================================================================================
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2000
Commission file number 0-22619
VALUESTAR CORPORATION
(Name of Small Business Issuer in its charter)
Colorado 84-1202005
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
360 - 22nd Street, 4th Floor
Oakland, California 94612
(510) 808-1300
(Address and telephone number of principal executive offices)
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
common stock, par value $0.00025
(Title of class)
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___
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year. $2,090,773
The aggregate market value of the issuer's common stock held by non-affiliates
as of September 15, 2000 (assuming for this purpose that only directors,
officers and 10% or more shareholders of registrant are affiliates of
registrant), based on the average of the closing bid and asked prices on that
date, was approximately $32,619,000.
As of September 15, 2000 there were 15,653,323 shares of ValueStar Corporation
common stock, par value $.00025, outstanding.
Documents Incorporated By Reference: The information required by Items 9, 10, 11
and 12 of Part III of this Report is incorporated by reference from ValueStar's
definitive proxy statement relating to the annual meeting of stockholders to be
held in 2000, which definitive proxy statement shall be filed with the
Securities and Exchange Commission within 120 days after the end of the fiscal
year to which this Report relates-
Transitional Small Business Disclosure Format (check one): Yes ___ No _X_
================================================================================
<PAGE>
<TABLE>
TABLE OF CONTENTS
<CAPTION>
Page
PART I
<S> <C> <C>
ITEM 1. Description of Business 2
ITEM 2. Description of Property 13
ITEM 3. Legal Proceedings 13
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Common Equity and Related Stockholder Matters 13
ITEM 6. Management's Discussion and Analysis or Plan of Operation 15
ITEM 7. Financial Statements 25
ITEM 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 25
PART III
ITEM 9. Directors, Executive Officers, Promoters and Control Persons; 25
Compliance With Section 16(a) of the Exchange Act
ITEM 10. Executive Compensation 25
ITEM 11. Security Ownership of Certain Beneficial Owners and Management 25
ITEM 12. Certain Relationships and Related Transactions 25
ITEM 13. Exhibits and Reports on Form 8-K 26
SIGNATURES 32
</TABLE>
FORWARD-LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT CONTAINS
FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES
LITIGATION REFORM ACT OF 1995 AND THE COMPANY DESIRES TO TAKE ADVANTAGE OF THE
"SAFE HARBOR" PROVISIONS THEREOF. THEREFORE, THE COMPANY IS INCLUDING THIS
STATEMENT FOR THE EXPRESS PURPOSE OF AVAILING ITSELF OF THE PROTECTIONS OF SUCH
SAFE HARBOR WITH RESPECT TO ALL OF SUCH FORWARD-LOOKING STATEMENTS. THE
FORWARD-LOOKING STATEMENTS IN THIS REPORT 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 HEREIN, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR THOSE ANTICIPATED. IN THIS REPORT, THE WORDS
"ANTICIPATES," "ESTIMATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," "GOAL,"
"OBJECTIVE" 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.
Part I
ITEM 1. DESCRIPTION OF BUSINESS.
OUR COMPANY
We are a leading provider of branded rating content on local service businesses.
Our ratings of local service businesses enhance online and offline commerce
between buyers and sellers. We estimate that the total commerce in the U.S.
exceeds $2 trillion annually for all service businesses. As an infomediary, we
help consumer and business buyers make informed purchasing decisions among the
estimated 6 million local service businesses in America. Our ratings provide
service businesses a tool to distinguish themselves from their competitors.
Service businesses pay us research and rating fees and we are developing a new
commission system to generate revenues by connecting member service businesses
with quality seeking buyers. Our ratings and commission system will offer
Internet portals, credit card issuers and other aggregators of consumer and
business buyers a new source of recurring revenue.
2
<PAGE>
We are creating a large database of credential data consisting of license
information, legal status and business profiles that we aggregate for buyers
from over 2,000 databases nationwide. At August 31, 2000 we had approximately
6,000,000 service businesses in our database, essentially all service businesses
in the United States. We have completed ratings on approximately 350,000 service
businesses across the United States. We deliver our credential information
through easy to recognize rating symbols. Our ValueStar Verified(TM) rating
indicates that a service business has passed a credential review. ValueStar
Top-Rated(TM) is a premium certification mark indicating evidence of high
customer satisfaction. To assure unbiased customer satisfaction ratings, we use
the Public Research Institute of San Francisco State University and the Consumer
Law Project of the University of Houston Law Center to audit our survey
research.
We market a licensing program to rated service businesses. Service businesses
that are ValueStar Verified or ValueStar Top-Rated are encouraged to license the
ValueStar program. Our program is designed to provide our licensed or member
businesses preferred access to a flow of quality-seeking buyers. Member
businesses are also licensed to use our rating symbols in their marketing and
promotional activities.
Through technology our rating and buyer information and proprietary shopping
tools are available on the Internet through our Web site (valuestar.com). While
our customer satisfaction ratings are currently conducted offline through
telephone surveys, we are developing technology to automate ratings by buyers
after transactions are completed. Our proprietary shopping tools assist
consumers in selecting among quality service businesses with the freedom to
transact online or offline. We also target and promote the broad distribution of
our rating content through other Internet sites and through offline marketing by
us and by our licensed service businesses. We recently entered into content
agreements with Experian, InfoUSA and Netcentives and rating distribution
alliances with home service portals: Contractor.com, OurHouse.com,
SimplyDone.com; auto portals: CompleteCar.com and FindGarage.com; and other
vertical portals: e.Attorney.com, Foodscape.com, rentals.com and geoTouch.com.
We generate revenues from a combination of fixed certification and rating fees
paid by service businesses. We are developing the technology to collect a
commission on the value of transactions between registered buyer members and
licensed member service businesses. Since a large number of purchases are being
researched online but still consummated offline, a key advantage of our program
is that we expect to receive transaction revenues whether transactions are
consummated online or offline. Buyers are registered free through Internet
alliances, credit-card issuers and through other aggregators of consumers and
business buyers who participate in transaction commissions. Buyers will receive
benefits including loyalty points, satisfaction guarantees and other benefits
for purchasing from ValueStar member service businesses.
Our principal executive offices are located at 360-22nd Street, Oakland,
California, 94612. Our telephone number is 510-808-1300 and our Internet Web
site is www.valuestar.com. The information found on our Web site is not part of
this annual report.
OUR MARKET OPPORTUNITY
We believe there is a compelling buyer need for unbiased ratings on local
services. North America contains fragmented, highly competitive local service
industries. This creates a large number of choices for buyers. For local service
businesses, it is increasingly difficult and costly to differentiate on quality
or customer satisfaction due to the proliferation of claims, the growth of new
media outlets, competition and increasing buyer skepticism. We believe buyers
want to know which businesses are better than others. This need for unbiased
reliable information has been a factor in the growth of Consumer Reports
magazine (product evaluations and ratings), J.D. Powers (customer satisfaction
ratings on vehicles, computers and other businesses) and the growth experienced
by consumer and market research companies.
The total dollar value of buyer services transacted in the United States in
categories rated by ValueStar is estimated at over two trillion dollars annually
based on U.S. Department of Commerce statistics. These services include auto,
home, health, personal, professional and business-to-business services.
According to information analyzed from the U.S. Bureau of Labor Statistics' 1998
Consumer Expenditures Survey, our research indicates that American households,
numbering 107 million, spend approximately $6,200 per year on local services,
while total business-to-business spending exceeds this amount. We believe that
there is a need and a demand for local ratings of service providers comparable
to that available on many products. We believe that the more than six million
service businesses in the United States (estimated from data supplied by
American Business Information) that make up the service and professional
business market provide a large opportunity for ratings. And although directory
type information is available from yellow page listings and city guide services
and certain information about complaints is available through the Better
Business Bureau, our research indicates buyers want to know which companies have
adequate credentials and those that have been rated high in
3
<PAGE>
customer satisfaction.
International Data Corporation, a leading provider of information technology
data, estimates that annual worldwide commerce over the Internet will increase
from $111.4 billion in 1999 to $1.3 trillion by 2003 and that the number of
shoppers worldwide who buy goods and services online will grow from 48 million
in 1999 to approximately 183 million in 2003. Increasing numbers of buyers are
drawn to the Internet to shop but seek unbiased information needed to make
informed shopping decision for local services. Local service businesses, in
turn, are searching for ways to distinguish themselves from competitors, obtain
quality customers through the Internet and to participate in the growth of
e-commerce.
The credit card industry is mature and highly competitive. According to the
Nilson Report, seventy percent of American adults carry an average of 4.3 credit
cards and, even though new card solicitations flood mailboxes, cardholder growth
has slowed. We offer the credit card industry and other membership organizations
a new free member benefit program to aid to reduce member attrition rates,
increase credit card use for service shopping and increase new member
acquisition rates.
OUR SOLUTION
We respond to the needs of buyers and sellers of local services by providing:
o A free searchable database of qualified service businesses meeting
certain licensing and legal status. We are increasing the distribution of
this data primarily through alliances with Internet portals.
o Certifications of the top-rated service businesses from statistically
valid surveys of their prior customers.
o New benefits to buyers that purchase from authorized ValueStar rated
service businesses. These benefits include:
o ValueStar Rating Points redeemable for travel, products and services
o Complaint resolutions services provided by ValueStar
o A money-back satisfaction guarantee (up to $500, subject to
limitations)
o The ability for buyers to use a variety of technology tools to access,
search and shop among competing, but qualified, service businesses
without limiting the buyer to a limited number of discount or referred
businesses.
o The ability for quality sellers to participate in the e-commerce
revolution and to differentiate themselves from other sellers.
We believe consumers want to find the best companies with the best information,
want to be treated as a special customer as they purchase, and if things go
wrong want outside help getting a fair resolution. And finally, if they are
still not happy, they want their money back. Our program and package of benefits
respond to these consumer needs.
We believe businesses want access to quality buyers and want to distinguish
themselves from their competitors on value. We have over eight years of
experience helping quality service businesses use ValueStar certification
symbols to improve their operations.
OUR STRATEGY
Our objective is to be the leader in providing local service ratings and content
to enhance online and offline commerce in local services. To accomplish this
objective we intend to:
o Establish ValueStar as a widely distributed local rating brand both
online and offline.
o Achieve broad reach and recognition by providing ValueStar branded
ratings to Internet portals, yellow pages and shopping engines and by
licensing our brand to local service businesses.
o Deliver accurate, trusted and relevant content on local service
businesses by:
o Maintaining high-quality credential certifications
o Certifying service business customer satisfaction only on the basis
of proven transactions with real customers
o Providing buyers compelling benefits to participate in rating service
businesses
o Generate transaction based revenues by providing relevant benefits to
buyers, sellers and referring partners:
o Buyers receive loyalty points, satisfaction guarantees and related
benefits
o Buyers have clout from the knowledge they will rate the service
business
o Sellers obtain access to new quality conscious buyers
o Referring partners participate in a recurring transaction-based
revenue stream
4
<PAGE>
o Develop and improve on technology to provide the most relevant
information to facilitate commerce in local services.
o Expand our brand and influence throughout North America and
internationally in selected foreign markets.
HISTORY OF DEVELOPMENT
We were incorporated in Colorado in 1987. Our operations are conducted through
our wholly owned California subsidiary, ValueStar, Inc., incorporated in 1991.
During late 1990 and 1991, James Stein (our Chief Executive Officer) developed
the basic operating concept of ValueStar. This concept was developed from Mr.
Stein's own research and prior experience in the Yellow Page publishing industry
and studies conducted by San Francisco State University and The Institute of
Social Research at California State - Stanislaus.
Our sales and licensing activities commenced in the greater San Francisco Bay
area in 1992. On January 1, 1996, we launched our Internet site on the World
Wide Web at valuestar.com. In 1997, we expanded our Internet services by adding
our SmartShopper buying utility, a communication link between buyers and highly
rated businesses.
In July 1999, capitalizing on our expertise in customer satisfaction research
and ratings, we commenced the design, development and testing of an expanded
Internet initiative. This initiative consists of (a) developing proprietary
content on the majority of service businesses in the United States, and (b)
developing an Internet-based system that generates commissions from transactions
driven by the content. The goal of our development is to position ValueStar as
the dominant rating system for local service businesses.
In addition to creating proprietary content on America's service companies, we
are also developing strategic relationships to provide complementary content and
to increase the distribution of the ValueStar brand and related content.
o In January 2000 we entered into a strategic data agreement with Experian,
a leading provider of global information solutions. This alliance
provides financial and legal status on local service businesses as a part
of our content development. We provide Experian with the results of our
branded proprietary research on local service businesses for distribution
to their clients.
o In April 2000 we entered into an alliance with Netcentives to manage our
ValueStar Rating Points award program. As a part of this relationship, we
expect the four million consumer members of Netcentives shopping network,
ClickRewards(TM), will become trial ValueStar members for opt-in
activation.
o Commencing in May 2000 we began to form distribution partnerships with
leading Internet portals and service referral companies to broadly
distribute our ratings. Our roster of distribution partners includes home
service portals: Ourhouse.com, Simplydone.com and Contractor.com; auto
service portals CompleteCar.com and Findgarage.com; and other vertical
portals which are eAttorney.com, rentals.com and GeoTouch.com.
o In June 2000 we entered into a database agreement with InfoUSA, Inc. to
provide certain raw database information.
o We are developing Internet-based software to match transactions between
licensed businesses and registered member buyers. We are working with
several processors of credit card transactions to support our program.
We are also working to develop other alliances and relationships to expand our
content, add highly rated service businesses to our program, extend our brand
and distribute our ratings to consumers. Our marketing and sales activities are
focused on increasing member service businesses and enrolling buying members. In
September 2000 we announced a pilot program for the San Francisco Bay area
credit card holders of First National Bank of Omaha.
We are developing the systems to register buyers and monitor future
transactions. Until this system is operating, we do not anticipate any
significant revenues from these markets. We continue to incur selling costs and
rating costs associated with enrolling member service companies in the ValueStar
program. We believe this investment will accelerate the launch of our new
program by allowing us to have a number of registered service companies already
enrolled by the time we launch our transaction fee system.
Our plan is to have the systems to monitor, record and collect on a transaction
basis during the last quarter of calendar year 2000. However unknown technical
issues and barriers could arise that could delay implementation or preclude us
from executing this plan. In such an event we may be required to revert to a
fixed fee basis.
5
<PAGE>
INDUSTRY BACKGROUND
Delivery of Information to Buyers
We communicate information to buyers in the form of a certification or rating
mark or symbol. The certification mark industry includes trade association and
various accrediting marks. Examples of these marks include the Good Housekeeping
Seal, AAA Approved Auto Repair, J.D. Powers, ISO 9000 and various lodging and
restaurant industry ratings and marks. Since we provide a valuable resource for
consumers to contact to obtain a particular category of business, we share
aspects of referral services and agencies like 1-800 Dentists, 1-800 Plumber,
and medical and contractor referrals. And since we publish and distribute a
periodic listing of businesses rated high in customer satisfaction, we share
industry characteristics of service guide publishers and the yellow pages
industry. And finally, we maintain an Internet site of qualifying service
businesses and buyer information sharing aspects of the growing market for
Internet content such as electronic yellow pages, directories, and city guide
information services.
Factors Unique to Shopping for Services
The factors affecting the selection of a local service are different than those
involving a widely available product: (a) typically, compared to a product
purchase, a buyer has more service provider choices from which to discern, (b)
the quality level of services is less consistent, (c) it is more difficult to
experience or compare a service prior to purchase, (d) services cannot be
returned, and (e) therefore the entire decision process is riskier and more
frustrating for buyers. We respond to these factors by providing buyers and
businesses with important information delivered in various media.
Limitations to Traditional Service Shopping Information
Although traditional shopping is familiar to buyers and the offline market for
services is quite large, highly fragmented and geographically diverse,
purchasing services is time-consuming, costly, inefficient and fraught with risk
to buyers who are unable to sample or return the purchased services. In order to
make an informed purchase decision, buyers typically have to undertake
independent research and interview and evaluate a number of businesses and
non-standard offers with unsubstantiated claims. The market for local services
is inherently inefficient and information available to buyers is generally
limited. We believe our ratings provide highly relevant and easy to use buyer
information unavailable elsewhere.
Growth of Commerce on the Internet
The rapid growth of the Internet and online commerce has revolutionized the way
in which buyers and sellers communicate, share information and conduct business.
A number of unique characteristics differentiate the Internet from traditional
media. Buyers can communicate or access dynamic and interactive content on a
real-time basis without geographic or time limitations, access a broader range
of online offerings, and communicate and interact instantaneously with one or
more sellers at minimal cost. As a result, the Internet has the potential to
support a highly efficient market in which buyers and sellers will be able to
interact based on real-time supply and demand information. This new e-commerce
model will enable buyers to efficiently and conveniently gather comparative
purchasing data, to shop and to communicate with sellers in many new ways. This
model may provide sellers with additional revenue opportunities by making
available a dynamic source of aggregated customer and demand information and by
greatly enhancing the speed and efficiency of transactions between buyers and
sellers. In addition, sellers may be able to acquire more buyers at a lower
cost.
When it comes to America's six million local service businesses, we believe the
major search engines and portals have two major limitations. First, they
currently present a list of local companies to their consumer users that include
unlicensed and bad companies, and second, they generate limited or no revenue
from these local companies. Our strategy is to provide search engines, portals
and related sites with branded ratings allowing their users to make better
purchasing decisions.
