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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
_X_ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 1998.
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Commission File Number 0-22619
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VALUESTAR CORPORATION
(Exact name of registrant as specified in its charter)
Colorado 84-1202005
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(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
1120A Ballena Blvd., Alameda, California 94501
- ---------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(510) 814-7070
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(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES X NO
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State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Common Stock, $.00001 par value 8,682,496
- ------------------------------- ---------
(Class) (Outstanding at October 31, 1998)
Transitional Small Business Disclosure Format (check one): YES NO X
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<PAGE>
VALUESTAR CORPORATION
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 1998 and
and June 30, 1998 3
Consolidated Statements of Operations for the three
months ended September 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the three
months ended September 30, 1998 and 1997 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 2. Changes in Securities 15
Item 3. Defaults upon Senior Securities 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 5. Other Information 15
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1998
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 118,515 $ 398,604
Receivables 453,900 361,369
Inventory 18,982 24,396
Prepaid expenses -- 3,902
-------------------------------------
Total current assets 591,397 788,271
PROPERTY AND EQUIPMENT 151,050 56,697
DEFERRED COSTS 49,142 130,930
-------------------------------------
Total assets $ 791,589 $ 975,898
=====================================
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Bank line of credit $ 250,000 $ 250,000
Accounts payable 433,780 197,410
Accrued liabilities and other payables 126,175 145,445
Current portion of term note 9,195 --
Deferred revenues 44,889 27,020
Shareholder loans 200,000 --
-------------------------------------
Total current liabilities 1,064,039 619,875
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LONG-TERM DEBT 1,607,451 1,525,357
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STOCKHOLDERS' DEFICIT
Common stock, $.00025 par value; 20,000,000 shares
authorized, 8,682,496 shares issued and outstanding
each period 2,171 2,171
Additional paid-in capital 4,257,160 4,247,160
Accumulated deficit (6,139,232) (5,418,665)
-------------------------------------
Total stockholders' deficit (1,879,901) (1,169,334)
-------------------------------------
Total liabilities and stockholders' deficit $ 791,589 $ 975,898
=====================================
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended
September 30,
1998 1997
------------------- -------------------
REVENUES $ 605,660 $ 524,216
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OPERATING EXPENSES
Cost of revenues 193,347 153,515
Selling 382,220 176,572
Marketing and promotion 294,329 261,678
General and administrative 392,703 155,654
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1,262,599 747,419
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LOSS FROM OPERATIONS (656,939) (223,203)
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OTHER INCOME (EXPENSE)
Interest expense (59,559) (5,229)
Miscellaneous (4,069) -
------------------- -------------------
(63,628) (5,229)
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NET LOSS $ (720,567) $ (228,432)
=================== ===================
LOSS PER COMMON SHARE $ (0.08) $ (0.03)
=================== ===================
WEIGHTED AVERAGE OF COMMON SHARES
OUTSTANDING 8,682,496 8,326,246
=================== ===================
See accompanying notes to interim consolidated financial statements.
4
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<CAPTION>
Three Months Ended
September 30,
1998 1997
----------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (720,567) $ (228,432)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation 8,652 2,249
Amortization of bond discount 17,249 --
Changes in:
Receivables (92,531) (30,229)
Inventory 5,414 10,706
Prepaid expenses 3,902 7,035
Deferred costs 81,788 (23,466)
Accounts payable 236,370 (31,612)
Accrued liabilities and other payables (19,270) (21,431)
Deferred revenues 17,869 (8,495)
----------- ------------
Net cash used by operating activities (461,124) (323,675)
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CASH FLOWS FROM INVESTING ACTIVITIES
Property and equipment acquisitions (103,005) (2,988)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of stock -- 50,000
Net borrowings under line of credit -- 250,000
Proceeds from debt 285,000 --
Payments on debt (960) --
----------- ------------
Net cash provided by financing activities 284,040 300,000
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NET INCREASE (DECREASE) IN CASH (280,089) (26,663)
CASH, beginning of year 398,604 44,225
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CASH, end of year $ 118,515 $ 17,562
=========== ===========
SUPPLEMENTAL CASH-FLOW INFORMATION:
Cash paid during the period for:
Interest $ 42,310 $ 5,229
Income taxes $ -- $ --
Non-cash investing and financing activities:
None
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
5
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1998
1. OPERATIONS
The Company, a Colorado corporation, conducts its operations through ValueStar,
Inc., a wholly-owned subsidiary. ValueStar, Inc. was incorporated in California
in 1991, and is a rating company that has pioneered a new business certification
mark (ValueStar Certified(R)) - - signifying high customer satisfaction - -
enabling consumers to quickly determine the best local service businesses. The
Company generates revenues by conducting customer satisfaction research on local
service companies in 150 industries; licensing the certification mark to highly
rated businesses; and selling ancillary materials and services. The Company's
activities are currently concentrated within one industry segment in California.
