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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 1999
Commission File Number 0-22619
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)
360-22nd Street, #210, Oakland, California 94612
(Address of principal executive offices) (Zip Code)
(510) 808-1400
(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, $.00025 par value 9,569,132
- ------------------------------- ---------
(Class) (Outstanding at November 8, 1999)
Transitional Small Business Disclosure Format (check one): YES __ NO X
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<PAGE>
<TABLE>
VALUESTAR CORPORATION
INDEX
<CAPTION>
Page
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 1999 and
June 30, 1999 3
Consolidated Statements of Operations for the three
months ended September 30, 1999 and 1998 4
Consolidated Statements of Cash Flows for the three
months ended September 30, 1999 and 1998 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURES 18
</TABLE>
2
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<CAPTION>
ASSETS
September 30, June 30,
1999 1999
------------ ------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 671,949 $ 270,149
Receivables 454,785 409,806
Inventory 12,725 4,008
Prepaid expenses 35,571 59,446
------------ ------------
Total current assets 1,175,030 743,409
PROPERTY AND EQUIPMENT 606,947 501,605
DEFERRED COSTS 117,379 100,839
INTANGIBLE AND OTHER ASSETS 190,027 194,130
------------ ------------
Total assets $ 2,089,383 $ 1,539,983
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 364,261 461,825
Accrued liabilities and other payables 285,101 189,759
Deferred revenues 48,369 27,430
Note payable - shareholder 285,000 280,000
Current portion of capitalized leases 31,658 30,018
Current portion of long-term debt 1,041,654 1,032,664
------------ ------------
Total current liabilities 2,056,043 2,021,696
CAPITAL LEASE OBLIGATIONS, net of current portion 104,984 113,541
LONG-TERM DEBT, net of current portion 1,828,927 1,795,438
------------ ------------
Total liabilities 3,989,954 3,930,675
STOCKHOLDERS' DEFICIT
Preferred stock, $.00025 par value; 5,000,000 shares
authorized, 500,000 shares designated Series A Convertible,
225,000 Series A shares issued and outstanding at
September 30, 1999 56 --
Common stock, $.00025 par value; 20,000,000 shares
authorized, 9,374,132 shares issued and outstanding 2,344 2,344
Additional paid-in capital 8,787,194 6,485,373
Accumulated deficit (10,690,165) (8,878,409)
------------ ------------
Total stockholders' deficit (1,900,571) (2,390,692)
------------ ------------
Total liabilities and stockholders' deficit $ 2,089,383 $ 1,539,983
============ ============
<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,
------------------------------
1999 1998
----------- -----------
REVENUES $ 722,125 $ 605,660
----------- -----------
OPERATING EXPENSES
Cost of revenues 382,276 193,347
Selling 648,720 382,220
Marketing and promotion 550,068 294,329
Product development 273,869 --
General and administrative 472,060 392,703
----------- -----------
2,326,993 1,262,599
----------- -----------
LOSS FROM OPERATIONS (1,604,868) (656,939)
----------- -----------
OTHER INCOME (EXPENSE)
Interest expense (180,135) (59,559)
Miscellaneous 6,124 (4,069)
----------- -----------
(174,011) (63,628)
----------- -----------
NET LOSS $(1,778,879) $ (720,567)
=========== ===========
NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS $(1,811,756) $ (720,567)
=========== ===========
LOSS PER COMMON SHARE $ (0.19) $ (0.08)
=========== ===========
WEIGHTED AVERAGE OF COMMON SHARES
OUTSTANDING 9,374,132 8,682,496
=========== ===========
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,
------------------------------------
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,778,879) $ (720,567)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation 59,473 8,652
Amortization of intangible assets 4,624 --
Amortization of bond discount 56,335 17,249
Change in allowance for doubtful accounts (8,670) --
Accrued interest included in long-term debt 7,500 --
Options issued for services 59,000 --
Changes in:
Receivables (36,309) (92,531)
Inventory (8,717) 5,414
Prepaid expenses 23,875 3,902
Deferred costs (16,540) 81,788
Other assets (2,811) --
Accounts payable (97,564) 236,370
Accrued liabilities and other payables 95,342 (19,270)
Deferred revenues 20,939 17,869
----------- -----------
Net cash used by operating activities (1,622,402) (461,124)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Property and equipment acquisitions (164,815) (103,005)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of preferred stock 2,210,000 --
Proceeds from debt -- 285,000
Payments on capital leases (6,917) --
Payments on debt (14,066) (960)
----------- -----------
Net cash provided by financing activities 2,189,017 284,040
----------- -----------
NET INCREASE (DECREASE) IN CASH 401,800 (280,089)
CASH, beginning of period 270,149 398,604
----------- -----------
CASH, end of period $ 671,949 $ 118,515
=========== ===========
SUPPLEMENTAL CASH-FLOW INFORMATION
Cash paid during the year for:
Interest $ 112,252 $ 42,310
Income taxes $ 800 $ --
Non-cash investing and financing activities:
Accrued dividends on Series A Preferred Stock $ 32,877 $ --
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
5
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1999
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 300 industries; certifying highly rated businesses; and
selling ancillary materials and services. The Company's activities are currently
concentrated in eight regional markets. 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, 1999.