Challenges Facing Online Buyers and Sellers of Local Services
Although the advent of online commerce has given buyers and sellers a more
convenient channel to interact, we believe the online marketplace still suffers
from many of the limitations of the offline marketplace. Like traditional
service businesses, businesses listed online are often limited and offer
services of unknown quality and consistency. In addition, in order to make
informed purchasing decisions, buyers still have to conduct online research and,
in many cases, perform substantive offline evaluation and research.
The Internet also poses new challenges to buyers and sellers. Online shoppers
compare service information from multiple service businesses before making a
selection. Online resources only provide limited information about local service
businesses. Typical online shopping engines focus on product shopping and
provide only limited information on services.
6
<PAGE>
Buyers need to be able to find relevant sites and information and sellers need
to develop a brand to distinguish themselves from other, often similar, online
sellers. The increasing number of online commerce opportunities and the ease
with which buyers may navigate online, has increased pressure on service sellers
to find online methods of attracting buyers. And the fragmented nature of local
service businesses make Internet marketing a difficult challenge to meet the new
competitive pressures brought about by the Internet.
Limitations of Online Shopping for Services
For consumers, the Web brings information and services to the home with
unparalleled usefulness and immediacy. We believe that although certain services
such as travel are experiencing rapid Internet growth, the lack of standardized,
independent and unbiased buyer information impedes the growth of local services
being transacted on the Internet. As a result, we believe that ratings and
unbiased information on local service businesses delivered over the Internet
will be a catalyst for increased shopping of local services on the Internet.
To address the significant challenges faced by buyers and sellers of local
services, a number of different online services have emerged:
o Online referral services generally take requests from buyers and refer to
service businesses with which they have a financial relationship.
Typically this online category of lead generation has focused on home
improvement or contracting.
o General purpose online portals and sites (both national and local
community sites) often provide a range of information on service
businesses consistent with the yellow pages and shopping guide approach.
o Comparison shopping services generally focus on products but are capable
of focusing on local services.
o Auction and reverse auction sites focus on some services and are expected
to expand into a greater breadth of local services.
While the above sites and online services provide some information to buyers of
local services, they do not provide the shopping content we believe is unique to
local services. This content includes data on licensing and legal status and the
important attribute of an unbiased rating based on prior customer satisfaction.
THE VALUESTAR SHOPPING EXPERIENCE
Consumer and business buyers use our ratings and content to quickly identify
highly rated local service and professional businesses (including auto, home,
health, personal and professional providers of services) and to make better
shopping choices. Our credential data, identified by the ValueStar Verified
mark, assures buyers that the listed service businesses have the requisite
licensing favorable legal and credit status. Our top tier ValueStar Top-Rated
ratings are based on high customer satisfaction, which we believe is intuitively
logical to most buyers. A study conducted by Public Research Institute in 1993
and updated through 1996 concluded that 2 out of 3 customers who knew a business
had earned ValueStar were influenced by this factor in selecting a service
business.
Buyers seek to avoid problems by using ValueStar rated businesses. In addition
by registering with ValueStar, participating in the ValueStar program and
agreeing to rate businesses online after a purchase, buyers receive a package of
ValueStar benefits.
We also provide a number of technology tools to assist buyers of services. In
addition to anytime access to ValueStar ratings through our Web site and
listings by alliance partners, buyers can directly access and communicate with
top-rated service companies through e-mail and Web links from our or associated
Web sites. After conducting a search for a specific type of top-rated business,
buyers are able to conduct their own personal "shopping auction" by using our
SmartShopper service to send requirements to selected top-rated companies with
one simple form. We intend to continue to enhance the technology available to
buyers by adding features, products, services and additional benefits.
We also provide relevant editorial content for buyers on our Web site including:
o ValueStar Company Profiles - templated displays of shopping information
including owner's philosophy, specialties, years in business, education
and training, company size, affiliations and equipment. Photos and logos
are also included when available.
o ValueStar Reports - articles researched and written by ValueStar for
buyers or sellers in selected service categories. ValueStar Reports help
provide buyers with industry knowledge about how to shop for and transact
with local service companies.
7
<PAGE>
VALUESTAR SERVICE BUSINESS EXPERIENCE
Our rated businesses use the ValueStar program to (a) bring in more qualified
customers, (b) convert shoppers to buyers, (c) reduce pricing pressure on
services, (d) distinguish their services from competitors, (e) improve customer
loyalty, (f) increase customer referral rates, (g) speed up the selling cycle,
(h) improve employee morale, (i) enhance marketing and advertising promotions,
and (j) improve business reputation. -
Our free listing of qualified businesses on the Internet offers small business
owners a presence on the Web at no additional cost. Our alliances with Internet
portals and our SmartShopper service offers businesses Web generated traffic. We
also offer businesses the opportunity to link their Internet site with our Web
site.
While we rate and provide data on a large number of local companies, not all
participate in the ValueStar benefits program. Licensees in this program are
offered a package of benefits and agree to pay either a fixed annual fee or a
commission based fee (generally 5% of matched transactions between authorized
service providers and ValueStar registered buyers). Local service companies that
earn the ValueStar Verified or ValueStar Top-Rated symbol are invited to become
a ValueStar member company and abide by the ValueStar Customer's Bill of Rights.
ValueStar member companies agree to be rated by ValueStar Rating Partners
(consumers or buyers registered with ValueStar), maintain credential and
customer satisfaction standards and abide by written complaint resolution
procedures.
ValueStar licensed member companies receive the following benefits:
o A flow of new, quality-seeking customers.
o A license to use the ValueStar ratings and brands in all of their
marketing activities to differentiate their company based on quality and
assurance.
o A package of signs, labels, brochures, other materials and training to
maximize their implementation of the ValueStar member program.
o Priority position within ValueStar listings on most Web sites. In most
cases the default sort order puts ValueStar member companies at the top
of the list of rated companies.
Our brand recognition is enhanced by daily use by businesses in all manners of
advertising and media supplementing our marketing and promotion activities to
create and enhance buyer, business and brand awareness.
PARTNERSHIPS AND ALLIANCES
We target partnerships and alliances for the creation and distribution of
ratings content, the implementation of our online ratings and the acquisition of
buyer and seller participants by developing strategic partnerships in Internet
distribution, transaction processing, buyer reward, credit agency, government
regulation, financial institution and membership fields. We have created a
program where these partners can participate in commissions generated from
transactions between member buyers and sellers of local services. We categorize
these partnerships or alliances in the following categories:
Infrastructure Alliances
ValueStar's infrastructure alliances provide operational support, software,
infrastructure services and raw data that feed our ratings, ValueStar benefits
and online ratings. Examples of these alliance arrangements include
relationships with Netcentives, Experian, Sesame Technology, MapInfo, InfoUSA,
and various government agencies.
Distribution Partners
ValueStar's distribution partners receive licensing rights to display ValueStar
ratings on their Web site. Examples of these alliances include home service
portals Ourhouse.com, Simplydone.com and Contractor.com; auto service portals
CompleteCar.com and Findgarage.com; and other vertical portals such as
e.Attorney.com, Foodscape.com, rentals.com and geoTouch.com. We also have a
rating agreement with Maid Brigade and COIT Services, Inc. to rate their
members.
Membership Partners
Membership partners provide their customer or membership base our package of
ValueStar benefits. The goal is to increase their member loyalty, increase
members' switching costs, increase member acquisition rates and participate in
the ValueStar commission stream as their members purchase from ValueStar
licensed companies. Examples of membership partners include a marketing alliance
with Netcentives that creates four million opt-in trial members from their base
of ClickReward members and our relationship with eAttorney that makes all
eAttorney members eligible for opt-in participation in the ValueStar benefits
program.
8
<PAGE>
Financial Services Partners
Financial services partners provide their customers and cardholders with our
package of ValueStar benefits. We believe their goals are to increase cardholder
loyalty, increase new card acquisition rates, increase credit balances, decrease
interest rate sensitivity, increase card use and participate in commissions as
their cardholders purchase from ValueStar licensees that participate in
providing benefits to buyers. An example includes our pilot agreement with First
National Bank of Omaha to provide our benefit program to their credit card
holders in the San Francisco Bay area.
VALUESTAR BUYING SYSTEM TECHNOLOGY AND INFRASTRUCTURE
We believe that the technology and database information we are developing can
separate our service from other listing and referral services. We are designing
our technology and an improved Web site ourselves while using contractors and
off-the-shelf systems and tools where appropriate. We believe our heavy
involvement in our systems and technology will allow us to adapt to evolving
marketing strategies and user preferences. The primary elements that distinguish
us are our database-driven architecture that provides the core for our
Internet-based systems.
Database-driven architecture
We have built a scalable user interface that is based primarily on internally
developed proprietary software. The backbone of our service is our merchant
processing system and our database architecture. We have automated the
acquisition of certain data elements from government and private databases
important in determining aggregate credential information.
Systems
Our systems are designed to provide access to our Web site 24 hours per day,
seven days a week. Physical hosting and communications systems are provided by
GlobalCenter, a provider of Web and application hosting solutions to businesses,
which provides redundant communications lines and emergency power backup. We
have designed our systems based on industry standard technologies and have
engineered them to minimize system interruptions in the event of outages or
catastrophic occurrences. We have implemented Cisco Load Director as our load
balancing system and have redundant servers to provide for fault tolerance. Our
database is Oracle 8i, installed on a Solaris E4500.
ValueStar Ratings
We have designed a buying utility to generate transaction commissions from sales
that are driven by ValueStar ratings and create continuously updated customer
satisfaction ratings on local businesses driven by actual purchases. This
ratings program is intended to be operational during the last calendar quarter
of 2000.
After a ValueStar buying member makes a purchase from a ValueStar member
business, a short customer satisfaction survey is generated for the buyer to
complete. Each completed survey is tabulated updating the business member's
rating scorecard and recalculates its total average rating score. At
predetermined threshold levels, the business members rating brand is
automatically changed to a higher or lower rating symbol level.
Our buying members may register their credit cards online with ValueStar to
conveniently receive their ValueStar benefits with each purchase. In most cases,
our buying members will be using a pre-registered credit card issued by a
participating credit-card-issuing bank or other membership organization. We
intend to also match offline purchases on each registered credit card with each
registered ValueStar member business.
Our buying members may also purchase services from ValueStar member businesses
using cash, checks or unregistered credit or debit cards. In these cases,
ValueStar buying members may complete a survey online, and we verify the
purchase. After verification, the buying member receives ValueStar benefits, and
the rating score is posted.
We expect to receive a revenue stream from transaction fees generated as buying
members make purchases from ValueStar member businesses.
For the successful operation of our ratings system, we will be relying in part
on information and processing to be provided by credit card processing firms.
The failure to successfully implement and operate these third party processing
systems or the loss of these relationships would have an adverse impact on our
proposed revenue model and future operating results.
ValueStar SmartShopper Service
Buyers have free access to ValueStar ratings from popular Web sites, portals and
valuestar.com. Buyers do not have to register to use ValueStar ratings and can
shop and purchase any way they want. Once a buyer finds a list of rated
companies in the desired area and industry, the buyer is not forced to fill out
forms, or participate in an auction or reverse marketplace. A buyer may pick up
the telephone and call the company, email the company, or use ValueStar's
9
<PAGE>
SmartShopper service. SmartShopper allows a buyer to send one email request form
to multiple companies simultaneously.
ValueStar's strategy is to license popular buying utilities or partner with
companies that have developed them, and make them available to buyers in the
future. The strategy is to offer buyers the best buying content and the freedom
to choose their favorite buying utility, such as a phone, a personal digital
assistant, or a personal computer.
Some aspects of our technology and programs are subject of a patent application.
We may in the future file additional patent applications on other aspects of our
technology.
RATINGS, SALES AND MARKETING
We have designed our rating, sales and marketing strategies to acquire large
numbers of buyers and sellers interacting through the use of ValueStar ratings.
Our sales strategy focuses on adding credential verified service businesses into
both our top-rated brand and into the ValueStar member program. At the present
time we are not focusing sales or marketing efforts targeted at adding
individual buyers into our program. But alternatively, through our business
development team, we focus on adding buyers through Internet portals, credit
card issuers and other membership organizations. We have designed our marketing
strategy to increase business sales, support business development and increasing
brand awareness.
Ratings
We are in the process of rating each local service company on a credential
basis. At August 31, 2000 we had information on approximately 6,000,000
businesses in our database. During fiscal year 2000 we developed the methodology
and systems to access more than 2,000 government, commercial and proprietary
databases and other businesses to perform our credential based rating. At August
31, 2000 we had completed ratings on over 350,000 businesses which have been
assigned the ValueStar Verified or ValueStar Top-Rated certification. Our goal
in the next four months is to rate an aggregate of 2,000,000 businesses and
ultimately substantially all of the six million service businesses in the United
States.
To perform the Top-Rated customer satisfaction rating, we draw a random sample
of past customers and conduct a telephone survey. In the future, businesses will
also be able to qualify for the Top-Rated designation through on-line ratings
performed by actual customers.
We intend to market our license program to an increasing number of these rated
businesses. At August 31, 2000 approximately 6,300 service businesses were
enrolled and licensed into the ValueStar program. These businesses have agreed
to either pay commissions on transactions with our member buyers as our systems
are completed or pay us an annual fixed licensing fee.
Prior to adding the ValueStar Verified rating in June 2000, we only rated
service businesses in eight markets that had passed both the credential and the
customer satisfaction requirements. We do not charge businesses for credential
ratings but perform these ratings to provide the database for our program
offering. We currently charge a fee ranging from $0 to $570 to perform the
customer satisfaction research for those verified businesses applying to be
Top-Rated.
All customer satisfaction rating business applicants receive a ValueStar
Research and Rating Report with the results of our research. Successful
applicants may license the use of the ValueStar Top-Rated mark, pursuant to
contractual guidelines specified in the terms of our license agreement, in their
advertising, collateral and sales materials, stationery, signage, announcements,
bid forms, etc. A rated and certified business also receives a ValueStar plaque,
program manual and labels for their doors and letterhead.
In order to assure buyers that customer satisfaction ratings performed by
ValueStar are independent, scientific, accurate and unbiased, we maintain
agreements with university partners to audit our customer satisfaction research
and reports. In 1992, we engaged The Public Research Institute, an auxiliary
unit of San Francisco State University, to perform or audit surveys of each
applicant's former customers. In June 1999, we engaged our first regional
auditor, the Consumer Law Project of the University of Houston, to audit our
customer satisfaction ratings on a regional basis.
Sales
All service businesses and professionals located in market regions we serve may
apply to be rated. These include more than 300 industry categories within five
broad groups: Automobile Services (examples include auto body shops, auto
repair, and towing firms), Health and Well Being Services (examples include
acupuncture, physicians and dentists and health clubs), Home Services and
Repairs (examples include alarm companies, carpet cleaners, movers, locksmiths
and
10
<PAGE>
roofers), Personal Services (examples include beauty salons, limousine services
and travel agents) and Professional Services (examples include accountants,
attorneys, employment services, insurance and real estate brokers).
Our sales activities focus on a targeted list of service and professional
businesses resulting from our rating activities which identifies the high
priority accounts among the larger population of verified service and
professional businesses. We use direct mail, advertising, telephone sales,
third-party telemarketing firms and other methods emphasizing the benefits of
becoming a ValueStar program licensee. Our field consultant personnel deliver
Top-Rated awards to successful applicants and also handle renewals and ancillary
sales.
We have also entered into sales and marketing alliances that assist us in
marketing to prospective service businesses. These alliances include
OurHouse.com, Foodscape.com, and geoTouch.com. We pay commissions from time to
time for successful business rating leads from these alliance partners.
Our business development team focuses its sales efforts on alliance partners in
the categories outlined in Partnerships and Alliances above.
Marketing
Our marketing strategy involves a variety of traditional and online marketing
programs as well as our business development and promotional activities. We have
employed radio and billboards in the past and expect to use these methods in the
future to increase brand awareness and encourage businesses to apply to be
rated.
We expect that our alliance partners will be an important part of our
promotional efforts in the future as they inform their members about the
advantages of ValueStar benefits. We also employ co-branding as a key strategy
to expand ValueStar brand awareness.
COMPETITION
We are not aware of a directly competitive rating mark or credentialing service
targeted for a broad range of service industries and delivered across multiple
channels. However, we expect competitive offerings to develop in the future. We
compete for the limited budgets for spending on advertising and promotions among
service and professional businesses. We also compete with a variety of online
offerings discussed below. Current and potential offline competition includes
yellow page publishers, newspapers and periodicals, radio and television
stations and other forms of advertising employed in the consumer service
marketplace. Other current and potential competitors include referral agencies,
telephone services, complaint agencies, service guide publishers, industry
specific certification marks and others. The competition for service business
advertising and promotional funds is intense. There are a large number of
competing firms and a wide variety of product offerings.
The Internet is rapidly evolving and intensely competitive with limited barriers
to entry. There are a number of potentially competitive companies engaged in
facilitating commerce on the Internet including providing more security for
buyers and greater informational content including service business listings,
referrals and information. We expect new Internet competition to develop and
intensify in the future. Existing and potential online competitors can be
divided into several groups:
o Comparison shopping services, although targeting primarily products, may
expand into providing comparison shopping information on services. These
services include companies such as mySimon, BottomDollar, Jango,
StoreRunner, PriceScan, ShopOnline123, BuyBuddy, PriceWatch, PricePulse,
PriceGrabber, 20-20 Consumer, EvenBetter and KillerApp.
o Online referral companies provide online databases and matching services
for buyers and sellers of services. Companies operating in this area
include Improvenet, ServiceMagic.com, iMandi, iCastle, repairnet,
HomesSpud, OurHouse.com, Handyman Online, BidExpress, Contractor.com and
Remodel.com (HomeStore.com).
o Reverse auction sites, such as Priceline.com, Nextag and Respond.com,
that may enter into service industry categories in which we operate.
o Merchant guides, such as Yahoo! Shopping, ShopNow.com, Shopping.com,
Lycos Shop, eShop, Excite and 4anything.com, although focusing primarily
on products, may expand their data to include service industry categories
in which we operate.
o Consumer buying guides, such as Ecompare, Comparenet, Deja.com,
Brandwise, BizRate.com and Gomez Advisors focus primarily on Web sites
but may also enter into categories in which we operate.
