<PAGE>
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 April 4, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File No.: 0-18114
VIRTUALFUND.COM, INC.
(Exact name of registrant as specified in charter)
Minnesota 41-1612861
--------- ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
7090 Shady Oak Road, Eden Prairie, Minnesota 55344
- -------------------------------------------- -----
(Address of principal executive offices) (Zip code)
(612) 941-8687
--------------
(Registrant's telephone number, including area code)
(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 4/30/99
- ----- ----------------------
Common Stock, $.01 par value 15,778,866
1
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VIRTUALFUND.COM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
April 4,
1999 June 30,
(Unaudited) 1998
ASSETS ------------- ----------------
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 769,822 $ 5,011,181
Accounts receivable, less allowance for
doubtful accounts and sales returns of
$1,187,000 and $1,662,000, respectively 9,044,029 11,311,178
Receivable - related parties 1,113,542 337,460
Inventory 8,074,334 6,819,968
Other current assets 2,222,136 1,918,258
Deferred income taxes 1,214,000 1,214,000
------------- ----------------
TOTAL CURRENT ASSETS 22,437,863 26,612,045
PROPERTY AND EQUIPMENT, NET 3,844,961 2,776,339
GOODWILL, less accumulated amortization of $598,044 8,372,625
DEFERRED INCOME TAXES 3,552,000 3,552,000
OTHER ASSETS 237,233 179,286
------------- ----------------
$ 38,444,682 $ 33,119,670
============= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable $ 3,187,772 $ 2,015,988
Notes payable - related parties 2,235,766
Current maturities of long-term debt 615,829 259,550
Convertible subordinated debenture 375,866
Accounts payable 12,701,888 10,524,613
Accrued liabilities 4,748,428 4,109,603
------------- ----------------
TOTAL CURRENT LIABILITIES 23,489,683 17,285,620
LONG-TERM DEBT, less current maturities 799,118 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; 1,499,998 issued and outstanding 15,000
Additional paid in capital 40,500,420 32,995,320
Accumulated deficit (26,517,328) (17,379,805)
------------- ----------------
TOTAL STOCKHOLDERS' EQUITY 14,155,881 15,767,304
------------- ----------------
$ 38,444,682 $ 33,119,670
============= ================
</TABLE>
See notes to consolidated financial statements
2
<PAGE>
VIRTUALFUND.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------- -----------------------------
April 4, March 29, April 4, March 29,
1999 1998 1999 1998
------------- -------------- ------------- -------------
SALES
<S> <C> <C> <C> <C>
Products $ 17,693,662 $ 21,272,836 $ 50,674,201 $ 58,225,444
Professional Services 1,520,076 1,943,630
------------- ------------- ------------- --------------
NET SALES 19,213,738 21,272,836 52,617,831 58,225,444
COST OF SALES
Products 9,886,747 12,317,283 29,236,695 35,114,794
Professional Services 1,051,022 1,395,540
------------- ------------- ------------- --------------
TOTAL COST OF SALES 10,937,769 12,317,283 30,632,235 35,114,794
------------- ------------- ------------- --------------
GROSS PROFIT 8,275,969 8,955,553 21,985,596 23,110,650
OPERATING EXPENSES
Sales and Marketing 3,666,414 4,065,326 11,417,870 10,500,813
Research and Development 2,165,489 1,657,187 6,340,175 4,648,037
Acquired In-Process Technology 2,500,000
General and Administrative 3,294,800 2,201,338 8,314,375 7,166,919
Goodwill Amortization 448,533 598,044
Restructuring and Other Special Charges (Reversal) (600,000)
------------- ------------- ------------- --------------
9,575,236 7,923,851 28,570,464 22,315,769
------------- ------------- ------------- --------------
OPERATING (LOSS) PROFIT (1,299,267) 1,031,702 (6,584,868) 794,881
OTHER INCOME (EXPENSE)
Interest Expense (240,417) (179,003) (635,457) (650,393)
Interest Income 31,194 37,453 90,201 65,739
Other Income (Expense) 160,462 30,972 43,861 (37,337)
------------- ------------- ------------- --------------
(48,761) (110,578) (501,395) (621,991)
------------- ------------- ------------- --------------
NET (LOSS) EARNINGS $ (1,348,028) $ 921,124 $ (7,086,263) $ 172,890
============= ============= ============= ==============
NET (LOSS) EARNINGS PER COMMON SHARE $ (0.09) $ 0.06 $ (0.45) $ 0.01
NET (LOSS) EARNINGS PER COMMON
SHARE - ASSUMING DILUTION $ (0.09) $ 0.06 $ (0.45) $ 0.01
Weighted average common shares outstanding 15,778,866 14,808,887 15,746,492 14,619,091
Weighted average common and dilutive
potential common shares outstanding 15,778,866 15,955,323 15,746,492 15,283,667
</TABLE>
See notes to consolidated financial statements
3
<PAGE>
VIRTUALFUND.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
--------------------------------
April 4, March 29,
1999 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net (loss) earnings $ (7,086,263) $ 172,890
Adjustments to reconcile net (loss) earnings to
net cash provided by operating activities:
Depreciation and amortization 1,503,367 1,578,123
Amortization of goodwill 598,044
Acquired in-process research and development 2,500,000
Loss on sale of property and equipment 4,079 84,516
Change in current assets and current liabilities, net
of effects of acquisition:
Accounts receivable 3,399,856 1,523,740
Inventory (843,744) 1,699,530
Other current assets (328,243) 177,051
Accounts payable 1,671,074 346,707
Accrued liabilities (894,780) (599,715)
------------- ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 523,390 4,982,842
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans to related parties (846,873)
Collection of loans from related parties 351,181
Additions to property and equipment (786,771) (539,239)
Proceeds from sale of property and equipment 15,590 20,059
Additions to patents and other assets (17,230) (33,135)
Payments for acquisition of K&R Technologies, Inc.
net of cash acquired (1,388,655)
------------- ------------
NET CASH USED IN INVESTING ACTIVITIES (2,672,758) (552,315)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of related party note payable (1,798,588)
Payment of debenture (375,866)
Proceeds from issuance of common stock 112,924
Net borrowing (payments) under revolving credit lines 584,489 (1,923,400)
Proceeds from long-term debt 228,908
Payments on long term debt (730,934) (530,790)
------------- ------------
NET CASH USED IN FINANCING ACTIVITIES (2,091,991) (2,341,266)
------------- ------------
(DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (4,241,359) 2,089,261
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 5,011,181 484,106
------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 769,822 $ 2,573,367
============= ============
</TABLE>
See notes to consolidated financial statements
4
<PAGE>
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 three months
and nine months ended April 4, 1999 are not necessarily indicative of the
results that may be expected for the year ending June 30, 1999.