The Company communicates information about highly rated service and professional
firms that have earned "ValueStar Certified" to consumers through various media
including its Internet Web site (www.valuestar.com) and the Consumer ValueStar
Report ("CVR"), a bi-annual publication.
The Company's revenues are primarily from certification and rating fees, and are
recognized when all related services are provided to the customer. Rating
services include a research survey of prior customers and the delivery of a
research report. Services associated with certification include an orientation
on becoming a ValueStar Certified business and the delivery of certification
materials and manuals. Businesses must reapply for certification each year.
Sales of marketing materials and Web advertising and other services are
recognized as materials are shipped or over the period services are rendered.
Costs incurred in printing and distributing the Company's CVR consumer
publication published in January and July, and any related revenues are
recognized upon publication.
2. STATEMENT PRESENTATION
The accompanying unaudited interim financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. They do not include all information and footnotes required by
generally accepted accounting principles. The interim financial statements and
notes thereto should be read in conjunction with the Company's audited financial
statements and notes thereto for the year ended June 30, 1998.
In the opinion of management, the interim financial statements reflect all
adjustments of a normal recurring nature necessary for a fair statement of the
results for interim periods. Operating results for the three month periods are
not necessarily indicative of the results that may be expected for the year.
Certain reclassifications have been made in the prior year to conform to the
current period presentation.
3. INVENTORY
Inventory is recorded at the lower of cost (using the first-in first-out method
of accounting) or market. Inventory consists of brochures and related materials
for resale.
4. DEFERRED COSTS
All direct costs related to marketing and advertising the ValueStar
certification to businesses and consumers are expensed in the period incurred,
except for direct-response advertising costs, which are capitalized and
amortized over the expected period of future benefits. Deferred costs are
periodically evaluated to determine if adjustments for impairment are necessary.
Based on an ongoing evaluation of the expected period of future benefits from
the direct-response advertising, the period of amortization has been reduced
from twelve months to sixty days. Revenues associated with the direct-response
advertising costs, which are primarily certification fees from businesses new to
ValueStar, are being recognized approximately sixty days after the telemarketing
costs are incurred. This change in estimate of the amortization period resulted
in a one-time, non-cash increase in selling expenses of $81,788 in the first
fiscal quarter ended September 30, 1998.
6
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1998
5. LINE OF CREDIT
The Company has a $250,000 revolving bank line of credit, with interest at prime
plus 2%. Subsequent to September 30, 1998 the line of credit was transferred to
a new bank and increased to an aggregate of $350,000. The bank's commitment
under this agreement matures in December, 1999. The line of credit is guaranteed
by the three directors of the Company.
6. SHAREHOLDER LOANS
Two shareholders advanced $200,000 at September 30, 1998 pursuant to 12% demand
notes. An additional $45,000 was advanced subsequent to September 30, 1998. The
Company is negotiating to convert this financing to some form of long-term debt
or equity financing.
<TABLE>
7. LONG-TERM DEBT
Long-term debt at September 30, 1998, consists of the following:
<CAPTION>
<S> <C>
12% Notes Payable - $100,000 of Notes payable with interest at 12%
payable monthly; with all principal due on March 31, 2001, or sooner at
the Company's discretion; unsecured; net of unamortized bond discount
of $10,000 $ 90,000
12% Subordinated Notes Payable - $1,000,000 principal of subordinated
notes payable with interest at 12% payable monthly; with all principal
due on June 30, 2000, or sooner at the Company's discretion; unsecured.
Net of unamortized bond discount of $47,069 952,931
6% Convertible Notes Payable - $525,000 principal of subordinated
convertible notes payable with interest at 6% payable in kind on
conversion or at maturity on June 30, 2001; no prepayment is allowed;
unsecured; convertible at $1.00 per common share. Net of unamortized
bond discount of $49,025. Includes accrued interest of $13,700 due at
maturity 489,675
15% Term Equipment Note - $85,000 of principal, payable in monthly
installments of principal and interest of $2,022 to maturity in August
2003; secured by equipment and software 84,040
----------
$1,616,646
Less current potion 9,195
----------
$1,607,451
==========
</TABLE>
At September 30, 1998, the 6% Convertible Notes and accrued interest thereon
would have been convertible into 538,700 common shares.
8. STOCKHOLDERS' DEFICIT
There were no issuances of common stock during the three months ended September
30, 1998. The Company issued 50,000 warrants in connection with refinancing of
the $100,000 of 12% Notes Payable. The Company calculated the fair value of the
warrants at issuance and is amortizing this amount as interest expense over the
life of the debt.
