-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GJDCjoahf+aokWVGBWvDw9SFNtl8ZxbWeF9NtoMd1LlZOk1K8qA0l88Hh9yrk2i/ 7G2wRKjgTH/ymfFknDhoFg== 0000950144-99-004561.txt : 19990416 0000950144-99-004561.hdr.sgml : 19990416 ACCESSION NUMBER: 0000950144-99-004561 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VSI ENTERPRISES INC CENTRAL INDEX KEY: 0000846775 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 841104448 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10927 FILM NUMBER: 99595198 BUSINESS ADDRESS: STREET 1: 5801 GOSHEN SPRINGS RD CITY: NORCROSS STATE: GA ZIP: 30071 BUSINESS PHONE: 7702427566 MAIL ADDRESS: STREET 1: 5801 GOSHEN SPRINGS ROAD CITY: NORCROSS STATE: GA ZIP: 30071 FORMER COMPANY: FORMER CONFORMED NAME: FI TEK III INC DATE OF NAME CHANGE: 19910219 10-K 1 VSI ENTERPRISES, INC. 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------- FORM 10-K --------------------- Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 1998 ------------------------------ Commission File No. 1-10927 VSI ENTERPRISES, INC. A Delaware Corporation (IRS Employer Identification No. 84-1104448) 5801 Goshen Springs Road Norcross, Georgia 30071 (770) 242-7566 Securities Registered Pursuant to Section 12(b) of the Securities Exchange Act of 1934: None ---- Securities Registered Pursuant to Section 12(g) of the Securities Exchange Act of 1934: Common Stock, $.001 par value per share --------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of the common stock of the registrant held by non-affiliates of the registrant (10,703,808 shares) on March 30, 1999 was approximately $8,027,856, based on the closing price of the registrant's common stock as quoted on the Nasdaq SmallCap Market on March 30, 1999. For the purposes of this response, officers, directors and holders of 5% or more of the registrant's common stock are considered the affiliates of the registrant at that date. The number of shares outstanding of the registrant's common stock, as of March 30, 1999: 12,300,144 shares of $.001 par value common stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement to be delivered to shareholders in connection with for the 1999 annual meeting of shareholders scheduled to be held on June 11, 1999, are incorporated by reference in response to Part III of this Report. 1 2 PART I ITEM 1. BUSINESS. GENERAL VSI Enterprises, Inc. (the "Company"), through its wholly-owned subsidiaries, is in the videoconferencing and system integration business. The Company offers customers mission-critical solutions by supplying videoconferencing products and services to support video, voice and data applications. Its core business is the design, manufacture, marketing and servicing of interactive group videoconferencing and control systems (the "VSI Systems"). Each VSI System is designed with open software and modular subsystems which allow a VSI System to be expanded or reconfigured as technologies, user requirements or new applications evolve. The Company's products are designed to allow multiple participants at geographically dispersed sites to see and hear each other on live television and share graphical and pictorial information using standard commercially available telecommunications transmission facilities. The Company integrates standard video, audio and transmission components with its own proprietary video, audio and computer control components and software. The Company's open software and modular subsystems streamline production and allow the product to be tailored to meet customers' specific needs, with or without the necessity of custom design. The Company's lead products are marketed under the trade name Omega(TM). Customers are offered a variety of option packages to fit specific applications. Customers are also offered upgrade packages that make the Company's new products compatible with older models. To date, the Company has sold over 1,700 videoconferencing systems to approximately 325 customers, including Bank of America, Bell Atlantic, Boeing, Duracell, MCI, General DataComm and Johnson & Johnson; various foreign, U.S. and state government departments and agencies; educational institutions; and health care facilities. The Company was incorporated under the laws of Delaware on September 19, 1988 as Fi-Tek III, Inc. ("Fi-Tek") for the purpose of raising capital and to seek out business opportunities in which to acquire an interest. On August 21, 1990, the Company acquired 89.01% of the total common stock and common stock equivalents then issued and outstanding of Videoconferencing Systems, Inc., a Delaware corporation ("VSI"). VSI was founded in 1985 through the acquisition of a portion of the assets of a Sprint Corporation videoconferencing subsidiary. In December 1990, the Company changed its name from Fi-Tek III, Inc. to VSI Enterprises, Inc. During the first half of 1991, the Company acquired the remaining additional outstanding shares of common stock of VSI. In addition to its VSI subsidiary, the Company conducted its operations in 1998 through the following four subsidiaries: - - Videoconferencing Systems, n.v. ("VSI Europe") is a distributor of the Company's 2 3 videoconference systems in Europe. VSI Europe has offices located in London and Antwerp. - - VSI Solutions Inc. ("VSI Solutions") is a software company whose products include a reservation system for the management of videoconferencing systems. The Company expects to close VSI Solutions by July 1, 1999, upon the completion of a contract with a customer. - - VSI Network Services, Inc., d/b/a Integrated Network Services, Inc. ("INS") was engaged in the design, installation and support of local and wide area networks. INS was an integration firm specializing in the connectivity of multi-protocol environments, ranging from small, local area networks to large, enterprise-wide networks employing WAN