10KSB/A 1 doc1.txt U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB/A AMENDMENT NO. 3 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 31, 2001. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ---------- ----------- Commission file number: 000-30326 VSOURCE, INC. (Exact name of small business issuer as specified in its charter) DELAWARE 77-0557617 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 5740 RALSTON STREET, SUITE 110 VENTURA, CALIFORNIA 93003 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (805) 677-6720 SECURITIES REGISTERED PURSUANT TO SECTION 12 (b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT: COMMON STOCK, PAR VALUE $0.01 PER SHARE Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B 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-KSB or any amendment to this Form 10-KSB. [X]
State issuer's revenues for the fiscal year ended January 31, 2001 . . . . . . . . . . . . . $ 35,000 Aggregate market value of the Registrant's Common Stock (based on the price at which such equity was sold on April 30, 2001) held by non-affiliates of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . 5,066,517 Number of shares of common stock outstanding as of April 30, 2001. . . . . . . . . . . . . . 18,685,814 Number of shares of Series 1-A Convertible Preferred Stock outstanding as of April 30, 2001. 1,804,105 Number of shares of Series 2-A Convertible Preferred Stock outstanding as of April 30, 2001. 1,350,176
Documents Incorporated By Reference The information required by Part III of this report, to the extent not set forth herein, is incorporated herein by reference from the issuer's definitive proxy statement relating to the annual meeting of stockholders to be held in 2001, which definitive proxy statement will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates.
TABLE OF CONTENTS ----------------- Page ---- PART I Item 1. DESCRIPTION OF BUSINESS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Item 2. DESCRIPTION OF PROPERTY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Item 3 LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . . . . . . . . . . . . . . . 20 PART II Item 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS . . . . . . . . . . . . . . . 20 Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. . . . . . . . . . . . . . . . . . . . . . . . . 26 Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. . . . . . . . . . . . . . . . . . . . . . 29 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS . . . . . . . . . . . . . . . . . 29 CONSOLIDATED BALANCE SHEET . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 CONSOLIDATED STATEMENTS OF OPERATIONS. . . . . . . . . . . . . . . . . . . . . . . . 32 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY. . . . . . . . . . . . . . . . . . . 33 CONSOLIDATED STATEMENTS OF CASH FLOWS. . . . . . . . . . . . . . . . . . . . . . . . 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . 35 Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 48 PART III Item 9 DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. . . . . . . . . . . . . . . . . . 49 Item 10. EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. . . . . . . . . . .. . 53 Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . . . . . . . . . . . . . . . 56 Item 13. EXHIBITS, REPORTS ON FORM 8-K, AND FINANCIAL STATEMENT SCHEDULES. . . . . . . . . . . 58 EXHIBITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 REPORTS ON FORM 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
PART I ITEM 1. DESCRIPTION OF BUSINESS OVERVIEW Vsource, Inc. (the "Company"), through its subsidiary Online Transaction Technologies, Inc. ("OTT"), is an Application Service Provider ("ASP") that develops and hosts transaction solutions for public (many to many) and private (one to many) exchanges. Among the solutions is LiquidMarketplace(TM), a suite of integrated digital marketplace or transaction solutions, including auctions and fixed-price catalogs. These solutions are identified as LiquidAuction(TM) and LiquidCatalog(TM). This suite allows public exchange clients to handle both seller and buyer-initiated transactions in their e-Marketplaces. The Company's private exchange solution, LiquidStore(TM), offers private catalog and auction functionality to LiquidMarketplace(TM) participants or stand-alone clients. In addition to offering a suite, the Company has developed a proprietary framework that reduces customization and deployment time and simplifies integration. Through the fiscal year ended January 31, 2001, the Company was engaged principally in the development and sale of its Virtual Source Network ("VSN") e-Procurement software, also delivered as an ASP. In March 2001, subsequent to year-end, the Company announced that it was ceasing further development of VSN and withdrawing it from the market. The Company also announced that it would proceed with the development and sale of LiquidMarketplace(TM) and other OTT products added with the acquisition of Online Transaction Technologies, Inc., which was effective January 22, 2001. The Company's objective is to create the leading pure Internet-based ASP electronic commerce network platform for the business-to-business customer and supplier. The Company intends to create a leading virtual marketplace for business-to-business goods and services, and feels that the ASP technology provides customers an advantage not presently offered by competitive electronic marketplace providers. PRODUCT OFFERINGS Business-to-Consumer - LiquidAuction The Company launched LiquidAuction, its first dynamic pricing engine, in mid 2000, for businesses that seek to conduct live auctions over the Internet. This market solution provides an outsourced application that allows companies to set up an online auction in minutes and be in business the same day under their own storefront and brand identity. By bringing together buyers and sellers, this product helps businesses create new sales channels, manage inventory, attract new customers, introduce new products, and strengthen relationships with existing partners and customers. LiquidAuction provides many competitive advantages to other solutions on the market. These include cost, ease of use, quick deployment, and the use of advanced technologies. Online auction deployment is inherently expensive and beyond the reach of most companies. In many cases, merchants find it uneconomical and inefficient to develop these complex solutions in-house. LiquidAuction is a completely outsourced solution that allows merchants to get up and running quickly with limited up-front investment in hardware, software or network infrastructure. - Superior Economics Through data center scale economies and browser-based application architecture, the solution reduces the total cost of ownership and lowers up-front expenditures for clients. Additionally, the Company reduces up-front capital costs by supplying the necessary services and infrastructure required to run enterprise-class applications that are quickly and easily deployable. 2 - Simplified IT Management The Company's applications reduce the need to build and maintain complex technological competencies. This allows merchants to get their site up and running quickly, using advanced technology. The Company buys and configures the hardware, manages the application and server architecture, maintains and upgrades the software and provides customer support for back-end operations. The Company manages the day-to-day infrastructure responsibilities, allowing merchants to focus on their core business objectives. - Vsource-- - One Stop LiquidAuction is 100% web-based, allowing merchants to set up their own auction utilizing their own brand identity. Using LiquidAuction, online merchants can run auctions at reduced cost and with professional levels of service. Business-to-Business - Digital Marketplace Technology The Company is currently developing solutions for creating digital marketplaces. Among the solutions is LiquidMarketplace(TM), a suite of integrated digital marketplace or transaction solutions, including auctions and fixed-price catalogs. These solutions are identified as LiquidAuction(TM) and LiquidCatalog(TM). This suite allows public exchange clients to handle both seller and buyer-initiated transactions in the eMarketplaces. Unlike single-sided solutions, these are specifically designed to enable multi-buyer/multi-seller interaction and collaboration. They provide a common trading hub, where buyers and sellers can come together to conduct auctions, reverse auctions, and fixed-price transactions, without compromising individual processes and relationships among the participants. Although the specific business model and associated benefits differ across marketplace models, a general set of core benefits can be recognized. The Company's private exchange solution, LiquidStore(TM), offers private catalog and auction functionality to LiquidMarketplace(TM) participants or stand-alone clients. Following are some of the key benefits for each of the digital marketplace participants: - Advanced technology and expertise - Lower costs or risks - New marketing and distribution channels to customers - Better customer service through online interaction - No on-going software upgrades and maintenance costs - Outsourced expertise - New Digital Marketplace Models The Company is developing a set of core competencies, particularly in the areas of exchanges. The technologies include seller-oriented tools such as auctions and fixed price catalogs as well as buyer enablement tools. The Company provides technology to companies that possess expertise in a particular industry or for companies seeking to exploit critical inefficiencies in distribution or sales. These companies use the marketplace as a strategy to bring buyers and sellers together. Depending on the industry or market, companies can automate existing distribution channels or divert business from those channels by creating new exchanges. Vertical marketplaces support industry-specific supply chains by providing new distribution channels for raw materials, secondary inventory, and supplies. Transactions are streamlined, information flows freely, inventory and sales costs are reduced, and the marketplace host generates revenue. Major distributors, resellers or new market makers typically host these vertical marketplaces. 3 INDUSTRY BACKGROUND GROWTH OF THE INTERNET AND E-COMMERCE The Internet has emerged as the fastest growing communication medium in history. The Internet is dramatically changing how businesses and individuals communicate, share information and conduct business, such as business-to-consumer and person-to-person electronic commerce. Recently, the widespread adoption of intranets and the acceptance of the Internet as a business communications medium have created a foundation for business-to-business electronic commerce that will enable organizations to streamline complex processes, lower costs and improve productivity. INEFFICIENCIES IN TRADITIONAL BUSINESS PROCUREMENT Historically, most organizations have sold and purchased goods and services through paper-based or semi-automated processes. These processes are costly, time consuming, complex and often include the re-keying of information, lengthy approval cycles and significant attention of financial and administrative personnel. Furthermore, corporate purchasing has historically been highly fragmented and decentralized, thus making it difficult for businesses to manage employee purchases, control spending and prevent duplicative or unauthorized ordering. The cost of each corporate purchasing transaction often exceeds the cost of the items being purchased. Facing increasing competitive pressures to lower costs and improve productivity, businesses are seeking to replace these traditional paper-based transactions with centralized eProcurement solutions that provide cost-effective and efficient networks for the purchase of goods and services. TRADITIONAL ELECTRONIC PROCUREMENT SOLUTIONS The Internet is changing the world. It is launching a technological revolution that is resulting in explosive rates of growth. It is changing how individuals and businesses gather information. It is changing how consumers shop and merchants communicate with their customers and vendors. It is making a reality of the theoretical economic model of perfect competition in which buyers and sellers have perfect information about each other and the markets. Although initially acknowledged for its efficiency and cost savings opportunities, the Internet has created the need for new dynamic pricing models that are confounding established corporations. The Internet enables market information to be disseminated more quickly, in greater quantity, and to a wider audience than has been possible with traditional forms of media. In addition, the interactive nature of the Internet and its ability to transmit information on a real-time basis has caused users to become more comfortable with continuous market refinement of pricing. Currently a number of companies provide traditional eProcurement solutions that attempt to reduce the inefficiencies of corporate purchasing through the implementation of information technology. However, while these solutions do facilitate eProcurement transactions, the Company believes that each of these solutions has limitations that will prevent widespread adoption of the platforms by business consumers and suppliers. - Businesses have historically looked to electronic data interchange ("EDI") systems to address procurement cycle inefficiencies. EDI has gained wide acceptance in automating the sale and procurement of goods, principally in environments characterized by high dollar-volume transactions with a limited number of suppliers. EDI systems involve a uniform set of formats for commercial documents used in procurement that are exchanged across private networks without human intervention. Because the EDI model relies on the uniformity of documentation, and therefore transactions, it is not well suited to address the requirements of a dynamic procurement environment involving a large community of buyers and sellers of a wide variety of goods and services. Furthermore, the EDI model does not provide real-time interaction between the buyer and seller, thus leaving the buyer with supplier information that may not be up to date. Lastly, the EDI model involves a high-cost of installation and maintenance in addition to significant transaction fees making it an unsuitable solution for most businesses. 4 - Many vendors have developed purchasing software systems to coordinate the purchasing of goods and services across large enterprises. However, these systems tend to be cost-prohibitive due to up-front licensing fees that can exceed $1 million and maintenance fees. Furthermore, these systems tend to be very complex, thus requiring a lengthy and expensive implementation process. Neither of these current solutions provides the full spectrum of online functions, such as placing simultaneous bid requests with multiple suppliers, that is needed to create an open electronic marketplace for the procurement of goods and services. Furthermore, both solutions are too costly for all but the largest businesses. The Internet, on the other hand, provides the cost-effective medium through which an open and interoperable trading community can be established and grown. With the widespread adoption of the Internet as a business communication platform, a significant market opportunity exists for an Internet-based business-to-business electronic commerce solution. EMERGENCE OF DYNAMIC PRICING Certain characteristics of traditional commerce, such as multi-tiered distribution, costly product delivery requirements, and limited ability to collect and process real-time pricing information, have led to fixed-pricing as the dominant transactional format. The Internet has streamlined the process of production and distribution of goods and has made large amounts of information accessible in real time. These factors have reduced the need to adhere to fixed-pricing of goods and services. AUCTIONS Auctions are among the oldest forms of dynamic pricing. Prior to the Internet, auctions faced critical shortcomings, including location and time constraints, which limited the degree to which buyers and sellers could interact. When information is more difficult to obtain, pricing is a less efficient process. Even in cases where intermediaries, such as auction houses, become involved to mitigate some of these problems, their fees often reduce the practicality and attractiveness of an auction marketplace. The Internet alleviates many of these problems. It has no geographic or time boundaries and allows large quantities of information to be transmitted instantaneously. Accordingly, online auctions can offer more products to more people over a wider geographic area, providing a better pricing mechanism for both buyers and sellers. The online auction fuels even the savviest consumer with a competitive spirit. Unlike other forms of electronic commerce, such as online catalog sales, auctions create immediacy, urgency, and a willingness to win. The current online auction environment has, up to this point, catered to the end user. The potential market size for businesses with their own product and brand identity is basically unlimited, according to Forrester Research. BENEFITS OF ONLINE AUCTIONS The benefits of online auctions are many. A few are summarized below: - Sellers benefit by liquidating surplus or testing new delivery systems and price points for first run products. The features of the LiquidAuction solution allow companies to sell excess or obsolete inventories when they want to. This creates an immediate impact on profitability. - Online auctions present the opportunity to refine business models since they are able to aggregate geographically dispersed buyers interested in particular products and let targeted demand set the value of these products. - Buyers gain access to a wider range of goods at highly competitive prices - with lower information and transaction costs. - The efficiency of a real-time inventory auction can increase the velocity of goods, allowing products to move through sales channels faster, thereby reducing inventory carrying costs, write-downs, and write-offs. The market for this type of auction is enormous. The excess inventory and idle assets market represents a $362 billion market and will grow to $380 billion by 2002. Over $50 billion of excess inventories are traded annually in the US alone, according to US Department of Commerce and World Bank. - Auctions represent a new source of revenue. - Internet auctions move goods quickly and at a lower cost than direct sales, catalogs or off-line auctions. Self-service, web-based, online facilities reduce much of the labor costs associated with other sales processes. - Auctions can be used as a stand-alone promotional tool to drive traffic and solicit demographic information from consumers. 5 BRANDED STOREFRONTS VS. PORTALS A key feature of the LiquidStore(TM) is that the tools allow vendors to create branded storefronts. Corporate sites can provide a better customer experience and can be perceived to be more legitimate. Additionally, corporate sites can be perceived to be better structured and ordered, allowing buyers to find products more easily. The Company anticipates that a growing number of online merchants will seek auction solutions that enable them to create and maintain their own brand images, control their customers' experience and collect bidder activity data. Merchants are also likely to be attracted to solutions that are simple to implement, become quickly operational and facilitate targeted interaction with visitors to their sites. DIGITAL MARKETPLACES One of the primary engines driving the acceleration of Internet growth in the future will be the concept of the digital marketplace. Bringing together a widely diverse group of buyers and sellers, digital marketplaces will erase geographic boundaries, bypass today's conventional distribution channels, and realign buyer-seller relationships, many of which have been in place for decades. Corporate America is rapidly recognizing the opportunities inherent in this shift. Throughout the 1990's, companies have primarily focused on re-engineering internal business processes, using client/server computing technologies and integrated ERP systems to streamline back-office operations. Today's challenge is to understand the competitive changes that will occur within the Internet economy, to anticipate the various new business models that will be developed, and to adopt the right technology to support the rapidly changing landscape. Perhaps most importantly, businesses must understand how buyers and sellers will come together in new ways via digital marketplaces and exchanges. Examples of possible Digital Marketplaces: - A large distributor who seeks to automate processes among several buyers, suppliers or manufacturers. - A franchise or trade association that wants to aggregate its members' orders from approved suppliers by providing online procurement services. - A new market maker that is trying to replace existing distribution channels by offering online information and services to a specific industry. - A third-party service provider who wants to create a common marketplace by providing hosted procurement services to a specific set of suppliers and their customers. The formation of new digital marketplaces and exchanges will change the way we think about business-to-business commerce and will play a major role in the growth of the Internet economy. Equally important, the creation of digital marketplaces enables innovative new methods of dynamic exchange. Digital marketplaces create entirely new methods of commerce, such as online sourcing, auctions, and negotiations. They also enable trading communities to share common information and knowledge more easily. According to AMR Research, there are 600 to 800 public online marketplaces in existence today. These marketplaces offer big advantages over extranets. Companies are able to connect to many buyers without having to create point-to-point connections to each, allowing them to reach new customers and leverage information from competitors to increase sales. 6 STRATEGIC RELATIONSHIPS The Company and International Business Machines Corporation ("IBM") entered into an Alliance Agreement in September 2000 wherein Vsource agreed to recommend IBM as a preferred Information Technology and Systems Integration provided to certain of its clients, and IBM agreed to assist Vsource in closing new business, and both parties agreed to establish a marketing agreement to focus on a combined offering of the products and services of both companies. The marketing agreement has not yet been implemented. The Company was also a paying client of IBM for services related to implementation of VSN client contracts until the Company withdrew its VSN product in March 2001. The Company's subsidiary, OTT, has a PartnerWorld partnership agreement with IBM. The Company, during the year ended January 31, 2001, through its since discontinued VSN product, has also been a party to alliance agreements or informal understandings with NeTune Corporation, Internet Commerce Corp ("ICC"), U.S. West, Inc, Vitria Technology, Inc., ZoomOn, Inc., Corporate Express, Inc., and PriceWaterhouseCoopers. The U.S. West, Inc. agreement was terminated by its successor, Qwest, Inc., in November 2000. The Vitria Technology, Inc. agreement was terminated by the Company in 2000 and is contested in litigation described under Item 3. LEGAL PROCEEDINGS. All other agreements are dormant or have expired. SALES AND MARKETING The Company sells its services through two primary channels. First, a direct sales force, consisting of three sales professionals, two based in Southern California and one in the Silicon Valley area of Northern California. These sales professionals focus on selling LiquidMarketplace(TM) to mid-sized enterprise organizations, typically companies with annual sales of $50 million to $1 billion per year. The Company has also developed an indirect channel through its alliance relationship to leverage and accelerate market adoption of LiquidMarketplace(TM). REVENUE MODEL Revenue is derived from LiquidMarketplace(TM) products through a client contract that provides for an initial "set-up" fee and an ongoing license fee. The "set-up" fee is based on specific client requirements, generally in the $100,000 to $200,000 range. The license fee and accompanying service level agreement is based on a fixed monthly charge, with additional charges for a pilot implementation and for client-specific modifications to the LiquidMarketplace(TM) products. These are anticipated to be billed, as required, on a time and materials basis. CUSTOMER SERVICE, TRAINING AND SUPPORT The Company uses IBM as its preferred provider of consulting and systems integration services for its clients for most ERP and legacy systems integration. The Company has also contracted IBM Global Services to provide full training services for up front system planning, user training, ongoing training design and help desk services. RESEARCH AND DEVELOPMENT In fiscal year 2001, the company spent $11,654,679 on research and development, including $5,432,372 of stock based compensation. In fiscal year 2000, the Company spent $3,458,933. (These amounts do not include research and development spending of Online Transaction Technologies, Inc., acquired on January 22, 2001.) The significant increase is due to the increasing development requirements of the VSN product, which was withdrawn subsequent to year end. The Company is presently performing applied research and development, based on LiquidMarketplace(TM) and other OTT products. COMPETITION The market for Company software products is very competitive and likely to become more so, and is subject to rapid technological change. (See "RISK FACTORS - COMPETITIVE "BUSINESS-TO-BUSINESS" INTERNET COMMERCE MARKET; EFFECT ON MARKET SHARE AND BUSINESS)." Although management believes that LiquidMarketplace(TM) compares favorably with respect to most competitive offerings (several having greater financial capability than the Company), and favorably with respect to overall cost, the Company's products do not yet have a large referral base, nor large numbers of buyers or vendors using the network. As a result, it is yet to be seen whether LiquidMarketplace(TM) or other Company products can compete successfully. 