2. Earnings Per Share Calculation -
The following table summarizes the reconciliation of the basic and diluted
average common shares outstanding:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------ ----------------------------
April 4, March 29, April 4, March 29,
1999 1998 1999 1998
----------- ----------- ------------ ----------
<S> <C> <C> <C> <C>
Average common shares outstanding 15,778,866 14,808,887 15,746,492 14,619,091
Assumed conversion of stock options 1,005,103 570,354
Assumed issuance of common stock
related to settlement of litigation 141,333 94,222
----------- ----------- ------------ ----------
Average common and assumed
conversion shares 15,778,866 15,955,323 15,746,492 15,283,667
=========== =========== ============ ==========
</TABLE>
The following table summarizes securities that could potentially dilute
basic earnings per share in the future that were not included in the
computation of diluted earnings (loss) per share because to do so would
have been antidilutive for the periods presented:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------------ -----------------------
April 4, March 29, April 4, March 29,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Stock options 3,741,139 142,000 3,741,139 2,406,406
Warrants 3,034,953 3,049,953 3,034,953 3,049,953
Convertible preferred stock 1,499,998 1,499,998
Convertible debenture 239,173 239,173
--------- --------- --------- ---------
Average common and assumed
conversion shares 8,276,090 3,431,126 8,276,090 5,695,532
========= ========= ========= =========
</TABLE>
5
<PAGE>
3. Inventory -
Inventory consists of the following:
April 4, June 30,
1999 1998
------------ ------------
Raw materials $ 4,116,548 $ 3,285,194
Work in process 248,320 207,303
Finished goods:
Consumables 2,216,880 2,604,318
Hardware 1,492,586 723,153
------------ ------------
$ 8,074,334 $ 6,819,968
============ ============
4. Acquisition -
In December 1998, the Company, through its wholly owned subsidiary
RSPnet.com, Inc., issued 1,499,998 shares of Series A Convertible
Preferred Stock and notes payable of $3,678,227, in exchange for all of
the common stock of K&R Technologies, Inc. d/b/a TEAM Technologies, a
privately held information technology company. Each share of Series A
Convertible Preferred Stock is convertible into Common Stock of the
Company, initially at the rate of one share of Common Stock for each share
of Series A Convertible Preferred Stock, and has a guaranteed value of $5
per share after two years from the date of issuance. The Series A
Convertible Preferred Stock has been valued at $5 per share for accounting
purposes. The acquisition has been accounted for using the purchase method
of accounting. Accordingly, the aggregate purchase price of approximately
$11,278,000, including transaction costs, has been allocated to the assets
acquired and liabilities assumed based upon the fair market values at the
date of acquisition. The historical carrying amounts of the assets
acquired and liabilities assumed approximated their fair value with
liabilities assumed exceeding assets acquired by $193,000. A portion of
the purchase price in the amount of $2,500,000 was allocated to in-process
technology and was charged to operations because such in-process
technology had not reached the stage of technological feasibility at the
acquisition date and had no alternative future use. The remaining purchase
price and the liabilities assumed in excess of the book value of tangible
assets acquired has been recorded as goodwill in the amount of $8,971,000
and is being amortized on a straight-line basis over five years. Assets
acquired and liabilities assumed as of December 1, 1998 include the
following:
(Unaudited)
Accounts receivable $ 983,000
Notes receivable - related party 444,000
Property, plant and equipment 1,236,000
Other assets 195,000
Note payable 568,000
Term debt 1,230,000
Accounts payable 346,000
Accrued compensation 423,000
Other liabilities 484,000
The operating results of the acquired business have been included in the
consolidated statement of operations from December 1, 1998, the effective date
of acquisition. The following pro forma results of operations for the nine
months ended April 4, 1999 and March 29, 1998 assume the acquisition occurred as
of July 1, 1997:
6
<PAGE>
<TABLE>
<CAPTION>
April 4, March 29,
1999 1998
------------ ------------
<S> <C> <C>
Net sales $ 55,630,000 $ 61,866,000
Net loss (5,796,000) (1,748,000)
Net loss per common share - basic (.37) (.12)
Net loss per common share - assuming dilution (.37) (.12)
</TABLE>
5. Supplemental disclosure of cash flow information and non-cash financing
activities -
<TABLE>
<CAPTION>
Nine Months Ended
------------------------
April 4, March 29,
1999 1998
--------- ----------
<S> <C> <C>
The Company paid and received cash for the following items:
Interest paid $ 547,454 $ 506,654
Income tax (received) paid, net (118,827) 6,550
Financing transactions not affecting cash:
Increase in accumulated deficit from exchange of 600,000
shares of common stock for liabilities assumed in excess of
assets acquired related to the Kilborn Photo Products, Inc. 2,051,260
Convertible preferred stock issued for acquisition of K&R
Technologies, Inc. 7,499,990
Notes payable issued for acquisition of K&R Technologies, Inc. 3,678,227
Convertible subordinated debenture and accrued interest
converted to common stock 1,413,687
Capital lease obligations 101,178
</TABLE>
6. Accounting Changes -
Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income, was issued in June 1997 and was adopted by the
Company at the beginning of fiscal 1999. The statement requires companies
to disclose comprehensive income and its components in their financial
statements. This statement had no material impact on the Company's
financial statements.
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information", was issued in June
1997 and will be adopted by the Company in the fourth quarter of fiscal
1999. The statement establishes standards which redefine how operating
segments are determined and requires public companies to report financial
and descriptive information about reportable operating segments.
Statement of Financial Accounting Standards No. 132, "Employer's
Disclosure About Pensions and Other Postretirement Benefits", was issued
in February 1998 and will be adopted by the Company in the fourth quarter
of fiscal 1999. The statement revises employer's disclosures about pension
and other postretirement benefit plans.
Since all of these pronouncements relate primarily to changes in
disclosure requirements, the Company does not believe the new requirements
will significantly affect its financial condition or operating results.
7
<PAGE>
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 and intense competition, 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, risks associated with the acquisition and integration of
new businesses, risks related to the diversification into new internet software
and information technology business, the outcome of 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 December 18, 1998 our wholly owned subsidiary, RSPnet.com, Inc., acquired all
of the outstanding common stock of K&R Technologies, Inc. d/b/a TEAM
Technologies (TEAM), in exchange for 1,499,998 shares of VirtualFund.com, Inc.
Series A Convertible Preferred Stock and notes payable of $3,678,227. TEAM is an
information technology consulting company specializing in Internet solutions and
is located in Cedar Falls, Iowa. The business combination was accounted for
under the purchase method of accounting. Operating results of TEAM have been
included in the consolidated statement of operations from December 1, 1998, the
effective date of acquisition.
Results of Operations
Net sales for the quarter ended April 4, 1999 were $19.2 million compared to
$21.3 million for the same period one year ago. Net loss, excluding merger
related charges, for the quarter ended April 4, 1999 was $899,000 or $.06 per
share compared to net income of $921,000 or $.06 per share for the quarter ended
March 29, 1998. Net sales for the nine months ended April 4, 1999 were $52.6
million compared to $58.2 million for the same period one year ago. Net loss,
excluding merger related charges, for the nine months ended April 4, 1999 was
$4.0 million or $.25 per share compared to net income of $173,000 or $.01 per
share for the nine months ended March 29, 1998. Merger related charges for the
three month period ended April 4, 1999 include $449,000 in amortization of
goodwill. Merger related charges for the nine month period ended April 4, 1999
include non-cash charges of $2.5 million for acquired in-process technology and
$598,000 in amortization of goodwill. These charges account for losses of $.03
and $.20 per share for the three and nine month periods ended April 4, 1999,
respectively. Net loss including these acquisition related charges for the three
and nine month periods ending April 4, 1999 was $1.3 million or $.09 per share
and $7.1 million or $.45 per share, respectively.
