UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 2000
Commission File Number 0-22619
VALUESTAR CORPORATION
(Exact name of registrant as specified in its charter)
Colorado 84-1202005
-------- ----------
(State or other jurisdiction of (I.R.S. Empl. Ident. No.)
incorporation or organization)
360-22nd Street, #210, Oakland, California 94612
------------------------------------------ -----
(Address of principal executive offices) (Zip Code)
(510) 808-1300
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
YES X NO
----- ----
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Common Stock, $.00025 par value 15,674,990
------------------------------- ----------
(Class) (Outstanding at October 31, 2000)
Transitional Small Business Disclosure Format (check one): YES __ NO X
-
================================================================================
<PAGE>
VALUESTAR CORPORATION
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited):
Consolidated Balance Sheets as of September 30, 2000
and June 30, 2000 3
Consolidated Statements of Operations for the three
months ended September 30, 2000 and 1999 4
Consolidated Statements of Cash Flows for the three
months ended September 30, 2000 and 1999 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 16
Item 2. Changes in Securities 16
Item 3. Defaults upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
2
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
ASSETS
<CAPTION>
September 30, June 30,
2000 2000
------------ ------------
<S> <C> <C>
CURRENT ASSETS
Cash $ 4,527,913 $ 5,287,385
Receivables 499,064 454,233
Inventory 10,230 16,898
Prepaid expenses 542,710 416,573
------------ ------------
Total current assets 5,579,917 6,175,089
PROPERTY AND EQUIPMENT 5,828,581 5,415,358
RESTRICTED CASH 296,000 296,000
DEFERRED COSTS -- 23,949
OTHER ASSETS 89,241 89,489
------------ ------------
Total assets $ 11,793,739 $ 11,999,885
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,656,887 1,665,030
Accrued liabilities and other payables 1,042,669 1,254,035
Deferred revenues 407,647 137,520
Current portion of capitalized leases 293,570 285,458
Current portion of long-term debt 648,766 450,503
------------ ------------
Total current liabilities 4,049,539 3,792,546
CAPITAL LEASE OBLIGATIONS, net of current portion 331,976 408,492
LONG-TERM DEBT, net of current portion 1,231,103 853,997
------------ ------------
Total liabilities 5,612,618 5,055,035
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 56 56
800,000 shares designated Series B Convertible, with
688,586 shares issued and outstanding 172 172
1,333,333 shares designated Series C Convertible, with
233,689 shares issued and outstanding at September 30, 2000 58 --
Common stock, $.00025 par value; 20,000,000 shares
authorized, 15,674,990 and 15,587,543 shares issued
and outstanding respectively 3,919 3,897
Subscribed preferred stock 22,500 --
Additional paid-in capital 37,500,077 32,162,473
Accumulated deficit (31,345,661) (25,221,748)
------------ ------------
Total stockholders' equity 6,181,121 6,944,850
------------ ------------
Total liabilities and stockholders' equity $ 11,793,739 $ 11,999,885
============ ============
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
-3-
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<CAPTION>
Three Months Ended
September 30,
2000 1999
------------ ------------
<S> <C> <C>
REVENUES $ 273,747 $ 722,125
------------ ------------
OPERATING EXPENSES
Buyer benefits 265,516 186,620
Ratings and content 173,218 368,584
Sales and marketing 2,273,467 1,025,860
Product and content development 2,325,904 266,255
General and administrative 677,017 422,492
Depreciation and amortization 569,083 64,097
------------ ------------
6,284,205 2,333,908
------------ ------------
LOSS FROM OPERATIONS (6,010,458) (1,611,783)
------------ ------------
OTHER INCOME (EXPENSE)
Interest Income 43,727 6,924
Interest expense (92,879) (173,220)
Miscellaneous 377 (800)
------------ ------------
(48,775) (167,096)
------------ ------------
NET LOSS $ (6,059,233) $ (1,778,879)
============ ============
NET LOSS AVAILABLE TO COMMON
STOCKHOLDERS $ (7,786,792) $ (1,811,756)
============ ============
LOSS PER COMMON SHARE $ (0.50) $ (0.19)
============ ============
WEIGHTED AVERAGE OF COMMON SHARES
OUTSTANDING 15,662,718 9,374,132
============ ============
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
-4-
<PAGE>
<TABLE>
VALUESTAR CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Three Months Ended
September 30,
2000 1999