technologies to connect multiple sites. INS discontinued operations in December, 1998. - - VSI Network Solutions, Inc., d/b/a Eastern Telecom, Inc. ("ETI") is a company engaged in the business of marketing and sales of telecommunications services and products. ETI sells network services such as Centrex, frame relay and basic rate interface, primary rate interface and ISDN connections on behalf of a number of major telecommunications providers. References to the Company herein refer to VSI Enterprises, Inc. and its consolidated subsidiaries, unless the context indicates otherwise. The Company operates through two primary reportable segments (i) videoconferencing and (ii) through its ETI subsidiary, telephone network reselling. See Note K to the Company's consolidated financial statements for certain financial information relating to these two segments. On January 15, 1999, the Company implemented a 1-for-4 reverse split of the shares of VSI Common Stock. All share and per share amounts included in this report reflect the effects of the reverse split. The Company's principal executive offices and manufacturing facilities are located at 5801 Goshen Springs Road, Norcross, Georgia 30071, and its telephone number is (770) 242-7566. VSI SYSTEMS & APPLICATIONS VSI Systems enable participants in multiple locations to hold interactive group meetings remotely, thus avoiding costly and time-consuming travel. Participants at any connected location can be seen and heard by all other participants. If the VSI System is equipped with the appropriate options, the participants can also utilize slides, graphs, plain paper drawings, computer-generated graphics, computer data, laser discs and video tape interactively. Unlike audio teleconferencing systems which only allow voice communications, audiographic teleconferencing which is limited to voice plus still images, and business television which does not provide for interaction among the participants (also known as one-way videoconferencing), the Company believes its VSI Systems foster the look and feel of live, face-to-face meetings and promote a natural interaction among the participants. A typical videoconference involves three major elements: (i) access to transmission services, (ii) a "codec" for coding/decoding digitized signal transmissions and (iii) the VSI System, which contains television monitors, cameras, audio system, microphones, cabinetry, various control systems for interfacing the components to the user, and various optional components specific to the user's application. As the name implies, codecs are used to encode and decode (or compress and decompress) various types of data -- particularly those that would otherwise use up inordinate amounts of disk space, such as sound and video files. Common codecs include those for converting analog video signals into compressed 3 4 video files (such as MPEG) or analog sound signals into digitized sound (such as RealAudio). Codecs can be used with either streaming (live video or audio) or files-based (AVI, WAV) content. The Company designs, manufactures, assembles, installs and services the VSI Systems, and it has nonexclusive marketing agreements with codec manufacturers to resell the codecs. Customers secure the transmission services independently though telecommunications carriers for either fixed monthly or hourly usage prices. These transmission services may vary, depending upon the customer's application and preferences, and include a range of transmission bandwidths. In general, the higher the bandwidth the better the quality of the transmitted images, although the choice of codec will affect image quality for a given speed. The VSI Systems operate over the range of available transmission bandwidths and are compatible with all major brands of codecs known by the Company to be currently available; they also operate without codecs, for certain specialized networks. The primary users of VSI's videoconferencing products and services are major corporations, government agencies, educational institutions and health care facilities. Corporate and government organizations often use meetings to provide information, review operations, make plans, resolve problems, introduce new ideas or products, conduct training sessions and communicate with customers and vendors. Such conventional group meetings usually require at least some of the participants to travel to the meeting site. When meetings are required on a frequent, repetitive or emergency basis, travel costs and productivity losses can be substantial. The VSI Systems provide users with the ability to hold two-way and multi-way meetings, often at significant savings over the costs of travel and lost productivity while traveling. As an added and in some cases a more important benefit, because travel time and costs are eliminated, it may be more economic for more people to participate via videoconferencing, thereby causing the direct dissemination of pertinent information to more parties simultaneously, which may improve efficiency in problem solving and decision making. The Company also supplies and installs the VSI Systems for use in educational and training settings to connect one or more distant classrooms with a centrally-based instructor. These "distance learning" applications of videoconferencing are used by corporations, state and federal governments, hospitals and clinics, high schools, technical school, colleges and universities. The Company also provides "judicial systems" to state and local governments. Judicial systems equip court systems with the ability to link court rooms with prisons and jails, thereby reducing the costs and security risks associated with inmate-related travel including: arraignments, attorney/client conferences, booking and prisoner processing and depositions. PROPRIETARY TECHNOLOGY The Company has