8
<PAGE>
The following table sets forth certain items from the Consolidated Statements of
Operations expressed as a percentage of net sales:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------- --------------------
April 4, March 29, April 4, March 29,
1999 1998 1999 1998
----- ----- ----- -----
<S> <C> <C> <C> <C>
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of Goods Sold 56.9 57.9 58.2 60.3
----- ----- ----- -----
Gross Profit 43.1 42.1 41.8 39.7
Operating Expenses:
Sales and Marketing 19.1 19.1 21.7 18.0
General and Administrative 17.1 10.4 15.8 12.3
Research and Development 11.3 7.8 12.0 8.0
Acquired In-Process Technology -- -- 4.8 --
Goodwill Amortization 2.3 -- 1.1 --
Restructuring and Other Special Charges (Reversal) -- -- (1.1) --
----- ----- ----- -----
Total Operating Expenses 49.8 37.3 54.3 38.3
----- ----- ----- -----
Operating (Loss) Profit (6.7) 4.8 (12.5) 1.4
----- ----- ----- -----
Other Income (Expense):
Interest Expense (1.3) (0.8) (1.2) (1.1)
Interest Income 0.2 0.2 0.2 0.1
Other 0.8 0.1 -- (0.1)
----- ----- ----- -----
Net (Loss) Profit (7.0)% 4.3% (13.5)% 0.3%
===== ===== ===== =====
</TABLE>
Net Sales. Sales of the Company's new DisplayMaker(R) Series XII printer, which
became available during the last two weeks of the quarter, were $1.7 million.
The Company expects sales of these production printers to grow significantly
over the next several quarters. Overall, the Digital Graphics Business Unit
(DGBU) experienced hardware sales of $6.7 million for the quarter ended April 4,
1999 compared to $9.2 million in the same period one year ago. The $2.5 million
decline is comprised in part of a decrease in the sales of our older four-color
inkjet printers, black-and-white typesetting and server products totaling $1.4
million. Sales of our DisplayMaker HiRes 8-Color products (DMX) decreased $3.6
million as the product line was repositioned as a lower price point product when
the Series XII product line was introduced. Sales of the Giclee PrintMakerFA(TM)
printer increased by $800,000 from the same period a year ago.
During the quarter ended April 4, 1999 our DGBU recorded consumables sales,
consisting primarily of ink, media, film, maintenance contracts and spare parts,
of $10.5 million or 61% of DGBU net sales compared to $12.1 million or 57% of
DGBU net sales in the same period one year ago. The $1.6 million decrease in
consumables sales for the quarter ended April, 1999 from the prior year is
primarily attributable to a $2.3 million reduction in consumables sales for our
older four-color and black-and-white typesetting products which have been in the
field for several years. This decrease was partially offset by a $1.3 million
increase in sales of ink for our DMX and Series XII Color printers.
Hardware sales were $17.8 million or 36% of DGBU net sales in the nine months
ended April 4, 1999 compared to $23.6 million or 41% of DGBU net sales in the
same period one year ago. Consumables sales were $32.3 million or 64% of DGBU
net sales in the nine months ended April 4, 1999 compared to $34.6 million or
59% of DGBU net sales in the same period one year ago.
During the quarter ended April 4, 1999 our Internet/Software Business Unit
(ISBU) recorded revenues of $2.0 million consisting of $1.5 million in
professional services revenue and $504,000 in revenues from products such as web
hosting, advertising, electronic commerce software and VAR (value added
reseller) products. We expect growth in the ISBU to come from hosting related
activities including sales of proprietary software, including the recently
released E-Com Tools(TM) Internet based electronic commerce software, VAR
products, and professional services revenue related to these products. The ISBU
is currently marketing the E-Com Tools software product to reseller channel
partners called Affiliates and Designated Systems Integrators.
9
<PAGE>
International Sales. The following table sets forth international sales by
region expressed in thousands and as a percentage of total net sales:
<TABLE>
<CAPTION>
Three months ended Nine months ended
--------------------------------------- --------------------------------------------
April 4, 1999 March 29, 1998 April 4, 1999 March 29, 1998
----------------- ----------------- --------------------- ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Europe $3,771 19.6% $4,454 21.0% $10,910 20.7% $12,184 20.9%
Japan, Asia/Pacific 1,837 9.6 2,157 10.1 4,735 9.0 6,941 11.9
Latin America 713 3.7 1,048 4.9 2,299 4.4 3,304 5.7
Canada 500 2.6 803 3.8 1,445 2.7 2,116 3.6
----- ---- ------ ----- ------- ----- ------- -----
Total international sales $6,821 35.5% $8,462 39.8% $19,389 36.8% $24,545 42.1%
====== ==== ====== ===== ======= ===== ======== =====
</TABLE>
International sales are all related to DGBU activity. The decreases in revenues
in these regions from the prior year are consistent with the overall decrease in
revenue experienced by our DGBU. We expect sales in these regions to remain
below historical levels for the remainder of fiscal 1999. While 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, the DGBU does
borrow funds in Dutch Guilders to pay its European expenses. Significant
fluctuations in that relatively stable currency are not expected, but if the
fluctuations were to occur, they could have an adverse impact on the Company.
Gross Profit. Gross profit on product revenues, expressed as a percent of net
sales for the DGBU, was 44.1% in the quarter ended April 4, 1999 compared to
42.1% in the same period one year ago. A one-time retroactive price concession
for certain components and a vendor settlement accounted for approximately 3% of
the increased gross margin percentage during the quarter ended April 4, 1999.
Gross profit on product revenues, expressed as a percent of net sales for the
DGBU, was 42.3% in the nine months ended April 4, 1999 compared to 39.7% in the
same period one year ago. Gross profit on professional services revenue was
30.9% in the quarter ended April 4, 1999. Gross profit on professional services
is expected to fluctuate between 30% and 35% depending on seasonal issues and
our ability to quickly utilize our professionals in a chargeable manner as we
expand into new markets.
Operating Expenses. Sales and Marketing expenses for the quarter ended April 4,
1999 were $3.7 million compared to $4.1 million in the same period one year ago.
The decrease in Sales and Marketing expenses in the quarter ended April 4, 1999
consists of decreases in DGBU marketing expenses of $245,000 and sales expenses
of $538,000 offset by an increase in ISBU sales and marketing expenses of
$383,000. Sales and marketing expenses were $11.4 million in the nine months
ended April 4, 1999 compared to $10.6 million in the prior year. The increase in
sales and marketing expenses in the nine months ended April 4, 1999 compared to
the prior year consists of a $744,000 increase in marketing expenses and a
$173,000 increase in sales expenses.
Research and Development expenses were $2.2 million in the quarter ended April
4, 1999, compared to $1.7 million in the same period one year ago. The increase
in research and development expenses over the prior year includes approximately
$189,000 related to product development for the ISBU and $204,000 in expenses
related to our Advanced Research Technology Center in San Jose, California.
Research and development expenses were $6.3 million (excluding $2.5 million in
acquired in-process technology) in the nine months ended April 4, 1999 compared
to $4.6 million in the same period one year ago. The increase is primarily due
to $545,000 in expenses related to our new Advanced Research Technology Center
and a $600,000 increase in electronic commerce software development expenses.
General and Administrative expenses were $3.3 million for the quarter ended
April 4, 1999 compared to $2.2 million in the same period one year ago and $8.3
million in the nine months ended April 4, 1999 compared to $7.2 million in the
same period one year ago. The increase in general and administrative expenses
compared to
10
<PAGE>
the previous year is primarily the result of increased ISBU expenses of
approximately $945,000 and $1.2 million in the quarter and nine months ended
April 4, 1999, respectively.
Other. Interest expense was $240,000 for the quarter ended April 4, 1999
compared to $179,000 in the same period one year ago. The increase in interest
expense is due to higher average outstanding borrowings despite lower average
interest rates.
