<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 January 3, 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 X 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 1/29/99
- ----- ----------------------
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
ASSETS
<TABLE>
<CAPTION>
January 3, June 30,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 528,213 $ 5,011,181
Accounts receivable, less allowance for
doubtful accounts and sales returns of
$1,283,000 and $1,662,000, respectively 8,515,654 11,311,178
Receivable - related parties 1,071,822 337,460
Inventory 6,630,832 6,819,968
Other current assets 1,880,428 1,918,258
Deferred income taxes 1,214,000 1,214,000
------------ ------------
TOTAL CURRENT ASSETS 19,840,949 26,612,045
PROPERTY AND EQUIPMENT, NET 4,023,784 2,776,339
GOODWILL, less accumulated amortization of $149,511 8,821,158
DEFERRED INCOME TAXES 3,552,000 3,552,000
OTHER ASSETS 299,250 179,286
------------ ------------
$ 36,537,141 $ 33,119,670
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable $ 2,265,542 $ 2,015,988
Notes payable - related parties 3,678,227
Current maturities of long-term debt 630,470 259,550
Convertible subordinated debenture 375,866
Accounts payable 8,455,595 10,524,613
Accrued payroll and payroll taxes 1,703,930 1,475,317
Other current liabilities 1,892,196 1,412,021
Deferred revenue 1,665,372 1,222,265
------------ ------------
TOTAL CURRENT LIABILITIES 20,291,332 17,285,620
LONG-TERM DEBT, less current maturities 741,900 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 shares issued and outstanding 15,000
Additional paid in capital 40,500,420 32,995,320
Accumulated deficit (25,169,300) (17,379,805)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 15,503,909 15,767,304
------------ ------------
$ 36,537,141 $ 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 Six Months Ended
---------------------------- ---------------------------
January 3, December 28, January 3, December 28,
1999 1997 1999 1997
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
SALES
Products $ 17,625,245 $21,647,009 $32,980,539 $36,952,608
Services 423,554 423,554
------------ ----------- ----------- -----------
NET SALES 18,048,799 21,647,009 33,404,093 36,952,608
COST OF SALES 11,276,267 13,075,682 19,694,466 22,797,511
------------ ----------- ----------- -----------
GROSS PROFIT 6,772,532 8,571,327 13,709,627 14,155,097
OPERATING EXPENSES:
Sales & Marketing 4,038,142 3,672,171 7,751,456 6,435,487
General & Administrative 2,740,609 2,337,617 5,019,575 4,965,581
Research & Development 2,222,118 1,437,992 4,174,686 2,990,850
Acquired In-Process Technology 2,500,000 2,500,000
Goodwill Amortization 149,511 149,511
Restructuring and Other Special Charges (Reversal) (600,000)
------------ ----------- ----------- -----------
11,650,380 7,447,780 18,995,228 14,391,918
------------ ----------- ----------- -----------
OPERATING (LOSS) PROFIT (4,877,848) 1,123,547 (5,285,601) (236,821)
OTHER INCOME (EXPENSE):
Interest Expense (237,975) (209,645) (395,040) (471,390)
Interest Income 24,819 21,682 59,007 28,286
Other Income (Expense) 21,441 (37,977) (116,601) (68,309)
------------ ----------- ----------- -----------
(191,715) (225,940) (452,634) (511,413)
------------ ----------- ----------- -----------
(LOSS) EARNINGS BEFORE INCOME TAXES (5,069,563) 897,607 (5,738,235) (748,234)
INCOME TAX
------------ ----------- ----------- -----------
NET (LOSS) EARNINGS $(5,069,563) $ 897,607 $(5,738,235) $ (748,234)
=========== =========== =========== ===========
NET (LOSS) EARNINGS PER COMMON SHARE $ (.32) $ .06 $ (.36) $ (.05)
NET (LOSS) EARNINGS PER COMMON
SHARE - ASSUMING DILUTION $ (.32) $ .06 $ (.36) $ (.05)
Weighted average common shares outstanding 15,778,866 14,575,814 15,730,738 14,524,193
Weighted average common and dilutive
potential common shares outstanding 15,778,866 15,423,107 15,730,738 14,524,193
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
VIRTUALFUND.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended
---------------------------
January 3, December 28,
1999 1997
----------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(5,738,235) $ (748,234)
Adjustments to reconcile net loss to net
cash (used in) provided by operating activities:
Depreciation and amortization 875,824 981,592
Amortization of goodwill 149,511
Amortization of deferred financing costs 111,351 105,011
Acquired in-process research and development 2,500,000
(Gain) loss on sale of property and equipment (4,417) 78,536
Change in current assets and current liabilities:
Accounts receivable 3,946,224 322,754
Inventory 599,758 430,597
Other current assets 13,464 184,237
Accounts payable (2,575,219) 1,866,507
Accrued payroll and payroll taxes (28,103) (260,605)
Other current liabilities (574,619) (126,171)
Deferred revenue 221,013 (108,995)
----------- -----------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (503,448) 2,725,229
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans to related parties (869,946)
Collection of loans from related parties 351,181
Additions to property and equipment (566,258) (211,912)
Proceeds from sale of property and equipment 15,164 9,396
Additions to patents and other assets (7,847) (16,013)
Cash acquired from K&R Technologies, Inc. 53,806
----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (1,023,900) (218,529)
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 72,188
Net payments under revolving credit lines (337,741) (1,811,031)
Payments on long-term debt (443,425) (424,229)
----------- -----------
NET CASH USED IN FINANCING ACTIVITIES (2,955,620) (2,163,072)
----------- -----------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (4,482,968) 343,628
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,011,181 484,106
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 528,213 $ 827,734
=========== ===========
</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 quarter ended
January 3, 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 Six Months Ended
------------------------------ ------------------------------
January 3, December 28, January 3, December 28,
1999 1997 1999 1997
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Average common shares outstanding 15,778,866 14,575,814 15,730,738 14,524,193
Assumed conversion of stock options 705,960
Assumed issuance of common stock
related to settlement of litigation 141,333
---------- ------------ ---------- ------------
Average common and assumed
conversion shares 15,778,866 15,423,107 15,730,738 14,524,193
========== ========== ========== ==========
</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 Six Months Ended
------------------------------ ------------------------------
January 3, December 28, January 3, December 28,
1999 1997 1999 1997
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Stock options 3,785,539 504,100 3,785,539 3,538,610
Warrants 3,034,953 3,049,953 3,034,953 3,049,953
Shares issuable relating to
settlement of litigation 141,333
Convertible preferred stock 1,499,998 1,499,998
Convertible Debenture 409,031 409,031
--------- ---------- --------- ----------
Average common and assumed
conversion shares 8,320,490 3,963,084 8,320,490 7,138,927
========= ========= ========= =========
</TABLE>
5
<PAGE>
3. Inventory -
Inventory consists of the following:
January 3, June 30,
1999 1998
---------- ----------
Raw materials $3,368,213 $3,285,194
Work in process 235,543 207,303
Finished goods:
Consumables 1,911,217 2,604,318
Hardware 1,115,859 723,153
---------- ----------
$6,630,832 $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. Preliminarily
and subject to change, 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
six months ended January 3, 1999 and December 28, 1997 assume the
acquisition occurred as of the beginning of the periods presented:
January 3, December 28,
1999 1997
----------- ------------
Net sales $36,417,000 $40,029,000
Net (loss) earnings (4,448,000) (2,200,000)
(Loss) earnings per common
share - basic (.28) (.15)
(Loss) earnings per common
share - assuming dilution (.28) (.15)
6
<PAGE>
5. Supplemental disclosure of cash flow information and
non-cash financing activities -
<TABLE>
<CAPTION>
Six Months Ended
-------------------------
January 3, December 28,
1999 1997
---------- ------------
<S> <C> <C>
The Company paid and received cash for the following items:
Interest paid $ 304,487 $ 343,531
Financing transactions not affecting cash:
Decrease 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.
acquisition 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 804,687
</TABLE>
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 in the computer printing industry and intense
competition in that industry, the Company's dependence on sales of newer
products with untested market acceptance, dependence on numerous product
components that are available from single sources, fluctuations in quarterly
operating performance, the strength of the Company's intellectual property
protection, risks associated with the acquisition and integration of new
businesses, risks related to the diversification into new internet software and
information technology business, the costs of pending litigation, and the size
of the Company's international operations. These and other factors, which are
set forth in Exhibit 99 to this Form 10-Q, have caused wide fluctuations in the
market price of the Company's common stock and can be expected to cause similar
fluctuations in the future. Refer to Exhibit 99 of this Form 10-Q for certain
important cautionary factors, risks and uncertainties related to forward-looking
statements.
On 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 income from December 1, 1998, the
effective date of acquisition.