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(6,059,233) $(1,778,879)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation 568,835 59,473
Amortization of intangible assets 248 6,914
Amortization of bond discount 10,208 54,045
Change in allowance for doubtful accounts (6,976) (8,670)
Accrued interest included in long-term debt -- 7,500
Options issued for services -- 59,000
Gain on disposal of assets (1,898) --
Changes in:
Receivables (37,855) (36,309)
Inventory 6,668 (8,717)
Prepaid expenses (126,137) 23,875
Deferred costs 23,949 (16,540)
Other assets -- (2,811)
Accounts payable (8,143) (97,564)
Accrued liabilities and other payables (211,366) 95,342
Deferred revenues 270,127 20,939
----------- -----------
Net cash used by operating activities (5,571,573) (1,622,402)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Property and equipment acquisitions (980,160) (164,815)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of preferred stock 5,223,003 2,210,000
Proceeds from sale of common stock 50,001 --
Proceeds from sale of subscribed preferred stock 22,500 --
Proceeds from debt 732,796 --
Payments on capital leases (68,404) (6,917)
Payments on debt (167,635) (14,066)
----------- -----------
Net cash provided by financing activities 5,792,261 2,189,017
----------- -----------
NET INCREASE (DECREASE) IN CASH (759,472) 401,800
CASH, beginning of period 5,287,385 270,149
----------- -----------
CASH, end of period $ 4,527,913 $ 671,949
=========== ===========
SUPPLEMENTAL CASH-FLOW INFORMATION
Cash paid during the period for:
Interest $ 85,672 $ 112,252
Income taxes $ -- $ 800
Non-cash investing and financing activities:
Accrued dividends on Series A Preferred Stock $ 47,630 $ 32,877
Accrued dividends on Series C Preferred Stock $ 17,050 $ --
<FN>
See accompanying notes to interim consolidated financial statements.
</FN>
</TABLE>
-5-
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2000
1. 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.
The Company's revenues have been primarily from rating and certification
services. Rating services are primarily related to a survey of a business'
customers, verification of credential information 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 rating and certification fee to a percentage commission fee
based on the value of 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 commission fees and will not
collect fees or incur certain benefit costs, which include loyalty points and
customer satisfaction guarantees, until the systems are operational. In the
future the Company expects the majority of its revenues to be derived from
transaction commissions.
Due to the change in the Company's program, the Company will recognize
commission revenues as reported and earned. Because of the changes in the
program and method of generating revenue, commencing July 1, 2000 the Company is
recognizing fixed rating and certification fees on a straight-line basis over
the term of a participating business license, generally one year. Costs of
benefits provided to buyers are recognized as provided, with accruals for any
future benefit obligations.
Because of the changes in the Company's program certain amounts in the current
period are not comparable to the prior period and certain amounts in the
consolidated interim statements have been reclassified to conform to the fiscal
2001 presentation.
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 current fiscal year. The Company believes it is recognizing
revenues within the guidance provided by SAB 101.
2. STATEMENT PRESENTATION
The accompanying unaudited interim financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. They do not include all information and footnotes required by
generally accepted accounting principles. The interim financial statements and
notes thereto should be read in conjunction with the Company's audited financial
statements and notes thereto for the year ended June 30, 2000.
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,
that 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.
6
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2000
2. STATEMENT PRESENTATION (Cont'd)
The consolidated interim 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.
In the opinion of management, the interim financial statements reflect all
adjustments of a normal recurring nature necessary for a fair statement of the
results for interim periods. Operating results for the three month period ended
September 30, 2000 are not necessarily indicative of the results that may be
expected for the year ending June 30, 2001.