developed proprietary technology in the areas of videoconferencing control systems, system diagnostics, information access and communications access. While VSI Systems make use of some other manufacturers' components, the Omega(TM) utilizes internally developed proprietary software and products as key elements in differentiating the Company's systems in the marketplace. Since VSI Systems use standards-based codecs, they are interoperable with systems of other standards-compliant manufacturers. The heart of the Omega(TM) is the System Controller, a proprietary software suite that must be installed on a properly configured personal computer. The software suite includes the Omega(TM) real time operating system, Omega(TM) videoconferencing application package, device drivers, and a third party SQL 4 5 database engine (as licensed to VSI for resale). This software is delivered in object code format. The Company has also developed and manufactures certain proprietary components: Omega(TM) Audio Processor, Omega(TM) Video Processor, Omega(TM) Power Supply, the Omega(TM) Basic/Serial IQ Connectors, the Omega(TM) Pan/Tilt/Zoom/Focus Controller, the Omega(TM) Infra-red User Control Panel and proprietary cabinetry. These proprietary components are designed to work exclusively with the Omega(TM) System Controller software. The Company regards its Omega(TM) software as proprietary and has implemented protective measures of both a legal (copyright) and practical nature. The Company derives considerable practical protection for its software by supplying and licensing only a non-modifiable run-time version to its customers and keeping confidential all versions that can be modified. By licensing the software rather than transferring title, the Company in most cases has been able to incorporate restrictions in the licensing agreements which impose limitations on the disclosure and transferability of the software. No determination has yet been made, however, as to the legal or practical enforceability of these restrictions or the extent of customer liability for violations. The Company has been granted seven patents from the U.S. Patent and Trademark Office that cover certain aspects of the Omega(TM) user interface, remote management and system architecture (which is a network videoconferencing system which combines the advantages of central and distributed intelligence systems). The patents protect the Company's innovative technology and enables the Company to pursue opportunities to license its technology to other manufacturers. Currently, the patents secure payment of a $900,000 promissory note at an interest rate of 14% per annum, with $300,000 due February 16, 1999 and $600,000 due May 16, 1999. In the event of default, the debt holder could foreclose on its security interest in the patents. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors") The Company also has confidentiality agreements with certain of its employees and has implemented other security measures. PRODUCTS The Company believes that the videoconferencing world is becoming a world of "networks of systems" where all systems from boardroom to rollabout to desktop will have to interconnect. The Company believes that most systems in use today are not equipped to handle these demands. The Company's lead products are marketed under the trade name Omega(TM). The key features and benefits of the Omega(TM) platform include: - - Compression Technology Independence - separating control system from compression technology - - Open Network Architecture - wide support for options and peripherals; flexibility; support for most network connection technologies; and centralized network management - - Ease of Use - point-and-click camera control and on-screen icons to control all functions - - System Management - remote management support and open system support of industry standards - - Software-Based System - remote upgrades of software; customization; and sign-on security and system accounting 5 6 The Omega(TM) product line offers a complete range of group videoconferencing systems, through three product families: Achiever, Performer and Ovation. The Achiever product family is designed for low to moderate usage of videoconferencing. The systems utilize the best board level codec on the market, a patented mouse driven graphical user interface and click and zoom camera control. These products can be upgraded to include remote diagnostics capabilities, sign on security and additional peripherals. The Performer product family is designed for moderate to high usage of videoconferencing. The system encompasses the highest quality codec, advanced audio and video processors, SCAN technology that supports onscreen control of peripheral devices and supplies information to a database in the system controller, remote diagnostics and an open architecture. The Ovation product family is designed for videoconferencing users with specific needs. These systems are specially designed for use in distance learning, video arraignment, large conference rooms and auditoriums. Customers are offered a menu of options which allows them to tailor systems to meet their specific needs. The Omega(TM) is sold on a standalone basis, with or without codec. The Omega(TM) is offered with single, dual or more color monitors of 27" to 35" size, for rollabout cabinets or in-the-wall installation. Other options include: audio and video expansion packages, multiple cameras (either single or three chip), a graphics stand, a computer graphics interface, facsimile transmission and reception, transmission network interface, and a variety of videocassette recorders, slides chains and peripheral devices. Video Administrator is a custom software package that facilitates network management, offered through VSI Solutions. Video Administrator will cease to be provided upon the