7 In 1999 management identified Ariba (Nasdaq: ARBA) and Commerce One (Nasdaq: CMRC) as the principal competitors to the VSN product, both of which had significantly larger capital resources and were further into their development than the Company. VSN was marketed by trade journal advertisements and trade shows and sold primarily by Company executives and sales representatives. In the fall of 2000 the Company's marketing strategy was revised to target mid-sized businesses (large public and private businesses smaller than Fortune 500 companies) with its competitor list expanded to include specialists such as PurchasePro (Nasdaq:PPRO) and a broad list of major software suppliers. GOVERNMENT APPROVALS While there are no governmental approvals required specifically related to the licensing or use of Company software, and no direct governmental regulation, that could change. In those circumstances, competitors with larger administrative staffs and more financial resources will be in a better position to comply with this regulation and obtain any necessary approvals. However, management is not aware of any pending or anticipated government regulations that will negatively impact the Company in a material way. DEPENDENCE UPON SUPPLIERS The Company is not dependent on suppliers of raw materials, although it is dependent on the Internet, including the ability to communicate with its remote servers. The Company's clients are also dependent on the Internet for this communication, without which clients would be unable to use any of the Internet- based services provided by the Company. Should the Company and its clients not be able to access the Internet for an extended period of time, it could have an adverse material effect on the Company's operations. TRADEMARKS The Company holds trademarks LiquidMarketplace(TM), LiquidAuction(TM), VIRTUAL SOURCE(TM) and VSOURCE(TM). It also has applied for the service mark "DELIVERING ON THE PROMISE OF THE INTERNET". Neither Vsource nor OTT have patents or patent applications pending. Company technology is protected by the security of the Company-maintained Web site in which Company software code resides, by confidentiality agreements it has with its development personnel, and by the separation of development responsibilities and access authorities. EMPLOYEES As of May 11, 2001, the Company employed 14 full-time employees and 2 part-time contract employees, consisting of 3 executives, 4 accounting and administrative, 4 marketing and sales, and 6 research, development, operations and customer relationship management personnel. The Company believes that its future success will depend in part on its ability to attract, hire and maintain qualified personnel. There can be no assurance that the Company will be able to do so. Competition for such personnel in the online industry is intense. None of the Company's employees are represented by a labor union, and the Company has never experienced a work stoppage. The Company believes its relationship with its employees to be good. The following table sets forth the names, ages, and positions of the officers and directors of the Company as of May 11, 2001. 8
NAME AGE POSITION Sandford T. Waddell 60 Chief Financial Officer, Treasurer, and Secretary Michael Shirman 38 Chief Technology Officer Colin Kruger 39 Vice President, Business Development I. Steven Edelson 41 Acting Chairman of the Board Scott T. Behan 39 Director, Member of the Audit Committee Ramin Kamfar 37 Director, Member of the Audit Committee Robert N. Schwartz 61 Director, Member of the Audit Committee Nathaniel Kramer 39 Director
SANDFORD T. WADDELL. Mr. Waddell has served as the Company's Chief Financial Officer and Secretary since March 2000. From October 1999 to March 2000, Mr. Waddell served as the Chief Financial Officer for Snyder Diamond, Inc., a privately owned retail company. From March 1998 to October 1999, Mr. Waddell served as Chief Financial Officer for Rampage Clothing Company, a privately held clothing manufacturer which was in bankruptcy, and for which he helped to restore to profitability and effected a successful reorganization. From October 1966 to March 1988, Mr. Waddell served initially as Chief Financial Officer and later also as Interim Chief Executive Officer at Reddi Brake Supply Corporation, a wholesale auto parts distributor, where he directed a reorganization of the company's operating subsidiary. From February 1992 to October 1996, Mr. Waddell served as Interim Chief Financial Officer or Financial Consultant for approximately twelve privately held companies. Mr. Waddell holds a B.S. in Engineering from Michigan Technological University and an M.B.A. from University of Minnesota. MICHAEL SHIRMAN. Mr. Shirman joined the Company in January 2001 as a result of the merger with Online Transaction Technologies, Inc. ("OTT"). As a co-founder of OTT, he has over 15 years of experience in the Information Technology industry. Prior to the formation of OTT in 1999, Mr. Shirman was CEO and co-founder of CODA Software, a developer of custom e-Commerce software, served as President of InterSoft Consulting, a firm specializing in vertical business applications, and held senior development and managerial positions in the banking, manufacturing, publishing, finance, distribution, and telecommunications industries. Mr. Shirman holds a Masters Degree in Electrical Engineering (Telecommunications) from the Institute of Telecommunication Technology in Leningrad (St. Petersburg) and a Masters Degree in Computer Science from the Leningrad (St. Petersburg) Polytechnic Institute. COLIN KRUGER. Mr. Kruger joined the Company in January 2001 as a result of the merger with Online Transaction Technologies, Inc. ("OTT"). As a co-founder of OTT, he was responsible for business development, strategic relationships, and finance. Prior to OTT, Mr. Kruger was President of ZAUCTION, America Online's first auction and a top 100 web site he founded in 1995. Previously, Mr. Kruger was Vice President for the Glasser Group, Inc. and served as general manager for Recycled Computer Outlets, Inc., a Glasser Group subsidiary he founded. Earlier, Mr. Kruger held management roles with Equitable Real Estate Investment Management, Inc. Mr. Kruger holds a GSE in Economics from Christs College, London, and a BS in Business Administration from San Diego State University. I. STEVEN EDELSON. Mr. Edelson has served on the Company's board since January 2001 and was elected Acting Chairman in March 2001. Mr. Edelson has been Managing Director of Mercantile Companies, Inc., Northbrook, Illinois, since 1986. He is also a principal of Mercantile Capital Group, LLC, and he is the Managing Partner of Mercantile Capital Partners I, LP. SCOTT T. BEHAN. Mr. Behan has served on the Company's board since January 1998. For the past five years, Mr. Behan has been employed as the Executive Vice President of AML Communications, Inc., a manufacturer of wireless amplifiers. He has been a director of AML since February 1999. Mr. Behan has a B.S. in Electrical Engineering from Worcester Polytechnic Institute. RAMIN KAMFAR. Mr. Kamfar has served on the Company's board since April 2000. Mr. Kamfar is a Managing Partner at New World Venture Partners, Inc., an investment banking boutique focusing on technology and new economy companies. Since 1993, Mr. Kamfar has also served in various capacities at New World Coffee - Manhattan Bagel, Inc., a company he founded. Most recently he has served as Chairman and Chief Executive Officer. From 1988 to 1993 Mr. Kamfar worked in the investment banking department of Lehman Brothers, Inc., most recently as a Vice President in private placements. Mr. Kamfar has a B.S. in Finance from the University of Maryland and an M.B.A. in Finance from The Wharton School at the University of Pennsylvania. 9 ROBERT N. SCHWARTZ. Mr. Schwartz has served on the Company's board since January 1998. From 1981 to the present, Mr. Schwartz has been a Senior Research Scientist at HRL Laboratories, LLC, Malibu, California. From 1979 to the present, Mr. Schwartz has been a visiting professor at U.C.L.A. He has a B.A. in Mathematics, Chemistry and Physics, and an M.S. in Chemical Physics from the University of Connecticut, and a PhD. in Chemical Physics from the University of Colorado. NATHANIEL C. A. KRAMER. Mr. Kramer has served on the Company's Board since January 2001. Mr. Kramer is a principal of Mercantile Capital Group, LLC and is Managing Director of its New York office. From 1999 to 2000 he was a vice president with Allen & Company, Inc., a private equity firm. From 1994 to 1999 he was president and CEO of Greenhouse Film Group Limited and is currently Chairman. Mr. Kramer produced the Emmy nominated documentary "Choices" and the Tony Award winning 1998 revival of Arthur Miller's "A View From the Bridge. FACTORS THAT MAY AFFECT FUTURE PERFORMANCE RISK RELATED TO THE COMPANY'S BUSINESS Need For Additional Capital ------------------------------ The Company has recorded substantial operating losses and, as of January 31, 2001, has an accumulated deficit of approximately $50.9 million. The Company received funding of approximately $10.7 million in August and September 2000 related to the issuance of preferred shares. Although the Company believes that these funds will provide operating capital for one year or more, the Company anticipates that it will require additional funding before it can finance its operations and growth wholly on internally generated funds. Uncertainty of Realizing New Strategic Relationships --------------------------------------------------------- As an alternative to total dependence of the LiquidMarketplace(TM) product line and potential new internally developed products, the Company has announced a search for strategic relationships that could result in one or more new product lines, including businesses that are already producing significant revenues and have attained or are approaching a cash flow breakeven point. However, the Company's prior performance and current financial market conditions present obstacles for the development of such relationships. There is no certainty that such a relationship or relationships can be realized within the foreseeable future. Anti-Takeover Provisions ------------------------- In connection with the Company's reincorporation in Delaware, the Company increased the number of shares of common stock authorized for issuance to 100,000,000. The issuance of additional shares of common stock could have the effect of delaying, deferring or preventing a change in control of the Company, even if such change in control would be beneficial to the Company's stockholders. The terms of certain provisions of the Company's Certificate of Incorporation and Bylaws may have the effect of discouraging a change in control of the Company. Such provisions include the requirement that all stockholder action must be effected at a duly called annual meeting or special meeting of the stockholders and the requirement that stockholders follow an advance notification procedure for stockholder business to be considered at any meeting of stockholders. Limited Operating History --------------------------- The Company has had a limited operating history that makes an evaluation of the Company's future prospects very difficult. There can be no assurances that the Company's products will meet the needs of potential customers or that the products will operate correctly. 10 Risks of Early Stage Company; New, Rapidly Changing Market; Need to Attract -------------------------------------------------------------------------------- Large Corporations ------------------- The market for Internet applications and services is at an early stage and changing rapidly. Internet procurement is a relatively new market. Its rate of growth and change is unpredictable, as is the nature of this change. The Company will encounter the risks and difficulties often encountered by early stage companies in new and rapidly evolving markets. The Company's initial success may depend, in part, upon attracting several large, technologically advanced corporations to use the Company's products, and their favorable results from this usage. Subsequent success will depend on the Company's ability to communicate these early successes to the marketplace, thus attracting significant numbers of other businesses and buying organizations. No assurance can be given that the Company will be successful in the marketplace, or if successful, that it will attract significant numbers of clients. There can be no assurance that an adequate demand for, and usage of, the Company's products will develop. Complex Implementation and Integration of the Company's Products May Impede -------------------------------------------------------------------------------- Market Penetration ------------------- The installation of the Company's products, including integration with a client's systems currently in use, can be a complex, time consuming and expensive process. The Company anticipates that some of its initial customers will be mid-sized or larger organizations that will require that the Company's products undergo substantial customization to meet their needs. These firms will also likely require that the Company's products be integrated with existing internal Enterprise Resource Planning ("ERP") and other operational systems. The Company's management estimates that the installation and integration process may take anywhere from one month to six weeks or longer in some cases, depending on the size of the client, the complexity of its operations, the configurations of its current computer systems, and other systems projects that compete for the time and attention of the Information Technology departments of the clients. Management also expects that most integration projects in larger companies will involve various integrators as outside systems consultants to the client. The Company's ability to continually enhance the features of the Company's products, in response to clients' widely differing needs, is yet to be proven. The Company's ability to develop a simplified version for smaller businesses that is inexpensive to implement is also unproven. As a result, the Company's products may not achieve significant market penetration in the near future, or ever. Large Operating Losses Expected to Continue ------------------------------------------------ As discussed above, the Company has accumulated substantial net losses through January 31, 2001. Since inception, the Company has not had material revenues, and has recognized only a small amount of revenue from the Internet version of its prior product, Virtual Source Network ("VSN") and very limited revenue from the LiquidMarketplace(TM) product acquired in January 2001. Although the Company has significantly reduced ongoing expenses, there is no assurance that the Company will achieve positive cash flow and operating profitability within the limits of its available capital. Failure to Maintain Listing on Major Stock Market -------------------------------------------------------- Although the Company's common stock began trading on the Nasdaq National Market System on October 30, 2000, there is no assurance that the Company will continue to be listed on the Nasdaq National Market System. The Company's common stock is currently trading below $1.00 per share. The Company received a notice of noncompliance with the Nasdaq listing maintenance standards on April 24, 2001. If the stock continues to trade below $1.00 per share consistently or if the Company is unable to comply with any of the other Nasdaq listing maintenance standards, the Company may be the subject of delisting. In addition, the Company received a second notice of noncompliance on May 3, 2001 asserting that the Company's common stock has failed to maintain a minimum market value of public float ("MVPF") of $5,000,000 over the last 30 trading days preceding the notice. In both instances the Company has a 90-day period to cure the non-compliance, but it is uncertain if the Company will be able to cure both within the allotted periods. While the listing of the Company's stock does not have a direct effect on the Company's operations, it has an effect on the perception of the Company among potential investors and can have an effect on the ability of the Company to raise additional funds. It can also impact the dilution associated with any financing. 11 Dependence on Limited Product Line for Anticipated Revenues ------------------------------------------------------------------ The Company expects that when revenues do develop, substantially all of those revenues will come from clients that buy or license its products. Although fees are believed by management of the Company to be below those currently charged for leading competitive systems and services, future reductions in competitive prices could negatively impact the demand for, or usage of, the Company's products. These changes may impede the products' ability to achieve broad market acceptance, thus negatively impacting the Company's opportunity to eventually become profitable. There can be no assurance that broad and timely acceptance of the Company's products, which is critical to the Company's future success, will be achieved. Failure to achieve anticipated revenues would have adverse consequences for the Company. Dependence on One Product ---------------------------- At the present time all of the Company's resources are being devoted to the development and marketing of the LiquidMarketplace(TM) product line and to finding a strategic partner. Unless it finds a partner, the Company expects to depend on LiquidMarketplace(TM) for substantially all of the Company's revenues for the foreseeable future. Accordingly, if LiquidMarketplace(TM) is not accepted by customers or potential customers, or does not generate the demand or revenues necessary to the Company, the Company may face significant adverse financial consequences. Dependence on Sales and Marketing Relationships for Growth ----------------------------------------------------------------- The Company's business model includes generating sales through its alliance and affiliate programs. Consequently, the Company will depend, in part, on sales and marketing strategic relationships for growth. The Company has established and plans to continue to establish sales and marketing strategic relationships with large organizations as part of our growth strategy. Such relationships may not contribute to increased use of the Company's services, help the Company add new clients, or increase the Company's revenue. The Company may not be able to enter into new relationships or renew existing relationships on favorable terms, if at all. In addition, the Company may not be able to recover the costs and the expenses associated with these programs. Third Party Implementation/Integration of Products; Negative Impact upon Revenue -------------------------------------------------------------------------------- Goals If Third Parties Unavailable or Do Not Perform ------------------------------------------------------------ The Company expects to rely, to a large degree, on a number of third parties to propose and explain its products to prospective clients and to integrate its products with clients' existing systems, and to train users when its products are rolled out for general usage. The Company itself is planning to work with clients and third parties to implement the pilot projects. If the Company is unable to establish and maintain effective, long-term relationships with these third parties, if these third parties are unable to meet the needs and expectations of clients, the Company will likely have difficulty achieving its revenue goals. Unsuccessful Acquisitions Could Harm Our Operating Results, Business and Growth -------------------------------------------------------------------------------- The Company may acquire businesses, products and technologies that complement or augment the Company's existing businesses, services and technologies. The inability to integrate any newly acquired entities or technologies effectively could harm the Company's operating results, business and growth. Integrating any newly acquired businesses or technologies may be expensive and time consuming. To finance any acquisitions, the Company may need to raise additional funds through public or private financings. Any equity or debt 12 financings, if available at all, may be on terms that are not favorable to the Company and, in the case of equity financings, may result in dilution to the Company's stockholders. The Company may not be able to operate any acquired businesses profitably or otherwise implement the Company's business strategy successfully. Long Sales Cycle for Large Corporate Accounts Could Cause Delays in Revenue -------------------------------------------------------------------------------- Growth ------ The Company's sales cycles for large corporate accounts may take many months to complete and may vary from contract to contract. Further, the Company expects that a large number of the Company's clients may be introduced to its products through such large accounts. Lengthy sales cycles for large corporate accounts could cause delays in revenue growth, and result in significant fluctuations in the Company's quarterly operating results. The length of the sales cycle may vary depending on a number of factors over which the Company may have little or no control, including the internal decision making process of the potential customer and the level of competition that the Company encounters in its selling activities. Additionally, since the market for business-to-business e-commerce is relatively new, the Company believes that it will have to educate many potential customers about the use and benefits of the Company's products and services, which can in turn prolong the sales process. Sales made through third parties, such as the Company's alliance partners, can further extend sales cycles. Quarterly Results May Be Subject to Significant Fluctuations; Expectations of -------------------------------------------------------------------------------- Investors and Analysts May Not Be Met ------------------------------------------- The Company expects that its quarterly operating results will fluctuate significantly due to many factors, many of which are outside the control of the Company. Such factors include: - Demand for and market acceptance of its products - Deletions from, additions to or changes to its product line - Inconsistent growth, if any, of the Company's client base - Loss of key customers or strategic partners - Timing of the recognition of revenue for large contracts - Variations in the dollar volume of transactions effected through its products - Intense and increased competition - Introductions of new services or enhancements, or changes in pricing policies, by the Company and its competitors - The Company's ability to control costs - Reliable continuity of the Company's products' availability The Company believes that quarterly revenues, expenses and operating results are likely to vary significantly in the future, that period-to-period comparisons of results of operations are not necessarily meaningful and that, as a result, such comparisons should not be relied upon as indications of future performance. Due to these and other factors, it is likely that the Company's operating results will be below market analysts' expectations in some future quarters, which would cause the market price of the Company's stock to decline. Competitive "Business-to-Business" Internet Commerce Market; Effect on Market -------------------------------------------------------------------------------- Share and Business -------------------- The market for the Company's products is very competitive, evolving and subject to rapid technological change. Intensity of competition is likely to increase in the future. Increased competition from new competitors is likely to result in loss of any future market share the Company may achieve, which could negatively impact the Company's business. Competitors vary in size, and in the scope and breadth of the products and services offered. The Company will encounter competition from Ariba, Clarus, Commerce One, GE Information Services, i2 Technologies, Intelisys, PurchasePro, TRADE'ex Electronic Commerce Systems and other eProcurement competitors. The Company may also encounter competition from several major enterprise software developers, such as Oracle, PeopleSoft and SAP who are not presently considered to be direct competitors, but who have announced intentions to enter into the market. In addition, because there are relatively low barriers to entry in this market, additional competition from other established and emerging companies may develop. 