Liquidity and Capital Resources
Net cash provided by operating activities during the nine months ended April 4,
1999 was $523,000 compared to net cash provided by operating activities of $5.0
million in the same period one year ago. Cash flows were negatively impacted by
a $4.0 million loss from operations, excluding non-cash acquisition related
charges, in the nine months ended April 4, 1999 compared to net earnings from
operations of $173,000 in the same period one year ago. Cash flows were also
negatively impacted by an $844,000 increase in inventory in the nine months
ended April 4, 1999 compared to a decrease of $1.7 million in the same period
one year ago. Cash flow was positively impacted by a $3.4 million reduction in
accounts receivable and a $1.7 million increase in accounts payable during the
nine months ended April 4, 1999.
Net cash used in investing activities was $2.7 million during the nine months
ended April 4, 1999 compared to $552,000 in the same period one year ago. We
advanced $496,000, net of repayments, to related entities in the nine months
ended April 4, 1999. Investment in capital equipment was $787,000 in the nine
months ended April 4, 1999 compared to $539,000 in the same period one year ago.
Payments, net of cash acquired, for the acquisition of K&R Technologies, Inc.
(TEAM) were $1.4 million in the nine months ended April 4, 1999.
Net cash used in financing activities was $2.1 during the nine months ended
April 4, 1999 compared to $2.3 million 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 nine months ended April 4, 1999. The Company
paid the balance on the convertible subordinated debenture of $376,000 and its
related interest during the nine months ended April 4, 1999. Net borrowing under
revolving credit lines was $584,000 during the nine months ended April 4, 1999
compared to net repayments of $1.9 million in the same period one year ago.
ColorSpan's revolving credit facility agreement with General Electric Capital
Corporation (GE) expired January 17, 1999 and was subsequently extended until
June 30, 1999. However, GE has notified us of their intent not to renew the
credit facility as we do not meet the account size objectives of their
portfolio. GE will continue to hold its equity interest in the Company. The
principal balance due GE under this agreement was $1,606,777 as of April 4,
1999. In addition, the RSPnet.com, Inc. revolving credit facility assumed with
the TEAM acquisition expired on May 1, 1999. The lender has given written notice
of its desire to terminate the credit facility as soon as possible and is
pursuing collection on personal guarantees provided by the former shareholders.
The principal balance due this lender under this agreement was $652,995 as of
April 4, 1999. We are currently in the final stages of negotiations with a new
primary lender who is expected to replace the credit relationships for both
businesses before June 30, 1999.
We expect revenues to increase in the June 1999 quarter compared to the first
three quarters of fiscal 1998. The shipment of production quantities of the new
Displaymaker Series XII printer released in March 1999 should provide the
additional revenue. Currently, we have not made significant commitments for
capital expenditures and do not expect to incur substantial cash outlays related
to planned strategic acquisitions of information technology consulting companies
in fiscal 1999 in excess of the $2.2 million required in the June 1999 quarter
related to the TEAM acquisition. We expect to finance this $2.2 million
requirement and any additional acquisitions primarily through the issuance of
equity securities which will cause further dilution to our current shareholders.
We expect to finance operations throughout the remainder of fiscal 1999 through
cash flow from operating activities and short term borrowings. Longer term
financing for the RSPnet.com, Inc. business will likely require the issuance of
additional equity in VirtualFund.com, Inc. or RSPnet.com, Inc. stock. If sales
are less than expected or reasonably priced sources of alternative financing are
not available, we may be required to revise our RSPnet.com, Inc. business plan
or further restructure the capitalization of the Company.
11
<PAGE>
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
and termination devices 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. Currently, we estimate any additional costs for this issue will not
exceed $25,000. We currently expect to have the project completed by September
1999.
Our Products. Our products do not use real time date information. However, we
design and sell products that are heavily reliant on other company's operating
system software. While we have taken appropriate steps to ensure the readiness
of our 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
are currently contacting essential third parties to ascertain their readiness
and the impact they would have on our contingency planning. 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 (LMC), now known as ColorSpan Corporation, against
Sentinel Imaging, a division of Sentinel Business Systems, Inc. (Sentinel)
alleging Sentinel's theft of trade secrets related to LMC's Big Ink(R) Delivery
System and customer information and breach of a confidentiality agreement with a
former LMC employee. In October 1997, the 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 counter-claimed alleging
copyright misuse and unfair competition.
12
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In March 1998, Sentinel filed for Chapter 11 bankruptcy protection. The
bankruptcy court permitted the appeal on the initial case to move forward in the
federal courts. Sentinel challenged the claim of ColorSpan related to the suit
filed in January 1998. Sentinel 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 secured
claim of Kilborn should be equitably subordinated and to rescind an alleged
fraudulently procured security right. Kilborn denied all such allegations.
The bankruptcy court approved a sale of the assets of Sentinel to a subsidiary
of Charrette Corp. in January 1999. The sale proceeds are cash and a promissory
note which is guaranteed by Charrette Corp.
On May 5, 1999, the bankruptcy court approved a settlement of all claims between
Sentinel, ColorSpan and Kilborn. The settlement provides for payment to
ColorSpan and Kilborn of $1.5 million. $1.15 million has been received and the
remaining $350,000 is due when there is payment to creditors from the proceeds
of the note from Charrette and its subsidiary, which is expected in mid 2000.
The amount paid is subject to adjustment if there is a shortfall of funds
available to pay other unsecured creditors.
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
Nothing to report.
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
Jean Louis Gassee resigned from his position as a director of the Company on May
6, 1999, citing time and travel commitments related to an initial public
offering of Be, Inc. where he is the chief executive officer. On May 17, 1999
Rohan Champion also resigned from the board of directors. Mr. Champion resigned
to devote full time to his position as chief executive officer of E-Time, Inc.
where he is raising funds, managing and promoting a new internet software
venture, E-Time, Inc.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Listing of Exhibits
99. Cautionary Factors Under Private Securities Litigation Reform Act of
1995.
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(b) Reports on Form 8-K
Form 8-K/A dated March 3, 1999 and filed March 3, 1999, disclosed the
required financial statements in connection with the previously reported
acquisition of K&R Technologies, Inc. d/b/a TEAM Technologies.
14
<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: May 19, 1999
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INTERNAL
FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JAN-04-1999
<PERIOD-END> APR-04-1999
<CASH> 769,822
<SECURITIES> 0
<RECEIVABLES> 10,157,571
<ALLOWANCES> 1,187,000
<INVENTORY> 8,074,334
<CURRENT-ASSETS> 22,437,863
<PP&E> 3,844,961
<DEPRECIATION> 17,442,151
<TOTAL-ASSETS> 38,444,682
<CURRENT-LIABILITIES> 23,489,683
<BONDS> 0
0
15,000
<COMMON> 157,789
<OTHER-SE> 13,983,092
<TOTAL-LIABILITY-AND-EQUITY> 38,444,682
<SALES> 19,213,738
<TOTAL-REVENUES> 19,213,738
<CGS> 10,937,769
<TOTAL-COSTS> 10,937,769
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 240,417
<INCOME-PRETAX> (1,348,028)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,348,028)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,348,028)
<EPS-PRIMARY> (0.09)
<EPS-DILUTED> (0.09)
</TABLE>
<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. 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; risks associated
with the acquisition and integration of new businesses; risks related to the
diversification into new internet software and information technology business;
and, the impact of the initiation, defense and resolution of litigation.