completion in June, 1999 of a project with one customer, and the operations of VSI Solutions will be discontinued at that time. NEW PRODUCT DEVELOPMENT The Company continues to upgrade its present products and to develop new and innovative products for the videoconferencing market. Extensions of its product line will include a LAN-based gateway offering and software upgrades of existing products. Additional system and network management products are under development. NETWORK SERVICES The Company, through its ETI subsidiary, serves as a sales agent for a number of major telecommunications clients, primarily Bell Atlantic. ETI is paid a commission by its clients for products and services sold to other entities. Among ETI's core product offerings are network services such as Centrex, frame relay and basic rate interface, primary rate interface and ISDN connections. CUSTOMER SERVICE The Company generally provides a warranty for parts and labor on its systems for 90 days from the date of delivery. The Company maintains videoconference rooms and the necessary transmission facilities and codecs to provide on-line assistance to its installed customers at its executive offices near 6 7 Atlanta, Georgia and at its European office. It also provides a telephone helpline to assist customers in the diagnosis of system failures. Approximately 90% of all customer calls for assistance have been resolved through telephone or videoconference contact. The remaining 10% have generally been resolved by the removal and replacement of field replaceable units by Company or customer personnel. The Company maintains a spare parts inventory, and its policy is to replace failed units which are under warranty or subject to a service contract within 24 hours of notification. The Company offers several different maintenance programs, ranging from "helpline" telephone consultation to extended field service on a contract basis, which includes parts, labor, and travel service with a guaranteed on-site response within 48 hours. Warranty and contract service is provided from the Company's U.S. and European locations. MARKETS The Company has defined its target markets as the "Fortune 1000" companies in North America and Europe. Typically, these large companies, often with numerous offices in different cities, are more likely to realize significant savings on travel and related costs by installing a videoconferencing network. Cost/benefit analyses are generally performed by the Company's customers themselves prior to purchasing a system. In addition, the Company has targeted as a secondary market small to mid-sized companies, as well as educational institutions, governments and healthcare providers. The Company's systems are marketed through a direct sales force, as well as through a select group of co-marketing partners and distributors, including partners for whom the Company is an original equipment manufacturer ("OEM"). For each of the fiscal years ended December 31, 1998, 1997 and 1996, international sales (sales outside of the United States and Canada) represented approximately 27%, 14% and 20%, respectively, of the Company's total sales. Net product sales attributable to VSI Europe increased from approximately $2,768,000 during the year ended December 31, 1997 to $2,922,056 for the year ended December 31, 1998. VSI Europe has historically contributed substantially all of the Company's international sales, although sales in China of $2,300,000 were recorded in 1998 by VSI. No sales opportunities in China are being pursued in 1999. The Company believes it presently maintains an approximate 1% to 2% share of the total worldwide videoconferencing equipment market as measured by 1998 total sales volume for the industry. CUSTOMERS The Company's customers include Fortune 1000 companies, mid-sized corporations, agencies of state, local and federal governments, and health care facilities. They include Bank of America, Boeing, MCI, Duracell, BellSouth, Bell Atlantic and Johnson & Johnson. During fiscal 1998, approximately 37% of the Company's revenue - primarily, commissions earned by wholly-owned subsidiary ETI -- were from Bell Atlantic. During fiscal 1997, approximately 37% of the Company's sales were to Bell Atlantic. One other customer - the China Yuanwang Corp. -- accounted for approximately 12% of the Company's revenue during the year ended December 31, 1998. No other client accounted for more than 10% of the Company's revenue in the years ended December 31, 1998 or 1997. 7 8 INVENTORY The Company had inventories of $1,059,142 at December 31, 1998. The total excludes an approximately $1.7 million writeoff of obsolete or slow moving inventory taken at that time. COMPETITION The Company competes in the videoconferencing industry by providing application-specific and custom solutions (products and services) for its customers' videoconferencing needs. Because the Company's videoconferencing systems are compression technology-independent, they can be sold to customers with standard codecs, high speed codecs, board-level codecs or specialty codecs, as well as with direct links to ATM and fiber optic networks. The videoconferencing industry covers a broad spectrum of videoconferencing services available to businesses and others, all of which are, in a general sense, competitive with the Company's systems. The VSI Systems, however, are designed and marketed primarily for the group and custom videoconferencing segment of the industry. Within this segment of the industry, the Company presently competes primarily with two companies which presently have significantly greater resources and market shares than the Company. In addition, three of the Company's suppliers of codecs directly compete with the Company in the group videoconferencing segment. The Company believes demand for videoconferencing will continue