3. 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."
4. 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.
<TABLE>
5. LONG-TERM DEBT
<S> <C>
Long-term debt at September 30, 2000 consists of the following:
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 $95,834 $1,006,760
15% Equipment Note due in monthly installments of principal and interest of
$22,363 through July 2003, with a balloon payment of $109,919 due on September
1, 2003; secured by equipment 688,071
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 59,362
12% Notes; interest is paid monthly, with a balloon payment due in March 2001;
net of unamortized note discount of $114; unsecured; $50,000 of the notes is due
a relative of a stockholder and director 68,636
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 57,040
------------
1,879,869
Less current portion 648,766
-----------
$1,231,103
==========
</TABLE>
7
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2000
6. STOCKHOLDERS' EQUITY
<TABLE>
The following table summarizes equity transactions during the three months ended
September 30, 2000:
<CAPTION>
Preferred Stock Common Stock Additional Subscribed
------------------- --------------------- Paid-In Preferred Accumulated
Shares Amount Shares Amount Capital Stock Deficit Total
--------- ------- ---------- -------- ------------ ------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance July 1, 2000 913,586 $ 228 15,587,543 $ 3,897 $ 32,162,473 -- $(25,221,748) $ 6,944,850
Issuance of Series C Convertible
Preferred Stock, net of issuance
costs of $35,000 233,689 $ 58 -- -- 5,222,945 -- -- 5,223,003
Accrued 8% dividends on Series A
and Series C Preferred Stock -- -- -- -- 64,680 -- (64,680) --
Stock issued on exercise of options -- -- 87,447 22 49,979 -- -- 50,001
Subscribed preferred stock 22,500 -- 22,500
Net loss -- -- -- -- -- -- (6,059,233) (6,059,233)
--------- ------- ---------- -------- ------------ ------- ------------ ------------
Balance September 30, 2000 1,147,275 $ 286 15,674,990 $ 3,919 $ 37,500,077 $22,500 $(31,345,661) $ 6,181,121
========= ======= ========== ======== ============ ======= ============ ============
</TABLE>
During the first quarter the Company issued 233,689 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 by the Board of Directors or upon liquidation or conversion. The dollar
amount of Series C Stock 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
antidilution and registration rights, has a liquidation preference, after
payment of the preferential amount for the Series A and Series B preferred
stock, of $22.50 per share plus accrued and unpaid dividends. The Series C Stock
has voting rights equal to the number of common shares into which it is
convertible. In addition, as long as there are at least 200,000 shares of Series
C Stock outstanding, then the holders are entitled to elect one member of the
Company's Board of Directors.
The Company has agreed to issue to an outside financial advisor warrants to
purchase an aggregate of approximately 99,100 shares of common stock at an
exercise price of $2.25 per share with a five year term in connection with the
sale of the Series C Stock.
At September 30, 2000 the Company's Series A, B and C convertible preferred
stock was convertible into approximately 10.5 million shares of common stock.
At September 30, 2000 the Company had received subscriptions for 1,000 shares of
Series C Stock. See Note 13.
7. STOCK OPTIONS AND WARRANTS
The following table summarizes option activity for the period ended September
30, 2000:
Weighted Average Weighted
Shares Exercise Price Average Life
------ -------------- ------------
Outstanding July 1, 2000 2,233,938 $4.19 3.75
Granted 367,500 $3.69
Canceled (157,099) $9.50
Exercised (90,001) $0.64
Expired (5,000) $0.50
---------
Outstanding September 30, 2000 2,349,338 $3.94 3.82
=========
Exercisable at September 30, 2000 822,340 $2.25 3.05
=========
8
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1999
7. STOCK OPTIONS AND WARRANTS (Cont'd)
At September 30, 2000 the Company had the following stock purchase warrants
outstanding each exercisable into one common share:
Number Exercise Price Expiration Date
------ -------------- ---------------
187,500 (1) $1.25 September 2002
20,000 (1) $1.25 December 2002
12,500 (3) $2.00 April 2003
50,000 $1.75 May 2003
25,000 $1.25 March 2001
350,000 (1) $1.00 December 2003
152,728 (1) $1.375 March 2004
30,000 (1) $1.50 March 2004
75,000 $2.50 December 2004
66,300 (2) $5.85 March 2003
64,713 (2) $5.85 April 2003
30,000 $5.85 April 2005
50,000 $10.00 April 2003
22,802 $6.14 April 2005
1,158,445 (4) $2.25 September 2003
---------
2,294,988
=========
(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 $5.00 per share subject to
certain conditions.
