencing and
demonstration inventory ($1.88 million); the loss from the sale of investments
in two companies ($450,000); a write-down of capitalized software development
costs ($180,000); and the write-off of most of the goodwill from the
acquisitions of VSI Europe in 1992 and ETI in 1996 ($7.76 million).
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Revenues for the year ended December 31, 1997 were $19.6 million, an
approximately 54% increase over revenues for the year ended December 31, 1996.
The increase was primarily due to the recognition of a full year of revenue from
wholly-owned subsidiary ETI in 1997, compared to three months of revenue from
ETI in 1996. ETI was acquired in October 1996.
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<PAGE> 29
GROSS MARGIN
Gross margin as a percentage of revenues for the year ended December
31, 1997 was 51%, up from 28% for the year ended December 31, 1996, due to the
addition of high margin sales and account management commissions from ETI, a
sales agency for a number of major telecommunications companies.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the year ended
December 31, 1997 were $13,503,540, an increase of $5,248,453, or 64%, over the
year ended December 31, 1996, due to an increase in the Company's sales,
marketing and distribution initiatives in the United States (primarily due to
the October 1996 acquisition of ETI and its sales force) and the Far East.
RESEARCH AND DEVELOPMENT EXPENSES
The Company charges research and development costs to expense as
incurred until technological feasibility of a software product has been
established. Software development costs incurred after technological feasibility
has been established are capitalized and amortized over the useful life of the
product. For the year ended December 31, 1997, the Company's research and
development expenses were $1,031,814, a 13% decrease over the year ended
December 31, 1996. Expenses in 1996 had been somewhat higher than historical
levels, due to an expansion in the research and development workforce to
accommodate projects related to forthcoming generations of the Omega( product
line and other software projects. Many of those projects were completed or were
winding down by first quarter 1997, and the workforce -- primarily at subsidiary
VSI Solutions, Inc. -- was reduced.
OTHER EXPENSES/INCOME TAXES
Non-operating expenses and income taxes for the year ended December 31,
1997 were $269,410, a 94% increase over non-operating expenses and income taxes
for the year ended December 31, 1996. The increase was primarily due to the
payment of state taxes in Rhode Island by ETI, which was profitable in 1997.
NET LOSS
Net loss for the year ended December 31, 1997 was $5,817,366, a 13%
improvement over the net loss for the year ended December 31, 1996. Excluding a
charge to reflect obsolescence of certain inventory of approximately $2.1
million, the net loss for the year was approximately $3.7 million, a 44%
improvement over 1996. The decrease in the loss was primarily due to a 54%
increase in revenues and a substantial improvement in gross margins.
LIQUIDITY AND SOURCES OF CAPITAL
GENERAL
As of December 31, 1998, the Company had cash and cash equivalents of
$1,134,231. The Company's liquidity sources include existing cash and credit
facilities. In order to meet its cash flow requirements, short-term debt and
approximately $600,000 in accrued but unpaid sales tax obligations,
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<PAGE> 30
the Company will require additional funding in 1999. This additional funding
could be in the form of the sale of assets, debt, equity, or a combination. A
further reduction in operating expenses has also been effected in order to
maximize the Company's allocation of cash resources. However, there can be no
assurance that the Company will be able to obtain such financing if and when
needed, or that if obtained, such financing will be sufficient or on terms and
conditions acceptable to the Company.
On February 23, 1998, the Company issued $3,000,000 of 5% Convertible
Debentures due February 2000 ("the Debentures") to Thomson Kernaghan & Co. Ltd.
("Thomson Kernaghan"), the proceeds of which were utilized for working capital
purposes. The debentures were convertible into shares of common stock of the
Company at the option of the holder at the lesser of (i) $8.00 per share or (ii)
85% of the average closing bid price of the Company's common stock. The
debenture holder was also granted warrants to purchase 9,375 shares of common
stock of the Company, at an exercise price of $2.40 per share. An agent involved
in the placement of the debentures received warrants to purchase 9,375 shares of
common stock of the Company, at an exercise price of $10.00 per share.
During the year, $710,000 of debentures, plus accrued interest of
$13,531, were converted by the debenture holder into 445,956 shares of common
stock of the Company. The Company also paid $128,858 in accrued interest and
fees.
Also, in November 1998, $1,440,000 of debentures were redeemed by the
Company at face value as follows: (i)$1,040,000 of debentures were bought back
at face value on October 1, 1998 (at which time the Company paid $128,858 in
accrued interest and fees); and (ii) $400,000 of debentures were bought back at
face value on November 16, 1998 (at which time the Company paid a fee of
$50,000). The remaining debentures were converted on November 16, 1998 into a
$900,000 term note to Thomson Kernaghan, at an interest rate of 14% per annum,
due on or before May 16, 1999. At that time, Thomson Kernaghan was issued
warrants to purchase 25,000 shares of common stock of the Company, at an
exercise price of $2.40 per share.
Of the 445,956 shares issued upon conversion of the debentures, 50,000
shares were held in escrow at December 31, 1998, with 25,000 of these shares
issued in January 1999 and 25,000 issued in February 1999. To secure payment of
the note, VSI granted the debt holder a security interest in VSI's seven patents
issued by the U.S. Patent & Trademark Office. In the event of default, the debt
holder could foreclose on its security interest in the patents.
VSI has not paid a $300,000 installment of principal under the term
note, which installment was due February 16, 1999. The failure to make this
payment subjects VSI to a $30,000 per month penalty fee until the full balance
is repaid. If VSI does not repay the note on or before May 16, 1999, VSI will be
obligated to pay the debt holder an additional penalty of $30,000 on the 16th of
each month until the debt is paid. As of March 30, 1999, the outstanding balance
under this note, including accrued interest and penalties, was $1,006,257.
The Company is current negotiating with Thomson Kernaghan to
restructure the term note. The restructuring of this note may involve a cash
payment by the Company and the issuance of shares of common stock of the Company
to Thomson Kernaghan to repay the note. If the debt to Thomson Kernaghan cannot
be restructured, Thomson Kernaghan may take possession of the Company's patents
which secure this debt. In the event the Company is unable to license this
technology from Thomson Kernaghan, the Company will be unable to manufacture,
sell and service its videoconferencing systems. See "Factors Affecting Future
Performance."
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<PAGE> 31
The cash redemption of a portion of the convertible debentures was
funded in part from the proceeds of a private placement of term notes by the
Company in October and November of 1998. The notes mature on March 31, 2000 and
accrue interest at an annual rate of prime plus 3% per annum. Purchasers of
notes also received a warrant to purchase one share of common stock of the
Company for each $8.00 of notes purchased. Warrants have an exercise price of
$1.68 per share and are exercisable commencing on April 1, 2000. The Company is
delinquent in the payment of approximately $35,000 of interest due March 31,
1999 with respect to these term notes. Payment of this amount has been deferred
pending resolution of the Company's negotiations regarding the restructuring of
the Thomson Kernaghan term note.
In December 1998, the Company received $250,000 from the sale of the
Company's investment in Educational Video Conferencing, Inc., a New York-based
provider of distance education services. In October 1998, the Company received
$243,000 from the sale of the Company's investment in Global TeleMedix, Inc., a
Massachusetts-based provider of telemedicine software.
In October, 1998, the Board of Directors of the Company authorized a
stock repurchase program pursuant to which management is authorized to
repurchase up to 250,000 shares of common stock of the Company. As of March 15,
1999, the Company had not repurchased any shares of its common stock. Any future
purchases will be financed from the Company's cash reserves.
CREDIT FACILITIES
VSI
Since June 1995, Videoconferencing Systems, Inc. (VSI), a subsidiary of
the Company, has had a revolving credit and security agreement with Fidelity
Funding of California Inc. This credit facility provides the Company with up to
$4,000,000 at an interest rate of prime plus 2% per annum. Funds available under
the credit facility are based on 80% of eligible VSI accounts receivable
invoices, with certain restrictions. The credit facility is secured by the
accounts receivable, inventory and certain fixed assets of VSI. At December 31,
1998, approximately $83,000 was owed to Fidelity Funding.
ETI
On October 8, 1998, ETI entered into a financing agreement with RFC
Capital, Inc., whereby RFC Capital, Inc. purchases eligible accounts receivable
for 90% of the accounts receivable amount, up to $1,500,000, at an interest rate
of prime plus 2.75% per annum. This amount may be increased, subject to
additional payment of commitment fees by ETI, to $5,000,000. If any account
receivable is not paid within 90 days, ETI is required to buy back the account
receivable for the full purchase price. The credit facility is secured by
eligible accounts receivable. As of December 31, 1998, approximately $1,403,000
was owed to RFC Capital, Inc.
