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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Fiscal Year Ended December 31, 1998
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Commission File No. 1-10927
VSI ENTERPRISES, INC.
A Delaware Corporation
(IRS Employer Identification No. 84-1104448)
5801 Goshen Springs Road
Norcross, Georgia 30071
(770) 242-7566
Securities Registered Pursuant to Section 12(b)
of the Securities Exchange Act of 1934:
None
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Securities Registered Pursuant to Section 12(g)
of the Securities Exchange Act of 1934:
Common Stock, $.001 par value per share
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not 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-K or any amendment to
this Form 10-K.
The aggregate market value of the common stock of the registrant held by
non-affiliates of the registrant (10,703,808 shares) on March 30, 1999 was
approximately $8,027,856, based on the closing price of the registrant's common
stock as quoted on the Nasdaq SmallCap Market on March 30, 1999. For the
purposes of this response, officers, directors and holders of 5% or more of the
registrant's common stock are considered the affiliates of the registrant at
that date.
The number of shares outstanding of the registrant's common stock, as of March
30, 1999: 12,300,144 shares of $.001 par value common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement to be
delivered to shareholders in connection with for the 1999 annual meeting of
shareholders scheduled to be held on June 11, 1999, are incorporated by
reference in response to Part III of this Report.
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PART I
ITEM 1. BUSINESS.
GENERAL
VSI Enterprises, Inc. (the "Company"), through its wholly-owned
subsidiaries, is in the videoconferencing and system integration business. The
Company offers customers mission-critical solutions by supplying
videoconferencing products and services to support video, voice and data
applications. Its core business is the design, manufacture, marketing and
servicing of interactive group videoconferencing and control systems (the "VSI
Systems"). Each VSI System is designed with open software and modular
subsystems which allow a VSI System to be expanded or reconfigured as
technologies, user requirements or new applications evolve.
The Company's products are designed to allow multiple participants at
geographically dispersed sites to see and hear each other on live television
and share graphical and pictorial information using standard commercially
available telecommunications transmission facilities. The Company integrates
standard video, audio and transmission components with its own proprietary
video, audio and computer control components and software.
The Company's open software and modular subsystems streamline production
and allow the product to be tailored to meet customers' specific needs, with or
without the necessity of custom design. The Company's lead products are
marketed under the trade name Omega(TM). Customers are offered a variety of
option packages to fit specific applications. Customers are also offered
upgrade packages that make the Company's new products compatible with older
models. To date, the Company has sold over 1,700 videoconferencing systems to
approximately 325 customers, including Bank of America, Bell Atlantic, Boeing,
Duracell, MCI, General DataComm and Johnson & Johnson; various foreign, U.S.
and state government departments and agencies; educational institutions; and
health care facilities.
The Company was incorporated under the laws of Delaware on September 19,
1988 as Fi-Tek III, Inc. ("Fi-Tek") for the purpose of raising capital and to
seek out business opportunities in which to acquire an interest. On August 21,
1990, the Company acquired 89.01% of the total common stock and common stock
equivalents then issued and outstanding of Videoconferencing Systems, Inc., a
Delaware corporation ("VSI"). VSI was founded in 1985 through the acquisition
of a portion of the assets of a Sprint Corporation videoconferencing
subsidiary. In December 1990, the Company changed its name from Fi-Tek III,
Inc. to VSI Enterprises, Inc. During the first half of 1991, the Company
acquired the remaining additional outstanding shares of common stock of VSI.
In addition to its VSI subsidiary, the Company conducted its operations
in 1998 through the following four subsidiaries:
- - Videoconferencing Systems, n.v. ("VSI Europe") is a distributor of
the Company's
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videoconference systems in Europe. VSI Europe has offices located in
London and Antwerp.
- - VSI Solutions Inc. ("VSI Solutions") is a software company whose
products include a reservation system for the management of
videoconferencing systems. The Company expects to close VSI
Solutions by July 1, 1999, upon the completion of a contract with a
customer.
- - VSI Network Services, Inc., d/b/a Integrated Network Services, Inc.
("INS") was engaged in the design, installation and support of local
and wide area networks. INS was an integration firm specializing in
the connectivity of multi-protocol environments, ranging from small,
local area networks to large, enterprise-wide networks employing WAN
technologies to connect multiple sites. INS discontinued operations
in December, 1998.
- - VSI Network Solutions, Inc., d/b/a Eastern Telecom, Inc. ("ETI") is
a company engaged in the business of marketing and sales of
telecommunications services and products. ETI sells network services
such as Centrex, frame relay and basic rate interface, primary rate
interface and ISDN connections on behalf of a number of major
telecommunications providers.
References to the Company herein refer to VSI Enterprises, Inc. and
its consolidated subsidiaries, unless the context indicates otherwise.
The Company operates through two primary reportable segments (i)
videoconferencing and (ii) through its ETI subsidiary, telephone network
reselling. See Note K to the Company's consolidated financial statements for
certain financial information relating to these two segments.
On January 15, 1999, the Company implemented a 1-for-4 reverse split
of the shares of VSI Common Stock. All share and per share amounts included in
this report reflect the effects of the reverse split.
The Company's principal executive offices and manufacturing facilities
are located at 5801 Goshen Springs Road, Norcross, Georgia 30071, and its
telephone number is (770) 242-7566.
VSI SYSTEMS & APPLICATIONS
VSI Systems enable participants in multiple locations to hold
interactive group meetings remotely, thus avoiding costly and time-consuming
travel. Participants at any connected location can be seen and heard by all
other participants. If the VSI System is equipped with the appropriate options,
the participants can also utilize slides, graphs, plain paper drawings,
computer-generated graphics, computer data, laser discs and video tape
interactively. Unlike audio teleconferencing systems which only allow voice
communications, audiographic teleconferencing which is limited to voice plus
still images, and business television which does not provide for interaction
among the participants (also known as one-way videoconferencing), the Company
believes its VSI Systems foster the look and feel of live, face-to-face
meetings and promote a natural interaction among the participants.
A typical videoconference involves three major elements: (i) access to
transmission services, (ii) a "codec" for coding/decoding digitized signal
transmissions and (iii) the VSI System, which contains television monitors,
cameras, audio system, microphones, cabinetry, various control systems for
interfacing the components to the user, and various optional components
specific to the user's application.
As the name implies, codecs are used to encode and decode (or compress
and decompress) various types of data -- particularly those that would
otherwise use up inordinate amounts of disk space, such as sound and video
files. Common codecs include those for converting analog video signals into
compressed
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video files (such as MPEG) or analog sound signals into digitized sound (such
as RealAudio). Codecs can be used with either streaming (live video or audio)
or files-based (AVI, WAV) content.
The Company designs, manufactures, assembles, installs and services
the VSI Systems, and it has nonexclusive marketing agreements with codec
manufacturers to resell the codecs. Customers secure the transmission services
independently though telecommunications carriers for either fixed monthly or
hourly usage prices. These transmission services may vary, depending upon the
customer's application and preferences, and include a range of transmission
bandwidths. In general, the higher the bandwidth the better the quality of the
transmitted images, although the choice of codec will affect image quality for
a given speed. The VSI Systems operate over the range of available transmission
bandwidths and are compatible with all major brands of codecs known by the
Company to be currently available; they also operate without codecs, for
certain specialized networks.
The primary users of VSI's videoconferencing products and services are
major corporations, government agencies, educational institutions and health
care facilities.
Corporate and government organizations often use meetings to provide
information, review operations, make plans, resolve problems, introduce new
ideas or products, conduct training sessions and communicate with customers and
vendors. Such conventional group meetings usually require at least some of the
participants to travel to the meeting site. When meetings are required on a
frequent, repetitive or emergency basis, travel costs and productivity losses
can be substantial. The VSI Systems provide users with the ability to hold
two-way and multi-way meetings, often at significant savings over the costs of
travel and lost productivity while traveling. As an added and in some cases a
more important benefit, because travel time and costs are eliminated, it may be
more economic for more people to participate via videoconferencing, thereby
causing the direct dissemination of pertinent information to more parties
simultaneously, which may improve efficiency in problem solving and decision
making.
The Company also supplies and installs the VSI Systems for use in
educational and training settings to connect one or more distant classrooms
with a centrally-based instructor. These "distance learning" applications of
videoconferencing are used by corporations, state and federal governments,
hospitals and clinics, high schools, technical school, colleges and
universities.
The Company also provides "judicial systems" to state and local
governments. Judicial systems equip court systems with the ability to link
court rooms with prisons and jails, thereby reducing the costs and security
risks associated with inmate-related travel including: arraignments,
attorney/client conferences, booking and prisoner processing and depositions.
PROPRIETARY TECHNOLOGY
The Company has developed proprietary technology in the areas of
videoconferencing control systems, system diagnostics, information access and
communications access. While VSI Systems make use of some other manufacturers'
components, the Omega(TM) utilizes internally developed proprietary software
and products as key elements in differentiating the Company's systems in the
marketplace. Since VSI Systems use standards-based codecs, they are
interoperable with systems of other standards-compliant manufacturers.
The heart of the Omega(TM) is the System Controller, a proprietary
software suite that must be installed on a properly configured personal
computer. The software suite includes the Omega(TM) real time operating system,
Omega(TM) videoconferencing application package, device drivers, and a third
party SQL
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database engine (as licensed to VSI for resale). This software is delivered in
object code format. The Company has also developed and manufactures certain
proprietary components: Omega(TM) Audio Processor, Omega(TM) Video Processor,
Omega(TM) Power Supply, the Omega(TM) Basic/Serial IQ Connectors, the Omega(TM)
Pan/Tilt/Zoom/Focus Controller, the Omega(TM) Infra-red User Control Panel and
proprietary cabinetry. These proprietary components are designed to work
exclusively with the Omega(TM) System Controller software.
The Company regards its Omega(TM) software as proprietary and has
implemented protective measures of both a legal (copyright) and practical
nature. The Company derives considerable practical protection for its software
by supplying and licensing only a non-modifiable run-time version to its
customers and keeping confidential all versions that can be modified. By
licensing the software rather than transferring title, the Company in most
cases has been able to incorporate restrictions in the licensing agreements
which impose limitations on the disclosure and transferability of the software.
No determination has yet been made, however, as to the legal or practical
enforceability of these restrictions or the extent of customer liability for
violations.
The Company has been granted seven patents from the U.S. Patent and
Trademark Office that cover certain aspects of the Omega(TM) user interface,
remote management and system architecture (which is a network videoconferencing
system which combines the advantages of central and distributed intelligence
systems). The patents protect the Company's innovative technology and enables
the Company to pursue opportunities to license its technology to other
manufacturers. Currently, the patents secure payment of a $900,000 promissory
note at an interest rate of 14% per annum, with $300,000 due February 16, 1999
and $600,000 due May 16, 1999. In the event of default, the debt holder could
foreclose on its security interest in the patents. (See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Risk Factors")
The Company also has confidentiality agreements with certain of its
employees and has implemented other security measures.
PRODUCTS
The Company believes that the videoconferencing world is becoming a
world of "networks of systems" where all systems from boardroom to rollabout to
desktop will have to interconnect. The Company believes that most systems in
use today are not equipped to handle these demands.
The Company's lead products are marketed under the trade name
Omega(TM). The key features and benefits of the Omega(TM) platform include:
- - Compression Technology Independence - separating control system from
compression technology
- - Open Network Architecture - wide support for options and peripherals;
flexibility; support for most network connection technologies; and
centralized network management
- - Ease of Use - point-and-click camera control and on-screen icons to
control all functions
- - System Management - remote management support and open system support
of industry standards
- - Software-Based System - remote upgrades of software; customization;
and sign-on security and system accounting
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The Omega(TM) product line offers a complete range of group
videoconferencing systems, through three product families: Achiever, Performer
and Ovation.
The Achiever product family is designed for low to moderate usage of
videoconferencing. The systems utilize the best board level codec on the
market, a patented mouse driven graphical user interface and click and zoom
camera control. These products can be upgraded to include remote diagnostics
capabilities, sign on security and additional peripherals.
The Performer product family is designed for moderate to high usage of
videoconferencing. The system encompasses the highest quality codec, advanced
audio and video processors, SCAN technology that supports onscreen control of
peripheral devices and supplies information to a database in the system
controller, remote diagnostics and an open architecture.
The Ovation product family is designed for videoconferencing users
with specific needs. These systems are specially designed for use in distance
learning, video arraignment, large conference rooms and auditoriums.
Customers are offered a menu of options which allows them to tailor
systems to meet their specific needs. The Omega(TM) is sold on a standalone
basis, with or without codec. The Omega(TM) is offered with single, dual or
more color monitors of 27" to 35" size, for rollabout cabinets or in-the-wall
installation. Other options include: audio and video expansion packages,
multiple cameras (either single or three chip), a graphics stand, a computer
graphics interface, facsimile transmission and reception, transmission network
interface, and a variety of videocassette recorders, slides chains and
peripheral devices.
Video Administrator is a custom software package that facilitates
network management, offered through VSI Solutions. Video Administrator will
cease to be provided upon the completion in June, 1999 of a project with one
customer, and the operations of VSI Solutions will be discontinued at that
time.
NEW PRODUCT DEVELOPMENT
The Company continues to upgrade its present products and to develop
new and innovative products for the videoconferencing market. Extensions of its
product line will include a LAN-based gateway offering and software upgrades of
existing products. Additional system and network management products are under
development.
NETWORK SERVICES
The Company, through its ETI subsidiary, serves as a sales agent for a
number of major telecommunications clients, primarily Bell Atlantic. ETI is
paid a commission by its clients for products and services sold to other
entities. Among ETI's core product offerings are network services such as
Centrex, frame relay and basic rate interface, primary rate interface and ISDN
connections.