Results of Operations
Net sales for the quarter ended January 3, 1999 were $18.0 million compared to
$21.6 million for the same period one year ago. Net loss, excluding acquisition
related charges, for the quarter ended January 3, 1999 was $2.4 million or $.15
per share compared to net income of $898,000 or $.06 per share for the quarter
ended December 28, 1997. Net sales for the six months ended January 3, 1999 were
$33.4 million compared to $37.0 million for the same period one year ago. Net
loss, excluding acquisition related charges, for the six months ended January 3,
1999 was $3.1 million or $.20 per share compare to a net loss of $748,000 or
$.05 per share for the six months ended December 28, 1997. Acquisition related
charges for the three and six month periods ending January 3, 1999 include
non-cash charges of $2.5 million for acquired in-process technology and $150,000
in amortization of goodwill. These charges account for losses of $.17 per share
for the three and six month periods ending January 3, 1999, respectively. Net
loss including these acquisition related charges for the three and six month
periods ending January 3, 1999 was $5.1 million or $.32 per share and $5.7
million or $.36 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 Six Months Ended
------------------------- -------------------------
January 3, December 28, January 3, December 28,
1999 1997 1999 1997
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 62.5 60.4 59.0 61.7
----- ----- ----- -----
Gross Profit 37.5 39.6 41.0 38.3
Operating Expenses:
Sales and Marketing 22.4 17.0 23.2 17.4
General and Administrative 15.2 10.8 15.0 13.4
Research and Development 12.3 6.6 12.5 8.1
Acquired In-Process Technology 13.8 -- 7.5 --
Goodwill Amortization 0.8 -- 0.4 --
Restructuring and Other Special Charges(Reversal) -- -- (1.8) --
----- ----- ----- -----
Total Operating Expenses 64.5 34.4 56.8 38.9
----- ----- ----- -----
Operating (Loss) Profit (27.0) 5.2 (15.8) (0.6)
----- ----- ----- -----
Other Income (Expense):
Interest expense (1.3) (1.0) (1.2) (1.3)
Interest income 0.1 0.1 0.1 0.1
Other 0.1 (0.2) (0.3) (0.2)
----- ----- ----- -----
(Loss) Profit Before Income Taxes (28.1) 4.1 (17.2) (2.0)
Income Tax -- -- -- --
----- ----- ----- -----
Net (Loss) Profit (28.1)% 4.1% (17.2)% (2.0)%
===== ===== ===== =====
</TABLE>
Net Sales. During the quarter ended January 3, 1999 our Digital Graphics
Business Unit (DGBU) recorded hardware sales of $7.1 million or 40% of DGBU net
sales compared to $9.5 million or 44% of DGBU net sales in the same period one
year ago. The $2.4 million decrease in hardware revenues in the January 3, 1999
quarter compared to the prior year consists of an $840,000 decrease in sales of
our black-and-white typesetting products, a $900,000 decrease in sales of our
older discontinued wide-format color products, and a $660,000 decrease in sales
due to an overall lower average selling price per unit of our DisplayMaker HiRes
8-Color (DMX) series printers despite an increase in unit sales over the
previous year. The decrease in sales of our older discontinued wide-format color
products is primarily attributable to the introduction of new DMX printers that
incorporate embedded controllers with a print server function and licensing of
other company's print servers reducing demand for the Company's own print
servers. We anticipate an increase in hardware revenues in the quarter ending
March 31, 1999 as we launch a new product line in the spring of 1999.
During the quarter ended January 3, 1999 the DGBU recorded consumables sales,
consisting primarily of ink, media, film, maintenance contracts and spare parts,
of $10.5 million or 60% of DGBU net sales compared to $12.1 million or 56% of
DGBU net sales in the same period one year ago. The $1.6 million decrease in
consumables sales for the quarter ended January 3, 1999 from the prior year is
primarily due to a $900,000 decrease in consumables sales for our
black-and-white, typesetting products and a $700,000 decrease in the sale of ink
and media for older model discontinued color hardware products that have been in
the field for several years.
During the quarter ended January 3, 1999 the Internet/Software Business Unit
(ISBU) recorded revenues of $487,000 which represents revenue from December 1,
1998 related to the operations of TEAM. We expect growth in the ISBU to come
from sales of our recently released E-Com Tools Internet-based, electronic
commerce software products. These products are currently being marketed to
several potential resellers called Agency Affiliates. In addition, TEAM's core
information technology consulting business has been growing in the past years
and is expected to increase up to 25% in the next year. We also plan to pursue
additional acquisitions to continue the ISBU growth.
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 Six months ended
----------------------------------------- -------------------------------------------
January 3, 1999 December 28, 1997 January 3, 1999 December 28, 1997
----------------- ------------------- ------------------- --------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Europe $ 3,845 21.3% $4,537 21.0% $ 7,139 21.4% $ 7,730 20.9%
Japan, Asia/Pacific 1,699 9.4 3,247 15.0 2,898 8.7 4,784 12.9
Latin America 921 5.1 1,087 5.0 1,586 4.7 2,256 6.1
Canada 542 3.0 763 3.5 945 2.8 1,313 3.6
------- ---- ------ ---- ------- ---- ------- ----
Total international sales $ 7,007 38.8% $9,634 44.5% $12,568 37.6% $16,083 43.5%
======= ==== ====== ==== ======= ==== ======= ====
</TABLE>
The decrease in sales in Japan, Asia/Pacific compared to the prior year is
primarily related to the economic turmoil in that region and the higher relative
prices due to lower local currency values relative to the U.S. dollar. We expect
sales in these regions to remain below historical levels for the remainder of
fiscal 1999. 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, expressed as a percent of net sales, was 37.5% in
the quarter ended January 3, 1999 compared to 39.6% in the same period one year
ago. The decrease in gross profit from the prior year is primarily due to a
similar amount of fixed manufacturing overhead being spread over lower revenue.
Operating Expenses. Sales and Marketing expenses for the quarter ended January
3, 1999 were $4.0 million compared to $3.7 million in the same period one year
ago. The increase in Sales and Marketing expenses in the quarter ended January
3, 1999 is primarily related to increased marketing expenses in the DGBU along
with increased selling and marketing expenses in the ISBU of $153,000.
Research and Development expenses were $2.2 million in the quarter ended January
3, 1999, compared to $1.4 million in the same period one year ago. The increase
in research and development expenses over the prior year includes approximately
$250,000 related to product development for the ISBU and $218,000 in expenses
related to our new Advanced Research Technology Center in San Jose, California.
General and Administrative expenses were $2.7 million for the quarter ended
January 3, 1999 compared to $2.3 million in the same period one year ago. The
increase in general and administrative expenses in the quarter ended January 3,
1999 compared to the previous year is primarily the result of increased expenses
incurred for the implementation of the ISBU strategy of approximately $284,000.
Other. Interest expense was $238,000 for the quarter ended January 3, 1999
compared to $210,000 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 used in operating activities during the six months ended January 3,
1999 was $503,000 compared to net cash provided by operating activities of $2.7
million in the same period one year ago. Cash flows were negatively impacted by
a $3.1 million loss from operations, excluding acquisition related charges, in
the six months ended January 3, 1999 compared to a net loss from operations of
$748,000 in the same period one year ago. Cash flows were also negatively
impacted by a $2.6 million decrease in accounts payable in the six months ended
January 3, 1999 compared to an increase in accounts payable of $1.9 million in
the same period one year
10
<PAGE>
ago. Cash was provided by a $3.9 million reduction in accounts receivable in the
six months ended January 3, 1999 as a result of better collection procedures and
lower sales volume compared to the same period one year ago.
Net cash used in investing activities was $1.0 million during the six months
ended January 3, 1999 compared to $219,000 in the same period one year ago. We
advanced $519,000, net of repayments, to related entities in the six months
ended January 3, 1999. Investment in capital equipment was $566,000 in the six
months ended January 3, 1999 compared to $212,000 in the same period one year
ago. The increase in capital expenditures is primarily related to additional
production equipment and the expansion and upgrade of certain internal
information systems.
Net cash used in financing activities was $3.0 during the six months ended
January 3, 1999 compared to $2.2 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 six months ended January 3, 1999. The
Company paid the balance on the convertible subordinated debenture and its
related interest of $376,000 during the six months ended January 3, 1999. Net
repayments under revolving credit lines were $338,000 during the six months
ended January 3, 1999 compared to $1.8 million in the same period one year ago.
ColorSpan's revolving credit facility agreement with General Electric (GE)
expired January 17, 1999. GE has notified us of their intent not to renew the
credit facility as we do not meet the minimum borrowing objectives of their
portfolio. However, GE has agreed to extend the credit agreement through March
31, 1999, and has advanced us $1 million above our borrowing base to facilitate
the acquisition of TEAM. GE will continue to hold its equity interest in the
Company. In addition, the RSPnet.com,Inc. revolving credit facility for TEAM was
due to expire on May 1, 1999. However, the lender has given written notice of
its desire to terminate the credit facility as soon as possible due to merger
related covenant issues associated with our purchase of TEAM. We are actively
pursuing a number of alternate financing sources to replace the financing
provided by both lenders. Although we expect to have a qualified lender or
lenders in place by March 31, 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 the Company's needs, or that sources of financing will be available to the
Company on favorable terms.
We expect revenues to increase in the March 1999 quarter and the remainder of
fiscal 1999 compared to the September and December 1998 quarters. The shipment
of production quantities of a new product line to be released in the spring of
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 $1.4
million which was paid in the March 1999 quarter and $2.2 million required in
the June 1999 quarter related to the TEAM acquisition. We expect to finance
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 profitable operating activities. If sales are less than expected or
reasonably priced sources of alternative financing are not available, we may be
required to delay the acquisition strategy or further restructure the
capitalization of the Company.
Year 2000
We are currently working to resolve the potential impact of the Year 2000 on the
processing of time-sensitive information by computerized information systems.
Year 2000 issues may arise if computer programs have been written using two
digits (rather than four) to define the applicable year. In such cases, programs
that have time-sensitive logic may recognize a date using "00" as the year 1900
rather than the year 2000, which could result in miscalculations or system
failures. We utilize a number of computer programs across the entire operation.
Year 2000 issues could impact our information systems as well as computer
hardware and equipment that is part of our telephone network such as switches,
termination devices and SONET rings that contain embedded software or
"firmware."
11
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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 the end of
our fiscal year in June.
Our Products. We design and sell products that are heavily reliant on software.
While we have taken appropriate steps to ensure the readiness of this software
and believe it to be compliant, we cannot be certain that the software will
operate error free, or that we will not be subject to litigation, whether the
software operates error free or not. However, we believe that based on our
efforts to ensure compliance and the fact that the calculations needed in and by
our products are not date dependent, it is not reasonably likely that we will be
subject to such litigation.
Contingency Plans. We have not yet completed our planning and preparations to
handle the most reasonably likely worst case scenarios described above. We
intend to develop contingency plans for these scenarios during fiscal 1999. We
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(TM) 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.