The Company has reserved 250,000 shares of common stock for each of its 1992 ISO
Plan and 1992 NSO Plan, 300,000 shares of common stock for the 1996 Stock Option
Plan and 500,000 shares of common stock for the 1997 Stock Option Plan. The
Company has also issued 200,000 shares outside of the option plans. The
following table summarizes option activity for the period ended September 30,
1998:
7
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1998
8. STOCKHOLDERS' DEFICIT (Continued)
Weighted Average Weighted
Shares Exercise Price Average Life
------ -------------- ------------
Outstanding July 1, 1998 877,550 $0.59 2.45
Granted 267,800 $1.19
Canceled (65,967) $0.70
Exercised --
Expired --
Outstanding September 30, 1998 1,079,383 $0.73 2.91
========= ===== ====
Exercisable at September 30, 1998 766,666 $0.56
========= =====
On March 14, 1997 the Company adopted the 1997 Employee Stock Compensation Plan
providing for the issuance of up to 4,000 common shares to non-executive
employees. At September 30, 1998 an aggregate of 2,900 common shares had been
granted pursuant to this plan.
At September 30, 1998 the Company had the following stock purchase warrants
outstanding each exercisable into one common share:
Number Exercise Price Expiration Date
------ -------------- ---------------
150,000 $0.75 April, 2002
200,000 $1.25 June, 2002
300,000 $1.25 September, 2002
200,000 $1.25 December, 2002
500,000 $1.25 December, 2000
262,500 $1.25 April, 2003
262,500 $2.00 April, 2003
50,000 $1.75 May, 2003
50,000 $1.25 March, 2001
---------
1,975,000
=========
Subsequent to September 30, 1998 the Company granted warrants on 200,000 common
shares at $0.75 per share.
The Company has authorized 5 million shares of capital stock as preferred stock,
with a par value of $0.00025 per share. No preferred stock is issued or
outstanding.
9. INCOME TAXES
At September 30, 1998 a valuation allowance has been provided to offset the net
deferred tax assets as management has determined that it is more likely than not
that the deferred tax asset will not be realized. The Company has for federal
income tax purposes net operating loss carryforwards of approximately $4,800,000
which expire through 2013 of which certain amounts are subject to limitations
under the Internal Revenue Code, as amended.
8
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1998
10. NET LOSS PER SHARE
The Company has implemented Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share." Previously the Company followed the provisions of
Accounting Principles Board Opinion ("APB") 15, "Earnings Per Share." SFAS No.
128 provides for the calculation of "Basic" and "Diluted" earnings per share
("EPS"). Basic EPS includes no dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution of
securities that could share in the earnings of an entity, similar to fully
diluted earnings per share. The Company's net losses for the periods presented
cause the inclusion of potential common stock instruments outstanding to be
antidilutive and, therefore, in accordance with SFAS No. 128, the Company is not
required to present a diluted EPS. Stock options, warrants and convertible notes
exercisable into 3,593,083 of common stock were outstanding at September 30,
1998. These securities were not included in the computation of diluted EPS
because of the net losses but could potentially dilute EPS in future periods.
11. RECENT ACCOUNTING PRONOUNCEMENTS
Effective July 1, 1998, the Company adopted the Financial Accounting Standards
Board SFAS No. 130, "Reporting Comprehensive Income". This statement established
standards for reporting and display of comprehensive income and its components
(revenue, expenses, gains and losses) in a full set of general-purpose financial
statements. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. The adoption of this statement
had no material impact on the Company's financial condition or results of
operation as of September 30, 1998 and for the three month periods ended
September 30, 1998 and 1997. Total comprehensive income did not differ from the
Company's net loss for the three months ended September 30, 1998 or 1997.
The Company has also adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", which supersedes Statement of Financial
Accounting Standards No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS 131 establishes standards for the way that public companies
report information about operating segments in annual financial statements and
requires reporting of selected information about operating segments in interim
financial statements issued to the public. It also establishes standards for
disclosures regarding products and services, geographic areas and major
customers. SFAS 131 defines operating segments as components of a company about
which separate financial information is available that is evaluated regularly by
the chief operating decision maker in deciding how to allocate resources and in
assessing performance. Quarterly disclosures are not required in this first year
of adoption. Management believes that SFAS 131 will not have a significant
impact on the Company's disclosure of segment information in the future.
12. YEAR 2000 COMPLIANCE
The Company, like most owners of computer software, will be required to modify
significant potions of its software so that it will function properly in the
year 2000. Preliminary estimates of the total costs to be incurred by the
Company to resolve this problem range from $10,000 to $20,000. Since the Company
mainly uses third party "off-the-shelf" software, it does not anticipate a
problem in resolving the year 2000 problem in a timely manner. Maintenance or
modification costs will be expensed as incurred, while the costs of new software
will be capitalized and amortized over the software's useful life.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE
COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW AND IN THE COMPANY'S ANNUAL
REPORT ON FORM 10-KSB FOR THE YEAR ENDED JUNE 30, 1998.