CUSTOMER SERVICE
The Company generally provides a warranty for parts and labor on its
systems for 90 days from the date of delivery. The Company maintains
videoconference rooms and the necessary transmission facilities and codecs to
provide on-line assistance to its installed customers at its executive offices
near
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Atlanta, Georgia and at its European office. It also provides a telephone
helpline to assist customers in the diagnosis of system failures. Approximately
90% of all customer calls for assistance have been resolved through telephone
or videoconference contact. The remaining 10% have generally been resolved by
the removal and replacement of field replaceable units by Company or customer
personnel. The Company maintains a spare parts inventory, and its policy is to
replace failed units which are under warranty or subject to a service contract
within 24 hours of notification.
The Company offers several different maintenance programs, ranging
from "helpline" telephone consultation to extended field service on a contract
basis, which includes parts, labor, and travel service with a guaranteed
on-site response within 48 hours. Warranty and contract service is provided
from the Company's U.S. and European locations.
MARKETS
The Company has defined its target markets as the "Fortune 1000"
companies in North America and Europe. Typically, these large companies, often
with numerous offices in different cities, are more likely to realize
significant savings on travel and related costs by installing a
videoconferencing network. Cost/benefit analyses are generally performed by the
Company's customers themselves prior to purchasing a system. In addition, the
Company has targeted as a secondary market small to mid-sized companies, as
well as educational institutions, governments and healthcare providers. The
Company's systems are marketed through a direct sales force, as well as through
a select group of co-marketing partners and distributors, including partners
for whom the Company is an original equipment manufacturer ("OEM").
For each of the fiscal years ended December 31, 1998, 1997 and 1996,
international sales (sales outside of the United States and Canada) represented
approximately 27%, 14% and 20%, respectively, of the Company's total sales. Net
product sales attributable to VSI Europe increased from approximately
$2,768,000 during the year ended December 31, 1997 to $2,922,056 for the year
ended December 31, 1998. VSI Europe has historically contributed substantially
all of the Company's international sales, although sales in China of $2,300,000
were recorded in 1998 by VSI. No sales opportunities in China are being pursued
in 1999. The Company believes it presently maintains an approximate 1% to 2%
share of the total worldwide videoconferencing equipment market as measured by
1998 total sales volume for the industry.
CUSTOMERS
The Company's customers include Fortune 1000 companies, mid-sized
corporations, agencies of state, local and federal governments, and health care
facilities. They include Bank of America, Boeing, MCI, Duracell, BellSouth,
Bell Atlantic and Johnson & Johnson.
During fiscal 1998, approximately 37% of the Company's revenue -
primarily, commissions earned by wholly-owned subsidiary ETI -- were from Bell
Atlantic. During fiscal 1997, approximately 37% of the Company's sales were to
Bell Atlantic. One other customer - the China Yuanwang Corp. -- accounted for
approximately 12% of the Company's revenue during the year ended December 31,
1998. No other client accounted for more than 10% of the Company's revenue in
the years ended December 31, 1998 or 1997.
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INVENTORY
The Company had inventories of $1,059,142 at December 31, 1998. The
total excludes an approximately $1.7 million writeoff of obsolete or slow
moving inventory taken at that time.
COMPETITION
The Company competes in the videoconferencing industry by providing
application-specific and custom solutions (products and services) for its
customers' videoconferencing needs. Because the Company's videoconferencing
systems are compression technology-independent, they can be sold to customers
with standard codecs, high speed codecs, board-level codecs or specialty
codecs, as well as with direct links to ATM and fiber optic networks.
The videoconferencing industry covers a broad spectrum of
videoconferencing services available to businesses and others, all of which
are, in a general sense, competitive with the Company's systems. The VSI
Systems, however, are designed and marketed primarily for the group and custom
videoconferencing segment of the industry. Within this segment of the industry,
the Company presently competes primarily with two companies which presently
have significantly greater resources and market shares than the Company. In
addition, three of the Company's suppliers of codecs directly compete with the
Company in the group videoconferencing segment. The Company believes demand for
videoconferencing will continue to increase, which will attract additional
competitors to the industry, some of which may have greater financial and other
resources than the Company.
RESEARCH AND DEVELOPMENT
All of the Company's product engineering, including costs associated
with design and configuration of fully-developed VSI Systems for particular
customer applications, is accounted for in the Company's financial statements
as research and development expenses. During the years ended December 31, 1998,
1997 and 1996, the Company's aggregate expenditures for research and
development of new products or new components for existing VSI Systems were
$786,103, $1,031,814 and $1,192,010, respectively. During fiscal 1998, the
Company's research and development expenses decreased by approximately 24% due
to a reduction in workforce.
EMPLOYEES
As of March 15, 1999, the Company employed 124 persons full time,
including five executive officers. Of the full-time employees who were not
executive officers, 45 were engaged in sales and marketing, 6 in production, 38
in service, seven in research and development, and 23 in general
administration. The workforce has been reduced by approximately 15% since
December 31, 1998, due to the closing of INS and consolidation of VSI's
operations. Employee relations are considered good, and the Company has no
collective bargaining contracts covering any of its employees.
ITEM 2. PROPERTIES.
The Company maintains its executive and sales offices, as well as its
production facilities, in 26,140 square feet of leased office and warehouse
space in Norcross, Georgia, under a five-year lease which expires in September,
2003. The Company also leases 18,000 square feet of office and warehouse space
in an adjoining facility which it is currently attempting to sublease. The
Company leases a number of other facilities in the United States and Europe
under operating lease agreements that expire at various dates through 2003. Two
of those leases for sales offices in New York and Washington, D.C. will expire
in 1999 and will not be renewed, since those sales offices have been closed as
part of an effort to
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consolidate the Company's operations.
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings to which the Company is a
party or to which its properties are subject; nor are there any material
proceedings known to the Company to be contemplated by any governmental
authority; nor are there any material proceedings known to the Company, pending
or contemplated, in which any director, officer or affiliate or any principal
security holder of the Company, or any associate of any of the foregoing is a
party or has an interest adverse to the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There has been no occurrence requiring a response to this Item.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded on the Nasdaq SmallCap Market
under the Nasdaq symbol "VSIN". The Company's Common Stock had been traded on
the Boston Stock Exchange under the symbol "VSI" from November, 1991 until
February 18, 1998, when the Company voluntarily delisted from the exchange. The
Common Stock has been quoted on the Nasdaq SmallCap Market since February 28,
1992.
On January 15, 1999, the Company implemented a 1-for-4 reverse split
of shares of the Company's common stock. The following table sets forth the
quarterly high and low bid quotations per Common Share on the Nasdaq SmallCap
Market as reported for the periods indicated, adjusted to reflect the effects
of the reverse split. These prices also represent inter-dealer quotations
without retail mark-ups, mark-downs, or commissions and may not necessarily
represent actual transactions.
HIGH LOW
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FISCAL YEAR ENDED DECEMBER 31, 1997
First Quarter $12.00 $4.00
Second Quarter 6.24 4.12
Third Quarter 8.00 4.24
Fourth Quarter 11.00 4.88
FISCAL YEAR ENDED DECEMBER 31, 1998
First Quarter $6.38 $4.00
Second Quarter 4.88 2.63
Third Quarter 3.50 1.00
Fourth Quarter 2.75 0.88
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As of March 15, 1999, the Company had approximately 400 holders of
record of its Common
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Shares and in excess of 7,500 beneficial holders of its Common Shares.
The Company has never paid cash dividends on its Common Stock and has
no plans to pay cash dividends in the foreseeable future. The policy of the
Company's Board of Directors is to retain all available earnings for use in the
operation and expansion of the Company's business. Whether dividends may be
paid on the Common Shares in the future will depend upon the Company's
earnings, capital requirements, financial condition, prior rights of the
preferred stockholders, and other relevant factors.
RECENT SALES OF UNREGISTERED SECURITIES
During the period from October 1, 1998 to November 18, 1998, the
Company issued $1,333,000 of term notes to 27 accredited investors. The notes
mature on March 31, 2000 and accrue interest at an annual rate of prime plus
3%. Purchasers of notes also received a warrant to purchase one share of common
stock of the Company for each $8.00 of notes purchased. Accordingly, warrants
to purchase an aggregate of 166,625 shares of common stock were issued by the
Company to these investors. The warrants have an exercise price of $1.68 per
share and are exercisable commencing on April 1, 2000.
On February 23, 1998, the Company issued $3.0 million of convertible
debentures to an accredited investor. During 1998, 395,956 shares of common
stock were issued upon conversion of the debentures. On November 16, 1998, the
Company agreed to issue an additional 25,000 shares of common stock on each of
January 18, 1999 and February 22, 1999 as part of the debenture holder's
agreement to retire the debentures. In connection with the retirement of the
debentures, the Company on November 16, 1998 issued to the debenture holder
warrants to purchase an aggregate of 34,375 shares of common stock at an
exercise price of $2.40 per share.
Also, on February 23, 1998, the Company issued to an agent involved in
the debenture transaction warrants to purchase 9,375 shares of common stock at
an exercise price of $10.00 per share.
All issuances of securities described above were made in reliance on
the exemption from registration provided by Section 4(2) and/or 3(b) of the
Securities Act of 1933 as transactions by an issuer not involving a public
offering. All of the securities were acquired by the recipients thereof for
investment and with no view toward the resale or distribution thereof. In each
instance, the offers and sales were made without any public solicitation and
the stock certificates bear restrictive legends. No underwriter was involved in
the transactions and, except for the issuance of the warrant to purchase 9,375
shares of common stock discussed above, no commissions were paid.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data for the five years ended
December 31, 1998, 1997, 1996, 1995 and 1994 are derived from the consolidated
financial statements of the Company. All financial information prior to 1997
was restated to reflect the June 1996 acquisition by the Company of Integrated
Network Services, Inc. (INS), which was accounted for as a pooling of interest.
INS was closed in December 1998, so its results for each year listed below are
stated as discontinued operations. See Note C and D to the consolidated
financial statements. Information for the years ended December 31, 1998, 1997
and 1996 includes Eastern Telecom, Inc., which was acquired in October 1996.
Information for the years ended December 31, 1998, 1997, 1996 and 1995 includes
VSI Solutions Inc., which was acquired in April 1995. The data should be read
in conjunction with the consolidated financial statements, related notes and
other financial information included herein.
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Year Ended December 31,
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1998 1997 1996 1995 1994
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(in thousands, except per share data)
STATEMENT OF INCOME DATA:
Revenue ................. $ 19,437 $ 19,620 $ 12,709 $ 11,920 $ 13,003
Cost of revenues ........ 12,243 9,687 9,115 8,344 9,059
Gross Profit ............ 7,194 9,933 3,594 3,576 3,944
Operating and other
expenses ............ 23,711(1) 14,805 9,586 8,168 6,606
-------- -------- -------- -------- --------
Net loss from continuing
operations .......... (16,517) (4,872) (5,992) (4,592) (2,662)
Loss from discontinued
operations .......... (419) (945) (715) (748) (58)
Net loss ................ (16,936) (5,817) (6,707) (5,340) (2,720)
Net loss per share from
continuing operations $ (1.38) $ (0.45) $ (0.66) $ (0.59) $ (0.49)
-------- -------- -------- -------- --------
December 31,
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1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(In thousands)
BALANCE SHEET DATA:
Working capital ......... $ (49) $ 3,690 $ 5,634 $ 6,904 $ 1,260
Total assets ............ 10,961 22,880 24,832 19,666 13,393
Long-term debt .......... 1,106 -- 4,250 -- 44
Stockholders' equity .... 1,003 15,591 13,819 10,535 4,401
(1) As part of an ongoing effort to restructure and refocus the strategic
direction of the Company, and to eliminate assets that are either
non-performing, impaired or unrelated to the core business, the Company took a
non-cash and non-recurring charge of approximately $10.3 million in 1998. The
charge included: the write-down of obsolete or slow-moving videoconferencing
and demonstration inventory ($1.88 million); the loss from the sale of
investments in two companies ($450,000); a write-down of capitalized software
development costs ($180,000); and the write-off of most of the goodwill from
the acquisitions of VSI Europe in 1992 and ETI in 1996 ($7.76 million).
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
As a result of the Company's recurring losses from operations and the
Company's ratio of current assets/current liabilities, the Company's independent
auditors for the year ended December 31, 1998 have included a paragraph in their
audit report accompanying the Company's consolidated financial statements
regarding the Company's ability to continue as a going concern.
In response to those concerns, the Company has undertaken a
restructuring of the business operations and balance sheet that, when fully
implemented, are intended to achieve profitable operations
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and provide positive operating cash flows as well as to improve prospects for
additional equity capital investments. During the first quarter of 1999, the
Company reviewed its operating expenses and substantially reduced fixed
management and overhead expenses. In addition, the Company proposes to
restructure certain of its outstanding indebtedness. (See "Liquidity and
Sources of Capital.")
As of December 31, 1998, the Company had an accumulated deficit of
$46,877,847, of which $16,935,972 was realized in 1998. The Company believes
that its ongoing effort to restructure and refocus the strategic direction of
the organization, and to eliminate assets that are either non-performing,
impaired or unrelated to the core business (resulting in a non-recurring charge
of approximately $10.3 million in 1998), will enable it to compete in the
domestic videoconferencing and control system market.
FINANCIAL CONDITION
During the year ended December 31, 1998, the Company's total assets
decreased approximately 52% to $10,960,965 from $22,880,459 at December 31,
1997. A large part of the decrease resulted from a $7,767,444 impairment charge
of most of the goodwill from two non-core assets. Other factors were:
- - 92% decrease in other long-term assets, primarily due to the sale and
impairment of investments in two other companies
- - 57% decrease in inventories, primarily due to an approximately $1.68
million write-down of obsolete or slow-moving videoconferencing
inventory
- - 86% decrease in rental and demonstration inventory, due to write-downs
of obsolete demonstration inventory and the closing of several sales
offices
- - 89% decrease in software development costs, net, due to impairment of
capitalized costs
Cash and cash equivalents as of December 31, 1998 increased $282,732,
or approximately 32%, to $1,134,231 from $859,684 on December 31, 1997.
