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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended October 4, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to _____
Commission File No.: 0-18114
VIRTUALFUND.COM, INC.
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(Exact name of registrant as specified in charter)
Minnesota 41-1612861
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
7090 Shady Oak Road, Eden Prairie, Minnesota 55344
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(Address of principal executive offices) (Zip code)
(612) 941-8687
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(Registrant's telephone number, including area code)
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(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class Outstanding at 10/30/98
- ----- -----------------------
Common Stock, $.01 par value 15,778,866
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VIRTUALFUND.COM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
ASSETS
October 4, June 30,
1998 1998
------------ ------------
CURRENT ASSETS:
Cash and cash equivalents $ 508,596 $ 5,011,181
Accounts receivable, less allowance for
doubtful accounts and sales returns of
$1,222,000 and $1,662,000, respectively 8,205,974 11,648,638
Inventory 9,817,418 6,819,968
Other current assets 2,351,962 1,918,258
Deferred income taxes 1,214,000 1,214,000
------------ ------------
TOTAL CURRENT ASSETS 22,097,950 26,612,045
PROPERTY AND EQUIPMENT, NET 2,970,901 2,776,339
DEFERRED INCOME TAXES 3,552,000 3,552,000
ACQUIRED TECHNOLOGY, PATENTS
AND LICENSES, less accumulated
amortization of $772,620 and
$747,719, respectively 159,670 179,286
------------ ------------
$ 28,780,521 $ 33,119,670
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable $ 1,488,223 $ 2,015,988
Current maturities of long-term debt 205,683 259,550
Convertible subordinated debenture 375,866 375,866
Accounts payable 10,216,019 10,524,613
Accrued payroll and payroll taxes 699,950 1,475,317
Other current liabilities 1,422,204 1,412,021
Deferred revenue 1,254,774 1,222,265
------------ ------------
TOTAL CURRENT LIABILITIES 15,662,719 17,285,620
LONG-TERM DEBT, less current maturities 44,329 66,746
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; authorized
30,000,000 shares; 15,778,866 and
15,178,866 shares issued and
outstanding, respectively 157,789 151,789
Preferred stock, $.01 par value; authorized
5,000,000 shares; no shares issued or
outstanding
Additional paid in capital 33,015,420 32,995,320
Accumulated deficit (20,099,736) (17,379,805)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 13,073,473 15,767,304
------------ ------------
$ 28,780,521 $ 33,119,670
============ ============
See notes to consolidated financial statements
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VIRTUALFUND.COM, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended
----------------------------
October 4, September 28,
1998 1997
------------ ------------
NET SALES $ 15,355,294 $ 15,305,599
COST OF GOODS SOLD 8,418,199 9,721,829
------------ ------------
GROSS PROFIT 6,937,095 5,583,770
OPERATING EXPENSES:
Sales & Marketing 3,713,314 2,763,316
Research & Development 1,952,568 1,552,858
General & Administrative 2,278,966 2,627,964
Restructuring and Other Special Charges (600,000)
------------ ------------
7,344,848 6,944,138
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OPERATING LOSS (407,753) (1,360,368)
OTHER INCOME (EXPENSE):
Interest Expense (157,065) (261,745)
Interest Income 34,188 6,604
Other Expense (138,042) (30,332)
------------ ------------
(260,919) (285,473)
------------ ------------
LOSS BEFORE INCOME TAXES (668,672) (1,645,841)
INCOME TAX BENEFIT
------------ ------------
NET LOSS $ (668,672) $ (1,645,841)
============ ============
NET LOSS PER COMMON SHARE $ (.04) $ (.11)
Weighted average common shares outstanding 15,685,116 14,473,018
See notes to consolidated financial statements.
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VIRTUALFUND.COM, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
Three Months Ended
----------------------------
October 4, September 28,
1998 1997
------------ -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (668,672) $ (1,645,841)
Adjustments to reconcile net loss to net
cash (used in) provided by operating
activities:
Depreciation and amortization 418,903 501,889
Amortization of deferred financing
costs 54,834 51,843
(Gain) loss on sale of property and
equipment (2,379) 50,710
Change in current assets and current
liabilities:
Accounts receivable 3,597,478 2,607,931
Inventory (2,586,828) 297,292
Other current assets (483,227) 242,835
Accounts payable (343,300) (410,776)
Accrued payroll and payroll taxes (774,108) (392,792)
Other current liabilities (755,563) (243,006)
Deferred revenue 32,509 (38,621)
------------ ------------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES (1,510,353) 1,021,464
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (315,684) (70,514)
Proceeds from sale of property and equipment 10,315 2,296
Additions to patents and other assets (5,285) (6,206)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (310,654) (74,424)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of related party note payable (1,798,588)
Notes receivable - related party (175,000)
Collection of notes receivable - related
party 175,000
Net payments under revolving credit lines (547,065) (697,482)
Payments on long-term debt (335,925) (272,823)
------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (2,681,578) (970,305)
------------ ------------
DECREASE IN CASH AND CASH EQUIVALENTS (4,502,585) (23,265)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD 5,011,181 484,106
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 508,596 $ 460,841
============ ============
See notes to consolidated financial statements.
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VIRTUALFUND.COM, INC., AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of presentation -
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form
10-Q and Rule 10-01 of Regulation S-X. They do not include all
information and footnotes required by generally accepted accounting
principles for complete financial statements. However, except as
disclosed herein, there has been no material change in the information
disclosed in the notes to consolidated financial statements included in
the Annual Report on Form 10-K of VirtualFund.com, Inc. and
subsidiaries (the "Company") for the year ended June 30, 1998. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been
included. Operating results for the quarter ended October 4, 1998, are
not necessarily indicative of the results that may be expected for the
year ending June 30, 1999.
2. Earnings Per Share Calculation -
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per
Share. The following table summarizes the securities that could
potentially dilute basic earnings per share in the future that were not
included in the computation of loss per share because to do so would
have been antidilutive for the periods presented:
Quarter Ended
----------------------------
October 4, September 28,
1998 1997
------------ -------------
Stock options 3,775,539 3,575,110
Warrants 3,034,953 3,049,953
Shares issuable relating to
settlement of litigation 141,333
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Average common and assumed
conversion shares 6,810,492 6,766,396
============ ============
3. Inventory -
Inventory consists of the following:
October 4, September 28,
1998 1997
------------ -------------
Raw materials $ 4,527,222 $ 3,285,194
Work in process 252,046 207,303
Finished goods:
Consumables 3,174,722 2,604,318
Hardware 1,863,428 723,153
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$ 9,817,418 $ 6,819,968
============ ============
4. Business Combination -
On July 15, 1998, the Company issued 600,000 shares of common stock in
exchange for all of the common stock of Kilborn Photo Products, Inc.
(Kilborn). Kilborn is an inkjet coating facility for specialty media
and is based in Cedar Rapids, Iowa. The business combination was
accounted for as a pooling of interests. The results of Kilborn's
operations, which are not material, are included in the consolidated
financial statements from July 15, 1998. Prior periods have not been
restated as the amounts are also not material. Kilborn reported net
sales of $1.9 million (unaudited) for the year ended December 31, 1997.
Assets acquired and liabilities assumed include the following as of
July 15, 1998:
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(Unaudited)
Accounts receivable $ 155,000
Inventory 411,000
Property, plant and equipment, net 280,000
Other assets 91,000
Notes payable and accrued interest 2,956,000
Other liabilities 6,000
5. Supplemental disclosure of cash flow information and non-cash
financing activities -
Quarter Ended
----------------------------
October 4, September 28,
1998 1997
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The Company paid and received cash
for the following items:
Interest paid $ 105,109 $ 190,428
Financing transactions not
affecting cash:
Convertible subordinated
debenture and accrued interest
converted to common stock 234,375
Decrease in retained earnings
from exchange of 600,000 shares
of common stock for liabilities
assumed in excess of assets
acquired related to the
Kilborn Products, Inc.
acquisition 2,025,160
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
This Management's Discussion and Analysis contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995 (the
"Act"). These forward looking statements are subject to a number of risks,
including the Company's continuing need for additional cash, sensitivity of the
Company to technology changes in the computer printing industry and intense
competition in that industry, the Company's dependence on sales of newer
products with untested market acceptance, dependence on numerous product
components that are available from single sources, fluctuations in quarterly
operating performance, the strength of the Company's intellectual property
protection, the costs of pending litigation, and the size of the Company's
international operations. These and other factors which are set forth in Exhibit
99 to this Form 10-Q have caused wide fluctuations in the market price of the
Company's common stock and can be expected to cause similar fluctuations in the
future. Refer to Exhibit 99 of this Form 10-Q for certain important cautionary
factors, risks and uncertainties related to forward-looking statements.