(3) These warrants are callable at a stock price of $4.50 per share subject to
certain conditions.
(4) These warrants are callable at a stock price of $6.00 per share subject to
certain conditions.
9
<PAGE>
VALUESTAR CORPORATION
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2000
8. INCOME TAXES
At September 30, 2000 a valuation allowance has been provided to offset the net
deferred tax assets as management has determined that it is more likely than not
that the deferred tax asset will not be realized. The Company has for federal
income tax purposes net operating loss carryforwards of approximately $26.5
million which expire through 2020 of which certain amounts are subject to
limitations under the Internal Revenue Code, as amended.
9. LOSS PER COMMON SHARE
Loss per common share is computed using the weighted average number of common
shares outstanding. Since a loss from operations exists, a diluted earnings per
common share number is not presented because the inclusion of common stock
equivalents in the computation would be antidilutive. Common stock equivalents
associated with warrants, stock options and preferred stock, which are
exercisable into approximately 13.6 million shares of common stock at September
30, 2000 could potentially dilute earnings per share in future periods.
The provisions of the Series A and Series C Stock provide for cumulative 8%
dividends and provide, upon conversion, a similar accretion whether or not such
dividends have been declared by the Board of Directors. These amounts increase
the net loss available to common stockholders. Net loss attributable to common
stockholders was also increased by $1,662,879 in computing net loss per share
for an imputed deemed dividend from a discount provision included in the Series
C Stock, which provided for a converson price less than the market price on the
date of issuance. The imputed non-cash dividend is not a contractual obligation
on the part of the Company to pay such dividend. Net loss available to common
stockholders is computed as follows:
Three Months Ended
September 30,
2000 1999
---- ----
Net loss $(6,059,233) $(1,778,879)
Beneficial conversion of Series C Preferred Stock (1,662,879) -
Accrued dividends on Series A and Series C
Preferred Stock (64,680) (32,877)
----------- -----------
Net loss available to common stockholders $(7,786,792) $(1,811,756)
=========== ===========
10. 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.
11. SUBSEQUENT EVENT
Subsequent to September 30, 2000 the Company sold and issued an additional 3,780
shares of Series C Stock providing gross cash proceeds of $85,000. The Company
also issued 1,000 shares which was subscribed at September 30, 2000 (see Note
6).
10
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO THE
COMPANY'S FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A
VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW AND IN THE COMPANY'S ANNUAL
REPORT ON FORM 10-KSB FOR THE YEAR ENDED JUNE 30, 2000.
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 , 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
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
information and develop computer and related systems for this new service.
During the first quarter of fiscal 2001 we expended approximately $2.3 towards
these activities. 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 (second fiscal quarter of
2001). 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. Due to the change in our
program and until we can recognize sufficient commission revenues we expect
comparative revenues in current periods to be less than prior periods.
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.
11
<PAGE>
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. In December 1999, in all eight current markets except Northern
California, we changed from a fixed rating and certification fee to a percentage
commission fee based on the value of transactions between buyers registered with
us and participating companies rated and licensed with 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 rated 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.
At September 30, 2000 we had approximately 7,350 licensed service businesses
compared to approximately 1,640 at September 30, 1999. We expect these
businesses and new businesses being enrolled to produce commission revenue in
future periods. In our new business model 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.