Total stockholders' equity decreased $14,588,279, or approximately
94%, from December 31, 1997, primarily because of the $16,935,972 net loss for
the year.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
As part of an ongoing effort to restructure and refocus the strategic
direction of the Company, and to eliminate assets that are either
non-performing, impaired or unrelated to the core business, the Company took a
non-cash and non-recurring charge of approximately $10.3 million in 1998. The
charge included: the write-down of obsolete or slow-moving videoconferencing
and demonstration inventory ($1.88 million); the loss from the sale of
investments in two companies ($450,000); a write-down of capitalized software
development costs ($180,000); and the write-off of most of the goodwill from
the acquisitions of VSI N.V. in 1992 and ETI in 1996 ($7.76 million). As a
result, many of the comparisons between 1998 and 1997 financial results in
several categories have been significantly impacted by the non-recurring
charges and/or the related changes in organizational structure and strategic
direction.
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Also, results for 1998 and 1997 reflect the December 1998 closure of
INS. Results for years presented have been restated to reflect the
discontinuance of operations of INS.
REVENUES
Revenues for the year ended December 31, 1998 were $19.4 million, an
approximately 1% decrease over revenues for the year ended December 31, 1997. An
approximately 12% increase in videoconferencing systems revenues was more than
offset by an approximately 21% decrease in commissions from telephone network
reselling. That decrease was due to lower revenues during 1998 at ETI, the
Company's network reselling subsidiary, that resulted from lower commission
rates and higher than anticipated chargebacks for disconnections and
cancellations.
GROSS MARGIN
Gross margin as a percentage of revenues for the year ended December
31, 1998 was approximately 37%, down from 51% for the year ended December 31,
1997. The decrease was due to higher than usual sales of lower margin
videoconferencing products during the second and third quarters of 1998,
primarily from a $2.3 million order to a customer in China, and to lower
revenues during the first quarter of 1998 at ETI.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the year ended
December 31, 1998 were $13,023,732, a decrease of $479,808, or approximately
4%, over the year ended December 31, 1997, due to improvements in parts
procurement and ongoing cost reduction programs; and an approximately 10%
reduction in workforce during 1998.
RESEARCH AND DEVELOPMENT EXPENSES
The Company charges research and development costs to expense as
incurred until technological feasibility of a software product has been
established. Software development costs incurred after technological
feasibility has been established are capitalized and amortized over the useful
life of the product. For the year ended December 31, 1998, the Company's
research and development expenses were $786,103, an approximately 24% decrease
over the year ended December 31, 1997. The decrease was due to a reduction in
workforce.
IMPAIRMENT LOSS
At December 31, 1998, an impairment loss of $7,767,444 was charged to
operations. The majority of that loss -- $6,995,211 - was charged to operations
as an impairment of the original goodwill recorded with the Company's
acquisition of ETI. Management decreased ETI's goodwill to its estimated value
based on expected future undiscounted cash flows from ETI's operations,
primarily due to a change in the commission structure initiated by ETI's major
customer. An additional $577,077 impairment loss was recorded to eliminate all
remaining goodwill related to VSI Europe, and an additional $195,156 impairment
loss was recorded to write down VSI Europe's net assets to zero. Management
recorded the impairment loss in light of VSI Europe's continuing operating
losses. See Note A-7 and A-10 to the consolidated financial statements.
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OTHER EXPENSES
Other expenses, primarily finance charges, were $1,682,303 for the year
ended December 31, 1998, an increase of $1,606,134 over the year ended December
31, 1997. The increase was primarily due to amortization of debt discount costs
during the vesting period (the second and third quarters of 1998) of the
conversion feature of the Company's convertible debentures; the amortization of
debt issuance costs associated with the Company's convertible debentures; and
interest expense on the convertible debentures.
NET LOSS
Net loss for the year ended December 31, 1998 was $16,935,972, a
$11,118,606, or approximately 191%, increase over the net loss of $5,817,366 for
the year ended December 31, 1997. Net loss from continuing operations was
$16,516,999, a $11,645,395, or approximately 239%, increase over the net loss of
$4,871,604 for the year ended December 31, 1997. The increase in net loss was
due primarily to non-cash and non-recurring charges of approximately $10.3
million in 1998.
Excluding the non-recurring charges of approximately $10.3 million, the
net loss was approximately $6.6 million, an approximately $800,000 increase over
the net loss for the year ended December 31, 1997. The non-recurring charges
included: the write-down of obsolete or slow-moving videoconferencing and
demonstration inventory ($1.88 million); the loss from the sale of investments
in two companies ($450,000); a write-down of capitalized software development
costs ($180,000); and the write-off of most of the goodwill from the
acquisitions of VSI Europe in 1992 and ETI in 1996 ($7.76 million).
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Revenues for the year ended December 31, 1997 were $19.6 million, an
approximately 54% increase over revenues for the year ended December 31, 1996.
The increase was primarily due to the recognition of a full year of revenue from
wholly-owned subsidiary ETI in 1997, compared to three months of revenue from
ETI in 1996. ETI was acquired in October 1996.
GROSS MARGIN
Gross margin as a percentage of revenues for the year ended December
31, 1997 was 51%, up from 28% for the year ended December 31, 1996, due to the
addition of high margin sales and account management commissions from ETI, a
sales agency for a number of major telecommunications companies.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the year ended
December 31, 1997 were $13,503,540, an increase of $5,248,453, or 64%, over the
year ended December 31, 1996, due to an increase in the Company's sales,
marketing and distribution initiatives in the United States (primarily due to
the October 1996 acquisition of ETI and its sales force) and the Far East.
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RESEARCH AND DEVELOPMENT EXPENSES
The Company charges research and development costs to expense as
incurred until technological feasibility of a software product has been
established. Software development costs incurred after technological
feasibility has been established are capitalized and amortized over the useful
life of the product. For the year ended December 31, 1997, the Company's
research and development expenses were $1,031,814, a 13% decrease over the year
ended December 31, 1996. Expenses in 1996 had been somewhat higher than
historical levels, due to an expansion in the research and development
workforce to accommodate projects related to forthcoming generations of the
Omega(TM) product line and other software projects. Many of those projects were
completed or were winding down by first quarter 1997, and the workforce --
primarily at subsidiary VSI Solutions, Inc. -- was reduced.
OTHER EXPENSES/INCOME TAXES
Non-operating expenses and income taxes for the year ended December
31, 1997 were $269,410, a 94% increase over non-operating expenses and income
taxes for the year ended December 31, 1996. The increase was primarily due to
the payment of state taxes in Rhode Island by ETI, which was profitable in
1997.
NET LOSS
Net loss for the year ended December 31, 1997 was $5,817,366, a 13%
improvement over the net loss for the year ended December 31, 1996. Excluding a
charge to reflect obsolescence of certain inventory of approximately $2.1
million, the net loss for the year was approximately $3.7 million, a 44%
improvement over 1996. The decrease in the loss was primarily due to a 54%
increase in revenues and a substantial improvement in gross margins.
LIQUIDITY AND SOURCES OF CAPITAL
General
As of December 31, 1998, the Company had cash and cash equivalents of
$1,134,231. The Company's liquidity sources include existing cash and credit
facilities. In order to meet its cash flow requirements, short-term debt and
approximately $600,000 in accrued but unpaid sales tax obligations, the Company
will require additional funding in 1999. This additional funding could be in the
form of the sale of assets, debt, equity, or a combination. A further reduction
in operating expenses has also been effected in order to maximize the Company's
allocation of cash resources. However, there can be no assurance that the
Company will be able to obtain such financing if and when needed, or that if
obtained, such financing will be sufficient or on terms and conditions
acceptable to the Company.
On February 23, 1998, the Company issued $3,000,000 of 5% Convertible
Debentures due February 2000 ("the Debentures") to Thomson Kernaghan & Co. Ltd.
("Thomson Kernaghan"), the proceeds of which were utilized for working capital
purposes. The debentures were convertible into shares of common stock of the
Company at the option of the holder at the lesser of (i) $8.00 per share or
(ii) 85% of the average closing bid price of the Company's common stock. The
debenture holder was also granted warrants to purchase 9,375 shares of common
stock of the Company, at an exercise price of $2.40
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per share. An agent involved in the placement of the debentures received
warrants to purchase 9,375 shares of common stock of the Company, at an
exercise price of $10.00 per share.
During the year, $710,000 of debentures, plus accrued interest of
$13,531, were converted by the debenture holder into 445,956 shares of common
stock of the Company. The Company also paid $128,858 in accrued interest and
fees.
Also, in November 1998, $1,440,000 of debentures were redeemed by the
Company at face value as follows: (i)$1,040,000 of debentures were bought back
at face value on October 1, 1998 (at which time the Company paid $128,858 in
accrued interest and fees); and (ii) $400,000 of debentures were bought back at
face value on November 16, 1998 (at which time the Company paid a fee of
$50,000). The remaining debentures were converted on November 16, 1998 into a
$900,000 term note to Thomson Kernaghan, at an interest rate of 14% per annum,
due on or before May 16, 1999. At that time, Thomson Kernaghan was issued
warrants to purchase 25,000 shares of common stock of the Company, at an
exercise price of $2.40 per share.
Of the 445,956 shares issued upon conversion of the debentures, 50,000
shares were held in escrow at December 31, 1998, with 25,000 of these shares
issued in January 1999 and 25,000 issued in February 1999. To secure payment of
the note, VSI granted the debt holder a security interest in VSI's seven
patents issued by the U.S. Patent & Trademark Office. In the event of default,
the debt holder could foreclose on its security interest in the patents.
VSI has not paid a $300,000 installment of principal under the term
note, which installment was due February 16, 1999. The failure to make this
payment subjects VSI to a $30,000 per month penalty fee until the full balance
is repaid. If VSI does not repay the note on or before May 16, 1999, VSI will
be obligated to pay the debt holder an additional penalty of $30,000 on the
16th of each month until the debt is paid. As of March 30, 1999, the
outstanding balance under this note, including accrued interest and penalties,
was $1,006,257.
The Company is currently negotiating with Thomson Kernaghan to
restructure the term note. The restructuring of this note may involve a cash
payment by the Company and the issuance of shares of common stock of the Company
to Thomson Kernaghan to repay the note. If the debt to Thomson Kernaghan cannot
be restructured, Thomson Kernaghan may take possession of the Company's patents
which secure this debt. In the event the Company is unable to license this
technology from Thomson Kernaghan, the Company will be unable to manufacture,
sell and service its videoconferencing systems. See "Factors Affecting Future
Performance."
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The cash redemption of a portion of the convertible debentures was
funded in part from the proceeds of a private placement of term notes by the
Company in October and November of 1998. The notes mature on March 31, 2000 and
accrue interest at an annual rate of prime plus 3% per annum. Purchasers of
notes also received a warrant to purchase one share of common stock of the
Company for each $8.00 of notes purchased. Warrants have an exercise price of
$1.68 per share and are exercisable commencing on April 1, 2000. The Company
is delinquent in the payment of approximately $35,000 of interest due March
31, 1999 with respect to these term notes. Payment of this amount has been
deferred pending resolution of the Company's negotiation regarding the
restructuring of the Thomson Kernaghan term note.
In December 1998, the Company received $250,000 from the sale of the
Company's investment in Educational Video Conferencing, Inc., a New York-based
provider of distance education services. In October 1998, the Company received
$243,000 from the sale of the Company's investment in Global TeleMedix, Inc., a
Massachusetts-based provider of telemedicine software.
In October, 1998, the Board of Directors of the Company authorized a
stock repurchase program pursuant to which management is authorized to
repurchase up to 250,000 shares of common stock of the Company. As of March 15,
1999, the Company had not repurchased any shares of its common stock. Any
future purchases will be financed from the Company's cash reserves.
Credit Facilities
VSI
Since June 1995, Videoconferencing Systems, Inc. (VSI), a subsidiary
of the Company, has had a revolving credit and security agreement with Fidelity
Funding of California Inc. This credit facility provides the Company with up to
$4,000,000 at an interest rate of prime plus 2% per annum. Funds available
under the credit facility are based on 80% of eligible VSI accounts receivable
invoices, with certain restrictions. The credit facility is secured by the
accounts receivable, inventory and certain fixed assets of VSI. At December 31,
1998, approximately $83,000 was owed to Fidelity Funding.
ETI
On October 8, 1998, ETI entered into a financing agreement with RFC
Capital, Inc., whereby RFC Capital, Inc. purchases eligible accounts receivable
for 90% of the accounts receivable amount, up to $1,500,000, at an interest
rate of prime plus 2.75% per annum. This amount may be increased, subject to
additional payment of commitment fees by ETI, to $5,000,000. If any account
receivable is not paid within 90 days, ETI is required to buy back the account
receivable for the full purchase price. The credit facility is secured by
eligible accounts receivable. As of December 31, 1998, approximately $1,403,000
was owed to RFC Capital, Inc.
INS
In December 1996, VSI Network Services, Inc. (d/b/a Integrated Network
Services, or INS), a wholly owned subsidiary of the Company, established a
revolving credit and security agreement with Presidential Financial
Corporation. This credit facility provides INS with up to $750,000 at an
interest rate of prime plus 3% per annum. Funds available under the credit
facility are based on 80% of eligible accounts receivable invoices, with
certain restrictions. The credit facility is secured by accounts
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receivable, inventory and fixed assets of INS. At December 31, 1998,
approximately $248,000 was owed to Presidential Financial Corporation.
With INS ceasing operations on December 31, 1998, VSI is obligated to
repay the balance owed Presidential Financial Corporation. On March 31, 1999,
that amount was approximately $138,000. The Company expects to repay the full
amount during 1999 upon the collection of outstanding INS accounts receivable.
VSI n.v.
In February 1998, Videoconferencing Systems, n.v., a wholly owned
subsidiary of the Company, entered into a revolving credit and security
agreement with Kredietbank, n.v. This credit facility provides
Videoconferencing Systems, n.v. with up to $550,000 at an interest rate of 5%
per annum. The credit facility is secured by 137,500 shares of common stock of
the Company, held in escrow by Kredietbank, n.v. At December 31, 1998,
approximately $253,000 was owed to Kredietbank, n.v.