In March 1998, Sentinel filed for Chapter 11 bankruptcy protection. The
bankruptcy court has permitted the appeal on the initial case to move forward in
the federal courts. Sentinel has challenged the claim of ColorSpan related to
the suit filed in January, 1998. Sentinel has also brought an action against
Kilborn Photo Products, Inc. alleging that it received preferential payments
which are required to be returned for the benefit of creditors, that the current
secured claim of Kilborn should be equitably subordinated and to rescind an
alleged fraudulently procured security right. Kilborn denied all such
allegations. Although ColorSpan and Kilborn believe that the allegations of
Sentinel are without merit and that the claims alleged in the bankruptcy are
valid and enforceable obligations, we cannot assure that Sentinel will not
reduce or eliminate certain claims, or
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succeed in asserting a right to recovery of sums already collected by Kilborn or
damages from ColorSpan. If Sentinel prevails in its claims against ColorSpan or
Kilborn, the outcome could have a material effect on the financial condition of
the Company. Because of the uncertainty surrounding this activity, we have not
recorded any assets or liabilities associated with this action.
The bankruptcy court approved a sale of the assets of Sentinel to Charrette
Corp. in January 1999. The proceeds of such sale and the proceeds of the actions
with ColorSpan and Kilborn will be used to pay claimants in the Sentinel
bankruptcy. We believe the proceeds will pay only a portion of the amount of the
claims of any creditor who does not have a valid and enforceable security
interest. Even if ColorSpan were successful in the appeal on the initial suit
and in the claims asserted in the second suit, only a portion of such damages
are expected to be collected from Sentinel.
The Company is also involved in various legal proceedings related to customer
credit and product warranty and performance issues in the normal course of
business. In certain proceedings the claimants have alleged claims for exemplary
or punitive damages which may or may not bear a direct relationship to the
alleged actual incurred damages, and therefore could have a material adverse
effect on the Company. At this time the Company is not aware of any proceedings
or claims which are expected to have a material effect on the Company's
operations or financial position.
See Exhibit 99, attached, for additional discussion of risks factors related to
legal proceedings.
ITEM 2: CHANGES IN SECURITIES
On December 14, 1998, the Board of Directors adopted a resolution providing for
the authorization of 1,500,000 shares of Series A Convertible Preferred Stock,
with certain powers, preferences, rights, qualifications, limitations and
restrictions. Among other things, holders of the Series A Convertible Preferred
Stock have the same voting rights as the Company's Common stockholders. In
addition, the Series A Convertible Preferred Stock is convertible into Common
Stock 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 complete description of the
Series A Preferred Stock is attached in Exhibit 4.1. By letter agreement, stock
issued under the guarantee of value process cannot exceed 19.9% of the Company's
outstanding common stock.
On December 18, 1998, the Company issued 1,499,998 shares of Series A
Convertible Preferred Stock in exchange for all of the outstanding shares of K&R
Technologies, Inc. d/b/a TEAM Technologies.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Nothing to report.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Nothing to report.
ITEM 5: OTHER INFORMATION
Nothing to report.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Listing of Exhibits
4.1 Certificate of Designation of the Powers, Preferences and
Rights, and Qualifications, Limitations and Restrictions, of
Series A Convertible Preferred Stock of VirtualFund.com, Inc.
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99. Cautionary Factors Under Private Securities Litigation Reform
Act of 1995.
(b) Reports on Form 8-K
Form 8-K dated December 18, 1998 and filed December 31, 1998
reported the acquisition of K&R Technologies, Inc. d/b/a
TEAM Technologies.
14
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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: February 17, 1999
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
VIRTUALFUND.COM, INC.
- -------------------------------------
Melvin L. Masters
Chief Executive Officer
- -------------------------------------
James H. Horstmann
Chief Financial Officer and Principal
Accounting Officer
Dated: February 17, 1999
16
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EXHIBIT 4.1
CERTIFICATE OF DESIGNATION
OF THE
POWERS, PREFERENCES AND RIGHTS,
AND QUALIFICATIONS, LIMITATIONS AND RESTRICTIONS,
OF
SERIES A CONVERTIBLE PREFERRED STOCK
OF
VIRTUALFUND.COM, INC.
VirtualFund.com, Inc., a corporation (the "Corporation") organized and
existing under the Minnesota Business Corporation Act (the "Act"), does hereby
certify that pursuant to the authority conferred upon the Board of Directors of
the Corporation by the Articles of Incorporation of the Corporation, as amended,
and pursuant to the provisions of Section 302A.401 of the Act, the Board of
Directors of Corporation, at a meeting duly held on December 14, 1998, adopted a
resolution providing for the authorization of shares of Series A Convertible
Preferred Stock, which resolution is as follows:
RESOLVED, That, pursuant to Section 3.1 of the Articles of Incorporation of
the Corporation as amended, out of the authorized capital stock of the
Corporation, the Corporation does hereby authorize and create One Million Five
Hundred Thousand (1,500,000) shares of Series A Convertible Preferred Stock, par
value $.01 per share, to be designated "Series A Convertible Preferred Stock,"
and that the powers, preferences and rights of such series, and the
qualifications, limitations and restrictions thereof, be as follows:
1. Dividends and Distributions. If a dividend or distribution is declared
or otherwise is to be made (whether in liquidation or otherwise) on or in
respect of the Common Stock of the Corporation, the holders of shares of the
Series A Convertible Preferred Stock shall be paid dividends or distributions in
an amount equal to the amount that would have been paid on or in respect of the
Common Stock into which the shares of Series A Convertible Preferred Stock are
then convertible as if all such Common Stock had been issued upon conversion and
had been entitled to such dividends or distributions.
2. Liquidation Rights.
(a) In the event of any liquidation, dissolution or winding up of the
business of the Corporation, whether voluntary or involuntary, each holder
of any shares of Series A Convertible Preferred Stock shall be entitled to
receive for each share thereof, out of assets of the Corporation legally
available therefor, before the payment, distribution or setting apart for
payment or distribution of any amount for the holders of Common Stock, a
preferential amount in cash equal to $5.00 per share for each share of
Series A Convertible Preferred Stock, adjusted for stock
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splits, stock dividends and similar recapitalizations, and no more. If the
assets of Corporation to be distributed to holders of shares of preferred
stock of the Corporation are insufficient to pay the full preferential
amount so payable to such holders, all assets to be distributed to such
holders will be distributed among them, pro rata, in proportion to their
respective liquidation preferences.
(b) For purposes of Section 2(a) above, the consolidation or merger of
the Corporation with or into another entity or entities and the sale or
transfer by the Corporation of all or substantially all of its assets
(determined on a consolidated basis) shall be deemed to be a liquidation,
dissolution or winding up of the Corporation, and the holders of shares of
the Series A Convertible Preferred Stock shall be entitled to receive
payment of the amount payable with respect to shares of the Series A
Convertible Preferred Stock upon a liquidation, dissolution or winding up
in cancellation of their shares upon the consummation of any such
transaction; provided that the foregoing provision shall not apply to any
merger or consolidation in which (i) the Corporation is the surviving
entity and (ii) the holders of the Corporation's outstanding capital stock
immediately prior to the merger continue to own the Corporation's
outstanding capital stock possessing the voting power (under ordinary
circumstances) to elect a majority of the Corporation's Board of Directors
immediately after the merger.
3. Voting Rights. Except as otherwise provided by law or as otherwise
provided herein, the holders of shares of Common Stock and the holders of shares
of Series A Convertible Preferred Stock shall vote together as a single class on
all matters as to which the holders of shares of Common Stock may be entitled to
vote, and the holders of shares of Series A Convertible Preferred Stock shall be
entitled to the number of votes equal to the number of shares of Common Stock
into which the shares of Series A Convertible Preferred Stock are convertible at
such time pursuant to Section 4 hereof. The shares of Series A Convertible
Preferred Stock shall not be entitled to vote as a separate class with respect
to any merger, consolidation or exchange offer that may be submitted to a vote
of the shareholders of the Corporation.
4. Conversion. Shares of the Series A Convertible Preferred Stock shall be
convertible into fully paid and non-assessable shares of the Common Stock of the
Corporation as provided in this Section 4. On the date hereof, the ratio of
number of shares of Common Stock into which each share of Series A Convertible
Preferred Stock shall be convertible (the "Conversion Rate") is one (1) share of
Common Stock for each share of Series A Convertible Preferred Stock.
(a) In order to prevent dilution of the conversion rights granted
under this Section 4, the Conversion Rate shall be subject to adjustment
from time to time as provided in this Section 4(a).
(i) If the Corporation at any time subdivides (by any stock
split, stock dividend, recapitalization or otherwise) its outstanding
shares
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<PAGE>
of Common Stock into a greater number of shares, the Conversion Rate
in effect immediately prior to such subdivision shall be
proportionately increased. If the Corporation at any time combines (by
reverse stock split or otherwise) its outstanding shares of Common
Stock into a smaller number of shares, the Conversion Rate in effect
immediately prior to such combination shall be proportionately
decreased.
(ii) Any recapitalization, reorganization, reclassification,
consolidation, merger, sale of all or substantially all of the
Corporation's assets to another person or entity or other transaction
which is effected in such a way that holders of Common Stock are
entitled to receive (either directly or upon subsequent liquidation)
stock, securities or assets with respect to or in exchange for Common
Stock is referred to herein as "Fundamental Change." Upon the
consummation of any Fundamental Change, the Corporation shall make
appropriate provision to insure that all holders of shares of Series A
Convertible Preferred Stock shall thereafter have the right to acquire
and receive in lieu of the shares of Common Stock immediately
theretofore acquirable and receivable upon the exercise of the
conversion right granted hereunder, such shares of stock, securities
or assets as may be issued or payable with respect to or in exchange
for the number of shares of Common Stock immediately theretofore
acquirable and receivable upon exercise of the conversion right
granted hereunder had such Fundamental Change not taken place. The
Corporation shall not effect any such consolidation, merger or sale,
unless prior to the consummation thereof, the successor entity (if
other than the Corporation) resulting from such consolidation or
merger or the entity purchasing such assets assumes by written
instrument, the obligation to deliver to holders of shares of Series A
Convertible Preferred Stock such shares of stock, securities or assets
as, in accordance with the foregoing provisions, such holders may be
entitled to acquire.
