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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 March 31, 1998.
Commission File Number 0-22610
VALUESTAR CORPORATION
(Exact name of registrant as specified in its charter)
Colorado 84-1202005
-------- ----------
(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
1120A Ballena Blvd., Alameda, California 94501
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(Address of principal executive offices) (Zip Code)
(510) 814-7070
--------------
(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
--- ---
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 April 30, 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 March 31, 1998
and June 30, 1997 3
Consolidated Statements of Operations for the three
and nine months ended March 31, 1998 and 1997 4
Consolidated Statements of Cash Flows for the nine
months ended March 31, 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 9
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 14
Item 2. Changes in Securities 14
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 15
3
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
<CAPTION>
March 31, June 30,
1998 1997
------------------------------------
<S> <C> <C>
ASSETS
Current Assets
Cash $ 190,316 $ 44,225
Receivables - net 312,283 295,542
Inventory 3,094 27,863
Prepaid and other 10,123 7,035
------------------------------------
515,816 374,665
Deferred costs - net 205,910 134,085
Property, equipment and intangibles - net 49,090 49,422
------------------------------------
$ 770,816 $ 558,172
====================================
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities
Bank line of credit (Note 5) $ 150,000 $ --
Accounts payable 164,263 373,226
Accrued expenses 117,204 112,277
Deferred revenue 23,129 22,720
Notes payable (Note 6) 100,000 30,000
------------------------------------
554,596 538,223
------------------------------------
Long-Term Debt (Note 6) 1,000,000 100,000
------------------------------------
1,554,596 638,223
------------------------------------
Stockholders' Deficit (Note 7)
Common stock, $.00025 par value,
20,000,000 shares authorized,
8,682,496 and 8,326,246 shares issued
and outstanding, respectively 2,171 2,082
Additional paid-in capital 4,125,160 3,759,351
Accumulated deficit (4,911,111) (3,841,484)
------------------------------------
Total Stockholders' Deficit (783,780) (80,051)
------------------------------------
$ 770,816 $ 558,172
====================================
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
3
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<CAPTION>
Three months ended Nine months ended
March 31, March 31,
1998 1997 1998 1997
--------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 300,884 $ 68,719 $ 1,092,577 $ 578,175
Costs and Expenses:
Cost of revenues 158,088 68,002 412,346 319,348
Sales costs 176,649 323,046 547,170 697,358
Marketing and promotion 295,349 328,267 590,465 546,375
General and administrative 243,466 108,122 562,236 354,707
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873,552 827,437 2,112,217 1,917,788
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Loss from operations (572,668) (758,718) (1,019,640) (1,339,613)
--------------------------------------------------------------------------
Interest expense (34,790) (3,000) (49,987) (5,000)
--------------------------------------------------------------------------
Net loss $ (607,458) $ (761,718) $(1,069,627) $(1,344,613)
==========================================================================
Basic net loss per common
share (Note 9) $ (0.07) $ (0.11) $ (0.13) $ (0.19)
==========================================================================
Weighted average number of
common shares outstanding 8,591,246 7,067,438 8,439,695 7,067,438
==========================================================================
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
4
<PAGE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine months ended
March 31,
1998 1997
Cash Flows from Operating Activities
Net loss $(1,069,627) $(1,344,613)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 7,073 6,496
Warrants issued for services 20,000 --
Common stock issued for services 88,398 2,175
Changes in assets and liabilities:
Accounts receivable (16,741) (109,574)
Inventories 24,769 (23,707)
Prepaid expenses and other (3,088) (3,024)
Deferred costs (71,825) (13,781)
Accounts payable (208,963) 259,111
Accrued Expenses 4,927 79,826
Deferred revenue 409 (16,299)
--------------------------
Net Cash Flows Used by Operations (1,224,668) (1,163,390)
Cash Flows from Investing Activities
Equipment acquisitions (6,741) (17,565)
--------------------------
Net Cash Used by Investing Activities (6,741) (17,565)
Cash Flows from Financing Activities
Sale of common stock 227,500 750,000
Common stock subscribed -- 40,000
Proceeds from bank line 250,000 --
Repayment of bank line (100,000) --
Sale of long-term debt 1,000,000 100,000
Stockholder advances 90,000 --
Repayment of stockholder advances (90,000) --
--------------------------
Net Cash Provided by Financing Activities 1,377,500 890,000
--------------------------
Increase (Decrease) in Cash and Cash Equivalents 146,091 (290,955)
Cash at Beginning of Period 44,225 454,809
--------------------------
Cash at End of Period $ 190,316 $ 163,854
==========================
Supplemental Cash Flow Information:
Cash paid for interest $ 49,987 $ 5,000
Non-cash investing and financing activities:
Common stock issued for services $ 88,398 $ --
Common stock issued for accrued expenses $ -- $ 32,396
Notes converted to stock $ 30,000 $ --
Value assigned for warrants issued $ 20,000 $ 500
See accompanying notes to interim consolidated financial statements.