INS
In December 1996, VSI Network Services, Inc. (d/b/a Integrated Network
Services, or INS), a wholly owned subsidiary of the Company, established a
revolving credit and security agreement with Presidential Financial Corporation.
This credit facility provides INS with up to $750,000 at an interest rate of
prime plus 3% per annum. Funds available under the credit facility are based on
80% of eligible accounts receivable invoices, with certain restrictions. The
credit facility is secured by accounts receivable, inventory and fixed assets of
INS. At December 31, 1998, approximately $248,000 was
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<PAGE> 32
owed to Presidential Financial Corporation.
With INS ceasing operations on December 31, 1998, VSI is obligated to
repay the balance owed Presidential Financial Corporation. On March 31, 1999,
that amount was approximately $138,000. The Company expects to repay the full
amount during 1999 upon the collection of outstanding INS accounts receivable.
VSI n.v.
In February 1998, Videoconferencing Systems, n.v., a wholly owned
subsidiary of the Company, entered into a revolving credit and security
agreement with Kredietbank, n.v. This credit facility provides Videoconferencing
Systems, n.v. with up to $550,000 at an interest rate of 5% per annum. The
credit facility is secured by 137,500 shares of common stock of the Company,
held in escrow by Kredietbank, n.v. At December 31, 1998, approximately $253,000
was owed to Kredietbank, n.v.
At December 31, 1998, Videoconferencing Systems, n.v. had a secured
bank facility with Generale Bank of approximately $166,000, of which
approximately $157,000 was outstanding at that time.
OPERATING LOSS CARRYFORWARDS
As of December 31, 1998, the Company had operating loss carryforwards
for U.S. income tax purposes of approximately $29,389,000 available to reduce
future taxable income through 2013. The Company also has investment and research
and experimental credits of approximately $89,000 available to reduce future
income taxes payable through 2013. During 1993, the Company experienced a change
in control, as defined under Section 382 of the Internal Revenue Code. As a
result, the utilization of approximately $7,000,000 in tax loss carryforwards
will be limited to approximately $1,000,000 annually.
Videoconferencing Systems, n.v. has net operating loss carryforwards of
approximately $3,350,000 that can be used to offset future taxable income. These
carryforwards can be carried forward indefinitely. The resulting deferred income
tax asset has been reduced to zero by a related valuation allowance.
YEAR 2000
The Company has assessed the impact of the Year 2000 issue on its
computer systems and is in the process of remediating the affected hardware and
software.
The Company utilizes various computer workstations and software
packages as tools in running its accounting and operations areas. Most are
PC-based and are Year 2000 compliant, with the exception of some older
workstations that will be phased out by 2000. Also, the primary accounting
system is not currently Year 2000 compliant, and management plans during 1999 to
implement any necessary vendor upgrades and modifications to ensure continued
functionality with respect to any accounting software problems associated with
Year 2000.
With respect to the production of its own proprietary software and
hardware, the Company has taken the necessary steps to ensure that its
proprietary technology is Year 2000 compliant. The
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<PAGE> 33
Company's videoconferencing products use PC controllers of recent vintage that
are computed in and displayed in four-digit format. In addition, the Company's
Omega( software uses "C" libraries that compute the date based on a count of the
number of seconds from January 1970. Those software libraries are in no danger
of being out of compliance before the year 2038.
Also, the Company has surveyed the vendors who supply key
computer-based components for its videoconferencing systems and services, and
found that all are Year 2000 compliant. The Company will continue to monitor and
assess the Year 2000 situation on an ongoing basis, especially in its dealings
with new vendors or suppliers, and will take appropriate corrective action as
needed.
Contingency planning is a normal part of VSI's sales cycle, given lead
time for parts and installation windows. VSI has included Year 2000 concerns
into normal contingency planning without forming a separate department of task
force to address these concerns. The Company has not developed a separate Year
2000 contingency plan, since to date no adverse effect from the Year 2000 issue
has been identified. Should it be determined that any major vendors, service
providers or partners may be negatively impacted by the Year 2000 issue, the
Company will develop contingency plans for affected areas or make use of
alternate suppliers.
Expenditures for the Year 2000 project have to date been immaterial and
are being expensed as incurred. These expenditures have not had, and are not
expected to have, a material impact on the consolidated financial position,
results of operation or cash flows of the Company.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this filing are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995, such as statements relating to financial results and plans for future
business development activities, and are thus prospective. Such forward-looking
statements are subject to risks, uncertainties and other factors which could
cause actual results to differ materially from future results expressed or
implied by such forward-looking statements. Potential risks and uncertainties
include, but are not limited to, economic conditions, competition and other
uncertainties detailed from time to time in the Company's Securities and
Exchange Commission filings. (See "Risk Factors" in the section that follows).
FACTORS AFFECTING FUTURE PERFORMANCE
The Company is subject to the risks associated with being wholly
dependent upon the performance of its subsidiaries. The following summarizes
certain of the risks inherent in the Company's business:
Working Capital Requirements; Need for Additional Financing. The
Company will require additional capital or other financing to finance its
operations and continued growth. The Company may seek additional equity
financing through the sale of securities on a public or a private placement
basis on such terms as are reasonably attainable. There can be no assurance that
the Company will be able to obtain such financing when needed, or that if
obtained, it will be sufficient or on terms and conditions acceptable to the
Company.
No History of Profitability. After 13 years of operations, the Company
has not reported any profits for a full year of operations. There can be no
certainty regarding the Company's ability to achieve or sustain profitability in
the future. Whether or not the Company is able to operate profitably, the
Company will require additional capital to finance its operations.
29
<PAGE> 34
Restructuring of Indebtedness. The Company is currently in negotiations
to restructure all indebtedness of the Company owing to Thomson Kernaghan, which
currently totals approximately $1.0 million. A substantial portion of this
indebtedness may be retired in exchange for the issuance of common stock of the
Company, which will dilute the ownership of the Company's shareholders.
Additionally, sales and potential sales of substantial amounts of common stock
of the Company in the public market could adversely affect the prevailing market
prices for the common stock and impair the Company's ability to raise additional
capital through the sale of equity securities.
The failure of the Company to restructure its indebtedness to Thomson
Kernaghan would result in the Company being unable to repay the term note when
it comes due in May 1999. The failure of the Company to timely repay this
indebtedness may result in Thomson Kernaghan taking possession of the Company's
patents, which have been pledged by the Company as collateral for this debt. If
Thomson Kernaghan takes possession of the patents, the Company will no longer
have any rights in the technology described therein. To continue to be able to
sell its videoconferencing products, which embody the technology covered by the
patents, the Company will be required to license this technology from Thomson
Kernaghan. There can be no assurance that any such license will be granted on
commercially reasonable terms or at all. Accordingly, if the Company is unable
to restructure its debt with Thomson Kernaghan, and is unable to license the
technology covered by the patents on commercially reasonable terms, it will be
unable to continue to sell its videoconferencing products, in which event, the
Company may seek protection under federal bankruptcy laws.
Integration of Acquired Businesses. An important element of the
Company's growth strategy is to expand through acquisitions. The Company's
future success is dependent upon its ability to finance and effectively
integrate acquired businesses with the Company's operations. There can be no
assurance that past or future acquisitions will be successfully integrated or
that any such acquisition will otherwise be successful. In addition, the
financial performance of the Company is now and will continue to be subject to
various risks associated with the acquisition of businesses, including the
financial effects associated with the integration of such businesses. There can
be no assurance that the Company's acquisition strategy will be successful.
Technological Change and New Products. The market for the Company's
products is characterized by rapidly changing technology, evolving industry
standards and frequent product introductions. Product introductions are
generally characterized by increased functionality and better picture quality at
reduced prices. The introduction of products embodying new technology may render
existing products obsolete and unmarketable. The Company's ability to
successfully develop and introduce on a timely basis new and enhanced products
that embody new technology, and achieve levels of functionality and price
acceptable to the market will be a significant factor in the Company's ability
to grow and to remain competitive. If the Company is unable, for technological
or other reasons, to develop competitive products in a timely manner in response
to changes in the industry, the Company's business and operating results will be
materially and adversely affected.
Dependence on Third Parties. Substantially all of the Company's
components, subsystems and assemblies are made by outside vendors. Disruption in
supply, a significant increase in price of one or more of these components or
failure of a third-party supplier to remain competitive in functionality or
price could have a material adverse effect on the Company's business and
operating results. There can be no assurance that the Company will not
experience such problems in the future. Similarly, excessive rework costs
associated with defective components or process errors associated with the
Company's anticipated new product line of videoconferencing systems could
adversely affect the Company's business and operating
30
<PAGE> 35
results.