On July 15, 1998, the Company issued 600,000 shares of common stock in exchange
for all of the common stock of Kilborn Photo Products, Inc. (Kilborn). Kilborn
is an inkjet coating facility for specialty media and is based in Cedar Rapids,
Iowa. The business combination was accounted for as a pooling of interests. The
results of Kilborn's operations, which are not material, are included in the
consolidated financial statements for July 15, 1998. Prior periods have not been
restated as the amounts are also not material.
RESULTS OF OPERATIONS
Net sales for the quarter ended October 4, 1998 were $15.4 million compared to
$15.3 million for the same period one year ago. Net loss for the quarter ended
October 4, 1998 was $669,000 or $.04 per share compared to a net loss of $1.6
million or $.11 per share for the quarter ended September 28, 1997.
The following table sets forth certain items from the Company's Consolidated
Statements of Operations expressed as a percentage of net sales:
Quarter Ended
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October 4, September 28,
1998 1997
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Net sales 100.0% 100.0%
Cost of goods sold 54.8 63.5
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Gross profit 45.2 36.5
Operating expenses:
Sales and marketing 24.2 18.1
Research and development 12.7 10.1
General and administrative 14.8 17.2
Restructuring and other special charges (3.9)
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Total operating expenses 47.8 45.4
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Operating loss (2.6) (8.9)
Other expense:
Interest (1.0) (1.7)
Other (0.7) (0.2)
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Loss before income taxes (4.3) (10.8)
Income tax - -
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Net loss (4.3)% (10.8)%
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NET SALES. During the quarter ended October 4, 1998 the Company's Digital
Graphics Business Unit recorded hardware sales of $4.1 million or 27% of total
net sales compared to $4.9 million or 32% of total net sales in the same period
one year ago. The $800,000 decrease in hardware revenues in the September 1998
quarter compared to the prior year consists of a $1 million decrease in sales of
the black-and-white thermal film device, PressMate(R) and black-and-white
plain-paper typesetting equipment; a $2 million decrease in sales of our print
servers and first generation 4-color printers, DisplayMaker(R) Professional,
DisplayMaker Express and DisplayMaker XL60; and a $1 million decrease in sales
of DesignWinder; offset by a $3.2 million increase in sales of the company's
HiRes 8-color DisplayMaker 4000, 5000, 6000, and 7000 series (DMX) of printers.
We anticipate the majority of our future hardware revenue to come from the HiRes
8-color and recently released Gamut+ products, including the recently introduced
72" DisplayMaker model and the Giclee PrintmakerFA for fine art reproductions,
along with print servers and new printer technologies. Gamut+ is an option
available for ColorSpan products which allows a user to print with 6 colors, in
a lower resolution and with less ink usage or add up to 2 additional unique
"spot colors" which will increase the color gamut available to the user.
During the quarter ended October 4, 1998 the Company's Digital Graphics Business
Unit recorded consumables sales, consisting primarily of ink, media, film,
maintenance contracts and spare parts, of $11.3 million or 73% of total net
sales compared to $10.4 million or 68% of total net sales in the same period one
year ago. The increase in consumables sales in the quarter ended October 4, 1998
from the prior year is primarily due to a $2.5 million increase in sales of ink
for the Company's 8-color printers. This increase was partially offset by a
$775,000 decrease in the sale of ink for the company's 4-color printers and a
$545,000 decrease in consumables sales for the Company's black-and-white,
plain-paper typesetting products.
INTERNATIONAL SALES. The following table sets forth international sales by
region expressed in thousands and as a percentage of total net sales:
Quarter Ended
---------------------------------
October 4, September 28,
1998 1997
------------- -------------
Europe $3,294 21.5% $3,193 20.9%
Japan, Asia/Pacific 1,199 7.8 1,537 10.0
Latin America 665 4.3 1,169 7.6
Canada 403 2.6 550 3.6
------ ---- ------ ----
Total international sales $5,561 36.2% $6,449 42.1%
====== ==== ====== ====
The decrease in sales in Japan, Asia/Pacific and Latin America compared to the
prior year is primarily related to the economic turmoil in those regions and the
higher relative prices due to lower local currency values relative to the U.S.
dollar. We expect sales in these regions to remain below historical levels for
the remainder of fiscal 1999. A majority of the foreign transactions occur in
U.S. dollars, and, as a result, foreign currency risk is not expected to be a
significant risk factor.
GROSS PROFIT. Gross profit, expressed as a percent of net sales, was 45.2% in
the quarter ended October 4, 1998 compared to 36.5% in the same period one year
ago. The increase in gross profit as a percent of net sales compared to the
prior year is the result of a $587,000 reduction in manufacturing overhead, and
higher margins on our DMX series printers compared to our older model 4-color
printers. Of this $587,000 reduction in manufacturing overhead, the majority is
related to a reduction in inventory scrap, rework and obsolescence due to better
inventory control, purchasing and forecasting processes along with more
established printer technology.
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OPERATING EXPENSES. Sales and Marketing expenses for the quarter ended October
4, 1998 were $3.7 million compared to $2.8 million in the same period one year
ago. Marketing expenses in September 1998 increased over the same period one
year ago approximately $594,000. The increase in marketing expenditures is
largely related to the resumption of normal activities from extraordinarily low
levels in the September 1997 quarter. Sales expenses increased approximately
$356,000 as a result of increased activity in the Supplies-By-Air division, the
costs associated with a U.S. dealer "Road Show" which promoted new products, and
increased participation by dealers and Value Added Distributors in a cooperative
advertising program.
Research and Development expenses were $2.0 million in the quarter ended October
4, 1998, compared to $1.6 million in the same period one year ago. The increase
in research and development expenses over the prior year includes approximately
$250,000 related to product development for the Internet/Software Business unit
and approximately $125,000 in expenses related to the new Advanced Research
Technology Center in San Jose, California. This research facility is chartered
with developing the Company's next generation printing technology.
General and Administrative expenses were $2.3 million for the quarter ended
October 4, 1998, compared to $2.6 million in the same period one year ago. The
decrease in general and administrative expenses in the September 1998 quarter
compared to the previous year is primarily the result of a decrease in bad debt
expense due to better collection practices and improved reliability of the
products.
Included in the quarter ended October 4, 1998 is a $600,000 reversal of special
charges incurred in the fourth quarter of fiscal 1996 related to intellectual
property licenses. These charges, which were previously accrued and expensed by
the Company, are now determined to have been overestimated.
OTHER. Interest expense was $157,000 for the quarter ended October 4, 1998
compared to $262,000 in the same period one year ago. The decrease in interest
expense is the result of lower average outstanding borrowings in the September
1998 quarter compared to the previous year.
The Company recorded a valuation allowance for the tax benefit related to the
losses incurred in the September 1998 and September 1997 quarters as the
recovery of such benefit is not certain.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities during the quarter ended October 4, 1998
was $1.5 million compared to net cash provided by operating activities of $1.0
million in the same period one year ago. Cash flow in the quarter ended October
4, 1998 was positively affected by a decrease in accounts receivable of $3.5
million. Cash flow was negatively affected by two areas. Inventory on hand
increased a total of $2.6 million. The increase is related to the launch of two
new printer models during the quarter, the 72" DisplayMaker and the Giclee
PrintMakerFA, and lower than anticipated sales volumes of these products. In
addition, accounts payable and accrued liabilities decreased $1.9 million during
the quarter. This decrease included payment of $776,000 in liabilities assumed
in the Kilborn acquisition.