The interim consolidated financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. The Company has experienced
recurring losses from operations and the use of cash from operations.
Management's plan is to market and promote its existing program and develop new
rating content for consumers to achieve revenue growth and, ultimately,
profitable operations. Required new financing may not be available and it is
unlikely cash flows from operations will be sufficient to enable the Company to
meet its obligations. The Company could be forced to dramatically reduce its
level of operations and this would have a material adverse impact on the
Company's operations. These interim consolidated financial statements do not
give effect to any adjustments which would become necessary should the Company
be unable to continue as a going concern and therefore be required to realize
its assets and discharge its liabilities in other than the normal course of
business and at amounts different from those reflected in the accompanying
interim consolidated financial statements.
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 period ended
September 30, 1999 are not necessarily indicative of the results that may be
expected for the year ending June 30, 2000.
3. PRODUCT DEVELOPMENT COSTS
Prior to the current fiscal year, development expenses associated with the
design, development and testing of programs and services have not been material.
In the first quarter of fiscal 2000, the Company commenced the design,
development and testing of an expanded and new Internet initiative using
existing and new content. Product development expenses are being charged to
operations as incurred.
6
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1999
4. 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.
5. 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.
6. NOTE PAYABLE - SHAREHOLDER
The Company is obligated pursuant to a 15% unsecured subordinated note to a
company related to a shareholder/director in the principal amount of $300,000
due June 30, 2000.
<TABLE>
<CAPTION>
7. LONG-TERM DEBT
Long-term debt at September 30, 1999, consists of the following:
<S> <C>
8% Senior Secured Notes Payable; principal of $2,450,000; interest is paid
monthly, with the principal repayable in 16 quarterly payments of $153,125
commencing in March 2002, and maturing December 2005; net of unamortized note
discount of $1,378,074 $1,071,926
12% Notes; principal of $100,000; unsecured; interest is paid monthly, with a
balloon principal payment due in March 2001; net of unamortized note discount
of $5,454 94,546
12% Subordinated Notes: principal of $1,000,000; unsecured: interest is paid monthly,
with a balloon principal payment due in June 2000; net of unamortized note
discount of $20,173 979,827
6% Convertible Notes, principal of $500,000; subordinated and unsecured;
interest is payable in kind on conversion or at maturity in June 2001; includes
$41,550 of accrued interest; net of unamortized note discount of $28,077 513,473
15% Equipment Note due to related party; due in monthly installments of principal
and interest of $2,022 to maturity in August 2003; secured by equipment and software 71,575
15% Equipment Note due to related party; due in monthly installments of principal
and interest of $5,055 to maturity in June 2002; secured by equipment and software 139,234
-----------
2,870,581
Less current portion 1,041,654
-----------
$1,828,927
===========
The 6% Convertible Notes, and accrued interest thereon, are convertible into common stock at $1.00 per common share.
</TABLE>
7
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1999
<TABLE>
8. STOCKHOLDERS' DEFICIT
The following table summarizes equity transactions during the three months ended September 30, 1999:
<CAPTION>
Preferred Stock Common Stock Additional
----------------- ------------------------ Paid-In Accumulated
Shares Amount Shares Amount Capital Deficit Total
------- ------ --------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance July 1, 1999 -- -- 9,374,132 $ 2,344 $ 6,485,373 $ (8,878,409) $ (2,390,692)
Issuance of Series A Convertible
Preferred Stock, net of issuance
costs of $40,000 225,000 $ 56 -- -- 2,209,944 -- 2,210,000
Accrued 8% dividends on Series A
Preferred Stock -- -- -- -- 32,877 (32,877) --
Value assigned to options granted
for services -- -- -- -- 59,000 -- 59,000
Net loss -- -- -- -- -- (1,778,879) (1,778,879)
-------- ------ ------------ ------------ ------------ ------------ ------------
Balance September 30, 1999 225,000 $ 56 9,374,132 $ 2,344 $ 8,787,194 $(10,690,165) $ (1,900,571)
======== ====== ============ ============ ============ ============ ============
</TABLE>
During the first quarter the Company issued 225,000 shares of Series A
Convertible Preferred Stock, par value $.00025 ("Series A Preferred Stock") for
cash of $10 per share. Dividends of 8% per annum compounded are payable in
additional shares of Series A Preferred Stock. The dollar amount of Series A
Preferred Stock is convertible into shares of common stock at a conversion price
equal to $2.00 per share, and are automatically converted on the occurrence of
certain events. The Series A Preferred Stock has certain antidilution and
registration rights, has a liquidation preference of $10 per share plus accrued
and unpaid dividends, and has voting rights equal to the number of common shares
into which it is convertible. In addition, as long as there are at least 100,000
shares of Series A Preferred Stock outstanding, then the holders are entitled to
elect one member of the Company's Board of Directors.