(b) Automatic Conversion to Common Stock.
(i) Triggering Event: If the Common Stock has traded on the
Nasdaq system, on any recognized securities exchange or on the over
the counter market (the "Securities Markets") for:
(A) At least five dollars and 00/100 ($5.00) per share,
adjusted for stock splits, stock dividends and similar
recapitalizations, for thirty (30) consecutive calendar days at
any time prior to December 17, 2000 (the "Conversion Date"); or,
(B) At least five dollars and 00/100 ($5.00), adjusted for
stock splits, stock dividends and similar recapitalizations, for
ten (10)
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<PAGE>
calendar days during the sixty (60) calendar days immediately
prior to the Conversion Date,
the shares of Series A Convertible Preferred Stock shall automatically
be converted into shares of Common Stock at the then applicable
Conversion Rate (an "Automatic Conversion"). In addition to the
foregoing, this Automatic Conversion shall only be triggered if the
two (2) year restrictions on transfer set forth in Section 5 below
shall have been waived in writing by the Corporation. In the event of
an Automatic Conversion, the Corporation shall use its reasonable
efforts to promptly file a registration statement with the Securities
Exchange Commission ("SEC") following the Automatic Conversion, if
required to permit the resale by the holders of the shares of Common
Stock issuable upon such Automatic Conversion. If the shares of Common
Stock issuable upon such Automatic Conversion are eligible for resale
without restriction, other than the volume limitations, pursuant to
Rule 144 under the Securities Act of 1933, as amended, or any
successor to such rule ("Rule 144"), then the Corporation shall not be
required to file a registration statement with the SEC pursuant to
this Section 4(b).
(ii) Guarantee of Value Rights: The Common Stock issued as a
result of an Automatic Conversion will be convertible at the holder's
written request, effective upon such date as the holder gives notice
of exercise of the rights set forth in this Section 4(b)(ii) (the
"Date of Notice"), into the right to receive the per share price of
five dollars and 00/100 ($5.00), adjusted for stock splits, stock
dividends and similar recapitalizations, pursuant to the "Guarantee of
Value Process" described in Section 4(e) hereof until the earlier of:
(A) The next date Common Stock has traded on the Securities
Markets for five dollars and 00/100 ($5.00) per share, or more,
adjusted for stock splits, stock dividends and similar
recapitalizations, for at least two-thirds (2/3) of the trading
days during the prior ninety (90) calendar day period; provided
that the stock is eligible for resale without restriction, other
than the volume limitations, pursuant to Rule 144 during said
ninety (90) day period; or,
(B) Six months after the Conversion Date, unless extended by
the Corporation in its sole discretion.
If, on the Date of Notice, the average closing price of the shares of
Common Stock on the Securities Markets (the "Average Stock Price") for
the immediately preceding ten (10) trading days is less than five
dollars and 00/100 ($5.00) per share, adjusted for stock splits, stock
dividends and
4
<PAGE>
similar recapitalizations, the holders shall be entitled to
"Conversion Shares" as described in the Guarantee of Value Process
described in Section 4(e) hereof.
(c) Optional Shareholder Conversion to Common Stock. Upon written
notice to the transfer agent and surrender of the certificate or
certificates representing the shares of Series A Convertible Preferred
Stock to be converted, holders of shares of Series A Convertible
Preferred Stock may convert shares of Series A Convertible Preferred
Stock into shares of Common Stock at the then applicable Conversion
Rate (an "Optional Conversion"). Upon notice of an Optional Conversion
and surrender of the certificate or certificates as set forth above,
the Corporation shall use its reasonable efforts to promptly file a
registration statement with the SEC following the Optional Conversion,
if required to permit the resale by the holders of the shares of
Common Stock issuable upon such Optional Conversion. If the shares of
Common Stock issuable upon such Optional Conversion are eligible for
resale without restriction, other than the volume limitations,
pursuant to Rule 144, then the Corporation shall not be required to
file a registration statement with the SEC pursuant to this Section
4(c).
(d) Mandatory Conversion. If there has not been an Automatic
Conversion or an Optional Conversion prior to the Conversion Date, the
shares of Series A Convertible Preferred Stock shall, in the sole
discretion of the holder, be converted on the Conversion Date into the
right to receive either (i) shares of Common Stock at the then
applicable Conversion Rate or (ii) five dollars and 00/100 ($5.00) in
value per share of Series A Convertible Preferred Stock, adjusted for
stock splits, stock dividends and similar recapitalizations, or some
combination of the two options not to exceed the total number of
shares available to the Holder pursuant to the Guarantee of Value
Process described in Section 4(e) hereof.
(e) Guarantee of Value Process. The Guarantee of Value Process will
liquidate the "Conversion Liability" due to the holders of the shares
of Series A Convertible Preferred Stock under the terms of the Series
A Convertible Preferred Stock set forth in this Certificate of
Designation. The "Conversion Liability" is the dollar amount resulting
from multiplying the number of shares of Series A Convertible
Preferred Stock or shares of Common Stock issued or issuable upon
conversion thereof by the price of $5.00 per share, adjusted for stock
splits, stock dividends and similar recapitalizations, or an aggregate
amount of up to $7,500,000. Each holder of shares of Series A
Convertible Preferred Stock shall be required to give written notice
to the Corporation of such holder's election to have the shares Series
A Convertible Preferred Stock converted into the right to receive
either (i) shares of Common Stock at the then applicable Conversion
Rate or (ii) five dollars and 00/100 ($5.00) in cash per share of
Series A Convertible Preferred Stock, adjusted for stock splits, stock
dividends and similar recapitalizations, pursuant to the Guarantee of
Value Process described in this Section 4(e) within thirty (30) days
after the Conversion Date. The date of such
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<PAGE>
notice is referred to herein as the "Date of Notice" for purposes of
this Section 4(e). If any holder of shares of Series A Convertible
Preferred Stock fails to give the Corporation written notice of such
shareholder's election pursuant to this Section 4(e) within the
specified period of time, such holder will be deemed to have elected
to receive the shares of Common Stock at the then applicable
Conversion Rate upon conversion of the shares of Series A Convertible
Preferred Stock.
(i) Average Stock Price is Less than $5.00: If, on the Date
of Notice, the Average Stock Price for the immediately preceding
ten (10) trading days is less than five dollars and 00/100
($5.00), adjusted for stock splits, stock dividends and similar
recapitalizations, the holder shall be entitled to receive, upon
conversion of the shares of Series A Convertible Preferred Stock,
the shares of Common Stock then issuable at the applicable
Conversion Rate, plus "Conversion Shares." Each Conversion Share
shall entitle the holder to receive one share of Common Stock
adjusted for stock splits, stock dividends and similar
recapitalizations. The Conversion Shares may be immediately
convertible to Common Stock by the holder, and must be reasonably
liquidated in the market within 60 days from the date issued
unless such time is extended by the Corporation. The number of
"Conversion Shares" granted to each holder is calculated as
follows: Five dollars and 00/100 ($5.00), adjusted for stock
splits, stock dividends and similar recapitalizations, less the
Average Stock Price, multiplied by the number of shares of Series
A Convertible Preferred Stock converted; divided by the Average
Stock Price (rounded to the nearest whole number, no fractional
shares issued), shown as an equation as follows:
(($5.00 - Average Stock Price) x number of shares converted)
------------------------------------------------------------
Average Stock Price
(A) Additional Conversion Shares: If the holder
liquidates the stock sought to be converted, and the stock
received from selling the shares acquired from the
Conversion Shares in market value transactions within one
hundred eighty (180) days, or such extensions thereof as may
be granted by the Corporation in its sole discretion, and
does not receive proceeds from the sale which equal or
exceed the Conversion Liability on an aggregate basis for
the shares liquidated, the holder may request additional
Conversion Shares, which will have the same features as the
Conversion Shares provided for above. A request for
additional Conversion Shares may be made only one time, and
must be made by written notice to the Corporation no later
than one hundred eighty (180) days after the Conversion
Date. The Conversion Shares may be immediately convertible
to Common Stock by the holder, and must
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<PAGE>
be reasonably liquidated in the market within 60 days from
the date issued unless such time is extended by the
Corporation. The number of additional Conversion Shares the
holder is entitled to receive is determined by taking the
remaining Conversion Liability and dividing by the Average
Stock Price, shown as an equation as follows:
(($5.00 x number of shares converted) - sales proceeds to date)
---------------------------------------------------------------
Average Stock Price
(B) Cash or Stock Payment: One (1) year after the
Conversion Date, a holder who has elected to receive cash
upon conversion of the shares of Series A Convertible
Preferred Stock and who has received Conversion Shares under
Section 4(e)(i) or 4(e)(i)(A) hereof and who has disposed of
all Common Stock received from the Guarantee of Value
Process to date, but has not received proceeds from the sale
which equal or exceed the Conversion Liability to that
holder, may request payment in cash or stock, of the
difference between the sales proceeds received by such
holder to date and the Conversion Liability to that holder.