Net cash used in investing activities was $311,000 during the quarter ended
October 4, 1998 compared to $74,000 in the same period one year ago. Investment
in capital equipment was $316,000 in the quarter ended October 4, 1998 compared
to $71,000 in the same period one year ago.
Net cash used in financing activities was $2.7 million in the quarter ended
October 4, 1998 compared to $970,000 in the same period one year ago. As a
result of the Kilborn acquisition, the company assumed a liability for a note
payable to one of the Kilborn shareholders. The note in the amount of $1.8
million was paid in full during the quarter ended October 4, 1998. Net
repayments under revolving credit lines were $547,000 in the quarter ended
October 4, 1998 compared to $697,000 in the same period one year ago.
We expect revenues should increase in the December 1998 quarter and the
remainder of fiscal 1999 compared to the September 1998 quarter. The shipment of
production quantities of the new 72" DisplayMaker model, the new Giclee
PrintMakerFA and other new products and related consumables in addition to
normal seasonal increases over the traditionally slow first quarter should
provide the additional revenue. Currently, we have not made
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significant commitments for capital expenditures, however, we do expect to incur
substantial expenditures and potential dilution of current shareholders related
to the planned strategic acquisitions of information technology consulting
companies in fiscal 1999. We expect to finance the acquisitions through the
issuance of additional debt and equity securities, cash flow from operations,
and short term borrowings under the line of credit. We expect to finance
operations throughout the remainder of fiscal 1999 through cash flow from
profitable operating activities. If sales are less than expected or reasonably
priced sources of alternative financing are not available, we may be required to
delay the acquisition strategy or further restructure the capitalization of the
Company.
YEAR 2000
We are currently working to resolve the potential impact of the Year 2000 on the
processing of time-sensitive information by computerized information systems.
Year 2000 issues may arise if computer programs have been written using two
digits (rather than four) to define the applicable year. In such cases, programs
that have time-sensitive logic may recognize a date using "00" as the year 1900
rather than the year 2000, which could result in miscalculations or system
failures. We utilize a number of computer programs across the entire operation.
Year 2000 issues could impact our information systems as well as computer
hardware and equipment that is part of our telephone network such as switches,
termination devices and SONET rings that contain embedded software or
"firmware."
Our exposure to potential Year 2000 problems exists in two general areas:
technological operations under our sole control and technological operations
dependent in some way on one or more third parties. The majority of our exposure
in potential Year 2000 problems is in the latter area where the situation is
much less within our ability to predict or control. Our business is heavily
dependent on third parties, many of whom are themselves heavily dependent on
technology. We cannot control the Year 2000 readiness of those parties. In some
cases, our third-party dependence is on vendors of technology who are themselves
working towards solutions to Year 2000 problems. We have initiated projects to
identify and correct the potential problem in all of our systems. The costs
incurred to date total less than $30,000 and have been expensed in the financial
statements. We are using internal resources to test the software modifications.
Funding for this area is expected to, and has come from, cash flow from
operations. We estimate any additional costs for this issue will not be
material.
OUR PRODUCTS. We design and sell products that are heavily reliant on software.
While we have taken appropriate steps to ensure the readiness of this software
and believe it to be compliant, we cannot be certain that the software will
operate error free, or that we will not be subject to litigation, whether the
software operates error free or not. However, we believe that based on our
efforts to ensure compliance and the fact that the calculations needed in and by
our products are not date dependent, it is not reasonably likely that we will be
subject to such litigation.
Contingency Plans. We have not yet completed our planning and preparations to
handle the most reasonably likely worst case scenarios described above. We
intend to develop contingency plans for these scenarios during fiscal 1999. We
believe that this is the appropriate timeframe for developing such plans and
that efforts prior to that time should be focused on renovation, testing and
verification of our system modifications.
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
In prior reports on Form 10-Q, the Company has described the suit filed by
LaserMaster Corporation, now known as ColorSpan Corporation (LMC) against
Sentinel Imaging, a division of Sentinel Business Systems, Inc. (Sentinel)
alleging Sentinel's theft of trade secrets related to LMC's Big Ink(TM) Delivery
System and customer information and breach of a confidentiality agreement with a
former LMC employee. In October 1997, the
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Company prevailed in the trial of its suit against Sentinel and was awarded
damages of $2.17 million, plus interest against Sentinel. In addition, the
Federal District Court imposed an injunction on Sentinel preventing them from
using or disclosing information related to the stolen software trade secrets.
The judgement has been appealed by Sentinel and LMC has cross-appealed the
dismissal of certain claims prior to trial. Thereafter, in January 1998 the
Company commenced another suit against Sentinel related to direct and
contributory copyright infringement, tortious interference with contract and
unfair competition. Sentinel has counter-claimed alleging copyright misuse and
unfair competition.
In March 1998, Sentinel filed for Chapter 11 bankruptcy protection. The
bankruptcy court has permitted the appeal on the initial case to move forward in
the federal courts. Sentinel has challenged the claim of ColorSpan related to
the suit filed in January, 1998. ColorSpan will deny Sentinel's claim objection.
Sentinel has also brought an action against Kilborn Photo Products, Inc.
alleging that it received preferential payments which are required to be
returned for the benefit of creditors, that the current claim of Kilborn should
be equitably subordinated and to rescind an alleged fraudulently procured
security right. Kilborn will deny all such allegations. Although ColorSpan and
Kilborn believe that the allegations of Sentinel are without merit and that the
claims alleged in the bankruptcy are valid and enforceable obligations, we
cannot assure that Sentinel will not reduce or eliminate certain claims, or
succeed in asserting a right to recovery of sums already collected by Kilborn or
damages from ColorSpan. If Sentinel prevails in its claims against ColorSpan or
Kilborn, the outcome could have a material effect on the financial condition of
the Company. Sentinel has proposed a plan of reorganization which, if approved,
would pay only a portion of the amount of the claims of any creditor who does
not have a valid and enforceable security interest. Even if ColorSpan were
successful in the appeal on the initial suit and in the claims asserted in the
second suit, only a portion of such damages are expected to be collected from
Sentinel.
The Company is also involved in various legal proceedings related to customer
credit and product warranty and performance issues in the normal course of
business. In certain proceedings the claimants have alleged claims for exemplary
or punitive damages which may or may not bear a direct relationship to the
alleged actual incurred damages, and therefore could have a material adverse
effect on the Company. At this time the Company is not aware of any proceedings
or claims which are expected to have a material effect on the Company's
operations or financial position.
See Exhibit 99, attached, for additional discussion of risks factors related to
legal proceedings.
ITEM 2: CHANGES IN SECURITIES
On October 8, 1998 the board of directors of the Company adopted a shareholder
rights plan to protect the Company and its shareholders from unsolicited
attempts or inequitable offers to acquire the Company. The Shareholder Rights
Agreement has no immediate dilutive effect. Under the Shareholder Rights
Agreement, each VirtualFund.com shareholder of record at the close of business
on October 30, 1998 will receive as a dividend a distribution of one Preferred
Share Purchase Right for each outstanding share of VirtualFund.com Common Stock.
Each Right will entitle shareholders to buy one one-thousandth of a share of the
Company's Series A Junior Participating Preferred Stock at an exercise price of
$22.00. The Rights will become exercisable following the tenth business day
after: (a) a person or group announces acquisition of 15% or more of the
Company's Common Stock or the Company becomes aware of such an acquisition, (b)
a person or group announces commencement of a tender offer, the consummation of
which would result in ownership by a person or group of 15% or more of the
Company's Common Stock, or (c) the Company's Board of Directors determines that
a person or group is an "Adverse Person or Group" as defined in the Shareholder
Rights Agreement. For two current shareholders with significant holdings the
rights are triggered upon ownership of 20% of the Company's Common Stock.