Overview
ValueStar Corporation is a consumer research and rating company that has
designed a new rating system and certification mark, ValueStar Certified(R), for
service businesses. ValueStar's rating system is designed to enable consumers to
determine quickly and easily those local service businesses that have attained
the highest level of customer satisfaction.
The Company's revenues are generated primarily from research and rating fees
paid by new and renewal businesses, certification fees from highly rated
businesses and from the sale of information products and services. An important
aspect of the Company's business model is the recurring nature of revenues from
businesses renewing their certification.
Certification fees, ranging from $995 to approximately $2,000 depending on
business size, are recognized when material services or conditions relating to
the certification have been performed. The material services are the delivery of
certification materials along with an orientation and the material condition is
the execution of the certification agreement specifying the conditions and
limitations on using the certification. Research and rating fee revenue, ranging
up to $570, is deferred until the research report is delivered. Sales of
marketing materials and Web advertising and other services are recognized as
materials are shipped or over the period services are rendered. The Company from
time to time provides discounts, incentives from basic pricing and payment terms
on fees. Cancellations by certified businesses are nominal, less than 2%.
The Company expenses research and rating costs as incurred. Costs incurred in
printing and distributing the Company's Consumer ValueStar Report ("CVR")
publication for consumers, currently published in January and July, and any
related revenues are recognized upon publication. Accordingly, the revenues and
costs in the Company's first and third fiscal quarters are impacted by the costs
and revenues from the CVR publication.
Effective July 1, 1994, with the adoption by the Company of Statement of
Position No. 93-7 (SOP 93-7), Reporting on Advertising Costs, certain
direct-response advertising costs are deferred and amortized over the expected
period of future benefits. These costs, which relate directly to targeted new
business solicitations, primarily include targeted direct-response advertising
programs consisting of direct telemarketing costs. No indirect costs are
included in deferred advertising costs. Costs incurred for other than specific
targeted customers, including general marketing and promotion expenses, are
expensed as incurred.
Prior to July 1, 1998 the Company was amortizing deferred costs on a
straight-line basis over twelve months. Based on an ongoing evaluation of the
expected period of future benefits from the direct-response advertising, the
period of amortization has been reduced from twelve months to sixty days.
Revenues associated with the direct-response advertising costs, which are
primarily certification fees from businesses new to ValueStar, are being
recognized approximately sixty days after the telemarketing costs are incurred.
This change in estimate of the amortization period resulted in a one-time,
non-cash increase in selling expenses of $81,788 in the first fiscal quarter
ended September 30, 1998.
Deferred costs are periodically evaluated to determine if adjustments for
impairment are necessary.
Since inception the Company has been growing and developing its business and has
incurred losses in each year since inception and at September 30, 1998 had an
accumulated deficit of $6,139,232. There can be no assurance of future
profitability.
Effect of Growth in Certified Businesses and Renewals
The Company's business revenue model, similar to other membership based
organizations, is predicated on a growing number of certified businesses and
maintaining high renewal rates. Certified businesses that renew contribute
higher gross margins than new applicants due to reduced sales and rating costs.
Also a growing and larger base of certified businesses reduces the costs
(relative to revenues) associated with printing and distributing the Company's
Consumer ValueStar
10
<PAGE>
Report to consumers, maintaining the VALUESTAR.COM Internet site and providing
other services. The marginal fixed costs associated with more certified
businesses is minimal compared to these base printing, distribution and
maintenance costs.
Since a considerable portion of the Company's operations are engaged towards the
solicitation of new service and professional business applicants in order to
expand the base of certified businesses, the Company incurs substantial costs
towards this activity. Currently the Company is only deferring direct telephone
sales costs and amortizing them at the time of certification, an average of
approximately 60 days. Other costs are expensed as occurred.
At September 30, 1998 the Company had approximately 1,250 certified businesses.
The Company believes as a market region matures, and the Company has a larger
base of certified businesses, fixed and indirect costs will decline as a
percentage of revenues. The Company also believes that the opening of new market
regions will provide additional revenues to cover certain fixed selling,
marketing, administration and overhead costs. Management believes that the more
established Northern California market has achieved a base of certificate
holders sufficient to provide positive regional operating margins (prior to
allocation of corporate administration and overhead) in future periods, although
there can be no assurance thereof. Management also estimates that it could
substantially reduce operating costs to achieve break-even operations on reduced
levels of new sales and by maintaining the existing base of renewing businesses.