Foreign Sales and Operations. During the year ended December 31, 1998,
revenues from international sales represented approximately 27% of the Company's
net product sales, as compared to 14% of net product sales during the year ended
December 31, 1997. The Company's profitability and financial condition therefore
will be impacted by the success of these foreign operations. International sales
and operations are subject to inherent risks, including difficulties and delays
in obtaining pricing approvals and reimbursement, unexpected changes in
regulatory requirements, tariffs and other barriers, political instability,
difficulties in staffing and managing foreign operations, longer payment cycles,
greater difficulty in accounts receivable collection and adverse tax
consequences. Currency translation gains and losses on the conversion to United
States dollars from international operations could contribute to fluctuations in
the Company's results of operations. If for any reason exchange or price
controls or other restrictions on the conversion or repatriation of foreign
currencies were imposed, the Company's operating results could be adversely
affected. There can be no assurance that these factors will not have an adverse
impact on the Company's future international sales and operations and,
consequently, on the Company's operating results.
Concentration of Customers. The Company sells videoconferencing and
control systems and network services to a number of major customers. During the
year ended December 31, 1998, approximately 37% of the Company's revenues were
from Bell Atlantic. There can be no assurance that the loss of this or other
customers will not have an adverse effect on the Company's operations.
Dependence on Key Employees. The Company's development, management of
its growth and other activities depend on the efforts of key management and
technical employees. Competition for such persons is intense. The Company uses
incentives, including competitive compensation and stock option plans, to
attract and retain well-qualified employees. There can be no assurance, however,
that the Company will continue to attract and retain personnel with the
requisite capabilities and experience. The loss of one or more of the Company's
key management or technical personnel also could adversely affect the Company.
The Company does not have employment agreements with its key management
personnel or technical employees. The Company's future success is also dependent
upon its ability to effectively attract, retain, train, motivate and manage its
employees. Failure to do so could have a material adverse effect on the
Company's business and operating results.
Competition. Competition in the video communications market is intense.
In the videoconferencing market, the Company's primary competitors are
PictureTel Corporation, VTEL Corporation and Polycom Inc. The Company expects
other competitors, some with significantly greater technical and financial
resources, to enter the videoconferencing market. If the Company cannot continue
to offer new videoconferencing products with improved performance and reduced
cost, its competitive position will erode. Moreover, competitive price
reductions may adversely affect the Company's results of operations.
Fluctuations in Quarterly Performance. The Company's product sales have
historically been derived primarily from the sale of videoconferencing systems
and related equipment, the market for which is still developing. In addition,
the Company's revenues occur predominantly in the third month of each fiscal
quarter. Accordingly, the Company's quarterly results of operations are
difficult to predict, and delays in the closing of sales near the end of the
quarter could cause quarterly revenues and, to a greater degree, operating and
net income to fall substantially short of anticipated levels. The Company's
total revenues and net income levels could also be adversely affected by
cancellations or delays of orders, interruptions or delays in the supply of key
components, changes in customer base or product mix, seasonal patterns of
capital spending by customers, delays in purchase decisions due to new product
announcements by the Company or its competitors, increased competition and
reductions in average selling prices.
31
<PAGE> 36
No Assurance of Continued Trading Market in Company Securities. The
Company's Common Stock is traded on the Nasdaq SmallCap Market. While the
Company believes there are several securities broker/dealers making a market in
the Company's Common Stock, there is no assurance that a public market for the
Company's Common Stock will continue to be made or that persons purchasing the
Company's securities will be able to avail themselves of a public trading market
for the Common Shares in the future.
In order for the Company's Common Stock to be eligible for continued
listing on the Nasdaq SmallCap Market, the Common Stock must, among other
things, have a minimum bid price per share of $1.00 and net tangible assets of
not less than $2.0 million. The Company's Common Stock currently is trading at a
price below $1.00 per share and, as a result of the 1998 net loss, net tangible
assets are less than $2.0 million, putting the Company in jeopardy of falling
out of compliance with Nasdaq's continued listing requirements. There can be no
assurance that the Company will remain in compliance with Nasdaq's continued
listing requirements. If the Common Stock is delisted by Nasdaq, the trading
market for the Common Stock could be adversely affected, as price quotations for
the Common Stock will not be as readily obtainable.
No Dividends. The Company has never paid cash dividends on its Common
Stock and has no plans to pay cash dividends in the foreseeable future. The
policy of the Company's Board of Directors is to retain all available earnings
for use in the operation and expansion of the Company's business.
Possible Issuance of Preferred Stock. The Company is authorized to
issue up to 800,000 shares of Preferred Stock, $.00025 par value (the "Preferred
Stock"). Preferred Stock may be issued in one or more series, the terms of which
may be determined at the time of issuance by the Board of Directors, without
further action by stockholders, and may include voting rights (including the
right to vote as a series on particular matters), preferences as to dividends
and liquidation, conversion and redemption rights and sinking fund provisions.
No Preferred Stock is currently outstanding and the Company has no present plans
for the issuance thereof. The issuance of any Preferred Stock could affect the
rights of the holders of Common Stock, and therefore, reduce the value of the
Common Stock and make it less likely that holders of Common Stock would receive
a premium for the sale of their shares of Common Stock. In particular, specific
rights granted to future holders of Preferred Stock could be issued to restrict
the Company's ability to merge with or sell its assets to a third party.
32
<PAGE> 37
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
VSI Enterprises, Inc.
We have audited the accompanying consolidated balance sheet of VSI Enterprises,
Inc. (a Delaware corporation) and Subsidiaries as of December 31, 1998 and the
related statements of operations, stockholders' equity, and cash flows for the
years ended December 31, 1998 and 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VSI Enterprises, Inc. and
subsidiaries as of December 31, 1998, and the results of their operations and
their cash flows for the years ended December 31, 1998 and 1996, in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note B to the
financial statements, the Company has suffered recurring losses from operations
and the Company's current liabilities exceed current assets. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note B. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Grant Thornton LLP
Atlanta, Georgia
March 5, 1999
33
<PAGE> 38
Report of Independent Public Accountants
To the Board of Directors and Stockholders of VSI Enterprises, Inc.:
We have audited the accompanying consolidated balance sheet of VSI ENTERPRISES,
INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997 and the
related statements of operations, stockholders' equity, and cash flows for the
year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards requires that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VSI Enterprises, Inc. and
subsidiaries as of December 31, 1997 and the results of their operations and
their cash flows for the year then ended in conformity with generally accepted
accounting principles.