At December 31, 1998, Videoconferencing Systems, n.v. had a secured
bank facility with Generale Bank of approximately $166,000, of which
approximately $157,000 was outstanding at that time.
OPERATING LOSS CARRYFORWARDS
As of December 31, 1998, the Company had operating loss carryforwards
for U.S. income tax purposes of approximately $29,389,000 available to reduce
future taxable income through 2013. The Company also has investment and
research and experimental credits of approximately $89,000 available to reduce
future income taxes payable through 2013. During 1993, the Company experienced
a change in control, as defined under Section 382 of the Internal Revenue Code.
As a result, the utilization of approximately $7,000,000 in tax loss
carryforwards will be limited to approximately $1,000,000 annually.
Videoconferencing Systems, n.v. has net operating loss carryforwards
of approximately $3,350,000 that can be used to offset future taxable income.
These carryforwards can be carried forward indefinitely. The resulting deferred
income tax asset has been reduced to zero by a related valuation allowance.
YEAR 2000
The Company has assessed the impact of the Year 2000 issue on its
computer systems and is in the process of remediating the affected hardware and
software.
The Company utilizes various computer workstations and software
packages as tools in running its accounting and operations areas. Most are
PC-based and are Year 2000 compliant, with the exception of some older
workstations that will be phased out by 2000. Also, the primary accounting
system is not currently Year 2000 compliant, and management plans during 1999
to implement any necessary vendor upgrades and modifications to ensure
continued functionality with respect to any accounting software problems
associated with Year 2000.
With respect to the production of its own proprietary software and
hardware, the Company has taken the necessary steps to ensure that its
proprietary technology is Year 2000 compliant. The Company's videoconferencing
products use PC controllers of recent vintage that are computed in and
displayed in four-digit format. In addition, the Company's Omega(TM) software
uses "C" libraries that compute the date based on a count
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of the number of seconds from January 1970. Those software libraries are in no
danger of being out of compliance before the year 2038.
Also, the Company has surveyed the vendors who supply key
computer-based components for its videoconferencing systems and services, and
found that all are Year 2000 compliant. The Company will continue to monitor
and assess the Year 2000 situation on an ongoing basis, especially in its
dealings with new vendors or suppliers, and will take appropriate corrective
action as needed.
Contingency planning is a normal part of VSI's sales cycle, given lead
time for parts and installation windows. VSI has included Year 2000 concerns
into normal contingency planning without forming a separate department of task
force to address these concerns. The Company has not developed a separate Year
2000 contingency plan, since to date no adverse effect from the Year 2000 issue
has been identified. Should it be determined that any major vendors, service
providers or partners may be negatively impacted by the Year 2000 issue, the
Company will develop contingency plans for affected areas or make use of
alternate suppliers.
Expenditures for the Year 2000 project have to date been immaterial
and are being expensed as incurred. These expenditures have not had, and are
not expected to have, a material impact on the consolidated financial position,
results of operation or cash flows of the Company.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this filing are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995, such as statements relating to financial results and plans for future
business development activities, and are thus prospective. Such forward-looking
statements are subject to risks, uncertainties and other factors which could
cause actual results to differ materially from future results expressed or
implied by such forward-looking statements. Potential risks and uncertainties
include, but are not limited to, economic conditions, competition and other
uncertainties detailed from time to time in the Company's Securities and
Exchange Commission filings. (See "Risk Factors" in the section that follows).
FACTORS AFFECTING FUTURE PERFORMANCE
The Company is subject to the risks associated with being wholly
dependent upon the performance of its subsidiaries. The following summarizes
certain of the risks inherent in the Company's business:
Working Capital Requirements; Need for Additional Financing. The
Company will require additional capital or other financing to finance its
operations and continued growth. The Company may seek additional equity
financing through the sale of securities on a public or a private placement
basis on such terms as are reasonably attainable. There can be no assurance
that the Company will be able to obtain such financing when needed, or that if
obtained, it will be sufficient or on terms and conditions acceptable to the
Company.
No History of Profitability. After 13 years of operations, the Company
has not reported any profits for a full year of operations. There can be no
certainty regarding the Company's ability to achieve or sustain profitability
in the future. Whether or not the Company is able to operate profitably, the
Company will require additional capital to finance its operations.
Restructuring of Indebtedness. The Company is currently in negotiations
to restructure all indebtedness of the Company owing to Thomson Kernaghan,
which currently totals
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approximately $1.0 million. A substantial portion of this indebtedness may be
retired in exchange for the issuance of shares of common stock of the Company,
which will dilute the ownership of the Company's Shareholders. Additionally,
sales and potential sales of substantial amounts of common stock of the Company
in the public market could adversely affect the prevailing market prices for the
common stock and impair the Company's ability to raise additional capital
through the sale of equity securities.
The failure of the Company to restructure its indebtedness to Thomson
Kernaghan would result in the Company being unable to repay the term note when
it comes due in May 1999. The failure of the Company to timely repay this
indebtedness may result in Thomson Kernaghan taking possession of the Company's
patents, which have been pledged by the Company as collateral for this debt. If
Thomson Kernaghan takes possession of the patents, the Company will no longer
have any rights in the technology described therein. To continue to be able to
sell its videoconferencing products, which embody the technology covered by the
patents, the Company will be required to license this technology from Thomson
Kernaghan. There can be no assurance that any such license will be granted on
commercially reasonable terms or at all. Accordingly, if the Company is unable
to restructure its debt with Thomson Kernaghan, and is unable to license the
technology covered by the patents on commercially reasonable terms, it will be
unable to continue to sell its videoconferencing products, in which event, the
Company may seek protection under federal bankruptcy laws.
Integration of Acquired Businesses. An important element of the
Company's growth strategy is to expand through acquisitions. The Company's
future success is dependent upon its ability to finance and effectively
integrate acquired businesses with the Company's operations. There can be no
assurance that past or future acquisitions will be successfully integrated or
that any such acquisition will otherwise be successful. In addition, the
financial performance of the Company is now and will continue to be subject to
various risks associated with the acquisition of businesses, including the
financial effects associated with the integration of such businesses. There can
be no assurance that the Company's acquisition strategy will be successful.
Technological Change and New Products. The market for the Company's
products is characterized by rapidly changing technology, evolving industry
standards and frequent product introductions. Product introductions are
generally characterized by increased functionality and better picture quality
at reduced prices. The introduction of products embodying new technology may
render existing products obsolete and unmarketable. The Company's ability to
successfully develop and introduce on a timely basis new and enhanced products
that embody new technology, and achieve levels of functionality and price
acceptable to the market will be a significant factor in the Company's ability
to grow and to remain competitive. If the Company is unable, for technological
or other reasons, to develop competitive products in a timely manner in
response to changes in the industry, the Company's business and operating
results will be materially and adversely affected.
Dependence on Third Parties. Substantially all of the Company's
components, subsystems and assemblies are made by outside vendors. Disruption
in supply, a significant increase in price of one or more of these components
or failure of a third-party supplier to remain competitive in functionality or
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price could have a material adverse effect on the Company's business and
operating results. There can be no assurance that the Company will not
experience such problems in the future. Similarly, excessive rework costs
associated with defective components or process errors associated with the
Company's anticipated new product line of videoconferencing systems could
adversely affect the Company's business and operating results.
Foreign Sales and Operations. During the year ended December 31, 1998,
revenues from international sales represented approximately 27% of the
Company's net product sales, as compared to 14% of net product sales during the
year ended December 31, 1997. The Company's profitability and financial
condition therefore will be impacted by the success of these foreign
operations. International sales and operations are subject to inherent risks,
including difficulties and delays in obtaining pricing approvals and
reimbursement, unexpected changes in regulatory requirements, tariffs and other
barriers, political instability, difficulties in staffing and managing foreign
operations, longer payment cycles, greater difficulty in accounts receivable
collection and adverse tax consequences. Currency translation gains and losses
on the conversion to United States dollars from international operations could
contribute to fluctuations in the Company's results of operations. If for any
reason exchange or price controls or other restrictions on the conversion or
repatriation of foreign currencies were imposed, the Company's operating
results could be adversely affected. There can be no assurance that these
factors will not have an adverse impact on the Company's future international
sales and operations and, consequently, on the Company's operating results.
Concentration of Customers. The Company sells videoconferencing and
control systems and network services to a number of major customers. During the
year ended December 31, 1998, approximately 37% of the Company's revenues were
from Bell Atlantic. There can be no assurance that the loss of this or other
customers will not have an adverse effect on the Company's operations.
Dependence on Key Employees. The Company's development, management of
its growth and other activities depend on the efforts of key management and
technical employees. Competition for such persons is intense. The Company uses
incentives, including competitive compensation and stock option plans, to
attract and retain well-qualified employees. There can be no assurance, however,
that the Company will continue to attract and retain personnel with the
requisite capabilities and experience. The loss of one or more of the Company's
key management or technical personnel also could adversely affect the Company.
The Company does not have employment agreements with its key management
personnel or technical employees. The Company's future success is also dependent
upon its ability to effectively attract, retain, train, motivate and manage its
employees. Failure to do so could have a material adverse effect on the
Company's business and operating results.
Competition. Competition in the video communications market is
intense. In the videoconferencing market, the Company's primary competitors are
PictureTel Corporation, VTEL Corporation and Polycom Inc. The Company expects
other competitors, some with significantly greater technical and financial
resources, to enter the videoconferencing market. If the Company cannot
continue to offer new videoconferencing products with improved performance and
reduced cost, its competitive position will erode. Moreover, competitive price
reductions may adversely affect the Company's results of operations.
Fluctuations in Quarterly Performance. The Company's product sales
have historically been derived primarily from the sale of videoconferencing
systems and related equipment, the market for which is still developing. In
addition, the Company's revenues occur predominantly in the third month of each
fiscal quarter. Accordingly, the Company's quarterly results of operations are
difficult to predict, and
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delays in the closing of sales near the end of the quarter could cause
quarterly revenues and, to a greater degree, operating and net income to fall
substantially short of anticipated levels. The Company's total revenues and net
income levels could also be adversely affected by cancellations or delays of
orders, interruptions or delays in the supply of key components, changes in
customer base or product mix, seasonal patterns of capital spending by
customers, delays in purchase decisions due to new product announcements by the
Company or its competitors, increased competition and reductions in average
selling prices.
No Assurance of Continued Trading Market in Company Securities. The
Company's Common Stock is traded on the Nasdaq SmallCap Market. While the
Company believes there are several securities broker/dealers making a market in
the Company's Common Stock, there is no assurance that a public market for the
Company's Common Stock will continue to be made or that persons purchasing the
Company's securities will be able to avail themselves of a public trading
market for the Common Shares in the future.
In order for the Company's Common Stock to be eligible for continued
listing on the Nasdaq SmallCap Market, the Common Stock must, among other
things, have a minimum bid price per share of $1.00 and net tangible assets of
not less than $2.0 million. The Company's Common Stock currently is trading at
a price below $1.00 per share and, as a result of the 1998 net loss, net
tangible assets are less than $2.0 million, putting the Company in jeopardy of
falling out of compliance with Nasdaq's continued listing requirements. There
can be no assurance that the Company will remain in compliance with Nasdaq's
continued listing requirements. If the Common Stock is delisted by Nasdaq, the
trading market for the Common Stock could be adversely affected, as price
quotations for the Common Stock will not be as readily obtainable.
No Dividends. The Company has never paid cash dividends on its Common
Stock and has no plans to pay cash dividends in the foreseeable future. The
policy of the Company's Board of Directors is to retain all available earnings
for use in the operation and expansion of the Company's business.
Possible Issuance of Preferred Stock. The Company is authorized to
issue up to 800,000 shares of Preferred Stock, $.00025 par value (the
"Preferred Stock"). Preferred Stock may be issued in one or more series, the
terms of which may be determined at the time of issuance by the Board of
Directors, without further action by stockholders, and may include voting
rights (including the right to vote as a series on particular matters),
preferences as to dividends and liquidation, conversion and redemption rights
and sinking fund provisions. No Preferred Stock is currently outstanding and
the Company has no present plans for the issuance thereof. The issuance of any
Preferred Stock could affect the rights of the holders of Common Stock, and
therefore, reduce the value of the Common Stock and make it less likely that
holders of Common Stock would receive a premium for the sale of their shares of
Common Stock. In particular, specific rights granted to future holders of
Preferred Stock could be issued to restrict the Company's ability to merge with
or sell its assets to a third party.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The following financial statements are filed with this report:
22
23
Report of Independent Certified Public Accountants
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997
Consolidated Statements of Operations for Years Ended December 31, 1998, 1997
and 1996
Consolidated Statement of Stockholders' Equity for Years Ended December 31,
1998, 1997 and 1996
Consolidated Statements of Cash Flows for Years Ended December 31, 1998, 1997
and 1996
Notes to Consolidated Financial Statements
23
24
Report of Independent Certified Public Accountants
To the Board of Directors and Stockholders of
VSI Enterprises, Inc.