During the first quarter of 2001 we incurred product, system and database
development costs consisting of (a) capturing and verifying new 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 buyers 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 the second quarter. 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.
Rapid growth, due to the nature of our operations, is expected to contribute to
continued operating losses in the foreseeable future.
During the first quarter we refined our measurement criteria for ValueStar
Verified or ValueStar Top-Rated businesses listed on our Web site. At October
31, 2000 we listed approximately 720,000 ValueStar Verified or ValueStar
Top-Rated businesses and had licensed approximately 7,390 of these businesses as
members in either our commission program or our 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. In fiscal
2000 these fees were recognized as revenue when material services or conditions
relating to the certification had been performed. Due to the change in our
product offering and the benefits to be supplied to consumers, we changed the
method of recording fixed fee revenue effective July 1, 2000. We recognize fixed
fees on a straight-line basis over the term of a participating business license,
generally one year. We will recognize commission revenues as reported and
earned. Costs of benefits provided to buyers are recognized as provided, with
accruals for any future benefit obligations.
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 allowed
and 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.
12
<PAGE>
We expense rating and content maintenance costs as incurred. Costs incurred in
printing and distributing our ValueStar Report publication to buyers, currently
published in January and July, and any related revenues are recognized upon
publication.
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
our current fiscal year. We believe we are recognizing revenues within the
guidance provided by SAB 101.
Results of Operations
Revenues. Revenues consist of rating and certification 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 $273,747 for the three months ended
September 30, 2000 compared to $722,125 for the first three months of the prior
fiscal year. The decrease in revenues is due to the commencement in July 2000 of
recognizing fixed fee revenues on a straight-line basis over the term of the
annual license corresponding to the term we expect to provide benefits to buyers
transacting with a business. This change is due to the change in our product
offering and the change in benefits to be supplied to consumers. If the Company
had recognized revenues in the prior year fiscal quarter using the current
quarter's method, we would have reported total revenues of approximately
$260,000. During the first fiscal quarter of 2001, certification fees accounted
for 25% of revenue, compared to 79% for the prior year's first quarter. In the
first quarter of fiscal 2001 we were earning fixed new and renewal certification
fees from only one market with seven markets converted to the commission
program.
We reported approximately $82,000 of revenue from premium listings in our
ValueStar Report and on our Web site, a decrease of $3,000 from the $85,000
reported in the first three months of the prior year. The small decrease results
from a shift in focus from licensing merchants on a fixed fee basis to licensing
merchants into our commission based systems. We expect ValueStar Report revenues
may increase in future periods when we have an active relationship with sellers.
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. fixed fee 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 licensees up for renewal, (g) renewal rates, (h)
pricing policies, (i) timing of completion of ratings, and (j) other factors,
many 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 program. In such an event we may be required to revert to a fixed fee
basis.
Buyer Benefits. Buyer benefits consist of direct product costs for materials and
information provided to buyers, costs associated with the ValueStar report,
customer service costs for buyers, and in future periods the costs of loyalty
points and customer satisfaction guarantees. These costs of $265,516 represented
97% of sales during the three months ended September 30, 2000. This is an
increase from $186,620 or 26% of revenues for the three months ended September
30, 1999, although the percentage is not directly comparable due to the change
in revenue reporting outlined above. Printing and distribution costs for the
ValueStar Report increased by $26,000 as we printed and distributed more copies
with additional pages. Buyer customer service costs were $48,500. This
department did not exist in the prior period.
Ratings and Content. Ratings and content costs consist primarily of the costs of
rating service sellers, ongoing content and technology costs associated with
maintaining our databases and supporting our operations. In future quarters we
expect to incur certain transaction and matching fees with third parties. Rating
and content costs were $173,218, for the period ending September 30, 2000,
compared to $368,584 for the prior comparable period. The decrease is due
primarily to a reduction in fixed fee ratings and conversion to the new program,
still under development.