However, any such dramatic cutbacks would curtail growth and the ability to
expand regionally in the future.
Future operations are impacted by changes in the cost structure and elections
regarding advertising, promotions and growth rates (due to the lower margins in
the first year). Management intends, subject to financial resources, to continue
to expand the business geographically requiring increased numbers of sales,
marketing and support personnel, the exact number which is not currently
estimable and is dependent on decisions regarding expansion. Rapid growth, due
to the nature of the Company's operations, is expected to contribute to
continued operating losses in the foreseeable future.
During the first quarter of the current year, the Company expanded personnel,
computer systems and overhead to support the expansion into Southern California
and to prepare for future regional expansion, subject to financing. The number
of personnel has grown to 49 full-time and 22 part-time persons at September 30,
1998. During the first quarter the Company added four new executive positions in
anticipation of continued growth and regional expansion. The Company also
incurred marketing, selling and administrative costs in connection with the
Southern California region startup contributing to the loss in the first
quarter.
At September 30, 1998 the Company had 550 (490 new and 60 renewal) business
customers in the application and rating phase compared to 410 (349 new and 61
renewal) at June 30, 1998. Management has been installing new hardware, software
and systems to more automate the research and rating process. The installation
of new systems in the first quarter resulted in some delays in processing
applicants. Based on management's experience, the business customers in the
rating phase are expected to represent over $450,000 of revenues that should be
recognized in the second quarter of fiscal 1999 (generally analogous to
backlog).
Results of Operations
Revenues. Revenues consist of certification and rating fees from new and renewal
business applicants, sale proceeds from information materials and premium
listings in the CVR and on the Web site, and other ancillary revenues. The
Company reported total revenues of $605,660 for the three months ended September
30, 1998, a 16% increase over revenues of $524,216 for the first quarter of the
prior year and a 19% increase over the immediately preceding quarter (fourth
quarter of fiscal 1998). The first quarter of fiscal 1998 revenues of $524,216
was the highest revenue quarter of the prior year due to timing of new sales and
renewals.
The growth in revenues is the result of improved new sales velocity and the
impact of a larger base of renewals. During the first quarter certification fees
accounted for 79% of revenue (75% for the prior year's comparable quarter).
Renewing businesses represented 58% of certification fees in the current year's
first quarter compared to only 32% in the prior year's first quarter. Management
expects renewing businesses to grow in dollar amount, however the percentage
contribution attributable to renewals will vary depending in part on the volume
of new businesses being certified in any particular period.
11
<PAGE>
The Company reported approximately $94,000 of revenue from premium listings in
the CVR publication in July, an increase of $49,000 from the $45,000 reported in
July, 1997. The increase results from improved marketing efforts focused on
expanding ancillary revenues.
Revenues can vary from quarter to quarter due to the impact of distributing the
semi-annual CVR publication to consumers, seasonality, effectiveness of sales
methods and promotions, levels of expenditures targeted at prospective
businesses, the numbers of certificate holders up for renewal, renewal rates,
pricing policies, timing of completion of research and ratings and other
factors, some of which are beyond the control of management.
Cost of Revenues. Cost of revenues consists primarily of rating costs incurred
for performing customer satisfaction research on business applicants, costs
related to verifying insurance and complaint status, Web site operating costs
and costs of information products and certification materials. During December
1997, the Company made a change from using an outside vendor to perform customer
satisfaction research on applicants to in-house employees and related facility
and operating costs. This change has reduced rating costs on a per unit basis
and as a percentage of revenues. Cost of revenues represented 32% of revenues
during the first fiscal quarter ended September 30, 1998 comparable to the prior
year's first quarter which was lower than the average of the prior 1998 fiscal
year of 36% due to the record first quarter fiscal 1998 revenues. Management
focuses efforts on automating systems and procedures to make ratings more
efficient and economical. Increased volume of revenues reduces the percentage of
revenues associated with certain fixed rating costs. Cost of revenues may vary
significantly from quarter to quarter both in amount and as a percentage of
sales.
Selling Costs. Selling costs consist primarily of personnel costs for outside
sales consultants interacting with customers and direct marketing costs
including lead generation and telemarketing costs. Sales costs for the first
quarter of fiscal 1999 were $382,220, or 63% of revenues, compared to $176,572,
or 34% of revenues for the prior year's first quarter. The prior year's first
quarter was less than the average of 56% for fiscal 1998 due primarily to the
record revenues for the quarter. The current year's first quarter included an
$81,788 one-time, non-cash expense resulting from the change in estimate for
deferred costs described above. Also in the first quarter the Company initiated
sales activities in a new market region, Southern California, incurring an
estimated $57,000 of non-deferred sales costs consisting of $27,000 of outside
sales personnel related costs and $30,000 of lead generation costs. In the first
quarter of fiscal 1999 the Company reported only nominal revenues from the
Southern California region due to the approximately 60 day lag from selling
activities to initial revenues. Other than direct targeted telemarketing costs,
the Company expenses sales costs as incurred. The Company expects sales costs as
a percentage of revenues will vary in future periods resulting from levels of
future revenues, variances in renewal rates, the effect of new sales promotions
and costs thereof, timing of research and rating completions, timing and costs
of opening new market regions, level and percentage of fixed selling costs and
other factors, some beyond the control of management.