<TABLE>
9. STOCK OPTIONS AND WARRANTS
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 1,250,000 shares of common stock for the 1997 Stock Option Plan. The
Company has also issued options on 200,000 shares outside of the option plans.
The following table summarizes option activity for the period ended September
30, 1999:
<CAPTION>
Weighted Average Weighted
Shares Exercise Price Average Life
------ -------------- ------------
<S> <C> <C> <C>
Outstanding July 1, 1999 1,111,100 $0.78 2.49
Granted 583,000 $1.94
Canceled (14,999) $1.33
Exercised -- --
Expired (15,000) $0.50
---------
Outstanding September 30, 1999 1,664,101 $1.18 3.20
=========
Exercisable at September 30, 1999 809,505 $0.68
=========
</TABLE>
In connection with the sale of the 8% Senior Secured Notes on March 31, 1999
(see note 7) the noteholders were granted warrants to purchase an aggregate of
1,527,250 shares of Common Stock of the Company at an exercise price of $1.00
per share ("A Warrants"), warrants to purchase an aggregate of 527,514 shares of
Common Stock at a nominal per share exercise price of $0.00025 ("B Warrants")
and warrants to purchase an aggregate of 231,132 shares of Common Stock at an
exercise price of $1.00 per share ("C Warrants"). The C Warrants or underlying
shares of Common Stock may be repurchased by the Company at $6.00 per share
(less any unpaid exercise price) on an all or none basis until March 31, 2004 as
long as the Company is not in default with respect to the Senior Notes or
related agreements. The warrants expire on the earlier of six years from the
date the Senior Notes are paid in full or March 31, 2009. The warrants may be
exercised by payment of cash, cancellation of debt or on a cashless basis.
8
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1999
9. STOCK OPTIONS AND WARRANTS (Cont'd)
The holders of the A, B and C Warrants were granted antidilution provisions,
registration rights and certain equity and debt preemptive rights. Prior to a
qualifying public offering (proceeds of $15 million at a price of at least $5.00
per share and a valuation of at least $40 million), qualified sale (valuation of
at least $40 million and minimum proceeds of $5.00 to $7.00per share to Holders)
or a qualifying stock market listing (Nasdaq National Market or New York Stock
Exchange and minimum price and trading volume), in the event of a sale or
disposition of the Company or substantially all of its assets, the number of
shares of Common Stock for which the Warrants may be exercised may be increased,
without a corresponding increase in the aggregate consideration, to provide
additional consideration to the holders of the warrants based on a revenue based
valuation. A sale may also be initiated by the warrant holders in certain
instances as described in the next paragraph.
The holders of the A, B and C Warrants have certain "Drag Along Rights". Until a
qualifying public offering or sale is completed by the Company or a qualifying
market listing is achieved, then upon either (i) a change in control (the
current three directors owning less than 20% of the Company on a fully diluted
basis), or (ii) the loss of Mr. Stein as President without a replacement
acceptable to the holders, or (iii) a non-qualifying public offering, or (iv)
certain defaults under the Senior Notes, and (v) at any time between April 2004
and April 2009 (unless the rights are earlier terminated), the holders of the A,
B, and C Warrants may seek a buyer for the Company or its assets and the Company
and the current three directors are obligated to cooperate and take such actions
to complete a sale, consistent with their fiduciary duties. Upon such a sale,
the A, B and C Warrants may be exercised for additional shares of Common Stock
resulting in additional dilution to existing shareholders of the Company. This
dilution could be material should the Drag Along Rights become exercisable and
subsequently exercised by the holders.