13 Many current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources than the Company, significantly greater name recognition, and a larger installed base of customers. In addition, many of the competitors have well-established relationships with the Company's clients and potential clients, and have extensive knowledge of the industry. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address customer needs. Accordingly, it is possible that new competitors, or alliances among competitors, may emerge and rapidly acquire significant market share. Actions taken by the Company competitors, including price cuts, new product introductions and enhancements, could have material adverse consequences for the Company. There can be no assurance that the Company will be able to compete with price cuts, or develop, introduce and market enhancements to its service on a timely basis to compete successfully in this market. Revenues Expected from a Limited Number of Clients, Meaning Increased Potential -------------------------------------------------------------------------------- Impact of Customer Loss -------------------------- The Company expects that revenues, if any, during the current fiscal year will come from a small number of clients, perhaps as few as 20 or less. The loss of customers or a change in a client's budget could have a substantial negative impact on the business of the Company. Vendors Are Essential to Success of the Company's Products; Negative Impact of -------------------------------------------------------------------------------- Vendors' Failure to Join the Network ----------------------------------------- In certain applications, LiquidMarketplace(TM) requires that vendors (suppliers) be able to access the LiquidMarketplace(TM) network and that client buyers be able to communicate their requirements electronically to vendors. It is necessary that a client's key vendors join the network in order to achieve the full benefits of the system, such as buying from an electronic catalog. Ability to Enhance Features and Functionality of Products; Change in the Market -------------------------------------------------------------------------------- The success of the Company may depend on the need to tailor its products to meet the requirements of its clients, not only as such requirements are presently known and understood by the Company and its client base, but also as such requirements evolve. Such requirements may be driven by competitive products or the changing preferences of the Company's client base. An inability to offer enhanced products or features that anticipate or meet such requirements in a timely and efficient manner may result in a loss of sales and revenues and the obsolescence of the Company's products. There can be no assurance that the Company can make the changes and enhancements to its products necessary to meet and satisfy the demands of its clients. In addition, the rapid technological changes and rapidly changing industry standards that have characterized the Internet and companies doing business on the Internet may have the effect of rendering the Company, its business model and products obsolete. Making the adjustments, changes and adaptations necessary in this market may also require significant expenditures in equipment, infrastructure and product development. There can be no assurance that the Company will be able to adapt to such rapid changes. Failure to Maintain Accurate Databases ------------------------------------------ The Company must update and maintain extensive databases of the products, services and procurement network transactions for its clients. The Company's computer systems and databases must allow for expansion as a client's business grows without losing performance. Database capacity constraints may result in data maintenance and accuracy problems, which could cause a disruption in service and the Company's ability to provide accurate information to its clients. These problems may result in a loss of clients that could severely harm the Company's business. 14 Defects in Software; New Versions ------------------------------------- The Company's products are complex software. Software often contains defects, particularly when first introduced or when new versions are released. The Company's testing procedures may not discover software defects that affect new or current services or enhancements until after they are deployed. New versions of the products may not have the features or capability originally believed to exist by the Company or could reveal the lack of such features or capability in earlier versions of the products. Such defects could cause service interruptions, which could damage the Company's reputation or increase its service costs, cause it to lose revenue, delay market acceptance or divert development resources, any of which could severely harm the Company's business. System Failures, Service Delays and Interruptions ------------------------------------------------------ The Company's ability to provide acceptable levels of customer service largely depends on the efficient and uninterrupted operation of the Company's computer and communications hardware and procurement network systems. Any interruptions could severely harm the Company's business and result in a loss of customers. The Company's computer and communications systems are located in California. The Company does not maintain a redundant site, although is currently planning to do so. The Company's systems and operations are vulnerable to damage or interruption from a variety of sources including human error, sabotage, fire, flood, earthquake, power loss, telecommunications failure and similar events. The Company cannot give assurances that it will not experience system failures in the future. The occurrence of any system failure or similar event could harm the Company's business dramatically. Incomplete Disaster Recovery Plan ------------------------------------ The Company has developed a disaster recovery plan that is still in the implementation process. A second phase of the plan will include a dedicated backup facility in another state. Until the plan is completed, there are risks of localized Internet failure. The Company is also in the process of implementing redundancy and other improvements in its internal network operations. Until these improvements are completed, there will be greater risks of periodic network disruptions. Substantial Costs of Any Product Liability Claims; No Product Liability -------------------------------------------------------------------------------- Insurance --------- Errors, defects or other performance problems with the Company's products could result in financial or other damages to our clients. Management believes that contractual limits of liability, indemnification provisions and disclaimers of warranties should minimize the exposure of the Company in the event of a product liability claim. A product liability claim, however, even if not successful, would likely be time consuming and costly and could seriously harm the Company. The Company presently does not maintain product liability insurance. Although the terms and conditions in the Company's user agreements contain disclaimers of warranties designed to limit exposure to these claims, existing or future laws, or unfavorable judicial decisions, could weaken or negate these provisions and have materially adverse consequences for the Company. Legal Liability for Communication on Procurement Network -------------------------------------------------------------- The Company may be subject to legal claims relating to the content in its procurement network, or the downloading and distribution of such content. Claims could involve matters such as fraud, defamation, invasion of privacy and copyright infringement. Providers of Internet products and services have been sued in the past, sometimes successfully, based on the content of material. Even if the Company were ultimately successful in its defense of these claims, any such litigation is costly and these claims could harm the Company's reputation and business. 15 Success Depends on Key Personnel; No "Key Man" Life Insurance ---------------------------------------------------------------------- Future performance depends on the continued service of key personnel, and the ability to attract, train, and retain additional technical, marketing, customer support, and management personnel. The loss of one or more key employees could negatively impact the Company, and there is no "key man" life insurance in force at this time. Competition for qualified personnel is intense, and there can be no assurance that the Company will retain key employees, or attract and retain other needed personnel. Protection of Intellectual Property; Lack of Patents; Potential Pirating -------------------------------------------------------------------------------- The Company's success depends to a large extent on its exclusive technology, and relies on a combination of contractual provisions, confidentiality procedures, trade secrets, copyrights and trademark protections. The Company has no patents at this point, and the Company's technologies may not be patentable. Despite efforts to protect its exclusive rights, unauthorized parties may attempt to copy aspects of that technology, or to obtain and use our exclusive information. Policing unauthorized use of this technology is difficult. While the Company does not suspect that any of the Company's software has been subject to piracy, there can be no assurances that such piracy will not occur. Further, competitors may independently develop similar technology or duplicate the Company's services without violating the Company's intellectual property rights. At present, the Company's technologies are owned outright by the Company. However, the Company may in the future have to license or otherwise obtain access to intellectual property of third parties in order to remain competitive in the marketplace. Strain on Limited Resources Due to Need to Manage Growth and Expansion -------------------------------------------------------------------------------- The Company may experience a period of renewed expansion and growth, which would likely place significant strain upon management, employees, systems, and resources. Because the market could develop rapidly, it is difficult to project the rate of growth, if any. Failure to properly manage growth and expansion, if and when it occurs, will jeopardize the ability of the Company to sustain its third party and customer relationships. There can be no assurance that the Company will properly be able to manage growth, especially if such growth is more rapid than anticipated. Inability to Accurately Predict Usage Rates and Difficulty in Adapting Systems -------------------------------------------------------------------------------- in a Timely Manner --------------------- Traffic in the Company's marketplace network may increase to the point where the Company must expand and upgrade some of its transaction processing systems and procurement network hardware and software. The Company's systems have limited scalability. The Company may not be able to accurately predict the rate of increase in the usage of its procurement network. This may affect the Company's timing and ability to expand and upgrade its systems and procurement network hardware and software capabilities to accommodate increased use of its network. If the Company does not upgrade its systems and procurement network hardware and software in a timely fashion, the Company may experience downgraded service, interruptions or delays that could damage its business reputation, relationship with clients and its operating results. It might also be forced to delay bringing additional customers onto the system until such upgrades are completed. Risks of International Operation ----------------------------------- The Company is exploring international markets and considering the expansion of its operations and marketing efforts to include international markets. If the Company should elect to expand into such markets, it would be confronted with risks including: - Increased impact of recessions in economies outside of the United States 16 - Difficulties staffing and managing foreign operations - Political instability - The burdens of compliance with a wide variety of foreign laws and legal regimes - Unexpected changes in regulatory requirements - Tariffs, export controls and other barriers to trade - Potentially adverse tax consequences - Fluctuations in currency exchange rates - Longer payment cycles and difficulties in collecting accounts receivables - Seasonal fluctuations in business activity RISKS RELATED TO THE INTERNET AND E-COMMERCE Year 2000 Risk ---------------- While the Year 2000 issue has generally been considered resolved, there can be no assurances that the issue will not impact the rate at which the Company's products will be implemented inside client organizations. Management believes that its internally developed systems and technology are Year 2000 compliant and has so far had no indications that its products are not Y2K compliant. Nevertheless, because the Company relies on information technology supplied by third parties, it is still possible that year 2000 problems may yet surface that could adversely affect the Company, although none have surfaced to date. Further, the Internet itself could face serious disruptions arising from Year 2000 problems, although none have surfaced to date. Many potential clients, furthermore, may have implemented policies that prohibit or strongly discourage making changes or additions to their internal computer systems until after the impact of Year 2000 has been assessed. Volatility in Stock Price ---------------------------- The stock market and especially the stock prices of Internet related companies have been very volatile. This volatility may not be related to the operating performance of the companies. The broad market volatility and industry volatility may reduce the price of the Company's stock without regard to the Company's operating performance. The market price of the company's stock could significantly decrease at any time due to this volatility. The uncertainty that results from such volatility can itself depress the market price of the company's stock. Substantial Costs of Any Securities Litigation Could Divert Limited Resources of -------------------------------------------------------------------------------- the Company ------------ In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. The Company could become a target of similar securities litigation based upon the volatility of its stock in the marketplace. Litigation of this type could result in substantial costs and divert management's attention and resources. Substantial Costs of Any Intellectual Property Infringement Claims ------------------------------------------------------------------------- There has been a substantial amount of litigation in the software industry and the Internet industry regarding intellectual property rights. It is possible that in the future, third parties may claim that the Company's technology may infringe their intellectual property. Management is not aware of any infringement or claim of infringement by a third party. It is expected, however, that software product developers and providers of electronic commerce solutions will increasingly be subject to infringement claims as the number of products and competitors grows and the functionality of products in different industry segments overlaps. Any claims, with or without merit, could be time-consuming and result in costly litigation. Dependence Upon, and Risks Related To, the Internet ---------------------------------------------------------- The use of the Company's products and other ASP-based products depends on the increased acceptance and use of the Internet as a medium of commerce and communication. While management believes that acceptance and use of the Internet will continue to increase at very rapid rates, there can be no 17 assurances that such increase will continue to develop, or that use of the Internet as a means of conducting business will continue or increase. If growth in the use of the Internet does not continue, clients may not adopt or use these new Internet technologies at the rates or for the purposes management has assumed. This could, in turn, adversely impact the Company and the results of its business operations. Further, even if acceptance and use of the Internet does increase rapidly, but the technology underlying the Internet and other necessary technology and related infrastructure does not effectively support that growth, the Company's future would be negatively impacted. Potential Breaches of the Company's Security Systems ---------------------------------------------------------- A significant barrier to electronic commerce and communications is the secure transmission of confidential information over public networks. Advances in computer capabilities, new discoveries in the field of cryptography or other events or developments could result in compromises or breaches of the Company's security systems or those of other web sites to protect the Company's exclusive information. If any well-publicized compromises of security were to occur, it could have the effect of substantially reducing the use of the web for commerce and communications. Anyone who circumvents the Company's security measures could misappropriate its exclusive information or cause interruptions in services or operations. The Internet is a public network, and data is sent over this network from many sources. In the past, computer viruses, software programs that disable or impair computers, have been distributed and have rapidly spread over the Internet. Computer viruses could theoretically be introduced into the Company's systems, or those of our clients or vendors, which could disrupt products offered by the Company, or make it inaccessible to clients or vendors. Although language in its user agreement places responsibility with users to protect the Company's products from such threats, the Company may be required to expend significant capital and other resources to protect against the threat of security breaches or to alleviate problems caused by breaches. To the extent that the Company's activities may involve the storage and transmission of exclusive information, such as credit card numbers, security breaches could expose the Company to a risk of loss or litigation and possible liability. Despite provisions in its user agreements, which provide that the Company would not be liable for security breaches, the Company's security measures may be inadequate to prevent security breaches, and the Company's business could be seriously impacted if they are not prevented. Government Regulation ---------------------- As Internet commerce continues to grow, the risk that federal, state or foreign agencies will adopt regulations covering issues such as user privacy, pricing, content and quality of products and services, increases. It is possible that legislation could expose companies involved in electronic commerce to liability, which could limit the growth of electronic commerce generally. Legislation could dampen the growth in Internet usage and decrease its acceptance as a communications and commercial medium. If enacted, these laws, rules or regulations could limit the market for the Company's services. One or more states, furthermore, may seek to impose sales tax collection obligations on out-of-state companies like the Company that engage in or facilitate electronic commerce throughout numerous states. These proposals, if adopted, could substantially impair the growth of electronic commerce and could adversely affect the Company's opportunity to derive financial benefit from these activities. HISTORY The Company was incorporated in the state of Nevada on October 22, 1980, and ultimately adopted the name Vsource, Inc. on December 16, 1999. The Company was reincorporated in the state of Delaware on November 8, 2000. In conjunction with the Delaware reincorporation, the Company's authorized common stock was increased from 50,000,000 shares to 100,000,000 shares. On June 1, 1998, the Company acquired all of the outstanding stock of Wpg.Net, Inc. for 500,000 shares of common stock plus stock options for 500,000 shares. The options vest ratably, on a monthly basis, over the 3 years subsequent to the purchase. If Wpg.Net, Inc. division revenues reach $500,000 before the 3-year vesting period has expired, the 500,000 options vest immediately. The former shareholders of Wpg.Net, Inc. (Wpg.Net, Inc. Shareholders) are entitled to a 18 commission of 50% of revenue generated by the Wpg.Net, Inc. division. However, no Wpg.Net, Inc. revenues have been recorded since it was acquired and no revenue producing activities are contemplated. Wpg.Net, Inc. shareholders are entitled to 25% of revenues produced by Virtual Source, Inc. relating to sales of the currently inactive Virtual Source Publisher. In the event that Vsource is sold, the Wpg.Net, Inc. shareholders are entitled to a one-time payment of $3,000,000, the options vest immediately, and all commission obligations cease at that time. The Company guaranteed a minimum stock price of $7.00 per share for the stock held by Wpg.Net, Inc. shareholders upon the sale of the Company. The acquisition was accounted for as a purchase and was included with the combined operations for the dates subsequent to June 1, 1998. As a result of the acquisition, goodwill was recorded in the amount of $1,186,555. During the year ended January 31, 2000, the Company determined that the present value of future cash flows related to the acquisition of Wpg.Net, Inc. was not material. Consequently, the remaining unamortized goodwill has been written off as of January 31, 2000. Wpg.Net, Inc. was merged into Vsource, Inc. effective January 4, 2001. On December 14, 2000, the Company entered into an Agreement and Plan of Merger with OTT Acquisition Corp., a California corporation, Online Transaction Technologies, Inc., a California corporation ("OTT"), Colin P. Kruger and Michael Shirman (the "Merger Agreement") and on January 22, 2001, the transaction closed in accordance with the Merger Agreement. The merger is recorded on the purchase method of accounting and was included with the combined operations for the dates subsequent to January 22, 2001.The merger was a tax-free reorganization under Section 368(a) of the Internal Revenue Code. OTT is an Application Service Provider (ASP) that develops and hosts transaction solutions for public and private exchanges. Among the solutions that OTT brings to Vsource is LiquidMarketplace(TM) a complete suite of fully integrated transaction solutions, including auctions, fixed-price catalogs and RFP/RFQ engines. Item 2. DESCRIPTION OF PROPERTY The Company, through its subsidiary Virtual Source, Inc., leases approximately 5,500 square feet of standard office space at its principal location in Ventura, California. The lease expires on March 21, 2002. Rent is $8,307 per month. The Company is currently seeking a sub-tenant for part of this space during the remainder of the lease. The Company rents approximately 6,700 square feet of standard office in Bothell, Washington. The lease expires on October 21, 2002, under a 36-month lease. Rent is $11,117 per month. The Company vacated this office in March 2001. The premises are available for a sub-tenancy for the remainder of the lease. The Company, through its subsidiary OTT, rents 10,666 square feet of office space in Los Angeles, California. The Company's principal technical operations are housed in this facility. The lease expires March 6, 2002. Rate is $12,728 during the last year of the lease. The Company is currently seeking a sub-tenant for up to one half of this space during the remainder of the lease. 19 Item 3. LEGAL PROCEEDINGS On October 23, 2000, the Company filed a suit in the Superior Court of the State of California for the County of Los Angeles for fraudulent misrepresentation, fraudulent concealment, rescission and mutual mistake, seeking to rescind a contract the Company entered into with Vitria Technology, Inc. ("Vitria") in February 2000. The suit was transferred to Santa Clara County. Subsequent to January 31, 2001, Vitria denied the substantive allegations in the complaint and seeks the award of monetary damages against the Company for breach of contract. Because discovery is in the early stages, the Company cannot evaluate the likelihood of an outcome. On April 10, 2001 the Santa Clara County Superior Court granted Vitria's request for a writ of attachment against the Company in the sum of $600,000 to secure potential recovery in this case. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the year ended January 31, 2001, the following matters were submitted to a vote of security holders: At the annual meeting of shareholders held July 7, 2000, shareholders voted as follows by proxy or in person: Of the 18,532,777 shares outstanding and entitled to votes on the record date for the meeting, 16,668,123 shares were present in person or by proxy. The following nominees, being the only nominees, and having each received over a majority of the eligible votes, were elected as directors of the Corporation until the next annual meeting or their successors are duly elected and qualified: Robert C. McShirley Samuel E. Bradt Scott T. Behan Robert N. Schwartz Ramin Kamfar The resolution to reincorporate the Corporation in Delaware was approved by 10,795,408 votes in favor and 34,812 votes against. The resolution to ratify the appointment of Grant Thornton LLP as the Corporation's independent public accountants was approved by 16,573,943 votes in favor and 44,139 votes against. PART II Item 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS MARKET INFORMATION Prior to January 4, 2000, the Company's common stock traded under the symbol "IBNL" in the over-the-counter securities market. On January 4, 2000, the Company's common stock began trading under the symbol "VSRC.OB" in the over-the-counter securities market. The over-the-counter quotations reflect interdealer bid prices, without retail mark-up, markdown or commission, and may not represent actual transactions. The over-the-counter market does not constitute active trading and trading in the Company's common stock is limited and sporadic. On October 30, 2000, the Company began trading on Nasdaq National Market system under the symbol "VSRC". The following table sets forth the range of high bid and low bid quotations and the closing price for the fiscal quarters within the last two years. Prior to October 30, 2000, the source for this information is the Nasdaq OTC Bulletin Board. Since October 30, 2000, the source for this information is the Nasdaq National Market System. 20