Other factors include the following:
Credit Availability. ColorSpan's revolving credit facility agreement
with General Electric Capital Corporation (GE) expired January 17, 1999 and was
subsequently extended until June 30, 1999. However, GE has notified us of their
intent not to renew the credit facility as we do not meet the account size
objectives of their portfolio. The balance due GE under this agreement was
$1,606,777 as of April 4, 1999. GE will continue to hold its equity interest in
the Company. In addition, the RSPnet.com, Inc. revolving credit facility expired
on May 1, 1999 and the lender has given written notice of its desire to
terminate the credit facility as soon as possible. This lender is actively
pursuing the former principals of K&R Technologies, Inc. on their guaranty for
that financing. The balance due Firstar under this agreement was $652,995 as of
April 4, 1999. We are currently negotiating the terms of alternative financing
to replace the financing provided by both lenders. Although we expect to have a
new lender in place by June 30, 1999, there can be no assurances of this, or
that the cash available under any agreement which can be reached will be
adequate to meet our needs, or that sources of financing will be available to us
on favorable terms.
Cash Needs. Our credit agreement with a commercial finance company that
has financed its cash requirements in the past expired January 17, 1999 but was
extended to June 30, 1999. 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. We raised $11.8 million in these
private placements and have not pursued additional equity based financing since
that time. We expect to finance operations throughout the remainder of fiscal
1999 through cash flow from operating activities and short term borrowings.
Longer term financing for the RSPnet.com, Inc. business will likely require the
issuance of additional equity in VirtualFund.com, Inc. or RSPnet.com, Inc.
stock. There can be no assurances that cash availability under any credit
agreement which may be negotiated will be adequate to meet future needs, or that
other sources of financing will be available to us on favorable terms, or at
all, if our operations are further affected by declining revenue from a lack of
sales, significant research and
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development costs, 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 we
will achieve or maintain profitability on a quarterly or annual basis in the
future. In addition, we may need to raise additional funds in order to support
more rapid expansion, develop new or enhanced services and products, respond to
competitive pressures, acquire complementary businesses or technologies or take
advantage of unanticipated opportunities. Our future liquidity and capital
requirements will depend upon numerous factors, including the success of our
existing and new service offerings and competing technological and market
developments.
We may be required to raise additional funds through public or private
financing, strategic relationships or other arrangements, particularly as our
acquisition strategy matures. There can be no assurance that such additional
funding, if needed, will be available on terms acceptable to us, or at all.
Furthermore, any additional equity financing may be dilutive to stockholders,
and debt financing, if available, may involve restrictive covenants, which may
limit our operating flexibility with respect to certain business matters.
Strategic arrangements, if necessary to raise additional funds, may require us
to relinquish our rights to certain of our intellectual property or selected
business opportunities. If additional funds are raised through the issuance of
equity securities, the percentage ownership of our existing stockholders will be
reduced, stockholders may experience additional dilution in net book value per
share, and such equity securities may have rights, preferences or privileges
senior to those of the holders of our Common Stock or newly issued Preferred
Stock. If adequate funds are not available on acceptable terms, we may be unable
to develop or enhance our services and products, take advantage of future
opportunities or respond to competitive pressures, any of which could have a
material adverse effect on our business, financial condition, results of
operations and prospects.
Potential Acceleration of Senior Debt. Our current Senior Debt
Agreement includes financial covenants including capital expenditures, additions
to capitalized software and intellectual property, minimum debt service coverage
ratio and the maintenance of a minimum net worth, which we must meet. Our past
financial performance has made it necessary for us to renegotiate the minimum
net worth and minimum debt service coverage covenants to avoid being declared in
violation of the covenants by GE. The replacement financing is expected to
include certain financial covenants, which we must meet as a condition of the
financing. If future financial performance causes covenant violations and we are
unable to renegotiate our loan covenants at that time, we could be forced to
seek replacement financing at prices which may not be favorable to us. If
adequate sources of financing are not available, we may be required to sell
certain product lines or technologies on less than favorable terms. As of April
4, 1999, the outstanding balance on our Senior Debt Agreement was $1,606,777.
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 success for the Digital
Graphics Business Unit (DGBU) 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.
The market for Internet professional services and e-commerce is
characterized by rapid technological change, changes in user and client
requirements and preferences, frequent new product and service introductions
embodying new processes and technologies and evolving industry standards and
practices that could render our existing service practices and methodologies
obsolete. Our success will depend, in part, on
2
<PAGE>
our ability to improve our existing services and develop new services and
solutions that address the increasingly sophisticated and varied needs of our
current and prospective clients, and respond to technological advances, emerging
industry standards and practices, and competitive service offerings. Failure to
do so could result in the loss of existing customers or the inability to attract
and retain new customers, either of which could have a material adverse effect
on our business, financial condition, results of operations and prospects. There
can be no assurance that we will be successful in responding quickly,
cost-effectively and sufficiently to these developments. If we are unable, for
technical, financial or other reasons, to adapt in a timely manner in response
to changing market conditions or client requirements, our business, financial
condition, results of operations and prospects would be materially adversely
affected.
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. The time and expense
required to adopt new and emerging technologies and components, or to develop
new technologies cannot always be predicted with accuracy. There is no assurance
that new product design and development will occur within anticipated or
budgeted time and financial restrictions. New product design and development may
also delay product introductions, which could affect marketability of the
product, or may be more costly than anticipated.
The internet software industry is characterized by rapidly changing
technology and product development. There is no assurance that current product
development efforts for the Internet/Software Business Unit (ISBU) will properly
anticipate the market and target customer needs, or will not be displaced by new
or other technology, products or services offered by others.
Product Quality/Malfunction Issues. Any quality, durability or
reliability problems with existing or new products, regardless of materiality,
or any other actual or perceived problems with our products could have a
material adverse effect on market acceptance of such new products. Any quality
problems with components could result in wide-spread failures of the products in
the field causing return and refund requests that would likely have a material
effect on our financial results and future sales potential. Such problems or
perceived problems could potentially arise with respect to any existing
products. The 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.
We are aware of the intermittent presence of contaminants in certain
inks that caused perceived flaws in output from some of the Company's printers.
We have taken steps with our ink supplier to mitigate such contamination
problems and have compensated customers with replacement ink and media. In
addition, early versions of our PressMate(R) and DisplayMaker(R) Express
products experienced quality, durability and reliability problems associated
with the use of new technologies that had not received proper testing. We
believe we have addressed the problems associated with PressMate and
DisplayMaker Express by replacing certain components found in the original
designs. All of these problems contributed to our net losses incurred in fiscal
years 1997 and 1996. Two products which we introduced in the past several years
experienced what we consider "limited market acceptance." One product allowed
the use of a very limited variety of media types (paper, etc.) with the product.
Another product offering received limited market acceptance due to the amount of
manual intervention needed to produce output from the device. While the device
delivered significantly higher quality output than any competitive product
available at the time, the manual media handling and required maintenance was
seen by some users as a product limitation.
3
<PAGE>
Although we do not believe that we have a quality and reliability
reputation that may unfavorably affect products at this time, if one or more
products experiences product failures, we may develop an unfavorable reputation
which could dissuade a purchaser from our products. Such a reputation, if it
were to develop, may unfavorably affect new products even though they may not
suffer from any similar quality or reliability problems.
Product Acceptance/Market Anticipation. Our products may not achieve
market acceptance. In addition, the market anticipation or the announcement of
new products and technologies, whether offered by us or our competitors, could
cause customers to defer purchases of our existing products, which could have a
material adverse effect on our business and financial condition.
Our Digital Graphics Business Unit introduced a new family of printers,
the DisplayMaker Series XII, during March 1999. Although we have 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. We may not be successful with current or
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. Our inability to achieve market acceptance,
for technological or other reasons, could have a material adverse effect on our
financial condition.