We have audited the accompanying consolidated balance sheet of VSI Enterprises,
Inc. (a Delaware corporation) and Subsidiaries as of December 31, 1998 and the
related statements of operations, stockholders' equity, and cash flows for the
years ended December 31, 1998 and 1996. 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 audit 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 that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of VSI Enterprises, Inc. and
subsidiaries as of December 31, 1998, and the results of their operations and
their cash flows for the years ended December 31, 1998 and 1996, in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note B to the
financial statements, the Company has suffered recurring losses from operations
and the Company's current liabilities exceed current assets. These factors
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these matters are also described in
Note B. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
/s/ Grant Thornton LLP
Atlanta, Georgia
March 5, 1999
24
25
Report of Independent Public Accountants
To the Board of Directors and Stockholders of VSI Enterprises, Inc.:
We have audited the accompanying consolidated balance sheet of VSI
ENTERPRISES, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31,
1997 and the related statements of operations, stockholders' equity, and cash
flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards requires that we plan and perform the audit 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 that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of VSI Enterprises,
Inc. and subsidiaries as of December 31, 1997 and the results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
/s/ Arthur Andersen LLP
Atlanta, Georgia
April 12, 1999
25
26
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS
1998 1997
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 1,134,231 $ 859,684
Accounts receivable, less allowance
for doubtful accounts of $1,141,091
and $415,989 at December 31, 1998
and 1997, respectively 5,975,254 5,703,560
Inventories, less allowance for obsolescence
of $1,677,440 and $178,235 at December 31,
1998 and 1997, respectively 1,059,142 2,464,818
Demonstration inventory, net of allowance for
obsolescence of $1,074,765 and $839,184 at
December 31, 1998 and 1997, respectively 136,883 990,054
Prepaid expenses and other current assets 164,088 404,181
Current assets of discontinued operations, net 334,022 557,121
----------- -----------
Total current assets 8,803,620 10,979,418
PROPERTY AND EQUIPMENT, net 1,048,983 1,071,381
OTHER ASSETS OF DISCONTINUED OPERATIONS -- 131,912
OTHER ASSETS
Goodwill, net 955,688 9,020,715
Software development costs, net 75,349 658,052
Other long-term assets 77,325 1,018,981
----------- -----------
1,108,362 10,697,748
----------- -----------
$10,960,965 $22,880,459
=========== ===========
The accompanying notes are an integral part of these statements.
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VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS - CONTINUED
December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997
----------- -----------
CURRENT LIABILITIES
Current portion of notes payable $ 2,637,948 $ 1,143,012
Short-term borrowings 157,376 154,938
Accounts payable 2,235,852 3,036,587
Accrued expenses 1,463,536 878,813
Accrued commissions 501,515 849,078
Deferred revenue 1,522,416 445,245
Current liabilities of discontinued operations 334,022 781,862
----------- -----------
Total current liabilities 8,852,665 7,289,535
NOTES PAYABLE, LESS CURRENT PORTION 1,105,655 --
COMMITMENTS AND CONTINGENCIES (Note L)
STOCKHOLDERS' EQUITY
Preferred stock, $.00025 par value; authorized
800,000 shares, none issued and outstanding -- --
Common stock, authorized 15,000,000 shares of
$.001 par value; issued and outstanding
12,300,144 and 11,546,242 shares at
December 31, 1998 and 1997, respectively 12,300 11,546
Additional paid-in capital 48,209,039 45,976,291
Accumulated deficit (46,877,847) (29,941,875)
Cumulative comprehensive income (340,847) (455,038)
----------- -----------
1,002,645 15,590,924
----------- -----------
$10,960,965 $22,880,459
=========== ===========
The accompanying notes are an integral part of these statements.
27
28
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
1998 1997 1996
------------ ------------ ------------
Revenue
Videoconferencing systems $ 13,574,213 $ 12,168,107 $ 11,159,943
Commissions from telephone network
reselling 5,863,198 7,451,686 1,549,281
------------ ------------ ------------
19,437,411 19,619,793 12,709,224
------------ ------------ ------------
Costs and expenses
Cost of videoteleconferencing systems 12,242,823 9,686,633 9,115,556
Selling, general and administrative 13,023,732 13,503,540 8,255,087
Research and development 786,103 1,031,814 1,192,010
Impairment loss 7,767,444 -- --
------------ ------------ ------------
33,820,102 24,221,987 18,562,653
------------ ------------ ------------
Loss from operations (14,382,691) (4,602,194) (5,853,429)
Loss on sale of investments 452,005 -- --
Other expenses, primarily financing charges 1,682,303 76,169 139,048
------------ ------------ ------------
Net loss from continuing operations
before income taxes (16,516,999) (4,678,363) (5,992,477)
Income taxes -- 193,241 --
------------ ------------ ------------
Net loss from continuing operations (16,516,999) (4,871,604) (5,992,477)
Discontinued operations
Operating loss from discontinued operations (763,705) (945,762) (714,417)
Gain on disposal of a subsidiary 344,732 -- --
------------ ------------ ------------
Loss from discontinued operations (418,973) (945,762) (714,417)
------------ ------------ ------------
NET LOSS $(16,935,972) $ (5,817,366) $ (6,706,894)
============ ============ ============
Net loss per common share
Loss from continuing operations $ (1.38) $ (0.45) $ (0.66)
Loss from discontinued operations (0.04) (0.09) (0.08)
------------ ------------ ------------
$ (1.42) $ (0.53) $ (.74)
============ ============ ============
Weighted average shares outstanding 11,931,232 10,901,620 9,119,233
============ ============ ============
The accompanying notes are an integral part of these statements.
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29
VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the years ended December 31, 1998, 1997 and 1996
Common stock
-------------------------- Additional
Number of paid-in Accumulated
Shares Par value capital deficit
----------- --------- ----------- ------------
Balance, December 31, 1995 35,007,176 $8,751 $28,091,591 $(17,417,615)
----------- ------ ----------- ------------
Net loss for the year -- -- -- (6,706,894)
Other comprehensive income
Foreign currency translation adjustment -- -- -- --
----------- ------ ----------- ------------
Comprehensive income -- -- -- (6,706,894)
----------- ------ ----------- ------------
Reverse common stock split (26,255,382) -- -- --
Issuance of common shares in lieu of cash compensation 27,694 28 139,464 --
Issuance of common shares for employee stock purchase plan 11,119 11 109,413 --
Exercise of stock options 76,408 76 298,789 --
Issuance of common shares for products and services 62,500 63 599,946 --
Issuance of common shares for conversion of notes payable 61,204 61 337,052 --
Private placement of common shares, net of issuance costs
of $41,998 280,590 281 2,388,247 --
Issuance of common shares for acquisition of
Eastern Telecom, Inc. 501,835 502 5,499,498 --
Issuance of common shares for conversion of
convertible debentures 105,918 106 758,005 --
----------- ------ ----------- ------------
Other
comprehensive
income Total
------------- ------------
Balance, December 31, 1995 $(147,669) $ 10,535,058
--------- ------------
Net loss for the year -- (6,706,894)
Other comprehensive income
Foreign currency translation adjustment (141,005) (141,005)
--------- ------------
Comprehensive income (141,005) (6,847,899)
--------- ------------
Reverse common stock split -- --
Issuance of common shares in lieu of cash compensation -- 139,492
Issuance of common shares for employee stock purchase plan -- 109,424
Exercise of stock options -- 298,865
Issuance of common shares for products and services -- 600,009
Issuance of common shares for conversion of notes payable -- 337,113
Private placement of common shares, net of issuance costs
of $41,998 -- 2,388,528
Issuance of common shares for acquisition of
Eastern Telecom, Inc. -- 5,500,000
Issuance of common shares for conversion of
convertible debentures -- 758,111
--------- ------------
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VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
For the years ended December 31, 1998, 1997 and 1996
Common stock
-------------------------- Additional
Number of paid-in Accumulated
Shares Par value capital deficit
----------- --------- ----------- ------------
Balance, December 31, 1996 9,879,062 9,879 38,222,005 (24,124,509)
----------- ------ ----------- ------------
Net loss for the year -- -- -- (5,817,366)
Other comprehensive income
Foreign currency translation adjustment -- -- -- --
----------- ------ ----------- ------------
Comprehensive income -- -- -- (5,817,366)
----------- ------ ----------- ------------
Issuance of common shares for products and services 137,500 138 650,001 --
Issuance of common shares for conversion of
convertible debentures 866,368 866 4,352,772 --
Issuance of common shares for employee stock purchase plan 36,653 37 156,002 --
Issuance of common shares for conversion of private placement 563,471 563 2,486,937 --
Exercise of stock options 63,188 63 108,574 --
----------- ------ ----------- ------------
Balance, December 31, 1997 11,546,242 11,546 45,976,291 (29,941,875)
----------- ------ ----------- ------------
Net loss for the year -- -- -- (16,935,972)
Other comprehensive income
Foreign currency translation adjustment -- -- -- --
----------- ------ ----------- ------------
Comprehensive income -- -- -- (16,935,972)
----------- ------ ----------- ------------
Issuance of common shares for products and services 237,500 238 516,606 --
Issuance of common shares for conversion of
convertible debentures 445,956 446 702,097 --
Issuance of common shares for employee stock purchase plan 20,446 20 59,019 --
Exercise of stock options 50,000 50 124,969 --
Issuance of stock warrants -- -- 830,057 --
----------- ------- ----------- ------------
Balance, December 31, 1998 12,300,144 $12,300 $48,209,039 $(46,877,847)
=========== ======= =========== ============
Other
comprehensive
income Total
------------- ------------
Balance, December 31, 1996 (288,674) 13,818,701
--------- ------------
Net loss for the year -- (5,817,366)
Other comprehensive income
Foreign currency translation adjustment (166,364) (166,364)
--------- ------------
Comprehensive income (166,364) (5,983,730)
--------- ------------
Issuance of common shares for products and services -- 650,139
Issuance of common shares for conversion of
convertible debentures -- 4,353,638
Issuance of common shares for employee stock purchase plan -- 156,039
Issuance of common shares for conversion of private placement -- 2,487,500
Exercise of stock options -- 108,637
--------- ------------
Balance, December 31, 1997 $(455,038) $ 15,590,924
--------- ------------
Net loss for the year -- (16,935,972)
Other comprehensive income
Foreign currency translation adjustment 114,191 114,191
--------- ------------
Comprehensive income 114,191 (16,821,781)
--------- ------------
Issuance of common shares for products and services -- 516,844
Issuance of common shares for conversion of
convertible debentures -- 702,543
Issuance of common shares for employee stock purchase plan -- 59,039
Exercise of stock options -- 125,019
Issuance of stock warrants -- 830,057
--------- ------------
Balance, December 31, 1998 $(340,847) $ 1,002,645
========= ============
The accompanying notes are an integral part of this statement.
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VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
1998 1997 1996
------------ ----------- -----------
Cash flows from operating activities:
Net loss $(16,935,972) $(5,817,366) $(6,706,894)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 1,838,296 1,438,054 1,420,547
Provision for doubtful accounts 1,903,248 176,174 62,000
Allowance to reduce inventory to
lower of cost or market 1,499,205 (315,645) 250,000
Issuance of common stock in
lieu of cash compensation -- -- 139,492
Loss on sale of property and equipment -- -- 28,145
Impairment loss 7,767,444 -- --
Loss on sale of investments 452,005 -- --
Gain on disposal of discontinued
operations (344,732) -- --
Changes in related assets and
liabilities, net of businesses acquired:
Accounts receivable (2,055,078) (900,018) 2,797,035
Inventories (211,748) 584,122 794,139
Demonstration inventory 617,590 568,877 (1,491,934)
Prepaid expenses and other
current assets 108,986 (73,230) 344,616
Accounts payable (156,758) 991,498 (139,772)
Accrued expenses 806,863 339,554 (746,742)
Deferred revenue 1,015,238 (218,484) 289,483
------------ ----------- -----------
Net cash used in operating
activities (3,695,413) (3,226,464) (2,959,885)
------------ ----------- -----------
Cash flows from investing activities:
Cash paid for business acquisitions,
net of cash acquired -- -- (3,668,131)
Proceeds from sale of property and
equipment -- -- 30,314
Purchases of property and equipment (381,348) (400,230) (418,304)
Capitalized software development costs -- (77,886) (153,007)
Other assets -- (442,596) (405,760)
Proceeds from sale of investments 492,776 -- --
------------ ----------- -----------
Net cash provided by (used in)
investing activities 111,428 (920,712) (4,614,888)
------------ ----------- -----------
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VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
1998 1997 1996
------------ ----------- -----------
Cash flows from financing activities:
Change in notes payable and short-term
borrowings, net 2,008,468 (586,588) (2,062,849)
Proceeds from convertible debentures 3,000,000 -- 5,000,000
Cash redemption of convertible debentures (1,440,000) -- --
Proceeds from exercise of stock options
and warrants, net of related costs 125,000 264,676 298,865
Proceeds from issuance of common stock,
net of issuance costs 59,058 650,139 109,424
Proceeds from private placement
financings, net of issuance costs -- 2,487,500 2,388,528
------------ ----------- -----------
Net cash provided by financing
activities 3,752,526 2,815,727 5,733,968
------------ ----------- -----------
Effect of exchange rate changes on cash
and cash equivalents 114,191 (62,727) (101,623)
------------ ----------- -----------
Increase (decrease) in cash
and cash equivalents 282,732 (1,394,176) (1,942,428)
Change in cash and cash equivalents included
in current assets of discontinued operations (8,185) (6,325) --
Cash and cash equivalents at beginning
of year 859,684 2,260,185 4,202,613
------------ ----------- -----------
Cash and cash equivalents at end of year $ 1,134,231 $ 859,684 $ 2,260,185
============ =========== ===========
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VSI Enterprises, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
1998 1997 1996
--------- ----------- -----------
Supplementary disclosure:
Interest paid $ 411,439 $ 247,744 $ 357,216
========= =========== ===========
Income taxes paid $ -- $ 180,000 $ --
========= =========== ===========
Supplemental schedule of noncash
investing and financing activities:
Noncash investing and financing activities:
Conversion of debt to common stock $ 702,543 $ 4,353,638 $ 1,095,224
========= =========== ===========
Common stock issued for products and
services $ 516,844 $ 650,139 $ 600,009
========= =========== ===========
Acquisition of businesses
Fair value of assets acquired $ -- $ -- $ 9,540,923
Cash paid -- -- (3,685,128)
Common stock and options issued -- -- (5,500,000)
--------- ----------- -----------
Liabilities assumed $ -- $ -- $ 355,795
========= =========== ===========
The accompanying notes are an integral part of these statements.
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VSI Enterprises, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
VSI Enterprises, Inc. was incorporated in Delaware in September 1988 and,
together with its wholly-owned subsidiaries (the "Company"), provides
videoconferencing systems, software, and service; and commission-based reselling
of telephone network services for telephone operating companies and related
communication entities.