Selling and Marketing Costs. Selling and marketing costs consist primarily of
personnel costs for outside sales consultants interacting with licensed sellers,
an inside customer service team for licensed sellers, direct marketing costs
including lead
13
<PAGE>
generation, telemarketing costs and marketing, advertising and promotion
expense. Selling costs for the three months ended September 30, 2000, were
$2,273,467, compared to $1,025,860 for the first quarter of the prior year.
Sales related expenses totaled $949,525 compared to $648,720 for the prior
year's first fiscal quarter. The large increase is due to the commencement in
December 1999 of enrolling local service providers into our commission based
program described earlier. We expect selling costs will vary in future periods,
resulting from levels of future revenues, variances in renewal rates, the effect
of new sales promotions and costs thereof, timing of research and rating
completions, level and percentage of fixed selling costs, the number of new
market regions opened, the mix of sales between fixed fee certifications and
commission based certifications and other factors, some beyond our control.
Marketing and promotion expenses related expenses aggregated $1,323,942 during
the first quarter of fiscal 2000, compared to $351,133 for the prior period.
During the first quarter of fiscal 2000, we expended $243,000 on paid
advertising targeted at expanding consumer awareness of ValueStar Certified.
Paid advertising of $218,000 was employed in the prior year's first quarter.
During the first quarter of fiscal 2001, we expended $262,000 on promotions
compared to $54,000 for the prior year's first quarter with the increase due to
an increased number of promotions in the period. We spent approximately $250,000
on agency fees and market research in the current fiscal quarter with no
comparable expenses in the prior comparable quarter. Expenses related to wages
and consultants in marketing were $550,000 in the current fiscal quarter
compared to $71,000 in the prior fiscal quarter with the large increase due to
the hiring of executives and increased staff in the marketing, product
development and business development departments.
Marketing and promotion expenses are subject to significant variability based on
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 Costs. Product and content development costs
consist primarily of expenses associated with the design, development and
testing of our expanded Internet initiative using existing and new content.
These costs include development of our website and the associated back office
solutions, developing our new proprietary ratings content for our website and
wages in our technology department associated with new product and content
development. During the three months ended September 30, 2000 we expended
$2,325,904 on new program development. This compares to $266,255 during the same
period last year. The prior year fiscal quarter was the first quarter the
Company began segregating these costs. The major component of product
development costs were compensation and related costs of $998,000, partner and
alliance implementation costs of $225,000 and expenses related to the gathering
of new content of $96,000. During the first quarter of fiscal 2001 we allocated
$460,000 of general and administrative costs to product and content development
to reflect the percentage of product and content development expenses relative
to overall expenses.
We have capitalized an additional $494,000 of product and content development
costs as website development and software that are specifically related to
internal software development. The Company capitalized $1,001,000 in the prior
fiscal year. The Company will begin depreciation of this asset upon commencement
of tracking transactions between rating partners and local service providers.
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. General and administrative expenses were $677,017 for the
three months ended September 30, 2000, compared to $422,492 for the prior year's
first quarter, an increase of $254,525. The major increases include a $330,000
increase in compensation and benefits due primarily to the increased number of
executive, administrative and finance personnel added in connection with an
expansion of the employee base; a $42,000 increase in travel and entertainment
costs, a $265,000 increase in occupancy and telephone costs due to additional
personnel and expanded office facilities and a $57,000 increase in legal and
accounting expense due to expanded operations. Management anticipates that
general and administrative costs will continue to exceed prior period levels due
to increased personnel added to support growth and increased general computer,
operating, occupancy and corporate costs.
Depreciation and Amortization. Depreciation and amortization expenses were
$569,083 for the three months ended September 30, 2000, compared to $64,097 for
the prior year period. The large increase is due to the acquisition of
technology equipment and software infrastructure to support an expanded employee
base and our new program, our web site and various internal databases.