The cash payment option shall not be available, if in the
opinion of the Corporation's tax counsel, such payment would
have a reasonable chance to impact the tax-free treatment of
the original merger transaction under Internal Revenue Code
section 368(a). A request for a cash or stock payment must
be made in writing, with evidence of sales of the Common
Stock in commercially reasonable transactions. A request for
a cash payment may be made no earlier than one (1) year
after the Conversion Date, and no later than one (1) year
and thirty (30) days after the Conversion Date. The
Corporation shall have the discretion to either pay the
difference between the Conversion Liability and the sales
proceeds received by such holder to date no later than
twenty (20) days after receipt of such written request or
provide the holder with Conversion Shares, the number of
which is determined by dividing the remaining Conversion
Liability after deducting all sales proceeds to date by the
Average Stock Price for the ten (10) trading days following
the receipt of the written request for a cash or stock
payment stated as an equation as follows:
(($5.00 x number of shares converted) - sales proceeds to date)
---------------------------------------------------------------
Average Stock Price
(ii) Average Stock Price is Greater than $5.00: If, on the
Date of Notice, the Average Stock Price for the immediately
preceding ten (10) trading days is equal to or greater than five
dollars and 00/100 ($5.00),
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<PAGE>
holders will not receive any Conversion Shares at that time. If
holders who do not receive Conversion Shares liquidate the stock
sought to be converted in commercially reasonable transactions within
thirty (30) days of the Conversion Date, unless extended by
Corporation, and the proceeds of such liquidation are less than the
Conversion Liability to that holder, the holder may seek Conversion
Shares in an amount to satisfy the remaining Conversion Liability. A
request for Conversion Shares must be made in writing with evidence of
sales of the Common Stock in commercially reasonable transactions
within the specified time period and may be made no earlier than one
hundred eighty (180) days after the Conversion Date. The Corporation
shall provide the holder with Conversion Shares, the number of which
is determined by dividing the remaining Conversion Liability after
deducting all sales proceeds on an aggregate basis for all shares
liquidated to date by the Average Stock Price for the ten (10) trading
days immediately following the receipt of the written notice stated as
an equation as follows:
(($5.00 x number of shares to be converted) - sales proceeds to date
--------------------------------------------------------------------
Average Stock Price
If holders liquidate the Conversion Shares within thirty (30) days of
the date received, unless extended by the corporation in its sole
discretion, and the aggregate proceeds of such liquidation together
with the aggregate proceeds of the sale of stock received from the
conversion are less than the Conversion Liability to that holder, such
holder may seek a cash or stock payment of the difference between the
sale proceeds of the stock and the Conversion Liability to that
holder. A request for a cash or stock payment must be made in writing
with evidence of the sale of the Common Stock in commercially
reasonable transactions. A request for cash or stock payment may be
made no earlier than one (1) year after the Conversion Date and no
later than one (1) year and thirty (30) days after the Conversion
Date. The Corporation shall have the discretion to either pay the
difference between the Conversion Liability and the aggregate sale
proceeds received by such holder from the liquidation of stock
received to date no less than twenty (20) days after receipt of such
written request or provide the holder with additional Conversion
Shares, the number of which is determined by dividing the remaining
Conversion Liability after deducting the aggregate sales proceeds from
the liquidation of the stock by the Average Stock Price for the ten
(10) trading days following the receipt of the written request for a
cash or stock payment stated as an equation as follows:
($5.00 x number of shares converted) - sale proceeds to date
------------------------------------------------------------
Average Stock Price
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(f) Prohibition on Short Sales. During the period that any shares of
Series A Convertible Preferred Stock remain issued and outstanding and
convertible into shares of Common Stock or other consideration under
the terms of this Section 4, the holders of such shares of Series A
Convertible Preferred Stock are prohibited from engaging in any "short
sale," as such term is defined in Rule 3b-3 under the Securities
Exchange Act of 1934, as amended, with respect to any outstanding
securities of the Corporation. If any holder of shares of Series A
Convertible Preferred Stock engages in any such short sale in
violation of this Section 4(f), the holder shall be subject to
forfeiture of the conversion rights set forth in this Section 4 with
respect to any shares of Series A Convertible Preferred Stock then
held by such holder.
(g) Restrictions on Distributions. The obligations of the Corporation
under this Section 4 are subject to compliance by the Corporation with
the applicable requirements of the Minnesota Business Corporation Act
(the "MBCA"), including without limitation the requirements of
302A.551 of the MBCA with respect to distributions in respect of
shares of capital stock. The compliance by the Corporation with the
requirements of the MBCA may prevent the Corporation from meeting the
obligations of the Corporation under this Section 4 in the time
periods set forth therein.
(h) Reservation of Shares. The Corporation shall at all times reserve
from its authorized Common Stock a sufficient number of shares to
provide for conversion for all shares of Series A Convertible
Preferred Stock from time to time outstanding. As a condition
precedent to the taking of any action which would cause an adjustment
increasing the number of shares into which the outstanding Series A
Convertible Preferred Stock may be converted the Corporation shall
take such corporate action as may be necessary in order that it may
validly and legally issue to the holders of shares of Series A
Convertible Preferred Stock upon conversion fully paid and
non-assessable shares of Common Stock as may be required by this
Section 4. If the Common Stock issuable upon conversion of shares of
Series A Convertible Preferred Stock is listed on any national
securities exchange, the Corporation shall cause all shares reserved
for such conversion to be listed on such exchange, subject to official
notice of issuance upon such conversion.
5. Restrictions on Transfer.
(a) Restrictions. For a period from the date of issuance thereof
through December 17, 2000, the shares of Series A Convertible
Preferred Stock and the shares of Common Stock issuable upon
conversion thereof may not be sold, assigned, transferred, pledged,
encumbered or otherwise disposed of in any manner without the express
prior written consent of a duly authorized officer of
9
<PAGE>
the Corporation. Except with such prior written consent, all voluntary
sales, assignments, transfers, pledges, encumbrances or other
dispositions by any holder of any such shares ("Voluntary Transfers"),
and all involuntary transfers of any such shares by operation of law
to any person (including without limitation to a deceased
shareholder's estate, a shareholder's trustee in bankruptcy, a
purchaser at any creditor's or court sale, or the guardian of an
incompetent shareholder) other than to the Corporation ("Involuntary
Transfers"), shall be void, and shall vest no right, title or interest
in the purported transferee. In the event of any purported prohibited
Voluntary Transfer or Involuntary Transfer, the shares purported to be
transferred shall remain bound by the terms of this Certificate of
Designation.
(b) Legend. All of the shares of Series A Convertible Preferred Stock
and the shares of Common Stock issuable upon conversion thereof shall
be subject to and bound by the terms and conditions of this
Certificate of Designation, and the terms and conditions of this
Certificate of Designation shall attach to, run with, and bind all of
such shares. The certificates issued by the Corporation representing
any of such shares shall bear the following or a substantially similar
legend:
THE SALE, ASSIGNMENT, TRANSFER, PLEDGE, ENCUMBRANCE OR OTHER
DISPOSITION (VOLUNTARY OR INVOLUNTARY) OF THE SHARES REPRESENTED BY
THIS CERTIFICATE IS RESTRICTED UNDER THE TERMS OF A CERTIFICATE OF
DESIGNATION OF THE POWERS, PREFERENCES AND RIGHTS, AND QUALIFICATIONS,
LIMITATIONS AND RESTRICTIONS, OF THE SERIES A CONVERTIBLE PREFERRED
STOCK OF VIRTUALFUND.COM, INC. (THE "CERTIFICATE OF DESIGNATION"), A
COPY OF WHICH IS ON FILE AT THE OFFICE OF THE CORPORATION. THE
CERTIFICATE OF DESIGNATION PROVIDES, AMONG OTHER THINGS, THAT THE
SHARES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO CERTAIN
RESTRICTIONS ON TRANSFER. BY ACCEPTING THE SHARES OF STOCK REPRESENTED
BY THIS CERTIFICATE, THE HOLDER AGREES TO BE BOUND BY THE CERTIFICATE
OF DESIGNATION.
IN WITNESS WHEREOF, I have hereunto set my hand this 18th day of December,
1998.
By: /s/ Melvin L. Masters
----------------------------------
Title: CEO
-------------------------------
10
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INTERNAL
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FINANCIAL STATEMENTS.
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<PERIOD-START> JUL-01-1998
<PERIOD-END> JAN-03-1999
<CASH> 528,213
<SECURITIES> 0
<RECEIVABLES> 9,587,476
<ALLOWANCES> 1,283,000
<INVENTORY> 6,630,832
<CURRENT-ASSETS> 19,840,949
<PP&E> 4,023,784
<DEPRECIATION> 16,967,386
<TOTAL-ASSETS> 36,537,141
<CURRENT-LIABILITIES> 20,291,332
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15,000
<COMMON> 157,789
<OTHER-SE> 15,331,120
<TOTAL-LIABILITY-AND-EQUITY> 36,537,141
<SALES> 18,048,799
<TOTAL-REVENUES> 18,048,799
<CGS> 11,276,267
<TOTAL-COSTS> 11,276,267
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 237,975
<INCOME-PRETAX> (5,069,563)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,069,563)
<DISCONTINUED> 0
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<PAGE>
Exhibit 99
Cautionary Factors Under the
Private Securities Litigation Reform Act of 1995
We desire to take advantage of the "safe harbor" provisions contained in the
Private Securities Litigation Reform Act of 1995 (the "Act"). This Form 10-Q
contains statements which are intended as "forward-looking statements" within
the meaning of the Act. The words or phrases "expects", "will continue", "is
anticipated", "we believe", "estimate", "projects", "hope" or expressions of a
similar nature denote forward-looking statements. Those statements are subject
to certain risks and uncertainties that could cause actual results to differ
materially from historical results or results presently anticipated or
projected. We wish to caution you not to place undue reliance on forward-looking
statements. You are also advised that the factors listed below have affected the
Company's performance in the past and could affect future performance. Those
factors include, but are not limited to, the risk that a product may not ship
when expected or may contain technical difficulties; uncertain demand for new or
existing products; the impact of competitor's advertising, products or pricing;
availability or reliability of component parts, including sole source parts;
manufacturing limitations; availability of sources of financing; economic
developments, both domestically and internationally; new accounting standards;
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 (GE) expired January 17, 1999. GE has notified us of their
intent not to renew the credit facility as we do not meet the minimum borrowing
objectives of their portfolio. However, GE has agreed to extend the credit
agreement through March 31, 1999, and has advanced us $1 million above our
borrowing base to facilitate the acquisition of K & R Technologies, Inc. GE will
continue to hold its equity interest in the Company. In addition, the
RSPnet.com,Inc. revolving credit facility was due to expire on May 1, 1999.