5
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 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 provider of service and professional business rating
information to consumers. A certification trademark, ValueStar Certified(R) is
issued to businesses that have successfully passed an independent rating of
their customer's satisfaction. The Company's activities are currently
concentrated in Northern California. The Company communicates information about
highly rated service and professional firms that have earned "ValueStar
Certified" through various media including its Internet site (www.valuestar.com)
and a periodic publication Consumer ValueStar Reports.
The Company's revenues are primarily from research and rating fees paid by new
and renewal customers, annual certification fees from qualified applicants and
renewal customers, and sales of information service products. The Company, from
time to time, provides discounts, incentives and satisfaction guarantees to
first time applicants, and may extend payment terms on the annual certification
fee. Certification fees and related cost of sales consisting of research and
rating fees are recognized when all related services are provided to the
customer. The Company provides a reserve for customer satisfaction guarantees.
Sales of information services are recognized as materials are delivered or
shipped or services are rendered.
Costs incurred in printing and distributing the Company's consumer publication,
Consumer ValueStar Report, 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, 1997.
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 and nine 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 business and consumers are expensed in the period incurred,
except for direct-response advertising costs, which are capitalized and
amortized over a twelve month period. Deferred costs consist solely of
telemarketing costs. Deferred costs are periodically evaluated to determine if
adjustments for impairment are necessary.
5. LINE OF CREDIT
The Company has a $250,000 revolving bank line of credit, with interest at prime
plus 2%. At March 31, 1998 the Company had $100,000 available under this line of
credit. The bank's commitment under this agreement matures in August 1998. The
line of credit is guaranteed by certain officers, directors and shareholders of
the Company.
6
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998
6. LONG-TERM DEBT
The Company is obligated on two 12% notes in the amount of $50,000 each for an
aggregate of $100,000 one of which is payable to the spouse of a director. These
notes are due on September 30, 1998 and included in current liabilities.
The Company has obtained $1,000,000 from the sale of long-term unsecured 12%
subordinated notes due June 30, 2000 (12% Notes). Interest on the 12% Notes is
payable monthly. In connection with the sale of the 12% Notes, the Company
issued warrants exercisable into 500,000 common shares at $1.25 per share until
December 31, 2000.
7. STOCKHOLDERS' DEFICIT
<TABLE>
The following table summarizes equity transactions during the nine months ended
March 31, 1998:
<CAPTION>
Shares Par Value Paid in Capital Total $
---------- ---------- --------------- ----------
<S> <C> <C> <C> <C>
Balance June 30, 1997 8,326,246 $ 2,082 $3,759,351 $3,761,433
Private placement at $1.00 per unit, consisting of
one share and one warrant 250,000 62 249,938 250,000
Value assigned to 250,000 warrants granted for
bank guarantee -- -- 20,000 20,000
Common stock issued for services rendered 91,250 23 88,375 88,398
Exercise of stock options 15,000 4 7,496 7,500
---------- ---------- ---------- ----------
Balance March 31, 1998 8,682,496 $ 2,171 $4,125,160 $4,127,331
========== ========== ========== ==========
</TABLE>
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
following table summarizes option activity for the period ended March 31, 1998:
Weighted Average Weighted
Shares Exercise Price Average Life
------ -------------- ------------
Outstanding July 1, 1997 704,000 $ 0.47 3.28
Granted 190,550 $ 1.00 5.00
Canceled (2,000) $ 1.00 --
Exercised (15,000) $ 0.50 --
Expired -- -- --
-------
Outstanding March 31, 1998 877,550 $ 0.59 3.00
======= ======== ====
Exercisable at March 31, 1998 753,998 $ 0.56 2.84
======= ======== ====
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 March 31, 1998 an aggregate of 2,900 common shares had been
granted pursuant to this plan.