11
<PAGE>
o Auction sites, such as eBay, Yahoo! Auctions, ONSALE and Amazon.com or
other auction sites may elect to enter into the service arena.
We believe that the principal competitive factors in our market are brand
recognition, the depth of distribution of our ratings and credential data,
comprehensiveness of service business coverage, the quality and nature of our
content, our Web site user-friendliness, and the quality of results obtained by
buyers and sellers.
We expect to experience significant competition in the future from companies
that we have identified above as well as new entrants. Other companies with
strong brand recognition, technical expertise and experience in online and
offline commerce and direct marketing may seek to compete in the rating and
credentialing market. Many of our competitors have significantly longer
operating histories, larger and broader customer bases and greater technical
expertise, brand recognition and online commerce experience than we have. Many
of our competitors may be able to devote significantly greater resources than we
have available for marketing and promotional campaigns, attracting traffic to
their Web sites, hiring and retaining key employees and developing Web site and
other systems. In addition, barriers to entry for rudimentary service business
listings or referral services are low, and new competitors may be able to offer
competing services at relatively low cost.
RESEARCH AND PRODUCT DEVELOPMENT
Prior to fiscal 2000, our research and product development expenses associated
with the design, development and testing of our programs and services were not
material. In the first quarter of fiscal 2000, capitalizing on our expertise in
customer satisfaction research and ratings, we commenced the design, development
and testing of an expanded Internet initiative. This initiative consists of (a)
developing proprietary content on the majority of service businesses in the
United States, and (b) developing an Internet-based system that generates
commissions from transactions driven by the content. The goal of our development
is to position ValueStar as the dominant rating program of local service
businesses. Failure to implement this new initiative could have a material
adverse effect on our future operations.
During the year ended June 30, 2000 we expended $5,860,062 on research and
product and content development. These costs consist of (a) capturing and
verifying credential data on a large number of service companies in the United
States (our proprietary content), (b) developing systems to store, monitor and
update this content, (c) developing systems to register consumers and (d)
developing systems to monitor and generate commissions based on transactions
between buyers and sellers of local services. We expect these product, system
and content development costs to continue at high levels during early fiscal
2001.
We seek to maintain and advance our market position by continually enhancing the
performance of our Web site and the services and benefits we provide to buyers,
sellers and partners. We expect that enhancements to our site and services will
come from both internally and externally developed technologies.
EMPLOYEES
As of August 31, 2000, we employed 159 full-time persons, of which 6 are in
senior management, 68 in marketing and sales, 43 in research and rating, 24 in
technology and systems, and 18 in accounting and administration. We employ up to
5 part-time personnel from time to time and use outside contractors from time to
time for various marketing and other services. None of our employees are
represented by a collective bargaining arrangement and we have experienced no
work stoppages. We consider our relations with employees to be favorable.
Our future success will depend in large measure upon the continued contributions
of our CEO, James Stein, and our ability to attract and retain quality sales and
management personnel. We experience competition for qualified sales personnel
who are in demand by many competitors and businesses with other sales
activities. The loss of the services of Mr. Stein could have a material adverse
effect on our business. We entered into a three-year employment contract with
Mr. Stein effective July 1, 1998. We own a $3 million "key man" life insurance
policy on Mr. Stein.
TRADEMARKS, SERVICE MARKS AND OTHER PROPRIETARY RIGHTS
We own a U.S. federally registered certification mark on "ValueStar" and the
"ValueStar Certified" symbol and have applied for protection on "Consumer
ValueStar" in Canada and "ValueStar Certified" in the European Communicty. We
have also received a registration for "Only the Best Pass the Test" as a service
mark in the U.S. We consider our trademarks and symbol to be material to our
business. We intend to vigorously protect and defend our trademarks against
infringement and other unauthorized use. We are not aware of any other
significant infringement or other unauthorized use of our trademarks. We cannot
assure that we can protect our trademarks and symbol. The loss or infringement
of our ValueStar trademark and symbol or our inability to protect our mark
adequately would have a material adverse effect on
12
<PAGE>
our business and operations. It is possible that competitors or others will
adopt service names similar to "ValueStar", thereby impeding our ability to
build brand identity and possibly leading to customer and consumer confusion.
We seek to maintain certain aspects of our business operations as trade secrets.
We have developed consumer and business databases, training systems, software
and systems that are proprietary. With the increased use of patents to protect
service products and techniques, we are currently reviewing the use of patent
applications as an additional tool to protect new products and services we are
developing. There can be no assurance of future patents or protection.
GOVERNMENT REGULATION AND LEGAL ISSUES
We are not currently subject to direct regulation other than federal and state
regulation applicable to businesses generally. Some service businesses are
prohibited by state or other regulations from paying a commission or
referral-type fee. Examples include lawyers and certain medical professionals
and counselors. These kinds of businesses will continue to be licensed under a
fixed fee program. There can be no assurance that we will not be impacted in the
future by various state and local regulations regarding certain aspects of our
business model.
Our operations require that our certification mark only be used by qualifying
companies and that its use be discontinued if a business ceases to be a
licensee. We vigorously defend our contract rights, including taking legal
action as required. As we expand to new areas and our certification becomes more
recognized and valuable, it may be increasingly difficult to police unauthorized
use of our certification mark or confusing marks.
Although we are not a direct referral service, we may be subject to claims by
buyers for the actions of certified businesses. Although we do not believe a
claim would have merit, the costs of defense could be substantial. There is no
assurance our errors and omissions insurance would adequately cover any claims.
To date we have not been subject to any material claims by customers of
licensees.
Privacy is one of America's long-standing concerns, and the issue of privacy on
the Internet is the latest manifestation of that concern. We are sensitive to
those concerns and have created a privacy policy to govern our Internet data
collection, which we believe is consistent with present laws and regulation. We
have examined our new business model in light of the recent Gramm-Leach-Bliley
Act ("GLB"), signed into law November 1999, which regulates many aspects of
financial privacy, both on and off the Internet. Our conclusion is that
compliance with GLB, which primarily involves adequate and thorough disclosure,
will not adversely impact our business model.
ITEM 2. DESCRIPTION OF PROPERTY
Our corporate and operating offices are located in approximately 40,000 square
feet of improved office space located at 360 - 22nd Street, Oakland, California.
This facility accommodates administration, sales and marketing and research and
rating personnel. This facility is leased pursuant to four five-year leases
effective June 1999 and January 2000 at a monthly rate aggregating approximately
$53,000. This facility is adequate for present operations but should we continue
to expand or elect to provide new products or services, then we may require
additional space in the future. We believe that additional office space at
reasonable leasing rates is available in the greater Oakland area should
additional space be required in the future.
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any threatened or pending legal proceeding other than
routine litigation that is incidental to our business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of the fiscal year to a vote
of security holders.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
On May 28, 1997 our common stock commenced trading and is quoted on the National
Association of Securities Dealers, Inc. ("NASD") OTC Electronic Bulletin Board
(symbol "VLST"). The market for our common stock has often been sporadic and
limited.
13
<PAGE>
The following table sets forth the high and low bid quotations for our common
stock for the fiscal years ended June 30, 2000 and 1999 as provided by the NASD.
Bid Quotations
High Low
---- ---
Fiscal Year Ending June 30, 1999
First Quarter $0.7813 $0.5313
Second Quarter $0.9375 $0.625
Third Quarter $1.4375 $0.75
Fourth Quarter $1.6563 $1.1875
Fiscal Year Ending June 30, 2000
First Quarter $1.9375 $1.3125
Second Quarter $8.8750 $1.7500
Third Quarter $8.0625 $5.9375
Fourth Quarter $6.5000 $2.6875
The above quotations reflect inter-dealer prices, without retail markup,
markdown or commission and may not represent actual transactions.
The OTC Electronic Bulletin Board is a screen-based trading system administered
by the NASD. Securities traded on the Bulletin Board are, for the most part,
thinly traded and subject to special regulations (described below) not imposed
on securities listed or traded on the National Association of Securities Dealers
Automated Quotation ("NASDAQ") system or on a national securities exchange.
Like that of securities of other small, growth-oriented companies, our 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 by one or more holders could adversely and
dramatically affect the prevailing market price of our common stock due to its
thinly traded attributes. 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
us or our competitors, quarterly variations in operating results, announcements
of technological or service innovations, the introduction of new products or
services, changes in pricing policies by us 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 our 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.
Our common stock is defined as a "penny stock" under the Securities Exchange Act
of 1934, as amended (the "Exchange Act"), and rules of the Securities and
Exchange Commission thereunder. The Exchange Act and penny stock rules generally
impose additional sales practice and disclosure requirements upon broker-dealers
who sell our 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 our shares and
thus may also affect the ability of purchasers of shares to resell shares in the
public markets.
We had 150 holders of record of our common stock at June 30, 2000, which we
believe represents approximately 700 beneficial owners. We have never paid a
cash dividend on our common stock and do not expect to pay cash dividends in the
foreseeable future. No cash dividends may be paid on our common stock unless a
like cash dividend has been paid on our preferred stock on an
as-converted-basis.We are also obligated to pay accrued cumulative stock
dividends to our holders of Series A preferred stock on conversion to our common
stock.
14
<PAGE>
Recent Sales of Unregistered Securities
No equity securities were sold during the year ended June 30, 2000 under an
exemption from the Securities Act that were not previously reported in prior
quarterly filings or described in the following paragraphs. All such sales were
made under an exemption from either Section 4(2) or Rule 506 of Regulation D
under the Securities Act.
On April 4, 2000 we completed the second closing of a private offering and sale
of 647,087 units. Each unit consisted of one share of common stock at $5.85 per
share and one warrant for each ten shares ("585 Unit"), each warrant granting
the right to purchase one common share at $5.85 for a period of three years.
Warrants for an aggregate of 64,713 shares of common stock were issued in
connection with this second closing. The aggregate second closing proceeds were
approximately $3,785,500 and were raised as working capital.
In connection with the sale of the 585 Units, we entered into an Investors
Rights Agreement with the investors providing the investors with certain
piggyback registration rights.
While the securities were sold by us without an underwriter or cash commission,
upon the second closing and for services provided during the first (March 24,
2000) and second closings, we issued to an outside financial advisor warrants to
purchase an aggregate of 30,000 shares of common stock at an exercise price of
$5.85 per share until April 4, 2005 and issued the lead investor, in
consideration of guaranteeing the purchase of a minimum of 1,000,000 units,
warrants to purchase an aggregate of 50,000 shares of common stock at an
exercise price of $10.00 per share until April 4, 2003.
In connection with the cancellation of $1,450,000 of senior notes applied to
exercise warrants for 1,977,382 common shares in March 2000, we agreed to call
and purchase 231,132 C warrants from three institutional holders. Effective
April 4, 2000 we called the C warrants. The $1,155,660 of net call proceeds was
applied by the recipients to purchase 77,382 common shares by exercising
warrants and the balance to purchase 184,320 of the 585 Units described above.
All of the securities were offered and sold without registration under the
Securities Act of 1933, as amended (the "Act"), in reliance upon the exemption
provided by Section 4(2) thereunder and/or Regulation D, Rule 506 and
appropriate legends were placed on the shares of common stock and warrants and
will be placed on the shares of common stock issuable upon exercise of the
warrants unless registered under the Act prior to issuance.
The descriptions of the 585 Unit financing is qualified in its entirety by the
full text of the agreements filed as exhibits to our Form 10-QSB for the quarter
ended March 31, 2000.
Subsequent Sale of Preferred Stock
During September 2000 and through the date of this annual report, we issued
227,689 shares of Series C Convertible Preferred Stock, par value $.00025
("Series C stock") for cash of $22.50 per share or gross proceeds of $5,123,000.
Cumulative dividends of 8% per annum are payable when and if declared. The
dollar amount of Series C stock plus an amount representing unpaid dividends is
convertible into shares of common stock at a conversion price equal to $2.25 per
common share, and are automatically converted on the occurrence of certain
events. The Series C Stock has certain registration rights, has a liquidation
preference of $22.50 per share plus accrued and unpaid dividends, and has voting
rights equal to the number of shares into which it is convertible. The Company
granted purchasers warrants to purchase 1,138,445 common shares at $2.25 per
share for a period of three years.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Overview
We are a provider of branded rating content on local service businesses. As an
infomediary we enhance online and offline commerce between buyers and sellers of
services by offering ratings enabling buyers to quickly determine the best local
service providers. Our ValueStar ratings are provided on the Internet at
www.valuestar.com, on other partner Internet sites, in our ValueStar Report and
through promotions by rated businesses.
In the first quarter of fiscal 2000, capitalizing on our expertise in customer
satisfaction research and ratings, we commenced the design, development and
testing of an expanded Internet initiative. This initiative consists of (a)
developing proprietary content and ratings on a large number of service
providers in the United States, and (b) developing an Internet-based system that
generates commissions from transactions driven by the content. The content being
developed includes credential information such as licensing, insurance, legal
and finance, company profiles and related information. During fiscal year 2000
we expended significant resources (approximately $5.8 million) to generate
database
15
<PAGE>
information and develop computer and related systems for this new service. The
goal of our development is to position ValueStar as the dominant rating system
for local service providers and operate a commission based system to match
buyers and sellers of local services.
Our plan is to have the systems to monitor, record and collect on a transaction
basis during the last quarter of calendar year 2000. However unknown technical
issues and barriers could arise that could delay implementation or preclude us
from executing this plan. In such an event we may be required to revert to a
fixed fee basis.
In addition to creating proprietary content on America's service companies, we
are also developing strategic relationships to provide data and to increase the
distribution of ValueStar's branded rating content:
o In January 2000 we entered into a strategic data agreement with Experian,
a leading provider of global information solutions. This alliance
provides financial and legal status on local service businesses as a part
of our content development. We provide Experian with the results of our
branded proprietary research on local service businesses for distribution
to their clients.
o In April 2000 we entered into an alliance with Netcentives to manage our
ValueStar Rating Points award program. As a part of this relationship, we
expect the four million consumer members of Netcentives shopping network,
ClickRewards(TM), will become trial ValueStar members for opt-in
activation.
o Commencing in May 2000 we began to form distribution partnerships with
leading Internet portals and service referral companies to broadly
distribute our ratings. Our roster of distribution partners includes home
service portals: Ourhouse.com, Simplydone.com and Contractor.com; auto
service portals CompleteCar.com and Findgarage.com; and other vertical
portals such as eAttorney.com, rentals.com and GeoTouch.com.
o In June 2000 we entered into a database agreement with InfoUSA, Inc. to
provide certain raw database information.
o We are developing Internet-based software to match transactions between
licensed businesses and registered member buyers. We are working with
several processors of credit card transactions to support our program.
o In September 2000 we announced a pilot program for the San Francisco Bay
area credit card holders of First National Bank of Omaha.
We have established a six person business development team to develop other
alliances and relationships to expand our content, add highly rated service
providers, extend our brand and distribute our ratings to consumers and other
buyers of local services.
Changing Revenue Model
During fiscal 2000 our revenues were 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. During the year we operated in eight regional markets. In December
1999, in all markets except Northern California, we changed from a fixed
certification and rating fee to a percentage based fee based on the value of
future transactions between buyers registered with us and participating
companies rated and authorized by us. We are currently developing the systems to
register buyers and monitor transactions. Until this system is operating, we do
not anticipate any significant revenues from these markets. We will continue to
incur selling costs and rating costs associated with enrolling participating
service businesses in our program. We believe this investment will accelerate
the launch of our new program by allowing us to have a number of verified and
licensed service companies already enrolled by the time we launch our
transaction fee system. We continue to charge a fixed certification fee in
Northern California but expect to also change this market to the new program at
a later date, not yet determined.
In the past our business revenue model was predicated on a growing number of
certified businesses and maintaining high renewal rates. Certified businesses
that renewed contributed higher gross margins than new applicants due to reduced
sales and rating costs. We are migrating to a transaction based revenue model
where our business will be predicated on creating and maintaining a growing
number of registered buyers and sellers transacting commerce in local services.
In the future we expect a majority of our revenues to be derived from
commissions from transactions between registered buyers and sellers of local
services. Renewals of businesses from year to year will still impact future
operations as we expend funds on enrolling new qualified businesses in our
licensing program.
Considerable portions of our operations have been in the past and are expected
in the future to be engaged towards the solicitation of new service and
professional business applicants and we incur substantial costs towards this
activity. We expect that these will continue to be significant costs in the
future.
16
<PAGE>
During the year ended June 30, 2000 we also incurred significant product, system
and database development costs consisting of (a) capturing and verifying
credential data on a large number of service companies in the United States (our
proprietary content), (b) developing systems to store, monitor and update this
content, (c) developing systems to register consumers and (d) developing systems
to monitor and generate commissions based on transactions between buyers and
sellers of local services. We expect these product, system and content
development costs to continue at high levels during early fiscal 2001. After our
content databases are developed, we will incur costs to maintain and update the
data on an ongoing basis. Exact amounts and timing of these expenditures and
costs are subject to a variety of factors and are not currently determinable by
management.