/s/ Arthur Andersen LLP
Atlanta, Georgia
April 12, 1999
34
<PAGE> 39
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 1,134,231 $ 859,684
Accounts receivable, less allowance
for doubtful accounts of $1,141,091
and $415,989 at December 31, 1998
and 1997, respectively 5,975,254 5,703,560
Inventories, less allowance for obsolescence
of $1,677,440 and $178,235 at December 31,
1998 and 1997, respectively 1,059,142 2,464,818
Demonstration inventory, net of allowance for
obsolescence of $1,074,765 and $839,184 at
December 31, 1998 and 1997, respectively 136,883 990,054
Prepaid expenses and other current assets 164,088 404,181
Current assets of discontinued operations, net 334,022 557,121
----------- -----------
Total current assets 8,803,620 10,979,418
PROPERTY AND EQUIPMENT, net 1,048,983 1,071,381
OTHER ASSETS OF DISCONTINUED OPERATIONS -- 131,912
OTHER ASSETS
Goodwill, net 955,688 9,020,715
Software development costs, net 75,349 658,052
Other long-term assets 77,325 1,018,981
----------- -----------
1,108,362 10,697,748
----------- -----------
$10,960,965 $22,880,459
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
35
<PAGE> 40
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS - CONTINUED
December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES
Current portion of notes payable $ 2,637,948 $ 1,143,012
Short-term borrowings 157,376 154,938
Accounts payable 2,235,852 3,036,587
Accrued expenses 1,463,536 878,813
Accrued commissions 501,515 849,078
Deferred revenue 1,522,416 445,245
Current liabilities of discontinued operations 334,022 781,862
------------ ------------
Total current liabilities 8,852,665 7,289,535
NOTES PAYABLE, LESS CURRENT PORTION 1,105,655 --
COMMITMENTS AND CONTINGENCIES (Note L)
STOCKHOLDERS' EQUITY
Preferred stock, $.00025 par value; authorized
800,000 shares, none issued and outstanding -- --
Common stock, authorized 15,000,000 shares of
$.001 par value; issued and outstanding
12,300,144 and 11,546,242 shares at
December 31, 1998 and 1997, respectively 12,300 11,546
Additional paid-in capital 48,209,039 45,976,291
Accumulated deficit (46,877,847) (29,941,875)
Cumulative comprehensive income (340,847) (455,038)
------------ ------------
1,002,645 15,590,924
------------ ------------
$ 10,960,965 $ 22,880,459
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
36
<PAGE> 41
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenue
Videoconferencing systems $ 13,574,213 $ 12,168,107 $ 11,159,943
Commissions from telephone network
reselling 5,863,198 7,451,686 1,549,281
------------ ------------ ------------
19,437,411 19,619,793 12,709,224
------------ ------------ ------------
Costs and expenses
Cost of videoteleconferencing systems 12,242,823 9,686,633 9,115,556
Selling, general and administrative 13,023,732 13,503,540 8,255,087
Research and development 786,103 1,031,814 1,192,010
Impairment loss 7,767,444 -- --
------------ ------------ ------------
33,820,102 24,221,987 18,562,653
------------ ------------ ------------
Loss from operations (14,382,691) (4,602,194) (5,853,429)
Loss on sale of investments 452,005 -- --
Other expenses, primarily financing charges 1,682,303 76,169 139,048
------------ ------------ ------------
Net loss from continuing operations
before income taxes (16,516,999) (4,678,363) (5,992,477)
Income taxes -- 193,241 --
------------ ------------ ------------
Net loss from continuing operations (16,516,999) (4,871,604) (5,992,477)
Discontinued operations
Operating loss from discontinued operations (763,705) (945,762) (714,417)
Gain on disposal of a subsidiary 344,732 -- --
------------ ------------ ------------
Loss from discontinued operations (418,973) (945,762) (714,417)
------------ ------------ ------------
NET LOSS $(16,935,972) $ (5,817,366) $ (6,706,894)
============ ============ ============
Net loss per common share
Loss from continuing operations $ (1.38) $ (0.45) $ (0.66)
Loss from discontinued operations (0.04) (0.09) (0.08)
------------ ------------ ------------
$ (1.42) $ (0.53) $ (.74)
============ ============ ============
Weighted average shares outstanding 11,931,232 10,901,620 9,119,233
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
37
<PAGE> 42
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Common stock
---------------------- Additional Other
Number of paid-in Accumulated comprehensive
Shares Par value capital deficit income Total
----------- --------- ----------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1995 35,007,176 $8,751 $28,091,591 $(17,417,615) $(147,669) $ 10,535,058
----------- ------ ----------- ------------ --------- ------------
Net loss for the year -- -- -- (6,706,894) -- (6,706,894)
Other comprehensive income
Foreign currency translation adjustment -- -- -- -- (141,005) (141,005)
----------- ------ ----------- ------------ --------- ------------
Comprehensive income -- -- -- (6,706,894) (141,005) (6,847,899)
----------- ------ ----------- ------------ --------- ------------
Reverse common stock split (26,255,382) -- -- -- -- --
Issuance of common shares in lieu of
cash compensation 27,694 28 139,464 -- -- 139,492
Issuance of common shares for employee
stock purchase plan 11,119 11 109,413 -- -- 109,424
Exercise of stock options 76,408 76 298,789 -- -- 298,865
Issuance of common shares for products
and services 62,500 63 599,946 -- -- 600,009
Issuance of common shares for conversion
of notes payable 61,204 61 337,052 -- -- 337,113
Private placement of common shares, net of
issuance costs of $41,998 280,590 281 2,388,247 -- -- 2,388,528
Issuance of common shares for acquisition of
Eastern Telecom, Inc. 501,835 502 5,499,498 -- -- 5,500,000
Issuance of common shares for conversion of
convertible debentures 105,918 106 758,005 -- -- 758,111
----------- ------ ----------- ------------ --------- ------------
</TABLE>
38
<PAGE> 43
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
For the years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Common stock
--------------------- Additional Other
Number of paid-in Accumulated comprehensive
Shares Par value capital deficit income Total
---------- --------- ----------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 9,879,062 9,879 38,222,005 (24,124,509) (288,674) 13,818,701
---------- ------- ----------- ------------ --------- ------------
Net loss for the year -- -- -- (5,817,366) -- (5,817,366)
Other comprehensive income
Foreign currency translation adjustment -- -- -- -- (166,364) (166,364)
---------- ------- ----------- ------------ --------- ------------
Comprehensive income -- -- -- (5,817,366) (166,364) (5,983,730)
---------- ------- ----------- ------------ --------- ------------
Issuance of common shares for products
and services 137,500 138 650,001 -- -- 650,139
Issuance of common shares for
conversion of
convertible debentures 866,368 866 4,352,772 -- -- 4,353,638
Issuance of common shares for employee
stock purchase plan 36,653 37 156,002 -- -- 156,039
Issuance of common shares for conversion
of private placement 563,471 563 2,486,937 -- -- 2,487,500
Exercise of stock options 63,188 63 108,574 -- -- 108,637
---------- ------- ----------- ------------ --------- ------------
Balance, December 31, 1997 11,546,242 11,546 45,976,291 (29,941,875) $(455,038) $ 15,590,924
---------- ------- ----------- ------------ --------- ------------
Net loss for the year -- -- -- (16,935,972) -- (16,935,972)
Other comprehensive income
Foreign currency translation adjustment -- -- -- -- 114,191 114,191
---------- ------- ----------- ------------ --------- ------------
Comprehensive income -- -- -- (16,935,972) 114,191 (16,821,781)
---------- ------- ----------- ------------ --------- ------------
Issuance of common shares for products
and services 237,500 238 516,606 -- -- 516,844
Issuance of common shares for conversion of
convertible debentures 445,956 446 702,097 -- -- 702,543
Issuance of common shares for employee stock
purchase plan 20,446 20 59,019 -- -- 59,039
Exercise of stock options 50,000 50 124,969 -- -- 125,019
Issuance of stock warrants -- -- 830,057 -- -- 830,057
---------- ------- ----------- ------------ --------- ------------
Balance, December 31, 1998 12,300,144 $12,300 $48,209,039 $(46,877,847) $(340,847) $ 1,002,645
========== ======= =========== ============ ========= ============
</TABLE>
The accompanying notes are an integral part of this statement.
39
<PAGE> 44
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
<TABLE>
<CAPTION>
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(16,935,972) $(5,817,366) $(6,706,894)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,838,296 1,438,054 1,420,547
Provision for doubtful accounts 1,903,248 176,174 62,000
Allowance to reduce inventory to
lower of cost or market 1,499,205 (315,645) 250,000
Issuance of common stock in
lieu of cash compensation -- -- 139,492
Loss on sale of property and equipment -- -- 28,145
Impairment loss 7,767,444 -- --
Loss on sale of investments 452,005 -- --
Gain on disposal of discontinued
operations (344,732) -- --
Changes in related assets and
liabilities, net of businesses acquired:
Accounts receivable (2,055,078) (900,018) 2,797,035
Inventories (211,748) 584,122 794,139
Demonstration inventory 617,590 568,877 (1,491,934)
Prepaid expenses and other
current assets 108,986 (73,230) 344,616
Accounts payable (156,758) 991,498 (139,772)
Accrued expenses 806,863 339,554 (746,742)
Deferred revenue 1,015,238 (218,484) 289,483
------------ ----------- -----------
Net cash used in operating
activities (3,695,413) (3,226,464) (2,959,885)
------------ ----------- -----------
Cash flows from investing activities:
Cash paid for business acquisitions,
net of cash acquired -- -- (3,668,131)
Proceeds from sale of property and
equipment -- -- 30,314
Purchases of property and equipment (381,348) (400,230) (418,304)
Capitalized software development costs -- (77,886) (153,007)
Other assets -- (442,596) (405,760)
Proceeds from sale of investments 492,776 -- --
------------ ----------- -----------
Net cash provided by (used in)
investing activities 111,428 (920,712) (4,614,888)
------------ ----------- -----------
</TABLE>
40
<PAGE> 45
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from financing activities:
Change in notes payable and short-term
borrowings, net 2,008,468 (586,588) (2,062,849)
Proceeds from convertible debentures 3,000,000 -- 5,000,000
Cash redemption of convertible debentures (1,440,000) -- --
Proceeds from exercise of stock options
and warrants, net of related costs 125,000 264,676 298,865
Proceeds from issuance of common stock,
net of issuance costs 59,058 650,139 109,424
Proceeds from private placement
financings, net of issuance costs -- 2,487,500 2,388,528
----------- ----------- -----------
Net cash provided by financing
activities 3,752,526 2,815,727 5,733,968
----------- ----------- -----------
Effect of exchange rate changes on cash
and cash equivalents 114,191 (62,727) (101,623)
----------- ----------- -----------
Increase (decrease) in cash
and cash equivalents 282,732 (1,394,176) (1,942,428)
Change in cash and cash equivalents included
in current assets of discontinued operations (8,185) (6,325) --
Cash and cash equivalents at beginning
of year 859,684 2,260,185 4,202,613
----------- ----------- -----------
Cash and cash equivalents at end of year $ 1,134,231 $ 859,684 $ 2,260,185
=========== =========== ===========
</TABLE>
41
<PAGE> 46
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
<TABLE>
<CAPTION>
1998 1997 1996
--------------- ----------- -----------
<S> <C> <C> <C>
Supplementary disclosure:
Interest paid $ 411,439 $ 247,744 $ 357,216
=============== =========== ===========
Income taxes paid $ -- $ 180,000 $ --
=============== =========== ===========
Supplemental schedule of noncash
investing and financing activities:
Noncash investing and financing activities:
Conversion of debt to common stock $ 702,543 $ 4,353,638 $ 1,095,224
=============== =========== ===========
Common stock issued for products and
services $ 516,844 $ 650,139 $ 600,009
=============== =========== ===========
Acquisition of businesses
Fair value of assets acquired $ -- $ -- $ 9,540,923
Cash paid -- -- (3,685,128)
Common stock and options issued -- -- (5,500,000)
--------------- ----------- -----------
Liabilities assumed $ -- $ -- $ 355,795
=============== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
42
<PAGE> 47
VSI Enterprises, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
VSI Enterprises, Inc. was incorporated in Delaware in September 1988
and, together with its wholly-owned subsidiaries (the "Company"),
provides videoconferencing systems, software, and service; and
commission-based reselling of telephone network services for telephone
operating companies and related communication entities.