At March 31, 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
10,000 $ 0.75 September, 1998
200,000 $ 1.25 June, 2002
300,000 $ 1.25 September, 2002
200,000 $ 1.25 December, 2002
500,000 $ 1.25 December, 2000
---------
1,360,000
=========
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.
7
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1998
8. INCOME TAXES
At March 31, 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 $3,300,000
which expire through 2012 of which certain amounts are subject to limitations
under the Internal Revenue Code, as amended.
9. 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 and warrants to purchase
2,237,550 and 817,000 shares of common stock were outstanding at March 31, 1998
and 1997, respectively. These securities were not included in the computation of
diluted EPS because of the net losses but could potentially dilute EPS in future
periods. All prior period loss per share data is presented in conformity with
the requirements of SFAS No. 128.
10. RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") has issued SFAS No. 130
"Reporting Comprehensive Income", SFAS No. 131 "Disclosures About Segments of an
Enterprise and Related Information" and SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." SFAS No. 130 establishes
standards for reporting and display of comprehensive income, its components and
accumulated balances. Comprehensive income is defined to include all changes in
equity except those resulting from investments by owners and distributions to
owners. Among other disclosures, SFAS No. 130 requires that all items that are
required to be recognized under current accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. SFAS No. 131 supersedes SFAS
No. 14 "Financial Reporting for Segments of a Business Enterprise." SFAS No. 131
establishes standards on the way that public companies report financial
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 disclosure
regarding products and services, geographic areas and major customers. SFAS No.
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. SFAS No. 132 standardizes the disclosure requirements for pensions
and other postretirement benefits and requires additional information on changes
in the benefit obligations and fair values of plan assets that will facilitate
financial analysis.
SFAS No. 130 and No. 131 are effective for financial statements for periods
beginning after December 15, 1997 and require comparative information for
earlier years to be restated. SFAS No. 132 is effective for years beginning
after December 15, 1997 and requires comparative information for earlier years
to be restated, unless such information is not readily available. Management
believes the adoption of these statements will have no material impact on the
Company's financial statements and that results of operations and financial
position will be unaffected by their implementation.
11. YEAR 2000 COMPLIANCE
The Company, like most owners of computer software, will be required to modify
significant portions 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.
8
<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 UNDER THE SUB-HEADING,
"BUSINESS RISKS." SEE ALSO THE COMPANY'S ANNUAL REPORT ON FORM 10-KSB PURSUANT
TO RULE 15d-2 FOR THE YEAR ENDED JUNE 30, 1997 AND THE Company's REGISTRATION
STATEMENT ON FORM 10-SB DATED MAY 29, 1997, AS AMENDED.
Overview
The Company provides a unique Internet shopping service allowing consumers to
identify and buy from ValueStar rated local service companies. ValueStar's
proprietary, branded rating information is also available free to consumers
through the Consumer ValueStar Report publication delivered to homeowners and
millions of customer interactions by licensed firms using the ValueStar
Certified brand in their own marketing and sales channels. Consumers use
VALUESTAR.COM and ValueStar's free rating information to make better shopping
choices for local service and professional firms.
The Company's revenues are generated primarily from research and rating fees
paid by new and renewal businesses, annual certification fees from qualified
applicants and renewals and from the sale of information products and services.
The Company from time to time provides discounts, incentives from basic pricing
and may provide satisfaction guarantees to first time applicants and also from
time to time extends payment terms on the annual certification fee.
Certification fees 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 license agreement specifying the conditions and
limitations on using the certification. Research and rating fee revenue is
deferred until the research report is delivered. Sales of information materials
and other services are recognized as materials are delivered or shipped or
services rendered.