to increase, which will attract additional competitors to the industry, some of which may have greater financial and other resources than the Company. RESEARCH AND DEVELOPMENT All of the Company's product engineering, including costs associated with design and configuration of fully-developed VSI Systems for particular customer applications, is accounted for in the Company's financial statements as research and development expenses. During the years ended December 31, 1998, 1997 and 1996, the Company's aggregate expenditures for research and development of new products or new components for existing VSI Systems were $786,103, $1,031,814 and $1,192,010, respectively. During fiscal 1998, the Company's research and development expenses decreased by approximately 24% due to a reduction in workforce. EMPLOYEES As of March 15, 1999, the Company employed 124 persons full time, including five executive officers. Of the full-time employees who were not executive officers, 45 were engaged in sales and marketing, 6 in production, 38 in service, seven in research and development, and 23 in general administration. The workforce has been reduced by approximately 15% since December 31, 1998, due to the closing of INS and consolidation of VSI's operations. Employee relations are considered good, and the Company has no collective bargaining contracts covering any of its employees. ITEM 2. PROPERTIES. The Company maintains its executive and sales offices, as well as its production facilities, in 26,140 square feet of leased office and warehouse space in Norcross, Georgia, under a five-year lease which expires in September, 2003. The Company also leases 18,000 square feet of office and warehouse space in an adjoining facility which it is currently attempting to sublease. The Company leases a number of other facilities in the United States and Europe under operating lease agreements that expire at various dates through 2003. Two of those leases for sales offices in New York and Washington, D.C. will expire in 1999 and will not be renewed, since those sales offices have been closed as part of an effort to 8 9 consolidate the Company's operations. ITEM 3. LEGAL PROCEEDINGS. There are no material legal proceedings to which the Company is a party or to which its properties are subject; nor are there any material proceedings known to the Company to be contemplated by any governmental authority; nor are there any material proceedings known to the Company, pending or contemplated, in which any director, officer or affiliate or any principal security holder of the Company, or any associate of any of the foregoing is a party or has an interest adverse to the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There has been no occurrence requiring a response to this Item. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's Common Stock is traded on the Nasdaq SmallCap Market under the Nasdaq symbol "VSIN". The Company's Common Stock had been traded on the Boston Stock Exchange under the symbol "VSI" from November, 1991 until February 18, 1998, when the Company voluntarily delisted from the exchange. The Common Stock has been quoted on the Nasdaq SmallCap Market since February 28, 1992. On January 15, 1999, the Company implemented a 1-for-4 reverse split of shares of the Company's common stock. The following table sets forth the quarterly high and low bid quotations per Common Share on the Nasdaq SmallCap Market as reported for the periods indicated, adjusted to reflect the effects of the reverse split. These prices also represent inter-dealer quotations without retail mark-ups, mark-downs, or commissions and may not necessarily represent actual transactions.
HIGH LOW ------ ----- FISCAL YEAR ENDED DECEMBER 31, 1997 First Quarter $12.00 $4.00 Second Quarter 6.24 4.12 Third Quarter 8.00 4.24 Fourth Quarter 11.00 4.88 FISCAL YEAR ENDED DECEMBER 31, 1998 First Quarter $6.38 $4.00 Second Quarter 4.88 2.63 Third Quarter 3.50 1.00 Fourth Quarter 2.75 0.88
- ------------------------- As of March 15, 1999, the Company had approximately 400 holders of record of its Common 9 10 Shares and in excess of 7,500 beneficial holders of its Common Shares. The Company has never paid cash dividends on its Common Stock and has no plans to pay cash dividends in the foreseeable future. The policy of the Company's Board of Directors is to retain all available earnings for use in the operation and expansion of the Company's business. Whether dividends may be paid on the Common Shares in the future will depend upon the Company's earnings, capital requirements, financial condition, prior rights of the preferred stockholders, and other relevant factors. RECENT SALES OF UNREGISTERED SECURITIES During the period from October 1, 1998 to November 18, 1998, the Company issued $1,333,000 of term notes to 27 accredited investors. The notes mature on March 31, 2000 and accrue interest at an annual rate of prime plus 3%. Purchasers of notes also received a warrant to purchase one share of common stock of the Company for each $8.00 of notes purchased. Accordingly, warrants to purchase an aggregate of 166,625 shares of common stock were issued by the Company to these investors. The warrants have an exercise price of $1.68 per share and are exercisable commencing on April 1, 2000. On February 23, 1998, the Company issued $3.0 million of convertible debentures to an accredited investor. During 1998, 395,956 shares of common stock were issued upon conversion of the debentures. On November 16, 1998, the Company agreed to issue an additional 25,000 shares of common stock on each of January 18, 1999 and February 22, 1999 as part of the debenture holder's agreement to retire the debentures. In connection with the retirement of the debentures, the Company on November 16, 1998 issued to the debenture holder warrants to purchase an