If the Rights become exercisable, each Right, other than those owned by an
acquirer or its related parties, will entitle the holder to purchase, at the
exercise price, shares of the Company's common stock having a value of twice the
Right's exercise price. In addition, if the Company is involved in a merger or
other business combination in which the Company does not survive or in which the
Company sells 50% or more of its assets or
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earning power to another person, each Right will entitle its holder to purchase,
at the exercise price, shares of common stock of such other company having a
value of twice the Right's current exercise price. The Company will be entitled
to redeem the Rights at $.001 per Right at certain times as provided in the
Shareholder Rights Agreement. The Shareholder Rights Agreement was adopted to
provide the Company's board of directors with sufficient time to assess and
evaluate any take-over bid and, in the event a bid is made and to provide the
board of directors with an appropriate period of time to explore and develop
alternatives which maximize shareholder value.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Nothing to report.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Nothing to report.
ITEM 5: OTHER INFORMATION
Nothing to report.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Listing of Exhibits
99. Cautionary Factors Under Private Securities Litigation
Reform Act of 1995.
(b) Reports on Form 8-K
none
12
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
VIRTUALFUND.COM, INC.
/s/ Melvin L. Masters
- --------------------------------
Melvin L. Masters
Chief Executive Officer
/s/ James H. Horstmann
James H. Horstmann
- --------------------------------
Chief Financial Officer and
Principal Accounting Officer
Dated: November 16, 1998
13
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
VIRTUALFUND.COM, INC.
- --------------------------------
Melvin L. Masters
Chief Executive Officer
- --------------------------------
James H. Horstmann
Chief Financial Officer and
Principal Accounting Officer
Dated: November 16, 1998
14
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INTERNAL
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FINANCIAL STATEMENTS.
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<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> OCT-04-1998
<CASH> 508,596
<SECURITIES> 0
<RECEIVABLES> 8,205,974
<ALLOWANCES> 1,222,000
<INVENTORY> 9,817,418
<CURRENT-ASSETS> 22,097,950
<PP&E> 2,970,901
<DEPRECIATION> 16,577,471
<TOTAL-ASSETS> 28,780,521
<CURRENT-LIABILITIES> 15,662,719
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0
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<COMMON> 157,789
<OTHER-SE> 12,915,684
<TOTAL-LIABILITY-AND-EQUITY> 28,780,521
<SALES> 15,355,294
<TOTAL-REVENUES> 15,355,294
<CGS> 8,418,199
<TOTAL-COSTS> 8,418,199
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 157,065
<INCOME-PRETAX> (668,672)
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<PAGE>
EXHIBIT 99
CAUTIONARY FACTORS UNDER THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
We desire to take advantage of the "safe harbor" provisions contained in the
Private Securities Litigation Reform Act of 1995 (the "Act"). This Form 10-Q
contains statements which are intended as "forward-looking statements" within
the meaning of the Act. The words or phrases "expects", "will continue", "is
anticipated", "we believe", "estimate", "projects", "hope" or expressions of a
similar nature denote forward-looking statements. Those statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from historical results or results presently anticipated or
projected. We wish to caution you not to place undue reliance on forward-looking
statements. You are also advised that the factors listed below have affected the
Company's performance in the past and could affect future performance. Those
factors include, but are not limited to, the risk that a product may not ship
when expected or may contain technical difficulties; uncertain demand for new or
existing products; the impact of competitor's advertising, products or pricing;
availability or reliability of component parts, including sole source parts;
manufacturing limitations; availability of sources of financing; economic
developments, both domestically and internationally; new accounting standards;
and, the impact of the initiation, defense and resolution of litigation.
Other factors include the following:
Cash Needs. The Company has a credit agreement with a commercial finance
company that has adequately financed its cash requirements in the past year.
Previously, net operating losses in fiscal 1996 of $10,461,534 and fiscal 1997
of $17,199,688 resulted in a need for additional financing. In September 1996,
projected cash requirements in excess of available sources required the issuance
of private placements of common stock and warrants to purchase common stock in
the Company. There can be no assurances that cash availability under the credit
agreement will be adequate to meet future needs, or that other sources of
financing will be available to the Company on favorable terms, or at all, if the
Company's operations are further affected by declining revenue from a lack of
sales or significant returns of existing products, introduction difficulties
with new product lines, competitive product introductions, or by market
conditions in general. In addition, there can be no assurance that the Company
will achieve or maintain profitability on a quarterly or annual basis in the
future.
Potential Acceleration of Senior Debt. The Company's Senior Debt Agreement
includes financial covenants, which the Company must meet. Currently, the
Company is in compliance with all of the financial covenants required by its
Senior Lender. For further information, refer to the Company Form 10-K for the
fiscal year ended June 30, 1998, Item 14(a)1 and financial statements, Note #5
of the Notes to Consolidated Financial Statements. Past financial performance of
the Company has made it necessary for the Company to renegotiate the financial
covenants to avoid being declared in violation of the covenants by General
Electric Capital Corporation. If future financial performance causes covenant
violations and the Company is unable to renegotiate its loan covenants at that
time, it could be forced to seek replacement financing at prices which may not
be favorable to the Company. If adequate sources of financing are not available,
the Company may be required to sell certain product lines or technologies on
less than favorable terms.
Technology and Industry Pressures/Reliance on New Technology. The pre-press
and wide-format color printing industries are highly competitive and are
characterized by frequent technological advances and new product introductions
and enhancements. As product life cycles get shorter, the resulting consumable
stream generated by the installed base may be negatively impacted. Accordingly,
we believe that our future
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success depends upon our ability to enhance current products, to develop and
introduce new and superior products on a timely basis and at acceptable pricing,
to respond to evolving customer requirements, and to design and build products
which achieve general market acceptance.
New Product Design and Development. The process of developing new products
involves adopting new and emerging technologies and components which may not
have product histories or long term use testing to establish expected life
cycles in the field or to assure long term field use.
Product Quality Issues. Any quality, durability or reliability problems
with existing or new products, regardless of materiality, or any other actual or
perceived problems with the Company's products could have a material adverse
effect on market acceptance of such new products. Any quality problems with
components could result in "epidemic" or wide-spread failures of the products in
the field causing return and refund requests that would likely have a material
effect on the Company's financial results and future sales potential. Such
problems or perceived problems could potentially arise with respect to any
existing products.
Product Acceptance/Market Anticipation. The Company's products may not
achieve market acceptance. In addition, the market anticipation or the
announcement of new products and technologies, whether offered by the Company or
its competitors, could cause customers to defer purchases of the Company's
existing products, which could have a material adverse effect on the Company's
business and financial condition.
The Company introduced a new family of printers, the DisplayMaker(R) 4000,
5000 and 6000 HiRes 8-Color series, during September 1997. Two new versions of
these printers have been introduced since February 1998. The DisplayMaker 7000
was introduced in August 1998. Additionally, in August 1998 the Company
introduced the Giclee PrintMakerFA, an 8-Color HiRes drum-based printer.
Although the Company has had successes introducing new products in the past,
some earlier products experienced limited market acceptance and the
introductions of some products have been delayed. In addition, the quality and
reliability reputation of certain existing products may unfavorably affect new
products. The Company may not be successful with future product introductions,
future market introductions may not be timely and competitive, future products
may not be priced appropriately, or future products may not achieve market
acceptance. The Company's inability to achieve market acceptance, for
technological or other reasons, could have a material adverse effect on our
financial condition.
Product Malfunction. We are aware of intermittent customer issues with the
performance and formulation of certain inks used in the Company's printers. We
have taken steps to address the ink issues with the supplier. However, failure
to resolve ink functionality issues, or some other failure of the product to
perform as expected by the customer may result in customer requests for
compensatory supplies or other requests which could have a material adverse
effect on our financial performance.