Our Internet/Software Business Unit announced during the second quarter
of fiscal 1999 the first outside customer site using E-Com(TM) Tools, our
proprietary e-commerce software. We have successfully used a version of the
software for our Supplies-By-Air(TM) business unit. However, there is no
assurance that outside customers will accept the software, or that it will be
sufficiently flexible to meet the variety of needs that exist in the target
marketplace, that the license fees for the software will be competitive, or that
future offerings by competitors will not displace current licenses of our
software product. Our products may not be accepted by the target market for
technological or other reasons. In addition, we have not previously sold
Internet commerce software and may lack the sales and marketing expertise to
successfully sell the product, or we may not accurately predict the sales cycle
or sales volume which could adversely affect the financial results. Our
inability to achieve market acceptance of the e-commerce product could have a
material adverse effect on our financial condition and may affect the ability of
the Internet/Software Business Unit to effectively market its other services or
other outside or proprietary software products.
Potential Liability to Clients. Many of our ISBU service and consulting
engagements involve the development, implementation and maintenance of
applications that are critical to the operations of our clients' businesses. Our
failure or inability to meet a client's expectations in the performance of our
services could injure our business reputation or result in a claim for
substantial damages against us, regardless of our responsibility for such
failure. In addition, RSPnet.com, Inc. provides data services that may include
confidential or proprietary client information. Although we have implemented
policies to prevent such client information from being disclosed to unauthorized
parties, lost, or used inappropriately, any such unauthorized disclosure, loss
or use could result in a claim for substantial damages. We have attempted to
limit contractually our damages arising from negligent acts, errors, mistakes or
omissions in rendering professional services; however, there can be no assurance
that any contractual protections will be enforceable in all instances or would
otherwise protect us from liability for damages. Although we maintain general
liability insurance coverage, including coverage for errors and omissions, there
can be no assurance that such coverage will continue to be available on
reasonable terms or will be available in sufficient amounts to cover one or more
large claims, or that the insurer will not disclaim coverage as to any future
claim. The successful assertion of one or more large claims against us that are
uninsured, exceed available insurance coverage or result in
4
<PAGE>
changes to our insurance policies, including premium increases or the imposition
of a large deductible or co-insurance requirements, could adversely affect our
business, results of operations and financial condition.
Dependence on Suppliers. Our aqueous inkjet printers require use of a
sole-sourced printhead supplied pursuant to a written contract with
Hewlett-Packard(R) Company (HP). We do not anticipate availability or quality
issues that would affect the supply of printheads supplied by HP. Our revenues
associated with sales of this product or products including those components
represent approximately 67% of our fiscal 1998 revenue. If we were unable to
resolve potential future availability or quality issues, our production and
support of our installed base will be materially adversely affected. We are also
dependent on sole-source suppliers for the heads for PressMate-FS 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, we have an installed base of PressMate-FS users
who purchase consumables from us and could experience head failure or need a
replacement. Overall, the percentage of our 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 printheads delivered by this supplier have also
been a problem in the past and, in some cases, have caused printer returns from
our customers. We believe we have addressed these problems by designing and
providing test equipment to enhance the manufacturing repeatability of the
critical components of the DME printheads and by having had certain employees
spend time at the vendor's facilities to identify and remove the contaminants
that were causing problems with the ink. Costs incurred by us to identify and
mitigate these problems and to meet our warranty obligations and keep these
printers operational contributed to our net losses incurred in fiscal years 1997
and 1996
Although we currently sell very few new DME printers, there is an
installed base of DME users who purchase consumables from us 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 we 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 returns of the DME
printer based on the inability to supply replacement printheads. Overall, the
percentage of our revenues related to the product utilizing this head was less
than 9% of fiscal 1998 revenue.
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.
Recently, HP offered significant rebates to potential customers. The
rebates included 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.
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Many competitors in the internet software industry are not profitable.
The need to be competitive with the prices and services offered by these
competitors may impair the ability of the ISBU to operate profitably.
Competition; Low Barriers to Entry. The market for Internet software
and hosting services is relatively new, intensely competitive, rapidly evolving
and subject to rapid technological change. We expect competition to persist,
intensify and increase in the future. Our ISBU competitors can be divided into
several groups: computer hardware and service vendors; Internet integrators and
Web presence providers; web design media and advertising agencies; large
information technology consulting service providers; telecommunications
companies; Internet and online service providers; and software vendors. Many of
our ISBU current and potential competitors have longer operating histories,
larger installed customer bases, longer relationships with clients and
significantly greater financial, technical, marketing and public relations
resources than us and could decide at any time to increase their resource
commitments to our target markets. In addition, the market for Intranet,
Extranet and web site development is relatively new and subject to continuing
definition, and, as a result, may better position our competitors to compete in
this market as it matures. As a strategic response to changes in the competitive
environment, we may from time to time make certain pricing, service, technology
or marketing decisions or business or technology acquisitions that could have a
material adverse effect on our business, financial condition, results of
operations and prospects. Competition of the type described above could
materially adversely affect our business, results of operations, financial
condition and prospects.
In addition, our ability to maintain its existing client relationships
and generate new clients will depend to a significant degree on the quality of
our services and our reputation among our clients and potential clients,
compared with the quality of services provided by, and the reputations of, our
competitors. To the extent we lose clients to our competitors because of
dissatisfaction with our services or our reputation is adversely affected for
any other reason, our business, financial condition, results of operations and
prospects could be materially adversely affected.
There are relatively low barriers to entry into the ISBU's business.
Because professional services firms rely on the skill of their personnel and the
quality of their client service, they have no patented technology that would
preclude or inhibit competitors from entering their markets. We are likely to
face additional competition from new entrants into the market in the future.
There can be no assurance that existing or future competitors will not develop
or offer services that provide significant performance, price, creative or other
advantages over those offered by us, which could have a material adverse effect
on our business, financial condition, results of operations and prospects.
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 of the DGBU 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.
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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 ink jet 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 600 dpi and 300 dpi inkjet
cartridges for use in our wide-format, roll-fed color inkjet printers. HP and
Encad have also introduced inkjet printers with a capability of producing output
resolution of 600 dpi. HP and other inkjet cartridge manufacturers are
continuing to develop new cartridges to enhance resolution or performance
features. If new cartridge technology developed by HP or other companies
provides a competitive advantage, we will need to secure an adequate source at
reasonable prices or develop a reasonably priced substitute. If we were unable
to secure a reasonable source or develop a substitute, sales of printer engines
and the related gross margins could be negatively impacted.
Our DGBU 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.
The ISBU has a web hosting data center which is a source of revenue. If
technological changes render the services or hardware used obsolete, or
negatively impact the prices that may be charged, our revenues could be
adversely affected.
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 we do, which may result in a competitive
advantage. Suppliers of wide-format print engines and systems compete on the
basis of print quality, cost, 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. Our thermal inkjet printers compete with piezo head printers which
offer greater media flexibility and increased outdoor durability for unlaminated
prints. Currently Encad and Hewlett-Packard are shipping new versions of their
printer lines with 600 dpi cartridges. Epson has released a new wide-format
printer and expects to ship in volumes in mid-1999. These products compete for
market share with our current DisplayMaker Series XII printers and anticipated
new product offerings. It is possible that our sales of certain products will
compete with, or displace sales of, other products we sell.
Our DisplayMaker Series XII DisplayMaker, HiRes 8-Color Series and
Giclee PrintMakerFA(TM) 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.
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Our DisplayMaker Series XII DisplayMaker, HiRes Series 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 such as greater color gamut and better
built-in productivity features, the 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 greater product distributions, brand
awareness, or 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 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 print head 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 our 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.
Although we have not experienced material delays in delivery schedules due to
our inability to pay suppliers, the 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
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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 our 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.
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 us or our 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 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 our financial
operations and results.