The Company expenses research and rating costs as incurred. Costs incurred in
printing and distributing the Company's Consumer ValueStar Report publication
published in January and July and any related revenues are recognized upon
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
advertising costs are deferred and amortized over a twelve month period on a
straight-line method. These costs, which relate directly to targeted new
licensee solicitations, primarily include targeted direct-response advertising
programs consisting of telephone sales, printing and mailing 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.
The net effect of capitalizing and amortizing deferred costs was a reduction in
costs and expenses of $71,825 and $13,781 for the nine months ended March 31,
1998 and 1997, respectively.
The Company estimates new licensees have an average life exceeding four years.
Accordingly, the Company believes deferred costs (which are amortized over
twelve months) will be realized from future operations. 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 March 31, 1998 had an
accumulated deficit of $4,911,111. There can be no assurance of future
profitability.
Effect of Growth in New Licensees and License Renewals
The Company's business revenue model, similar to other membership based
organizations, is predicated on growing new members (business licensees) and
maintaining high renewal rates. The Company's renewal licensees contribute
higher gross margins than new applicants due to reduced sales and rating costs.
Also a growing and larger base of licensees reduces the costs (relative to
revenues) associated with printing and distributing the Company's Consumer
ValueStar
9
<PAGE>
Report, maintaining the VALUESTAR.COM Internet site and providing other
services. The marginal fixed costs associated with more licensees 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 licensees, the Company incurs substantial costs towards this
activity. Currently the Company is only deferring direct telephone sales costs
and amortizing them over twelve months. Other costs are expensed as occurred.
At March 31, 1998 the Company had 1,085 licensees compared to 648 licensees on
March 31, 1997.
The Company believes as a market territory matures, and the Company has a larger
base of licensees, fixed and indirect costs will decline as a percentage of
revenues. The Company's operations require that it achieve a critical mass of
licensees sufficient to cover general management, overhead and indirect costs of
operations. Management estimates, based on the current cost structure and level
of advertising and promotion expenditures, that this critical mass is
approximately 1,400 licensees. There can be no assurance the Company can achieve
this level of licensees and thereafter, if achieved, operations can be impacted
by changes in the cost structure and elections regarding advertising, promotions
and growth rates (due to the lower margins associated with first year
licensees).
Effective January 1, 1997 the Company changed its new business marketing focus
to telephone sales from a field sales force. This has resulted in a significant
increase in applicants for ratings and reduced unit sales costs. In December
1997 the Company made a change from using an outside vendor to perform customer
satisfaction research on applicants to in-house employees. The Company expensed
approximately $40,000 in startup costs for this change in the third quarter
related to setting up the in-house research center and hiring and training
employees. This change is expected to reduce future unit rating costs and
provide improved quality control over the research and rating process. However
the change resulted in a delay in completing pending ratings during the second
and third fiscal quarters thereby reducing each quarters revenues. Management
expects to complete delayed ratings in the fourth fiscal quarter.
Because of the change, at March 31, 1998 the Company had 408 (388 new and 20
renewal) prospective licensees in the application and rating phase. At current
new sales rates the normal number of pending prospective licensees would
generally be 300. Generally there is a 60 day period between the initial sign-up
of an applicant and the execution of a license agreement for successful
applicants. Based on management's experience, these 408 prospective licensees
are expected to represent over $340,000 of revenues that should be recognized in
the fourth fiscal quarter (generally analogous to backlog).
Results of Operations
Revenues. Revenues consist of certification fees from new and renewal business
licensees, rating fees from new and renewal business applicants, sale proceeds
from information materials and premium listings, and other ancillary revenues.
The Company reported total revenues of $1,092,577 for the nine months ended
March 31, 1998, an 89% increase over revenues of $578,175 for the first nine
months of the prior fiscal year. During the first nine months license fees
accounted for 72% of revenue (71% for the prior year's first nine months). The
growth in revenues is the result of improved new sales velocity and the impact
of a larger base of business member renewals. Revenues for the third fiscal
quarter ended March 31, 1998 were $300,884 compared to $68,719 for the prior
year comparable quarter or a 337% increase. This large increase is the direct
effect of increased sales velocity, more renewal licensees and a backlog of
pending licensees at December 31, 1997 resulting from the change in research and
rating described above. At March 31, 1998 the Company had reduced the backlog of
pending licensees and expects by the end of the fiscal year that the number of
pending licensees will represent approximately 60 days of licensable sales. The
higher number of pending prospective licensees at March 31, 1998 over normal
levels represents an estimated $95,000 of pending revenue expected to be
realized in the fourth fiscal quarter rather than the third quarter of fiscal
1998 due to this timing difference.