14
<PAGE>
Interest and Other Expenses. We incurred interest expense for the three months
ended September 30, 2000 of $92,879 that included $10,208 of non-cash
amortization of bond discount. Interest for the prior comparable period was
$173,220, of which $54,045 was non-cash amortization of bond discount. The
decrease is due to conversion of senior and subordinated debt into equity in the
prior fiscal year. The Company generated interest income of $43,727 in the first
three months of fiscal 2001 compared to $6,924 in the comparable prior period.
Net Loss. We had a net loss of $6,059,233 for the three months ended September
30, 2000, compared to a loss of $1,778,879 for the three months ended September
30, 1999. Our increased loss is attributable to (a) increased selling and
marketing costs incurred related to enrolling larger numbers of service
businesses in anticipation of launching our commission program, (b) product and
content development costs associated with developing our commission based
program, and (c) increased general and administrative costs associated with
additional management and support for expanded operations. We anticipate we will
continue to experience operating losses until we achieve a combination of a
fully functional commission 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
commission 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 quarter ended September 30, 2000 due to the beneficial conversion
feature of the Series C preferred stock issued during the quarter. Net loss was
increased by $1,662,879 for this one-time non-cash imputed charge and increased
by $64,680 for non-cash accrued dividends on Series A and Series C 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
$5,571,573 for the three months ending September 30, 2000 and $1,622,402 for the
three months ended June 30, 1999. At September 30, 2000, we had a working
capital surplus of $1,530,378, including $648,766 representing the current
portion of long-term debt and $293,570 representing the current portion of
capitalized leases. For the three months ended September 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
commission based program with no immediate revenue, product and content
development costs and addition of new executive management. At September 30,
2000, our net accounts receivables were $499,064, representing approximately 164
days of revenues and an annualized turnover ratio of approximately 2.2 times.
This compares unfavorably to approximately 57 days of revenues and turnover of
approximately 6.3 times at September 30, 1999. The significant change is due to
the change in the way we recognize revenues. The Company bills fixed fees in
full at the time the contract starts and extends terms throughout the contract
period. As fixed fee revenue recognition builds over the course of the next
twelve months, we expect ratios should return to past levels. Please see our
discussion of the change in revenue recognition practices under the section
Revenue and Cost Recognition above for further information on this. We believe
that 60 to 90 days revenues in receivables is reasonable based on the nature of
our business and the terms we provide licensees. At September 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 August 2000 we drew down the balance of $732,796 from a
commitment for $2,000,000 in equipment financing obtained in the prior fiscal
year. Also during the three months ended September 30, 2000, we obtained
$5,295,504 from the sale of common, preferred and subscribed 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 $4,527,913 at September 30, 2000 and net accounts
receivable of $499,064, we have no material unused sources of liquidity at this
time. We expect to incur additional operating losses in future fiscal quarters
as a result of continued operations, product development expenditures and
investments in growth. The timing and amounts of these expenditures and the
extent of operating losses will depend on many factors, some of which are beyond
our control.
15
<PAGE>
Subsequent to September 30, 2000 the Company issued 3,780 shares of Series C
Stock, for cash of $85,050. 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 as subsequently reduced by management, 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 may require further 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, product and content development
and general operations. We may also have to curtail the number of market regions
in which we operate or revert to some form of fixed fee program. 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.
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.
Forward-Looking Statements and Business Risks
This Form 10-QSB includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended and Section 21E of the
Securities Exchange Act of 1934, as amended. The words "anticipate," "believe,"
"expect," "plan," "intend," "project," "forecasts," "could" and similar
expressions are intended to identify forward-looking statements. All statements
other than statements of historical facts included in this Form 10-QSB regarding
our financial position, business strategy, budgets and plans and objectives of
management for future operations are forward-looking statements. Although we
believe that the expectations reflected in such forward-looking statements are
reasonable, no assurance can be given that actual results may not differ
materially from those in the forward-looking statements herein for reasons
including the effect of competition, the level of sales and renewal
certifications, marketing, product development and other expenditures, economic
conditions, the legislative and regulatory environment and the condition of the
capital and equity markets.