Dependence on Consumables Revenues. We anticipate we will derive an
increasing percentage of our DGBU revenues and operating income from the sale of
ink, paper, film and other consumables to our customers. During the third
quarter of fiscal 1999, consumables revenue was 61% 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, our 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 our trade secrets to commence such
competition. Although we have been 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
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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(R) Delivery System, product patents, and consumable
formulations. Additional patent applications are pending. There can be no
assurance that patents will be issued from any 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
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methods and processes, mechanical printer features, media and inks. Many of
these patents are held by companies which are larger and have greater resources
to pursue violation of intellectual property. Although our 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.
Recently certain companies have sought and received patents for their
internet business model. As additional companies seek protection for business
models the Company's ISBU may be foreclosed from business opportunities
currently available or under consideration which could have an adverse effect on
revenues for the ISBU.
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 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 are engaged in various actions
related to transactional matters, employee matters, customers' credit and
product quality and/or warranty issues. In an action recently settled, it was
alleged that we were liable for copyright misuse and unfair competition. 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 a similar claim in other actions or 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 the Digital Graphics
Business Unit. In the third quarter of fiscal 1999, international operations
composed 35.5% of total sales, compared to 39.8% for the same three month period
one year ago. Worsening economic conditions and exchange rate problems in the
Japan, Asia/Pacific, Latin America and Europe regions contributed to this
decrease. 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
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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. Significant fluctuation in the relatively stable Dutch
guilder could have an adverse impact on the Company. Substantially all of our
other transactions are in U.S. dollars. There can be no assurance that we will
be successful in limiting our foreign currency exposure in the future.
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 Supplies-By-Air. Currently, our sales of products over
the Internet are less than 5% of the total revenues. Internet based software and
service activities represent an extension of many of our printing and publishing
tools which are integral to our core technology.
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.
Risks Related to Future Acquisitions or Partners. A key component of
our continued growth strategy is expected to be the acquisition or partnering of
professional service firms that meet our goals for strategic growth and
expansion. The successful implementation of this acquisition strategy will
depend on our ability to identify suitable acquisition candidates, acquire such
companies on acceptable terms and integrate their operations successfully with
those of ours. There can be no assurance that we will be able to continue to
identify additional 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 than us. Competition for these acquisition targets
may 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 management attention, potential disputes with
the sellers of one or more acquired entities and the possible failure to retain
key acquired personnel. Lack of client satisfaction
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or performance problems with an acquired firm could also have a material adverse
impact on our reputation as a whole, and any acquired company could
significantly underperform relative to our expectations. For all of these
reasons, our pursuit of an overall acquisition strategy or any individual
pending or future acquisition may have a material adverse effect on our
business, financial condition, results of operations and prospects. To the
extent we choose to use cash consideration for acquisitions in the future, we
may be required to obtain additional financing, and 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.
Integration of Acquired Businesses. During December 1998 we completed
the acquisition of K & R Technologies, Inc. Our future performance will depend
on our ability to integrate this and other acquired businesses, which, even if
successful, may take a significant period of time, may place a significant
strain on our management and resources, and could subject us to additional
expenses during the integration process and to the risks commonly encountered in
acquisitions of businesses. Such risks include, among other things, the
difficulty of assimilating the operations and personnel of the acquired
businesses, the potential disruption of our ongoing business, the inability of
management to maximize our financial and strategic position through the
successful incorporation of acquired personnel and clients, the maintenance of
uniform standards, controls, procedures and policies and the impairment of
relationships with employees and clients as a result of any integration of new
management personnel. There can be no assurance that the services, technologies,
key personnel and businesses of the acquired business(es) will be effectively
integrated into our business or service offerings, or that such integration will
not adversely affect our business, financial condition, results of operations or
prospects. There can also be no assurance that any acquired services,
technologies or businesses will contribute at anticipated levels to our sales or
earnings, or that the sales and earnings from combined business(es) will not be
adversely affected by the integration process. Because the acquisition was
completed in December 1998, we are currently facing all of these challenges and
our ability to meet them over the long term has not been established. The
failure to integrate such acquisitions successfully could have a material
adverse effect on our business, financial condition, results of operations and
prospects.
Recruitment and Retention of Consulting Professionals. Our business of
delivering Internet and information technology professional services is labor
intensive. Accordingly, our success depends in large part on our ability to
identify, hire, train and retain consulting professionals who can provide the
Internet strategy, technology, marketing, audience development and creative
skills required by clients. There is currently a shortage of such personnel, and
this shortage is likely to continue for the foreseeable future. We will
encounter intense competition for qualified personnel from other companies, and
there can be no assurance that we will be able to identify, hire, train and or
retain other highly qualified technical, marketing and managerial personnel in
the future. The inability to attract and retain the necessary technical,
marketing and managerial personnel would have a material adverse effect on our
business, financial condition, results of operations and prospects.
Dependence on Key Personnel. Our success depends to a significant
extent upon certain key personnel, including Mr. Masters, Chief Executive
Officer and President, and key research and development staff. 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 Mr. Masters. 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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Risks Associated with Failure to Manage Growth. The anticipated growth
of the ISBU and any future growth by acquisition would place a significant
strain on our limited personnel, management and other resources. In the future,
we will be required to attract, train, motivate and manage new employees
successfully, to effectively integrate new employees into our operations and to
continue to improve our operational, financial, management and information
systems and controls. There can be no assurance that our systems, procedures or
controls will be adequate to support our operations or that our management will
be able to achieve the rapid execution necessary to exploit the market for our
business model. The failure to effectively manage any further growth could have
a material adverse effect on our business, financial condition, results of
operations and prospects.
Developing Internet Economy, Market for E-Commerce Solutions. A
material portion of our revenues is expected to be derived from services that
depend upon the adoption of Internet solutions by companies to improve their
business positioning and processes, and the continued development of the World
Wide Web, the Internet and E-Commerce. The Internet may not prove to be a viable
commercial marketplace because of inadequate development of the necessary
infrastructure, lack of development of complementary products, implementation of
competing technology, delays in the development or adoption of new standards and
protocols required to handle increased levels of Internet activity, governmental
regulation, or other reasons. The Internet has experienced, and is expected to
continue to experience, significant growth in the number of users and volume of
traffic. There can be no assurance that the Internet infrastructure will
continue to be able to support the demands placed on it by this continued
growth. Our business model anticipates revenue and growth from Internet hosting
services. Technological changes in the delivery of Internet service could
adversely affect our ability to achieve operational and financial objectives.
Moreover, critical issues concerning the use of Internet and E-Commerce
solutions (including security, reliability, cost, ease of deployment and
administration and quality of service) remain unresolved and may affect the
growth of the use of such technologies to maintain, manage and operate a
business, expand product marketing, improve corporate communications and
increase business efficiencies. The adoption of Internet solutions for these
purposes, particularly by those individuals and enterprises that have
historically relied on traditional means, can be capital intensive and generally
requires the acceptance of a new way of conducting business and exchanging
information. If critical issues concerning the ability of Internet solutions to
improve business positioning and processes are not resolved or if the necessary
infrastructure is not developed, our business, financial condition, results of
operations and prospects will be materially adversely affected.
Even if these issues are resolved, there can be no assurance that
businesses will elect to outsource the design, development, hosting and
maintenance of their Web sites to Internet professional services firms.