aggregate of 34,375 shares of common stock at an exercise price of $2.40 per share. Also, on February 23, 1998, the Company issued to an agent involved in the debenture transaction warrants to purchase 9,375 shares of common stock at an exercise price of $10.00 per share. All issuances of securities described above were made in reliance on the exemption from registration provided by Section 4(2) and/or 3(b) of the Securities Act of 1933 as transactions by an issuer not involving a public offering. All of the securities were acquired by the recipients thereof for investment and with no view toward the resale or distribution thereof. In each instance, the offers and sales were made without any public solicitation and the stock certificates bear restrictive legends. No underwriter was involved in the transactions and, except for the issuance of the warrant to purchase 9,375 shares of common stock discussed above, no commissions were paid. ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data for the five years ended December 31, 1998, 1997, 1996, 1995 and 1994 are derived from the consolidated financial statements of the Company. All financial information prior to 1997 was restated to reflect the June 1996 acquisition by the Company of Integrated Network Services, Inc. (INS), which was accounted for as a pooling of interest. INS was closed in December 1998, so its results for each year listed below are stated as discontinued operations. See Note C and D to the consolidated financial statements. Information for the years ended December 31, 1998, 1997 and 1996 includes Eastern Telecom, Inc., which was acquired in October 1996. Information for the years ended December 31, 1998, 1997, 1996 and 1995 includes VSI Solutions Inc., which was acquired in April 1995. The data should be read in conjunction with the consolidated financial statements, related notes and other financial information included herein. 10 11
Year Ended December 31, ------------------------------------------------------------------ 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (in thousands, except per share data) STATEMENT OF INCOME DATA: Revenue ................. $ 19,437 $ 19,620 $ 12,709 $ 11,920 $ 13,003 Cost of revenues ........ 12,243 9,687 9,115 8,344 9,059 Gross Profit ............ 7,194 9,933 3,594 3,576 3,944 Operating and other expenses ............ 23,711(1) 14,805 9,586 8,168 6,606 -------- -------- -------- -------- -------- Net loss from continuing operations .......... (16,517) (4,872) (5,992) (4,592) (2,662) Loss from discontinued operations .......... (419) (945) (715) (748) (58) Net loss ................ (16,936) (5,817) (6,707) (5,340) (2,720) Net loss per share from continuing operations $ (1.38) $ (0.45) $ (0.66) $ (0.59) $ (0.49) -------- -------- -------- -------- -------- December 31, ------------------------------------------------------------------ 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (In thousands) BALANCE SHEET DATA: Working capital ......... $ (49) $ 3,690 $ 5,634 $ 6,904 $ 1,260 Total assets ............ 10,961 22,880 24,832 19,666 13,393 Long-term debt .......... 1,106 -- 4,250 -- 44 Stockholders' equity .... 1,003 15,591 13,819 10,535 4,401
(1) As part of an ongoing effort to restructure and refocus the strategic direction of the Company, and to eliminate assets that are either non-performing, impaired or unrelated to the core business, the Company took a non-cash and non-recurring charge of approximately $10.3 million in 1998. The charge included: the write-down of obsolete or slow-moving videoconferencing and demonstration inventory ($1.88 million); the loss from the sale of investments in two companies ($450,000); a write-down of capitalized software development costs ($180,000); and the write-off of most of the goodwill from the acquisitions of VSI Europe in 1992 and ETI in 1996 ($7.76 million). ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. As a result of the Company's recurring losses from operations and the Company's ratio of current assets/current liabilities, the Company's independent auditors for the year ended December 31, 1998 have included a paragraph in their audit report accompanying the Company's consolidated financial statements regarding the Company's ability to continue as a going concern. In response to those concerns, the Company has undertaken a restructuring of the business operations and balance sheet that, when fully implemented, are intended to achieve profitable operations 11 12 and provide positive operating cash flows as well as to improve prospects for additional equity capital investments. During the first quarter of 1999, the Company reviewed its operating expenses and substantially reduced fixed management and overhead expenses. In addition, the Company proposes to restructure certain of its outstanding indebtedness. (See "Liquidity and Sources of Capital.") As of December 31, 1998, the Company had an accumulated deficit of $46,877,847, of which $16,935,972 was realized in 1998. The Company believes that its ongoing effort to restructure and refocus the strategic direction of the organization, and to eliminate assets that are either non-performing, impaired or unrelated to the core business (resulting in a non-recurring charge of approximately $10.3 million in 1998), will enable it to compete in the domestic videoconferencing and control system market. FINANCIAL CONDITION During the year ended December 31, 1998, the Company's total assets decreased approximately 52% to $10,960,965 from $22,880,459 at December 31, 1997. A large part of the decrease resulted from a $7,767,444 impairment charge of most of the goodwill from two non-core assets. Other factors were: - - 92% decrease in other long-term assets, primarily due to the sale and impairment of investments in two other companies - - 57% decrease in inventories, primarily due to an approximately $1.68 million write-down of obsolete or slow-moving videoconferencing inventory - - 86% decrease in rental and demonstration inventory, due to write-downs of obsolete demonstration inventory and the closing of several sales offices - - 89% decrease in software development costs, net, due to impairment of capitalized costs Cash and cash equivalents as of December 31, 1998 increased $282,732, or approximately 32%, to $1,134,231 from $859,684 on December 31, 1997. Total stockholders' equity decreased $14,588,279, or approximately 94%, from December 31, 1997, primarily because of the $16,935,972 net loss for the year. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 As part of an ongoing effort to restructure and refocus the strategic direction of the Company, and to eliminate assets that are either non-performing, impaired or unrelated to the core business, the Company took a non-cash and non-recurring charge of approximately $10.3 million in 1998. The charge included: the write-down of obsolete or slow-moving videoconferencing and demonstration inventory ($1.88 million); the loss from the sale of investments in two companies ($450,000); a write-down of capitalized software development costs ($180,000); and the write-off of most of the goodwill from the acquisitions of VSI N.V. in 1992 and ETI in 1996 ($7.76 million). As a result, many of the comparisons between 1998 and 1997 financial results in several categories have been significantly impacted by the non-recurring charges and/or the related changes in organizational structure and strategic direction. 12 13 Also, results for 1998 and 1997 reflect the December 1998 closure of INS. Results for years presented have been restated to reflect the discontinuance of operations of INS. REVENUES Revenues for the year ended December 31, 1998 were $19.4 million, an approximately 1% decrease over revenues for the year ended December 31, 1997. An approximately 12% increase in videoconferencing systems revenues was more than offset by an approximately 21% decrease in commissions from telephone network reselling. That decrease was due to lower revenues during 1998 at ETI, the Company's network reselling subsidiary, that resulted from lower commission rates and higher than anticipated chargebacks for disconnections and cancellations. GROSS MARGIN Gross margin as a percentage of revenues for the year ended December 31, 1998 was approximately 37%, down from 51% for the year ended December 31, 1997. The decrease was due to higher than usual sales of lower margin videoconferencing products during the second and third quarters of 1998, primarily from a $2.3 million order to a customer in China, and to lower revenues during the first quarter of 1998 at ETI. SELLING, GENERAL & ADMINISTRATIVE EXPENSES Selling, general and administrative expenses for the year ended December 31, 1998 were $13,023,732, a decrease of $479,808, or approximately 4%, over the year ended December 31, 1997, due to improvements in parts procurement and ongoing cost reduction programs; and an approximately 10% reduction in workforce during 1998. RESEARCH AND DEVELOPMENT EXPENSES The Company charges research and development costs to expense as incurred until technological feasibility of a software product has been established. Software development costs incurred after technological feasibility has been established are capitalized and amortized over the useful life of the product. For the year ended December 31, 1998, the Company's research and development expenses were $786,103, an approximately 24% decrease over the year ended December 31, 1997. The decrease was due to a reduction in workforce. IMPAIRMENT LOSS At December 31, 1998, an impairment loss of $7,767,444 was charged to operations. The majority of that loss -- $6,995,211 - was charged to operations as an impairment of the original goodwill recorded with the Company's acquisition of ETI. Management decreased ETI's goodwill to its estimated value based on expected future undiscounted cash flows from ETI's operations, primarily due to a change in the commission structure initiated by ETI's major customer. An additional $577,077 impairment loss was recorded to eliminate all remaining goodwill related to VSI Europe, and an additional $195,156 impairment loss was recorded to write down VSI Europe's net assets to zero. Management recorded the impairment loss in light of VSI Europe's continuing operating losses. See Note A-7 and A-10 to the consolidated financial statements. 13 14 OTHER EXPENSES Other expenses, primarily finance charges, were $1,682,303 for the year ended December 31, 1998, an increase of $1,606,134 over the year ended December 31, 1997. The increase was primarily due to amortization of debt discount costs during the vesting period (the second and third quarters of 1998) of the conversion feature of the Company's convertible debentures; the amortization of debt issuance costs associated with the Company's convertible debentures; and interest expense on the convertible debentures. NET LOSS Net loss for the year ended December 31, 1998 was $16,935,972, a $11,118,606, or approximately 191%, increase over the net loss of $5,817,366 for the year ended December 31, 1997. Net loss from continuing operations was $16,516,999, a $11,645,395, or approximately 239%, increase over the net loss of $4,871,604 for the year ended December 31, 1997. The increase in net loss was due primarily to non-cash and non-recurring charges of approximately $10.3 million in 1998. Excluding the non-recurring charges of approximately $10.3 million, the net loss was approximately $6.6 million, an approximately $800,000 increase over the net loss for the year ended December 31, 1997. The non-recurring charges included: the write-down of obsolete or slow-moving videoconferencing and demonstration