During fiscal 1996 and the first half of fiscal 1997 the Company experimented
with various direct mail and direct sales methods. Effective January 1, 1997 the
Company changed from a field sales force to telephone sales to obtain new rating
applicants. The Company believes, based on its over 75% historical renewal rate,
that investments in new licensees will contribute to greater recurring revenues
in future periods. At March 31, 1998 the Company had 408 applicants in various
stages of rating, effectively a (anticipated revenue) backlog estimated at
$340,000 to be recognized in the fourth fiscal quarter ending June 30, 1998 from
license fees. As a result of this backlog, management expects, but there can be
no assurance, that fourth quarter fiscal 1998 (quarter ending June 30, 1998)
revenues will exceed both the third quarter of the current year and the fourth
quarter of the prior year when the Company reported $476,000 in revenues.
10
<PAGE>
Revenues can vary from quarter to quarter due to seasonality, effectiveness of
sales methods and promotions, levels of expenditures targeted at prospective
licensees, the numbers of licensees up for renewal, renewal rates, pricing
policies, timing of completion of research and ratings and other factors, some
beyond the control of management.
Cost of Revenues. Cost of revenues consist primarily of rating costs incurred
for performing customer satisfaction research on business applicants, costs
related to auditing insurance and complaint status and costs of information
products and licensing 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 is expected to reduce rating costs on a per unit basis and as a
percentage of revenues after a startup period. Included in cost of revenues in
the third fiscal quarter of 1998 were startup costs of approximately $40,000.
Cost of revenues represented 38% of sales in the first nine months of fiscal
1998 (53% in the third quarter), a reduction from 55% in the first nine months
of the prior year (99% for the third quarter of the prior year). The increase in
the third quarter percentage resulted from the startup costs and the decreased
revenue caused by the pending licensees. During the current year, the Company
made changes to make ratings more efficient and more economical. The increased
volume of revenues in the current year also 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.
Sales Costs. Sales costs for the nine months ended March 31, 1998 were $547,170
or 50% of revenues compared to $697,358 or 120% of revenues for the comparable
prior period. In the first nine months of the prior year, the Company relied on
a direct sales force supported by direct mail to generate sales. In the current
nine months, the Company had implemented the telephone sales approach, also
supported by direct mail. This has resulted in reduced unit selling costs. Also
in the first nine months of the current year approximately 36% of license fees
came from renewals with limited sales costs, compared to approximately 20% of
license fees coming from renewals in the prior periods first nine months. Sales
costs for the third quarter were $176,649 or 59% of revenues. The increase in
the third quarter over the average for the nine months is the result of the
pending licensees which reduced revenues in the third quarter. The Company
expects sales costs as a percentage of revenues will vary in future periods
resulting from variances in renewal rates, the effect of new sales promotions
and costs thereof, timing of research and rating completions, 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
$590,465 in the first nine months of fiscal 1998 compared to $546,375 in the
first nine months of fiscal 1997. Included in marketing and selling expenses in
each nine months were printing and distribution costs of the Company's Consumer
ValueStar Report (CVR) publication targeted at consumers. Printing and
distribution costs of $104,000 in the third fiscal quarter of fiscal 1998
approximated the $109,000 expensed in the third quarter of fiscal 1997 on the
previous publication of the CVR. During the nine months ended March 31, 1998 the
Company expended $240,000 on paid advertising targeted at expanding consumer
awareness of ValueStar Certified. Paid advertising of $190,000 was employed in
the prior year's first nine months. Marketing and promotion expenses were
$295,349 for the three months ended March 31, 1998 compared to $328,267 for the
prior comparable period primarily the result of reduced personnel costs.
Generally the first and third fiscal quarters have increased costs because the
CVR publication is printed and distributed during these quarters. Also generally
the Company expends limited advertising in the second fiscal quarter due to high
calendar year end media costs.