At September 30, 1999 the Company had the following stock purchase warrants
outstanding each exercisable into one common share:
Number Exercise Price Expiration Date
------ -------------- ---------------
500,000 (1) $1.25 December, 2000
50,000 $1.25 March, 2001
200,000 (1) $1.25 June, 2002
300,000 (1) $1.25 September, 2002
200,000 (1) $1.25 December, 2002
50,000 $1.75 May, 2003
262,500 (2) $1.25 April, 2003
262,500 (3) $2.00 April, 2003
200,000 $0.75 October, 2003
500,000 (1) $1.00 December, 2003
152,728 (1) $1.375 March, 2004
30,000 (1) $1.50 March, 2004
1,527,250 $1.00 March, 2009 (A Warrants)
527,514 $0.00025 March, 2009 (B Warrants)
231,132 (4) $1.00 March, 2009 (C Warrants)
---------
4,993,624
=========
(1) These warrants are callable at a stock price of $5.00 per share
subject to certain conditions.
(2) These warrants are callable at a stock price of $3.00 per share
subject to certain conditions.
(3) These warrants are callable at a stock price of $4.50 per share
subject to certain conditions.
(4) These warrants may be repurchased by the Company at $6.00 per share
until March 31, 2004 subject to certain conditions.
Subsequent to September 30, 1999 a total of 25,000 warrants were exercised at
$1.25 per share by reducing the principal of the Company's 12% Subordinated
Notes by $31,250. An additional 420,000 warrants were exercised for cash
proceeds of $475,000.
9
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1999
10. INCOME TAXES
At September 30, 1999 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 $8 million
which expire through 2019 of which certain amounts are subject to limitations
under the Internal Revenue Code, as amended.
11. LOSS PER COMMON SHARE
Loss per common share is computed using the weighted average number of common
shares outstanding. Since a loss from operations exists, a diluted earnings per
common share number is not presented because the inclusion of common stock
equivalents in the computation would be antidilutive. Common stock equivalents
associated with warrants, stock options and convertible notes and preferred
stock, which are exercisable into approximately 7.4 million shares of common
stock at September 30, 1999 could potentially dilute earnings per share in
future periods.
The provisions of the Series A Preferred Stock provide for cumulative 8%
dividends payable in additional shares of preferred stock and provide, upon
conversion, a similar accretion whether or not such dividends have been declared
by the Board of Directors. This amount increases the net loss available to
common stockholders. Net loss available to common stockholders is computed as
follows:
Three Months Ended
September 30,
1999 1998
---- ----
Net loss $(1,778,879) $(720,567)
Accrued dividends on Series A Preferred Stock (32,877) --
----------- ----------
Net loss available to common stockholders $(1,811,756) $(720,567)
=========== ==========
12. RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 is effective for
fiscal years beginning after June 15, 2000, and requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
market value. Gains or losses resulting from changes in the values of those
derivatives are accounted for depending on the use of the derivative and whether
it qualifies for hedge accounting. The key criterion for hedge accounting is
that the hedging relationship must be highly effective in achieving offsetting
changes in fair value or cash flows. The Company does not expect the adoption of
SFAS No. 133 to have a material effect on the Company's consolidated financial
statements.
13. YEAR 2000 COMPLIANCE
The Company has assessed its exposure with respect to Year 2000 technology
compliance as limited, although it is not possible to quantify the effects Year
2000 compliance issues will have on customers or suppliers, and does not expect
any interruption in its normal business activities. The Company has identified
and evaluated the changes to its computer systems necessary to achieve a Year
2000 date conversion and has substantially completed conversion efforts. The
costs of achieving Year 2000 compliance are not material. The Company believes,
based on available information, that it will be able to manage its Year 2000
transition without any material adverse effect on its business operations,
services or financial prospects.
10
<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, 1999.
Overview
We are a research and rating company and have designed a rating system and
certification mark, ValueStar Certified(R), for service businesses. Our rating
system is designed to enable buyers to quickly determine those local service
businesses that have attained the highest level of customer satisfaction. Our
ratings are provided on the Internet at www.valuestar.com, in print in the
Consumer ValueStar Report, through promotions by and buyer interactions with
certified businesses.
In the first quarter of fiscal 2000, we commenced the design, development and
testing of an expanded Internet initiative using existing and new content. The
goal of this development is to position ValueStar as the dominant infomediary
linking buyers with local service businesses. We plan to capitalize on our
existing expertise in customer satisfaction rating systems to create this new
Internet service.
Our revenues are generated primarily from research and rating fees paid by new
and renewal businesses, certification fees from qualified applicants and
renewals and from the sale of information products and services. An important
aspect of our 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. From time to
time we provide discounts, incentives from basic pricing and payment terms on
fees.
We expense research and rating costs as incurred. Costs incurred in printing and
distributing our Consumer ValueStar Report publication for buyers, currently
published in January and July, and any related revenues are recognized upon
publication. Accordingly, the costs and revenues from this publication impact
the revenues and costs in our first and third fiscal quarters.