1. Accounting Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and
liabilities and disclosures of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
2. Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
3. Cash and Cash Equivalents
For financial reporting purposes, the Company considers all highly
liquid investments with an original maturity of three months or less to
be cash equivalents.
4. Inventories
Inventories consist of videoconferencing system components and parts
and are valued at the lower of cost (first-in, first-out method) or
market.
5. Demonstration Inventory
Demonstration inventory is stated at cost. Demonstration inventory
allowance is provided for in amounts sufficient to reflect the asset at
its estimated fair value.
6. Property and Equipment
Property and equipment are stated at cost. Depreciation is provided for
in amounts sufficient to relate the cost of depreciable assets to
operations over their estimated useful lives on a straight-line basis.
43
<PAGE> 48
7. Goodwill
The excess acquisition cost over the fair value of net assets of
acquired businesses are amortized over 20 years on a straight-line
basis. At December 31, 1998, an impairment loss of $6,995,211 was
charged to operations as an impairment of the original goodwill
recorded with the Company's acquisition of its telephone network
reselling subsidiary, Eastern Telecom, Inc. ("ETI") due to a
significant change in 1998 in ETI's anticipated income stream.
Management decreased ETI's goodwill to its estimated value based on
expected future undiscounted cash flows from ETI's operations. Also,
based on changes in ETI's business, the remaining goodwill of $955,688
will be amortized over ten years on a straight-line basis. An
additional $577,077 impairment loss was recorded to eliminate all
remaining goodwill related to the Company's European subsidiary.
Management recorded the impairment loss in light of the Company's
European subsidiary's continuing operating losses and expectations of
future losses. Accumulated amortization of goodwill was $8,867,611 and
$802,584 at December 31, 1998 and 1997, respectively. Amortization
charged to operations (exclusive of the impairment loss) was $492,739,
$492,738 and $156,784 for the years ended December 31, 1998, 1997 and
1996, respectively.
8. Software Development Costs
All software development costs are charged to expense as incurred until
technological feasibility has been established for the product.
Software development costs incurred after technological feasibility has
been established are capitalized and amortized, commencing with product
release, on a straight-line basis over three years or the useful life
of the product, whichever is shorter. Accumulated amortization of
software development costs was $1,634,897 and $1,052,194 at December
31, 1998 and 1997, respectively. Amortization expense charged to
operations was $582,703, $399,945, and $416,407 for the years ended
December 31, 1998, 1997 and 1996, respectively.
9. Investments
The Company accounts for investments in entities in which it owns less
than 20% under the cost method. At December 31, 1997, other long-term
assets included $944,781 representing the Company's cost investments in
Global Telemedix and Educational Video Conferencing ("EVC"). Global
Telemedix provides computer hardware and software to healthcare
providers and EVC acts as a marketing and technological bridge between
higher education institutions and corporations. During 1998, the
Company sold its investments in these companies resulting in a loss of
$452,005. At December 31, 1998 and 1997, receivables outstanding from
investees were approximately $0 and $250,000, respectively. In
addition, sales to investees were approximately $116,000, $1,038,000
and $35,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
10. Accounting for Impairments in Long-Lived Assets
Long-lived assets and identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that
the carrying amounts of assets may not be recoverable. Management
periodically evaluates the carrying value and the economic useful life
of its long-lived assets based on the Company's operating performance
and the expected future undiscounted cash flows and will adjust the
carrying amount of assets which may not be recoverable. At December 31,
1998, the Company recorded a charge against operations of $7,572,288
related to the writedown of goodwill previously recorded upon the
Company's acquisition of its European subsidiary and telephone network
reselling subsidiary (Note A-7). The Company recorded an additional
impairment charge of $195,156 related to the writedown of the its
European subsidiary's net asset value to zero based on the European
subsidiary's continuing losses. Management believes that remaining
long-lived assets in the accompanying consolidated balance sheets are
appropriately valued.
11. Foreign Currency Translation
The asset and liability accounts of the Company's foreign subsidiaries
are translated into U.S. dollars at the current exchange rate in effect
at the balance sheet date. Stockholders' equity is translated at
historical rates.
44
<PAGE> 49
Income statement items are translated at average currency exchange
rates. The resulting translation adjustment is recorded as a separate
component of stockholder's equity.
Translation gains and losses were not significant for any period
presented.
12. Revenue Recognition
Revenue from sales of videoconferencing systems and related maintenance
contracts on these systems are included in videoconferencing systems
revenues. Revenue on system sales are recognized upon shipment. Revenue
on maintenance contracts are recognized over the term of the related
contract.
Commission revenue from telephone network service sales are recognized
upon receipt of order and when the Company has no further obligation
related to the order.
13. Income Taxes
The Company accounts for income taxes using the asset and liability
method. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates applied to taxable
income. The effect on deferred tax assets and liabilities of a change
in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is provided for deferred tax
assets when it is more likely than not that the asset will not be
realized.
14. Stock Based Compensation
The Company accounts for its stock-based compensation plans under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees. Effective in 1995, the Company adopted the disclosure
option of Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation. SFAS No. 123 required that
companies that do not choose to account for stock-based compensation as
prescribed by the statement, shall disclose the pro forma effects on
earnings and earnings per share as if SFAS No. 123 had been adopted.
Additionally, certain other disclosures are required with respect to
stock compensation and the assumptions used to determine the pro forma
effects of SFAS No. 123 (see Note H).
15. Net Loss Per Common Share
In 1997, the Company adopted SFAS No. 128, Earnings Per Share. That
statement requires the disclosure of basic net earnings (loss) per
share and diluted net earnings (loss) per share when different from
basic. Basic net earnings (loss) per share is computed by dividing net
earnings (loss) available to common stockholders by the weighted
average number of common shares outstanding during the period. Diluted
net earnings (loss) per share gives effect to all potentially dilutive
securities. There is no difference between basic loss per share and
diluted loss per share for any period presented.
During 1998, the shareholders approved a one-for-four reverse common
stock split, effective January 15, 1999 to shareholders of record on
January 14, 1999. All references to shares of common stock, stock
options and per share amounts have been restated to reflect this
reverse common stock split.
16. Fair Value of Financial Instruments
The Company's financial instruments include cash, cash equivalents and
notes payable. Estimates of fair value of these instruments are as
follows:
45
<PAGE> 50
Cash and cash equivalents - The carrying amount of cash and cash
equivalents approximates fair value due to the relatively short
maturity of these instruments.
Notes payable - The carrying amount of the Company's notes payable
approximate fair value based on borrowing rates currently available to
the Company for borrowings with comparable terms and conditions.