Marketing and promotion expenses are subject to significant variability based on
decisions regarding the timing and size of distribution of CVR 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 licensee base
but anticipates a decreasing annual percentage of revenues as revenues grow.
However, amounts and percentages on a quarterly basis may vary significantly.
General and Administrative Expenses. General and administrative expenses consist
primarily of expenses for finance, office operations, administration and general
management activities, including legal, accounting and other professional fees.
They totaled $562,236 for the nine months ended March 31, 1998 compared to
$354,707 for the comparable prior period. The major increases include a $16,000
increase in personnel costs due to increased personnel, a $19,000 increase in
occupancy costs due to additional personnel and the startup of in-house
research, a $25,000 increase in corporate costs due to the public trading of
common shares of the Company in the current year, a $24,000 increase in
guarantees and bad debts due to increased volumes, a $8,000 increase in postage
due to increased activities and the incurrence of $108,000 of non-cash
compensation expenses related to consulting and guarantees on financings during
the current fiscal year.
11
<PAGE>
General and administrative expenses were $243,466 for the third quarter compared
to $108,122 for the prior year's third quarter. The primary increase was $88,398
in non-cash stock compensation. Management anticipates that current year general
and administrative costs will continue to exceed the prior year due to increased
personnel, the effect of the non-cash expenses 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.
Net Loss. The Company had a net loss of $1,069,627 for the nine months ended
March 31, 1998 compared to a net loss of $1,344,613 in fiscal 1997is first nine
months. The decreased loss resulted primarily from improved sales volumes and
selling efficiency which reduced the effect of fixed operating costs. The
Company anticipates it will continue to experience operating losses until it
achieves a critical mass base of renewing licensees as it pursues aggressive
growth in new licensees. As the Company is rapidly increasing its business
volume (new and renewal) 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
licensees and renewal licensees 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
$1,519,799 for the fiscal year ended June 30, 1997, and $722,518 for the fiscal
year ended June 30, 1996. At June 30, 1997 the Company had a working capital
deficit of $163,558 and at March 31, 1998 a working capital deficit of $38,780
resulting from a portion of operations being financed by current debt. For the
nine months ended March 31, 1998 negative cash flow from operating activities
was $1,224,668 due to the continued operating losses, heavy investment in new
licensee growth and startup of the in-house research department. Included in
working capital at March 31, 1998 is net accounts receivable of $312,283
representing approximately 75 days of revenues and an annualized turnover ratio
of approximately 4.7. This compares to approximately 102 days of revenues and
turnover of approximately 3.6 at June 30, 1997. The improved turnover and
reduced receivable level results from increased revenues and concentrated
collection efforts. Management believes that 60 to 90 days sales in receivables
is reasonable based on the nature of the Company's business. At March 31, 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, shareholder loans subsequently converted to common stock and debt
financing. Other than the $100,000 available on the credit line 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.
During fiscal 1997 the Company obtained $1,122,175 from equity and debt sources.
For the nine months ended March 31, 1998 the Company obtained $250,000 from a
bank line of credit, $1,000,000 in 12% Note financing and $227,500 from common
stock sales and received and repaid $90,000 of shareholder advances during the
period and reduced the credit line by $100,000. The bank line of credit is
guaranteed by certain officers, directors and a shareholder.
Other than cash on hand of $190,316 at March 31, 1998, accounts receivable of
$312,283, and the $100,000 of bank credit, the Company has no material unused
sources of liquidity at this time and the Company expects to incur additional,
although reduced, operating losses in future fiscal quarters as a result of
continued operations and investments in licensee 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.
The Company believes, but there can be no assurance, given the above sources of
liquidity and the combination of anticipated renewal revenues, current levels of
new sales and licensee growth, that it will require funds to repay or refinance
the $250,000 bank line and the $100,000 September notes to continue operations
for the next twelve months. However the Company has plans to expand to new
markets and expects to require, in addition, a minimum of $500,000 to finance
planned expansion during the next twelve months. However should actual results
differ significantly from management's plans, then the Company may require
substantially greater additional operating funds. There can be no assurance that
additional funding will be available or on what terms. Potential sources of such
funds include shareholder and other debt financing or additional equity
offerings. In such an event, should the refinancing or additional funds not be
12
<PAGE>
available or planned operations not meet management's expectations, the Company
may be required to curtail or scale back staffing and operations in more
reliance on higher profitable renewals and limit new licensee growth.