Companies may decide to assign the design, development, and implementation of
Internet solutions and hosting of the site to their internal information
technology divisions, which have ready access to both key client decision makers
and the information required to prepare proposals for such solutions. If
independent providers of Internet professional services prove to be unreliable,
ineffective or too expensive, or if software companies develop tools that are
sufficiently user-friendly and cost-effective, enterprises may choose to design,
develop or maintain all or part of their Intranets, Extranets or web sites
in-house. If the market for such services does not continue to develop or
develops more slowly than expected, or if our services do not achieve market
acceptance, our business, results of operations, financial condition and
prospects will be materially adversely affected.
Government Regulation and Legal Uncertainties. The Securities and
Exchange Commission (SEC), Nasdaq and the Financial Accounting Standards Board
(FASB) all have recently issued or are currently considering regulations or
requirements that can or will impact our financial results and/or potentially
our stock price in the future. Certain accounting treatments commonly used by
Technology companies have been limited
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or changed recently. The use of the Pooling of Interest method of accounting for
certain mergers has come under direct scrutiny by the SEC and the related
accounting boards. Future use of this treatment will be significantly limited if
the proposals under review at this time are adopted.
With the use of the Pooling treatment significantly limited, most
companies will be forced to use the Purchase method of accounting when
accounting for future and current acquisitions. One of the accounting principles
associated with this area utilized by many technology related acquisitions,
including our acquisition of TEAM Technologies, has been the practice of taking
a current charge to operations for certain "In Process Research and Development
Expenses" at the time of acquisition. The SEC has been issuing new guidelines
and examining many of these charges as a result. Many companies have been
required to restate acquisition-related charges as a result of these activities
by the SEC. The restatement of acquisition related costs could result in a
material change in our previously reported results which could have an adverse
impact on our stock price.
The SEC is currently examining some regulations regarding Audit
Committees and Director Compensation that would be proposed to the various Stock
exchanges for assistance in implementation in the market. In addition, Nasdaq
has recently changed some of its own listing requirements in an effort to
upgrade the quality of the companies that it lists on its exchange. While we
have never violated any listing requirements, we have in the past had a level of
tangible net worth resulting from our operating losses that approached the
minimum level required by Nasdaq. In addition, several of the other requirements
can be difficult to meet for a stock which is thinly traded and has smaller
capitalization levels. If Nasdaq on its own or at the suggestion of the SEC
changes or raises the minimum listing requirements or our operations cause us to
fall below the existing requirements and we may not meet the new or changed
requirements and the impact on our stock price and the liquidity of our
shareholders could be negatively affected.
Our ISBU is not currently subject to direct government regulation,
other than pursuant to certain franchising regulations, the securities laws and
the regulations thereunder applicable to all publicly owned companies, and laws
and regulations applicable to businesses generally, and there are currently few
laws or regulations directly applicable to access to or commerce on the
Internet. However, due to the increasing popularity and use of the Internet, it
is likely that a number of laws and regulations may be adopted at the local,
state, national or international levels with respect to the Internet covering
issues such as user privacy, freedom of expression, pricing of products and
services, taxation, advertising, intellectual property rights, information
security or the convergence of traditional communications services with Internet
communications. For example, the Telecommunications Act of 1996 (the
"Telecommunications Act") imposes criminal penalties on anyone who distributes
obscene or indecent communications over the Internet. Although the
anti-indecency provisions of the Telecommunications Act have been declared
unconstitutional by the federal courts, the increased attention focused upon
these liability issues as a result of the Telecommunications Act could adversely
affect the growth of the Internet and therefore demand for our services. In
addition, because of the growth in the electronic commerce market, Congress has
held hearings on whether to regulate providers of services and transactions in
the electronic commerce market, which regulations could negatively affect client
demand for Internet solutions that facilitate electronic commerce. Moreover, the
adoption of any such laws or regulations may decrease the growth of the
Internet, which could in turn decrease the demand for our services or increase
the cost of doing business or in some other manner have a material adverse
effect on our business, financial condition, results of operations or prospects.
In addition, the applicability to the Internet of existing laws governing issues
such as property ownership, copyrights and other intellectual property issues,
taxation, libel and personal privacy is uncertain. The vast majority of such
laws were adopted prior to the advent of the Internet and related technologies
and, as a result, do not contemplate or address the unique issues of the
Internet and related technologies. Changes to such laws intended to address
these issues, including some
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recently proposed changes, could create uncertainty in the marketplace which
could reduce demand for our services or increase the cost of doing business as a
result of costs of litigation or increased service delivery costs, or could in
some other manner have a material adverse effect on our business, financial
condition, results of operations and prospects.
Dependence on Key Accounts. The ISBU current revenues are based mainly
on staff augmentation and service agreements with customers of the operations
acquired in December 1998. A significant portion of the revenue for that
operation has historically come from engagements with John Deere operations. To
the extent that any or all of the John Deere contracts are terminated there
could be a direct and immediate material adverse effect on our business,
financial condition, results of operations and prospects. Additionally, once a
project is completed there can be no assurance that a client will engage the
ISBU for further services. In addition, the ISBU's clients may unilaterally
reduce their use of the ISBU's services or terminate existing projects. The
termination of the ISBU's business relationship with any of its significant
clients or a material reduction in the use of ISBU's services by a significant
client may have a material adverse effect on our business, financial condition
and operating results.
Client Uncertainty; Conflicts. Uncertainty regarding the acquisition
may affect the ability of the ISBU to maintain existing relationships or attract
new clients. In addition, some clients desire that their vendors avoid providing
similar services to the competitors of such clients. The ISBU is actively
engaging non-exclusive channel partners to facilitate the licensing and service
opportunities for the e-commerce software and cross selling of services.
Contracts with channel partners or certain customers may generate client
conflicts and potentially cause the loss of current clients or an inability to
perform services for certain competing businesses. The loss of significant
clients or an inability to provide services to a significant group of potential
clients could have a material adverse effect on our business, financial
condition, results of operations and prospects.
Risks of Fixed-Price Engagements. The ISBU generates a portion of its
revenues through project fees in a fixed fee for service basis and based on
current trends, it may need to increase the percentage of its engagements that
are billed on a fixed-price basis to remain competitive, and as a result,
increase the percentage of revenues derived from fixed-price engagements. The
ISBU will assume greater financial risk from fixed-price type contracts than on
either time-and-material or cost-reimbursable contracts. The failure to estimate
accurately the resources and time required for an engagement, to manage client
expectations effectively regarding the scope of services to be delivered for the
estimated fees or to complete fixed-price engagements within budget, on time and
to clients' satisfaction would expose us to risks associated with cost overruns
and, in certain cases, penalties, any of which could have a material adverse
effect on our business, results of operations and financial condition.
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
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 and termination devices 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
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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.
Currently, we estimate any additional costs for this issue will not exceed
$25,000. We currently expect to have the project completed by the end of
September 1999.
Our Products. We design and sell products that are heavily reliant on
operating software developed by other companies. 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 are currently contacting essential third parties to ascertain their
readiness and the impact they would have on our contingency planning. 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.
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 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. We have been contacted by
one state recently regarding possible sales and use tax nexus as a result of the
use of third parties to service products sold by us. An audit of our records is
underway.
Deferred Tax Assets. We have recorded Deferred tax assets and the
related valuation allowances in accordance with the existing accounting
standards. The valuation of these assets is dependent on our ability to generate
taxable income with which to utilize these assets. There can be no assurance
with our operating
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history that sufficient taxable income can be generated to utilize these assets.
If the utilization of these assets comes into question, additional valuation
allowances will need to be recorded. The recording of additional valuation
allowances could have a material adverse affect on our financial results.
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 our 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.
Our Board has adopted a shareholder rights agreement. 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
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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.
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 its
distribution channels, we entered into select OEM and private label arrangements
that allow it 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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