Common Stock ------------- For Fiscal Year Ended January 31, 2000 High Low Close -------------------------------------- ------ ------ ------ Quarter ended April 30, 1999 $ 2.38 $ 1.38 $ 1.41 Quarter ended July 31, 1999 $ 2.13 $ 1.38 $ 2.13 Quarter ended October 31, 1999 $ 2.88 $ 1.53 $ 1.88 Quarter ended January 31, 2000 $19.88 $ 1.88 $15.19 For Fiscal Year Ended January 31, 2001 High Low Close -------------------------------------- ------ ------ ------ Quarter ended April 30, 2000 $85.00 $14.50 $26.69 Quarter ended July 31, 2000 $28.13 $ 9.13 $15.63 Quarter ended October 31, 2000 $16.25 $ 6.38 $14.13 Quarter ended January 31, 2001 $15.81 $ 1.47 $ 2.25
SHAREHOLDERS As of April 30, 2001, there were 958 stockholders of record of the Company's common stock. Of the 18.6 million outstanding shares of the Company's common stock at April 30, 2001, 13.5 million shares were held in "street name" by Cede, Inc. on behalf of shareholders. As of April 30, 2001, there were 48 holders of the Company's Series 1-A convertible preferred stock and 19 of Series 2-A convertible preferred stock. DIVIDENDS The Company has never declared or paid cash dividends on its common stock. The Company currently intends to retain all future earnings to finance future growth and, therefore, does not anticipate paying any cash dividends in the foreseeable future. RECENT SALE OF UNREGISTERED SECURITIES The following are all securities sold by the Company or issued as warrants within the three (3) year period prior to January 31, 2001 which were not registered under the Securities Act: In June 1998, the Company issued 500,000 shares of its common stock and granted an option to purchase an additional 500,000 shares in exchange for all of the shares of Wpg.Net, Inc., a Washington corporation. The shares and options were issued to DX3, Inc., a Washington corporation wholly owned by the three Wpg.Net, Inc. shareholders. The options have an exercise price of $0.59 per share and vest ratably each month over a three-year period subject to acceleration upon the achievement of certain revenue goals. No underwriters were used, and no commissions were paid. The issuances were a private placement and exempt from registration under Section 4(2) of the Securities Act. The transactions did not involve a public offering. There were three shareholders of Wpg.Net, Inc. who were also the sole shareholders of DX3, each of whom was familiar with the Company. DX3 represented its intention to acquire the shares and option for investment purposes only, and not with a view to resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the 21 transfer restrictions were placed on each stock certificate issued and will be placed on each stock certificate issued upon exercise of the options. Each individual had ample access to the kind of information from the Company that a registration statement would include. During March and April of 1999, the Company sold 737,493 shares of unrestricted common stock, and received $999,942 less offering costs. No underwriters were used, and no commissions were paid. Legal fees approximated $5,000. This offering was a private placement and was exempt from registration under the Securities Act and made in accordance with Regulation D. The Company was again eligible under Securities and Exchange Commission Rule 504, which allowed the shares sold in this private placement to be issued without restrictive legend. Because Rule 504 was changed effective April 7, 1999, the last sale of shares under this offering was made on April 6, 1999. The recipients of these shares, primarily existing Company investors, or friends, relatives and business associates of the Company officers, directors and investors, represented their intention to acquire the shares for investment purposes only, and not with a view to resale or distribution. On May 15, 1999, the Company issued an aggregate of 636,100 shares of common stock upon the exercise of options by three of the Company's executive officers. The exercise prices ranged from $0.18 to $0.625. No underwriters were used, and no commissions were paid. The issuances were exempt pursuant to Rule 701 promulgated by the Securities and Exchange Commission under the Securities Act. The option grants were made under written compensatory contracts. Appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions were placed on each stock certificate when issued. During the period May 1999 to October 1999, the Company granted options to purchase 1,039,500 shares of its common stock to officers, employees and consultants. The exercise prices ranged from $0.75 to $1.10. The options vest over periods of 27 to 36 months from date of grant. No underwriters were used, and no commissions were paid. The issuances were exempt pursuant to Rule 701 promulgated by the Securities and Exchange Commission under the Securities Act. The consultants were natural persons and the option grants were made under written compensatory contracts. Appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each stock certificate when issued. During the period July 1, 1999 to December 31, 1999, the Company sold 757,720 shares of restricted common stock, and received $1,140,000. No underwriters were used and no commissions were paid. The sales were a private placement and exempt from registration under Section 4(2) of the Securities Act. The transactions did not involve a public offering. There were eleven offerees and nine purchasers, each of whom was an accredited investor, and familiar with the Company and four of whom were existing shareholders. The investors represented their intention to acquire the shares for investment purposes only, and not with a view to resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each stock certificate when issued. Each individual had ample access to the kind of information from the Company that a registration statement would include. As of July 31, 1999, the Company converted all of its then outstanding convertible debt to equity. The convertible demand notes totaled $971,553 in aggregate principal amount and accrued interest at 10% per annum. The notes were convertible at rates ranging from $0.20 to $1.30 per share. In order to induce the conversion, the Company offered an additional three months of interest. Interest and principal were converted into an aggregate of 2,210,201 shares of the company's common stock. No underwriters were used, and no commissions were paid. The issuance of the Company's common stock upon the conversion of the notes was a private placement to 22 investors and exempt from registration under Section 4(2) of the Securities Act. The investors represented their intention to acquire the shares for investment purposes only, and not with a view to resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each stock certificate when issued. Each investor had ample access to the kind of information from the Company that a registration statement would include. In November 1999, the Company issued an aggregate of $150,000 of 10% convertible demand notes due on demand after December 2000 to two accredited investors. The notes, principal and interest, are convertible into restricted shares of the Company's common stock at a rate of $2.50 per share. No underwriters were used, and no commissions were paid. The issuance of the Company's notes was a private placement exempt from registration under Section 4(2) of the Securities Act. Prior to conversion, the investors must represent their intention to acquire the conversion shares for investment purposes only, and not with a view to resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each 22 stock certificate when issued. Each investor had ample access to the kind of information from the Company that a registration statement would include. These notes were converted as of January 31, 2001. During the period November 1999 to February 2000, the Company issued or committed to issuing warrants to purchase an aggregate of 870,000 shares of common stock to one consultant and four corporations at exercise prices which range from $2.00 to $25.00 in exchange for financial consulting and distribution and marketing services. No underwriters were used, and no commissions were paid. The warrants were issued or will be issued as a private placement exempt from registration under Section 4(2) of the Securities Act. The warrant holders represented their intention to acquire the warrants for investment purposes only, and not with a view to resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each warrant and each stock certificate when issued. Each warrant holder had ample access to the kind of information from the Company that a registration statement would include. During the period December 1, 1999 to February 24, 2000, the Company sold 2,802,000 shares of Series 1-A Convertible Preferred Stock to 46 accredited investors and received $7,005,000 less offering costs. Each share of preferred stock is initially convertible into one share of common stock at the election of the holder, upon an underwritten public offering with aggregate proceeds to the Company of at least $10 million or upon the election of a majority of the outstanding shares of preferred stock. No underwriters were used. Offering costs were approximately $109,583 including transfer agent fees, printing costs, legal fees and commissions or finders' fees. The offering was a private placement made in accordance with Regulation D. All of the purchasers were accredited investors. No form of general solicitation or general advertising was used for any offer or sale. The investors represented their intention to acquire the shares for investment purposes only, and not with a view to resale or distribution, and appropriate restrictive legends were placed on each stock certificate issued pursuant to this offering. In connection with the sales of the Series 1-A Convertible Preferred Stock, the Company issued warrants to purchase an aggregate 386,691 shares of common stock at exercise prices ranging from $2.50 to $6.00 as additional finder's fees and commissions and for other services in connection with the offering. No underwriters were used, and no commissions were paid. The warrants were issued, or will be issued, to five consultants and as a private placement exempt from registration under Section 4(2) of the Securities Act. The warrant holders represented their intention to acquire the warrants for investment purposes only, and not with a view to resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each warrant and each stock certificate when issued. Each investor had ample access to the kind of information from the Company that a registration statement would include. On January 14, 2000, the Company granted options to purchase an aggregate of 78,750 shares of common stock to 6 key employees exercisable at $1.66 per share. No underwriters were used, and no commissions were paid. The grants were intended to be private placements exempt from registration under Section 4(2) of the Securities Act. The option grants were made under written compensatory contracts. Appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each stock certificate when issued. On February 3, 2000, the Company granted options to purchase an aggregate of 125,000 shares of common stock to an executive officer exercisable at $2.50 per share. No underwriters were used, and no commissions were paid. The grants were a private placement exempt from registration under Section 4(2) of the Securities Act. The option grants were made under written compensatory contracts. Appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each stock certificate when issued. On March 27, 2000, the Company granted options to purchase an aggregate of 100,000 shares of common stock to an executive officer exercisable at $3.00 per share. No underwriters were used, and no commissions were paid. The grants were a private placement exempt from registration under Section 4(2) of the Securities Act. The option grants were made under written compensatory contracts. Appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each stock certificate when issued. During the period August 28, 2000 to September 18, 2000, the Company sold 1,672,328 shares of Series 2-A Convertible Preferred Stock to 25 accredited investors and received $10,719,623 less offering costs. Each share of preferred stock is convertible into one share of common stock at the election of the holder. Each purchaser also received a warrant to purchase common stock at an exercise price of $6.41 per share, with a five-year term. The aggregate of such 23 shares of common stock is 145,550. No underwriters were used and offering costs were $531,792 including transfer agent fees, printing cost, legal fees and commissions or finders fees. The offering was a private placement made in accordance with Regulation D. All of the purchasers were accredited investors. No form of general solicitation or general advertising was used for any offer or sale. The investors represented their intention to acquire the shares for investment purposes only, and not with a view for resale or distribution, and appropriate restrictive legends were placed on each stock certificate issued pursuant to this offering. The Company is obligated to register the shares of Common Stock underlying the Series 2-A Preferred and the warrants held by the holders of the Series 2-A Preferred. The registration statement was required to be effective on or before January 16, 2001, or the Company was required to issue to each holder of Series 2-A Preferred an additional warrant to purchase Common Stock in an aggregate amount equal to two percent (2%) of the registrable shares held by such holder for each thirty day period this registration statement is not effective by January 16, 2001. The additional warrants would have terms of five (5) years and an exercise price of $6.41 per share. The registration statement was effective prior to January 16, 2001. In connection with the sales of the Series 2-A Convertible Preferred Stock, the Company issued warrants to purchase an aggregate of 144,881 shares of common stock at exercise prices ranging from $6.41 to $6.69 as additional finder's fees, commissions and other services in connection with the offering. No underwriters were used, and no commissions were paid. The warrants were issued to two consultants and as a private placement exempt from registration under section 4(2) of the Securities Act. The warrant holders represented their intention to acquire the warrants for investment purposes only, and not with a view for resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be placed on each warrant and each stock certificate when issued. Each investor had ample access to the kind of information from the Company that a registration statement would include. In the event of any liquidation or dissolution, either voluntary or involuntary, the holders of the series 2-A Convertible Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets or surplus funds, to the holders of the Common Stock by reason of their ownership thereof, a preference amount per share consisting of the sum of (A) $6.41 for each outstanding share of Series 2-A Preferred Stock, and (B) an amount equal to declared but unpaid dividends on such shares, if any. Each share of Series 2-A Preferred Stock shall be convertible at any time after the date of issuance of such shares, into such number of fully paid shares of Common Stock as is determined by dividing the Original Issue Price by the then applicable Conversion Price, in effect on the date the certificate evidencing such share is surrendered for conversion. Under certain circumstances, such as stock splits, these shares are subject to stated Conversion Price Adjustments. In September 2000, the Chief Financial Officer and the Chief Operating Officer each purchased shares of the Company's Series 2-A Convertible Preferred Stock for nominal cash and three-year promissory notes of $124,000 each, which bear interest at a rate of 8% per annum and principal amounts each. The preferred stock purchased was 19,501 for each officer. In connection with these transactions, they also each received a warrant to purchase 1,697 shares of common stock with an exercise price of $6.41 and a term of five years. In December 2000, the Company terminated a strategic relationship with U.S. West, Inc. (now known as Qwest Communications) of Denver, Colorado, to which the two firms had agreed to make VSN available to Qwest's business customers. In exchange for services to be rendered and a nominal amount of cash, Vsource had granted to Qwest 600,000 warrants with a three-year term, at an exercise price of $5.00. The terms of the distribution and marketing agreement were renewable each year, however, it was subject to cancellation by either party giving notice of its intent to terminate the agreement. When the warrants were granted, the Company's stock was valued at $17.50 per share, resulting in a charge to the Company of $8,412,000. The Company recognized the full balance as a marketing expense in the year ended January 31, 2001 due to the cancellation of this arrangement. On January 22, 2001, Company closed an Agreement and Plan of Merger with Online Transaction Technologies, Inc., a California corporation ("OTT"). The aggregate purchase price payable at Closing was 1,089,389 shares of the Company's common stock. The number of shares was calculated based on a specific formula in the Merger Agreement. Such aggregate price shall be subject to adjustment based on reductions or increases in the net book value of the assets of OTT since September 30, 2000. As a result of the acquisition, including direct expenses related to the transaction, goodwill was recorded in the amount of $4,592,863. In connection with the Closing, two key employees of OTT were granted options to purchase 100,000 shares each of the Company's common stock which vest over 24 months and have an exercise price of $6.41 per share. 24 During the year ended January 31, 2001, 364,646 shares of Series 1-A Convertible Preferred Stock and 296,411 shares of Series 2-A Convertible Preferred Stock were converted into common shares, 307,391 shares of common stock were issued upon exercise of stock options and warrants, 65,654 shares upon conversion of convertible demand notes, and 8,250 shares in return for services provided to the Company. Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the Company's financial statements and the related notes thereto appearing elsewhere herein. FORWARD LOOKING STATEMENTS This Annual Report on Form 10-KSB and the documents incorporated herein by reference contain forward-looking statements based on current expectations, estimates and projections about the Company's industry, management's beliefs and certain assumptions made by management. All statements, trends, analyses and other information contained in this report relative to trends in net sales, gross margin, anticipated expense levels and liquidity and capital resources, as well as other statements including, but not limited to, words such as "anticipate," "believe," "plan," "estimate," "expect," "seek," "intend," and other similar expressions, constitute forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. Accordingly, actual results may differ materially from those anticipated or expressed in such statements. PARTICULAR ATTENTION SHOULD BE PAID TO THE CAUTIONARY STATEMENTS INVOLVING THE COMPANY'S LIMITED OPERATING HISTORY, THE UNPREDICTABILITY OF ITS FUTURE REVENUES, THE COMPANY'S NEED FOR AND THE AVAILABILITY OF CAPITAL RESOURCES, THE EVOLVING NATURE OF ITS BUSINESS MODEL, THE INTENSELY COMPETITIVE MARKET FOR BUSINESS-TO-BUSINESS ELECTRONIC SOFTWARE, AND THE RISKS ASSOCIATED WITH SYSTEMS DEVELOPMENT, MANAGEMENT OF GROWTH OF BUYER/SELLER ENABLEMENT SOFTWARE AND TOOLS. Except as required by law, the Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. Readers, however, should carefully review the factors set forth in other reports or documents that the Company files from time to time with the Securities and Exchange Commission ("SEC"). OVERVIEW Vsource, Inc. ("Vsource" or the "Company") creates and markets Internet-based applications for businesses. An Internet-based application is best described as computer software and data that reside on a remote server, rather than the user's computer, where that software and data are accessed over the Internet. The Company intends to generate fees by licensing its Internet-based applications for use by businesses. Currently, the Company offers LiquidMarketplace(TM) as its primary application. LiquidMarketplace(TM) may be used by corporate clients to purchase goods and services via the Internet. The Company has also developed and has previously offered non-Internet procurement software, Virtual Source Publisher, a do-it-yourself Internet web site builder, and Virtual Source Network ("VSN"), an Internet based procurement software. These products are currently inactive, but the Company retains all related technology and rights. The Company's product, LiquidMarketplace(TM), has been used on a continuing basis for over one year by one client. This limited operating history makes the prediction of future operating results very difficult. In particular, the Company believes that period-to-period comparisons of operating results should not be relied upon as predictive of future performance. Operating results are expected to vary significantly from quarter to quarter and are difficult or impossible to predict. The Company's operating prospects must be considered in relationship to the risks, expenses and difficulties encountered by any company at an early stage of development, particularly companies in new and rapidly evolving markets. The Company may not be successful in addressing such risks and difficulties. 25 Management has taken steps to revise its operating and financial requirements, which it believes are sufficient to provide the company with the ability to continue its operations through January 31, 2002. These steps include expense reductions, marketing and sale of LiquidMarketplace(TM) products, consideration of merger opportunities, and plans to raise additional capital through equity transactions. The Company has implemented cash conservation measures and is currently expending approximately $325,000 per month of cash and cash equivalents. At this rate, without additional capital or revenues, the Company believes it can continue operations, with minimum cash reserves, through January 31, 2002. The Company is presently engaged in marketing and sales of its LiquidMarketplace(TM) products, but has not determined that these products, and the markets toward which they are directed, represent a sufficient business opportunity for a major commitment of the Company's available capital resources. The Company, therefore, is limiting further development and marketing expenses related to LiquidMarketplace(TM), while it evaluates consolidation opportunities with compatible technology companies and plans for raising additional capital. For more information, please refer to "Item 1. DESCRIPTION OF BUSINESS - FACTORS THAT MAY AFFECT FUTURE PERFORMANCE." Doubt About the Company's Ability To Continue as a Going Concern The Company has sustained operating and cash losses since inception, resulting in an accumulated deficit of approximately $52 million as at January 31, 2001. Continued losses are projected for the foreseeable future, raising doubt as to the Company's ability to raise new financing to fund operations and continue as a going concern. The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles and contemplate the continuation of the Company as a going concern. The report of the auditors of the Company's financial statements for the year ended January 31, 2001 states in an explanatory paragraph that there is substantial doubt and uncertainty about the Company's ability to continue as a going concern. Numerous factors could affect the Company's operating results including, but not limited to, general economic conditions, competition and changing technologies. A change in any of these factors could have an adverse effect on the Company's consolidated financial position or results of operations. During the 2001 fiscal year, the Company was required to raise additional capital in order to continue its operations. The issuances of Series 1-A and 2-A Preferred Stock were completed to finance the Company's operations at the end of the 2000 fiscal year. If the current economic slowdown continues, the Company may not be able to generate revenues, control costs and attract needed additional capital. RECENT EVENTS RESULTS OF OPERATIONS - FISCAL YEAR 2001 VERSUS FISCAL YEAR 2000 REVENUES: Revenues for the year ended January 31, 2001 increased to $35,000 from revenues of $3,500 for the year ended January 31, 2000, an increase of $31,500, or 900%. Revenues increased primarily because the Company had ceased its sales of subscriptions to the software version of VSN in the year ended January 31, 2000, and began the implementation of the new Internet version of VSN in the year ended January 31, 2001. GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses increased to $16,123,943 for the year ended January 31, 2001 from $1,167,328 for the year ended January 31, 2000, an increase of $14,956,615, or 1281%. The increase was due to major increases of $1,440,241 in advertising and marketing to support the product implementation, and including expenses associated with an increase in personnel, including payroll, rent and travel and a substantial increase of $11,846,863 in the recognition of stock-based compensation. RESEARCH AND DEVELOPMENT: Research and development expenses increased to $11,654,679 for the year ended January 31, 2001 from $3,458,933 for the year ended January 31, 2000, an increase of $8,195,746, or 237%. The increase was due to increased costs associated with the development of the Company's Internet version of its VSN electronic purchasing system. Such increased costs include additional personnel and personnel-related expenses at $2,458,264 as well as increased licensing fees for development-related tools and systems and a substantial increase of $5,432,372 in the recognition of stock-based compensation. 