Future operations will be impacted by changes in cost structure and elections
regarding new product development, advertising, promotions and growth rates. We
have recently increased numbers of sales, marketing, development 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 June 30, 2000 we had 5,521 licensees. On August 31, 2000 we had over 350,000
ValueStar Verified or ValueStar Top-Rated businesses listed on our Web site and
had licensed approximately 6,300 of these businesses as members in either our
commission program or our annual fixed-fee license program.
Revenue and Cost Recognition
During fiscal 2000 a majority of our revenues were from fixed certification fees
ranging from $995 to approximately $2,000 depending on business size. These fees
have been recognized as revenue 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 but often waived or discounted, has been deferred until the research
report is delivered. Sales of marketing materials and Web advertising and other
services have been recognized as materials are shipped or over the period
services are rendered. From time to time we provide discounts, incentives from
basic pricing, refunds and payment terms on fees. Refunds have averaged less
than 2.5% of certification fees during the last two years. In the past we have
provided no ongoing support or services to certificate holders necessary to earn
the revenue.
We have expensed research and rating costs as incurred. Costs incurred in
printing and distributing our ValueStar Report publication for buyers, currently
published in January and July, and any related revenues have been recognized
upon publication.
Certain direct-response advertising costs have been 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.
In fiscal 2001 we expect a majority of our revenues to be derived from
commissions from transactions between registered buyers and sellers of local
services. In certain industries where collection of commissions is not
allowedand in other instances we expect to obtain a fixed annual license fee. We
may provide payment terms and discounts from time to time. We have also changed
our program offering by providing a package of buyer benefits applicable for the
term of the business license. These benefits will be a cost of sales related to
our revenues.
Because of this significant change in the program we expect that we will
recognize commission revenues as reported and earned by us. Commencing July 1,
2000 we began recognizing fixed fee revenues on a straight-line basis over the
term of the annual license. Costs of benefits provided to consumers will be
recognized as provided with reserves made for any future benefit obligations.
The Securities and Exchange Commission staff (the "Staff") issued "Staff
Accounting Bulletin No. 101-Revenue Recognition in Financial Statements" ("SAB
101") in December 1999 which provides guidance on the recognition, presentation
and disclosure of revenue in financial statements of all public registrants. The
provisions of SAB 101 are effective for transactions beginning in our fiscal
year 2001. We intend to recognize revenues in the future consistent with the
requirements of SAB 101.
17
<PAGE>
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 ValueStar Report and on our Web site, and other ancillary
revenues. We reported total revenues of $2,090,773 for the fiscal year ended
June 30, 2000, a 10% decline over revenues of $2,329,219 for the prior fiscal
year. The decrease in revenues is due to the commencement in December 1999 of
enrolling local service providers into our commission based program described
above. During fiscal 2000, certification fees accounted for 77% of revenue,
compared to 76% for the prior year. Revenues for the fourth fiscal quarter ended
June 30, 1999, were $419,895 compared to $559,466 for the prior year comparable
quarter or a 25% decrease. In the fourth quarter of fiscal 2000 we were earning
fixed certification fees from only one market with seven markets converted to
the commission program.
Revenues for the year from premium listings in our ValueStar Report and on our
Web site were $210,520, a decrease of 5% from the $222,100 for the prior year.
The decrease, as above, is due to the commencement in December 1999 of enrolling
local service providers into our commission based program.
Our revenues can vary from quarter to quarter due to (a) management's decision
on the mix of sales effort between enrolling local service providers into
commission based vs. subscription based programs, (b) the impact of distributing
the semi-annual ValueStar Report to buyers, (c) seasonality, (d) effectiveness
of sales methods and promotions, (e) levels of expenditures targeted at
prospective businesses, (f) the numbers of certificate holders up for renewal,
(g) renewal rates, (h) pricing policies, (i) timing of completion of research
and ratings, and (j) other factors, some of which are beyond our control. The
timing of implementation of our commission based processing will materially
impact future revenues. There can be no assurance we can successfully implement
this program as scheduled in the second fiscal quarter of 2001. Unknown
technical or business issues and barriers could arise that could delay
implementation or preclude us from executing our commission based transaction
plan. In such an event we may be required to revert to a fixed fee basis.
Cost of Revenues. Cost of revenues consists primarily of rating costs incurred
for performing customer satisfaction research on business applicants enrolled
into our subscription program, costs related to verifying insurance and
complaint status for those same applicants and costs of information products.
Cost of revenues represented 60% of sales during the fiscal year ended June 30,
2000 (54% in the fourth quarter), an increase from 44% for the fiscal year ended
June 30, 1999 (58% for the fourth quarter). The increase in the current year is
attributable primarily to increased staffing and related costs from expanding
our rating department to handle increased volume in anticipation of the
commission based system. Cost of revenues may vary significantly from quarter to
quarter both in amount and as a percentage of sales.
We have invested in telephony equipment that we expect to reduce the unit costs
related to performing future customer satisfaction research. We have also made
investments in computer and software equipment to track licensing, financial and
credit information for local service businesses. We believe these investments
will reduce rating and content development unit costs in future periods.
In the future, under the planned commission based program, the components of
cost of sales will change versus the fixed fee certification program of prior
years. Costs associated with revenues will include benefits to buying members
and commissions payable to referring partners. We expect content costs to be
reported separately as we provide content to various portals and others without
a corresponding revenue stream. We estimate, but there can be no assurance, that
the cost of revenues for our commission based program, when and as implemented,
will range between 50% and 60% of revenues.
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 fiscal
year ended June 30, 2000, were $3,797,530, or 182% of revenues, compared to
$1,776,390, or 76% of revenues for the prior year. The large increase is due to
the commencement in December 1999 of enrolling local service providers into our
commission based program described earlier. These sales do not result in
immediate revenues. Other than direct targeted telemarketing costs for fixed fee
subscription sales in Northern California, 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 market
regions opened and other factors, some of which are beyond our control.
Marketing and Promotion Expenses. Marketing and promotion expenses aggregated
$3,037,502, or 145% of revenues during fiscal 2000, comparable to $778,435, or
33% of revenues for fiscal 1999. Included in marketing and selling
18
<PAGE>
expenses are printing and distribution costs of our ValueStar Report publication
targeted at buyers. Printing and distribution costs were $336,000 in fiscal 2000
compared to the fiscal 1999 total of $266,000, as we printed and distributed
more copies with additional pages. During fiscal 2000, we expended $1,125,000 on
paid advertising targeted at expanding consumer awareness of ValueStar. We
embarked on an aggressive media campaign, especially in the Northern California
market, during fiscal 2000. Paid advertising of $206,000 was employed in the
prior year. During fiscal 2000, we expended $153,000 on promotions compared to
$134,000 for the prior year with the increase due to an increased number of
promotions in the period. Wage expenses in marketing during fiscal 2000 were
$954,000 compared to $126,000 for the prior year, due to expanded staff related
to building the marketing and business development groups in the third and
fourth quarters. Generally, the first and third fiscal quarters have increased
costs because our 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 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 and Content 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. This work has led to building a transaction based
rating system described above. During the twelve months ended June 30, 2000 we
expended $5,860,062 on new program development and segregated these costs as
product and content development costs. Fourth quarter product development costs
were $3,014,531, an increase from the $1,664,051 in the third quarter of this
fiscal year. The major components of product development costs during the twelve
months were compensation and related costs of $3,078,220, partner and alliance
implementation costs of $490,000 and expenses related to the gathering of
licensing and other verification information of $344,000. We have capitalized
$1,001,000 of product and content development costs as website development and
software that are specifically related to internal software development. The
Company will begin depreciation of this asset in fiscal 2001 over a period of
time not to exceed three years upon commencement of tracking transactions
between rating partners and local service providers.
In March 2000 we entered into a three-year contract with a third party to
provide certain insurance verification services on a national basis.
Subsequently, we determined we could more effectively perform these services
internally. Accordingly in the fourth quarter we accrued and expensed $600,000
representing future quarterly minimum bill rates over the next twelve quarters.
The penalty payable is $50,000 per quarter commencing May 2000.
We expect that product and content development expenses will continue to be
significant in early fiscal 2001 due to increased numbers of personnel and the
use of outside branding, computer and system consultants employed to develop our
commission based system. We expect costs to decline as the commission system is
implemented and initial content fully developed. Thereafter content maintenance
costs will be treated as operating costs. Future levels of product development
costs will depend on many factors not currently estimable by 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 $2,444,516 or 117% of revenues for the year
ended June 30, 2000, compared to $1,734,564 or 75% of revenues for the prior
year, an increase of $709,952. The Company allocated a proportion of general and
administrative costs to product and content development during the fiscal year
to reflect a proportional share of administration costs devoted to product and
content development. The major increases in general and administrative costs
include a $539,500 increase in compensation and benefits due primarily to the
increased number of executive and management personnel added in connection with
employee growth and expanded operations; a $680,000 increase in occupancy,
telephone and insurance costs due to additional personnel and expanded
operations; a $791,000 increase in depreciation due to additional equipment
related to building the transaction based system and accommodating employee
growth; and a $107,000 increase in travel and entertainment due to expanded
operations. General and administrative costs increased to $1,108,170 or 264% of
revenues during the fourth quarter of fiscal 2000 compared to $577,147 or 103%
of revenues for the prior year's fourth quarter. The major increase in the
fourth quarter is due to increased depreciation expense of $535,279 compared to
the prior year. Management anticipates that general and administrative costs
will continue to exceed prior period levels due to increased personnel added to
support future growth, increased general computer, operating, occupancy and
corporate costs.
19
<PAGE>
We incurred $77,000 of stock-based compensation during the twelve months ended
June 30, 2000 resulting from non-employee options and warrants compared to
$68,000 for the prior year.
We incurred interest expense for the year ended June 30, 2000 of $2,076,519 that
included $1,696,150 of non-cash amortization of bond discount, paid-in-kind
interest and amortized financing. Included in the $1,696,150 of non-cash
interest and financing costs are $1,312,130 of lump sum amortization resulting
from the early payoff of debt and $153,333 of lump sum amortization of
capitalized financing costs associated with senior debt cancellation for common
stock. Interest for the prior fiscal year was $395,890, including $114,506 of
non-cash amortization of bond discount and accrued paid-in-kind interest. The
Company generated interest income of $279,785 in fiscal 2000. The increase in
cash interest expense is a result of higher levels of debt in fiscal 2000
compared to the prior year.
Net Loss. We had a net loss of $16,175,462 for the fiscal year ended June 30,
2000, compared to a loss of $3,459,744 for the fiscal year ended June 30, 1999.
Our increased loss is attributable primarily to (a) increased selling costs
resulting from the expansion of sales personnel to new market regions and to
incurring sales costs related to bringing on service providers into the
transaction program that do not result in immediate revenue, (b) product and
content development costs associated with developing our commission based
program, (c) increased general and administrative costs associated with
additional management and support for employee growth and business development,
and (d) increased non cash amortization expense related to early cancellation of
debt for equity. We anticipate we will continue to experience operating losses
until we achieve a combination of a fully functional transaction program and a
critical mass of buying and selling members. Future quarterly results will be
greatly impacted by future decisions regarding new markets, advertising and
promotion expenditures and growth rates. Achievement of positive operating
results will require that we build a working transaction program and that we
obtain a sufficient base of buying and selling members to support our operating
and corporate costs. There can be no assurance we can successfully build a
transaction program, sustain sufficient buyer and seller member rates or achieve
a profitable base of operations.
The net loss available to common stockholders includes an increase in the net
loss for the fiscal year ended June 30, 2000 due to the beneficial conversion
feature of the Series B preferred stock issued during the year. Net loss was
increased by $11,650,255 for this one-time non-cash imputed charge and increased
by $167,877 for non-cash accrued dividends on Series A preferred stock. These
non-cash imputed amounts had no effect on our financial position.
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 $11,415,947 for the year ended June 30, 2000 and
$2,941,846 for the year ended June 30, 1999. At June 30, 2000, we had a working
capital surplus of $2,382,543, including $450,502 representing the current
portion of long-term debt and $285,458 representing the current portion of
capitalized leases. For the year ended June 30, 2000, our negative cash flow
from operating activities was due primarily to our continued operating losses,
selling costs associated with enrolling local service companies into our
transaction based program with no immediate revenue, product and content
development costs and addition of new executive management. At June 30, 2000,
our net accounts receivables were $454,233, representing approximately 90 days
of revenues and an annualized turnover ratio of approximately 4.0 times. This
compares unfavorably to approximately 64 days of revenues and turnover of
approximately 5.7 times at June 30, 1999. This is due in part to decreased
revenues in fiscal 2000. 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 June 30, 2000, 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 April 2000 we obtained a commitment for $2,000,000 in
equipment financing. At June 30, 2000 we had drawn $1,278,737 of this
commitment. We drew down an additional $732,796 on August 15, 2000. Also during
the year ended June 30, 2000, we obtained $250,000 in additional net note and
debt financing and $21,316,507 from the sale of common and preferred stock. We
have no commitments for future investments and there can be no assurance that we
can continue to finance our operations through these or other sources. In the
past, shareholders, including from time to time directors, have advanced funds
and at times cancelled debt for equity on terms of new forms of financing. There
can be no assurance that shareholders or directors or others will provide us
with any future financing.
Other than cash on hand of $5,287,385 at June 30, 2000, net accounts receivable
of $454,233, and the proceeds from drawing down the balance of the equipment
financing commitment in August 2000, 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
20
<PAGE>
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.
Subsequent to June 30, 2000 we obtained approximately $5.1 million of new
investment capital. We expect that we will require a minimum of $8 million of
additional capital to finance operations during the next twelve months. This
estimate is based on the first fiscal 2001 quarter level of operations,
anticipated revenues, anticipated launch of our commission program and budgeted
product development and operating costs. To expand the enrollment of new member
buyers and sellers or to launch new products or services, we will 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. 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.
New Accounting Pronouncements and Issues
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Investments
and Hedging Activities" ("SFAS No. 133") which establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
The statement also requires that changes in the derivative's fair value be
recognized currently in earnings unless specific hedge accounting criteria are
met. SFAS No. 133 is effective for fiscal years beginning after June 15, 2000.
The Company does not expect the adoption of SFAS No. 133 to have a material
effect on the Company's consolidated financial statements.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements" (SAB 101), which
provides guidance on the recognition, presentation and disclosure of revenue in
financial statements of all public registrants. The provisions of SAB 101 are
effective for transactions beginning in the Company's fiscal year 2001. As
described above, the Company has modified its program and the nature of its
future revenues. The Company intends to recognize revenue in fiscal 2001 in
compliance with SAB 101. However there can be no assurance, given the
uncertainty in this area, that the SEC staff may not take a contrary position at
some future date. Any potential changes could have a material impact on the
manner in which we recognize revenue. Any such changes would have no effect on
reported cash flow or the underlying economic value of our business.
On March 31, 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, " Accounting for Certain Transactions Involving Stock
Compensation"("FIN 44"). This statement is effective for certain transactions
from December 15, 1998 and is to be applied commencing July 1, 2000. The Company
has not completed its assessment of the impact of FIN 44 and has not determined
its effect, if any, on its future reported results of operations.
Year 2000 Readiness Disclosure
We are aware of the issues associated with the programming code in existing
computer systems because of the Year 2000. The "Year 2000" problem is concerned
with whether computer systems properly recognize date sensitive information
connected with year changes to 2000. Systems that do not properly recognize such
information can generate erroneous data or cause a system to fail. To date, we
have not experienced any Year 2000 problems in our computer systems or
operations. However, other companies, including us, could experience latent Year
2000 problems.
While we are not currently aware of any internal or external Year 2000 failures
impacting our operations, we continue to monitor the compliance of our major
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 have adequately assessed and
addressed 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
21
<PAGE>
process transactions, deliver certifications and products, send invoices or
engage in similar normal business activities at our office or with our vendors
and suppliers. We currently do not have any contingency plans with respect to
potential Year 2000 failures of our suppliers or customers and at the present
time we do not intend to develop one. If these failures occur, depending upon
their duration and severity, they could have a material adverse effect on our
business, results of operations and financial condition.
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, 2000, we had approximately $26.5 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.
Business Risks
This report contains a number of forward-looking statements that reflect our
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," "goal,"
"objective" 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. We undertake no obligation to publicly revise
these forward-looking statements, to reflect events or circumstances that may
arise after the date hereof.
We Have a History of Losses and Anticipate Continued Losses in Fiscal
2001 - We have incurred significant operating losses since our
inception and anticipate a continuation of losses in fiscal 2001. Our
operating results have fluctuated in the past and are expected to
fluctuate in the future due to a number of factors, many of which are
outside our control. There can be no assurance that we can achieve
profitable operations.
We Have a New Senior Management Team And We Have Recently Expanded Our
Business To Offer New Services. As A Result, We Have A Limited History
Which Makes It Difficult To Evaluate Our Business - We commenced
operations in 1992; however, we did not begin developing our expanded
ratings and commission based program until July 1999. Our prior
operations depended on fixed fee certifications. In July 1999 we
commenced recruiting an expanded senior management team, including our
president, chief operating officer, chief marketing officer,
vice-president business development, vice-president engineering and
general counsel. Commencing in February 2000 we announced the beginning
of our distribution alliances with various portals. In July 2000 we
announced details on our ratings of a large number of service
businesses. We are preparing to launch our new commission based revenue
system anticipated in the second quarter of fiscal 2001. As a result,
we have a limited history upon which you can evaluate our business and
the performance of our senior management team. Furthermore, even if our
business is successful, we may change our business to enter into new
business areas, including areas in which we do not have extensive
experience. Before investing, you should evaluate the risks, expenses
and problems frequently encountered by companies such as ours that are
in the early stages of development and that are entering new and
rapidly changing markets like the Internet.