However, the lender has given written notice of its desire to terminate the RSPN
credit facility as soon as possible due to merger related covenant issues
associated with our purchase of the stock of K & R Technologies, Inc. We are
actively pursuing a number of alternate financing sources to replace the
financing provided by both lenders. Although we expect to have a qualified
lender or lenders in place by March 31, 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 the Company's needs, or that sources of financing will be
available to the Company on favorable terms.
Cash Needs. The Company's credit agreement with a commercial finance
company that has financed its cash requirements in the past expired January 17,
1999 but was extended to March 31, 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. The Company raised $11.8
million in these private placements and has not pursued additional outside
financing since that time beyond normal course equipment financing and employee
exercises of stock options. The Company expects to seek additional debt and/or
equity financing in the near future to fund its acquisition strategy. 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 the Company on favorable terms, or at all, if the
Company's operations are further affected by declining revenue from a lack of
sales, significant research and 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 the Company
1
<PAGE>
will achieve or maintain profitability on a quarterly or annual basis in the
future. In addition, the Company 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. The Company's
future liquidity and capital requirements will depend upon numerous factors,
including the success of the Company's existing and new service offerings and
competing technological and market developments. The Company may be required to
raise additional funds through public or private financing, strategic
relationships or other arrangements, particularly as its acquisition strategy
matures. There can be no assurance that such additional funding, if needed, will
be available on terms acceptable to the Company, 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 the Company's
operating flexibility with respect to certain business matters. Strategic
arrangements, if necessary to raise additional funds, may require the Company to
relinquish its rights to certain of its intellectual property or selected
business opportunities. If additional funds are raised through the issuance of
equity securities, the percentage ownership of the stockholders of the Company
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 the Company's Common Stock or newly
issued Preferred Stock. If adequate funds are not available on acceptable terms,
the Company may be unable to develop or enhance its services and products, take
advantage of future opportunities or respond to competitive pressures, any of
which could have a material adverse effect on the Company's business, financial
condition, results of operations and prospects.
Potential Acceleration of Senior Debt. The Company's current Senior Debt
Agreement includes financial covenants, which the Company must meet. Currently,
the Company is in compliance with all of the financial covenants required by its
Senior Lender. For further information, refer to the Company Form 10-K for the
fiscal year ended June 30, 1998, Item 14(a)1 and financial statements, Note #5
of the Notes to Consolidated Financial Statements. Past financial performance of
the Company has made it necessary for the Company to renegotiate the minimum net
worth and minimum debt service coverage covenants to avoid being declared in
violation of the covenants by GE. Any replacement financing is expected to
include certain financial covenants which the Company must meet as a condition
of the financing. If future financial performance causes covenant violations and
the Company is unable to renegotiate its loan covenants at that time, it could
be forced to seek replacement financing at prices which may not be favorable to
the Company. If adequate sources of financing are not available, the Company may
be required to sell certain product lines or technologies on less than favorable
terms. As of January 3, 1999, the outstanding balance on the Company's Senior
Debt Agreement was $606,000.
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
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 the Company's existing service practices and
methodologies obsolete. The Company's success will depend, in part, on its
ability to improve its existing services, develop new services and solutions
that address the increasingly sophisticated and varied needs of its current and
prospective clients, and respond
2
<PAGE>
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 developments could have a material adverse effect on the Company's
business, financial condition, results of operations and prospects. There can be
no assurance that the Company will be successful in responding quickly,
cost-effectively and sufficiently to these developments. If the Company is
unable, for technical, financial or other reasons, to adapt in a timely manner
in response to changing market conditions or client requirements, its 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 and such new product design and
development may delay product introductions, which could affect marketability of
the product, or may be more costly than anticipated.
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 the Company's products could have a material
adverse effect on market acceptance of such new products. Any quality problems
with components could result in "epidemic" or wide-spread failures of the
products in the field causing return and refund requests that would likely have
a material effect on the Company's financial results and future sales potential.
Such problems or perceived problems could potentially arise with respect to any
existing products. 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.
The Company is aware of the intermittent presence of contaminants in
certain inks that caused perceived flaws in output from some of the Company's
printers. The Company has taken steps with its ink supplier to mitigate such
contamination problems and has compensated customers with replacement ink and
media. In addition, early versions of the Company's PressMate and Displaymaker
Express products experienced quality, durability and reliability problems
associated with the use of new technologies that had not received proper
testing. The Company believes it has addressed the problems associated with
PressMate and DisplayMaker Express by replacing certain components found in the
original designs. All of these problems contributed to the net losses incurred
by the Company in fiscal years 1997 and 1996. Two products which the Company
introduced in the past several years experienced what the Company considers
"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.
Although the Company does not believe that it has a quality and reliability
reputation that may unfavorably affect products at this time, if one or more
products experiences product failures, the Company may develop an unfavorable
reputation which could dissuade a purchaser from the Company's 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. The Company's products may not
achieve market acceptance. In addition, the market anticipation or the
announcement of new products and technologies, whether offered by the Company or
its competitors, could cause customers to defer purchases of the Company's
existing products, which could have a material adverse effect on the Company's
business and financial condition.
The Company's Digital Graphics Business Unit introduced a new family of
printers, the DisplayMaker(R) 4000, 5000 and 6000 HiRes 8-Color series, during
September 1997. Two new versions of these printers have been introduced since
February 1998. The DisplayMaker 7000 was introduced in August 1998.
Additionally, in August 1998 the Company introduced the Giclee PrintMakerFA, an
8-Color HiRes drum-based printer. Although the Company has had successes
introducing new products in the past, some earlier products experienced limited
market acceptance and the introductions of some products have been delayed. In
addition, the quality and reliability reputation of certain existing products
may unfavorably affect new products. The Company may not be successful with
future product introductions, future market introductions may not be timely and
competitive, future products may not be priced appropriately, or future products
may not achieve market acceptance. The Company's inability to achieve market
acceptance, for technological or other reasons, could have a material adverse
effect on our financial condition.
The Company's Internet/Software Business Unit (ISBU) recently announced the
first outside customer site using E-Com Tools, the Company's proprietary
e-commerce software. The Company has successfully used a version of the software
for its Supplies-By-Air 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 offering
by competitors will not displace current licenses of the Company's software
product. In addition,
3
<PAGE>
the Company's products may not be accepted by the target market for
technological or other reasons. The Company's 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 other its services or other outside or proprietary
software products.
Potential Liability to Clients. Many of the Company's ISBU service and
consulting engagements involve the development, implementation and maintenance
of applications that are critical to the operations of their clients'
businesses. The Company's failure or inability to meet a client's expectations
in the performance of its services could injure the Company's business
reputation or result in a claim for substantial damages against the Company,
regardless of its responsibility for such failure. In addition, RSPnet.com, Inc.
provides data services that may include confidential or proprietary client
information. Although the Company has 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. The Company has attempted to limit contractually
their 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 the Company from liability for damages. Although the Company maintains
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 the Company that are uninsured, exceed available insurance coverage or
result in changes to the Company's insurance policies, including premium
increases or the imposition of a large deductible or co-insurance requirements,
could adversely affect the Company's business, results of operations and
financial condition.
Dependence on Suppliers. The Company's aqueous inkjet printers require use
of a sole-sourced printhead supplied pursuant to a written contract with
Hewlett-Packard Company. The Company does not anticipate availability or quality
issues which would affect the supply of printheads supplied by Hewlett-Packard
Company (HP). The revenues of the Company associated with sales of this product
or products including those components represent approximately 67% of the
Company fiscal 1998 revenue. If we were unable to resolve a potential future
availability or quality issue, our production and support of our installed base
will be materially adversely affected. The Company is also dependent on sole-
source suppliers for the heads for PressMate-FS(R) and DisplayMaker Express
(DME). Over the time that we have worked with the supplier for the PressMate
printheads, there have been quality and consistency issues with the printheads
supplied. We do not have a written agreement with this supplier and cannot
purchase the supplies from another source. Currently, we do not sell significant
numbers of the PressMate-FS printers which utilize the sole-sourced component.
However, the Company has an installed base of printers who purchase consumables
from the Company and could experience head failure or need a replacement.
Overall, the percentage of the Company's revenues related to the product
utilizing this head was less than 7% of fiscal 1998 revenue. We are also
dependent upon a sole-source supplier for the heads for the DME printer. The
quality and consistency of the printheads delivered by this supplier have also
been a problem in the past and in some cases, has caused printer returns from
the Company's customers. The Company believes it has addressed these problems by
designing and providing test equipment to enhance the manufacturing
repeatability of the critical components of the DME printheads and 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 the
Company to identify and mitigate these problems and to meet its warranty
obligations and keep these printers operational contributed to the net losses
incurred by the Company in fiscal years 1997 and 1996. Although we currently
sell very few new DME printers, there is an installed base of printers who
purchase consumables from the Company and could experience printhead failure or
require replacement. We have a written agreement with the sole-source supplier
of the DME heads. The written agreement includes the manufacturing
specifications and directions which would allow a second supplier to produce the
printheads if the current supplier were unable to cure any defaults under the
manufacturing and supply agreement. If the Company were unable to resolve a
quality or supply issue with the head supplier the effect may be material and
could result in a significant increase in the returns of the DME printer based
on the inability to supply replacement printheads.
4
<PAGE>
Overall, the percentage of the Company's 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 include the trade-in of ColorSpan and other wide-format devices for the
reduction of the purchase price of a comparable HP printer. Programs such as
this can potentially impact us by reducing the number of printers we sell
currently and by reducing the installed base of printers to which we sell
consumables.