Readers are cautioned to consider the specific business risk factors described
in our annual report on Form 10-KSB for the fiscal year ended June 30, 2000 and
not to place undue reliance on the forward-looking statements contained herein,
which speak only as of the date hereof. We undertake no obligation to publicly
revise forward-looking statements to reflect events or circumstances that may
arise after the date hereof.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
(a) See description of Series C preferred stock in (c) below.
(b) See description of Series C preferred stock in (c) below.
(c) The following is a description of equity securities sold by the
Company during the first fiscal quarter ended September 30, 2000
that were not registered under the Securities Act:
In September 2000, ValueStar Corporation (the "Company") sold
an aggregate of 233,689 shares of Series C Convertible
Preferred Stock, par value $0.00025 ("Series C Stock"), at
$22.50 per preferred share (each share of which is initially
convertible into ten shares of common stock). This sale was
made in a private offering. A total of 1,333,333 shares of
preferred stock have been authorized and designated by the
Company as Series C Stock.
16
<PAGE>
In connection with the sale, the Company issued to the
purchasers warrants exercisable at $2.25 per share into an
aggregate of 1,158,445 shares of common stock ("Warrants").
These Warrants have a three year term and are callable by the
Company if the stock price exceeds $6.00 per share, subject to
certain additional conditions.
The aggregate gross proceeds from the sale of the Series C
Stock of $5,258,003 included $975,000 in cash from entities
affiliated with three directors, including $250,000 from
eCompanies Venture Group, L.P.
The Series C Stock has a cumulative dividend of 8% per annum
payable when and if declared by the Board of Directors or upon
liquidation or conversion.
The dollar amount of the Series C Stock is convertible at the
option of the holder into shares of common stock at an initial
conversion price, negotiated with outside unaffiliated
investors, of $2.25 per share and are automatically converted
on the occurrence of certain events.
The Series C Stock has a liquidation preference, after payment
of the preferential amount for the Series A and Series B
Stock, of $22.50 per share of Series C Stock plus an
additional amount accruing at the rate of 8% per annum.
The Series C Stock has antidilution rights for certain
issuances below the conversion price. The Series C Stock has
voting rights equal to the number of shares of common stock on
an as-converted basis. In addition, as long as there are at
least 200,000 shares of Series C Stock issued and outstanding,
the holders are entitled, voting as a separate class, to elect
one member of the Company's board of directors.
In connection with the sale of Series C Stock, the Company
entered into a Registration Rights Agreement with the Series C
Stock investors. This agreement provides that within 120 days
following the initial closing on September 15, 2000, that the
Company will use its best efforts to prepare and file a
registration statement on Form S-3 (provided that at such time
the Company is eligible to use S-3 and, if not, use its best
efforts to prepare and file a registration statement on Form
S-3 at such later date as the Company is so eligible).
While the securities were sold by the Company without an
underwriter or cash commission, the Company has agreed to
issue to an outside financial advisor warrants to purchase an
aggregate of approximately 99,100 shares of common stock at an
exercise price of $2.25 per share with a five year term in
connection with this transaction.
All of these 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 Series C Stock and Warrants and
will be placed on the shares of common stock issuable upon
conversion unless registered under the Act prior to issuance.
The Company incurred cash costs estimated at $35,000 in
connection with the offering.
The descriptions of these transactions are qualified in their
entirety by the full text of the agreements attached as
exhibits to the Company's Form 8-K dated September 29, 2000.
(d) None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
17
<PAGE>
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
27 Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed a Form 8-K on September 29, 2000 reporting
one Item 5 Other Event.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
VALUESTAR CORPORATION
Date: November 13, 2000 By: /s/ JAMES A. BARNES
--------------------
James A. Barnes
Secretary and Treasurer
(Principal Financial Officer and duly
authorized to sign on behalf of the Registrant)
19