Certain direct-response advertising costs are deferred and amortized over the
expected period of future benefits, approximately 60 days. 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. Deferred costs are
periodically evaluated to determine if adjustments for impairment are necessary.
Since inception, we have been growing and developing our business and have
incurred losses in each year. At September 30, 1999, we had an accumulated
deficit of $10,690,165. There can be no assurance of future profitability.
Effect of Growth in Certified Businesses and Renewals
Our 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 our Consumer ValueStar Report to
buyers, maintaining our www.valuestar.com Internet site and providing other
services. The marginal fixed costs associated with increased numbers of
certified businesses are minimal compared to these base printing, distribution
and maintenance costs.
11
<PAGE>
Since considerable portions of our operations are engaged towards the
solicitation of new service and professional business applicants, we incur
substantial costs towards this activity. Currently, we defer direct telephone
sales costs and amortize them at the time of certification, an average of
approximately 60 days. Other costs are expensed as incurred.
At September 30, 1999, we had 1,636 certified businesses.
As a market region matures and we attain a larger base of certified businesses,
we expect fixed and indirect costs will decline as a percentage of revenues. We
believe our 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, overhead and elective
advertising and promotion costs). We believe we could reduce operating costs to
achieve break-even operations on reduced levels of new sales and by maintaining
the existing base of renewing businesses in California. However, any dramatic
cutbacks would curtail growth and our ability to expand in the future.
Future operations are impacted by changes in cost structure and elections
regarding new product development, advertising, promotions and growth rates (due
to the lower margins in the first year). We have recently increased numbers of
sales, marketing and support personnel. Rapid growth, due to the nature of our
operations, is expected to contribute to continued operating losses in the
foreseeable future.
At September 30, 1999, we had 929 (823 new and 106 renewal) business customers
in the application and rating phase. The total represents approximately 70 days
sales. Business customers in the rating phase are expected to represent
approximately $590,000 of revenues that should be recognized in the second
quarter of fiscal 2000 (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 our Consumer ValueStar Report and on the Web site, and other
ancillary revenues. We reported total revenues of $722,125 for the three months
ended September 30, 1999, a 19% increase over revenues of $605,660 for the first
three months of the prior year. During the most recent quarter, certification
fees accounted for 77% of revenue, compared to 79% for the first quarter of the
prior year. The growth in revenues is the result of our regional expansion,
improved new sales velocity and the impact of a larger base of business member
renewals in Northern California. We expect renewing businesses to continue 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.
We reported approximately $85,000 of revenue from premium listings in our
Consumer ValueStar Report and on our Web site, a decrease of $9,000 from the
$94,000 reported in the first three months of the prior year. The decrease
results in a shift of focus to licensing revenue on the part of the Company.
Additionally, we provided listings free of charge to all business certified in
the new markets for the most recent Consumer ValueStar Report.
Our revenues can vary from quarter to quarter due to (a) the impact of revenues
from upgraded profiles in the semi-annual Consumer ValueStar Report, (b)
seasonality, (c) effectiveness of sales methods and promotions, (d) levels of
expenditures targeted at prospective businesses, (d) the numbers of certificate
holders up for renewal, (e) renewal rates, (f) pricing policies, (g) customer
passing and sign-up rates (h) timing of completion of research and ratings, and
(i) other factors, some of which are beyond our control.
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. Cost of revenues totaled $382,276 and
represented 53% of sales during the three months ended September 30, 1999. This
is an increase from 32% for the three months ended September 30, 1998. We made
changes in fiscal 1999 to make our ratings more timely and efficient. However,
during the first quarter of the current year, as compared to the comparable
period of the prior year, we incurred increased rating costs on a higher number
of businesses that elected not to become certified, primarily in new markets
where the value of our services is less recognized. Cost of revenues may vary
significantly from quarter to quarter both in amount and as a percentage of
sales.
12
<PAGE>
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. Selling costs for the three
months ended September 30, 1999, were $648,720, or 90% of revenues, compared to
$382,220, or 63% of revenues for the first quarter of the prior year. In fiscal
1999 we commenced rating businesses in seven new market regions and continue to
incur increased selling costs associated with early startup of these new
regions. New market regions provide only nominal revenues in the first quarter
of opening due to the approximately 60 to 90 day lag from selling activities to
initial revenues. Other than direct targeted telemarketing costs, we expense
selling costs as incurred. We expect selling 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, level and percentage of fixed selling costs,
the number of new market regions opened and other factors, some beyond our
control.