1. Accounting Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amount of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
2. Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation.
3. Cash and Cash Equivalents
For financial reporting purposes, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
4. Inventories
Inventories consist of videoconferencing system components and parts and are
valued at the lower of cost (first-in, first-out method) or market.
5. Demonstration Inventory
Demonstration inventory is stated at cost. Demonstration inventory allowance is
provided for in amounts sufficient to reflect the asset at its estimated fair
value.
6. Property and Equipment
Property and equipment are stated at cost. Depreciation is provided for in
amounts sufficient to relate the cost of depreciable assets to operations over
their estimated useful lives on a straight-line basis.
7. Goodwill
The excess acquisition cost over the fair value of net assets of acquired
businesses are amortized over 20 years on a straight-line basis. At December 31,
1998, an impairment loss of $6,995,211 was charged to operations as an
impairment of the original goodwill recorded with the Company's acquisition of
its telephone network reselling subsidiary, Eastern Telecom, Inc. ("ETI") due to
a significant change in 1998 in ETI's anticipated income stream. Management
decreased ETI's goodwill to its estimated value based on expected future
undiscounted cash flows from ETI's operations. Also, based on changes in ETI's
business, the remaining goodwill of $955,688 will be amortized over ten years on
a straight-line basis. An additional
34
35
$577,077 impairment loss was recorded to eliminate all remaining goodwill
related to the Company's European subsidiary. Management recorded the impairment
loss in light of the Company's European subsidiary's continuing operating losses
and expectations of future losses. Accumulated amortization of goodwill was
$8,867,611 and $802,584 at December 31, 1998 and 1997, respectively.
Amortization charged to operations (exclusive of the impairment loss) was
$492,739, $492,738 and $156,784 for the years ended December 31, 1998, 1997 and
1996, respectively.
8. Software Development Costs
All software development costs are charged to expense as incurred until
technological feasibility has been established for the product. Software
development costs incurred after technological feasibility has been established
are capitalized and amortized, commencing with product release, on a
straight-line basis over three years or the useful life of the product,
whichever is shorter. Accumulated amortization of software development costs was
$1,634,897 and $1,052,194 at December 31, 1998 and 1997, respectively.
Amortization expense charged to operations was $582,703, $399,945, and $416,407
for the years ended December 31, 1998, 1997 and 1996, respectively.
9. Investments
The Company accounts for investments in entities in which it owns less than 20%
under the cost method. At December 31, 1997, other long-term assets included
$944,781 representing the Company's cost investments in Global Telemedix and
Educational Video Conferencing ("EVC"). Global Telemedix provides computer
hardware and software to healthcare providers and EVC acts as a marketing and
technological bridge between higher education institutions and corporations.
During 1998, the Company sold its investments in these companies resulting in a
loss of $452,005. At December 31, 1998 and 1997, receivables outstanding from
investees were approximately $0 and $250,000, respectively. In addition, sales
to investees were approximately $116,000, $1,038,000 and $35,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
10. Accounting for Impairments in Long-Lived Assets
Long-lived assets and identifiable intangibles are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amounts
of assets may not be recoverable. Management periodically evaluates the carrying
value and the economic useful life of its long-lived assets based on the
Company's operating performance and the expected future undiscounted cash flows
and will adjust the carrying amount of assets which may not be recoverable. At
December 31, 1998, the Company recorded a charge against operations of
$7,572,288 related to the writedown of goodwill previously recorded upon the
Company's acquisition of its European subsidiary and telephone network reselling
subsidiary (Note A-7). The Company recorded an additional impairment charge of
$195,156 related to the writedown of the its European subsidiary's net asset
value to zero based on the European subsidiary's continuing losses. Management
believes that remaining long-lived assets in the accompanying consolidated
balance sheets are appropriately valued.
11. Foreign Currency Translation
The asset and liability accounts of the Company's foreign subsidiaries are
translated into U.S. dollars at the current exchange rate in effect at the
balance sheet date. Stockholders' equity is translated at historical rates.
Income statement items are translated at average currency exchange rates. The
resulting translation adjustment is recorded as a separate component of
stockholder's equity.
Translation gains and losses were not significant for any period presented.
12. Revenue Recognition
Revenue from sales of videoconferencing systems and related maintenance
contracts on these systems are included in videoconferencing systems revenues.
Revenue on system sales are recognized upon shipment. Revenue on maintenance
contracts are recognized over the term of the related contract.
Commission revenue from telephone network service sales are recognized upon
receipt of order and when the Company has no further obligation related to the
order.
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36
13. Income Taxes
The Company accounts for income taxes using the asset and liability method.
Under this method, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates applied to taxable income. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date. A valuation allowance is provided for deferred
tax assets when it is more likely than not that the asset will not be realized.
14. Stock Based Compensation
The Company accounts for its stock-based compensation plans under Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Effective in 1995, the Company adopted the disclosure option of Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation. SFAS No. 123 required that companies that do not choose to account
for stock-based compensation as prescribed by the statement, shall disclose the
pro forma effects on earnings and earnings per share as if SFAS No. 123 had been
adopted. Additionally, certain other disclosures are required with respect to
stock compensation and the assumptions used to determine the pro forma effects
of SFAS No. 123 (see Note H).
15. Net Loss Per Common Share
In 1997, the Company adopted SFAS No. 128, Earnings Per Share. That statement
requires the disclosure of basic net earnings (loss) per share and diluted net
earnings (loss) per share when different from basic. Basic net earnings (loss)
per share is computed by dividing net earnings (loss) available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted net earnings (loss) per share gives effect to all
potentially dilutive securities. There is no difference between basic loss per
share and diluted loss per share for any period presented.
During 1998, the shareholders approved a one-for-four reverse common stock
split, effective January 15, 1999 to shareholders of record on January 14, 1999.
All references to shares of common stock, stock options and per share amounts
have been restated to reflect this reverse common stock split.
16. Fair Value of Financial Instruments
The Company's financial instruments include cash, cash equivalents and notes
payable. Estimates of fair value of these instruments are as follows:
Cash and cash equivalents - The carrying amount of cash and cash equivalents
approximates fair value due to the relatively short maturity of these
instruments.
Notes payable - The carrying amount of the Company's notes payable approximate
fair value based on borrowing rates currently available to the Company for
borrowings with comparable terms and conditions.
17. Technological Change and New Products
The market for the Company's products is characterized by rapidly changing
technology, evolving industry standards and frequent product introductions.
Product introductions are generally characterized by increased functionality and
better videoconferencing picture quality at reduced prices. The introduction of
products embodying new technology may render existing products obsolete and
unmarketable. The Company's ability to successfully develop and introduce on a
timely basis new and enhanced products that embody new technology, and achieve
levels of functionality at a price acceptable to the market, will be a
significant factor in the Company's ability to grow and to remain competitive.
If the Company is unable, for technological or other reasons, to develop
competitive products in a timely manner in response to changes in the industry,
the Company's business and operating results will be materially and adversely
affected.
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37
18. Dependence on Third Parties
Substantially all of the Company's components, subsystems and assemblies are
made by outside vendors. Disruption in supply, a significant increase in the
price of one or more of these components, or failure of a third party supplier
to remain competitive in functionality or price could have a material adverse
effect on the Company's business and operating results. There can be no
assurance that the Company will not experience such problems in the future.
Similarly, excessive rework costs associated with defective components or
process errors associated with the Company's anticipated new product line of
videoconferencing systems could adversely affect the Company's business and
operating results.
19. Foreign Sales and Operations
International sales and operations are subject to inherent risks, including
difficulties and delays in obtaining pricing approvals and reimbursement,
unexpected changes in regulatory requirements, tariffs and other barriers,
political instability, difficulties in staffing and managing foreign operations,
longer payment cycles, greater difficulty in accounts receivable collection and
adverse tax consequences. Currency translation gains and losses on the
conversion to United States dollars and international operations could
contribute to fluctuations in the Company's results of operations. If for any
reason, exchange or price controls or other restrictions on the conversion or
repatriation of foreign currencies were imposed, the Company's operating results
could be adversely affected. There can be no assurance that these factors will
not have an adverse impact on the Company's future international sales and
operations and, consequently, on the Company's operating results.
20. Reclassifications
Certain amounts in the 1997 financial statements have been reclassified to
conform to the current year presentation.
NOTE B - REALIZATION OF ASSETS
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplate continuation of the
Company as a going concern. However, the Company has sustained substantial
losses from operations in recent years, and such losses have continued through
March 5, 1999. Also, the Company has defaulted on the first installment of
$300,000 due February 16, 1999 on its term note payable (Note F) an additional
installment of $600,000 is due on May 16, 1999. In addition, the Company has
used, rather than provided, cash in its operations.
In view of the matters described in the preceding paragraph, recoverability of a
major portion of the recorded asset amounts shown in the accompanying balance
sheet is dependent upon continued operations of the Company, which in turn is
dependent upon the Company's ability to meet its financing requirements on a
continuing basis, to maintain present financing, and to succeed in its future
operations. The financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should the Company be
unable to continue in existence.
In response to the matters described in the preceding paragraphs, management of
the Company has undertaken a restructuring of the business operations that, when
implemented, is intended to achieve profitable operations and provide positive
operating cash flows as well as provide for additional equity capital
investments. Subsequent to year end, the company has reviewed its operating
expenses and substantially reduced fixed management and overhead expenses.
Management also intends to close and or spin off non-strategic business
operations and has recognized asset impairment losses that reflect its
decisions.
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38
NOTE C - MERGERS AND ACQUISITIONS
INS Merger
On June 25, 1996, the Company, through its wholly-owned subsidiary, INS
Acquisition Co., issued 120,418 shares of its common stock in exchange for
all of the outstanding common stock of Integrated Network Services, Inc.
("INS"). The merger has been accounted for as a pooling of interests and
accordingly, the Company's consolidated financial statements have been
restated to include the accounts and operations of INS for all periods prior
to the merger. During 1998, the company discontinued operations of INS (see
Note D). INS provided integration services for local and wide area networks.
Separate results of operations for the periods prior to the merger are as
follows for the year ending December 31, 1996.
Revenue:
VSI $ 12,709,224
INS 4,346,723
-------------
$ 17,055,947
=============
Net (loss) earnings from continuing operations:
VSI $ (5,992,477)
INS (714,417)
-------------
$ (6,706,894)
=============
Net loss:
VSI $ (5,992,477)
INS (714,417)
-------------
$ (6,706,894)
=============
Acquisitions
In October 1996, the Company acquired all of the outstanding common stock of
Eastern Telecom, Inc. ("ETI") in exchange for 501,835 shares of VSI common
stock, 31,939 options to purchase VSI common stock at less than $.04 per
share and $3,500,000 in cash. The cash portion of the purchase was funded
from the issuance of $5,000,000 of convertible debentures. The acquisition
was valued at approximately $9,185,000 including acquisition costs of
approximately $185,000. ETI is engaged in the selling of network services of
telephone operating companies and long distance carriers.
The ETI acquisition was accounted for as a purchase. Accordingly, the
purchase price was allocated to assets and liabilities based on their
estimated fair values at the date of acquisition. Results of operations of
ETI have been included in the consolidated financial statements from the
respective date of acquisition. Goodwill of approximately $9,000,000 related
to the purchase was being amortized on a straight-line basis over 20 years.
At December 31, 1998, the Company recorded an impairment loss on this
goodwill of $6,995,211 and reduced the amortization period to ten years
reflecting 1998 changes in ETI's business and based on expected future
undiscounted cash flows from ETI's operations (Note A-7).
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39
NOTE D - DISCONTINUED OPERATIONS
During the fourth quarter of 1998, the Company discontinued operations of its
system integration subsidiary, Integrated Network Services, Inc. Accordingly,
operating results for the discontinued operation have been reclassified and
reported as discontinued operations in accordance with Accounting Principles
Board Opinion No. 30 for the years ended December 31, 1998, 1997 and 1996.
Summary operating results of the discontinued system integration operations
are as follows:
1998 1997 1996
------------ ------------ ------------
Revenues $ 1,518,952 $ 2,145,388 $ 4,346,723
Costs and expenses 2,282,657 3,091,150 5,061,140
------------ ------------ ------------
Loss from discontinued operations $ (763,705) $ (945,762) $ (714,417)
============ ============ ============
Assets and liabilities of the discontinued system integration operations are
included in the consolidated balance sheets as assets and liabilities of
discontinued operations and are made up as follows:
1998 1997
-------- --------
Cash and cash equivalents $ 14,510 $ 6,325
Accounts receivable 319,512 439,376
Inventories -- 76,936
Other current assets -- 34,484
Property and equipment -- 123,527
Other assets -- 8,385
-------- --------
Total assets $334,022 $689,033
======== ========
Notes payable $248,116 $279,355
Accounts payable -- 364,960
Accrued expenses 85,906 75,615
Deferred revenue -- 61,932
-------- --------
Total liabilities $334,022 781,862
======== ========
The Company recognized a gain on disposal of the system integration segment
at December 31, 1998 of approximately $345,000.
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NOTE E - PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of December 31, 1998 and
1997:
Estimated
Service
1998 1997 Life
----------- ----------- ----------
Machinery and equipment $ 3,468,988 $ 3,199,101 3-10 years
Furniture and fixtures 723,132 668,132 10 years
Leasehold improvements 203,656 169,857 5 years
----------- -----------
4,395,776 4,037,090
Less accumulated depreciation (3,346,793) (2,842,182)
Less amounts included in other assets
of discontinued operations -- (123,527)
----------- -----------
$ 1,048,983 $ 1,071,381
=========== ===========
Depreciation expense charged to operations was approximately $527,000, $562,000
and $814,000 for the years ended December 31, 1998, 1997 and 1996, respectively
and is included in selling, general and administrative expense in the
accompanying consolidated statements of operations.