26 TOTAL EXPENSES: Total expenses increased to $27,778,622 for the year ended January 31, 2001 from $4,626,261 for the year ended January 31, 2000, an increase of $23,152,361, or 501%. The increase in total expenses was due primarily to the increases in both research and development and general and administrative expenses of $8,195,746 and $14,956,615, respectively, including a substantial increase of $17,279,235 in the recognition of stock-based compensation. LOSS FROM OPERATIONS: The Company had a loss from operations of $27,743,622 for the year ended January 31, 2001 versus a loss of $4,622,761 for the year ended January 31, 2000, an increase of $23,120,861, or 500%. The loss increased because of increased costs associated with developing the Internet version of VSN versus a decline in revenues associated with discontinuing the software version of VSN and a substantial increase in the recognition of stock-based compensation. INTEREST INCOME: Interest income increased to $152,431 for the year ended January 31, 2001 from $15,394 for the year ended January 31, 2000, an increase of $137,037, or 890%. The increase was due primarily to the increase in cash in interest bearing accounts. The cash was received from the issuance of preferred stock through two private placements. LOSS ON IMPAIRMENT OF INTANGIBLE ASSETS: The Company incurred no loss on impairment of assets in the year ended January 31, 2001; however, a loss of $527,356 was incurred for the year ended January 31, 2000. The Company determined in the year ended January 31, 2000, that its June 1998 investment in Wpg.Net, Inc., and its technology, did not continue to carry the value originally anticipated. As a result, the goodwill remaining on the books as of January 31, 2000 was eliminated and charged to expense. OTHER INCOME: Other Income increased to $4,018 for the year ended January 31, 2001 an increase from no other income for the year ended January 31, 2000. Other income in 2001 was derived primarily from the sale of miscellaneous short-term assets. INTEREST EXPENSE: Interest expense decreased to $11,589 for the year ended January 31, 2001 from $388,571 for the year ended January 31, 2000, a decrease of $376,982, or 97.0%. The decrease was due primarily to the decrease in Convertible Demand Notes. NET LOSS: The net loss of $27,598,762 for the year ended January 31, 2001 increased from $5,523,294 for the year ended January 31, 2000, an increase of $22,075,468, or 400%, almost entirely as a result of increased loss from operations, including a substantial increase in the recognition of stock-based compensation. BASIC WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: The weighted average number of shares of 16,020,510 for the year ended January 31, 2001 increased from 13,931,634 for the year ended January 31, 2000, an increase of 2,088,876 shares, or 15%. The increase resulted from issuing 2,131,741 shares of common stock, resulting from issuing 307,391 shares upon exercise of stock options and warrants, 65,654 shares upon conversion of convertible demand notes, the conversion of 661,057 shares of preferred stock and the issuance of 1,089,389 shares in relation to the acquisition of OTT and 8,250 shares in return for services provided to the Company. NET LOSS PER COMMON SHARE: The net loss per common share of ($2.63) for the year ended January 31, 2001 increased from net loss per common share of ($0.40) for the year ended January 31, 2000, an increase of ($2.23), or 558%, as a result of the increased net loss for the year, partially offset by the increase in outstanding Common Shares, as noted above. CHANGES IN CONSOLIDATED STATEMENT OF CASH FLOWS CASH FLOWS FROM OPERATING ACTIVITIES: The Company used $9,593,418 of cash in operating activities in the year ended January 31, 2001, versus $2,863,183 of cash used in operating activities in the year ended January 31, 2000, an increase of $6,730,235 or 235%, in the use of cash for operations. The increased use of cash resulted from a net loss of $27,598,762 offset by non-cash items affecting income and changes in operating assets and liabilities of $18,005,344. The net loss was primarily due to increases in general and administrative and research and development expenses associated with the development of the Company's now discontinued Internet version of its VSN procurement software, while the Company generated little revenue. 27 CASH FLOWS FROM INVESTING ACTIVITIES: For the year ended January 31, 2001, cash used in investing activities was $1,187,652 primarily because of the investment in OTT of $407,163, acquisition of property and equipment of $689,801, and advances to employees of $90,688. For the year ended January 31, 2000, cash used in investing activities was $282,028 because of advances to employees of $41,820 and acquisition of property and equipment of $240,208. CASH FLOWS FROM FINANCING ACTIVITIES: For the year ended January 31, 2001, cash provided by financing activities was $10,982,165, consisting of $10,789,936 from the private placement of preferred stock and $192,229 from the issuance of common stock. For the year ended January 31, 2000, cash provided by financing activities was $8,292,441, consisting of $6,002,500 from the private placement of preferred stock, $2,139,941 from the issuance of common stock, and $150,000 from borrowings on convertible notes. This debt has all been converted into equity (See Item 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS - RECENT SALE OF UNREGISTERED SECURITIES). LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of cash and cash equivalents for the year ended January 31, 2001 were derived from private sales of the Company's equity and debt securities and funds received from implementation fee revenues of VSN of $35,000. The major source of funds for the Company from the date of inception through January 31, 2001, has been from sale of equity and debt securities. The Company completed the year ended January 31, 2001 with cash and cash equivalents totaling approximately $5.4 million. As of April 30, 2001 the total of cash and cash equivalents was approximately $3.4 million. The Company has implemented cash conservation measures and is currently expending approximately $325,000 per month of cash and cash equivalents. At this rate, without additional capital or revenues, the Company believes it can continue operations, with minimum cash reserves, through January 31, 2002. The Company is presently engaged in marketing and sales of its LiquidMarketplace(TM) products, but has not determined that these products, and the markets toward which they are directed, represent a sufficient business opportunity for a major commitment of the Company's available capital resources. The Company, therefore, is limiting further development and marketing expenses related to LiquidMarketplace(TM), while it evaluates consolidation opportunities with compatible technology companies and plans for raising additional capital. 28 Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors Vsource, Inc. We have audited the accompanying consolidated balance sheet of Vsource, Inc. (a Delaware corporation) and subsidiaries as of January 31, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity (deficit) and cash flows for the years then ended. The consolidated 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 auditing standards generally accepted in the United States of America. 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 audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vsource, Inc. and subsidiaries as of January 31, 2001 and 2000, and the results of their operations and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2, the Company has sustained substantial losses from operations since inception, has used, rather than provided, cash from operations and has an accumulated deficit of approximately $52 million. Continued losses are projected for the next fiscal year. At present, the Company has no proven plan for generation of material revenue. These factors, and others, raise substantial doubt about the Company's ability to continue as a going concern. The ability of the Company to continue operations is subject to its ability to secure additional capital to meet its obligations and to fund operations. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Grant Thornton LLP Los Angeles, California April 13, 2001 (except for Note 13, as to which the date is May 3, 2001 and except for Note 14, as to which the date is September 24, 2001.) 29
VSOURCE, INC. CONSOLIDATED BALANCE SHEETS January 31, (Restated) ASSETS 2001 2000 ------------ ----------- CURRENT ASSETS Cash $ 5,360,525 $5,124,399 Restricted cash 47,737 82,768 Accounts receivable 4,200 -- Notes receivable-related parties 150,000 -- Prepaid expenses 103,687 -- ------------ ----------- Total current assets 5,666,149 5,207,167 PROPERTY AND EQUIPMENT Equipment and fixtures 1,099,628 240,208 Less - accumulated depreciation (167,283) (17,708) ------------ ----------- 932,345 222,500 OTHER ASSETS Goodwill 4,592,863 -- Notes receivable-related parties 50,000 110,728 Other assets 19,559 -- ------------ ----------- $11,260,916 $5,540,395 ============ =========== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES Accounts payable $ 598,717 $ 247,472 Accrued expenses 311,686 100,937 Amounts related to in-process private placement of preferred stock -- 6,002,500 Convertible notes payable -- 150,000 ------------ ----------- 910,403 6,500,909 COMMITMENTS AND CONTINGENCIES -- -- PREFERRED STOCK Preferred stock Series 1-A ($0.01 par value, 2,900,000 shares authorized; 2,437,354 shares issued and outstanding. Aggregate liquidation value is $6,093,385.) 5,984,802 -- Preferred stock Series 2-A ($0.01 par value, 2,100,000 shares authorized; 1,375,917 shares issued and outstanding. Aggregate liquidation value is $8,819,628) 8,244,026 -- ------------ ----------- Total preferred stock 14,228,828 -- ------------ -----------
The accompanying notes are an integral part of these statements. 30
VSOURCE, INC. CONSOLIDATED BALANCE SHEETS January 31, (Restated) 2001 2000 ------------ ------------ SHAREHOLDERS' EQUITY (DEFICIT) Common stock ($0.01 par value, 100,000,000 shares authorized; 17,938,912 and 15,807,130 issued and outstanding as of January 31, 2001 and 2000, respectively) 179,389 158,071 Additional paid-in capital 54,073,495 10,645,934 Deferred compensation (5,804,851) (1,780,817) Accumulated deficit (51,899,550) (9,804,904) Notes receivable from the sale of stock (426,798) (178,798) ------------ ------------ Total shareholders' equity (deficit) (3,878,315) (960,514) ------------ ------------ 11,260,916 $ 5,540,395 ============ ============
The accompanying notes are an integral part of these statements. 31
VSOURCE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS For the years ended January 31, (Restated) 2001 2000 ------------- ------------ Revenue $ 35,000 $ 3,500 General and administrative expenses (including $12,271,129 and $424,266 of stock based compensation for the years ended January 31, 2001 and 2000, respectively) 16,123,943 1,167,328 Research and development (including $5,432,372 of stock based compensation for the year ended January 31, 2001. No stock based compensation is included for the year ended January 31, 2000) 11,654,679 3,458,933 ------------- ------------ Total expenses 27,778,622 4,626,261 ------------- ------------ Loss from operations (27,743,622) (4,622,761) Other income (expense): Interest expense (11,589) (388,571) Loss on impairment of intangible asset -- (527,356) Interest income 152,431 15,394 Other income 4,018 -- ------------- ------------ Net loss $(27,598,762) $(5,523,294) ============= ============ Loss available to common stockholders (See notes 11 and 14) $(42,094,646) $(5,523,294) ============= ============ Basic and diluted weighted average number of common shares outstanding 16,020,510 13,931,634 ============= ============ Basic and diluted net loss per share available to common stockholders (See note 14) $ (2.63) $ (0.40) ============= ============
The accompanying notes are an integral part of these statements. 32
VSOURCE, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (Restated) Total Common Stock Additional Deferred Notes Accumulated Shareholder's Shares Amount Paid-in- Compensation Receivable Deficit Equity ---------- -------- ------------ -------------- ------------ ------------- --------------- Balance at January 31, 1999 11,401,492 $114,014 $ 4,296,392 -- -- $ (4,281,610) $ 128,796 Issuance of common stock, net of issuance costs 1,495,213 14,952 2,124,990 2,139,942 Issuance of common stock upon conversion of demand notes 2,210,201 22,102 949,451 971,553 Issuance of common stock for services 64,165 642 112,735 113,377 Granting of common stock options for services 2,123,832 (1,780,817) 343,015 Issuance of warrants - related party 435,136 435,136 -- Beneficial conversion feature 349,710 349,710 Modification in terms of stock options 81,251 81,251 Exercise of stock options 636,100 6,361 172,437 (178,798) -- Net loss (5,523,294) (5,523,294) ---------- -------- ------------ -------------- ------------ ------------- --------------- Balance at January 31, 2000 15,807,171 $158,071 10,645,934 (1,780,817) (178,798) (9,804,904) (960,514) Issuance of preferred stock -- -- (248,000) (248,000) Conversion of preferred stock 661,057 6,610 2,804,999 2,811,609 Issuance of common stock- acquisition of OTT 1,089,389 10,894 4,047,360 4,058,254 Issuance of common stock Upon conversion of demand notes 65,654 657 163,480 164,137 Beneficial conversion feature and deemed non-cash dividend to preferred stockholders 14,495,884 (14,495,884) -- Compensation related to: options granted for services 11,942,646 (6,684,383) 5,258,263 warrants issued for services 10,966,310 10,966,310 Issuance of stock for services 8,250 83 319,216 319,299 Expired and forfeited options (2,660,349) 2,660,349 -- Exercise of stock options 209,334 2,094 1,348,995 1,351,089 Exercise of warrants 98,057 980 (980) -- Net loss (27,598,762) (27,598,762) ---------- -------- ------------ -------------- ------------ ------------- --------------- Balance at January 31, 2001 17,938,912 $179,389 $54,073,495 $ (5,804,851) $ (426,798) $(51,899,550) $ (3,878,315) ========== ======== ============ ============== ============ ============= ===============
The accompanying notes are an integral part of these statements. 33
VSOURCE, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended January 31, (Restated) 2001 2000 ------------- ------------ Increase (decrease) in cash Cash flows from operating activities: Net loss $(27,598,762) $(5,523,294) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 150,457 436,671 Interest expense related to the beneficial conversion feature -- 349,710 Interest expense converted to equity -- 36,568 Impairment of intangible asset -- 527,356 Compensation expense on stock options granted 4,643,928 424,266 Compensation expense on warrants issued 10,966,310 -- Services paid with equity 2,093,263 548,513 Settlement of rent litigation -- 37,500 Changes in assets and liabilities: Accounts receivable -- 3,590 Prepaid expenses (103,687) -- Accounts payable 139,829 198,250 Deferred revenue -- (3,250) Accrued liabilities 115,244 100,937 ------------- ------------ Net cash used in operating activities (9,593,418) (2,863,183) Cash flows from investing activities: Investment in OTT (407,163) -- Purchase of property and equipment (689,801) (240,208) Advances to related parties (90,688) (41,820) ------------- ------------ Net cash used in investing activities (1,187,652) (282,028) Cash flows from financing activities: Proceeds from issuance of common stock 192,229 2,139,941 Proceeds from issuance of preferred stock 10,789,936 6,002,500 Proceeds from borrowings -- 150,000 ------------- ------------ Net cash provided by financing activities 10,982,165 8,292,441 ------------- ------------ Net increase in cash 201,095 5,147,230 ------------- ------------ Cash at beginning of period 5,207,167 59,937 ------------- ------------ Cash at end of period $ 5,408,262 $ 5,207,167 ============= ============
Supplemental disclosure: See Note 1 - STATEMENT OF CASH FLOWS The accompanying notes are an integral part of these statements. 34 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES ORGANIZATION AND BUSINESS Vsource, Inc. ("Vsource" or the "Company") creates and markets Internet-based applications for businesses. An Internet-based application is best described as computer software and data that reside on a remote server, rather than the user's computer, where that software and data are accessed over the Internet. The Company intends to generate fees by licensing its Internet-based applications for use by businesses. Currently, the Company offers LiquidMarketplace(TM) as its primary application. LiquidMarketplace(TM) may be used by corporate clients to purchase goods and services via the Internet. The Company has also developed and has previously offered a non-Internet procurement software, Virtual Source Publisher, a do-it-yourself Internet web site builder, and Virtual Source Network ("VSN"), an Internet based procurement software. These products have been discontinued, but the Company retains all related technology and rights. Vsource was incorporated in Nevada on October 22, 1980 as Cinema-Star Corporation and, in September 1989, was renamed Dyna-Seal Corporation. Prior to February 1, 1995, the Company's name was changed several times, and its former line of business (manufacturing, packaging and distribution of coatings, sealants and adhesive for use in aircraft and marine industries) was completely discontinued. In July 1995, the Company changed its name to Interactive Buyers Network International, Ltd., and acquired all of the outstanding shares of Buyer/Seller Interactive Software, Inc., a Nevada corporation whose name was subsequently changed to Virtual Source, Inc., ("VSI"). The Company changed its name to Vsource, Inc. in December 1999. On June 1, 1998, the Company acquired all of the outstanding stock of Wpg.Net, Inc. for 500,000 shares of common stock plus stock options for 500,000 shares. The options vest ratably, on a monthly basis, over the 3 years subsequent to the purchase. If Wpg.Net, Inc. division revenues reach $500,000 before the 3-year vesting period has expired, the 500,000 options vest immediately. The former shareholders of Wpg.Net, Inc. (Wpg.Net, Inc. Shareholders) are entitled to a commission of 50% of revenue generated by the Wpg.Net, Inc. division. However, no Wpg.Net, Inc. revenues have been recorded since it was acquired and no revenue producing activities are contemplated. Wpg.Net, Inc. shareholders are entitled to 25% of revenues produced by Virtual Source, Inc. relating to sales of the currently inactive Virtual Source Publisher. In the event that Vsource is sold, the Wpg.Net, Inc. shareholders are entitled to a one-time payment of $3,000,000, the options vest immediately, and all commission obligations cease at that time. The Company guaranteed a minimum stock price of $7.00 per share for the stock held by Wpg.Net, Inc. shareholders upon the sale of the Company. The acquisition was accounted for as a purchase and was included with the combined operations for the dates subsequent to June 1, 1998. As a result of the acquisition, goodwill was recorded in the amount of $1,186,555. During the year ended January 31, 2000, the Company determined that the present value of future cash flows related to the acquisition of Wpg.Net, Inc. was not material. Consequently, the remaining unamortized goodwill has been written off as of January 31, 2000. Wpg.Net, Inc. was merged into Vsource, Inc. effective January 4, 2001. The Company reincorporated in the state of Delaware on November 8, 2000. On December 14, 2000, the Company entered into an Agreement and Plan of Merger with OTT Acquisition Corp., a California corporation, Online Transaction Technologies, Inc., a California corporation ("OTT"), Colin P. Kruger and Michael Shirman (the "Merger Agreement") to acquire OTT. On January 22, 2001, the transaction closed in accordance with the Merger Agreement. The merger was recorded using the purchase method of accounting and the results of operations of OTT are included in the consolidated operations of the Company for the period subsequent to January 22, 2001.The merger was a tax-free reorganization under Section 368(a) of the Internal Revenue Code. OTT is an Application Service Provider ("ASP") that develops and hosts transaction solutions for public and private exchanges. Among the solutions that OTT brings to Vsource is LiquidMarketplace(TM), a complete suite of fully integrated transaction solutions, including auctions, fixed-price catalogs and RFQ (request for quotations) /RFP (request for proposal) engines. 35 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) These solutions are identified as LiquidAuction(TM), LiquidCatalog(TM) and RFP/RFQ products. This suite allows public exchange clients to handle both seller- and buyer-initiated transactions in their e-Marketplaces. OTT's private exchange solution, LiquidStore(TM), offers private catalog and auction functionality to LiquidMarketplace(TM) participants or stand-alone clients. In addition to offering a complete suite, OTT has developed proprietary modules and applications that reduce customization and deployment time and simplify integration. See Note 3. The Company is presently engaged in marketing and sales of its LiquidMarketplace(TM) products, but has not determined that these products, and the markets toward which they are directed, represent a sufficient business opportunity for a major commitment of the Company's available capital resources. The Company, therefore, is limiting further development and marketing expenses related to LiquidMarketplace(TM), while it evaluates consolidation opportunities with compatible technology companies and plans for raising additional capital. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Vsource, Inc. and its wholly owned subsidiaries Virtual Source, Inc. and Online Transaction Technologies, Inc. Significant intercompany accounts have been eliminated. REVENUE RECOGNITION The Company accounts for revenue in accordance with the Financial Accounting Standards Board issued EITF 00-3, which provides guidance on applying generally accepted accounting principles for recognizing revenues. The Company provides Web based auction services and presently has one client operating month-to-month under an expired services agreement. A monthly maintenance fee is charged which is recognized currently in the month during which the services are performed. Revenue is derived from LiquidMarketplace(TM) products through a client contract that provides for an initial "set-up" fee and an ongoing license fee. The "set-up" fee is based on specific client requirements, generally in the $100,000 to $200,000 range. The license fee and accompanying service level agreement is based on a fixed monthly charge, with additional charges for a pilot implementation and for client-specific modifications to the LiquidMarketplace(TM) products. These are typically billed, as required, on a time and materials basis. RESEARCH AND DEVELOPMENT Research and development expenditures are charged to operations as incurred, until technological feasibility has been established, at which time such costs are capitalized until the product is available for general release to customers. To date, the Company's software has been not been available for general release concurrent with technological feasibility, and accordingly, no development costs have been capitalized. (See discussion under Software Development Costs.) SOFTWARE DEVELOPMENT COSTS Software development costs have been accounted for in accordance with Statement of Financial Accounting Standard (SFAS) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. Under that standard, capitalization of software development costs begins upon the establishment of technological feasibility, subject to net realizable value considerations. Capitalized software costs are amortized over the greater of: 1) the amount computed using the ratio that current gross revenues for a product bear to the total current and anticipated future gross revenues for that product; or 2) the straight-line method over the remaining estimated useful life of the product in which the life is generally estimated to be three years. The Company has not incurred any significant capitalizable costs, other than those acquired in the merger with OTT. 36 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) PROPERTY AND EQUIPMENT Property and equipment are stated at cost. The assets are depreciated using the straight-line method over their estimated useful lives of five to seven years. Carrying values are reviewed periodically for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. The policy of the Company is to capitalize significant improvements and to expense repairs and maintenance. Depreciation expense for the years ended January 31, 2001 and 2000 was $149,575 and $40,275, respectively. IMPAIRMENT OF LONG-LIVED ASSETS The Company reviews long-lived assets, certain identifiable intangible assets and goodwill related to these assets for impairment. For assets to be held and used, including acquired intangibles, the Company initiates a review whenever events or changes in circumstances indicate that the carrying value of a long-lived asset may not be recoverable. Recoverability of an asset is measured by comparison of its carrying value to the future undiscounted cash flows that the asset is expected to generate. Any impairment to be recognized is measured by the amount by which the carrying value exceeds the projected discounted future operating cash flows. Assets to be disposed of and for which management has committed a plan to dispose of the assets, whether through sale or abandonment, are reported at the lower of carrying value or fair value less costs to sell. INTANGIBLE ASSETS Intangible assets, principally goodwill, are amortized on the straight-line method over a period of 3 years. Goodwill represents the excess of the purchase price paid over the fair value of tangible and identifiable intangible net assets acquired. The Company regularly assesses the carrying amounts of intangible assets for impairment when operating profit (loss) from the related business indicates the carrying amounts of the assets may not be recoverable. Carrying values are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts of intangible assets may not be recoverable. No such impairment is indicated for the year ended January 31, 2001. The Company recorded an impairment of goodwill in the amount of $527,356 for the year ended January 31, 2000. The Company allocated $3,949,039 of the purchase price of OTT to goodwill. In addition, $643,824 of direct expenses related to the transaction were recorded. Goodwill for the year ended January 31, 2001 was $4,592,863. Amortization for the years ended January 31, 2001 and 2000 was $881and $396,396, respectively. STOCK BASED COMPENSATION The Company accounts for stock based compensation in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," ("SFAS 123"), which allows companies to continue to recognize compensation expense pursuant to Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees", but requires companies to disclose the effect on earnings of compensation expense for stock options based on the fair value of the options at the grant date. Accordingly, employee compensation cost for stock options is measured as the excess of the fair market value over the exercise price at the measurement date. LOSS PER SHARE Basic and diluted loss per share of common stock is computed by dividing the loss available to common stockholders by the weighted average number of common shares outstanding during the period shown. Common stock equivalents are not included in the determination of diluted loss per share, as their inclusion would be antidilutive. ADVERTISING COST The Company charges advertising costs to expense as incurred. Advertising expense for the years ended January 31, 2001 and 2000 was $939,576 and $245,680, respectively. 37 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) STATEMENT OF CASH FLOWS For the purpose of the statement of cash flows, cash includes amounts "on-hand" and amounts deposited with financial institutions. Supplemental disclosure of cash flow information is as follows: Cash paid during the period:
For the Years Ended January 31, ---------------------------------- 2001 2000 -------------- ------------------ Interest $ -- $ -- ============== ================== Income taxes $ 1,600 $ 1,600 ============== ==================
Supplemental schedule of non-cash investing and financing transactions: Issuance of common stock in connection with the following transactions:
For the Years Ended January 31, ---------------------------------- 2001 2000 -------------- ------------------ Conversion of debt to equity $ 6,002,500 $ 996,553 ============== ================== Purchase of OTT $ 4,058,854 $ -- ============== ==================
For the year ended January 31, 2000, options for 636,100 shares of common stock were exercised for notes receivable in the amount of $178,798. In the year ended January 31, 2001 the Chief Financial Officer and the Chief Operating Officer each purchased 19,501 shares of the Company's Series 2-A Convertible Preferred Stock for nominal cash and three-year promissory notes of $124,000 each, which bear interest at a rate of 8% per annum. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from estimates and assumptions made. 2. REALIZATION OF ASSETS The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("US GAAP"), which contemplate continuation of the company as a going concern. However, as shown in the accompanying financial statements, the Company has sustained substantial losses since its inception. In addition, the company has used, rather than provided, cash in its operations and, at present, has no committed plan for generation of material revenue. 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 38 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) 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. Management has taken steps to revise its operating and financial requirements, which it believes are sufficient to provide the company with the ability to continue its operations. These steps include expense reductions, marketing and sale of LiquidMarketplace(TM) products, consideration of presently identified merger opportunities, and plans to raise additional capital through equity transactions. The Company has implemented cash conservation measures and is currently expending approximately $325,000, per month of cash and cash equivalents. At this rate, without additional capital or revenues, the Company believes it can continue operations, with minimum cash reserves, through January 31, 2002. 3. ACQUISITION OF OTT On December 14, 2000, the Company entered into an Agreement and Plan of Merger with OTT Acquisition Corp., a California corporation, Online Transaction Technologies, Inc., a California corporation ("OTT"), Colin P. Kruger and Michael Shirman (the "Merger Agreement"). On January 22, 2001, the transaction closed in accordance with the Merger Agreement. The merger is recorded on the purchase method of accounting and is a tax-free reorganization under Section 368(a) of the Internal Revenue Code. The aggregate purchase price payable at Closing was 1,089,389 shares of the Company's common stock. The number of shares was calculated based upon a specific formula in the Merger Agreement. The purchase price was subject to adjustment based on reductions or increases in the net book value of the assets of OTT from September 30, 2000 through Closing. In accordance with Accounting Principles Board Opinion 16, the total recorded value of the shares issued was based on the average market price of the Company's stock for a stated period both before and after the Company's announcement of the acquisition. The Company recorded $3,949,039 of the purchase price of OTT and $643,824 of direct and accrued expenses as Goodwill. The Company is in the process of obtaining a valuation of the acquired assets. Accordingly, the amounts recorded are subject to adjustment. In connection with the Closing, two key employees of OTT entered into employment contracts with the Company providing for, among other things, salaries of $125,000 and options to purchase 100,000 shares of the Company's common stock which vest over 24 months and have an exercise price of $6.41 per share. Twenty-five percent of the equity securities comprising the aggregate purchase price will be held for six months in escrow (the "Escrow Securities"). The Escrow Securities and Company shares issued to OTT management shareholders will be the sole recourse for the Company for indemnification against claims and losses arising from breaches by OTT of representations and warranties or covenants made pursuant to the definitive agreements. Such representations and warranties shall terminate over varying periods. The Escrow Securities will be valued for purposes of any such indemnification at the Acquisition Price. OTT shareholders may at their option pay any such indemnity in cash in lieu of Escrow Securities. 4. NOTES RECEIVABLE - RELATED PARTIES A. Notes receivable-related parties: In October 2000, Robert C. McShirley, then the Company's Chief Executive Officer, borrowed $400,000 from the Company in exchange for a secured ninety-day promissory note, which bears interest at a rate of 8% per annum, and was due on January 9, 2001. In late October 2000, Mr. McShirley repaid the Company $250,000 of the original balance, leaving a balance of $150,000 which is included in current assets. On January 30, 2001, the Company's board of directors approved an extension of this note for 90 days. (See Note 13 - Subsequent Events) 39 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) In addition, the then Chief Operating Officer borrowed $50,000 from the Company in exchange for a two-year promissory note, which bears interest at a rate of 8% per annum, is due on October 12, 2002 and is included in other assets. B. Notes receivable from the sale of stock: The Company has unsecured notes receivables from several officers which totaled $426,798 and $178,798 as of January 31, 2001 and 2000, respectively. The notes as of January 31, 2000 are unsecured, due on demand and bear interest at an annual rate of 6%. The notes were granted in connection with the exercise of 636,100 stock options on May 15, 1999. Notes received in the year ended January 31, 2001 for $248,000 were granted in connection with the issuance of 39,002 shares of Series 2-A convertible Preferred Stock. The notes are secured by the 39,002 shares of related stock, bear interest at an annual rate of 8% and are due on September 15, 2003. 5. CONVERTIBLE NOTES PAYABLE In November 1999, the Company issued $150,000 of 10% convertible notes due December 31, 2000 to certain investors. The notes were convertible into shares of restricted common stock at a price per share of $2.50. All of the notes had been converted as of January 31, 2001. During the year ended January 31, 2000, the Company allocated a portion of the convertible notes to the embedded beneficial conversion feature in the convertible notes and credited paid-in capital. The portion allocated to the beneficial conversion feature was charged to interest expense at the date of issuance. The amount charged to interest expense related to convertible notes was $11,589 for the year ended January 31, 2001 and $349,710 for the year ended January 31, 2000. 6. STOCK OPTIONS AND WARRANTS OPTIONS The Company has granted various non-qualified stock options to key executives, management and other employees at exercise prices equal to or below the market price at the date of grant. In general, options become exercisable from 8 months to 3 years from the grant date. On June 10, 1998, the Board of Directors granted options to shareholders' of Wpg.Net, Inc. to purchase 500,000 shares of the Company's restricted common stock at an exercise price of $0.59 per share. The options are fully vested and have a term ending in June 2008. In July 2000, the Company approved a stock option plan ("Plan"). The Plan authorizes the grant of Incentive Stock Options and Non-statutory Stock Options covering an aggregate of 795,000 shares of the Company's common stock (subject to limitations of applicable laws, and adjustment in the event of stock dividends, stock splits, reverse stock splits and certain other corporate events.) The Plan expires on July 6, 2010, unless it is sooner terminated or suspended by the board. The Plan is not subject to any provisions of the Employee Retirement Income Security act of 1974. 40 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) The following table summarizes information about stock option transactions for the years ended January 31, 2001 and 2000:
Weighted Average Exercise Shares Price ---------- ---------------- Outstanding at January 31, 1999 1,136,100 0.49 Granted 1,273,250 0.93 Exercised (636,100) 0.28 Cancelled (130,000) 1.25 ---------- Outstanding at January 31, 2000: 1,643,250 0.85 Granted 1,053,469 4.72 Exercised (209,334) 0.92 Cancelled (642,073) 2.24 ---------- Outstanding at January 31, 2001 1,845,312 2.57 ========== Exercisable at January 31, 2001 1,065,390 1.24 ==========
Weighted average fair value of options granted during the year is as follows:
Exercise price below market value at date of grant $21.04 Exercise price equal to market value at date of grant -- Exercise price above market value at date of grant $ 7.59
The following table summarizes information about stock options outstanding at January 31, 2001:
Weighted Average Weighted Remaining Exercisable Number of Average Years of Number Of Weighted Range of Exercise Options Exercise Contractual Options Average Prices Outstanding Price Life Exercisable Exercise Price ------------------ ----------- --------- ----------- ----------- --------------- 0.59 - 1.10 947,625 $ .74 8.0 778,455 $ .72 1.66 - 3.05 568,839 $ 2.57 8.6 282,890 $ 2.63 6.00 - 9.43 270,169 $ 6.73 9.7 4,045 $ 6.00 10.00 - 16.01 58,679 $ 13.20 9.6 -- -- ----------- ---------- Total 1,845,312 1,065,390 =========== ==========
The Company has elected to continue using the intrinsic-value method of accounting for stock-based awards granted to employees in accordance with APB 25. The following table reflects pro forma net income and earnings per share had the Company elected to adopt the fair value approach of SFAS 123 for the years ended: 41 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated)
January 31, January 31, ------------- ------------- 2001 2000 ------------- ------------- Net loss as reported $(27,598,762) $ (5,523,294) Pro forma $(28,411,728) $ (6,921,005) Loss per share as reported $ (2.63) $ (0.40) Pro forma $ (2.68) $ (0.50)
For the year ended January 31, 2001, the estimated fair value of each option granted is calculated using the Black-Scholes option-pricing model with a weighted average risk free rate of 6.0%, volatility of 161% and expected life of 10 years. WARRANTS The Company has granted various warrants for payment of services. The Company accounts for warrants issued under the fair value approach of SFAS 123. The following table summarizes information about warrant transactions for the years ended January 31, 2001 and 2000:
Weighted Average Exercise Shares Price ---------- ---------------- Outstanding at January 31, 1999 -- -- Granted 120,000 2.00 Exercised -- -- Cancelled -- -- Outstanding at January 31, 2000 120,000 2.00 ---------- Granted 1,733,421 6.37 Exercised (120,000) 2.00 Cancelled -- -- ---------- Outstanding and exercisable at January 31, 2001 1,733,421 6.37 ==========
In December 2000, the Company cancelled a strategic relationship with Qwest Communications of Denver, Colorado. In exchange for services to be rendered and a nominal amount of cash, Vsource had granted to Qwest 600,000 warrants with a three-year term, at an exercise price of $5.00. When the warrants were granted, the Company's stock was valued at $17.50 per share, resulting in a charge to the Company of $8,412,000. Due to the cancellation of this arrangement the Company recognized the full balance as a marketing expense in the year ended January 31, 2001. For the years ended January 31, 2001 and 2000, the Company recorded stock-based compensation expense in the amounts of $17,703,501 and $424,266, respectively. 7. INCOME TAXES Income taxes are provided pursuant to SFAS No. 109 Accounting for Income Taxes. The statement requires the use of an asset and liability approach for financial reporting for income taxes. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized. 42 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) Accordingly, as the realization and use of the net operating loss carryforward is not probable at January 31, 2001 or 2000, the tax benefit of the loss carryforward has been offset by a valuation allowance of the same amount. The composition of deferred tax assets is as follows:
January 31, ---------------------------- 2001 2000 ------------- ------------- Total deferred tax assets $ 10,095,923 $ 2,424,637 Total valuation allowance (10,095,923) (2,434,637) ------------- ------------- Total deferred tax assets $ - $ - ============= =============
The tax effects of temporary differences and carryforwards that give rise to deferred assets are as follows:
January 31, ------------------------- 2001 2000 ------------ ----------- Deferred tax assets: Net operating loss carryforwards $ 38,097,821 $9,149,575 ============ =========== Stock option conversion $ 1,294,403 $ 164,217 ============ ===========
As of January 31, 2001, the Company had approximately $38,097,821 of federal and $19,048,000 of state loss carryforwards available to reduce future federal and state tax liability through the year 2021 for federal loss carryforwards and 2006 for the state loss carryforwards. 8. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company has used market information for similar instruments and applied judgment to estimate fair values of financial instruments. At January 31, 2001 and 2000, the fair values of cash, accounts receivable, notes receivable-related parties, notes payable and accounts payable approximated carrying values because of the short-term nature of these instruments. 9. PREFERRED STOCK Effective February 24, 2000, the Company authorized 5,000,000 shares of preferred stock of which 2,900,000 shares were designated as preferred stock "Series 1-A Convertible Preferred Stock", of which 2,802,000 shares were initially issued, with a conversion feature of $2.50 per share. The Company allocated the net proceeds of $6,868,397 from the issuance of the preferred stock to an embedded beneficial conversion feature. Also recorded was a deemed non-cash discount resulting from the allocation, which was fully amortized through retained earnings at issuance. In the event of any liquidation or dissolution, either voluntary or involuntary, the holders of the Series 1-A Convertible Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets or surplus funds, to the holders of the Common Stock by reason of their ownership thereof, a preference amount per share consisting of the sum of (A) $2.50 for each outstanding share of Series 1-A Preferred Stock, and (B) an amount equal to declared but unpaid dividends on such shares, if any. Each share of Series 1-A Preferred Stock shall be convertible at any time after the date of issuance of such shares, into such 43 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) number of fully paid shares of Common Stock as is determined by dividing the Original Issue Price by the then applicable Conversion Price, in effect on the date the certificate evidencing such share is surrendered for conversion. Under certain circumstances, such as stock splits, these shares are subject to stated Conversion Price Adjustments. The remaining 2,100,000 authorized shares were designated as "Series 2-A Convertible Preferred Stock", of which 1,672,328 were initially issued, with rights, preferences and privileges as designated by the board of directors. (See discussion below on Series 2-A Convertible Preferred Stock.) Each share of Series 1-A Preferred Stock, subject to the surrendering of the certificates of the Series 1-A Preferred Stock, shall be automatically converted into shares of Common Stock at the then effective Conversion Price, immediately upon closing of a public offering of the Company's Common Stock with an aggregate gross proceeds of at least $10,000,000 and a per share price of at least five dollars, or at the election of the holders of a majority of the outstanding shares of Series 1-A Preferred Stock. The holder of each share of Series 1-A Preferred Stock shall have the right to that number of votes equal to the number of shares of common stock issued upon conversion of the Series 1-A Preferred Stock. Holders of the Series 1-A Convertible Preferred Stock are entitled to noncumulative dividends, if declared by the Board of directors, of $0.20 per share annually. In the event of a liquidation or dissolution of the Company, the holders of the Series 1-A Convertible Preferred Stock shall be entitled to receive a preference amount for each outstanding share equal to $2.50 plus declared but unpaid dividends. The recorded value of Series 1-A Convertible Preferred Stock was $5,984,802 on January 31, 2001. There were no shares of Series 1-A Convertible Preferred Stock issued as of January 31, 2000. In conjunction with expenses relating to the issuance of the "Series 1-A Convertible Preferred Stock", 235,985 warrants were granted at an exercise price of $6.00 per share and 150,706 warrants were granted at an exercise price of $2.50 per share. During the quarter ended July 31, 2000, 120,000 warrants were granted at an exercise price of $2.00 per share, as compensation for services rendered. Ramin Kamfar, who subsequently was elected as a director of the Company, is a partner in a partnership that was awarded 60,000 of the 120,000 warrants granted at an exercise price of $2.00 per share. During the period August 28, 2000 to September 18, 2000, the Company sold 1,672,328 shares of Series 2-A Convertible Preferred Stock to 25 accredited investors and received $10,719,623, less offering costs. Each share of preferred stock is convertible into one share of common stock at the election of the holder. Each purchaser also received a warrant to purchase common stock at an exercise price of $6.41 per share, with a five-year term. The aggregate of such shares of common stock is 145,550. No underwriters were used and offering costs were $531,792, including transfer agent fees, printing cost, legal fees and commissions or finders fees. The offering was a private placement made in accordance with Regulation D. All of the purchasers were accredited investors. No form of general solicitation or general advertising was used for any offer or sale. The investors represented their intention to acquire the shares for investment purposes only, and not with a view for resale or distribution, and appropriate restrictive legends were placed on each stock certificate issued pursuant to this offering. In connection with the sales of the Series 2-A Convertible Preferred Stock, the Company issued warrants to purchase an aggregate of 144,881 shares of common stock at exercise prices ranging from $6.41 to $6.69 as additional finder's fees, commissions and other services in connection with the offering. No underwriters were used, and no commissions were paid. The warrants were issued to two consultants and as a private placement exempt from registration under Section 4(2) of the Securities Act. The warrant holders represented their intention to acquire the warrants for investment purposes only, and not with a view for resale or distribution, and appropriate stop transfer instructions and restrictive legends indicating the transfer restrictions will be place on each warrant and each stock certificate when issued. Each investor had ample access to the kind of information from the Company that a registration statement would include. 44 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) The Company allocated $7,627,487 of the net proceeds from the issuance of the Series 2-A Preferred Stock to Common Stock as required by an embedded beneficial conversion feature. The deemed non-cash discount resulting from the allocation was fully amortized through retained earnings at issuance. In the event of any liquidation or dissolution, either voluntary or involuntary, the holders of the series 2-A Convertible Preferred Stock shall be entitled to receive, prior and in preference to any distribution of any of the assets or surplus funds, to the holders of the Common Stock by reason of their ownership thereof, a preference amount per share consisting of the sum of (A) $6.41 for each outstanding share of Series 2-A Preferred Stock, and (B) an amount equal to declared but unpaid dividends on such shares, if any. Each share of Series 2-A Preferred Stock shall be convertible at any time after the date of issuance of such shares, into such number of fully paid shares of Common Stock as is determined by dividing the Original Issue Price by the then applicable Conversion Price, in effect on the date the certificate evidencing such share is surrendered for conversion. Under certain circumstances, such as stock splits, these shares are subject to stated Conversion Price Adjustments. The recorded value of Series 2-A Convertible Preferred Stock was $8,244,026 on January 31, 2001. There were no shares of Series 2-A Convertible Preferred Stock issued as of January 31, 2000. In September 2000, the Chief Financial Officer and the Chief Operating Officer each purchased shares of the Company's Series 2-A Convertible Preferred Stock for nominal cash and three-year promissory notes of $124,000 each, which bear interest at a rate of 8% per annum and principal amounts each. The preferred stock purchased was 19,501 for each officer. In connection with these transactions, they also each received a warrant to purchase 1,697 shares of common stock with an exercise price of $6.41 and a term of five years. During the year ended January 31, 2001, 364,646 shares of Series 1-A Convertible Preferred Stock and 296,411 shares of Series 2-A Convertible Preferred Stock were converted into common shares, 307,391 shares of common stock were issued upon exercise of stock options and warrants, 65,654 shares upon conversion of convertible demand notes, and 8,250 shares in return for services provided to the Company. 10. SHAREHOLDERS' EQUITY (DEFICIT) In December 2000, the Company terminated a strategic relationship with U.S. West, Inc. (now known as Qwest Communications) of Denver, Colorado, to which the two firms had agreed to make VSN available to Qwest's business customers. In exchange for services to be rendered and a nominal amount of cash, Vsource had granted to Qwest 600,000 warrants with a three-year term, at an exercise price of $5.00. The terms of the distribution and marketing agreement were renewable each year; however, it was subject to cancellation by either party giving notice of its intent to terminate the agreement. The warrants were granted in the third quarter of the fiscal year when the Company's stock was valued at $17.50 per share, resulting in a charge to the Company of $8,412,000. The Company recognized the full balance as a marketing expense in the year ended January 31, 2001 due to the cancellation of this arrangement. On January 22, 2001, Company closed an Agreement and Plan of Merger with Online Transaction Technologies, Inc., a California corporation ("OTT"). The aggregate purchase price payable at Closing was 1,089,389 shares of the Company's common stock. The number of shares was calculated based on a specific formula in the Merger Agreement. Such aggregate price shall be subject to adjustment based on reductions or increases in the net book value of the assets of OTT since September 30, 2000. As a result of the acquisition, including direct expenses related to the transaction, goodwill was recorded in the amount of $4,592,863. In connection with the Closing, two key employees of OTT were granted options to purchase 100,000 shares each of the Company's common stock which vest over 24 months and have an exercise price of $6.41 per share. 45 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) 11. BASIC LOSS AVAILABLE TO SHAREHOLDERS Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period. The loss available to common shareholders for the years ended January 31, 2001 and 2000 is the net loss for the period, adjusted for deemed non-cash dividends on preferred stock. The following table is a calculation of basic and diluted earnings/(loss) per share:
2001 2000 --------------- --------------- Net loss $ ( 27,598,762) $( 5,523,294) Less - deemed non-cash dividend to preferred shareholders ( 14,495,884) -- --------------- --------------- Basic loss available to common shareholders $ ( 42,094,646) $( 5,523,294) =============== ===============
Weighted average common shares outstanding for dilution purposes do not take into account the exercise of options or warrants because to do so would be antidilutive. 12. COMMITMENTS AND CONTINGENCIES LEASES The Company leases its main office facilities under a noncancellable operating lease agreement expiring March 31, 2002. The Company leases a second facility in Bothell, Washington, under a noncancellable operating lease expiring October 31, 2002. The Company is in the process of finding a sub-lessee to assume the liability, however, the estimated liability is included below. The company has a third location in Los Angeles, California under a noncancellable operating lease expiring April 6, 2002. The future minimum rent expense that will be incurred under operating leases are as follows:
2001 $407,505 2002 165,537 2003 -- 2004 -- -------- $573,042 ========
Rent expense for the years ended January 31, 2001 and 2000 was $243,315 and $114,221, respectively. EMPLOYMENT AGREEMENTS The Company has employment agreements with two officers at the rate of $125,000 per year. The employment agreements are "at will"; however, the Company has agreed to a severance payment of the greater of the base year through the first anniversary of the date of employment or twelve weeks of the salary in effect at the date of termination. In no event shall the Company be required to make any severance payment unless and until the employee executes a general release, discharging the Company of any claims related to said employment. In addition, the company agreed to pay employment bonuses to the two officers, of $50,000 each, within 30 days of the fiscal year ended January 31, 2001. 46 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) LEGAL On October 23, 2000, the Company filed a suit for fraudulent misrepresentation, fraudulent concealment, rescission and mutual mistake, seeking to rescind a contract the Company entered into with Vitria Technology, Inc. ("Vitria") in February 2000. Subsequent to January 31, 2001, Vitria denied the substantive allegations in the complaint and seeks the award of monetary damages against the Company for breach of contract. Because discovery is in the early stages, it is not possible for the Company to evaluate the likelihood of an outcome. On April 10, 2001, the Santa Clara County Superior Court granted Vitria's request for a writ of attachment in the sum of $600,000 to secure potential recovery in this case. (See Note 13 - Subsequent Events) FILING OF REGISTRATION STATEMENT The Company was obligated to register the shares of Common Stock underlying the Series 2-A Preferred and the warrants held by the holders of the Series 2-A Preferred. The registration statement was required to be effective on or before January 16, 2001 or the Company must issue to each holder of Series 2-A Preferred an additional warrant to purchase Common Stock in an aggregate amount equal to two percent (2%) of the registrable shares held by such holder for each thirty day period this registration statement was not effective by January 16, 2001. The SB-2 Registration statement was filed on December 29, 2000 and brought effective January 11, 2001. (See Note 13 - Subsequent Events) 13. SUBSEQUENT EVENTS On March 12, 2001, the Company announced it had received resignations of the Chairman of the Board and Chief Executive Officer, Robert C. McShirley, and the Chief Operating Officer, P. Scott Turner, and Director, Samuel E. Bradt. On the same date the Company announced that it was withdrawing its VSN product, closing its Bothell, Washington development center, and would lay off at least of 60% of its workforce. It also announced that it would move forward with the recently acquired LiquidMarketplace(TM) product line while evaluating other strategic alternatives. In the quarter ended January 31, 2001, the Company reversed $165,000 of VSN related revenue recorded during the nine months ended October 31, 2000. On February 26, 2001, the board of directors named I. Steven Edelson as Acting Chairman of the Board. Mr. Edelson is a Managing partner of Mercantile Capital Group, LLC, one of the largest individual shareholders of the Company. On March 8, 2001, in accordance with the above mentioned resignations, the Company approved a revision of the notes receivable from officers. The notes receivable from Robert C. McShirley are collectively collateralized by 300,000 shares of the Company stock as sole recourse. The terms of the notes receivable from Robert C. McShirley were extended to August 27, 2001. The notes receivable from P. Scott Turner are collectively collateralized by 19,507 shares of the Company stock and all associated warrants, as sole recourse. The Turner note for $50,000, per the terms of the agreement, shall become payable on demand, 60 days from the last day of employment. The Turner note for $124,000 shall become payable on demand, 90 days from the last day of employment. Due to pending inquiries by its board of directors leading to the March 12, 2001 announcement, on February 7, 2001, the Company suspended registration of its securities under the Form SB-2 registration statement referenced in Note 11 above. The Company plans to file an amended registration statement on Form S-3 subsequent to the filing of the Company's annual report on Form 10-KSB for the year-end January 31, 2001. The Company was engaged in a lawsuit with Vitria Technology, Inc. as of the year ended January 31, 2001, as referenced in Note 11 - LEGAL. On April 10, 2001, the Santa Clara County Superior Court granted Vitria's request for a writ of attachment in the sum of $600,000 to secure potential recovery in this case. This was executed on April 20, 2001. Because discovery is in the early stages, it is not possible for the Company to evaluate the likelihood of an outcome. 47 VSOURCE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 31, 2001 (Restated) On April 24, 2001, the Company received notice from Nasdaq, citing the Company's failure to maintain a minimum bid price of $1.00 per share of common stock over the previous 30 consecutive trading days. The Company will be given until July 23, 2001 to regain compliance. If the Company is unable to demonstrate compliance with the minimum bid price requirement for at least ten consecutive trading days prior to July 23, 2001, the Nasdaq staff will issue notification to the Company that its securities will be delisted. In addition, the Company received a second notice of noncompliance on May 3, 2001 asserting that the Company's common stock has failed to maintain a minimum market value of public float ("MVPF") of $5,000,000 over the last 30 trading days preceding the notice. If the Company is unable to demonstrate compliance with the minimum MVPF requirement for at least ten consecutive trading days prior to August 1, 2001, the Nasdaq staff will issue notification to the Company that its securities will be delisted. 14. RESTATEMENT OF FINANCIAL STATEMENTS The consolidated balance sheets at January 31, 2001 and 2000 have been changed to reflect a reclassification of Series 1-A and Series 2-A Convertible Preferred Stock, previously included in Shareholders' equity (deficit) and now shown as preferred stock at January 31, 2001, in accordance with EITF-D98 issued July 2001. The deemed non-cash dividend to preferred shareholders was restated from $13,499,177 to $14,495,884 for the year ended January 31, 2001. Net loss per share available to common shareholders increased from ($2.57) to ($2.63) as a result of the restatement. 15. SUBSEQUENT EVENT (UNAUDITED) The Company has received letters from Nasdaq stating, inter alia, that Nasdaq has determined that the company's acquisition of Netcel360 constituted a reverse merger. The Company disagrees with Nasdaq's determination and has made a submission to Nasdaq refuting this determination. The Company has prepared these financial statements as if the acquisition of Netcel360 is an acquisition and not a reverse merger. The Company has been granted an oral hearing before a Nasdaq Listing Qualifications Panel (the "Panel") scheduled for September 28, 2001 to inter alia appeal this determination. Should the Company be unsuccessful in respect of this issue at the Panel meeting then it is highly likely that the Company would need to restate its financial statements in respect of the transaction with Netcel360 to account for it as a reverse merger and, accordingly, the financial statements of the Company will then revert to the financial statements of Netcel360 as of the acquisition date. Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. On February 8, 2000, the Audit Committee of Vsource's Board of Directors accepted the resignation of Lucas, Horsfall, Murphy & Pindroh, LLP as Vsource's independent public accountants with respect to the audit of Vsource's consolidated financial statements for the fiscal year ended January 31, 2000 (the "2000 Audit"). On February 8, 2000, the Audit Committee also selected and appointed Grant Thornton LLP ("GT") to serve as Vsource's independent public accountants with respect to the 2000 Audit. Neither the report of GT with respect to the 2000 Audit nor the reports of Lucas, Horsfall, Murphy & Pindroh, LLP with respect to the audits of Vsource's consolidated financial statements for the fiscal years ended January 31, 1999 or January 31, 1998 contained an adverse opinion or a disclaimer of opinion, or were qualified or modified as to uncertainty, audit scope, or accounting principles. In addition, during Vsource's fiscal years ended January 31, 2000 and January 31, 1999 and through February 8, 2000 there were no disagreements with Lucas, Horsfall, Murphy & Pindroh, LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure with respect to Vsource's consolidated financial statements, which disagreements, if not resolved to the satisfaction of Lucas, Horsfall, Murphy & Pindroh, LLP, would have caused it to make reference to the subject matter of the disagreements in connection with its reports. 48 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Our directors and executive officers, as of May 11, 2001, are as follows:
Name Age Principal Position with Registrant ------------------- --- ------------------------------------------------ I. Steven Edelson 41 Acting Chairman of the Board Scott T. Behan 39 Director Ramin Kamfar 37 Director Robert N. Schwartz 61 Director Nathaniel Kramer 39 Director Sandford T. Waddell 60 Chief Financial Officer, Treasurer and Secretary Michael Shirman 38 Chief Technology Officer Colin Kruger 39 Vice President, Business Development
I. STEVEN EDELSON. Mr. Edelson has served on the Company's board since January 2001 and was elected Acting Chairman in March 2001. Mr. Edelson has been Managing Director of Mercantile Companies, Inc., Northbrook, Illinois, since 1986. He is also a principal of Mercantile Capital Group, LLC, and he is the Managing Partner of Mercantile Capital Partners I, LP. SCOTT T. BEHAN. Mr. Behan has served on the Company's board since August 1998. For the past five years, Mr. Behan has been employed as the Executive Vice President of AML Communications, Inc., a manufacturer of wireless amplifiers. He has been a director of AML since February 1999. Mr. Behan has a B.S. in Electrical Engineering from Worcester Polytechnic Institute. RAMIN KAMFAR. Mr. Kamfar has served on the Company's board since April 2000. Mr. Kamfar is a Managing Partner at New World Venture Partners, Inc., an investment banking boutique focusing on technology and new economy companies. Since 1993, Mr. Kamfar has also served in various capacities at New World Coffee- Manhattan Bagel, Inc., a company he founded. Most recently he has served as Chairman and Chief Executive Officer. From 1988 to 1993 Mr. Kamfar worked in the investment banking department of Lehman Brothers, Inc., most recently as a Vice President in private placements. Mr. Kamfar has a B.S. in Finance from the University of Maryland and an M.B.A. in Finance from The Wharton School at the University of Pennsylvania. ROBERT N. SCHWARTZ. Dr. Schwartz has served on the Company's board since August 1998. From 1979 to the present, Dr. Schwartz has been a visiting professor at U.C.L.A. From 1981 to 2000, Dr. Schwartz was a Senior Research Scientist at HRL Laboratories, LLC, Malibu, California. He has a B.A. in Mathematics, Chemistry and Physics, and an M.S. in Chemical Physics from the University of Connecticut, and a PhD. in Chemical Physics from the University of Colorado. NATHANIEL C. A. KRAMER. Mr. Kramer has served on the Company's Board since January 2001. Mr. Kramer is a principal of Mercantile Capital Group, LLC and is Managing Director of its New York office. From 1999 to 2000 he was a vice president with Allen & Company, Inc., a private equity firm. From 1994 to 1999 he was president and CEO of Greenhouse Film Group Limited and is currently Chairman. Mr. Kramer produced the Emmy nominated documentary "Choices" and the Tony Award winning 1998 revival of Arthur Miller's "A View From the Bridge. SANDFORD T. WADDELL. Mr. Waddell has served as the Company's Chief Financial Officer and Secretary since March 2000. From October 1999 to March 2000, Mr. Waddell served as the Chief Financial Officer for Snyder Diamond, Inc., a privately owned retail company. From March 1998 to October 1999, Mr. Waddell served as Chief Financial Officer for Rampage Clothing Company, a privately held clothing manufacturer which was in bankruptcy, and for which he helped to restore to profitability and effected a successful reorganization. From October 1966 to March 1988, Mr. Waddell served initially as Chief Financial Officer and later also as Interim Chief Executive Officer at Reddi Brake Supply Corporation, a wholesale auto parts distributor, where he directed a reorganization of the company's operating subsidiary. From February 1992 to October 1996, Mr. Waddell served as Interim Chief Financial Officer or Financial Consultant for approximately twelve privately held companies. Mr. Waddell holds a B.S. in Engineering from Michigan Technological University and an M.B.A. from University of Minnesota. 49 MICHAEL SHIRMAN. Mr. Shirman joined the Company in January 2001 as a result of the merger with Online Transaction Technologies, Inc. ("OTT"). As a co-founder of OTT, he has over 15 years of experience in the Information Technology industry. Prior to the formation of OTT in 1999, Mr. Shirman was CEO and co-founder of CODA Software, a developer of custom e-Commerce software, served as President of InterSoft Consulting, a firm specializing in vertical business applications, and held senior development and managerial positions in the banking, manufacturing, publishing, finance, distribution, and telecommunications industries. Mr. Shirman holds a Masters Degree in Electrical Engineering (Telecommunications) from the Institute of Telecommunication Technology in Leningrad (St. Petersburg) and a Masters Degree in Computer Science from the Leningrad (St. Petersburg) Polytechnic Institute. COLIN KRUGER. Mr. Kruger joined the Company in January 2001 as a result of the merger with Online Transaction Technologies, Inc. ("OTT"). As a co-founder of OTT, he was responsible for business development, strategic relationships, and finance. Prior to OTT, Mr. Kruger was President of ZAUCTION, America Online's first auction and a top 100 web site he founded in 1995. Previously, Mr. Kruger was Vice President for the Glasser Group, Inc. and served as general manager for Recycled Computer Outlets, Inc., a Glasser Group subsidiary he founded. Earlier, Mr. Kruger held management roles with Equitable Real Estate Investment Management, Inc. Mr. Kruger holds a GSE in Economics from Christ's College, London, and a BS in Business Administration from San Diego State University. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act") requires the Company's directors and officers, and persons who beneficially own more than ten percent of our common stock, to file with the Securities and Exchange Commission ("SEC") reports of beneficial ownership and changes in beneficial ownership of common stock and other equity securities of the Company. Officers, directors and greater than ten-percent stockholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on the review of the copies of such reports furnished to the Company or written representations that no other reports were required, the Company believes that all Section 16(a) filing requirements applicable to its officers, directors and ten-percent stockholders were complied with in a timely fashion. 50 ITEM 10. EXECUTIVE COMPENSATION The following summary compensation table sets forth information regarding the compensation for the last three completed fiscal years of (a) the person who served as Chief Executive Officer of the Company during the most recent fiscal, (b) the mostly highly compensated executive officers other than the Chief Executive Officer who were serving as executive officers as of January 31, 2001, and (c) another executive officer who would have been among the highest paid executive officers if he had been an executive officer as of January 31, 2001 (the "Named Executive Officers").
SUMMARY COMPENSATION TABLE Fiscal Annual Compensation Long-Term Compensation Year ------------------------ ------------------------ Ended Restricted Securities Name and Jan. Stock Underlying All Other Principal Position 31, Salary Bonus Awards Options/SARs Compensation ------------------------------ ------ ----------- ----------- ---------- ------------- -------------- +Robert C. McShirley 2001 $ 147,115 $ 0 0 0 $ 115,000(1) Former Chief Executive 2000 114,000 0 0 200,000(2) 0 Officer 1999 63,750 0 0 80,000(3) 0 2001 $ 147,115 $ 0 0 0 $ 48,000(4) +Richard McShirley 2000 110,250 0 0 85,000(5) 0 Former Vice President 1999 90,000 0 0 35,000(6) 0 2001 $ 105,629 $ 0 0 125,000 0 Sandford T. Waddell(7) 2000 0 0 0 0 0 Chief Financial Officer 1999 0 0 0 0 0 +Ronald Sanderson(8) 2001 $ 104,500 $ 0 0 0 0 Former Vice President of 2000 33,312 0 0 125,000 0 Marketing 1999 0 0 0 0 0
--------------------- + No longer employed by the Company (1) Represents the forgiveness of amounts that had been advanced to Robert McShirley by the Company and related payments to compensate Mr. McShirley for the tax consequences of such advances. (2) Options to purchase 100,000 shares of common stock were granted May 15, 1999, with an exercise price of $0.75 per share. In addition, options to purchase 100,000 shares of common stock granted on August 4, 1998, were repriced on May 15, 1999. (3) Options granted August 4, 1998, and exercised May 25, 1999. The options had an exercise price of $1.25 per share and were repriced to $0.625 per share on May 15, 1999. (4) Represents the forgiveness of amounts that had been advanced to Richard McShirley by the Company and related payments to compensate Mr. McShirley for the tax consequences of such advances. (5) Options to purchase 50,000 shares of common stock were granted May 15, 1999, with an exercise price of $0.75 per share. In addition, options to purchase 35,000 shares of common stock granted on August 4, 1998, were repriced on May 15, 1999. (6) Options granted August 4, 1998, and exercised May 25, 1999. The options had an exercise price of $1.25 per share and were repriced to $0.625 per share on May 15, 1999. (7) Mr. Waddell joined the Company in March 2000. (8) Mr. Sanderson was employed by the Company from September 1999 to December 2000. OPTIONS The following table sets forth certain information with respect to each Named Executive Officer concerning individual grants of options to purchase common stock made during the year ended January 31, 2001: 51
OPTION GRANTS IN LAST FISCAL YEAR (Individual Grants) % of Total Number of Options Shares Granted to Exercise of Name and Underlying Employees in Base Price Expiration Principal Position Options Granted Fiscal Year Per Share Date ----------------------------------- --------------- ------------- ------------ ---------- +Robert C. McShirley 0 0 - - Former Chief Executive Officer +Richard McShirley 0 0 - - Former Vice President Sandford T. Waddell 125,000 12% $ 2.50 3/1/10 Chief Financial Officer +Ronald Sanderson 0 0 - - Former Vice President
-------------------- + No longer employed by the Company. The following table sets forth certain information with respect to each Named Executive Officer concerning unexercised options to purchase common stock held as of end of the fiscal year ended January 31, 2001. None of the Named Executive Officers exercised any options to purchase common stock during such fiscal year.
FISCAL YEAR-END OPTION/SAR VALUES Number of Securities Underlying Value of Unexercised Unexercised Options at In-the-Money Options Name January 31, 2001 January 31, 2001(1) ---- -------------------------- ---------------------------- Exercisable Unexercisable Exercisable Unexercisable ----------- ------------- ------------ -------------- +Robert C. McShirley 50,000 50,000 $ 75,000 $ 75,000 Former Chief Executive Officer +Richard McShirley 25,000 25,000 $ 37,500 $ 37,500 Former Vice President Sandford T. Waddell 46,875 78,125 - - Chief Financial Officer +Ronald Sanderson 93,750 31,250 $ 36,875 $ 110,625 Former Vice President of Marketing
------------------------ + No longer employed by the Company. (1) Value is calculated in accordance with the rules of the SEC by subtracting the exercise price per share for each option from the fair market value of the underlying common stock as of January 31, 2001 and multiplying that difference by the number of shares of common stock subject to the option. The fair market value of one share of common stock as of January 31, 2001 was $2.25 per share. 52 DIRECTORS' COMPENSATION Upon election to the Board of Directors in April 2000, Ramin Kamfar was granted 2,500 shares of the Company's common stock. The Company does not currently offer any other compensation to the directors. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Common Stock The following table sets forth certain information as of April 30, 2001 regarding the beneficial ownership of the common stock by (i) all individuals known to beneficially own 5% or more of the outstanding common stock, (ii) each of the Named Executive Officers (as defined above under Executive Compensation) and directors and (iii) all of the Company's executive officers and directors as a group, in each case, to the best of the Company's knowledge. Except as otherwise indicated, the Company believes that the beneficial owners of the securities listed below have sole investment and voting power with respect to such shares. As of April 30, 2001, there were 18,685,814 shares of common stock outstanding.