Competition and Technological Changes May Adversely Affect Our Business
- The possibility exists that a business rating service and
certification mark similar to or competitive to ours will be developed.
It is also possible that future competition will try to duplicate our
concept. We 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 our business. As a provider of
consumer information through the Internet and various media, we will be
required to adapt to new and changing technologies. There can be no
assurance that our services will remain viable or competitive in the
face of technological change.
We Depend on Our CEO as the Public Image of ValueStar - We are
substantially dependent upon the experience and knowledge of our CEO,
James Stein. Mr. Stein is becoming a leader in customer satisfaction
22
<PAGE>
issues and is our public spokesperson for events, including customer
meetings and various radio and television appearances. The loss of Mr.
Stein could be detrimental to our development, especially since we may
not have the funds to hire a replacement with the requisite expertise.
We have a $3 million key-man life insurance policy on Mr. Stein.
We Rely on Third Parties for Important Services - Our operations depend
on a number of third parties. We have limited control over these third
parties. We do not own a gateway onto the Internet, but instead rely on
an Internet service provider to connect our Web site to the Internet.
Disruption, temporary or prolonged, of our Web site could have a
material adverse effect on our business. We depend on Netcentives to
provide and manage our benefits program. We are dependent on third
parties for printing and distribution of our ValueStar Report. We
depend on third parties for certain telemarketing and other services
fundamental to our operations. We also rely on a number of government
agencies and database companies to provide us credential information
and databases. Failure to maintain satisfactory relationships on
acceptable commercial terms with these third parties could affect the
timing and quality of our services to customers and adversely affect
our operating results.
We are Developing New Markets with No Proven Acceptance - Although we
believe the factors driving our business acceptance in the California
market are similar throughout the United States, there can be no
assurance of widespread acceptance. We also believe the factors that
drive business acceptance on a fixed fee basis will be similar as we
charge a commission. As a new and evolving business format, demand and
market acceptance are subject to a high level of uncertainty. We
believe the evolution of our business will depend in part on increasing
brand recognition. Development and awareness of our rating brand will
depend on co-branding with rated businesses and relationships with
distribution partners including portals to distribute our branded
ratings. Our success will depend in part in maintaining our position as
a leader in the rating of local service businesses.
The Failure to Establish the ValueStar Brand Would Impair our
Competitive Position - We are highly dependent on establishing and
maintaining our brand. Any event or circumstance that negatively
impacts our brand could have a direct and material adverse effect on
our business, results of operations and financial condition. As
competition develops, we believe that brand strength will become
increasingly important. The reputation of our brand will depend on our
ability to provide quality services to our customers and maintain
quality and the integrity of our rating and certification service to
businesses and consumers. We cannot assure you we will be successful in
maintaining our brand and delivering quality to customers and
consumers. If customers and consumers are not satisfied, their negative
experiences might result in publicity that could damage our reputation
and our competitive position could suffer.
We are Dependent on Existing and Future Strategic Partners for the
Success of our Services - We intend to seek new distribution partners
for our ratings content on the Internet and through traditional media.
We also intend to seek partners with large numbers of buyers to enroll
in the ValueStar benefits program. We expect to share certain revenues
with these partners. There is a risk that we will be unable to retain
current partners or be successful in recruiting new partners. The
failure to expand our partnerships could make it difficult to expand
our revenues or more costly to obtain comparable revenues. Should our
partners seek to establish competitive programs offered by others our
revenues could be reduced.
If We Fail to Manage Our Growth, Our Ability to Market, Sell and
Develop Our Services Could be Harmed - Our growth has placed and will
continue to place a significant strain on our management systems and
resources, and we may be unable to effectively manage our growth in the
future. We must plan and manage our growth effectively to offer our
services and achieve revenue growth and profitability in a rapidly
evolving market. We continue to increase the scope of our operations
and have added a number of employees recently, including employees in
key management and marketing positions. We grew from 82 employees at
June 30, 1999 to 159 employees at June 30, 2000. For us to effectively
manage our growth, we must continue to:
o improve our operational, financial and management systems and
controls;
o install new management and information systems and controls;
o develop and link a new web site with out alliance partners;
o locate additional office space in a number of geographic
locations; and
o hire, train and motivate our workforce.
Failure to manage our growth effectively would hinder our ability to
develop, market and sell our services and therefore harm our business.
23
<PAGE>
If We Experience System Failures, We May Lose Revenues and Our
Reputation Could be Harmed and We May Lose Buyers And Sellers In Our
Program, Causing Us to Lose Future Business - We will depend on the
efficient and uninterrupted operation of our computer and
communications hardware and software systems some of which are still in
development. We cannot guarantee that our systems will operate as
planned and the failure of any of our systems could result in delays in
launching new programs. Substantially all of our computer hardware for
operating our Web sites is currently located at GlobalCenter in
Sunnyvale, California. Other systems are maintained in our corporate
offices. These systems and operations are vulnerable to damage or
interruption from earthquakes, floods, fires, power loss,
telecommunication failures and similar events. They are also subject to
break-ins, sabotage, intentional acts of vandalism and similar
misconduct. We do not have fully redundant systems, a formal disaster
recovery plan or alternative providers of hosting services, and we do
not carry business interruption insurance to compensate us for losses
that could occur. Despite any precautions we may take, the occurrence
of a natural disaster or other unanticipated problems could result in
interruptions in our services. Any damage to or failure of our systems
could result in interruptions in our services. Any system failure could
create user questions and complaints that must be responded to by our
customer support personnel. The system failures of various third-party
Internet service providers, online service providers and other Web site
operators could result in interruptions in our service to those users
who require the services of these third-party providers and operators
to access our Web sites. These interruptions could reduce our revenues
and profits, and our future revenues and profits will be harmed if our
users believe that our system is unreliable.
We Need to Protect Our Trademarks and Intellectual Property - We regard
our trademarks, copyrights, trade secrets and similar intellectual
property as critical to our success. We rely on a combination of
copyright and trademark laws, trade secret protection, confidentiality
and contractual provisions with certain employees and third parties to
establish and protect our proprietary rights. There can be no assurance
that third parties will not infringe upon or misappropriate our
proprietary rights. Any misappropriation by competitors or unauthorized
use by service businesses of the trademark ValueStar or the ValueStar
Certified certification mark could have a material adverse impact on
our operations. A number of companies claim proprietary rights to
certain aspects of Internet operations. Although we are not aware of
any aspect of our operations that may infringe on the rights of other
companies, there is no assurance these claims will not arise in the
future. Although we have limited resources to protect our rights, we
intend to take aggressive actions to protect our certification mark.
We May Become Liable for Unexpected Benefit Costs Reducing Our Margins
or Creating Losses- We are preparing to offer ValueStar Benefits
including Netcentives managed rating points, complaint resolution and
certain money-back satisfaction guarantees. Should the cost of
providing these benefits exceed managements estimates or should
corresponding anticipated revenues not be realized then we could
experience reduced margins or could become liable for significant
benefit costs resulting in losses.
We May Become Subject to Government Regulation- We are not currently
subject to direct regulation other than federal and state regulation
applicable to businesses generally. However, the liability for Internet
content is an evolving area of litigation and regulation and our
operations may be impacted by litigation and regulation in the future.
We May Face Legal Uncertainties That Could Harm Our Business - We may
be subject to claims by consumers for the actions of certified
businesses. Although we do not believe a claim would have merit, the
costs of defense could be substantial. There is no assurance our errors
and omissions insurance would adequately cover any claims. In addition
to the direct legal and defense costs, litigation could negatively
impact our reputation and make selling to and certifying businesses
more difficult.
We May be Unable to Raise Additional Financing - We will need to raise
additional funds in the future in order to implement our business plan,
to fund more aggressive marketing programs or to acquire complementary
businesses, technologies or services. Any required additional financing
may be unavailable on terms favorable to us, or at all. If we raise
additional funds by issuing equity securities, you may experience
significant dilution of your ownership interest and these securities
may have rights senior to those of the holders of our common stock. If
additional financing is not available when required or is not available
on acceptable terms, we may be unable to fund our expansion, develop or
enhance our products and services, take advantage of business
opportunities or respond to competitive pressures.
Existing Stockholders Significantly Influence Us and Could Prevent New
Investors From Influencing Significant Corporate Decisions - The five
largest holders of our Series A and Series B Preferred Stock
effectively own
24
<PAGE>
approximately 52% of our Company assuming they converted their
Preferred Stock. The holders of Series A Preferred Stock also have the
right to elect one director, the holders of Series B Stock have the
right to elect two directors and the holders of Series C Stock have the
right to elect one director. The holders could also possibly elect the
additional three directors elected by common holders through their
right to vote with common shareholders. As a result, these stockholders
may be able to control all matters requiring stockholder approval,
including the election of directors and approval of significant
corporate transactions, which could delay or prevent a change of
control of ValueStar and could make some transactions difficult or
impossible without the support of these stockholders.
Stock Trading Risks and Uncertainties Increase Risk to Investors - Like
that of securities of other small, growth-oriented companies, our
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 by one or more
holders could adversely and dramatically affect the prevailing market
price of our common stock due to its thinly traded attributes. 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 ValueStar
or our competitors, quarterly variations in operating results,
announcements of technological or service innovations, the introduction
of new products or services, changes in pricing policies by us 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 our 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.
Our common stock is defined as a "penny stock" under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and rules of the
Securities and Exchange Commission thereunder. The Exchange Act and
penny stock rules generally impose additional sales practice and
disclosure requirements upon broker-dealers who sell our 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 our shares and thus may
also affect the ability of purchasers of shares to resell shares in the
public markets.
Item 7. Financial Statements
Our consolidated financial statements required to be included in this Item 7 are
set forth in a separate section of this report and commence on Page F-1
immediately following page 33.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
The information called for by Items 9, 10, 11 and 12 of Part III of Form 10-KSB
(consisting of Item 9 - Directors, Executive Officers, Promoters and Control
Persons; Compliance with Section 16(a) of the Exchange Act, Item 10 - Executive
Compensation, Item 11 - Security Ownership of Certain Beneficial Owners and
Management, and Item 12 - Certain Relationships and Related Transactions) is
incorporated by reference from ValueStar's definitive proxy statement, which
will be filed with the Securities and Exchange Commission within 120 days after
the end of the fiscal year to which this Report relates.
25
<PAGE>
Item 13. Exhibits and Reports on Form 8-K
(a) Exhibits
Each exhibit marked with an asterisk is filed with this Annual Report on Form
10-KSB. Each exhibit not marked with an asterisk is incorporated by reference to
the exhibit of the same number (unless otherwise indicated) previously filed by
us as indicated below.
Exhibit
Number Description of Exhibit
------ ----------------------
3.1 Articles of Incorporation of the Carson Capital
Corporation (Colorado) as filed on January 28, 1987 and
filed as Exhibit 2.1 to the Company's Registration
Statement on Form 10-SB, as amended.
3.1.1 Amendment to Articles of Incorporation as filed on
September 21, 1992 and filed as Exhibit 2.1.1 to the
Company's Registration Statement on Form 10-SB, as
amended.
3.1.2 Amendment to Articles of Incorporation as filed on April
24, 1997 and filed as Exhibit 2.1.2 to the Company's
Registration Statement on Form 10-SB, as amended.
3.1.3 Amendment to Certificate of Incorporation filed with the
Secretary of State of Colorado on November 23, 1999 filed
as Exhibit 3.1.3 to the Company's Form 8-K dated December
13, 1999.
3.2 Bylaws of the Company filed as Exhibit 2.2 to the
Company's Registration Statement on Form 10-SB, as
amended.
3.3 Certificate of Designation of Series A Convertible
preferred stock filed with the State of Colorado on July
21, 1999 filed as Exhibit 3.3 to the Company's Form 10-KSB
for the year ended June 30, 1999.
3.3.1 Certificate of Amendment to the Certificate of Designation
of Series A Convertible Preferred Stock filed with the
Secretary of State of Colorado on December 7, 1999 filed
as Exhibit 3.3.1 to the Company's Form 8-K dated December
13, 1999.
3.4 Certificate of Designation of Series B Convertible
Preferred Stock filed with the Secretary of State of
Colorado on December 7, 1999 filed as Exhibit 3.4 to the
Company's Form 8-K dated December 13, 1999.
4.1 Form of Certificate evidencing common stock of the Company
filed as Exhibit 3.1 to the Company's Registration
Statement on Form 10-SB, as amended.
4.3 Form of 12% Promissory Note with Non-Detachable Stock
Purchase Warrants Due March 31, 2001 as amended and
restated (aggregate of $100,000 principal with two
lenders) (individual agreements differ as to payee) and
filed as Exhibit 4.3 to the Company's Form 10-KSB for the
year ended June 30, 1998.
4.4 Form of Stock Purchase Warrant dated April 30, 1997
granted to five persons exercisable into an aggregate of
150,000 common shares at $0.75 per share until April 30,
2002 (Individual warrants differ as to holder and number
of shares) filed as Exhibit 3.4 to the Company's
Registration Statement on Form 10-SB, as amended.
4.5 Form of Stock Purchase Warrant dated June 30, 1997 granted
to three investors exercisable into an aggregate of
200,000 common shares at $1.25 per share until June 30,
2002 filed as Exhibit 3.5 to the Company's Registration
Statement on Form 10-SB, as amended.
26
<PAGE>
4.6 Form of Stock Purchase Warrant dated October 27, 1997
granted to two investors exercisable into an aggregate of
50,000 common shares at $1.25 per share until September
30, 2002 (individual warrants are for 25,000 shares each
and differ as to holder) filed as Exhibit 4.6 to the
Company's Form 10-QSB for the quarter ended December 31,
1997.
4.7 Form of Stock Purchase Warrant dated December 9, 1997
granted to four persons for bank guarantee exercisable
into an aggregate of 250,000 common shares at $1.25 per
share until September 30, 2002 (individual warrants are
for 62,500 shares each and differ as to holder). Holders
include officers/directors James Stein and James A. Barnes
and director Jerry E. Polis. Filed as Exhibit 4.7 to the
Company's Form 10-QSB for the quarter ended December 31,
1997.
4.8 Form of Stock Purchase Warrant dated December 12, 1997
granted to three investors exercisable into an aggregate
of 200,000 common shares at $1.25 per share until December
31, 2002 (individual warrants differ as to number and
holder). Officer/director James A. Barnes is holder of a
warrant on 20,000 of these shares. Filed as Exhibit 4.8 to
the Company's Form 10-QSB for the quarter ended December
31, 1997.
4.9 Form of unsecured 12% Subordinated Promissory Notes due
June 30, 2000 granted to investors (individual notes
differ as to date, principal amount and holder). Filed as
Exhibit 4.9 to the Company's Form 10-QSB for the quarter
ended December 31, 1997.
4.10 Form of Stock Purchase Warrant granted to 12% Subordinated
Promissory Note holders (at the rate of warrants on 500
common shares for each $1,000 of notes) exercisable at
$1.25 per common share until December 31, 2000 (each
individual warrant differs as to number of shares, date
and holder). Filed as Exhibit 4.10 to the Company's Form
10-QSB for the quarter ended December 31, 1997.
4.11 Form of unsecured 6% Convertible Subordinated Promissory
Notes due June 30, 2001 (individual notes aggregating
$525,000 were granted to four investors and differ as to
principal amount and holder). Filed as Exhibit 4.11 to the
Company's Form 8-K dated May 21, 1998.
4.12 Form of Stock Purchase Warrant granted to 6% Convertible
Subordinated Promissory Note holders (on an aggregate of
262,500 common shares) exercisable at $1.25 per common
share until April 30, 2003 (each individual warrant
differs as to number of shares and holder). Filed as
Exhibit 4.12 to the Company's Form 8-K dated May 21, 1998.
4.13 Form of Stock Purchase Warrant granted to 6% Convertible
Subordinated Promissory Note holders (on an aggregate of
262,500 common shares) exercisable at $2.00 per common
share until April 30, 2003 (each individual warrant
differs as to number of shares and holder). Filed as
Exhibit 4.13 to the Company's Form 8-K dated May 21, 1998.
4.14 Stock Purchase Warrant between the Company and Jackson
Strategic, Inc. dated May 18, 1998 (for 50,000 shares
exercisable at $1.75 per share) filed as Exhibit 4.14 to
the Company's Form 10-KSB for the year ended June 30,
1998.
4.15 Stock Purchase warrant between the Registrant and Viking
Group, LLC, dated October 20, 1998 (for 200,000 shares
exercisable at $0.75 per share) filed as Exhibit 4.15 to
the Company's Registration Statement on Form S-3 dated
October 27, 1998.
4.16 Form of Stock Purchase Warrant granted in December 1998
and January 1999 to seven investors exercisable into an
aggregate of 500,000 common shares at $1.00 per share
until December 31, 2003 (individual warrants differ as to
number, date and holder) filed as Exhibit 4.16 to the
Company's Form 10-QSB for the quarter ended December 31,
1998. Officer/director James A. Barnes is the indirect
holder of a warrant on 25,000 of these shares.
4.17 Note Purchase Agreement between the Company's wholly-owned
subsidiary (ValueStar, Inc.) and three institutional
investors dated March 31, 1999 filed as Exhibit 4.17 to
the Company's report on Form 8-K dated April 13, 1999.