Marketing and Promotion Expenses. Marketing and promotion expenses aggregated
$550,068, or 76% of revenues during the first quarter of fiscal 2000, compared
to $294,329, or 49% of revenues for the prior period. Included in marketing and
promotion expenses are printing and distribution costs of our Consumer ValueStar
Report publication targeted at buyers. Printing and distribution costs were
$173,000 in the first quarter compared to $107,000 in the prior year's first
quarter, as we printed and distributed more copies with additional pages. During
the first quarter of fiscal 2000, we expended $218,000 on paid advertising
targeted at expanding consumer awareness of ValueStar Certified. Paid
advertising of $98,000 was employed in the prior year's first quarter. These
increased costs reflect management decisions to increase advertising over prior
year levels and significant advertising rate inflation. During the first quarter
of fiscal 2000, we expended $74,000 on promotions compared to $54,000 for the
prior year's first quarter with the increase due to an increased number of
promotions in the period. Generally, the first and third fiscal quarters have
increased costs because our Consumer ValueStar Report publication is printed and
distributed during these quarters. Also, we generally expend less advertising in
our second fiscal quarter (fourth calendar quarter) due to higher media rates
associated with the holiday season.
Marketing and promotion expenses are subject to significant variability based on
decisions regarding the timing and size of distribution of our Consumer
ValueStar Report and decisions regarding paid advertising, public relations and
market and brand awareness efforts. We anticipate continuing to make significant
expenditures on marketing and promotion efforts to support a growing business
base but anticipate these costs will decrease as an annual percentage of
revenues as revenues grow. However, amounts and percentages on a quarterly basis
may vary significantly.
Product Development Expenses. In prior years development expenses associated
with the design, development and testing of our programs and services have not
been material. In the first quarter of fiscal 2000 we commenced the design,
development and testing of an expanded Internet initiative using existing and
new content. During the three months ended September 30, 1999 we expended
$273,869 on new program development and segregated these costs as product
development costs. The major component of product development costs were
compensation and related costs of $181,000. We expect, subject to adequate
financing, that product development expenses will increase in the second quarter
due to increased numbers of personnel. We estimate, but there can be no
assurance, that certain new products can produce revenue during fiscal 2000.
Future levels of product development costs will depend on factors not currently
estimable by our management.
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 $472,060 or 65% of revenues for the three months
ended September 30, 1999, compared to $392,703 or 65% of revenues for the prior
year's first quarter, an increase of $79,357. The major increases include a
$45,000 increase in compensation and benefits due primarily to the increased
number of executive and management personnel added in connection with regional
expansion; and a $62,000 increase in occupancy and telephone costs due to
additional personnel and expanded office facilities. Management anticipates that
general and administrative costs will continue to exceed prior period levels due
to increased personnel added to support growth and increased general computer,
operating, occupancy and corporate costs.
We incurred interest expense for the three months ended September 30, 1999 of
$180,135 that included $60,959 of non-cash amortization of bond discount and
accrued paid-in-kind interest. Interest for the prior comparable period was
$59,559. The increase resulted from the significant additions to our debt to
finance growth and our related losses.
13
<PAGE>
Net Loss. We had a net loss of $1,778,879 for the three months ended September
30, 1999, compared to a loss of $720,567 for the three months ended September
30, 1998. Our increased loss is attributable to (a) increased selling costs
resulting from the expansion of sales personnel to new market regions, (b)
increased marketing and promotion costs due to increased market regions, (c)
product development costs in the current period, and (d) increased general and
administrative costs associated with additional management and support for new
market regions. We anticipate we will continue to experience operating losses
until we achieve a critical mass base of renewing certificate holders or
revenues from new products. We are increasing our business volume (new and
renewal certifications) and future quarterly results will be greatly impacted by
future decisions regarding new markets, advertising and promotion expenditures,
launching of new products and services and growth rates. Achievement of positive
operating results will require that we obtain a sufficient base of revenues to
support our operating and corporate costs. There can be no assurance we can
achieve a profitable base of operations.
The loss available to common stockholders for the three months ended September
30, 1999 of $1,811,756 includes $32,877 of accrued dividends on Series A
Convertible Preferred Stock.