NOTE F - NOTES PAYABLE AND SHORT-TERM BORROWINGS
Notes Payable
-------------
1998 1997
---------- ----------
VSI line of credit; provides for maximum borrowings of $4,000,000, limited
to 80% of eligible accounts receivable, interest payable monthly at the
prime rate plus 2% (9.75% at December 31, 1998); collateralized by
accounts receivable, certain property and equipment and inventory of VSI. $ 82,556 $ 905,684
VSI term note payable in two installments of $300,000 and $600,000 due on
February 16, 1999 and May 16, 1999, respectively. Interest is payable
upon retirement of note at 14%; collateralized by security interests in
certain patents owned by VSI. Failure to pay the installments on these
respective due dates will result in a penalty of $30,000 per month until
the note is retired. 900,000 --
VSI term notes payable due on March 31, 2000; interest payable quarterly at
the prime rate plus 3% (10.75% at December 31, 1998). These term notes
are unsecured. The term notes payable are shown net of debt discount of
$227,345. 1,105,655 --
INS line of credit; provides for maximum borrowings of $750,000, limited to
80% of eligible accounts receivable; interest payable monthly at the
prime rate plus 3% (10.75% at December 31, 1998); collateralized by
accounts receivable, property and equipment and inventory of INS. 248,116 279,355
ETI line of credit; provides for maximum borrowings of $1,500,000, limited
to 90% of eligible accounts receivable; interest payable monthly at the
prime rate plus 2.75% (10.50% at December 31, 1998); collateralized by
eligible accounts receivable of ETI. 1,402,523 210,543
Note payable to bank of European subsidiary; provides for maximum
borrowings of approximately $550,000; interest payable monthly at 5%
This note is secured by 137,500 shares of the Company held in escrow by
the European bank. 252,869 26,785
---------- ----------
3,991,719 1,422,367
Current portion of notes payable 2,637,948 1,143,012
---------- ----------
1,353,771 279,355
Less notes payable included in current
liabilities of discontinued operations 248,116 279,355
---------- ----------
$1,105,655 $ --
========== ==========
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In 1997, the Company adopted SFAS No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities (the
"Statement"). This Statement provides accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of
liabilities. Those standards are based on consistent application of a
financial-components approach that focuses on control. Under that approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. At December 31, 1998 and 1997,
the Company has recognized approximately $1,733,000 and $1,396,000 of
accounts receivable financing, respectively, as notes payable in the
accompanying balance sheets.
During 1996, note agreements with directors were terminated. The remaining
balances of these notes of $299,656 plus accrued interest of $37,457 were
retired by the issuance of 61,204 common shares. Interest expense under notes
due to directors totaled approximately $0, $0 and $16,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
In March 1998, the Company secured a working capital loan for approximately
$2.0 million from AmTrade International Bank of Georgia. The loan was
guaranteed by the Export-Import Bank of the United States, and was
collateralized by a letter of credit from a VSI customer. Funds were used for
pre-/post-export financing for the manufacture and delivery of
videoconferencing equipment in China. The interest rate was prime plus 2.5%.
Repayment was made in 1998 through proceeds of the letter of credit, which
was applied first to the loan principal and interest, with the remaining
amount remitted to VSI. Interest expense related to this note was
approximately $57,000 for the year ended December 31, 1998.
During September 1998, the Company began offering $3,000,000 of term notes. A
minimum of $5,000 is required for each subscription and each purchaser of the
term notes receives warrants to purchase shares of common stock of the
company on the basis of one warrant for each $8.00 of term notes purchased.
The warrants have a term of five years, expiring on October 1, 2003 and
become exercisable on April 1, 2000 at an exercise price of $1.68 per share.
At December 31, 1998, the Company has issued $1,333,000 of term notes and
166,625 warrants. The Company has valued these warrants at $270,645 using the
Black-Scholes option-pricing model in accordance with SFAS No. 123,
Accounting for Stock-Based Compensation. This warrant value is recorded as
debt discount to be amortized to interest expense over the period until the
warrants become exercisable on April 1, 2000. Interest expense related to
these warrants was $43,300 for the year ended December 31, 1998.
Short-Term Borrowings
At December 31, 1998 and 1997, the company's foreign subsidiary had
short-term borrowings which provided for maximum borrowings of approximately
$166,000 and $219,000, respectively . These bank credit facilities are
collateralized by the subsidiary's accounts receivable and inventory and bear
interest at 7%. Outstanding borrowings under these agreements were $157,376
and $154,938 at December 31, 1998 and 1997, respectively.
NOTE G - CONVERTIBLE DEBENTURES
On February 23, 1998, the Company issued $3,000,000 of 5% convertible
Debentures due February 2000 (the "Debentures"), the proceeds of which were
utilized for working capital purposes. In addition, the Company issued 9,375
common stock purchase warrants to the holder of the Debentures and 9,375
common stock purchase warrants to an agent involved in the transaction. The
warrants, which expire on February 23, 2003, entitle the holder to purchase
one common stock share of the Company at the price of $10.00. The Debentures
were convertible at the lower of (i) $8.00 per share or (ii) 85% of the
average closing bid price of the Company's common stock. "Average closing bid
price" is defined to mean the lowest average of the daily last bid price for
the common stock for any three trading days in any 20-day period preceding
the conversion. During the year, $710,000 of Debentures plus accrued interest
of $13,531 were converted into 445,956 common shares; $1,440,000 of the
Debentures were redeemed by the Company at face value and the remaining
Debentures were converted into a $900,000 term note (see Note F). 50,000
shares of the 445,956 issued in connection with the
41
42
conversion were held in escrow at December 31, 1998 with 25,000 of these
issued in January 1999 and 25,000 issued in February 1999.
On November 16, 1998, the Company issued an additional 25,000 stock purchase
warrants to the holder of the Debentures to enable the Company to purchase
the $1,440,000 outstanding Debentures at face value. The warrants, which
expire on November 16, 2003, entitle the holder to shares of the common stock
of the Company at a price of $2.40 per share. At this time, the Company also
repriced the 9,375 warrants issued to the Debenture holder on February 23,
1998 to a price of $2.40 per share. This repricing had no impact on the
consolidated statement of operations.
In conjunction with the issuance of the 18,750 common stock warrants to the
Debenture holder and agent, $529,412 of the debt issuance proceeds relating
to the issuance of the Debentures was allocated to additional paid in capital
in the accompanying consolidated balance sheet, to recognize the beneficial
conversion feature of the Debentures. This debt discount was amortized to
interest expense upon conversion and redemption of the Debentures and is
included in other expenses in the consolidated statements of operations for
the year ended December 31, 1998. In conjunction with the issuance of the
additional 25,000 purchase warrants, the Company valued the warrants at
$30,000 using the Black-Scholes option pricing model in accordance with SFAS
No. 123, Accounting for Stock-Based Compensation. This warrant value was
recorded as interest expense upon issuance of the warrants.
NOTE H - STOCK OPTIONS, WARRANTS, AND EMPLOYEE STOCK PURCHASE PLAN
Stock Option Plan
The Company's board of directors has approved a stock option plan which
covers up to 915,514 shares of common stock. The plan provides for the
expiration of options ten years from the date of grant and requires the
exercise price of the options granted to be at least equal to 100% of market
value on the date granted. Stock option transactions are summarized below:
1998 1997 1996
-------------------- --------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- ------- ------- -------- ------- --------
Outstanding, beginning of year 475,867 $ 6.88 480,856 $ 6.52 484,242 $ 5.92
Granted 196,250 1.75 84,000 6.20 137,738 9.08
Exercised (50,000) 2.50 (63,189) 3.36 (76,408) 3.92
Forfeited (28,795) 7.82 (25,800) 10.76 (64,716) 10.32
------- ------- ------- -------- ------- --------
Outstanding, end of year 593,322 $ 5.46 475,867 $ 6.88 480,856 $ 6.52
======= ======= ======= ======== ======= ========
The following table summarizes information about stock options outstanding at
December 31, 1998:
Options Outstanding Options Exercisable
------------------------------------------- ------------------------------
Weighted
Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding at Contractual Exercise Exercisable at Exercise
Price December 31, 1998 Life (Years) Price December 31, 1998 Price
-------- ----------------- ------------ -------- ----------------- --------
$ 1.00 - $ 1.87 142,500 9.78 $ 1.08 38,750 $ 1.14
$ 2.50 - $ 3.76 60,667 8.02 2.80 29,417 2.63
$ 4.25 - $ 5.25 208,793 7.78 5.04 152,126 4.98
$ 5.50 - $ 7.76 57,333 6.62 6.77 53,166 6.80
$ 8.50 - $ 9.87 64,792 6.78 9.22 64,132 9.22
$11.00 - $14.75 41,600 7.30 13.83 37,354 13.80
$17.25 17,637 6.85 17.25 17,637 17.25
------- ---- ------- ------- -------
593,322 8.00 $ 5.46 392,582 $ 6.75
======= ==== ======= ======= =======
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The Company uses the intrinsic value method in accounting for its stock
option plans. In applying this method, no compensation cost has been
recognized. Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant dates for awards under those
plans, the Company's net loss and loss per share would have resulted in the
pro forma amounts indicated below:
1998 1997 1996
-------------- ------------- -------------
Net loss
As reported $ (16,935,972) $ (5,817,366) $ (6,706,894)
Pro forma (17,248,878) (6,490,242) (7,509,903)
Net loss per common share
As reported $ (1.42) $ (0.53) $ (0.74)
Pro forma (1.45) (0.60) (0.84)
For purposes of the pro forma amounts above, the fair value of each option
grant was estimated on the date of grants using the Black-Scholes options
pricing model with the following weighted average assumptions used for grants
in 1998, 1997 and 1996, respectively; expected volatility of 87%, 88% and
110%, risk-free interest rates of $5.0%-6.1%, $5.9%-6.7% and 5.3%-6.6% and
expected lives of 3-7 years for all periods presented.
Warrants
In connection with the purchase of the outstanding notes payable and
establishment of a line of credit during 1994, 62,500 common stock purchase
warrants were granted to a director at an exercise price of $1.60 per share.
These warrants expire in July 2004.
Employee Stock Purchase Plan
The Company has an employee stock purchase plan ("Plan") that provides for
the sale of up to 75,000 shares of common stock to eligible employees. The
purchase price for shares of common stock purchased pursuant to the Plan is
the lesser of: 85% of the fair market value of common stock on the first pay
date or 85% of the fair market value of common stock on the last pay date of
each plan period. 20,446 and 36,653 shares of common stock were purchased by
employees under this Plan for the years ended December 31, 1998 and 1997,
respectively. The Plan was suspended by the Board of Directors in September
1998. The Company has no current plans to reinstate the Plan.
NOTE I - INCOME TAXES
The Company's temporary differences result in a net deferred income tax asset
which is reduced to zero by a related deferred tax valuation allowance,
summarized as follows at December 31, 1998 and 1997:
1998 1997
------------ ------------
Deferred income tax assets:
Operating loss carryforwards $ 11,315,000 $ 7,700,000
Nondeductible accruals and allowances 1,117,000 758,000
Capitalized inventory costs 140,000 147,000
Tax credit carryforwards 89,000 89,000
Other 195,000 205,000
------------ ------------
Gross deferred income tax assets 12,856,000 8,899,000
Deferred income tax asset valuation allowance (12,675,000) (8,689,000)
------------ ------------
Net deferred income tax asset $ 181,000 $ 210,000
============ ============
Deferred income tax liabilities $ (181,000) $ (210,000)
============ ============
Net deferred income tax $ -- $ --
============ ============
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44
Income tax expense for 1997 of $193,241 represents state income taxes
associated with the operations of ETI and was calculated using the statutory
rates applicable in the various states to which income has been apportioned.
At December 31, 1998, the Company had operating loss carryforwards for U.S.
income tax purposes of approximately $29,389,000 available to reduce future
taxable income and approximately $89,000 of investment and research and
experimental credits available to reduce future income taxes payable, which
expire in varying amounts through the year 2013.
The Company's European subsidiary has net operating loss carryforwards of
approximately $3,350,000 that can be used to offset future taxable income.
These carryforwards can be carried forward indefinitely. The resulting
deferred income tax asset has been reduced to zero by a related valuation
allowance.
The Company experienced a change in control, as defined under Section 382 of
the Internal Revenue code during calendar year 1993. As a result, the
utilization of approximately $7,000,000 in tax loss carryforwards will be
limited to approximately $1,000,000 annually.
NOTE J- MAJOR CUSTOMERS
Revenue from health care providers and related entities comprised
approximately 7%, 10% and 25% of consolidated revenues for the years ended
December 31, 1998, 1997 and 1996, respectively. Revenue from telephone
operating companies and related communications entities comprised
approximately 36%, 43% and 23% of consolidated revenues for the years ended
December 31, 1998, 1997 and 1996, respectively. At December 31, 1998 and
1997, accounts receivable from telephone operating companies and related
communication entities comprised 43% and 44%, respectively, of consolidated
receivables. Accounts receivable from healthcare providers comprised 6% and
7%, respectively, of consolidated receivables.
Management believes that concentration of credit risk with respect to trade
receivables is minimal due to the composition of the customer base. The
Company's customers are primarily large national and multinational companies
and agencies of the U.S. government. Allowances are maintained for potential
credit losses, and such losses have been within management's expectations.
The Company's operations are subject to rapid technological developments.
Management periodically evaluates the realizability of its technology-related
assets, including inventories, software development costs and goodwill.
During the years ended December 31, 1998 and 1997, the Company recorded
approximately $1,651,000 and $2,111,000 of additional cost of
videoconferencing systems related to the write-down of certain inventories
determined to be technologically obsolete. Management believes that no
material impairment of remaining inventories and other assets existed at
December 31, 1998 and 1997. It is possible, however, that management's
estimates may change in the near term due to technological, regulatory, and
other changes in the Company's industry.
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NOTE K - OPERATING SEGMENTS AND RELATED INFORMATION
In 1998, the Company adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. This statement requires the disclosure of
certain information regarding the Company's operating segments.