Marketing and Promotion Expenses. Marketing and promotion expenses aggregated
$294,329 or 49% of revenues during the first quarter of fiscal 1999 comparable
to $261,678 or 50% of revenues incurred for the comparable quarter of fiscal
1997. Included in marketing and selling expenses in each period were printing
and distribution costs of the Company's CVR publication targeted at consumers.
Printing and distribution costs of $107,000 in fiscal 1999's first quarter were
comparable to fiscal 1998's first quarter total of $102,000, however the company
was able to print and distribute more copies with additional pages due to better
pricing. During the first quarter of fiscal 1999 the Company expended $98,000 on
paid advertising targeted at expanding consumer awareness of ValueStar
Certified. Paid advertising of $65,000 was employed in the prior year's first
quarter. In the first quarter of fiscal 1999 the Company expended $54,000 on
promotions for certified businesses compared to $30,000 for the prior comparable
quarter with the increase due to increased numbers of certified businesses.
Generally the first and third fiscal quarters have increased costs because the
CVR publication is printed and distributed as a service to consumers during
these quarters. Also, the Company generally expends less advertising in the
second fiscal quarter due to higher media costs in the calendar fourth quarter.
Marketing and promotion expenses are subject to significant variability based on
decisions regarding the timing and size of distribution of the CVR publication
and decisions regarding paid advertising, public relations and market and brand
awareness efforts. The Company anticipates continuing to make significant
expenditures in marketing and promotion efforts as the Company supports a
growing base of certificate holders and expands to new regions but anticipates
these costs will decrease as an annual percentage of revenues as revenues grow.
However, amounts and percentages on a quarterly basis may vary significantly.
12
<PAGE>
General and Administrative Expenses. General and administrative expenses consist
primarily of expenses for finance, office operations, administration and general
and executive management activities, including legal, accounting and other
professional fees. They totaled $392,703 for the first fiscal quarter ended
September 30, 1998, compared to $155,654 for the comparable quarter of the prior
year, an increase of $237,049. The major increases include a $60,000 increase
due to the increased number of executive and management personnel added in
anticipation of continued regional expansion; a $61,000 increase in occupancy
and telephone costs due to additional personnel and expanded operations; a
$35,000 increase in accounts receivable debt expense versus the prior comparable
quarter; an $18,000 increase in depreciation and other costs due to additional
equipment and increased activity; a $23,000 increase in corporate costs (legal,
accounting, filing, public relations and consulting) due to increased audit and
legal costs as a public company, and; a $10,000 increase in travel and
entertainment due to expanded operations. Management anticipates that general
and administrative costs will continue to exceed prior period levels due to
increased executive personnel added in anticipation of continued growth,
increased general computer, operating, occupancy and corporate costs as a
publicly traded company.
To date, development expenses associated with the design, development and
testing of the Company's programs and services have not been material and are
included in sales and marketing or general and administrative expenses (if
performed by executive management). In the future, as the Company develops new
programs or services, it anticipates that it may segregate development expenses
as an expense category.
The Company incurred interest expense in the first fiscal 1999 quarter of
$59,559 which included $17,249 of non-cash interest from amortization of bond
discount. Interest for the prior comparable quarter was $5,299. The increase
resulted from the significant additions of debt to finance growth and the
related losses incurred by the Company.
Net Loss. The Company had a net loss of $720,567 for the first quarter ended
September 30, 1998, compared to a net loss of $228,432 for the comparable
quarter ended September 30, 1997. The increased loss is attributable to (a) the
increased selling costs resulting from the change in amortization estimate and
expansion of sales personnel to the Southern California market, and (b) the
increased general and administrative costs associated with additional executive
management and support for expanded market regions. The Company anticipates it
will continue to experience operating losses until it achieves a critical mass
base of renewing certificate holders as it pursues aggressive growth. As the
Company is increasing its business volume (new and renewal certifications)
immediate future quarterly results will be greatly impacted by decisions
regarding new markets and growth rates. Achievement of positive operating
results will require obtaining a sufficient base of new and renewal business
certifications to support operating and corporate costs. There can be no
assurance the Company can sustain renewal rates or achieve a profitable base of
operations.