Dependence on Suppliers. The Company is dependent on sole source suppliers
for the heads for PressMate-FS(R) and DisplayMaker Express (DME). Over the time
that we have worked with the supplier for the PressMate printheads, there have
been quality and consistency issues with the printheads supplied. We do not have
a written agreement with this supplier and cannot purchase the supplies from
another source. Currently, we do not sell significant numbers of the
PressMate-FS printers which utilize the sole-sourced component. However, the
Company has an installed base of printers who purchase consumables from the
Company and could experience head failure or need a replacement. Overall, the
percentage of the Company's revenues related to the product utilizing this head
was less than 7% of fiscal 1998 revenue. We are also dependent upon a sole
source supplier for the heads for the DME printer. The quality and consistency
of the
2
<PAGE>
printheads delivered by this supplier have also been a problem. Although we
currently sell very few new DME printers, there is an installed base of printers
who purchase consumables from the Company and could experience printhead failure
or require replacement. We have a written agreement with the sole source
supplier of the DME heads. The written agreement includes the manufacturing
specifications and directions which would allow a second supplier to produce the
printheads if the current supplier were unable to cure any defaults under the
manufacturing and supply agreement. If the Company were unable to resolve a
quality or supply issue with the head supplier the effect may be material and
could result in a significant increase in the returns of the DME printer based
on the inability to supply replacement printheads. Overall, the percentage of
the Company's revenues related to the product utilizing this head was less than
9% of fiscal 1998 revenue.
The Company's aqueous inkjet printers are based on a printhead supplied
pursuant to a written contract with Hewlett-Packard Company. The Company does
not anticipate availability or quality issues which would affect the supply of
printheads supplied by Hewlett-Packard Company (HP). The revenues of the Company
associated with sales of this product or products including those components
represent approximately 67% of the Company's fiscal 1998 revenue. If we were
unable to resolve a potential future availability or quality issue, our
production and support of our installed base will be materially adversely
affected.
Competitive Pricing/Product Introductions. Various potential actions by any
of our competitors, especially those with a substantial market presence, could
have a material adverse effect on our business, financial condition and results
of operations. Such actions may include price reductions, increased promotion,
announcement or accelerated introduction of new or enhanced products, product
giveaways, product bundling or other competitive actions. Additionally, a
competitor's entry into the wide-format market in such ways to permit it to
compete more directly and effectively with our products could adversely affect
operational results.
Currently HP is offering significant rebates to potential customers. The
rebates include the trade-in of ColorSpan and other wide format devices for the
reduction of the purchase price of a comparable HP printer. Programs such as
this can potentially impact us by reducing the number of printers we sell
currently and by reducing the installed base of printers to which we sell
consumables.
Uncertainty Regarding Development of Wide-Format Market; Uncertainty
Regarding Market Acceptance of New Products. The Wide-Format market is
relatively new and evolving. Our future financial performance will depend in
large part on the continued growth of this market and the continuation of
present Wide-Format printing trends such as use and customization of
large-format advertisements, use of color, transferring of color images onto a
variety of substrates, point-of-purchase printing, in-house graphics design and
production and the demand for limited printing runs of less than 200 copies. If
the Wide-Format market does not achieve anticipated growth levels or there is a
substantial change in Wide-Format printing customer preferences, our business,
financial condition and results of operations could be adversely affected.
Additionally, in a new market, customer preferences can change rapidly and new
technology can quickly render existing technology obsolete. Our failure to
respond effectively to changes in the Wide-Format market, to develop or acquire
new technology or to successfully conform to industry standards could have a
material adverse effect on our business and financial condition and results of
operations.
Technological Advancements. The digital color inkjet printing market is
rapidly moving to two distinct technologies for the placement of ink on a
substrate: thermal inkjet cartridges and piezo-electric printheads. Without a
secure, economical source of one or both of these products we will face serious
competitive pricing and margin pressures going forward. We currently have a
license to remanufacture specific HP 300 dpi inkjet cartridges for use in our
wide-format, roll-fed color inkjet printers. HP has introduced a new inkjet
cartridge with a capability of producing output resolution of 600 dpi. We have
secured the use of this product in non-roll fed devices and have introduced a
product based on this cartridge. However, we consider the market for non-roll
fed devices a low volume market niche. In addition, Lexmark has developed a 600
dpi inkjet cartridge. Both companies are competitors in the wide-format color
market. The Company is seeking a source of 600 dpi printheads for use on roll
fed printers. We are also considering several component suppliers in our
3
<PAGE>
search for a dependable, manufacturable piezo-electric printhead. No one source
has been identified for use in a future product as of this time. If the market
for wide-format color demands the increased resolution provided by these new
products and we are unable to secure adequate supplies at reasonable prices or
develop a reasonably priced substitute from other sources, sales of our printer
engines and the related gross margins could be negatively impacted.
Our products target the market for high quality printing output. Hardware
and software technological advances have enhanced actual and perceived
resolution. Other companies may achieve actual or apparent resolution with less
expensive printers and supplies and therefore capture the market held by our
higher cost printers.
Expansion and Diversification to Software and Services Outside of our Core
Printer Business. Our continuing efforts to expand sales and increase profits
and desire to reposition ourselves as a diversified technology company is
stimulating a series of new product development activities. The current focus of
these new business opportunities is primarily internet based software and
service businesses. During this past year, we launched an electronic commerce
(e-commerce) initiative for selling specialty media for wide-format printers
under the brand name of SuppliesoByoAir(TM). Internet based software and service
activities represent an extension of many of our printing and publishing tools
which are integral to our core technology. We are currently developing a
commercialization of our internet software and have not generated any revenue
from sales of this product.
Our expansion into technologies outside of the core hard-copy base printer
business involves significant risk. Risks include, but are not limited to, the
following factors: New products may not meet customer needs or may face
significant competition from companies with lower overhead and product costs
and/or greater marketing and promotional budgets. In addition, we may not be
able to attract and retain key personnel and may not be able to develop the
products in the time needed to gain market acceptance. In addition, because of
early stage development, we may not be able to predict product features needed
to gain market acceptance, development may require more time and resources than
anticipated for the development, or it may turn out that the product can not be
feasibly developed. Our diversification also carries the risk that the new
activity will distract management time and resources from focusing on the core
hard-copy based printer business. In addition, diversification may involve risks
related to the resources required to participate in this new business including,
but not limited to, risks related to raising cash or obtaining cash investments,
doing business with one or more "partners" as a partnership or joint venture,
and risks related to acquisitions or other combinations of businesses.
Intense Competition. The computer printer industry is intensely competitive
and rapidly changing. Some of our existing competitors, as well as a number of
potential new competitors, have longer operating histories, greater technical
resources, more established and larger sales and marketing organizations,
greater name recognition, larger customer bases and significantly greater
financial resources than the Company, which may result in a competitive
advantage. Suppliers of wide-format print engines and systems compete on the
basis of print quality, color, print time, print size, product features,
including ease of use, service, and price. Competitive product sales practices
such as price reductions, increased promotion, product giveaways and bundling,
or announcement or accelerated introduction of new or enhanced products could
have a material adverse effect on our sales and financial condition. New product
introductions and changes in pricing structure by competitors have had, and can
be expected to continue to have, a significant impact on the demand for our
products. Currently, Hewlett-Packard is selling a new 54-inch wide-format inkjet
printer. ENCAD is shipping a new version of its printer line with 600 dpi
cartridges. These products compete for market share with the
4
<PAGE>
Company's current DisplayMaker 5000, 6000 and 7000 series of printers. It is
possible that our sales of certain products will compete with, or displace sales
of, other products we sell.
Our DisplayMaker HiRes 8-Color series, and DesignWinder and Giclee
PrintMakerFA products are based on relatively new technology, are complex and
must be reliable and durable to achieve market acceptance and enhance revenue
opportunities. Development and production of new, complex technologies and
products often have associated difficulties and delays. Consequently, customers
may experience unanticipated reliability and durability problems that arise only
as the product is subjected to extended use over a prolonged period of time. We
cannot assure that we have completely resolved operational problems that
have occurred in the past or that we will successfully resolve any future
problems in the manufacture or operation of our existing printers or any new
product. Our failure to resolve manufacturing or operational problems with
existing printers or any new product in a timely manner could have a material
adverse effect on our business, financial condition and results of operations.
Our HiRes 8-Color DisplayMaker series of printers, the DesignWinder and
Giclee PrintMakerFA products utilize HP licensed inkjet technology. We also
purchase licensed inkjet cartridges from HP who is a sole source of the
cartridge component for our aqueous ink consumable offerings. We also compete
with HP in the wide-format digital color printing market. Currently, we have
been granted access to these and selected new technologies for use in our
products and pay a royalty for these rights. Our revenue associated with the
sale of these products including HP components was approximately 67% of our
fiscal 1998 revenues. As new technologies are developed, there can be no
assurance that we will be able to negotiate additional licenses for newly
developed technologies or that the new terms are equal to the terms currently in
place.