17. Technological Change and New Products
The market for the Company's products is characterized by rapidly
changing technology, evolving industry standards and frequent product
introductions. Product introductions are generally characterized by
increased functionality and better videoconferencing picture quality at
reduced prices. The introduction of products embodying new technology
may render existing products obsolete and unmarketable. The Company's
ability to successfully develop and introduce on a timely basis new and
enhanced products that embody new technology, and achieve levels of
functionality at a price acceptable to the market, will be a
significant factor in the Company's ability to grow and to remain
competitive. If the Company is unable, for technological or other
reasons, to develop competitive products in a timely manner in response
to changes in the industry, the Company's business and operating
results will be materially and adversely affected.
18. Dependence on Third Parties
Substantially all of the Company's components, subsystems and
assemblies are made by outside vendors. Disruption in supply, a
significant increase in the price of one or more of these components,
or failure of a third party supplier to remain competitive in
functionality or price could have a material adverse effect on the
Company's business and operating results. There can be no assurance
that the Company will not experience such problems in the future.
Similarly, excessive rework costs associated with defective components
or process errors associated with the Company's anticipated new product
line of videoconferencing systems could adversely affect the Company's
business and operating results.
19. Foreign Sales and Operations
International sales and operations are subject to inherent risks,
including difficulties and delays in obtaining pricing approvals and
reimbursement, unexpected changes in regulatory requirements, tariffs
and other barriers, political instability, difficulties in staffing and
managing foreign operations, longer payment cycles, greater difficulty
in accounts receivable collection and adverse tax consequences.
Currency translation gains and losses on the conversion to United
States dollars and international operations could contribute to
fluctuations in the Company's results of operations. If for any reason,
exchange or price controls or other restrictions on the conversion or
repatriation of foreign currencies were imposed, the Company's
operating results could be adversely affected. There can be no
assurance that these factors will not have an adverse impact on the
Company's future international sales and operations and, consequently,
on the Company's operating results.
20. Reclassifications
Certain amounts in the 1997 financial statements have been reclassified
to conform to the current year presentation.
NOTE B - REALIZATION OF ASSETS
46
<PAGE> 51
The accompanying financial statements have been prepared in conformity
with generally accepted accounting principles, which contemplate
continuation of the Company as a going concern. However, the Company
has sustained substantial losses from operations in recent years, and
such losses have continued through March 5, 1999. Also, the Company has
defaulted on the first installment of $300,000 due February 16, 1999 on
its term note payable (Note F) an additional installment of $600,000 is
due on May 16, 1999. In addition, the Company has used, rather than
provided, cash in its operations.
In view of the matters described in the preceding paragraph,
recoverability of a major portion of the recorded asset amounts shown
in the accompanying balance sheet is dependent upon continued
operations of the Company, which in turn is dependent upon the
Company's ability to meet its financing requirements on a continuing
basis, to maintain present financing, and to succeed in its future
operations. The financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset
amounts or amounts and classification of liabilities that might be
necessary should the Company be unable to continue in existence.
In response to the matters described in the preceding paragraphs,
management of the Company has undertaken a restructuring of the
business operations that, when implemented, is intended to achieve
profitable operations and provide positive operating cash flows as well
as provide for additional equity capital investments. Subsequent to
year end, the company has reviewed its operating expenses and
substantially reduced fixed management and overhead expenses.
Management also intends to close and or spin off non-strategic business
operations and has recognized asset impairment losses that reflect its
decisions.
NOTE C - MERGERS AND ACQUISITIONS
INS Merger
On June 25, 1996, the Company, through its wholly-owned subsidiary, INS
Acquisition Co., issued 120,418 shares of its common stock in exchange
for all of the outstanding common stock of Integrated Network Services,
Inc. ("INS"). The merger has been accounted for as a pooling of
interests and accordingly, the Company's consolidated financial
statements have been restated to include the accounts and operations of
INS for all periods prior to the merger. During 1998, the company
discontinued operations of INS (see Note D). INS provided integration
services for local and wide area networks.
Separate results of operations for the periods prior to the merger are
as follows for the year ending December 31, 1996.
<TABLE>
<S> <C>
Revenue:
VSI $ 12,709,224
INS 4,346,723
------------
$ 17,055,947
============
Net (loss) earnings from continuing operations:
VSI $ (5,992,477)
INS (714,417)
------------
$ (6,706,894)
============
Net loss:
VSI $ (5,992,477)
INS (714,417)
------------
$ (6,706,894)
============
</TABLE>
47
<PAGE> 52
Acquisitions
In October 1996, the Company acquired all of the outstanding common
stock of Eastern Telecom, Inc. ("ETI") in exchange for 501,835 shares
of VSI common stock, 31,939 options to purchase VSI common stock at
less than $.04 per share and $3,500,000 in cash. The cash portion of
the purchase was funded from the issuance of $5,000,000 of convertible
debentures. The acquisition was valued at approximately $9,185,000
including acquisition costs of approximately $185,000. ETI is engaged
in the selling of network services of telephone operating companies and
long distance carriers.
The ETI acquisition was accounted for as a purchase. Accordingly, the
purchase price was allocated to assets and liabilities based on their
estimated fair values at the date of acquisition. Results of operations
of ETI have been included in the consolidated financial statements from
the respective date of acquisition. Goodwill of approximately
$9,000,000 related to the purchase was being amortized on a
straight-line basis over 20 years. At December 31, 1998, the Company
recorded an impairment loss on this goodwill of $6,995,211 and reduced
the amortization period to ten years reflecting 1998 changes in ETI's
business and based on expected future undiscounted cash flows from
ETI's operations (Note A-7).
NOTE D - DISCONTINUED OPERATIONS
During the fourth quarter of 1998, the Company discontinued operations
of its system integration subsidiary, Integrated Network Services, Inc.
Accordingly, operating results for the discontinued operation have been
reclassified and reported as discontinued operations in accordance with
Accounting Principles Board Opinion No. 30 for the years ended December
31, 1998, 1997 and 1996. Summary operating results of the discontinued
system integration operations are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenues $ 1,518,952 $ 2,145,388 $ 4,346,723
Costs and expenses 2,282,657 3,091,150 5,061,140
----------- ----------- -----------
Loss from discontinued operations $ (763,705) $ (945,762) $ (714,417)
=========== =========== ===========
</TABLE>
Assets and liabilities of the discontinued system integration
operations are included in the consolidated balance sheets as assets
and liabilities of discontinued operations and are made up as follows:
48
<PAGE> 53
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Cash and cash equivalents $ 14,510 $ 6,325
Accounts receivable 319,512 439,376
Inventories -- 76,936
Other current assets -- 34,484
Property and equipment -- 123,527
Other assets -- 8,385
-------- --------
Total assets $334,022 $689,033
======== ========
Notes payable $248,116 $279,355
Accounts payable -- 364,960
Accrued expenses 85,906 75,615
Deferred revenue -- 61,932
-------- --------
Total liabilities $334,022 781,862
======== ========
</TABLE>
The Company recognized a gain on disposal of the system integration
segment at December 31, 1998 of approximately $345,000.
NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of December 31, 1998
and 1997:
<TABLE>
<CAPTION>
Estimated
Service
1998 1997 Life
----------- ----------- ----------
<S> <C> <C> <C>
Machinery and equipment $ 3,468,988 $ 3,199,101 3-10 years
Furniture and fixtures 723,132 668,132 10 years
Leasehold improvements 203,656 169,857 5 years
----------- -----------
4,395,776 4,037,090
Less accumulated depreciation (3,346,793) (2,842,182)
Less amounts included in other assets
of discontinued operations -- (123,527)
----------- -----------
$ 1,048,983 $ 1,071,381
=========== ===========
</TABLE>
Depreciation expense charged to operations was approximately $527,000,
$562,000 and $814,000 for the years ended December 31, 1998, 1997 and
1996, respectively and is included in selling, general and
administrative expense in the accompanying consolidated statements of
operations.
NOTE F - NOTES PAYABLE AND SHORT-TERM BORROWINGS
Notes Payable
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
VSI line of credit; provides for maximum
borrowings of $4,000,000, limited to 80% of
eligible accounts receivable, interest
payable monthly at the prime rate plus 2%
(9.75% at December 31, 1998); collateralized
by accounts receivable, certain property and
equipment and inventory of VSI. $ 82,556 $ 905,684
</TABLE>
49
<PAGE> 54
<TABLE>
<S> <C> <C>
VSI term note payable in two installments of
$300,000 and $600,000 due on February 16,
1999 and May 16, 1999, respectively.