27
<PAGE>
4.17.1 First Amendment to Note Purchase Agreement amendment dated
September 20, 1999 between the Company and the Company's
wholly-owned subsidiary (ValueStar, Inc.) and three
institutional investors filed as Exhibit 4.17.1 to the
Company's Form 10-KSB for the year ended June 30, 1999.
4.17.2 Second Amendment to Note Purchase Agreement between the
Company's wholly-owned subsidiary (ValueStar, Inc.) and
three institutional investors dated December 8, 1999 filed
as Exhibit 4.17.2 to the Company's Form 8-K dated December
13, 1999.
4.18 Form of 8% Senior Note dated March 31, 1999 between
ValueStar, Inc. and three institutional investors for an
aggregate of $2.45 million (individual notes differ as to
holder and amount) filed as Exhibit 4.18 to the Company's
report on Form 8-K dated April 13, 1999.
4.19 Shareholder Agreement between the Company, three
institutional investors and certain stockholders of the
Company dated March 31, 1999 filed as Exhibit 4.19 to the
Company's report on Form 8-K dated April 13, 1999.
4.19.1 Waiver Agreement between the Company, three institutional
investors and certain stockholders of the Company dated
July 21, 1999 filed as Exhibit 4.19.1 to the Company's
Form 10-KSB for the year ended June 30, 1999.
4.19.2 Second Amendment to Shareholder Agreement between the
Company, three institutional investors and certain
stockholders of the Company dated December 8, 1999 filed
as Exhibit 4.19.2 to the Company's report on Form 8-K
dated December 13, 1999.
4.19.3 Waiver Agreement between the Company and three
institutional investors dated December 8, 1999 filed as
Exhibit 4.19.3 to the Company's report on Form 8-K dated
December 13, 1999.
4.20 Warrant Purchase Agreement between the Company, three
institutional investors and certain stockholders of the
Company dated March 31, 1999 filed as Exhibit 4.20 to the
Company's report on Form 8-K dated April 13, 1999.
4.21 Form of A, B and C Warrants issued by the Company to three
institutional investors dated March 31, 1999 (individual
warrants differ as to holder and number) filed as Exhibit
4.21 to the Company's report on Form 8-K dated April 13,
1999.
4.22 Security Agreement dated March 31, 1999 between ValueStar,
Inc. and three institutional investors filed as Exhibit
4.22 to the Company's report on Form 8-K dated April 13,
1999.
4.23 Trademark Security Agreement dated March 31, 1999 between
ValueStar, Inc. and three institutional investors filed as
Exhibit 4.23 to the Company's report on Form 8-K dated
April 13, 1999.
4.24 Form of Stock Purchase Warrant dated March 31, 1999 issued
to two individuals by the Company for an aggregate of
152,728 shares of common stock at an exercise price of
$1.375 (individual warrants differ as to holder) filed as
Exhibit 4.24 to the Company's report on Form 8-K dated
April 13, 1999.
4.24.1 Form of First Amendment to Stock Purchase Warrant dated
March 31, 1999. The Amendment is dated effective July 15,
1999 and filed as Exhibit 10.12.1 to the Company's Form
10-KSB for the year ended June 30, 1999.
4.25 Stock Purchase Warrant dated June 30, 1999 between the
Company and Davric Corporation for an aggregate of 30,000
common shares at an exercise price of $1.50 per share
filed as Exhibit 4.25 to the Company's Form 10-KSB for the
year ended June 30, 1999.
28
<PAGE>
4.26 Form of Series A preferred stock Purchase Agreement dated
as of July 21, 1999 between the Company and purchasers of
Series A stock (including two directors) filed as Exhibit
4.26 to the Company's Form 10-KSB for the year ended June
30, 1999.
4.27 Form of Registration Rights Agreement and Shareholders
Agreement Amendment dated July 21, 1999 between the
Company, senior note holders, two directors and Series A
stock purchasers filed as Exhibit 4.27 to the Company's
Form 10-KSB for the year ended June 30, 1999.
4.28 Form of Series B Preferred Stock Purchase Agreement dated
as of December 8, 1999 between the Company and Series B
stock purchasers filed as Exhibit 4.28 to the Company's
Form 8-K dated December 13, 1999.
4.29 Form of Investors Rights Agreement dated as of December 8,
1999 between the Company, three senior note holders, two
directors and Series A and Series B stock purchasers filed
as Exhibit 4.29 to the Company's Form 8-K dated December
13, 1999.
4.29.1 First Amended ValueStar Corporation Investor Rights
Agreement dated as of March 24, 2000 between the Company
and certain Series A, Series B and 585 Unit Investors
filed as Exhibit 4.29.1 to the Company's Form 10-QSB for
the quarter ended March 31, 2000.
4.30 Stock Purchase Warrant dated December 8, 1999 between the
Company and Jackson Strategic, Inc. for an aggregate of
75,000 common shares at $2.50 per share filed as Exhibit
4.30 to the Company's Form 8-K dated December 13, 1999.
4.31 Form of Securities Purchase Agreement dated as of March
24, 2000 between the Company and 585 Unit Investors filed
as Exhibit 4.31 to the Company's Form 10-QSB for the
quarter ended March 31, 2000.
4.32 Form of Stock Purchase Warrant dated as of March 24, 2000
between the Company and 585 Unit Investors filed as
Exhibit 4.32 to the Company's Form 10-QSB for the quarter
ended March 31, 2000.
10.1 Research and Rating Agreement between the Public Research
Institute of San Francisco State University and ValueStar,
Inc. effective April 30, 1997 filed as Exhibit 6.1 to the
Company's Registration Statement on Form 10-SB, as amended
10.2 1992 Incentive Stock Option Plan, As Amended and filed as
Exhibit 6.2 to the Company's Registration Statement on
Form 10-SB, as amended
10.2.1 Standard form of Incentive Stock Option Plan Agreement
filed as Exhibit 6.2.1 to the Company's Registration
Statement on Form 10-SB, as amended
10.3 1992 Non-Statutory Stock Option Plan, As Amended and filed
as Exhibit 6.3 to the Company's Registration Statement on
Form 10-SB, as amended
10.3.1 Standard form of Non-Statutory Stock Option Plan Agreement
filed as Exhibit 6.3.1 to the Company's Registration
Statement on Form 10-SB, as amended
10.4 Employment Agreement between the Company and James Stein
dated as of July 1, 1998 filed as Exhibit 10.4 to the
Company's Form 10-KSB for the year ended June 30, 1998.
10.5 Form of Office Lease between the Company's Subsidiary and
Broadlake Partners dated April 20, 1999, December 30,
1999, January 27, 2000 and March 3, 2000 filed as Exhibit
10.12.1 to the Company's Form 10-KSB for the year ended
June 30, 1999.
10.6 (not used)
29
<PAGE>
10.7 1996 Stock Option Plan, as amended and restated and filed
as Exhibit 6.7 to the Company's Registration Statement on
Form 10-SB, as amended
10.7.1 Standard form of 1996 Stock Plan Agreement filed as
Exhibit 6.7.1 to the Company's Registration Statement on
Form 10-SB, as amended
10.8 1997 Stock Option Plan filed as Exhibit 6.8 to the
Company's Registration Statement on Form 10-SB, as amended
10.8.1 Standard form of 1997 Stock Plan Agreement filed as
Exhibit 6.8.1 to the Company's Registration Statement on
Form 10-SB, as amended
10.8.2 First Amendment to 1997 Stock Option Plan dated March 31,
1998 and filed as Exhibit 10.8.2 to the Company's Form
10-KSB for the year ended June 30, 1998.
10.8.3 Second Amendment to 1997 Stock Option Plan dated August
31, 1999 and Approved by the Shareholders on November 19,
1999 as filed as Exhibit 10.8.3 to the Company's Form
10-QSB for the quarter ended March 31, 2000.
10.9 (not used)
10.10 Form of Non-Qualified Stock Option Agreement dated as of
July 6, 1998 between the Company and three directors
covering an aggregate of 200,000 shares (individual
agreements vary as to number of shares and holder, Mr.
Stein as to 100,000 shares and Mr. Polis and Mr. Barnes as
to 50,000 shares each) filed as Exhibit 10.10 to the
Company's Form 10-KSB for the year ended June 30, 1998.
10.11 Promissory Note between the Company and Davric Corporation
dated August 14, 1998 filed as Exhibit 10.11 to the
Company's Form 10-KSB for the year ended June 30, 1998.
10.12 Promissory Note between the Company and Davric Corporation
dated November 15, 1998 filed as Exhibit 10.12 to the
Company's Form 10-QSB for the quarter ended December 31,
1998.
10.12.1 First Amendment to Promissory Note between the Company and
Davric Corporation dated June 30, 1999 filed as Exhibit
10.12.1 to the Company's Form 10-KSB for the year ended
June 30, 1999.
10.13 Press release issued by the Company on April 1, 1999 filed
as Exhibit 10.13 to the Company's Form 8-K dated April 13,
1999.
10.14 Press release issued by the Company on December 9, 1999
share filed as Exhibit 10.14 to the Company's Form 8-K
dated December 13, 1999.
10.15 Press release issued by the Company on December 13, 1999
filed as Exhibit 10.15 to the Company's Form 8-K dated
December 13, 1999.
10.16 Non-Qualified Stock Option Agreement dated as of September
29, 1999 between the Company and James Stein as filed as
Exhibit 10.16 to the Company's Form 10-QSB for the quarter
ended December 31, 1999.
10.17 Non-Qualified Stock Option Agreement dated as of November
6, 1999 between the Company and Joshua M. Felser as filed
as Exhibit 10.17 to the Company's Form 10-QSB for the
quarter ended December 31, 1999.
10.18 Non-Qualified Stock Option Agreement dated as of January
28, 2000 between the Company and Robert Sick as filed as
Exhibit 10.18 to the Company's Form 10-QSB for the quarter
ended March 31, 2000.
30
<PAGE>
10.19 Non-Qualified Stock Option Agreement dated as of January
28, 2000 between the Company and Robert Sick as filed as
Exhibit 10.19 to the Company's Form 10-QSB for the quarter
ended March 31, 2000.
10.20 Incentive Stock Option Agreement dated as of January 28,
2000 between the Company and Robert Sick as filed as
Exhibit 10.20 to the Company's Form 10-QSB for the quarter
ended March 31, 2000.
10.21* 2000 Equity Incentive Plan adopted by the Board of
Directors on July 21, 2000.
10.21.1* Standard form of stock option agreement under the 2000
Equity Incentive Plan.
10.22* Lease Agreement between the Company's subsidiary and
Amplicon Financial dated March 23, 2000.
10.23* Master Loan and Security Agreement and Form of Promissory
Note between the Company and Transamerica Business Credit
Corporation dated April 7, 2000.
10.23.1* Stock Purchase Warrant between the Company and TBCC
Funding Trust II for an aggregate of 22,802 shares at
$6.14.
10.24* Database License Agreement between the Company's
subsidiary and InfoUSA.com, Inc. dated June 14, 2000.
[Portions of this Exhibit have been omitted (based upon a
request for confidential treatment) and have been filed
separately with the Securities and Exchange Commission
pursuant to Rule 24b-2)]
10.25* Service Agreement between the Company and Golden Retriever
Systems, L.L.C. dated June 1, 2000. [Portions of this
Exhibit have been omitted (based upon a request for
confidential treatment) and have been filed separately
with the Securities and Exchange Commission pursuant to
Rule 24b-2)]
10.26* Incentives Management Program Agreement between the
Company's subsidiary and Netcentives Inc. dated May 9,
2000. [Portions of this Exhibit have been omitted (based
upon a request for confidential treatment) and have been
filed separately with the Securities and Exchange
Commission pursuant to Rule 24b-2)]
21.1* Subsidiary of the Company
23.1* Consent of Moss Adams LLP
27.1* Financial Data Schedule
____________________________
* Filed herewith.
(1) Indicates management contract or compensatory plan.
(b) Reports on Form 8-K.
None
31
<PAGE>
Form 10KSB
--------------------------------------------------------------------------------
VALUESTAR CORPORATION
INDEPENDENT AUDITOR'S REPORT
AND
CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 AND 1999
--------------------------------------------------------------------------------
<PAGE>
--------------------------------------------------------------------------------
CONTENTS
PAGE
INDEPENDENT AUDITOR'S REPORT.................................................F-1
CONSOLIDATED FINANCIAL STATEMENTS
Balance sheets..........................................................F-2
Statements of operations................................................F-3
Statements of stockholders' equity......................................F-4
Statements of cash flows................................................F-5
Notes to financial statements...........................................F-7
--------------------------------------------------------------------------------
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
ValueStar Corporation
We have audited the accompanying consolidated balance sheets of ValueStar
Corporation, as of June 30, 2000 and 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of ValueStar
Corporation as of June 30, 2000 and 1999, and the results of its operations and
cash flows for the years then ended, in conformity with generally accepted
accounting principles.
The accompanying consolidated financial statements have been prepared assuming
ValueStar Corporation will continue as a going concern. As discussed in Note 2,
the Company's recurring losses and its inability to generate sufficient cash
flows from operations to meet its obligations raises substantial doubt about the
Company's ability to continue as a going concern. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
/s/ Moss Adams LLP
Santa Rosa, California
August 3, 2000, except for Note 15,
as to which the date is September 22, 2000
Page F-1
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, 2000 and 1999
----------------------------------------------------------------------------------------------------
<CAPTION>
ASSETS
2000 1999
------------ ------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 5,287,385 $ 270,149
Receivables 454,233 409,806
Inventory 16,898 4,008
Prepaid expenses 416,573 59,446
------------ ------------
Total current assets 6,175,089 743,409
PROPERTY AND EQUIPMENT 5,415,358 501,605
RESTRICTED CASH 296,000 --
DEFERRED COSTS 23,949 100,839
OTHER ASSETS 89,489 194,130
------------ ------------
Total assets $ 11,999,885 $ 1,539,983
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,665,030 $ 461,825
Accrued liabilities and other payables 1,254,035 189,759
Deferred revenues 137,520 27,430
Note payable - shareholder -- 280,000
Current portion of capitalized leases 285,458 30,018
Current portion of long-term debt 450,503 1,032,664
------------ ------------
Total current liabilities 3,792,546 2,021,696
CAPITAL LEASE OBLIGATIONS, net of current portion 408,492 113,541
LONG-TERM DEBT, net of current portion 853,997 1,795,438
------------ ------------
Total liabilities 5,055,035 3,930,675
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock, $.00025 par value; 5,000,000 shares authorized:
500,000 shares designated Series A Convertible, with 225,000
shares issued and outstanding at June 30, 2000 (liquidation
preference of $10.00 per share) 56 --
800,000 shares designated Series B Convertible, with 688,586
shares issued and oustanding at June 30, 2000 (liquidation
preference of $17.50 to $30.00 per share, see note 10) 172 --
Common stock, $.00025 par value; 50,000,000 shares
authorized, 15,587,543 and 9,374,132 shares issued and
outstanding in 2000 and 1999 3,897 2,344
Additional paid-in capital 32,162,473 6,485,373
Accumulated deficit (25,221,748) (8,878,409)
------------ ------------
Total stockholders' equity (deficit) 6,944,850 (2,390,692)
------------ ------------
Total liabilities and stockholders' equity $ 11,999,885 $ 1,539,983
============ ============
<FN>
See accompanying notes.
----------------------------------------------------------------------------------------------------
Page F-2
</FN>
</TABLE>
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended June 30, 2000 and 1999
----------------------------------------------------------------------------------
<CAPTION>
2000 1999
------------ ------------
<S> <C> <C>
REVENUES $ 2,090,773 $ 2,329,219
------------ ------------
OPERATING EXPENSES
Cost of revenues 1,250,189 1,035,401
Selling 3,797,530 1,776,390
Marketing and promotion 3,037,502 778,435
Product and content development 5,860,062 --
General and administrative 2,444,516 1,734,564
Stock-based compensation 77,000 68,000
------------ ------------
16,466,799 5,392,790
------------ ------------
LOSS FROM OPERATIONS (14,376,026) (3,063,571)
------------ ------------
OTHER INCOME (EXPENSES)
Interest income 279,785 --
Interest expense (2,076,519) (395,890)
Miscellaneous (2,702) (283)
------------ ------------
(1,799,436) (396,173)
------------ ------------
NET LOSS (16,175,462) (3,459,744)
BENEFICIAL CONVERSION ON SERIES B PREFERRED STOCK (11,650,255) --
ACCRUED DIVIDENDS ON SERIES A PREFERRED STOCK (167,877) --
------------ ------------
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS (NOTE 13) $(27,993,594) $ (3,459,744)
============ ============
LOSS PER COMMON SHARE $ (2.41) $ (0.39)
============ ============
WEIGHTED AVERAGE OF COMMON SHARES OUTSTANDING 11,630,262 8,966,203
============ ============
<FN>
See accompanying notes.