Certain companies that supply us with consumable products such as ink and
media compete with us by selling directly to our users or selling to competitors
who may offer the products to our users. Additionally, OEM private label ink
products that may be used in their own products may compete with ColorSpan(R)
products. Further, a number of competitors have introduced consumables which
they allege to be compatible with our products and have priced the consumables
below the ColorSpan-branded consumables.
Although we believe that our Big Color(R) products possess certain
advantages over the competitors' products, increased competition has negatively
impacted sales volumes and margins and may continue to impact volumes and
margins in the future. We have generally competed in these markets by
introducing technologically advanced products that create new market demand and
products which offer optimum performance characteristics. There can be no
assurance that we will be able to continue to innovate to the extent necessary
to maintain a competitive advantage in these markets or that other competitors
will not achieve sufficient product performance to achieve customer satisfaction
with their products offering better pricing or other competitive features.
Industry Consolidation. As a growth industry, the wide-format digital
printing market has generated many new entrants into the fragmented market with
new products and new technologies. As the market matures, and the industry's
growth rate slows, companies with technological or manufacturing efficiency
advantages will emerge as the market leaders maintaining or increasing their
market share. Companies with less marketable advantages will face significant
pressure on revenue growth and gross margins. In order to remain competitive,
the smaller companies within this sector may have to seek merger or
consolidation opportunities with other companies.
If we were to merge with another company within the printer industry,
short-term financial results and the market price of our stock may be negatively
impacted. Merger or consolidation of competitors may
5
<PAGE>
enhance the financial strength and competitive abilities of such competitor(s)
which could adversely affect our sales and financial performance.
Dependence on Component Availability and Costs. Certain components used in
our current and planned products, including printer marking engines and other
printer components, are currently available from sole sources, and certain other
components are available from only a limited number of sources. Substantially
all of the Company's revenue is subject to these risks. In the past we have
experienced delays as a result of the failure of certain suppliers to meet
requested delivery schedules and standards of product performance and quality.
In addition, past losses from operations have restricted cash availability and
the ability to keep supplier debt current or within the established credit
limits. The potential requirement to bring certain component suppliers' debt
obligations current, or other restrictions in credit terms of such component
suppliers, could result in an inability to manufacture certain product lines and
thereby adversely affect our financial performance. Our inability to obtain
sufficient supply of components, or to develop alternative sources, could result
in delays in product introductions, interruptions in product shipments, the need
to redesign products to accommodate substitute components or the need to
substitute alternative components which may not have the same performance
capabilities, any of which could have a material adverse effect on the Company's
operating results. A portion of the total manufacturing cost of our typesetting
and Big Color products is represented by certain components whose prices have
fluctuated significantly in recent years. Significant increases or decreases in
the price or reductions in the availability of certain components could have a
material affect on our operating results.
We are dependent on a sole-source supplier for the printheads and hot melt
ink used in DisplayMaker Express. We have experienced availability and quality
issues with this supplier that has affected shipping schedules and customer
satisfaction and has negatively impacted operating results in the past. While we
have taken strong corrective measures in dealing with this supplier, there can
be no assurance that this supplier will be able to meet our production
requirements in the future or that the quality of on-going product supply will
be acceptable.
We sell consumable print media and inks for use with its Big Color product
line, and film used with the PressMate-FS. We depend on the availability of
consumable products to support our installed base of print engines. There is no
assurance that the suppliers of these consumables will continue to offer their
products to us, or that the consumable products will continue to be available to
us at the same quantity, pricing and terms. Unavailability of consumable
products or negative changes in quality could adversely impact the market
acceptance of our new and existing products, and may adversely affect sales of
consumables.
Fluctuations in Quarterly Operating Results. Our quarterly results of
operations have fluctuated and are expected to continue to fluctuate
significantly. These fluctuations have been caused by various factors,
including, but not limited to: the timing of new product announcements; product
introductions and price reductions by the Company or its competitors; the
availability and cost of key components and materials for our products;
fluctuations and availability in customer financing; the relative percentages of
sales of consumables and printer architectures; risks related to international
sales and trade; and general economic conditions. In addition, our operating
results are influenced by the seasonal buying patterns of our customers, which
have in the past generally resulted in reduced revenues and earnings during our
first fiscal quarter. Further, our customers typically order products on an
as-needed basis, and, as a result, virtually all of our sales in any given
quarter result from orders received in that quarter. We rarely operate with a
backlog of orders from quarter to quarter. Certain products require significant
capital expenditures, causing some customers to delay their purchasing decision.
Delays in purchases of low-volume, high-cost printers may cause significant
fluctuations in the sales volume for a given period. Our manufacturing plans,
sales staffing levels and
6
<PAGE>
marketing expenditures are primarily based on sales forecasts. Accordingly,
deviations from these sales forecasts may cause significant fluctuations in
operating results from quarter to quarter and may result in unanticipated
quarterly earnings shortfalls or losses. Historically, a large percentage of
orders have been received and shipped near the end of each month. If anticipated
sales and shipments do not occur, expenditure and inventory levels may be
disproportionately high and operating results could be adversely affected.
Returns Reserves. We have established reserves for the return of
merchandise. The amount of the returns reserve is based on historical data
regarding returns of products. For new products there may be insufficient
information to accurately predict return rate and therefore the required reserve
may not be sufficient. Additionally, there may be an unknown or unanticipated
problem with a product or any component thereof, or a defect or shortage of
repair components or the consumable media or inks that are needed to use the
product which could cause the actual returns to exceed the reserves. Returns of
a product which exceed reserves could have an adverse effect on the financial
operations and results of the Company.
Dependence on Consumables Revenues. We anticipate we will derive an
increasing percentage of our revenues and operating income from the sale of ink,
paper, film and other consumables to our customers. During fiscal 1998,
consumables revenue was 59% of total revenue. To the extent sales of our
consumables are reduced because our customers are unsuccessful in marketing
their own printing services, product iterations by ourselves or competitors make
our products obsolete or customers substitute third-party or private label
consumables for ours, the Company's results of operations could be adversely
affected. Reduced life cycles of hardware products are expected to negatively
impact consumable revenues. Further, although our consumables are manufactured
specifically to operate with our printing products to produce optimum results,
there can be no assurances that other manufacturers of printing inks and papers
will not develop products that can be sold and compete with our printing
products, or that other products will not produce results which are satisfactory
to the customer at a lower cost. We allege that at least one manufacturer has
improperly used the Company's trade secrets to commence such competition.
Although we are involved in legal action against such manufacturer for
misappropriation of trade secrets, there can be no assurances that other
manufacturers will not independently or legitimately develop competing
consumable products. In addition, product quality issues, limitations in the
availability of sole source consumables or changes in credit or trade terms from
sole sources could adversely affect the sales of consumables.
Intellectual Property and Proprietary Rights. Our ability to compete
effectively will depend, in part, on our ability to maintain the proprietary
nature of our technologies through patents, copyrights and trade secrets.
Important features of our products are incorporated in proprietary software,
some of which is licensed from others and some of which we own. We attempt to
protect our proprietary software with a combination of patents, copyrights,
trademarks and trade secrets, employee and third-party nondisclosure agreements
and other methods of protection. Despite these precautions, unauthorized third
parties may be able to copy certain portions of our products or to
reverse-engineer or obtain and use information that we regard as proprietary.
Further, our intellectual property may not be subject to the same level of
protection in all countries where the products are sold. There can be no
assurance that the measures we take will be adequate to protect the intellectual
property or that others will not independently develop or patent products
similar or superior to those we have developed, patented or planned, or that
others will not be able to design products which circumvent any patents we rely
upon.
We have been granted various United States patents for inventions related
to resolution of conventional laser printer engines, high-resolution imaging and
image enhancement and wide-format printing technologies and techniques, our Big
Ink(TM) Delivery System, product patents, and consumable formulations.