Liquidity and Capital Resources
Since the Company commenced operations, it has had significant negative cash
flow from operating activities. The negative cash flow from operating activities
was $461,124 for the three months ended September 30, 1998 and $1,629,721 for
the fiscal year ended June 30, 1998. At September 30, 1998 the Company had a
working capital deficit of $472,642. For the three months ended September 30,
1998 the negative cash flow from operating activities was due to the continued
operating losses, expansion to the Southern California region, addition of new
executive management and investment in business growth. Included in the working
capital deficit at September 30, 1998 is net accounts receivable of $453,900,
representing approximately 68 days of revenues and an annualized turnover ratio
of approximately 5.3 times. This compares favorably to approximately 82 days of
revenues and turnover of approximately 4.4 times at June 30, 1998. The improved
turnover and reduced accounts receivable level results primarily from increased
revenues. Management believes that 60 to 90 days revenues in receivables is
reasonable based on the nature of the Company's business and the terms it
provides certifying companies. At September 30, 1998 the Company has not
experienced and does not anticipate any significant accounts receivable
recoverability problems.
The Company has financed its operations primarily through the sale of common
equity and debt financing. During fiscal year ended June 30, 1998 the Company
obtained $250,000 from a bank line of credit, $1,000,000 in a 12% Note
financing, $525,000 in 6% Convertible Subordinated Promissory Notes and $227,500
from common stock sales. During the first quarter ended September 30, 1998
shareholders advanced $200,000 to the Company. The bank line of credit is
guaranteed by certain officers, directors and a shareholder. Other than the
credit line which was fully utilized at September 30, 1998, there are no
commitments for future investments and there can be no assurance that the
Company can continue to finance its operations through these or other sources.
In the past shareholders, including from time to time directors, have advanced
funds and at times converted funds to debt or equity financing on terms of new
forms of financing. There can be no assurance that such shareholders or
directors will provide any future financing to the Company.
13
<PAGE>
Other than cash on hand of $118,515 at September 30, 1998 and net accounts
receivable of $453,900, the Company has no material unused sources of liquidity
at this time, and the Company expects to incur additional operating losses in
future fiscal quarters as a result of continued operations and investments in
growth. The timing and amounts of these expenditures and the extent of operating
losses will depend on many factors, some of which are beyond the Company's
control. Subsequent to September 30, 1998 the bank line of credit was increased
to $350,000 and shareholders advanced an additional $45,000 of financing.
The Company expects that it will require a minimum of $750,000 to finance
operations during the next twelve months. This estimate is based on a base level
of operations, anticipated renewal revenues, anticipated sales levels, growth
and budgeted operating costs. The Company has plans to continue to expand into
new market regions and would require and is seeking additional financing for
such expansion. The Company's actual results could differ significantly from
management's plans, and therefore the Company may require substantially greater
additional operating funds. In such an event, should the required and/or
additional funds not be available or planned operations not meet management's
expectations, the Company may be required to significantly curtail or scale back
staffing, advertising and other marketing expenditures and general operations in
more reliance on higher profitable renewals and limit new growth. There can be
no assurance that additional funding will be available or on what terms.
Potential sources of such funds include exercise of outstanding warrants and
options, loans from existing shareholders or other debt financing or additional
equity offerings.
New Accounting Pronouncements and Issues
The Financial Accounting Standards Board has issued a number of new
pronouncements as discussed in the footnotes to the Company's interim financial
statements (see page 9, Note 11). As discussed in the notes to the interim
financial statements, the implementation of these new pronouncements is not
expected to have a material effect on the financial statements.
On September 28, 1998, the SEC issued a press release and stated the "SEC will
formulate and augment new and existing accounting rules and interpretations
covering revenue recognition, restructuring reserves, materiality, and
disclosure;" for all publicly-traded companies. Until such time as the SEC staff
issues such interpretative guidelines, it is unclear what, if any, impact such
interpretative guidance will have on the Company's current accounting practices.
The Company's practices have been consistently applied since its initial filing
and review by the SEC in 1997. However, the potential changes in accounting
practice being considered by the SEC staff, if applied to certifications in a
manner different than currently recognized by the Company, could have a material
impact on the manner in which the Company recognizes revenue. Any such changes
would have no effect on reported cash flow or the economic value of the
Company's certifications.
Year 2000 Compliance
The Company is aware of the issues associated with the programming code in
existing computer systems as the Year 2000 approaches. The "Year 2000" problem
is concerned with whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. The Year 2000 problem is pervasive and complex as the computer
operation of virtually every company will be affected in some way.