----------------------------------------------------------------------------------
Page F-3
</FN>
</TABLE>
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30, 2000 and 1999
-----------------------------------------------------------------------------------------------------------
<CAPTION>
Preferred Stock Common Stock
--------------------------- ---------------------------
Shares Amount Shares Amount
------ ------ ------ ------
<S> <C> <C> <C> <C>
Balance, June 30, 1998 -- $ -- 8,682,496 $ 2,171
Sale of stock at $1.00 per unit,
consisting of one share and one
warrant -- -- 500,000 125
Exercise of warrants at $0.75 per
share -- -- 150,000 37
Options exercised at $0.75 per share -- -- 15,000 4
Conversion of debt to stock
at $1.00 per share -- -- 26,636 7
Issuance of warrants with debt -- -- -- --
Issuance of warrants for services -- -- -- --
Issuance of options for services -- -- -- --
Net loss -- -- -- --
------------ ------------ ------------ ------------
Balance, June 30, 1999 -- -- 9,374,132 2,344
Issuance of Series A Convertible
Preferred Stock, net of issuance
costs of $40,000 225,000 56 -- --
Accrued 8% dividends on Series A
Preferred Stock -- -- -- --
Issuance of Series B Convertible
Preferred Stock, net of issuance
costs of $75,000 688,586 172 -- --
Stock issued on conversion of 6%
convertible notes and interest -- -- 546,274 137
Stock issued on exercise of warrants
reducing 12% subordinated notes -- -- 525,000 131
Stock issued on exercise of A and
B warrants retiring 8% Senior
Secured Notes -- -- 1,977,382 494
Stock issued at $5.85 per share, net
of issuance costs of $25,000 -- -- 1,125,767 282
Stock issued at $5.85 per share on
cashless call of C warrants -- -- 184,320 46
C warrant call proceeds applied to
exercise A warrants on a
cashless basis -- -- 77,382 19
Stock issued on exercise of options
and warrants -- -- 1,752,479 438
Issuance of stock in connection with
contract -- -- 24,807 6
Value assigned to warrants granted in
connection with equipment note -- -- -- --
Unearned stock-based compensation -- -- -- --
Net loss -- -- -- --
------------ ------------ ------------ ------------
Balance, June 30, 2000 913,586 $ 228 15,587,543 $ 3,897
============ ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Additional
Paid-in Accumulated
Capital Deficit Total
------- ------- -----
<S> <C> <C> <C>
Balance, June 30, 1998 $ 4,247,160 $ (5,418,665) $ (1,169,334)
Sale of stock at $1.00 per unit,
consisting of one share and one
warrant 499,875 -- 500,000
Exercise of warrants at $0.75 per
share 112,463 -- 112,500
Options exercised at $0.75 per share 11,246 -- 11,250
Conversion of debt to stock
at $1.00 per share 26,629 -- 26,636
Issuance of warrants with debt 1,520,000 -- 1,520,000
Issuance of warrants for services 60,000 -- 60,000
Issuance of options for services 8,000 -- 8,000
Net loss -- (3,459,744) (3,459,744)
------------ ------------ ------------
Balance, June 30, 1999 6,485,373 (8,878,409) (2,390,692)
Issuance of Series A Convertible
Preferred Stock, net of issuance
costs of $40,000 2,209,944 2,210,000
Accrued 8% dividends on Series A
Preferred Stock 167,877 (167,877) --
Issuance of Series B Convertible
Preferred Stock, net of issuance
costs of $75,000 11,975,083 -- 11,975,255
Stock issued on conversion of 6%
convertible notes and interest 546,036 -- 546,173
Stock issued on exercise of warrants
reducing 12% subordinated notes 656,119 -- 656,250
Stock issued on exercise of A and
B warrants retiring 8% Senior
Secured Notes 1,449,506 -- 1,450,000
Stock issued at $5.85 per share, net
of issuance costs of $25,000 6,560,492 -- 6,560,774
Stock issued at $5.85 per share on
cashless call of C warrants (46) -- --
C warrant call proceeds applied to
exercise A warrants on a
cashless basis (19) -- --
Stock issued on exercise of options
and warrants 1,820,114 -- 1,820,552
Issuance of stock in connection with
contract 99,994 -- 100,000
Value assigned to warrants granted in
connection with equipment note 115,000 -- 115,000
Unearned stock-based compensation 77,000 -- 77,000
Net loss -- (16,175,462) (16,175,462)
------------ ------------ ------------
Balance, June 30, 2000 $ 32,162,473 $(25,221,748) $ 6,944,850
============ ============ ============
<FN>
See accompanying notes.
-------------------------------------------------------------------------------------------------
Page F-4
</FN>
</TABLE>
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2000 and 1999
-----------------------------------------------------------------------------------------------
<CAPTION>
2000 1999
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(16,175,462) $ (3,459,744)
Adjustments to reconcile net loss to net
cash from operating activities:
Depreciation 882,093 89,988
Amortization of intangible assets 174,361 7,657
Amortization of bond discount 1,509,667 84,645
Change in allowance for doubtful accounts 965 (30,921)
Accrued interest included in long-term debt 12,160 29,861
Warrants and options issued for services 77,000 68,000
Loss on disposal of assets 33,899 --
Changes in:
Receivables (45,393) (17,516)
Inventory (12,890) 20,388
Prepaid expenses (257,127) (55,544)
Deferred costs 76,890 30,091
Other assets (69,682) (17,890)
Accounts payable 1,203,206 264,415
Accrued liabilities and other payables 1,064,276 44,314
Deferred revenues 110,090 410
------------ ------------
Net cash from operating activities (11,415,947) (2,941,846)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Property and equipment acquisitions (5,239,157) (381,326)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of preferred stock, net of issuance cost 12,935,255 --
Proceeds from sale of common stock, net of issuance cost 8,381,252 623,750
Proceeds from senior debt -- 2,450,000
Debt acquisition fee -- (140,000)
Increase in restricted cash (296,000) --
Net borrowings (repayments) under line of credit -- (250,000)
Proceeds from debt 1,528,737 781,150
Payments on capital leases (40,196) (13,908)
Payments on debt (836,708) (256,275)
------------ ------------
Net cash from financing activities 21,672,340 3,194,717
------------ ------------
NET INCREASE (DECREASE) IN CASH 5,017,236 (128,455)
CASH, beginning of year 270,149 398,604
------------ ------------
CASH, end of year $ 5,287,385 $ 270,149
============ ============
<FN>
See accompanying notes.
------------------------------------------------------------------------------------------------
Page F-5
</FN>
</TABLE>
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended June 30, 2000 and 1999
------------------------------------------------------------------------------------------------
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
SUPPLEMENTAL CASH-FLOW INFORMATION
Cash paid during the year for:
Interest $ 380,369 $ 272,425
Income taxes $ 2,702 $ 800
Non-cash investing and financing activities:
Equipment acquired under capital leases $ 590,588 $ 157,467
Warrants issued with debt $ 115,000 $ 20,000
Accrued dividends on Series A Preferred Stock $ 167,877 $ --
8% Secured Noted converted to Series B Preferred Stock $1,000,000 $ --
Shareholder advances converted to Series B Preferred Stock $ 250,000 $ --
12% Notes converted upon warrant exercise $ 625,000 $ --
6% Convertible Notes and interest converted to equity $ 546,274 $ 25,000
8% Secured Notes converted upon warrant exercise $1,450,000 $ --
Call of C warrants converted to stock and additional warrants $1,093,754 $ --
12% Subordinated Notes converted upon warrant exercise $ 31,250 $ --
<FN>
See accompanying notes.
------------------------------------------------------------------------------------------------
Page F-6
</FN>
</TABLE>
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Description of operations - The Company, a Colorado corporation, conducts its
operations through ValueStar, Inc., a wholly owned subsidiary, in major
metropolitan areas located in California, Washington, Texas, Illinois, Georgia,
Pennsylvania, and the District of Columbia. ValueStar, Inc. was incorporated in
California in 1991, and is a provider of branded ratings on local service
businesses. The Company generates revenues from research and rating fees and is
developing a new commission system to generate revenues by connecting member
service businesses with member buyers.
Principles of consolidation - The consolidated financial statements include the
accounts of Valuestar Corporation and its wholly owned subsidiary. All material
intercompany transactions and balances have been eliminated.
Inventory - Inventory consists of promotional materials for sale to ValueStar
Certified businesses and direct advertising material, and is stated at the lower
of cost (first-in, first-out method) or market.
Property and equipment - Property and equipment are stated at cost and
depreciated using the straight-line method over estimated useful lives of two to
five years.
Income taxes - Income taxes are recognized using enacted tax rates, and are
composed of taxes on financial accounting income that is adjusted for
requirements of current tax law and deferred taxes. Deferred taxes are the
expected future tax consequences of temporary differences between the financial
statement carrying amounts and tax bases of existing assets and liabilities.
Use of estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires the Company make estimates and
assumptions affecting the reported amounts of assets, liabilities, revenues and
expenses, and the disclosure of contingent assets and liabilities. The amounts
estimated could differ from actual results.
Revenue recognition - The Company's revenues have been primarily from
certification and rating fees, and are recognized when all related services are
provided to the customer. Rating services are primarily related to a survey of a
business' customers and the delivery of a ratings report. Services associated
with certification include an orientation and the delivery of certification
materials and manuals. Sales of marketing materials and other services are
recognized as materials are shipped or services are rendered.
In December 1999, in all market areas except Northern California, the Company
changed from a fixed certification fee to a percentage fee based on the value of
future transactions between member service companies and member buyers. The
Company has also changed its program to provide benefits to buyers purchasing
from member businesses. The Company has not completed development of the systems
required to commence collection of percentage fees or to register buyers for
benefits and the Company will not collect fees or incur benefit costs until the
systems are operational. In the future the Company expects the majority of its
revenues to be derived from commissions.
Due to the change in the Company's program, the Company expects it will
recognize commission revenues as reported and earned. Commencing July 1, 2000
the Company also intends to recognize any fixed fees on a straight-line basis
over the term of a participating business license, generally one year. Costs of
benefits provided to buyers will be recognized as provided, with reserves for
any future benefits obligations.
The Securities and Exchange Commission's staff (the "Staff") issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"), in December 1999, which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements of all public
companies. The provisions of SAB 101 are effective for transactions beginning in
the Company's fiscal year 2001. The Company intends to recognize revenues from
its new revenue model, as described above, within the guidance provided by SAB
101.
--------------------------------------------------------------------------------
Page F-7
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
Research and development costs - Research and development expenses are charged
to operations as incurred. Certain internal software and web site development
costs, which are related to the Company's new revenue model, have been
capitalized as prescribed by the American Institute of Certified Public
Accountant's Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," and the Emerging Issues Task
Force consensus at EITF 00-2, "Accounting for Web Site Development Costs."
Concentration of credit risk - Financial instruments potentially subjecting the
Company to concentrations of credit risk consist primarily of demand deposits in
excess of FDIC limits and trade receivables. The Company's demand deposits are
placed with major financial institutions. The risk associated with trade
receivables is mitigated by the Company's ability to remove certification
information from the customer's premises. For the periods presented, there were
no customers that accounted for over 10% of revenues generated by the Company or
of accounts receivable.
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 share number is not presented because the
inclusion of common stock equivalents in the computation would be antidilutive.
Common stock equivalents associated with convertible preferred stock, warrants,
stock options and convertible notes, which are exercisable into 9,932,092 and
6,270,977 shares of common stock at June 30, 2000 and 1999, respectively, could
potentially dilute earnings per share in future years.
Fair value of financial instruments - The Company measures its financial assets
and liabilities in accordance with generally accepted accounting principles. The
fair value of a financial instrument is the amount at which the instrument could
be exchanged in a current transaction between willing parties. For certain of
the Company's financial instruments, including cash, accounts receivable and
accounts payable, the carrying amount approximates fair value because of the
short maturities. The carrying amount of the Company's short-term and long-term
debt approximates fair value because interest rates available to the Company for
issuance of similar debt with similar terms and maturities are approximately the
same.
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.
Stock-based compensation - The Company accounts for stock-based employee
compensation arrangements in accordance with the provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25"), and complies with the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Under APB No. 25, compensation expense is the
excess, if any, of the fair value of the Company's stock at a measurement date
over the amount that must be paid to acquire the stock. SFAS No. 123 requires a
fair value method to be used when determining compensation expense for stock
options and similar equity instruments. SFAS No. 123 permits a company to
continue to use APB No. 25 to account for stock-based compensation to employees,
but proforma disclosures of net income and earnings per share must be made as if
SFAS No. 123 had been adopted in its entirety. Stock options issued to
non-employees are valued under the provisions of SFAS No 123.
Comparative figures - Certain amounts in the 1999 consolidated financial
statements have been reclassified to conform to the 2000 presentation.
Recent accounting pronouncements - In December 1999, the Securities and Exchange
Commission issued Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB 101"), which provides guidance on the recognition,
presentation and disclosure of revenue in financial statements of all public
companies. The provisions of SAB 101 are effective for transactions beginning in
the Company's fiscal year 2001. As described above under "Revenue Recognition,"
the Company has addressed this issue, and the Company intends to recognize
revenues consistent with the requirements of SAB 101.
On March 31, 2000, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation" ("FIN 44"). This statement is effective for certain transactions
from December 15, 1998, and is to be applied commencing July 1, 2000. The
Company is in the process of determining the impact, if any, of FIN 44 on the
reporting of its future operations.
--------------------------------------------------------------------------------
Page F-8
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
NOTE 2 - GOING CONCERN
The Company has experienced recurring losses and the use of cash from
operations. A substantial portion of the losses is attributable to research and
development of the Company's commission based system, and marketing and
promotion costs associated with increasing consumers' awareness of the meaning
of ValueStar; marketing to businesses the advantages of becoming ValueStar
members; and discounting certain fees to encourage businesses to become
ValueStar members.
It is management's plan to seek additional financing through private placements
as well as other means. Management believes, but there can be no assurances, the
additional capital it is seeking will be available in the future and will enable
the Company to achieve sales growth and, ultimately, profitable operations.
The 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. Cash flows from future operations
may not be sufficient to enable the Company to meet its obligations, and market
conditions and the Company's financial position may inhibit its ability to
achieve profitable operations.
NOTE 3 - RECEIVABLES
2000 1999
---------- ----------
Trade receivables $ 499,277 $ 453,885
Less allowance for doubtful accounts 45,044 44,079
---------- ----------
$ 454,235 $ 409,806
========== ==========
NOTE 4 - PROPERTY AND EQUIPMENT
2000 1999
---------- ----------
Computer equipment $2,534,733 $ 336,575
Website development 1,001,000 --
Software 612,793 --
Fixtures and equipment 410,498 58,056
Office equipment 777,618 14,079
Equipment and software under capital leases 705,903 157,467
Leasehold improvements 251,445 46,994
---------- ----------
6,293,990 613,171
Less accumulated depreciation and amortization 878,632 111,566
---------- ----------
$5,415,358 $ 501,605
========== ==========
NOTE 5 - DEFERRED COSTS
Deferred costs consist of direct-response advertising programs consisting of
telemarketing, printing and mailing costs. These direct costs are capitalized
and amortized over a sixty-day period. Advertising and promotion costs charged
to expense were $2,734,265 and $1,273,400 for the years ended June 30, 2000 and
1999.
--------------------------------------------------------------------------------
Page F-9
<PAGE>
ALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
NOTE 6 - ACCRUED LIABILITIES AND OTHER PAYABLES
2000 1999
---------- ----------
Potential contract liability $ 600,000 $ --
Payroll and payroll taxes 470,551 118,880
Accrued vacations 105,829 32,782
Other 77,655 38,097
---------- ----------
$1,254,035 $ 189,759
========== ==========
The Company had entered into a contract with a third party that obligated the
Company to pay a $50,000 penalty each quarter over the three-year life of the
agreement if the Company did not generate a defined level of business activity.
The Company subsequently determined to abandon this contract, but it remains
liable for the quarterly penalties. The $600,000 has been reflected as a
liability at June 30, 2000.
NOTE 7 - CAPITAL LEASE OBLIGATIONS
The Company has entered into certain capital lease obligations related to the
purchase of equipment. The leases bear interest at rates ranging from 10% to 24%
and require monthly payments of principal and interest. The leases are secured
by the equipment, and mature through 2004. Pursuant to an equipment lease, the
Company agreed to maintain an irrevocable $296,000 standby letter of credit
throughout the lease term, which expires in June 2002. The bank issuing the
letter of credit required the Company to maintain $296,000 on deposit until the
related lease expires. This deposit is reflected as restricted cash on the
balance sheet.
Future minimum lease payments on capital lease obligations are as follows:
Year Ending June 30,
--------------------
2001 $ 352,148
2002 341,666
2003 92,526
2004 15,118
----------
801,458
Less portion representing interest 107,508
----------
Present value of net minimum lease payments 693,950
Less current portion 285,458
----------
$ 408,492
==========
--------------------------------------------------------------------------------
Page F-10
<PAGE>
<TABLE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
------------------------------------------------------------------------------------------------------
NOTE 8 - LONG-TERM DEBT
<CAPTION>
2000 1999
---------- ----------
<S> <C> <C>
15% Equipment Note due in monthly installments of principal and interest
of $39,023 through March 2003, with a balloon payment of $191,810 due on
April 1, 2003; secured by equipment; net of unamortized note discount
of $105,417 $1,071,202 $ --
15% Equipment Note due to a company affiliated with a stockholder and
director; due in monthly installments of principal and interest of $5,500 to
maturity in June 2002; secured by equipment and software 104,414 150,000
12% Notes; interest is paid monthly, with a balloon payment due in March
2001; net of unamortized note discount of $738; unsecured; $50,000 of the
notes is due a relative of a stockholder and director 68,011 93,636
15% Equipment Note due to a company affiliated with a stockholder and
director; due in monthly installments of principal and interest of $2,022 to
maturity in August 2003; secured by equipment and software 60,873 74,875
8% Senior Secured Notes; converted to common and preferred stock during
fiscal 2000 -- 1,034,499
12% Subordinated notes; unsecured notes repaid or converted to stock
during fiscal 2000 -- 973,104
6% Convertible notes; notes repaid or converted to stock during fiscal 2000 -- 501,988
---------- ----------
1,304,500 2,828,102
Less current portion 450,503 1,032,664
---------- ----------
$ 853,997 $1,795,438
========== ==========
</TABLE>
The Company's $2,450,000 of 8% Senior Secured Notes Payable ("Senior Notes")
that were issued in March 1999 were exchanged for equity securities during the
year ended June 30, 2000. In connection with a $1,000,000 principal reduction of
the Senior Notes in December 1999 applied to purchase 57,143 shares of Series B
Preferred Stock, the Company accelerated the amortization of the related note
discount by $563,126. In connection with the reduction of the $1,450,000
principal balance of the Senior Notes in March 2000, converted to exercise A and
B warrants for 1,977,382 shares of common stock, the Company amortized the
balance of the note discount of $741,022 and amortized $153,333 of other
previously capitalized finance costs. Likewise, on the reduction in certain 12%
Subordinated Notes by $625,000 from the exercise of warrants, the Company
accelerated the amortization of the related note discount by $7,982. These
amortization accelerations increased non-cash expenses by $1,465,463 for the
year ended June 30, 2000.