New Accounting Pronouncements
The Financial Accounting Standards Board has issued a number of new
pronouncements for future implementation as discussed in the footnotes to the
Company's interim financial statements (see page 8, Note 10). 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.
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.
Tax Loss Carryforwards
As of June 30, 1997, the Company had approximately $3.3 million of 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.
Business Risks
This quarterly report contains a number of forward-looking statements which
reflect the Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks and
uncertainties, including those discussed below, that could cause actual results
to differ materially from historical results or those anticipated. In this
report, the words "anticipates," "believes," "expects," "intends," "future" and
similar expressions identify forward-looking statements. Readers are cautioned
to consider the specific risk factors described below 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
these forward-looking statements, to reflect events or circumstances that may
arise after the date hereof.
Absence of Profitable Operations and Possible Insufficiency of Capital
- The Company has incurred significant operating losses since
inception. The Company incurred an operating loss of $1.4 million for
the fiscal year ended June 30, 1997 and $1.0 million for the nine
months ended March 31, 1998. The Company has had limited financial
results upon which investors may base an assessment of its potential.
There can be no assurance profitable operations can be achieved and
management believes that additional capital will be required.
Possible Inability to Continue as a Going Concern - The Company has
suffered recurring losses from operations. This factor, in combination
with (i) reliance upon debt and equity financing to fund losses from
operations and cash flow deficits, (ii) material net losses and cash
flow deficits from operations and (iv) the possibility that the Company
may be unable to meet its debts as they come due, raise doubt about the
Company's ability to continue as a going concern. The Company's ability
to continue as a going concern is dependent upon achieving and
maintaining profitable operations or obtaining additional capital, as
to which no assurance can be given.
Competition and Technological Change - The possibility exists that a
business rating service and certification mark similar to or
competitive with that of the Company will be developed. It is also
possible that future competition will try to duplicate the Company's
concept. The Company could face head-on competition from vastly larger
and better financed companies with the means to launch a high-impact
campaign locally or nationally. Technological changes in the manner of
selecting service businesses and communicating information to consumers
could also have a negative impact on the Company's business. As a
provider of consumer information through the Internet and various media
the Company will be required to adapt to new and changing technologies.
There can be no assurance that the Company's services will remain
viable or competitive in face of technological change.
Dependence on Officers and Directors - The Company is substantially
dependent upon the experience and knowledge of its officers and
directors. The loss to the Company of such persons, particularly Mr.
James Stein,
13
<PAGE>
could be detrimental to the Company's development, especially since it
may not have the funds to hire management personnel with the requisite
expertise. The Company has a $2 million key-man life insurance policy
on Mr. Stein.
Managing a Growing and Changing Business - The Company continues to
experience changes in its operations resulting from expansion of its
business and other factors which has and may place demands on its
administrative, operational and financial resources. The Company's
future performance will depend in part on its ability to manage growth
and to adapt its administrative, operational and financial control
systems to the needs of an expanding entity. The failure of management
to anticipate, respond to and manage changing business conditions could
have a material adverse effect on the Company's business and results of
operations.
Government Regulation and Legal Uncertainties - The Company is not
currently subject to direct regulation other than federal and state
regulation applicable to businesses generally. The Company may also be
subject to uninsured claims by consumers for actions of licensees or
other claims incident to its business operations.
Stock Trading Risks and Uncertainties - On May 28, 1997 the Company's
Common Stock commenced trading on the National Association of
Securities Dealers, Inc. (NASD) OTC Electronic Bulletin Board.