Number of Shares Beneficially Percent of Percent of Total Name of Beneficial Owner Owned Class Outstanding ** ------------------------------------------ ----------------- ----------- ----------------- Trusthouse 86 Ltd. 1,030,069(1) 5.50% 4.72% 4660 La Jolla Village Drive Suite 480 San Diego, CA 92122 I. Steven Edelson 773,336(2) 4.14% 3.54% 1372 Shermer Road Northbrook, IL 60062 Nathaniel C. A. Kramer 678,337(3) 3.63% 3.11% 641 Lexington Avenue Suite 1450 New York, NY 10022 Ramin Kamfar 2,500 * * 666 Greenwich St., #710 New York, NY 10014 Scott Behan 10,240 * * P.O. Box 1244 Somis, CA 91384 Robert N. Schwartz 19,647 * * UCLA, Dept. of Chemistry and Biochemistry 1224 Young Hall, 607 Circle Drive South Los Angeles, CA 90095 +Robert C. McShirley 867,442(4) 4.63% 3.97% 4536 Falkirk Bay Oxnard, CA 93035 +Richard S. McShirley 380,918(5) 2.04% 1.74% 794 Hot Springs Road Santa Barbara, CA 93108 Sandford T. Waddell 88,906(6) * * 5740 Ralston St., Suite 110 Ventura, CA 93003 +Ronald J. Sanderson 93,750(7) * * 1425 London Lane Glenview, IL 60025 Executive Officers and Directors 2,751,505(8) 13.80% 12.60% as a group (11 individuals)
53 ------------------------ * Less than 1%. ** Based on 21,840,095 shares of common stock outstanding as of April 30, 3001, which is derived from (i) 18,685,814 shares of common stock, (ii) 1,804,105 shares of Series 1-A Preferred Stock converted into common stock on a 1:1 basis and (iii) 1,350,176 shares of Series 2-A Preferred Stock converted into common stock on a 1:1 basis. + No longer employed by the Company. (1) Includes 38,374 shares of common stock issuable upon conversion of 38,374 shares of Series 1-A Preferred Stock. (2) Solely in his capacity as (a) a managing member of Mercantile Equity Partners III, LLC ("MEP, LLC"), and a trustee of the Edelson Family Trust dated September 17, 1997, which is also a managing member of MEP, LLC, (b) a member of Mercantile Capital Group, LLC ("MCG"), and (c) a member of the Investment Committee of Mercantile Capital Management Corp. ("MCM"). MCG is the general partner of Mercantile Capital Partners I, L.P ("MCP"). MEP, LLC is the general partner of Mercantile Equity Partners III, L.P. ("MEP, LP"). MEP, LP directly holds 91,161 shares of Series 1-A Preferred Stock, which are convertible into 91,161 shares of common stock. MCP directly holds 624,025 shares of Series 2-A Preferred Stock, which are convertible into 624,025 shares of common stock, and has a Warrant to purchase 54,312 shares of common stock. In addition, Mr. Edelson is the trustee of the Mercantile Companies Inc. Money Purchase Plan, which holds 3,838 shares of Series 1-A Preferred Stock, which are convertible into 3,838 shares of common stock. (3) Solely in his capacity as (a) a member of MCG and (b) a member of the Investment Committee of MCM. MCG is the general partner of MCP. MCP directly holds 624,025 shares of Series 2-A Preferred Stock, which are convertible into 624,025 shares of common stock, and has a Warrant to purchase 54,312 shares of common stock. (4) Includes 50,000 shares of common stock subject to options exercisable within 60 days of April 30, 2001. (5) Includes 25,000 shares of common stock subject to options exercisable within 60 days of April 30, 2001. (6) Includes (i) 19,501 shares of common stock issuable upon the conversion of 19,501 shares of Series 2-A Preferred Stock, (ii) 1,697 shares of common stock issuable upon the exercise of Warrants, and (iii) 67,708 shares of common stock subject to options exercisable within 60 days of April 30, 2001. (7) Includes 93,750 shares of common stock subject to options exercisable within 60 days of April 30, 2001. (8) Includes a total of (i) 738,525 shares of common stock issuable upon the conversion of Series 1-A and Series 2-A Preferred Stock, and (ii) 292,467 shares of common stock subject to options or warrants exercisable within 60 days of April 30, 2001. Preferred Stock Series 1-A Convertible Preferred Stock The Series 1-A Preferred Stock votes as a single class with the common stock, with each share entitled to the number of votes equal to that number of shares of common stock into which it would then be converted. The Series 1-A Preferred Stock is currently convertible on a 1:1 basis into common stock. The following table sets forth certain information as of April 30, 2001 regarding the beneficial ownership of Series 1-A Preferred Stock by (i) all individuals known to beneficially own 5% or more of the outstanding shares of such class of security, (ii) each of the Named Executive Officers (as defined above under Executive Compensation) and directors who own any shares of Series 1-A Preferred Stock and (iii) all of the Company's executive officers and directors as a group, in each case to the best of the Company's knowledge. As of April 30, 2001, there were 1,804,105 shares of Series 1-A Preferred Stock outstanding. 54
Number of Shares Beneficially Percent of Percent of Total Name of Beneficial Owner Owned Class* Outstanding ** ---------------------------------- ----------------- ----------- ---------------- 787, LLC 191,918 10.64% * c/o James F. Voelker 9919 S.E. Fifth Street Bellvue, WA 98004 Jeffries Employees Merchant 136,318 7.56% * Banking Fund LLD 11100 Santa Monica Blvd. Los Angeles, CA 90025 Denmore Investments Ltd 115,151 6.38% * C/o Refco Securities One World Financial Center 200 Liberty St., Tower A New York, NY 10281 Qwest Investment Company 115,151 6.38% * 1801 California St., Ste. 5100 Denver, CO 80202 Fidelity National Title Insurance 95,959 5.32% * Company of New York 3916 State Street, Suite 28 Santa Barbara, CA 93105 The R S Orphan Fund LP 95,383 5.29% * C/o RS Investment Mgmt. 388 Market Street Nbr 200 San Francisco, CA 94111 Mercantile Equity Partners III LP 91,161(1) 5.05% * 1372 Shermer Road Northbrook, IL 60062 I. Steven Edelson 94,999(2) 5.27% * 1372 Shermer Road Northbrook, IL 60062 Executive officers and directors 94,999 5.27% * as a group (11 individuals)
------------------------ * Less than one percent (1%) ** Based on 21,840,095 shares of common stock outstanding as of April 30, 3001, which is derived from (i) 18,685,814 shares of common stock, (ii) 1,804,105 shares of Series 1-A Preferred Stock converted into common stock on a 1:1 basis and (iii) 1,350,176 shares of Series 2-A Preferred Stock converted into common stock on a 1:1 basis. (1) These shares are also beneficially owned by MEP, LLC, its general partner, and Michael A. Reinsdorf, as a managing member of MEP, LLC. (2) Solely in his capacity as (i) a managing member of MEP, LLC and a trustee of the Edelson Family Trust dated September 17, 1997, which is also a managing member of MEP, LLC, and (ii) the trustee of the Mercantile Companies Inc. Money Purchase Plan which holds 3,838 shares of Series 1-A Preferred Stock. Series 2-A Convertible Preferred Stock The Series 2-A Preferred Stock votes as a single class with the common stock, with each share entitled to the number of votes equal to that number of shares of common stock into which it would then be converted. The Series 2-A Preferred Stock is currently convertible on a 1:1 basis into common stock. The following table sets forth certain information as of April 30, 2001 regarding the beneficial ownership of Series 2-A Preferred Stock by (i) all individuals known to beneficially own 5% or more of the outstanding shares of such class of security, (ii) each of the Named Executive Officers (as defined above under Executive Compensation) and directors who own any shares of Series 2-A Preferred Stock and (iii) all of the Company's executive officers and directors as a group, in each case to the best of the Company's knowledge. As of April 30, 2001, there were 1,350,176 shares of Series 2-A Preferred Stock outstanding. 55
Number of Shares Percent of Beneficially Percent of Total Name of Beneficial Owner Owned Class* Outstanding** --------------------------------- ----------------- ----------- -------------- Mercantile Capital Partners I LP 624,025(1) 46.21% 2.86% 1372 Shermer Road Northbrook, IL 60062 Stonehill Partners LP 156,006 11.55% * C/o WHX Corporation 110 East 59th Street New York, NY 10022 Crestview Capital Fund LP 132,605 9.82% * C/o Dillion Capital 3000 Dundee Road, Suite 105 Northbrook, IL 60062 I. Steven Edelson 624,025(2) 46.21% 2.86% 1372 Shermer Road Northbrook, IL 60062 Nathaniel C. A. Kramer 624,025(3) 46.21% 2.86% 641 Lexington Avenue Suite 1450 New York, NY 10022 Sandford T. Waddell 19,501 1.44% * 5740 Ralston St., Suite 110 Ventura, CA 93003 Executive officers and directors 643,526 47.66% 2.95% as a group (11 individuals)
------------------------ * Less than one percent (1%) ** Based on 21,840,095 shares of common stock outstanding as of April 30, 3001, which is derived from (i) 18,685,814 shares of common stock, (ii) 1,804,105 shares of Series 1-A Preferred Stock convertible into common stock on a 1:1 basis and (iii) 1,350,176 shares of Series 2-A Preferred Stock convertible into common stock on a 1:1 basis. (1) These shares are also beneficially owned by (i) MCG, the general partner of MCP, (ii) MCM, a manager of MCG, and (iii) Michael A. Reinsdorf, a member of MCP and a member of the Investment Committee of MCM. (2) Solely in his capacity as a member MCG and a member of the Investment Committee of MCM. (3) Solely in his capacity as a member of MCG and a member of the Investment Committee of MCM. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS NetCel360 Acquisition On May 24, 2001, the Company entered into an Acquisition Agreement with NetCel360 Holdings Limited, a Cayman Islands company ("NetCel360"), providing for the acquisition by the Company of substantially all assets of NetCel360 in exchange for approximately 19.9% of the Company's common shares and the assumption by the Company of approximately $3.45 million of bridge financing. The acquisition is expected to close in June 2001. Asia Internet Investment Group I, L.P. owns approximately 2.8% of NetCel360 and has provided approximately 8.5% of the bridge financing that the Company will assume in the proposed transaction. I. Stephen Edelson, the Acting Chairman of the Board of the Company, and Nathaniel Kramer, a director of the Company, are two of the managers of the general partner of AIIG. Notes Receivable 56 The Company has unsecured notes receivables from several former and current officers and directors which totaled $426,798 as of January 31, 2001. Certain of these notes, totaling $178,798, were granted in connection with the exercise of 636,100 stock options in May 1999 by the following executive officers and directors of the Company, each of whom resigned from the Company in March 2001: Robert McShirley, the Company's former Chief Executive Officer, Richard McShirley, the Company's former Vice President, and Samuel Bradt, a former director of the Company. The aggregate outstanding principal balance of Robert McShirley's notes at January 31, 2001, was $68,164; the aggregate outstanding principal balance of Richard McShirley's notes at January 31, 2001, was $101,259; and the aggregate outstanding principal balance of Mr. Bradt's notes at January 31, 2001, was $9,375. These notes, as of January 31, 2000, were unsecured, due on demand and bear interest at an annual rate of 6%. The remainder of the notes, in aggregate principal amount of $248,000, were granted in September 2000 in connection with the issuance of 19,501 shares of Series 2-A Preferred Stock to each of Sandford Waddell, the Company's Chief Financial Officer, and Mr. Turner, the Company's former Chief Operating Officer. The notes are secured by the shares of related stock, bear interest at an annual rate of 8% and are due on September 15, 2003. The total outstanding principal balance of Mr. Waddell's note at January 31, 2001, was $124,000, and the total outstanding principal balance of Mr. Turner's note at January 31, 2001, was $124,000. On March 8, 2001, in connection with Mr. Turner's resignation, the terms of Mr. Turner's note were revised to provide that (a) the note shall become payable on demand 90 days from the last day of employment and (b) all notes would be collateralized by 19,501 shares of Series 2-A Preferred Stock held by Mr. Turner as the Company's sole recourse. In October 2000, Robert McShirley borrowed $400,000 from the Company in exchange for a secured ninety-day promissory note which bears interest at a rate of 8% per annum and was due on January 9, 2001. The note receivable from Robert C. McShirley is collateralized by 300,000 shares of the Company stock as sole recourse. In late October 2000, Mr. McShirley repaid the Company $250,000 of the original balance, leaving a balance of $150,000. On January 30, 2001, the Company's board of directors approved an extension of this note for 90 days. On March 8, 2001, in connection with Mr. McShirley's resignation, the terms of the notes were extended to August 27, 2001, and were collectively collateralized by 300,000 shares of common stock held by Mr. McShirley as the Company's sole recourse. Also in October 2000, Mr. Turner borrowed $50,000 from the Company in exchange for a two-year promissory note which bears interest at a rate of 8%per annum and is due on October 12, 2002. On March 8, 2001, in connection with Mr. Turner's resignation, the terms of the note were revised to provide that (a) the note shall become payable on demand 60 days from the last day of employment, and (b) all notes would be collateralized by 19,501 shares of Series 2-A Preferred Stock held by Mr. Turner as the Company's sole recourse. Convertible Notes The Company has issued convertible demand notes, from time to time, each in a private transaction. In July 1999, Robert McShirley received an aggregate of 245,317 shares of common stock upon the conversion of notes held by him in the principal amount of $95,600. Also in July 1999, Richard McShirley received an aggregate of 188,116 shares of Common Stock upon the conversion of notes held by him in the principal amount of $33,100. Other Transactions In connection with the issuance of Series 1-A Preferred Stock, the Company issued to New World Investment Partners a warrant to purchase 60,000 shares of the Company's common stock. Subsequently to the issuance of the warrant, Ramin Kamfar, a principal of New World Investment Partners, was elected to the Company's Board of Directors. In December 2000, New World Investment Partners received 43,957 shares of common stock, pursuant to a cashless exercise of the warrant. These shares were subsequently transferred by New World Investment Partners to a third party. 57 Item 13. EXHIBITS AND REPORTS ON FORM 8-K EXHIBITS The Company will furnish a copy of any exhibit listed below upon written request of any shareholder receiving these materials without charge. Exhibit No. Description ----------- ----------- (a) Exhibits:
Exhibit No. Description ------------ ----------- 3.1(*) Certificate of Incorporation incorporated herein by reference to Exhibit 3.1 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000-30326) 3.2(*) Bylaws incorporated herein by reference to Exhibit 3.2 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000-30326) 4.1(*) Certificate of Designation of Series 2-A Convertible Preferred Stock incorporated herein by reference to Exhibit 4.1 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000- 30326) 4.2(*) Certificate of Merger incorporated herein by reference to Exhibit 4.2 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000-30326) 4.3(*) Form of Series 3 Convertible Demand Note incorporated herein by reference to Exhibit 3.2 to Registrant's Registration Statement on Form 10-SB filed on September 21, 1999 (SEC File No. 000- 26563) 4.4(*) Form of Series 2 Convertible Demand Note incorporated herein by reference to Exhibit 3.3 to Registrant's Registration Statement on Form 10-SB filed on September 21, 1999 (SEC File No. 000- 26563) 4.5(*) Form of Common Stock Purchase Warrant incorporated herein by reference to Registrant's Form 8-K filed September 26, 2000 (SEC File No. 000-30326) 4.6(*) Form of Registration Rights Agreement incorporated herein by reference to Registrant's Form 8-K filed September 26, 2000 (SEC File No. 000-30326) 10.1(*) Ventura Professional Center First Amendment to Lease between Virtual Source, Inc. and Security National Properties, LLC, dated October 27, 1998 incorporated herein by reference to Exhibit 10.2 to Registrants Form 10-KSB filed May 11, 2000 (SEC File No. 000-30326) 10.2(*) Lease - Razore Land Company, Landlord and Interactive Buyers Network International, Tenant, dated October 11, 1999 incorporated herein by reference to Exhibit 10.3 to Registrants Form 10-KSB filed May 11, 2000 (SEC File No. 000-30326) 10.3(*) Promissory Note by Robert C. McShirley dated October 11, 2000 incorporated herein by reference to Exhibit 10.4 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.4(*) Pledge and Security Agreement with Robert C. McShirley dated October 11, 2000 incorporated herein by reference to Exhibit 10.5 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.5(*) Promissory Note by P. Scott Turner dated October 13, 2000 incorporated herein by reference to Exhibit 10.6 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.6(*) Promissory Note by Sandford T. Waddell dated September 18, 2000 incorporated herein by reference to Exhibit 10.7 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.7(*) Pledge and Security Agreement with Sandford T. Waddell dated September 18, 2000 incorporated herein by reference to Exhibit 10.8 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.8(*) Promissory Note by P. Scott Turner dated September 18, 2000 incorporated herein by reference to Exhibit 10.9 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.9(*) Pledge and Security Agreement with P. Scott Turner dated September 18, 2000 incorporated herein by reference to Exhibit 10.10 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.10(*) Agreement and Plan of Merger dated as of December 14, 2000 incorporated herein by reference to Exhibit 10.11 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.11(*) Supplement to merger agreement with Colin Kruger and Michael Shirman dated December 14, 2000(SEC File No. 000-30326) 10.12(*) Form of Warrant Holder Agreement with OTT Shareholders (SEC File No. 000-30326) 58 10.13(*) Form of Registration Rights Agreement with OTT Shareholders (SEC File No. 000-30326) 10.14(*) At Will Employment Agreement with Colin P. Kruger (SEC File No. 000-30326) 10.15(*) At Will Employment Agreement with Michael Shirman (SEC File No. 000-30326) 10.16(*) Office Lease between L.A.T. Investment Corporation and Online Transaction Technologies, Inc. dated March 7, 1999 (SEC File No. 000-30326) 10.17(*) First Amendment to Lease between L.A.T. Investment Corporation dated February 1, 2000 (SEC File No. 000-30326) 10.18(*) Alliance Agreement between Registrant and IBM dated September 18, 2000 (SEC File No. 000- 30326) 10.19(*) IBM PartnerWorld Agreement - International Basic General Terms between OTT and IBM (SEC File No. 000-30326) 21.1(*) Subsidiaries of the Registrant (SEC File No. 000-30326) 99.1(*) Vsource, Inc. 2000 Stock Option Plan incorporated herein by reference to Exhibit 99.1 to Registrant's Form 10-QSB/A filed September 25, 2000 (SEC File No. 000-30326)
------------------------ * Previously filed with Securities and Exchange Commission. REPORTS ON FORM 8-K 1. The Company's Report on Form 8-K - Change in Registrant's Certifying Accountant, filed on February 14, 2000. 2. The Company's Report on Form 8-K - Other Events: Sale of Series 2-a Convertible Preferred Stock, filed on September 26, 2000. 3. The Company's Report on Form 8-K - Other Events: Preliminary Agreement to Acquire Online Transaction Technologies, Inc., filed on October 23, 2000. 4. The Company's Report on Form 8-K - Other Events: regarding Nasdaq listing and reincorporation in Delaware (SEC File No. 000-30326) filed November 14, 2000. 5. The Company's Report on Form 8-Changes in management, cost saving measures, change in business and product line and LiquidMarketplace (TM) product line (SEC File No. 000-30326); K filed March 20, 2001. 6. The Company's Report on Form 8-K - Other Events: Acquisition of assets with financial statements and exhibits regarding the acquisition of its subsidiary, Online Transaction Technologies, Inc. (SEC File No. 000-30326) filed on April 2, 2001. 59 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. Vsource, Inc. /s/ Phillip Kelly Date: February 20, 2002 -------------------------- Phillip Kelly Chief Executive Officer (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and dates indicated.
SIGNATURE TITLE DATE /s/ Phillip Kelly Chief Executive Officer February , 2002 -------------------------- Co-Chairman Phillip Kelly (Principal Executive Officer) /s/ Dennis Smith Vice-Chairman, Chief Financial Officer, February , 2002 -------------------------- Chief Strategy Officer Dennis Smith (Principal Accounting Officer) /s/ Scott T. Behan Director February 20, 2002 -------------------------- Scott T. Behan /s/ I. Steven Edelson Director February 20, 2002 -------------------------- I. Steven Edelson /s/ Ramin Kamfar Director February 20, 2002 -------------------------- Ramin Kamfar /s/ Nathaniel C. A. Kramer Director February 20, 2002 -------------------------- Nathaniel C. A. Kramer /s/ Robert N. Schwartz Director February 20, 2002 -------------------------- Robert N. Schwartz
60
EXHIBIT INDEX Exhibit No. Description ----------- ----------- 3.1(*) Certificate of Incorporation incorporated herein by reference to Exhibit 3.1 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000-30326) 3.2(*) Bylaws incorporated herein by reference to Exhibit 3.2 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000-30326) 4.1(*) Certificate of Designation of Series 2-A Convertible Preferred Stock incorporated herein by reference to Exhibit 4.1 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000-30326) 4.2(*) Certificate of Merger incorporated herein by reference to Exhibit 4.2 to Registrant's Form 8-K for the period ended October 30, 2000 (SEC File No. 000-30326) 4.3(*) Form of Series 3 Convertible Demand Note incorporated herein by reference to Exhibit 3.2 to Registrant's Registration Statement on Form 10-SB filed on September 21, 1999 (SEC File No. 000- 26563) 4.4(*) Form of Series 2 Convertible Demand Note incorporated herein by reference to Exhibit 3.3 to Registrant's Registration Statement on Form 10-SB filed on September 21, 1999 (SEC File No. 000- 26563) 4.5(*) Form of Common Stock Purchase Warrant incorporated herein by reference to Registrant's Form 8- K filed September 26, 2000 (SEC File No. 000-30326) 4.6(*) Form of Registration Rights Agreement incorporated herein by reference to Registrant's Form 8-K filed September 26, 2000 (SEC File No. 000-30326) 10.1(*) Ventura Professional Center First Amendment to Lease between Virtual Source, Inc. and Security National Properties, LLC, dated October 27, 1998 incorporated herein by reference to Exhibit 10.2 to Registrants Form 10-KSB filed May 11, 2000 (SEC File No. 000-30326) 10.2(*) Lease - Razore Land Company, Landlord and Interactive Buyers Network International, Tenant, dated October 11, 1999 incorporated herein by reference to Exhibit 10.3 to Registrants Form 10- KSB filed May 11, 2000 (SEC File No. 000-30326) 10.3(*) Promissory Note by Robert C. McShirley dated October 11, 2000 incorporated herein by reference to Exhibit 10.4 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.4(*) Pledge and Security Agreement with Robert C. McShirley dated October 11, 2000 incorporated herein by reference to Exhibit 10.5 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.5(*) Promissory Note by P. Scott Turner dated October 13, 2000 incorporated herein by reference to Exhibit 10.6 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.6(*) Promissory Note by Sandford T. Waddell dated September 18, 2000 incorporated herein by reference to Exhibit 10.7 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000- 30326) 10.7(*) Pledge and Security Agreement with Sandford T. Waddell dated September 18, 2000 incorporated herein by reference to Exhibit 10.8 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.8(*) Promissory Note by P. Scott Turner dated September 18, 2000 incorporated herein by reference to Exhibit 10.9 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.9(*) Pledge and Security Agreement with P. Scott Turner dated September 18, 2000 incorporated herein by reference to Exhibit 10.10 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.10(*) Agreement and Plan of Merger dated as of December 14, 2000 incorporated herein by reference to Exhibit 10.11 to Registrant's Form 10-QSB filed December 15, 2000 (SEC File No. 000-30326) 10.11(*) Supplement to merger agreement with Colin Kruger and Michael Shirman dated December 14, 2000(SEC File No. 000-30326) 10.12(*) Form of Warrant Holder Agreement with OTT Shareholders (SEC File No. 000-30326) 10.13(*) Form of Registration Rights Agreement with OTT Shareholders (SEC File No. 000-30326) 10.14(*) At Will Employment Agreement with Colin P. Kruger (SEC File No. 000-30326) 10.15(*) At Will Employment Agreement with Michael Shirman (SEC File No. 000-30326) 10.16(*) Office Lease between L.A.T. Investment Corporation and Online Transaction Technologies, Inc. dated March 7, 1999 (SEC File No. 000-30326) 10.17(*) First Amendment to Lease between L.A.T. Investment Corporation dated February 1, 2000 (SEC File No. 000-30326) 61 10.18(*) Alliance Agreement between Registrant and IBM dated September 18, 2000 (SEC File No. 000- 30326) 10.19(*) IBM PartnerWorld Agreement - International Basic General Terms between OTT and IBM (SEC File No. 000-30326) 21.1(*) Subsidiaries of the Registrant (SEC File No. 000-30326) 99.1(*) Vsource, Inc. 2000 Stock Option Plan incorporated herein by reference to Exhibit 99.1 to Registrant's Form 10-QSB/A filed September 25, 2000 (SEC File No. 000-30326)
------------------------ * Previously filed with Securities and Exchange Commission. 62