Additional patent applications are pending. There can be no assurance that
patents will be issued from any
7
<PAGE>
of these pending applications. With regard to current patents or patents that
may be issued, there can be no assurance that the claims allowed will be
sufficiently broad to protect our technology or that issued patents will not be
challenged, invalidated or violated, requiring expenditures of cash to pursue
and enforce our rights in the patented technology. Applications to patent the
basic TurboRes(R), ThermalRes(R) and Big Ink Delivery System approaches and
related technologies have been filed in selected foreign countries. Patent
applications filed in foreign countries are subject to laws, rules and
procedures which differ from those of the United States, and there can be no
assurance that foreign patents will be granted as a result of these
applications. Furthermore, even if these patent applications result in the
issuance of foreign patents, some foreign countries provide significantly less
patent protection than the United States.
We rely on a variety of trademarks in the promotion and identification of
our products. We have a variety of trademarks which are registered, and others
that are not registered, or cannot be registered. There is no assurance that
there will not be some challenge to our rights to use one or more trademarks, or
an allegation that the use or display of one or more trademark violates the
trademark rights of another party, which could subject us to damages and losses
related to the loss of our opportunity to use recognized marks in the promotion
of our products.
Additionally, patent, copyright and trademark protection has not been
sought, or may not be available in all foreign countries. Although we have not
received any notices from third parties alleging intellectual or proprietary
property infringement, there can be no assurance that third parties will not
assert infringement claims against us in the future or that any such assertion
will not require us to expend funds defending such claims or require us to enter
into royalty arrangements on such terms as may be available, which may adversely
affect our financial performance. Any claim that our current or future products
or manufacturing processes infringes on the proprietary rights of others, with
or without merit, could result in costly litigation which could adversely affect
our financial performance.
We are actively pursuing development of new and unique print solutions and
processes, media and inks. There are a significant number of patents which have
been filed relating to printing cartridges, printing methods and processes,
mechanical printer features, medias and inks. Many of these patents are held by
companies which are larger and have greater resources to pursue violation of
intellectual property. Although research and development process involves an
analysis of protected proprietary rights in any technology that is being
pursued, there is no assurance that we have completely reviewed and analyzed all
applicable patents, or that competitors or others will not interpret any such
products or processes we develop as violating protected intellectual rights and
pursue legal action, which could be costly and may affect our financial
performance. In addition, although we do not know of any violations of our
intellectual property rights, there can be no assurance that we will not be
forced to take action to protect our intellectual property portfolio. Such
enforcement activity could require us to expend significant cash resources and
could affect our financial performance.
Although we have not received notices from third parties alleging
infringement claims we believe would have a material adverse effect on our
business, there can be no assurance that third parties will not claim that our
current or future products or manufacturing processes infringe on their
proprietary rights. Any such claim, with or without merit, could result in
costly litigation or might require us to enter into a royalty or licensing
agreement. A royalty or licensing agreement, if required, may not be available
on terms acceptable to us, or at all, which could have a material adverse effect
upon our business, financial condition and results of operations. If we do not
obtain such licenses, we could encounter delays in product introductions while
we attempt to design around such patents, or we could find that the development,
manufacture or sale of products requiring such licenses could be enjoined. In
addition, we could incur substantial costs in defending ourselves
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in suits brought against us on such patents or in bringing suits to protect our
patents against infringement, which could adversely affect our financial
condition or results. If the outcome of any such litigation is adverse, our
business and financial results could be adversely affected.
Litigation and Litigation Costs. We have instituted action against a
competitor for copyright infringement and other causes of action. The competitor
has counter-claimed alleging copyright misuse and unfair competition by the
Company. Although we do not believe any of our practices violate applicable
copyright laws, there is no assurance that claims or actions will not be
commenced by customers, competitors or governmental authorities based on
copyright, trade or anti-competitive claims which could affect our operations
and cash position.
We are also engaged in various actions related to transactional matters,
employee matters, customers' credit and product quality and/or warranty issues.
Some of these actions include claims against us for punitive, exemplary or
multiple damages. An award of punitive damages may not bear a direct
relationship to the actual or compensatory damages claimed from us. Although we
do not believe there are any actions pending or threatened against us which
would have a material adverse impact on our financial position, there is no
assurance that there will not be an adverse award of multiple punitive or
exemplary damages which could adversely affect our cash position.
Any litigation which we are involved in may have an adverse impact on our
operations and may result in a distraction or diversion of management's
attention, thereby adversely affecting our operations.
International Operations. Historically international revenues have
represented a substantial portion of our total revenues. (In fiscal 1998,
international operations composed 42% of total sales.) International operations
are subject to various risks, including exposure to currency fluctuations,
political and economic instability, differing economic conditions and trends,
differing trade and business laws, unexpected changes in applicable laws, rules,
regulatory requirements or tariffs, difficulty in staffing and managing foreign
operations, longer customer payment cycles, greater difficulty in accounts
receivable collection, potentially adverse tax consequences and varying degrees
of intellectual property protection. Fluctuations in currency exchange rates
could result in lower sales volume reported in U.S. Dollars. Fluctuations in
foreign exchange rates are unpredictable and may be substantial. From time to
time we have engaged in limited foreign currency hedging transactions. Our
European subsidiary extends credit in the normal course of business in five
relatively stable European currencies. In addition, the financing agreement in
place allows our subsidiary to factor those receivables and receive Dutch
guilders in which it pays its expenses. Substantially all of our other
transactions are in U.S. dollars. There can be no assurance that the Company
will be successful in limiting its foreign currency exposure in the future.
Dependence on Key Personnel. Our success depends to a significant extent
upon certain key personnel, including Mr. Masters, Chief Executive Officer and
President, Lawrence Lukis, Chief Engineer, and key research and development
staff. While Mr. Lukis continues to serve as our Chief Engineer, he has cut back
his day to day activities to a part time status. The loss of our key management
or technical personnel could adversely affect our business. We maintain key
person life insurance in the amount of $2,000,000, payable to the Company, on
each of Mr. Masters and Mr. Lukis. In addition, we have certain non-compete and
continuation contracts with key personnel. We also depend on our ability to
attract and retain highly skilled personnel. Competition for employees in
technology related markets is high and there can be no assurance that we will be
able to attract and retain the employees needed. In addition, our past financial
performance may limit our ability to hire and retain management professionals.
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The Year 2000 Issue. We are currently working to resolve the potential
impact of the Year 2000 on the processing of time-sensitive information by our
computerized information systems. Year 2000 issues may arise if computer
programs have been written using two digits (rather than four) to define the
applicable year. In such case, programs that have time-sensitive logic may
recognize a date using "00" as the year 1900 rather than the year 2000, which
could result in miscalculations or system failures. We utilize a number of
computer programs across our entire operation. Year 2000 issues could impact our
information systems as well as computer hardware and equipment that is part of
our telephone network such as switches, termination devices and SONET rings
that contain embedded software or "firmware."
Our exposure to potential Year 2000 problems exists in two general areas:
technological operations in the sole control of the Company, and technological
operations dependent in some way on one or more third parties. The majority of
our exposure in potential Year 2000 problems is in the latter area where the
situation is much less within our ability to predict or control. Our business is
heavily dependent on third parties, many of whom are themselves heavily
dependent on technology. We cannot control the Year 2000 readiness of those
parties. In some cases, our third-party dependence is on vendors of technology
who are themselves working towards solutions to Year 2000 problems. We have
initiated projects to identify and correct the potential problem in all of our
enterprise systems. The costs incurred to date total less than $30,000 and have
been expensed in the financial statements. We are using internal resources to
test the software modifications. Funding for this area is expected to, and has
come from, cash flow from operations. We expect that additional costs for this
issue will not be material.
The Company's Products. We design and sell products which are heavily
reliant on software. While we have taken appropriate steps to ensure the
readiness of this software and believe it to be Year 2000 compliant, we cannot
be certain that the software will operate error free, or that we will not be
subject to litigation, whether the software operates error free or not. However,
we believe that based on our efforts to ensure compliance and the fact that the
calculations needed in and by our products are not date dependent, it is
relatively unlikely that we will be subject to such litigation.