Liquidity and Capital Resources
Since we commenced operations, we have had significant negative cash flow from
operating activities. Our negative cash flow from operating activities was
$1,622,402 for the three months ended September 30, 1999. At September 30, 1999,
we had a working capital deficit of $881,013, including $1,041,654 representing
the current portion of long-term debt. For the three months ended September 30,
1999, our negative cash flow from operating activities was due primarily to our
continued operating losses, losses in new market regions, addition of new
executive management and investment in new products and business growth. At
September 30, 1999, our net accounts receivables were $454,785 representing
approximately 57 days of revenues and an annualized turnover ratio of
approximately 6.3 times. This compares favorably to approximately 64 days of
revenues and turnover of approximately 5.7 times at June 30, 1999. Our improved
turnover and reduced accounts receivable level results primarily from increased
revenues and more diligent collection efforts. We believe that 60 to 90 days
revenues in receivables is reasonable based on the nature of our business and
the terms we provide certifying companies on certain fees. At September 30,
1999, we have not experienced and we do not anticipate any significant accounts
receivable recoverability problems.
We have financed our operations primarily through the sale of common equity and
debt financing. In July and August 1999, we sold $2,250,000 of Series A
preferred stock for cash. These funds are being used for operations and product
development. Subsequent to September 30, 1999 we obtained $475,000 from the
exercise of warrants for cash. We have no commitments for future investments
however we are discussing additional financing with investors to support new
product introduction and to finance operations. In the past, shareholders and
debt holders, including from time to time directors, have advanced funds and at
times some have converted debt funds to equity financing on terms of new forms
of financing. There can be no assurance that we can continue to finance our
operations through existing or new investors or from other sources. There can be
no assurance that shareholders or directors or others will provide any future
financing to ValueStar.
Other than cash on hand of $671,949 at September 30, 1999, net accounts
receivable of $454,785, and the funds received subsequent to September 30, 1999
described above, we have no material unused sources of liquidity at this time.
We expect to incur additional operating losses in future fiscal quarters as a
result of continued operations, product development expenditures 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 our
control.
We expect that we will require a minimum of $5 million of additional capital to
finance operations during the next twelve months. This estimate is based on the
first quarter level of operations, anticipated revenues and budgeted product
development and operating costs. To expand into new market regions or launch new
products or services, we would require additional financing. Our actual results
could differ significantly from plan and, therefore, we may require
substantially greater operating funds. Should required and/or additional funds
not be available or planned operations not meet our expectations, we may be
required to significantly curtail or scale back staffing, advertising, marketing
expenditures and general operations. We may also have to curtail the number of
market regions in which we operate, with more reliance on more established
market regions providing potentially higher profitable renewals. There can be no
assurance that additional funding will be available to us or on what terms.
Potential sources of funds include exercise of warrants and options, loans from
existing shareholders or other debt financing or additional equity offerings.
14
<PAGE>
New Accounting Pronouncements and Issues
The Financial Accounting Standards Board has issued new pronouncements as
discussed in the footnotes to our interim financial statements. As discussed in
the notes to our interim financial statements, the implementation of these new
pronouncements is not expected to have a material effect on our financial
statements.
On September 28, 1998, the SEC issued a press release and stated that 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. In response the SEC's Division
of Corporation Finance has established an Earnings Management Task Force to
focus staff resources on the review of filings where potential earnings
management issues may be present. Until such time as the SEC staff issues
interpretative guidelines, it is unclear what, if any, impact such
interpretative guidance and review of filings will have on our current
accounting practices. Our practices have been consistently applied since our
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 us, could have
a material impact on the manner in which we recognize revenue. Any changes would
have no effect on reported cash flow or the economic value of our certification
business.
Year 2000 Readiness Disclosure
We are 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 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 which could lead to
business disruptions in the U.S. and internationally.
We have identified the following areas that could be impacted by the Year 2000
issue. They are (a) our products, (b) internally used systems and software, (c)
products or services provided by key third parties, and (d) the inability of
certifying businesses and prospective customers to process business transactions
relating to certifying revenue and product sales.
During the first calendar quarter ended March 31, 1999, we completed an initial
review of our internal systems. The review consisted of an evaluation of
significant internal hardware systems and major software application programs
that are primarily packaged third party "off-the-shelf" software programs. As a
result of this review, we identified certain systems which required further
review and probable upgrades to be Year 2000 ready. At September 30, 1999 we
believe we have completed the required upgrades to our systems to be Year 2000
compliant. We do not believe our certification and other products have any
material Year 2000 problems.
In addition, we continue to assess the compliance of our customers, suppliers
and vendors. We believe that third-party relationships upon which we rely
represent the greatest risk with respect to the Year 2000 issue, because we
cannot guarantee that third parties will be able to adequately assess and
address their Year 2000 compliance issues in a timely manner. As a consequence,
we can give no assurances that issues related to Year 2000 will not have a
material adverse effect on our future results of operations or financial
condition.
To date, there have been no material direct out-of-pocket costs associated with
our Year 2000 compliance effort. Maintenance or modification costs are expensed
as incurred, while the costs of new computers or software are capitalized and
amortized over the respective useful life.