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. The Company expects competition to
persist, intensify and increase in the future. The Company's 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 the Company's 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 the Company and could decide at
any time to increase their resource commitments to the Company's 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 the Company's competitors to compete in this market as it
matures. As a strategic response to changes in the competitive environment, the
Company 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 the Company's business, financial condition, results
of operations and prospects. Competition of the type described above could
materially adversely affect the Company's business, results of operations,
financial condition and prospects.
In addition, the Company's ability to maintain its existing client
relationships and generate new clients will depend to a significant degree on
the quality of its services and its reputation among its clients and potential
clients, compared with the quality of services provided by, and the reputations
of, the Company's competitors. To the extent the Company loses clients to its
competitors because of dissatisfaction with the Company's services or its
reputation is adversely affected for any other reason, the Company's business,
financial condition, results of operations and prospects could be materially
adversely affected.
5
<PAGE>
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. The Company is
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 the Company, which could have a
material adverse effect on its 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 will depend in
large part on the continued growth of this market and the continuation of
present Wide-Format printing trends such as use and customization of
large-format advertisements, use of color, transferring of color images onto a
variety of substrates, point-of-purchase printing, in-house graphics design and
production and the demand for limited printing runs of less than 200 copies. If
the Wide-Format market does not achieve anticipated growth levels or there is a
substantial change in Wide-Format printing customer preferences, our business,
financial condition and results of operations could be adversely affected.
Additionally, in a new market, customer preferences can change rapidly and new
technology can quickly render existing technology obsolete. Our failure to
respond effectively to changes in the Wide-Format market, to develop or acquire
new technology or to successfully conform to industry standards could have a
material adverse effect on our business and financial condition and results of
operations.
Technological Advancements. The digital color inkjet printing market is
rapidly moving to two distinct technologies for the placement of ink on a
substrate: thermal inkjet cartridges and piezo-electric printheads. Without a
secure, economical source of one or both of these products we will face serious
competitive pricing and margin pressures going forward. We currently have a
license to remanufacture specific HP 300 dpi inkjet cartridges for use in our
wide-format, roll-fed color inkjet printers. HP has introduced a new inkjet
cartridge with a capability of producing output resolution of 600 dpi. The 600
dpi head is capable of producing output with greater resolution and at higher
speed. We have recently secured the use of this product and expect to be
entering into a supply contract for this product. The Company currently offers
one product which utilizes the 600 dpi head. However, the Company anticipates
that all future aqueous printer products may use this 600 dpi cartridge. We are
also considering several component suppliers in our search for a dependable,
manufacturable piezo-electric printhead. No one source has been identified for
use in a future product as of this time. If the market for wide-format color
demands the increased resolution provided by these new products and we are
unable to secure adequate supplies at reasonable prices or develop a reasonably
priced substitute from other sources, sales of our printer engines and the
related gross margins could be negatively impacted.
Our products target the market for high quality printing output. Hardware
and software technological advances have enhanced actual and perceived
resolution. Other companies may achieve actual or apparent resolution with less
expensive printers and supplies and therefore capture the market held by our
higher cost printers.
Intense Competition. The computer printer industry is intensely competitive
and rapidly changing. Some of our existing competitors, as well as a number of
potential new competitors, have longer operating histories, greater technical
resources, more established and larger sales and marketing organizations,
greater name recognition, larger customer bases and significantly greater
financial resources than the Company, which may result in a competitive
advantage. Suppliers of wide-format print engines and systems compete on the
basis of print quality, color, print time, print size, product features,
including ease of use, service, and price. Competitive product sales practices
such as price reductions, increased promotion, product giveaways and bundling,
or announcement or accelerated introduction of new or enhanced products could
have a material adverse effect on our sales and financial condition. New product
introductions and changes in pricing structure by competitors have had, and can
be expected to continue to have, a significant impact on
6
<PAGE>
the demand for our products. Currently, Hewlett-Packard is selling a new 54-inch
wide-format inkjet printer. ENCAD is shipping a new version of its printer line
with 600 dpi cartridges. Epson has released a new wide-format printer and
expects to ship in volumes in the Spring of 1999. These products compete for
market share with the Company's current DisplayMaker 5000, 6000 and 7000 series
of 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 HiRes 8-Color series, and DesignWinder and Giclee
PrintMakerFA products are based on relatively new technology, are complex and
must be reliable and durable to achieve market acceptance and enhance revenue
opportunities. Development and production of new, complex technologies and
products often have associated difficulties and delays. Consequently, customers
may experience unanticipated reliability and durability problems that arise only
as the product is subjected to extended use over a prolonged period of time. We
cannot assure that we have completely resolved operational problems that have
occurred in the past or that we will successfully resolve any future problems in
the manufacture or operation of our existing printers or any new product. Our
failure to resolve manufacturing or operational problems with existing printers
or any new product in a timely manner could have a material adverse effect on
our business, financial condition and results of operations.
Our HiRes 8-Color DisplayMaker series of printers, the DesignWinder and
Giclee PrintMakerFA products utilize HP licensed inkjet technology. We also
purchase licensed inkjet cartridges from HP who is a sole source of the
cartridge component for our aqueous ink consumable offerings. We also compete
with HP in the wide-format digital color printing market. Currently, we have
been granted access to these and selected new technologies for use in our
products and pay a royalty for these rights. Our revenue associated with the
sale of these products including HP components was approximately 67% of our
fiscal 1998 revenues. As new technologies are developed, there can be no
assurance that we will be able to negotiate additional licenses for newly
developed technologies or that the new terms are equal to the terms currently in
place.
Certain companies that supply us with consumable products such as ink and
media compete with us by selling directly to our users or selling to competitors
who may offer the products to our users. Additionally, OEM private label ink
products that may be used in their own products may compete with ColorSpan(R)
products. Further, a number of competitors have introduced consumables which
they allege to be compatible with our products and have priced the consumables
below the ColorSpan-branded consumables.
Although we believe that our Big Color(R) products possess certain
advantages over the competitors' products 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 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
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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 printer marking engines and other
printer components, are currently available from sole sources, and certain other
components are available from only a limited number of sources. Substantially
all of the Company's revenue is subject to these risks. In the past we have
experienced delays as a result of the failure of certain suppliers to meet
requested delivery schedules and standards of product performance and quality.
In addition, past losses from operations have restricted cash availability and
the ability to keep supplier debt current or within the established credit
limits. Although the Company has not experienced material delays in delivery
schedules due to its 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 the financial
performance of the Company. Our inability to obtain sufficient supply of
components, or to develop alternative sources, could result in delays in product
introductions, interruptions in product shipments, the need to redesign products
to accommodate substitute components or the need to substitute alternative
components which may not have the same performance capabilities, any of which
could have a material adverse effect on the Company's operating results. A
portion of the total manufacturing cost of our typesetting and Big Color
products is represented by certain components whose prices have fluctuated
significantly in recent years. Significant increases or decreases in the price
or reductions in the availability of certain components could have a material
affect on our operating results.
Fluctuations in Quarterly Operating Results. Our quarterly results of
operations have fluctuated and are expected to continue to fluctuate
significantly. These fluctuations have been caused by various factors,
including, but not limited to: the timing of new product announcements; product
introductions and price reductions by the Company or its competitors; the
availability and cost of key components and materials for our products;
fluctuations and availability in customer financing; the relative percentages of
sales of consumables and printer architectures; risks related to international
sales and trade; and general economic conditions. In addition, our operating
results are influenced by the seasonal buying patterns of our
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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 the financial
operations and results of the Company. In fiscal 1996, the Company recorded a
special $1 million charge for expected returns of its older model PressMate
product in excess of previously established reserves.
Dependence on Consumables Revenues. We anticipate we will derive an
increasing percentage of our revenues and operating income from the sale of ink,
paper, film and other consumables to our customers. During the second quarter of
fiscal 1999, consumables revenue was 60% of total revenue. To the extent sales
of our consumables are reduced because our customers are unsuccessful in
marketing their own printing services, product iterations by ourselves or
competitors make our products obsolete or customers substitute third-party or
private label consumables for ours, the Company's results of operations could be
adversely affected. Reduced life cycles of hardware products are expected to
negatively impact consumable revenues. Further, although our consumables are
manufactured specifically to operate with our printing products to produce
optimum results, there can be no assurances that other manufacturers of printing
inks and papers will not develop products that can be sold and compete with our
printing products, or that other products will not produce results which are
satisfactory to the customer at a lower cost. We allege that at least one
manufacturer has improperly used the Company's trade secrets to commence such
competition. Although we are involved in legal action against such manufacturer
for misappropriation of trade secrets, there can be no assurances that other
manufacturers will not independently or legitimately develop competing
consumable products. In addition, product quality issues, limitations in the
availability of sole source consumables or changes in credit or trade terms from
sole sources could adversely affect the sales of consumables.
Intellectual Property and Proprietary Rights. Our ability to compete
effectively will depend, in part, on our ability to maintain the proprietary
nature of our technologies through patents, copyrights and trade secrets.
Important features of our products are incorporated in proprietary software,
some of which is licensed from others and some of which we own. We attempt to
protect our proprietary software with a combination of patents, copyrights,
trademarks and trade secrets, employee and third-party nondisclosure agreements
and other methods of protection. Despite these precautions, unauthorized third
parties may be able to copy certain portions of our products or to
reverse-engineer or obtain and use information that we regard as proprietary.
Further, our intellectual property may not be subject to the same level of
protection
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in all countries where the products are sold. There can be no assurance that the
measures we take will be adequate to protect the intellectual property or that
others will not independently develop or patent products similar or superior to
those we have developed, patented or planned, or that others will not be able to
design products which circumvent any patents we rely upon.
We have been granted various United States patents for inventions related
to resolution of conventional laser printer engines, high-resolution imaging and
image enhancement and wide-format printing technologies and techniques, our Big
Ink(TM) Delivery System, product patents, and consumable formulations.