Prior to 1998, the Company's industry segments were made up of
videoconferencing, computer system integration and telephone network
reselling. These industry segments were all operating in separate, one
hundred percent owned, subsidiaries. In 1998, the Company discontinued
operations of its computer system integration subsidiary. As a result, at
December 31, 1998, the Company is primarily operating in the
videoconferencing segment and telephone network reselling segment as follows:
For the years ended December 31,
--------------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Revenue:
Videoconferencing systems $ 13,574,214 $ 12,168,107 $ 11,159,943
Network reselling 5,863,197 7,451,686 1,549,281
------------ ------------ ------------
19,437,411 19,619,793 12,709,224
Operating (loss) income:
Videoconferencing systems (6,166,394) (5,903,979) (6,339,722)
Network reselling (8,216,297) 1,301,785 486,293
------------ ------------ ------------
(14,382,691) (4,602,194) (5,853,429)
Capital expenditures:
Videoconferencing systems 13,373 98,096 369,117
Network reselling 367,975 302,134 49,187
------------ ------------ ------------
381,348 400,230 418,304
Identifiable assets:
Videoconferencing systems 6,274,667 10,659,140 13,344,581
Network reselling 4,352,276 11,532,286 10,267,688
System integration 334,022 689,033 1,219,988
------------ ------------ ------------
$ 10,960,965 $ 22,880,459 $ 24,832,257
============ ============ ============
The Company also has operations in the United States and Europe. Summary
information related to the United States and European operations are as
follows:
For the years ended December 31,
--------------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Revenue:
United States $ 16,515,355 $ 16,851,511 $ 10,209,556
Europe 2,922,056 2,768,282 2,499,668
------------ ------------ ------------
$ 19,437,411 $ 19,619,793 $ 12,709,224
============ ============ ============
Operating loss:
United States $(13,953,057) $ (4,564,382) $ (5,126,073)
Europe (429,634) (37,812) (727,356)
------------ ------------ ------------
$(14,382,691) $ (4,602,194) $ (5,853,429)
============ ============ ============
Capital expenditures:
United States $ 373,018 $ 331,897 $ 333,588
Europe 8,330 68,333 84,716
------------ ------------ ------------
$ 381,348 $ 400,230 $ 418,304
============ ============ ============
December 31,
----------------------------------
1998 1997
------------ ------------
Identifiable assets:
United States $ 10,203,619 $ 22,002,184
Europe 757,346 878,275
------------ ------------
$ 10,960,965 $ 22,880,459
============ ============
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NOTE L - COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space and equipment under noncancelable operating
leases expiring at various dates through April 2003. Rent expense for the
years ended December 31, 1998, 1997 and 1996 was approximately $660,000,
$572,000 and $660,000, respectively. Approximate minimum annual future rental
payments under the leases are as follows at December 31:
Year ending:
1999 $ 684,000
2000 633,000
2001 475,000
2002 382,000
2003 15,000
------------
$ 2,189,000
============
Litigation
The Company is also involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's financial position or results of operations.
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47
NOTE M - SUBSEQUENT EVENT - UNAUDITED
The Company is currently negotiating with a note holder to restructure a
$900,000 term note. (See note F). The restructuring of this note may involve
a cash payment by the Company and the issuance of shares of common stock of
the Company to the note holder to repay the note. If the debt cannot be
restructured, the note holder may take possession of the Company's patents
which secure this debt. In the event the Company is unable to license this
technology from the note holder, the Company will be unable to manufacture,
sell and service its videoconferencing systems.
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Report of Independent Certified Public Accountants
on Schedule II
Board of Directors
VSI Enterprises, Inc.
In connection with our audit of the consolidated financial statements of VSI
Enterprises, Inc. and Subsidiaries referred to in our report dated March 5,
1999, which is included in this report, we have also audited Schedule II for the
years ended December 31, 1998 and 1996. In our opinion, the schedule presents
fairly, in all material respects, the information required to be set forth
therein as of and for the years ending December 31, 1998 and 1996.
/s/ Grant Thornton LLP
Atlanta, Georgia
March 5, 1999
48
49
\
Report of Independent Certified Public Accountants
on Schedule II
To the Board of Directors and Stockholders
VSI Enterprises, Inc.
We have audited, in accordance with generally accepted auditing standards, the
consolidated balance sheet of VSI ENTERPRISES, INC. (a Delaware corporation) AND
SUBSIDIARIES as of December 31, 1997 and the related statements of operations,
stockholders' equity, and cash flows for the year then ended and have issued our
report thereon dated April 12, 1999. Our audit was made for the purposes of
forming an opinion on the basic financial statements taken as a whole. The
schedule listed in Item 14 hereon is the responsibility of management and is
presented for the purposes of complying with the Securities and Exchange
Commission's rules and is not a required part of a the basic financial
statements. This schedule has been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects, the financial data for the year ended December
31, 1997 as required to be set forth therein in relation of the basic financial
statements taken as a whole.
/s/ Arthur Andersen LLP
Atlanta, Georgia
April 12, 1999
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SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E
-------- ---------- ---------- --------------- ------------
Additions
Balance at Charged to Balance at
Beginning Costs and Deductions End of
Description of Period Expenses Describe (1)(2) Period
----------- ---------- ---------- --------------- ----------
Year ended December 31, 1998
Reserve for obsolete inventory $ 178,235 $ 1,499,205 $ -- $ 1,677,440
Reserve for doubtful accounts receivable 447,174 1,903,248 1,209,331 1,141,091
Year ended December 31, 1997
Reserve for obsolete inventory $ 494,200 $ 557,060 $ 873,025 $ 178,235
Reserve for doubtful accounts receivable 271,000 332,633 156,459 447,174
Year ended December 31, 1996
Reserve for obsolete inventory $ 244,200 $ 250,000 $ -- $ 494,200
Reserve for doubtful accounts receivable 658,402 (28,558) 358,844 271,000
(1) - Obsolete items which have been disposed and bad debt write offs.
(2) - Column C-2 "Charged to other accounts" has been omitted as the response
is "none".
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements on accounting and financial disclosure matters
which are required to be described by Item 304 of Regulation S-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information relating to directors and executive officers of the Company
contained in the registrant's definitive proxy statement to be delivered to
shareholders in connection with the 1999 annual meeting of shareholders
scheduled to be held on June 11, 1999 are incorporated hereby by reference.
ITEM 11. EXECUTIVE COMPENSATION.
The information relating to executive compensation contained in the registrant's
definitive proxy statement to be delivered to shareholders in connection with
the 1999 annual meeting of shareholders scheduled to be held on June 11, 1999
are incorporated hereby by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information relating to security ownership of certain beneficial owners and
management contained in the registrant's definitive proxy statement to be
delivered to shareholders in connection with the 1999 annual meeting of
shareholders scheduled to be held on June 11, 1999 are incorporated hereby by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information relating to related party transactions contained in the
registrant's definitive proxy statement to be delivered to shareholders in
connection with the 1999 annual meeting of shareholders scheduled to be held on
June 11, 1999 are incorporated hereby by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) 1. Financial Statements.
The following financial statements and accountant's report have been filed as
Item 8 in Part II of this report:
Report of Independent Certified Public Accountants
Report of Independent Public Accountants
Consolidated Balance Sheets as of December 31, 1998 and December 31,
1997
Consolidated Statements of Operations for Years Ended December 31,
1998, 1997 and 1996
Consolidated Statement of Stockholders' Equity for Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for Years Ended December 31,
1998, 1997 and 1996
Notes to Consolidated Financial Statements
2. Financial Statement Schedules.
The following financial statement schedule, of VSI Enterprises, Inc. for the
years ended December 31, 1998, 1997 and 1996 are included pursuant to Item B:
Report of Independent Certified Public Accountants on Schedule II....48
Report of Independent Certified Public Accountants on Schedule II....49
Schedule II: Valuation and Qualifying Accounts.......................50
51
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3. Exhibits.
The following exhibits are filed with or incorporated by reference into this
report. The exhibits which are denominated by an asterisk (*) were previously
filed as a part of, and are hereby incorporated by reference from either (i)
the Post-Effective Amendment No. 1 to the Company's Registration Statement on
Form S-18 (File No. 33-27040-D) (referred to as "S-18 No. 1"), (ii)
Post-Effective Amendment No. 2 to the Company's Registration Statement on Form
S-18 (File No. 33-27040-D) (referred to as "S-18 No. 2"), (iii) Post-Effective
Amendment No. 3 to the Company's Registration Statement on Form S-18 (File No.
33-27040-D) (referred to as "S-18 No. 3"); (iv) the Company's Quarterly Report
on Form 10-Q for the quarter ended December 31, 1992 (referred to as "1992
10-Q"); (v) the Company's Annual Report on Form 10-K for the year ended March
31, 1993 (referred to as "1993 10-K"); (vi) the Company's Registration
Statement Form S-1 (File No. 33-85754) (referred to as "S-1"); (vii) the
Company's Annual Report on Form 10-K for the year ended December 31, 1994
(referred to as "1994 10-K"); (viii) the Company's Annual Report on Form 10-K
for the year ended December 31, 1995 (referred to as "1995 10-K"); (ix) the
Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997
(referred to as "1997 10-Q"); (x) the Company's Annual Report on Form 10-K for
the year ended December 31, 1996 (referred to as "1996 10-K"); (xi) the
Company's Form S-8 Registration Statement (File No. 333-18239), (referred to as
"Warrant Plan S-8"), and (xii) the Company's Form S-8 Registration Statement
(File No. 333-18237), (referred to as "Option Plan S-8").
EXHIBIT NO. DESCRIPTION OF EXHIBIT
--------------------------------------------------------------------------
*3.1 Certificate of Incorporation, including Certificate of Stock Designation
dated September 25, 1990, and amendments dated December 26, 1990, August 19,
1991 and October 17, 1991 (S-18 No. 3, Exhibit 3-1)
*3.2 Amended Bylaws of the Registrant as presently in use (S-18 No. 1, Exhibit 3.2)
*3.3 Certificate of Amendment to Certificate of Incorporation filed on February 10, 1993 (1992 10-Q)
*3.6 Certificate of Amendment to Certificate of Incorporation filed on February 13, 1995 (1994 10-K)
*3.7 Certificate of Amendment to Certificate of Incorporation filed on September 8, 1995 (1995 10-K)
3.9 Certificate of Amendment of Certificate of Incorporation filed on January 13, 1999
*10.3 1991 Stock Option Plan (S-18 No. 2, Exhibit 10.1(a))
*10.3.1 Amendment No. 1 to 1991 Stock Option Plan (1993 10-K)
*10.3.2 Amendment No. 2 to 1991 Stock Option Plan (S-1)
*10.3.3 Amendment No. 3 to 1991 Stock Option Plan (S-1)
*10.3.4 Amendment No. 4 to 1991 Stock Option Plan (Option Plan S-8, Exhibit 4.5)
10.3.5 Amendment No. 5 to 1991 Stock Option Plan
52
53
*10.4 Revolving Credit and Security Agreement dated June 7, 1995 by and between Videoconferencing Systems,
Inc. ("VSI") and Fidelity Funding of California, Inc. (1995 10-K)
*10.5 1995 Performance Warrant Plan (Warrant Plan S-8, Exhibit 4.1)
*10.6 Employment Agreement dated August 4, 1997, by and between the Registrant and Judi North
*10.15 1994 Employee Stock Purchase Plan (1994 10-K)
10.16 Promissory Note, dated November 18, 1999, issued to Thomson Kernaghan & Co., Ltd. in the principal
amount of $900,000
10.17 Assignment of Security Interest in Patents, dated November 18, 1999, by and between the Registrant and
Thomson Kernaghan & Co., Ltd.
10.18 Receivable Sale Agreement, dated October 8, 1998, by and between VSI Network Solutions, Inc. and RFC
Capital Corporation
*21.1 Subsidiaries of the Registrant (1996 10-K)
23.1 Consent of Grant Thornton LLP
23.2 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule (SEC use only)
27.2 Financial Data Schedule - Restated 1997 (SEC use only)
27.3 Financial Data Schedule - Restated 1996 (SEC use only)
(b) Reports on Form 8-K.
The following report on Form 8-K was filed during the quarter
ended December 31, 1998: Current Report on Form 8-K dated October 5,
1998 (relating to private placement of term notes and warrants).
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
VSI ENTERPRISES, INC.
By: /s/ Julia B. North
--------------------------------
Date: April 15, 1999 Julia B. North, President & CEO
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons in the following
capacities on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Larry M. Carr Chairman of the Board April 15, 1999
- -----------------------------------
Larry M. Carr
/s/ Julia B. North President and April 15, 1999
- ----------------------------------- Chief Executive Officer
Julia B. North
/s/ Samuel D. Horgan Chief Financial Officer April 15, 1999
- ----------------------------------- (Principal Financial and
Samuel D. Horgan Accounting Officer)
/s/ Harlan D. Platt, Ph.D. Director April 15, 1999
- -----------------------------------
Harlan D. Platt, Ph.D.
/s/ Edward S. Redstone Director April 15, 1999
- -----------------------------------
Edward S. Redstone
54
55
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT
- ----------- ----------------------
3.9 Certificate of Amendment of Certificate of Incorporation filed on January 13, 1999
10.3.5 Amendment No. 5 to 1991 Stock Option Plan
10.16 Promissory Note, dated November 18, 1999, issued to Thomson Kernaghan & Co., Ltd.
in the principal amount of $900,000
10.17 Assignment of Security Interest in Patents, dated November 18, 1999, by and between
the Registrant and Thomson Kernaghan & Co., Ltd.
10.18 Receivable Sale Agreement, dated October 8, 1998, by and between VSI Network Solutions,
Inc. and RFC Capital Corporation
23.1 Consent of Grant Thornton LLP
23.2 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule (SEC use only)
27.2 Financial Data Schedule - Restated 1997 (SEC use only)
27.3 Financial Data Schedule - Restated 1996 (SEC use only)
55