Should we not be completely successful in mitigating internal and external Year
2000 risks, the likely worst case scenario could be a system failure causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, deliver certifications and products, send invoices or
engage in similar normal business activities at our office or with our vendors
and suppliers. If we determine certain suppliers are not Year 2000 compliant, we
may have to arrange for alternative sources of supply and the stockpiling of
inventory (mainly brochures) in the fall of 1999 in preparation for the Year
2000. We have no current plans to implement stockpiling, however should we elect
to do so, we cannot estimate at this time the cost or effect on our financial
condition of such action. We currently do not have any other contingency plans
with respect to potential Year 2000 failures of our suppliers or customers and
at the present time, after an initial evaluation, we do not intend to develop
one. If these failures would occur, depending upon their duration and severity,
they could have a material adverse effect on our business, results of operations
and financial condition.
15
<PAGE>
The information set forth above under this caption "Year 2000 Readiness
Disclosure" relates to our efforts to address the Year 2000 concerns regarding
our (a) operations, (b) products and technologies licensed or sold to third
parties and (c) major suppliers and customers. Such statements are intended as
Year 2000 Statements and Year 2000 Readiness Disclosures and are subject to the
"Year 2000 Information Readiness Act."
Tax Loss Carryforwards
As of June 30, 1999, we had approximately $8 million of federal tax loss
carryforwards. These losses create a deferred tax asset. We have recorded a
valuation allowance to reduce the net deferred tax asset to zero because, in our
assessment, it is more likely than not that the deferred tax asset will not be
realized. There may also be limitations on the utilization of tax loss
carryforwards to offset any future taxes.
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
our financial position, business strategy, budgets and plans and objectives of
management for future operations are forward-looking statements. Although we
believe 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, product development 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 our annual report on Form 10-KSB for the fiscal year ended June 30, 1999 and
not to place undue reliance on the forward-looking statements contained herein,
which speak only as of the date hereof. We undertake 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, 1999
that were not registered under the Securities Act:
During July and August we issued 225,000 shares of Series A
Convertible preferred stock, par value $.001 for cash of $10
per share for gross proceeds of $2,250,000. Dividends of 8%
per annum compounded are payable in additional shares of
Series A stock. The dollar amount of Series A stock is
convertible into shares of common stock at a conversion price
of $2.00 per share and are automatically converted on the
occurrence of certain events. The Series A stock has a
liquidation preference of $10 per share plus accrued and
unpaid dividends. The Series A stock has certain antidilution
and registration rights and has voting rights equal to the
number of shares of common stock that it is convertible. In
addition, as long as there are at least 100,000 shares of
Series A stock outstanding, then the holders thereof are
entitled to elect one member of our board of directors.
We sold the Series A stock without an underwriter and no
commissions were paid. The Series A stock was offered and sold
without registration under the Securities Act solely to
"accredited" investors in reliance on the exemption provided
by Regulation D and Section 4(2) thereunder and an appropriate
legend was placed on the Series A stock and will be placed on
the shares issuable on conversion unless registered under the
Securities Act prior to issuance.
16
<PAGE>
(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
17
<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, 1999 By: /s/ JAMES A. BARNES
--------------------
James A. Barnes
Secretary and Treasurer
(Principal Financial Officer and duly
authorized to sign on behalf of the Registrant)
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
UNAUDITED FINANCIAL STATEMENTS FOR QUARTER ENDED SEPTEMBER 30, 1999
INCLUDED IN THE QUARTERLY REPORT ON FORM 10QSB.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 671,949
<SECURITIES> 0
<RECEIVABLES> 490,194
<ALLOWANCES> 35,409
<INVENTORY> 12,725
<CURRENT-ASSETS> 1,175,030
<PP&E> 777,986
<DEPRECIATION> 171,309
<TOTAL-ASSETS> 2,089,383
<CURRENT-LIABILITIES> 2,056,043
<BONDS> 1,933,911
0
56
<COMMON> 2,344
<OTHER-SE> (1,902,971)
<TOTAL-LIABILITY-AND-EQUITY> 2,089,383
<SALES> 25,785
<TOTAL-REVENUES> 722,125
<CGS> 13,692
<TOTAL-COSTS> 382,276
<OTHER-EXPENSES> 1,930,296
<LOSS-PROVISION> 14,421
<INTEREST-EXPENSE> 180,135
<INCOME-PRETAX> (1,778,879)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,778,879)
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<EXTRAORDINARY> 0
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<NET-INCOME> (1,778,879)
<EPS-BASIC> (0.19)
<EPS-DILUTED> (0.19)
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