Additional patent applications are pending. There can be no assurance that
patents will be issued from any of these pending applications. With regard to
current patents or patents that may be issued, there can be no assurance that
the claims allowed will be sufficiently broad to protect our technology or that
issued patents will not be challenged, invalidated or violated, requiring
expenditures of cash to pursue and enforce our rights in the patented
technology. Applications to patent the basic TurboRes(R), ThermalRes(R) and Big
Ink Delivery System approaches and related technologies have been filed in
selected foreign countries. Patent applications filed in foreign countries are
subject to laws, rules and procedures which differ from those of the United
States, and there can be no assurance that foreign patents will be granted as a
result of these applications. Furthermore, even if these patent applications
result in the issuance of foreign patents, some foreign countries provide
significantly less patent protection than the United States.
We rely on a variety of trademarks in the promotion and identification of
our products. We have a variety of trademarks which are registered, and others
that are not registered, or cannot be registered. There is no assurance that
there will not be some challenge to our rights to use one or more trademarks, or
an allegation that the use or display of one or more trademark violates the
trademark rights of another party, which could subject us to damages and losses
related to the loss of our opportunity to use recognized marks in the promotion
of our products.
Additionally, patent, copyright and trademark protection has not been
sought, or may not be available in all foreign countries. Although we have not
received any notices from third parties alleging intellectual or proprietary
property infringement, there can be no assurance that third parties will not
assert infringement claims against us in the future or that any such assertion
will not require us to expend funds defending such claims or require us to enter
into royalty arrangements on such terms as may be available, which may adversely
affect our financial performance. Any claim that our current or future products
or manufacturing processes infringes on the proprietary rights of others, with
or without merit, could result in costly litigation which could adversely affect
our financial performance.
We are actively pursuing development of new and unique print solutions and
processes, media and inks. There are a significant number of patents which have
been filed relating to printing cartridges, printing methods and processes,
mechanical printer features, medias and inks. Many of these patents are held by
companies which are larger and have greater resources to pursue violation of
intellectual property. Although research and development process involves an
analysis of protected proprietary rights in any technology that is being
pursued, there is no assurance that we have completely reviewed and analyzed all
applicable patents, or that competitors or others will not interpret any such
products or processes we develop as violating protected intellectual rights and
pursue legal action, which could be costly and may affect our financial
performance. In addition, although we do not know of any violations of our
intellectual property rights, there can be no assurance that we will not be
forced to take action to protect our intellectual property portfolio. Such
enforcement activity could require us to expend significant cash resources and
could affect our financial performance.
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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 have instituted action against a
competitor for copyright infringement and other causes of action. The competitor
has counter-claimed alleging copyright misuse and unfair competition by the
Company. Although we do not believe any of our practices violate applicable
copyright laws, there is no assurance that claims or actions will not be
commenced by customers, competitors or governmental authorities based on
copyright, trade or anti-competitive claims which could affect our operations
and cash position.
We are also engaged in various actions related to transactional matters,
employee matters, customers' credit and product quality and/or warranty issues.
Some of these actions include claims against us for punitive, exemplary or
multiple damages. An award of punitive damages may not bear a direct
relationship to the actual or compensatory damages claimed from us. Although we
do not believe there are any actions pending or threatened against us which
would have a material adverse impact on our financial position, there is no
assurance that there will not be an adverse award of multiple punitive or
exemplary damages which could adversely affect our cash position.
Any litigation which we are involved in may have an adverse impact on our
operations and may result in a distraction or diversion of management's
attention, thereby adversely affecting our operations.
International Operations. Historically international revenues have
represented a substantial portion of our total revenues in the Digital Graphics
Business Unit. In the second quarter of fiscal 1999, international operations
composed 38.8% of total sales, compared to 44.5% 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 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 the Company
will be successful in limiting its foreign currency exposure in the future.
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Expansion and Diversification to Software and Services Outside of our Core
Printer Business. Our continuing efforts to expand sales and increase profits
and desire to reposition ourselves as a diversified technology company is
stimulating a series of new product development activities. The current focus of
these new business opportunities is primarily internet based software and
service businesses. During this past year, we launched an electronic commerce
(e-commerce) initiative for selling specialty media for wide-format printers
under the brand name of SuppliesoByoAir(TM). Currently, the Company's 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 the
Company's continued growth strategy is expected to be the acquisition or
partnering of professional service firms that meet the Company's goals for
strategic growth and expansion. The successful implementation of this
acquisition strategy will depend on the Company's ability to identify suitable
acquisition candidates, acquire such companies on acceptable terms and integrate
their operations successfully with those of the Company. There can be no
assurance that the Company will be able to continue to identify additional
suitable acquisition candidates or that the Company will be able to acquire such
candidates on acceptable terms. Moreover, in pursuing acquisition opportunities
the Company may compete with other companies with similar growth strategies,
certain of which competitors may be larger and have greater financial and other
resources than the Company. 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 the Company's 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 or performance problems with
an acquired firm could also have a material adverse impact on the reputation of
the Company as a whole, and any acquired company could significantly
underperform relative to the Company's expectations. For all of these reasons,
the Company's pursuit of an overall acquisition strategy or any individual
pending or future acquisition may have a material adverse effect on the
Company's business, financial condition, results of operations and prospects. To
the extent the Company chooses to use cash consideration for acquisitions in the
future, the Company 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 the Company issues stock to complete future acquisitions, existing
stockholders will experience further ownership dilution.
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Integration of Acquired Businesses. During December 1998 the Company
completed the acquisition of K & R Technologies, Inc. The Company's future
performance will depend on its 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 the Company's management and resources, and
could subject it 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 the Company's
ongoing business, the inability of management to maximize the financial and
strategic position of the Company 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 the Company's
business or service offerings, or that such integration will not adversely
affect the Company's 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 the
Company's 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, the Company is currently facing
all of these challenges and its 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 the business, financial condition, results of
operations and prospects of the Company.
Recruitment and Retention of Consulting Professionals. The Company's
business of delivering Internet and information technology professional services
is labor intensive. Accordingly, the Company's success depends in large part on
its 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.
The Company will encounter intense competition for qualified personnel from
other companies, and there can be no assurance that it 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 the Company's 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. Mr. Larry Lukis, who was
formerly Chief Engineer, has terminated his status as a regular employee and
anticipates working with the Company on a consulting basis. 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.
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 the Company's limited personnel, management and other resources. In the
future, the Company will be required to attract, train, motivate and manage new
employees successfully, to effectively integrate new employees into its
operations and to continue to improve its operational, financial, management and
information systems and controls. There can be no assurance that the Company's
systems, procedures or controls will be adequate to support the
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Company's operations or that the Company's management will be able to achieve
the rapid execution necessary to exploit the market for the Company's business
model. The failure to effectively manage any further growth could have a
material adverse effect on the Company's business, financial condition, results
of operations and prospects.
Developing Internet Economy, Market for E-Commerce Solutions. A material
portion of the Company's 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. The Company's business model anticipates revenue and growth from
Internet hosting services. Technological changes in the delivery of Internet
service could adversely affect the Company's ability to achieve its 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, the Company's 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 the Company's services do not achieve
market acceptance, its business, results of operations, financial condition and
prospects will be materially adversely affected.
Government Regulation and Legal Uncertainties. The Company's 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
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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 the Company's 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 the Company's services or
increase the cost of doing business or in some other manner have a material
adverse effect on the Company's 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 recently proposed changes,
could create uncertainty in the marketplace which could reduce demand for the
Company's 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 the Company's 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 the Company's
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 the Company's
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 the Company's 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 the Company to risks associated with cost
overruns and, in certain cases, penalties, any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition.
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The Year 2000 Issue. We are currently working to resolve the potential
impact of the Year 2000 on the processing of time-sensitive information by
computerized information systems. Year 2000 issues may arise if computer
programs have been written using two digits (rather than four) to define the
applicable year. In such cases, programs that have time-sensitive logic may
recognize a date using "00" as the year 1900 rather than the year 2000, which
could result in miscalculations or system failures. We utilize a number of
computer programs across the entire operation. Year 2000 issues could impact our
information systems as well as computer hardware and equipment that is part of
our telephone network such as switches, termination devices and SONET rings that
contain embedded software or "firmware."
Our exposure to potential Year 2000 problems exists in two general areas:
technological operations under our sole control and technological operations
dependent in some way on one or more third parties. The majority of our exposure
in potential Year 2000 problems is in the latter area where the situation is
much less within our ability to predict or control. Our business is heavily
dependent on third parties, many of whom are themselves heavily dependent on
technology. We cannot control the Year 2000 readiness of those parties. In some
cases, our third-party dependence is on vendors of technology who are themselves
working towards solutions to Year 2000 problems. We have initiated projects to
identify and correct the potential problem in all of our systems. The costs
incurred to date total less than $30,000 and have been expensed in the financial
statements. We are using internal resources to test the software modifications.
Funding for this area is expected to, and has come from, cash flow from
operations. 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
our fiscal year in June.
Our Products. We design and sell products that are heavily reliant on
software. While we have taken appropriate steps to ensure the readiness of this
software and believe it to be compliant, we cannot be certain that the software
will operate error free, or that we will not be subject to litigation, whether
the software operates error free or not. However, we believe that based on our
efforts to ensure compliance and the fact that the calculations needed in and by
our products are not date dependent, it is not reasonably likely that we will be
subject to such litigation.
Contingency Plans. We have not yet completed our planning and preparations
to handle the most reasonably likely worst case scenarios described above. We
intend to develop contingency plans for these scenarios during fiscal 1999. We
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.
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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. The Company has 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 the Company.
An audit of the Company's records is underway.
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.
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Control of the Company's Stock. As of August 31, 1998, officers and
directors as a group beneficially owned 21.32% of the outstanding shares of our
stock. One of our suppliers owned 14.7% of the Company's outstanding shares. The
impact of the holdings of the officers and directors and the supplier is not
believed to be material. However, such control may reduce liquidity of the stock
which may affect shareholder value.
The Company's 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 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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