Interest is payable upon retirement of note
at 14%; collateralized by security interests
in certain patents owned by VSI. Failure to
pay the installments on these respective due
dates will result in a penalty of $30,000
per month until the note is retired. 900,000 -
VSI term notes payable due on March 31,
2000; interest payable quarterly at the
prime rate plus 3% (10.75% at December 31,
1998). These term notes are unsecured. The
term notes payable are shown net of debt
discount of $227,345. 1,105,655 -
INS line of credit; provides for maximum
borrowings of $750,000, limited to 80% of
eligible accounts receivable; interest
payable monthly at the prime rate plus 3%
(10.75% at December 31, 1998);
collateralized by accounts receivable,
property and equipment and inventory of INS. 248,116 279,355
ETI line of credit; provides for maximum
borrowings of $1,500,000, limited to 90% of
eligible accounts receivable; interest
payable monthly at the prime rate plus 2.75%
(10.50% at December 31, 1998);
collateralized by eligible accounts
receivable of ETI. 1,402,523 210,543
Note payable to bank of European subsidiary;
provides for maximum borrowings of
approximately $550,000; interest payable
monthly at 5%. This note is secured by
137,500 shares of the Company held in escrow
by the European bank. 252,869 26,785
---------- ----------
3,991,719 1,422,367
Current portion of notes payable 2,637,948 1,143,012
---------- ----------
1,353,771 279,355
Less notes payable included in current
liabilities of discontinued operations 248,116 279,355
---------- ----------
$1,105,655 $ -
========== ==========
</TABLE>
In 1997, the Company adopted SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities (the
"Statement"). This Statement provides accounting and reporting
standards for transfers and servicing of financial assets and
extinguishments of liabilities. Those standards are based on consistent
application of a financial-components approach that focuses on control.
Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control
has been surrendered, and derecognizes liabilities when extinguished.
At December 31, 1998 and 1997, the Company has recognized approximately
$1,733,000 and $1,396,000 of accounts receivable financing,
respectively, as notes payable in the accompanying balance sheets.
During 1996, note agreements with directors were terminated. The
remaining balances of these notes of $299,656 plus accrued interest of
$37,457 were retired by the issuance of 61,204 common shares. Interest
50
<PAGE> 55
expense under notes due to directors totaled approximately $0, $0 and
$16,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
In March 1998, the Company secured a working capital loan for
approximately $2.0 million from AmTrade International Bank of Georgia.
The loan was guaranteed by the Export-Import Bank of the United States,
and was collateralized by a letter of credit from a VSI customer. Funds
were used for pre-/post-export financing for the manufacture and
delivery of videoconferencing equipment in China. The interest rate was
prime plus 2.5%. Repayment was made in 1998 through proceeds of the
letter of credit, which was applied first to the loan principal and
interest, with the remaining amount remitted to VSI. Interest expense
related to this note was approximately $57,000 for the year ended
December 31, 1998.
During September 1998, the Company began offering $3,000,000 of term
notes. A minimum of $5,000 is required for each subscription and each
purchaser of the term notes receives warrants to purchase shares of
common stock of the company on the basis of one warrant for each $8.00
of term notes purchased. The warrants have a term of five years,
expiring on October 1, 2003 and become exercisable on April 1, 2000 at
an exercise price of $1.68 per share. At December 31, 1998, the Company
has issued $1,333,000 of term notes and 166,625 warrants. The Company
has valued these warrants at $270,645 using the Black-Scholes
option-pricing model in accordance with SFAS No. 123, Accounting for
Stock-Based Compensation. This warrant value is recorded as debt
discount to be amortized to interest expense over the period until the
warrants become exercisable on April 1, 2000. Interest expense related
to these warrants was $43,300 for the year ended December 31, 1998.
Short-Term Borrowings
At December 31, 1998 and 1997, the company's foreign subsidiary had
short-term borrowings which provided for maximum borrowings of
approximately $166,000 and $219,000, respectively. These bank credit
facilities are collateralized by the subsidiary's accounts receivable
and inventory and bear interest at 7%. Outstanding borrowings under
these agreements were $157,376 and $154,938 at December 31, 1998 and
1997, respectively.
NOTE G - CONVERTIBLE DEBENTURES
On February 23, 1998, the Company issued $3,000,000 of 5% convertible
Debentures due February 2000 (the "Debentures"), the proceeds of which
were utilized for working capital purposes. In addition, the Company
issued 9,375 common stock purchase warrants to the holder of the
Debentures and 9,375 common stock purchase warrants to an agent
involved in the transaction. The warrants, which expire on February 23,
2003, entitle the holder to purchase one common stock share of the
Company at the price of $10.00. The Debentures were convertible at the
lower of (i) $8.00 per share or (ii) 85% of the average closing bid
price of the Company's common stock. (Average closing bid price( is
defined to mean the lowest average of the daily last bid price for the
common stock for any three trading days in any 20-day period preceding
the conversion. During the year, $710,000 of Debentures plus accrued
interest of $13,531 were converted into 445,956 common shares;
$1,440,000 of the Debentures were redeemed by the Company at face value
and the remaining Debentures were converted into a $900,000 term note
(see Note F). 50,000 shares of the 445,956 issued in connection with
the conversion were held in escrow at December 31, 1998 with 25,000 of
these issued in January 1999 and 25,000 issued in February 1999.
On November 16, 1998, the Company issued an additional 25,000 stock
purchase warrants to the holder of the Debentures to enable the Company
to purchase the $1,440,000 outstanding Debentures at face value. The
warrants, which expire on November 16, 2003, entitle the holder to
shares of the common stock of the Company at a price of $2.40 per
share. At this time, the Company also repriced the 9,375 warrants
issued to the Debenture holder on February 23, 1998 to a price of $2.40
per share. This repricing had no impact on the consolidated statement
of operations.
51
<PAGE> 56
In conjunction with the issuance of the 18,750 common stock warrants to
the Debenture holder and agent, $529,412 of the debt issuance proceeds
relating to the issuance of the Debentures was allocated to additional
paid in capital in the accompanying consolidated balance sheet, to
recognize the beneficial conversion feature of the Debentures. This
debt discount was amortized to interest expense upon conversion and
redemption of the Debentures and is included in other expenses in the
consolidated statements of operations for the year ended December 31,
1998. In conjunction with the issuance of the additional 25,000
purchase warrants, the Company valued the warrants at $30,000 using the
Black-Scholes option pricing model in accordance with SFAS No. 123,
Accounting for Stock-Based Compensation. This warrant value was
recorded as interest expense upon issuance of the warrants.
NOTE H - STOCK OPTIONS, WARRANTS, AND EMPLOYEE STOCK PURCHASE PLAN
Stock Option Plan
The Company's board of directors has approved a stock option plan which
covers up to 915,514 shares of common stock. The plan provides for the
expiration of options ten years from the date of grant and requires the
exercise price of the options granted to be at least equal to 100% of
market value on the date granted. Stock option transactions are
summarized below:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------- ----------------------- ----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- -------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 475,867 $6.88 480,856 $ 6.52 484,242 $ 5.92
Granted 196,250 1.75 84,000 6.20 137,738 9.08
Exercised (50,000) 2.50 (63,189) 3.36 (76,408) 3.92
Forfeited (28,795) 7.82 (25,800) 10.76 (64,716) 10.32
-------- ----- -------- ------ -------- ------
Outstanding, end of year 593,322 $5.46 475,867 $ 6.88 480,856 $ 6.52
======== ===== ======== ====== ======== ======
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------- -----------------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding at Contractual Exercise Exercisable at Exercise
Price December 31, 1998 Life (Years) Price December 31, 1998 Price
-------- ----------------- ------------ -------- ----------------- --------
<S> <C> <C> <C> <C> <C>
$ 1.00 - $ 1.87 142,500 9.78 $ 1.08 38,750 $ 1.14
$ 2.50 - $ 3.76 60,667 8.02 2.80 29,417 2.63
$ 4.25 - $ 5.25 208,793 7.78 5.04 152,126 4.98
$ 5.50 - $ 7.76 57,333 6.62 6.77 53,166 6.80
$ 8.50 - $ 9.87 64,792 6.78 9.22 64,132 9.22
$11.00 - $14.75 41,600 7.30 13.83 37,354 13.80
$17.25 17,637 6.85 17.25 17,637 17.25
------- ---- ------ -------- ------
593,322 8.00 $ 5.46 392,582 $ 6.75
======= ==== ====== ======== ======
</TABLE>
52
<PAGE> 57
The Company uses the intrinsic value method in accounting for its stock
option plans. In applying this method, no compensation cost has been
recognized. Had compensation cost for the Company's stock option plans
been determined based on the fair value at the grant dates for awards
under those plans, the Company's net loss and loss per share would have
resulted in the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Net loss
As reported $ (16,935,972) $ (5,817,366) $ (6,706,894)
Pro forma (17,248,878) (6,490,242) (7,509,903)
Net loss per common share
As reported $ (1.42) $ (0.53) $ (0.74)
Pro forma (1.45) (0.60) (0.84)
</TABLE>
For purposes of the pro forma amounts above, the fair value of each
option grant was estimated on the date of grants using the
Black-Scholes options pricing model with the following weighted average
assumptions used for grants in 1998, 1997 and 1996, respectively;
expected volatility of 87%, 88% and 110%, risk-free interest rates of
$5.0%-6.1%, $5.9%-6.7% and 5.3%-6.6% and expected lives of 3-7 years
for all periods presented.