Contingency Plans. We have not yet completed our planning and preparations
to handle the most reasonably likely worst case Year 2000 scenarios described
above. We intend to develop contingency plans for these scenarios during fiscal
1999. We believe that this is the appropriate timeframe for developing such
plans and that efforts prior to that time we should be focused on renovation,
testing and verification of our system modifications.
Environmental. We are subject to local and federal laws and regulations
regarding the use, storage and disposition of inks used with our print products.
Although we believe we are in compliance with all such laws and regulations, and
are not aware of any notice or complaint alleging any violation of such laws or
regulations, there can be no assurance that there will not be some accidental
contamination, disposal or injury from the use, storage, or disposition of inks
or other materials used in our operations. In the event of such accident, we
could be held liable for any damages that result and any such liability could
have a material adverse effect on our financial condition. In addition, there
can be no assurance that we will not be required to comply with environmental
claims, laws, or regulations in the future which could result in significant
costs which could materially adversely affect our financial condition.
Tax Liability. We sell our products from our offices in Eden Prairie,
Minnesota and report sales and income tax liability based on sales occurring at
that location. It is possible that one or more state or local taxing authorities
could determine that there have been taxable transactions occurring within their
jurisdiction and seek recovery of taxes for current and/or past periods. In
addition, it is possible that local, state or federal
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taxing authorities will take issue with the reporting or determination of tax
liability and seek additional taxes for current and/or past periods. We
currently have a net operating loss ("NOL") carryforward that may be used to
offset future federal taxable income. However, there is no assurance that the
NOL will continue to be available as an offset against future federal taxable
income or that there will be sufficient taxable income to fully utilize the NOL.
Volatility of Stock Price. The trading price of our common stock is subject
to wide fluctuations in response to variations in operating results, changes in
the laws or regulations to which we may be subject, announcements of new
products or technological innovations by us or our competitors, overall economic
conditions and indicators, market conditions unrelated to our performance, and
general conditions in the industry. Factors such as quarterly variation in
actual or anticipated operating results, changes in earnings estimates by
analysts, and analysts' reactions to our statements and actions also contribute
to stock price fluctuations. In addition, the prices of securities of many high
technology companies have experienced significant volatility in recent years for
reasons frequently unrelated to the operating performance of the specific
companies. These fluctuations may materially affect the market price of our
common stock.
One time in the past, following fluctuations in the market price of our
stock, a securities action was commenced alleging that the Company and certain
insiders had knowledge of certain material, adverse information about us prior
to the time that such information allegedly caused a drop in the market price of
the stock. Because our stock has historically fluctuated significantly, it is
possible that following a significant change in the market price of the stock
another securities action could be commenced against us. Such action, whether
commenced by one or more individuals or by a class of securities holders, could
result in substantial costs and diversion of our management's attention and
resources and thereby cause an adverse affect on our business and financial
performance.
Overall Market Fluctuations/Margin Calls. The overall stock market has been
relatively volatile recently. The price of small capitalization stocks like VFND
may be significantly impacted by overall market declines. The impact on the
price of VFND common stock during a market decline may be magnified because of
the limited "float" available for an investor or investors who may seek or may
be required to sell their shares of VFND common stock to satisfy margin calls
from their individual brokers. The impact of market declines may be enhanced if
Company "insiders" are required to sell their shares of the Company's common
stock in such a situation. Such a sale by an insider under these circumstances
could cause adverse market perceptions which could result in a widespread sell
off of the stock in the general market and cause the stock price to decrease
further. It is likely there will be further fluctuations in the overall stock
market due to the complexities of the world wide market that exists today. There
can be no assurance future market volatility will not precipitate a significant
sell off of VFND common stock.
Brand Awareness. We have recently changed the Company's name to
VirtualFund.com, Inc. and have changed the name of our principal operating
subsidiary from LaserMaster Corporation to ColorSpan Corporation. We have
significant brand awareness associated with our LaserMaster trade names. If the
market is unable to accept or delays the acceptance of the name change, our
financial performance and sales may be negatively impacted.
Control of the Company's Stock. As of August 31, 1998, officers and
directors as a group beneficially owned 21.32% of the outstanding shares of our
stock. One of our suppliers owned 14.7% of the Company's outstanding shares. The
impact of the holdings of the officers and directors and the supplier is not
believed to be material. However, such control may reduce liquidity of the stock
which may affect shareholder value.
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The Company's Board has adopted a shareholder rights agreement. For a
description of the shareholder right agreement see the Form 10-Q Part II, Item
2, Changes in Securities. The shareholder rights agreement was adopted to
provide our board of directors an opportunity to assess and evaluate any take
over bid, and in the event a bid is made, to provide the board with an
appropriate period of time to explore and develop alternatives which maximize
shareholder value. We cannot assure that shareholders or the market may view or
react adversely to this shareholder rights agreement adversely affecting
shareholder value.
In addition, Minnesota Statutes govern "control share acquisitions" and
require potential acquirers of at least 20% of the Company's stock to provide
notice and information to us about the proposed acquisition of stock and limits
voting rights in acquired stock unless such voting rights are approved by an
affirmative vote of shareholders and the control share acquisition is
consummated within 180 days after shareholder approval. The effect of the
statute is to limit the opportunity for a hostile takeover of control of the
Company unless a majority of shareholders consent. There is no assurance that
the control share acquisition statute will not adversely affect shareholder
value.
Dilution. We have outstanding a large number of stock options and warrants
to purchase our Common Stock. To the extent such options or warrants are
exercised, there will be further dilution. We expect to seek additional
acquisitions in pursuing our strategies and intend to grant additional stock
options and stock bonuses to the employees of the acquired companies. For these
reasons, our acquisition program will result in further substantial ownership
dilution to investors.
Risks Related to Acquisitions. A key component of our growth strategy is
the acquisition of Information Technology professional service firms that meet
our criteria for revenues, profitability, growth potential and operating
strategy. The successful implementation of this strategy depends on our ability
to identify suitable acquisition candidates, acquire such companies on
acceptable terms and integrate their operations successfully with ours. There
can be no assurance that we will be able to identify suitable acquisition
candidates or that we will be able to acquire such candidates on acceptable
terms. Moreover, in pursuing acquisition opportunities we may compete with other
companies with similar growth strategies, certain of which competitors may be
larger and have greater financial and other resources. Competition for these
acquisition targets likely could also result in increased prices of acquisition
targets and a diminished pool of companies available for acquisition.
Acquisitions also involve a number of other risks, including adverse effects on
our reported operating results from increases in goodwill amortization, acquired
in-process technology, stock compensation expense and increased compensation
expense resulting from newly hired employees, the diversion of our management's
attention, potential disputes with the sellers of one or more acquired entities
and the possible failure to retain key acquired personnel. Client satisfaction
or performance problems with an acquired firm could also have a material adverse
impact on our reputation as a whole, and any acquired subsidiary could
significantly underperform relative to our expectations. Our pursuit of an
overall acquisition strategy or any individual pending or future acquisition may
have a material adverse effect on our business, results of operations and
financial condition. To the extent we choose to use cash consideration for
acquisitions in the future, we may be required to obtain additional financing.
There can be no assurance that such financing will be available on favorable
terms, if at all. As we issue stock to complete future acquisitions, existing
stockholders will experience further ownership dilution.
Reliance on Indirect Distribution. We market and sell our products
domestically and internationally primarily through specialty distributors,
dealers, VARs and OEMs. Our sales are principally made through distributors,
which may carry competing product lines. Such distributors could reduce or
discontinue sales of our products, which could have a material adverse effect on
our business. There can be no assurance that these independent distributors will
devote the resources necessary to provide effective sales and marketing support
of our products. In addition, we are dependent upon the continued viability and
financial stability of these distributors, many of which are small organizations
with limited capital. These distributors, in turn, are substantially dependent
on general economic conditions and other unique factors affecting the wide-
format printer market. We believe that our future growth and success will
continue to depend in large part upon our distribution channels. To expand our
distribution channels, we entered into select OEM and private label arrangements
that allow us to address specific market segments. We cannot assure that we will
be successful in developing OEM and private label relationships, or that those
relationships will result in incremental business.
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