During the year ended June 30, 2000 the Company called for the conversion of
$500,000 of 6% convertible notes with the principal and accrued interest thereby
converted into 549,274 shares of common stock. An additional $31,250 of 12%
unsecured notes was applied to exercise warrants for 25,000 shares of common
stock.
In connection with a commitment for $2,000,000 of equipment financing in April
2000, the Company granted warrants for 22,802 shares of common stock exercisable
until April 2005 at $6.14 per share. These warrants were valued at $115,000 and
recorded as a note discount that is being amortized over the term of the note.
At June 30, 2000, the Company had drawn $1,278,737 on this commitment.
Maturities of long-term debt are as follows:
Year Ending June 30,
--------------------
2001 $ 450,503
2002 434,544
2003 521,639
2004 3,969
------------
$ 1,410,655
============
--------------------------------------------------------------------------------
Page F-11
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
NOTE 9 - INCOME TAXES
The significant temporary differences between the carrying amounts and tax bases
of existing assets and liabilities that give rise to deferred tax assets and
liabilities include deferring the deduction, for tax purposes, of various
reserves and accrued but unpaid expenses.
A valuation allowance is required for those deferred tax assets that are not
likely to be realized. Realization is dependent upon future earnings during the
period that temporary differences and carryforwards are expected to be
available. Because of the uncertain nature of their ultimate utilization, based
upon the Company's past performance, a complete valuation allowance is recorded
against these deferred tax assets.
The Tax Reform Act of 1986, and the California Conformity Act of 1987, impose
restrictions on the utilization of net operating losses in the event of an
"ownership change," as defined by Section 382 of the Internal Revenue Code.
There has not been a determination as to whether an ownership change has taken
place, as defined, but net-operating losses available to the Company for use in
future years may be limited because a change in ownership could result from the
issuance of additional stock.
The following table summarizes the components of net deferred tax assets:
2000 1999
----------- -----------
Federal tax loss carryforward $ 6,401,000 $ 2,030,000
State tax loss carryforward 1,018,000 336,000
Reserves and allowances 54,000 25,000
State tax deferrals (262,000) (109,000)
Unamortized bond discount 35,000 508,000
----------- -----------
7,246,000 2,790,000
Less valuation allowance 7,246,000 2,790,000
----------- -----------
$ -- $ --
=========== ===========
The Company's federal and state net operating losses that are available for
carryforward will expire as follows:
Date of Expiration Federal California
------------------ ------- ----------
2001 $ -- $ 736,000
2002 -- 701,000
2003 -- 759,000
2004 -- 1,668,000
2005 -- 9,154,000
2007 98,900 --
2008 410,500 --
2009 365,700 --
2010 178,600 --
2011 736,900 --
2012 1,403,000 --
2013 1,519,000 --
2019 3,460,000 --
2020 18,308,000 --
----------- -----------
$26,480,600 $13,018,000
=========== ===========
--------------------------------------------------------------------------------
Page F-12
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
NOTE 10 - CAPITAL STOCK
The Company has designated 5 million shares of capital stock as preferred stock,
with a par value of $0.00025 per share. There were no issued or outstanding
shares of preferred stock at June 30, 1999.
During the first quarter of fiscal 2000, the Company issued 225,000 shares of
Series A Convertible Preferred Stock, with a par value of $.00025 ("Series A
Stock"), for $10 per share. 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 equal to $2.00 per
share, and is automatically converted on the occurrence of certain events. The
Series A 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 Stock outstanding, then the holders are entitled to elect one member of the
Company's Board of Directors.
In connection with the Series A Stock financing the Company incurred legal and
related costs of $40,000. At June 30, 2000, the Series A Stock was convertible
into approximately 1,209,000 shares of common stock.
In December 1999 and January 2000, the Company issued 688,586 shares of Series B
Convertible Preferred Stock, with a par value of $.00025 ("Series B Stock"), at
$17.50 per share. A total of $1,000,000 of the Company's outstanding 8% Senior
Secured Notes and $250,000 of shareholder advances were converted into 71,429 of
these shares of Series B Convertible Stock.
The dollar amount of Series B Stock is convertible into shares of common stock
at a conversion price equal to $1.75 per share, and is automatically converted
on the occurrence of certain events. The Series B Preferred Stock has certain
antidilution and registration rights. The Series B Stock has a liquidation
preference, after payment of the preferential amount for the Series A Stock, of
$17.50 per share. Thereafter the holders of Series B Stock, on an as-converted
basis, and the holders of common stock, shall be paid pro-rata, from remaining
assets until the holders of Series B Stock shall have received an aggregate
preference price of $30.00 per share. Holders of Series B Stock are entitled to
receive non-cumulative dividends at an annual rate of 8% when and if declared by
the Board of Directors. However, no cash dividends shall be paid to common
stockholders unless a like cash dividend has been paid to holders of Series B
Stock on an as-converted basis. As long as there are at least 200,000 shares of
Series B Stock outstanding, then the holders are entitled to elect two members
of the Company's Board of Directors.
In connection with the Series B Stock financing the Company incurred legal and
related costs of $75,000. The Company also issued a warrant to purchase 75,000
shares of common stock at $2.50 per share until December 2004 as a placement
fee. At June 30, 2000, the Series B Stock was convertible into 6,885,860 shares
of common stock.
In March and April 2000, the Company issued 1,310,087 shares of common stock in
a unit financing at $5.85 per unit ("585 Units"), for gross proceeds of
approximately $7,664,000. For each ten units purchased, the Company granted
investors a warrant to purchase one share of common stock at $5.85 per share,
resulting in warrants on 131,013 shares of common stock. A total of 184,320 of
the units were issued in exchange for call proceeds of $1,078,278 to call and
thereby redeem certain C warrants by the Company. The Company incurred legal and
related costs of $25,000.
In connection with this 585 Unit financing, the Company issued a warrant to
purchase 50,000 shares of common stock at $10.00 per share until April 2003 and
a warrant to purchase 30,000 shares of common stock at $5.85 per share until
April 2005.
NOTE 11 - STOCK OPTIONS AND WARRANTS
Stock options - In 1992 the Board of Directors approved the 1992 Incentive Stock
Option Plan (ISO Plan) and the 1992 Non-Statutory Stock Option Plan (NSO Plan).
Both plans expire in 2002. Each plan reserves 250,000 shares of common stock for
incentive and nonstatutory stock options. Options under the ISO Plan and NSO
Plan expire over a period not to exceed ten years from the date of grant.
--------------------------------------------------------------------------------
Page F-13
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
In 1996 the stockholders approved the 1996 Stock Option Plan. The plan expires
in 2006 and reserves 300,000 shares of common stock for nonqualified stock
options. Options under the plan expire over a period not to exceed ten years
from the date of grant.
In 1997 the stockholders approved the 1997 Stock Option Plan. The plan expires
in 2007 and reserves 1,250,000 shares of common stock for incentive or
nonqualified stock options. Options under the plan expire over a period not to
exceed ten years from the date of grant.
Subsequent to June 30, 2000, on July 21, 2000, the Board of Directors
authorized, subject to shareholder approval, the 2000 Equity Incentive Plan,
which expires in July 2010, and reserved 2,500,000 shares of common stock for
Incentive or Nonqualified Stock Options. Options to be granted under the Plan
expire over a period not to exceed ten years from the date of grant.
The following tables summarize the number of options granted and exercisable at
June 30, 2000, and the weighted average exercise prices and remaining
contractual lives of the options:
Weighted
Average
Shares Exercise Price
--------- --------------
Balance, July 1, 1998 877,550 $ 0.59
Granted 395,600 1.18
Canceled (147,050) 0.73
Exercised (15,000) 0.75
Expired -- --
---------
Balance, June 30, 1999 1,111,100 $ 0.78
Granted 2,244,422 4.85
Canceled (679,782) 3.22
Exercised (426,802) 0.46
Expired (15,000) 0.50
---------
Balance, June 30, 2000 2,233,938 $ 4.19
=========
Exercisable at June 30, 2000 700,689 $ 1.82
=========
<TABLE>
<CAPTION>
Weighted Weighted average
average exercise price
Number Number Weighted remaining of options
Range of outstanding at exercisable at average contractual exercisable at
exercise prices June 30, 2000 June 30, 2000 exercise price life June 30, 2000
------------------ ------------------ ---------------- ---------------- ---------------- --------------------
<S> <C> <C> <C> <C> <C>
$ 0.50 150,000 150,000 $ 0.50 0.55 $ 0.50
0.75 20,000 20,000 0.75 1.74 0.75
1.00 231,299 173,269 1.00 2.88 1.00
1.25-1.375 220,000 146,669 1.28 3.03 1.25
1.50 70,000 30,000 1.50 4.07 1.50
1.69-2.00 373,967 65,767 1.98 4.23 1.99
3.00 85,600 38,934 3.00 4.33 3.00
4.00 294,500 - 4.00 4.88 4.00
7.00 668,572 76,050 7.00 4.46 7.00
10.00 40,000 - 10.00 2.17 10.00
15.00 40,000 - 15.00 2.42 15.00
20.00 40,000 - 20.00 2.67 20.00
------------------ ----------------
2,233,938 700,689 $ 4.19 3.75 $ 1.82
================== ================
</TABLE>
--------------------------------------------------------------------------------
Page F-14
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
The non-exercisable options vest over a period of up to five years.
During fiscal 2000, the Company recorded non-cash compensation expense of
$77,000 under its stock option plans to non-employees through the granting of
31,500 options.
Had compensation costs for the Company's stock option plans been determined
based upon the fair value at the grant date for awards under these plans
consistent with the methodology prescribed under SFAS 123, the Company's net
loss and loss per common share would have been as follows:
2000 1999
------------ ------------
Loss for the year $(16,175,462) $ (3,459,744)
Compensation expense (1,330,000) (93,766)
------------ ------------
Pro forma net loss (17,505,462) (3,553,510)
Beneficial conversion on Series B preferred stock (11,650,255) --
Accrued dividends on Series A preferred stock (167,877) --
------------ ------------
Proforma net loss available to common stockholders $(29,323,594) $ (3,553,510)
============ ============
Pro forma loss per common share $ (2.52) $ (0.40)
============ ============
The fair value of each option and warrant granted during 2000 and 1999, is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions: (1) dividend yield of 0%, (2) expected volatility of
72% to 107% in 2000 and 48% to 81% in 1999, (3) risk free interest rate of 4.6%
to 5.5%, and (4) an expected life of the options of from 3 to 5 years. Options
issued during 2000 and 1999, have an estimated weighted average fair value of
$2.46 and $0.28. The non-exercisable options vest over a period of up to five
years.
Stock Warrants
At June 30, 2000, the Company had the following stock purchase warrants
outstanding, each exercisable into one common share:
Number Exercise Price Expiration Date
--------------- -------------------- -----------------------
25,000 $ 1.25 March, 2001
187,500 (1) 1.25 September, 2002
20,000 (1) 1.25 December, 2002
66,300 (2) 5.85 March, 2003
64,713 (2) 5.85 April, 2003
50,000 10.00 April, 2003
12,500 (3) 1.25 April, 2003
50,000 1.75 May, 2003
350,000 (1) 1.00 December, 2003
152,728 (1) 1.38 March, 2004
30,000 (1) 1.50 March, 2004
75,000 2.50 December, 2004
30,000 5.85 April, 2005
22,802 6.14 April, 2005
---------------
1,136,543
===============
(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 $15.00 per share subject to
certain conditions.
(3) These warrants are callable at a stock price of $4.50 per share subject to
certain conditions.
An aggregate of 400,148 of the above warrants are held by officers and directors
of the Company or their affiliates. Some warrants contain certain registration
rights.
--------------------------------------------------------------------------------
Page F-15
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
In connection with the sale of the Senior Notes on March 31, 1999 (see note 8),
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 could 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.
In March 2000 the noteholders applied the $1,450,000 principal balance of the
Senior Notes towards the exercise of 527,514 B Warrants and 1,449,868 A
Warrants. The Company agreed, in connection with the Senior Note cancellation,
to call the C Warrants effective April 4, 2000 and the holders agreed to apply
the proceeds of the call towards the purchase of 585 Units and exercise of the
balance of the A warrants. On April 4, 2000, the holders of the C Warrants
converted the net call proceeds of $5.00 per share, $1,155,660 in the aggregate,
into 77,382 shares of common stock (A Warrant exercise) and 184,320 units of the
585 Unit financing. The call of the C Warrants and issuance of the 585 Units and
shares for the A warrants was on a cashless basis.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
The Company entered into a contract to purchase a minimum of $3,000,000 of
incentive reward points for its buyer awards program over the next 30 months
from a rewards program provider, with, $1,000,000 to be purchased in the first
18 months ending January 31, 2002, and $2,000,000 in the following 12 months
ending January 31, 2003. The Company has also agreed to purchase a minimum of
$250,000 of certain information services from a database service company over a
two-year period ending June 13, 2002. The Company has entered into a number of
other alliances providing for the payment of commissions and referral fees from
time to time.
The president of the Company has an employment agreement that provides, in part,
severance benefits equal to the amount of his annual base salary, $120,000, plus
bonuses.
In June 1999, the Company leased 14,900 square feet of improved office space in
Oakland, California. The Company executed an addendum to this lease for an
additional 5,400 square feet in January 2000. The lease expires on June 29,
2004. The Company entered into subsequent leases for improved office space in
the same building in February, April and June 2000, for a total of 20,000
additional square feet of improved office space. These three leases expire on
January 31, 2005. Office rent expense for the years ended June 30, 2000 and
1999, was $430,000 and $88,000.
Minimum future commitments under the operating lease are as follows:
Year Ending June 30,
--------------------
2001 $ 749,726
2002 635,256
2003 635,256
2004 635,256
2005 195,923
------------
$ 2,851,417
============
--------------------------------------------------------------------------------
Page F-16
<PAGE>
VALUESTAR CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
--------------------------------------------------------------------------------
NOTE 13 - LOSS PER COMMON SHARE
The provisions of the Series A 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
for $167,877 for the year ended June 30, 2000.
Net loss attributable to common stockholders was also increased by $11,650,255
in computing net loss per share for an imputed deemed dividend from a discount
provision included in the Series B Stock, which provided for a conversion price
less than the market price on the date of issuance. The imputed dividend is not
a contractual obligation on the part of the Company to pay such dividend.
NOTE 14 - EMPLOYEE BENEFIT PLAN
The Company provides a 401(k) Profit Sharing Plan covering substantially all
employees meeting certain service requirements. Plan contributions are made at
the discretion of management. There have been no contributions to the Plan for
the years ended June 30, 2000 and 1999.
NOTE 15 - SUBSEQUENT EVENT
During September 2000 the Company issued 227,689 shares of Series C Convertible
Preferred Stock, par value $.00025 ("Series C stock") for cash of $22.50 per
share. Cumulative dividends of 8% per annum are payable when and if declared.
The dollar amount of Series C stock is convertible into shares of common stock
at a conversion price equal to $2.25 per share, and are automatically converted
on the occurrence of certain events. The Series C Stock has certain registration
rights, has a liquidation preference of $22.50 per share plus accrued and unpaid
dividends, and has voting rights equal to the number of shares into which it is
convertible. The Company granted purchasers warrants to purchase 1,138,445
common shares at $2.25 per share for a period of three years.
--------------------------------------------------------------------------------
Page F-17
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
VALUESTAR CORPORATION
By: /s/ JAMES STEIN
---------------
James Stein
Chief Executive Officer
Date: September 25, 2000
<TABLE>
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
<CAPTION>
Name Position Date
---- -------- ----
<S> <C> <C>
/s/ JAMES STEIN Chief Executive Officer September 25, 2000
----------- and Director
James Stein (principal executive officer)
/s/ MICHAEL J. KELLY Controller September 25, 2000
---------------- (principal accounting officer)
Michael J. Kelly
/s/ JAMES A. BARNES Treasurer, Secretary and Director September 25, 2000
--------------- (principal financial officer)
James A. Barnes
/s/ JERRY E. POLIS Director September 25, 2000
--------------
Jerry E. Polis
/s/ FRITZ T. BEESEMYER Director September 25, 2000
------------------
Fritz T. Beesemyer
/s/ JOSH FELSER Director September 25, 2000
-----------
Josh Felser
/s/ STEVE LEDGER Director September 25, 2000
------------
Steve Ledger
/s/ JEFFREY HOLLAND Director September 25, 2000
---------------
Jeffrey Holland
</TABLE>