Warrants
In connection with the purchase of the outstanding notes payable and
establishment of a line of credit during 1994, 62,500 common stock
purchase warrants were granted to a director at an exercise price of
$1.60 per share. These warrants expire in July 2004.
Employee Stock Purchase Plan
The Company has an employee stock purchase plan ("Plan") that provides
for the sale of up to 75,000 shares of common stock to eligible
employees. The purchase price for shares of common stock purchased
pursuant to the Plan is the lesser of: 85% of the fair market value of
common stock on the first pay date or 85% of the fair market value of
common stock on the last pay date of each plan period. 20,446 and
36,653 shares of common stock were purchased by employees under this
Plan for the years ended December 31, 1998 and 1997, respectively. The
Plan was suspended by the Board of Directors in September 1998. The
Company has no current plans to reinstate the Plan.
NOTE I - INCOME TAXES
The Company's temporary differences result in a net deferred income tax
asset which is reduced to zero by a related deferred tax valuation
allowance, summarized as follows at December 31, 1998 and 1997:
53
<PAGE> 58
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Deferred income tax assets:
Operating loss carryforwards $ 11,315,000 $ 7,700,000
Nondeductible accruals and allowances 1,117,000 758,000
Capitalized inventory costs 140,000 147,000
Tax credit carryforwards 89,000 89,000
Other 195,000 205,000
------------ -----------
Gross deferred income tax assets 12,856,000 8,899,000
Deferred income tax asset valuation allowance (12,675,000) (8,689,000)
------------ -----------
Net deferred income tax asset $ 181,000 $ 210,000
============ ===========
Deferred income tax liabilities $ (181,000) $ (210,000)
============ ===========
Net deferred income tax $ -- $ --
============ ===========
</TABLE>
Income tax expense for 1997 of $193,241 represents state income taxes
associated with the operations of ETI and was calculated using the
statutory rates applicable in the various states to which income has
been apportioned.
At December 31, 1998, the Company had operating loss carryforwards for
U.S. income tax purposes of approximately $29,389,000 available to
reduce future taxable income and approximately $89,000 of investment
and research and experimental credits available to reduce future income
taxes payable, which expire in varying amounts through the year 2013.
The Company's European subsidiary has net operating loss carryforwards
of approximately $3,350,000 that can be used to offset future taxable
income. These carryforwards can be carried forward indefinitely. The
resulting deferred income tax asset has been reduced to zero by a
related valuation allowance.
The Company experienced a change in control, as defined under Section
382 of the Internal Revenue code during calendar year 1993. As a
result, the utilization of approximately $7,000,000 in tax loss
carryforwards will be limited to approximately $1,000,000 annually.
NOTE J- MAJOR CUSTOMERS
Revenue from health care providers and related entities comprised
approximately 7%, 10% and 25% of consolidated revenues for the years
ended December 31, 1998, 1997 and 1996, respectively. Revenue from
telephone operating companies and related communications entities
comprised approximately 36%, 43% and 23% of consolidated revenues for
the years ended December 31, 1998, 1997 and 1996, respectively. At
December 31, 1998 and 1997, accounts receivable from telephone
operating companies and related communication entities comprised 43%
and 44%, respectively, of consolidated receivables. Accounts receivable
from healthcare providers comprised 6% and 7%, respectively, of
consolidated receivables.
Management believes that concentration of credit risk with respect to
trade receivables is minimal due to the composition of the customer
base. The Company's customers are primarily large national and
multinational companies and agencies of the U.S. government. Allowances
are maintained for potential credit losses, and such losses have been
within management's expectations.
The Company's operations are subject to rapid technological
developments. Management periodically evaluates the realizability of
its technology-related assets, including inventories, software
development costs and goodwill. During the years ended December 31,
1998 and 1997, the Company recorded approximately $1,651,000 and
$2,111,000 of additional cost of videoconferencing systems related to
the write-down of certain inventories determined to be technologically
obsolete. Management believes that no material impairment of remaining
inventories and other assets existed at December 31, 1998 and 1997. It
is possible, however, that management's estimates may change in the
near term due to technological, regulatory, and other changes in the
Company's industry.
54
<PAGE> 59
NOTE K - OPERATING SEGMENTS AND RELATED INFORMATION
In 1998, the Company adopted SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information. This statement requires the
disclosure of certain information regarding the Company's operating
segments.
Prior to 1998, the Company's industry segments were made up of
videoconferencing, computer system integration and telephone network
reselling. These industry segments were all operating in separate, one
hundred percent owned, subsidiaries. In 1998, the Company discontinued
operations of its computer system integration subsidiary. As a result,
at December 31, 1998, the Company is primarily operating in the
videoconferencing segment and telephone network reselling segment as
follows:
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenue:
Videoconferencing systems $ 13,574,214 $ 12,168,107 $ 11,159,943
Network reselling 5,863,197 7,451,686 1,549,281
------------ ------------ ------------
19,437,411 19,619,793 12,709,224
Operating (loss) income:
Videoconferencing systems (6,166,394) (5,903,979) (6,339,722)
Network reselling (8,216,297) 1,301,785 486,293
------------ ------------ ------------
(14,382,691) (4,602,194) (5,853,429)
Capital expenditures:
Videoconferencing systems 13,373 98,096 369,117
Network reselling 367,975 302,134 49,187
------------ ------------ ------------
381,348 400,230 418,304
Identifiable assets:
Videoconferencing systems 6,274,667 10,659,140 13,344,581
Network reselling 4,352,276 11,532,286 10,267,688
System integration 334,022 689,033 1,219,988
------------ ------------ ------------
$ 10,960,965 $ 22,880,459 $ 24,832,257
============ ============ ============
</TABLE>
The Company also has operations in the United States and Europe.
Summary information related to the United States and European
operations are as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
----------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenue:
United States $ 16,515,355 $ 16,851,511 $ 10,209,556
Europe 2,922,056 2,768,282 2,499,668
------------ ------------ ------------
$ 19,437,411 $ 19,619,793 $ 12,709,224
============ ============ ============
Operating loss:
United States $(13,953,057) $ (4,564,382) $ (5,126,073)
Europe (429,634) (37,812) (727,356)
------------ ------------ ------------
$(14,382,691) $ (4,602,194) $ (5,853,429)
============ ============ ============
Capital expenditures:
United States $ 373,018 $ 331,897 $ 333,588
Europe 8,330 68,333 84,716
------------ ------------ ------------
$ 381,348 $ 400,230 $ 418,304
============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
December 31,
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
Identifiable assets:
United States $10,203,619 $22,002,184
Europe 757,346 878,275
----------- -----------
$10,960,965 $22,880,459
=========== ===========
</TABLE>
55
<PAGE> 60
NOTE L - COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space and equipment under noncancelable
operating leases expiring at various dates through April 2003. Rent
expense for the years ended December 31, 1998, 1997 and 1996 was
approximately $660,000, $572,000 and $660,000, respectively.
Approximate minimum annual future rental payments under the leases are
as follows at December 31:
<TABLE>
<CAPTION>
Year ending:
<S> <C>
1999 $ 684,000
2000 633,000
2001 475,000
2002 382,000
2003 15,000
-----------
$ 2,189,000
===========
</TABLE>
Litigation
The Company is also involved in various claims and legal actions
arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a
material adverse effect on the Company's financial position or results
of operations.
NOTE M - SUBSEQUENT EVENT - UNAUDITED
The Company is currently in negotiation with a note holder to
restructure a $900,000 term note (See note F). The restructuring of
this note may involve a cash payment by the Company and the issuance of
shares of common stock of the Company to the note holder to repay the
note. If the debt cannot be restructured, the note holder may take
possession of the Company's patents which secure this debt. In the
event the Company is unable to license this technology from the note
holder, the Company's will be unable to manufacture, sell and service
its videoconferencing systems.
56