Securities traded on the Bulletin Board are, for the most part thinly
traded and subject to special regulations. The Company's Common Stock
is currently defined as "penny stocks" under the Exchange Act, and
rules of the Securities and Exchange Commission thereunder. The
Exchange Act and such penny stock rules generally impose additional
sales practice and disclosure requirements upon broker-dealers who sell
the Company's securities to persons other than certain "accredited
investors" (generally, institutions with assets in excess of $5,000,000
or individuals with net worth in excess of $1,000,000 or annual income
exceeding $200,000, or $300,000 jointly with spouse) or in transactions
not recommended by the broker-dealer. For transactions covered by the
penny stock rules, the broker-dealer must make a suitability
determination for each purchaser and receive the purchaser's written
agreement prior to the sale. In addition, the broker-dealer must make
certain mandated disclosures in penny stock transactions, including the
actual sale or purchase price and actual bid and offer quotations, the
compensation to be received by the broker-dealer and certain associated
persons, and deliver certain disclosures required by the Securities and
Exchange Commission. Consequently, the penny stock rules may affect the
ability of broker-dealers to make a market in or trade the Company's
shares and thus may also affect the ability of purchasers of shares to
resell those shares in the public markets.
Like that of securities of other small, growth-oriented companies, the
Company's shares are expected to experience future significant price
and volume volatility, increasing the risk of ownership to investors.
Sales of substantial amounts of Common Stock in the public market could
adversely affect the prevailing market price of the Common Stock.
Future changes in market price and volume cannot be predicted as to
timing or extent. Any historical performance that may develop does not
guarantee or imply future performance. Future announcements concerning
the Company or its competitors, quarterly variations in operating
results, announcements of technological or service innovations, the
introduction of new products or services, changes in pricing policies
by the Company or competitors, litigation relating to services or other
litigation, changes in performance estimates by analysts or others,
issuances of or registration of additional securities, or other factors
could cause the market price of the Common Stock to fluctuate
substantially. In addition, the stock market has from time to time
experienced significant price and volume fluctuations that have
particularly affected the market price of small companies and have
often been unrelated to the operating performance of particular
companies.
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 third fiscal quarter ended March 31, 1998 that were not
registered under the Securities Act:
14
<PAGE>
1. During the quarter ended March 31, 1998 the Company sold for cash
$750,000 of unsecured 12% subordinated promissory notes due June
30, 2000 (12% Notes) to twenty-one persons. This is the balance of
an aggregate of $1,000,000 of such notes of which $250,000 was
sold in December 1997. The securities were sold by the Company
without an underwriter. The 12% Notes are not convertible and
interest is payable monthly in cash. Each purchaser was granted a
warrant to purchase 500 common shares at $1.25 per share until
December 31, 2000 ("Warrant") for each $1,000 of 12% Notes
purchased. The Warrants in connection with the 12% Notes sold
during the quarter are exercisable into 375,000 common shares in
the aggregate (aggregate warrants on 500,000 shares for the total
offering). These securities were offered and sold without
registration under the Act, in reliance upon the exemption
provided by Regulation D thereunder and an appropriate legend was
placed on the Notes and Warrants.
2. During December 1997 the Company issued for services rendered by
three persons 91,250 shares of its Common Stock at $0.96875 per
share or $88,398. The securities were issued by the Company
without an underwriter to three qualified investors (one
shareholders, one officer/director and one 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
shares and based on representations of the purchasers. An
appropriate legend was placed on the shares and warrants.
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
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: May 13, 1998 By: /s/BENJAMIN A. PITTMAN
----------------------
Benjamin A. Pittman
Secretary and Controller
(Principal Financial and Accounting
Officer and duly authorized to sign on
behalf of the Registrant)
15
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM STATEMENTS
FOR 9 MONTHS ENDED MARCH 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 190,316
<SECURITIES> 0
<RECEIVABLES> 355,487
<ALLOWANCES> 46,204
<INVENTORY> 3,094
<CURRENT-ASSETS> 515,816
<PP&E> 57,362
<DEPRECIATION> 8,272
<TOTAL-ASSETS> 770,816
<CURRENT-LIABILITIES> 554,596
<BONDS> 1,000,000
0
0
<COMMON> 2,171
<OTHER-SE> (785,951)
<TOTAL-LIABILITY-AND-EQUITY> 770,816
<SALES> 0
<TOTAL-REVENUES> 1,092,577
<CGS> 0
<TOTAL-COSTS> 412,346
<OTHER-EXPENSES> 1,699,871
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 49,987
<INCOME-PRETAX> (1,069,627)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,069,627)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,069,627)
<EPS-PRIMARY> (.13)
<EPS-DILUTED> (.13)
</TABLE>