The Company, like most owners of computer software, will be required to modify
significant potions of its software so that it will function properly in the
Year 2000. Preliminary estimates of the total costs to be incurred by the
Company to resolve this problem range from $10,000 to $20,000. Maintenance or
modification costs will be expensed as incurred, while the costs of new software
will be capitalized and amortized over the software's useful life.
Since the Company mainly uses third party "off-the-shelf" software, it does not
anticipate a problem in resolving the Year 2000 problem in a timely manner. The
Company is currently taking steps to ensure that its computer systems and
services will continue to operate on and after January 1, 2000. However, there
can be no assurance that Year 2000 problems will not occur with respect to the
Company's computer systems. Furthermore, the Year 2000 problem may impact other
entities with which the Company transacts business, and the Company cannot
predict the effect of the Year 2000 problem on such entities or the resulting
effect on the Company. As a result, if preventative and/or corrective actions by
the Company and those the Company does business with are not made in a timely
manner, the Year 2000 issue could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
has not yet developed a contingency plan to operate in the event that any
noncompliant critical systems are not remedied by January 1, 2000, but the
Company intends to develop such a plan in the near future.
14
<PAGE>
Tax Loss Carryforwards
As of June 30, 1998, the Company had approximately $4.8 million of federal tax
loss carryforwards. A valuation allowance has been recorded for the net deferred
tax asset arising primarily from such tax loss carryforwards because, in the
Company's assessment, it is more likely than not that the deferred tax asset
will not be realized.
Forward-Looking Statements and Business Risks
This Form 10-QSB includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. The words "anticipate," "believe,"
"expect," "plan," "intend," "project," "forecasts," "could" and similar
expressions are intended to identify forward-looking statements. All statements
other than statements of historical facts included in this Form 10-QSB regarding
the Company's financial position, business strategy, budgets and plans and
objectives of management for future operations are forward-looking statements.
Although the Company believes that the expectations reflected in such
forward-looking statements are reasonable, no assurance can be given that actual
results may not differ materially from those in the forward-looking statements
herein for reasons including the effect of competition, the level of sales and
renewal certifications, marketing and other expenditures, economic conditions,
the legislative and regulatory environment and the condition of the capital and
equity markets.
Readers are cautioned to consider the specific business risk factors described
in the Company's annual report on Form 10-KSB for the fiscal year ended June 30,
1998 and not to place undue reliance on the forward-looking statements contained
herein, which speak only as of the date hereof. The Company undertakes no
obligation to publicly revise forward-looking statements to reflect events or
circumstances that may arise after the date hereof.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
(a) None
(b) None
(c) The following is a description of equity securities sold by the
Company during the first fiscal quarter ended September 30, 1998
that were not registered under the Securities Act:
During July 1998 the Company issued as an inducement to extend
the due date on $100,000 of debt to two persons aggregate
warrants to purchase 50,000 shares of its Common Stock at
$1.25 per share until March 2001. The securities were issued
by the Company without an underwriter to two qualified
investors (one the spouse of a director). The issuance was
exempt by reason of Section 4(2) of the Act in reliance on the
private nature of the transaction, restrictions on transfer on
the warrants and underlying shares and based on
representations of the purchasers. An appropriate legend was
placed on the warrants.
(d) None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
27 Financial Data Schedule
(b) Reports on Form 8-K:
None
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
VALUESTAR CORPORATION
Date: November 12, 1998 By: /s/JAMES A. BARNES
-------------------
James A. Barnes
Secretary and Treasurer
(Principal Financial Officer and duly
authorized to sign on behalf of the Registrant)
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM UNAUDITED
FINANCIAL STATEMENTS FOR QUARTER ENDED SEPTEMBER 30, 1998 INCLUDED IN THE
QUARTERLY REPORT ON FORM 10-QSB AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 118,515
<SECURITIES> 0
<RECEIVABLES> 528,900
<ALLOWANCES> 75,000
<INVENTORY> 18,982
<CURRENT-ASSETS> 591,397
<PP&E> 172,631
<DEPRECIATION> 21,581
<TOTAL-ASSETS> 791,589
<CURRENT-LIABILITIES> 1,064,039
<BONDS> 1,607,451
0
0
<COMMON> 2,171
<OTHER-SE> (1,882,072)
<TOTAL-LIABILITY-AND-EQUITY> 791,589
<SALES> 14,781
<TOTAL-REVENUES> 605,660
<CGS> 11,437
<TOTAL-COSTS> 193,347
<OTHER-EXPENSES> 1,024,670
<LOSS-PROVISION> 44,582
<INTEREST-EXPENSE> 59,559
<INCOME-PRETAX> (720,567)
<INCOME-TAX> 0
<INCOME-CONTINUING> (720,567)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (720,567)
<EPS-PRIMARY> (0.08)
<EPS-DILUTED> (0.08)
</TABLE>