inventory ($1.88 million); the loss from the sale of investments in two companies ($450,000); a write-down of capitalized software development costs ($180,000); and the write-off of most of the goodwill from the acquisitions of VSI Europe in 1992 and ETI in 1996 ($7.76 million). YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 REVENUES Revenues for the year ended December 31, 1997 were $19.6 million, an approximately 54% increase over revenues for the year ended December 31, 1996. The increase was primarily due to the recognition of a full year of revenue from wholly-owned subsidiary ETI in 1997, compared to three months of revenue from ETI in 1996. ETI was acquired in October 1996. GROSS MARGIN Gross margin as a percentage of revenues for the year ended December 31, 1997 was 51%, up from 28% for the year ended December 31, 1996, due to the addition of high margin sales and account management commissions from ETI, a sales agency for a number of major telecommunications companies. SELLING, GENERAL & ADMINISTRATIVE EXPENSES Selling, general and administrative expenses for the year ended December 31, 1997 were $13,503,540, an increase of $5,248,453, or 64%, over the year ended December 31, 1996, due to an increase in the Company's sales, marketing and distribution initiatives in the United States (primarily due to the October 1996 acquisition of ETI and its sales force) and the Far East. 14 15 RESEARCH AND DEVELOPMENT EXPENSES The Company charges research and development costs to expense as incurred until technological feasibility of a software product has been established. Software development costs incurred after technological feasibility has been established are capitalized and amortized over the useful life of the product. For the year ended December 31, 1997, the Company's research and development expenses were $1,031,814, a 13% decrease over the year ended December 31, 1996. Expenses in 1996 had been somewhat higher than historical levels, due to an expansion in the research and development workforce to accommodate projects related to forthcoming generations of the Omega(TM) product line and other software projects. Many of those projects were completed or were winding down by first quarter 1997, and the workforce -- primarily at subsidiary VSI Solutions, Inc. -- was reduced. OTHER EXPENSES/INCOME TAXES Non-operating expenses and income taxes for the year ended December 31, 1997 were $269,410, a 94% increase over non-operating expenses and income taxes for the year ended December 31, 1996. The increase was primarily due to the payment of state taxes in Rhode Island by ETI, which was profitable in 1997. NET LOSS Net loss for the year ended December 31, 1997 was $5,817,366, a 13% improvement over the net loss for the year ended December 31, 1996. Excluding a charge to reflect obsolescence of certain inventory of approximately $2.1 million, the net loss for the year was approximately $3.7 million, a 44% improvement over 1996. The decrease in the loss was primarily due to a 54% increase in revenues and a substantial improvement in gross margins. LIQUIDITY AND SOURCES OF CAPITAL General As of December 31, 1998, the Company had cash and cash equivalents of $1,134,231. The Company's liquidity sources include existing cash and credit facilities. In order to meet its cash flow requirements, short-term debt and approximately $600,000 in accrued but unpaid sales tax obligations, the Company will require additional funding in 1999. This additional funding could be in the form of the sale of assets, debt, equity, or a combination. A further reduction in operating expenses has also been effected in order to maximize the Company's allocation of cash resources. However, there can be no assurance that the Company will be able to obtain such financing if and when needed, or that if obtained, such financing will be sufficient or on terms and conditions acceptable to the Company. On February 23, 1998, the Company issued $3,000,000 of 5% Convertible Debentures due February 2000 ("the Debentures") to Thomson Kernaghan & Co. Ltd. ("Thomson Kernaghan"), the proceeds of which were utilized for working capital purposes. The debentures were convertible into shares of common stock of the Company at the option of the holder at the lesser of (i) $8.00 per share or (ii) 85% of the average closing bid price of the Company's common stock. The debenture holder was also granted warrants to purchase 9,375 shares of common stock of the Company, at an exercise price of $2.40 15 16 per share. An agent involved in the placement of the debentures received warrants to purchase 9,375 shares of common stock of the Company, at an exercise price of $10.00 per share. During the year, $710,000 of debentures, plus accrued interest of $13,531, were converted by the debenture holder into 445,956 shares of common stock of the Company. The Company also paid $128,858 in accrued interest and fees. Also, in November 1998, $1,440,000 of debentures were redeemed by the Company at face value as follows: (i)$1,040,000 of debentures were bought back at face value on October 1, 1998 (at which time the Company paid $128,858 in accrued interest and fees); and (ii) $400,000 of debentures were bought back at face value on November 16, 1998 (at which time the Company paid a fee of $50,000). The remaining debentures were converted on November 16, 1998 into a $900,000 term note to Thomson Kernaghan, at an interest rate of 14% per annum, due on or before May 16, 1999. At that time, Thomson Kernaghan was issued warrants to purchase 25,000 shares of common stock of the Company, at an exercise price of $2.40 per share. Of the 445,956 shares issued upon conversion of the debentures, 50,000 shares were held in escrow at December 31, 1998, with 25,000 of these shares issued in January 1999 and 25,000 issued in February 1999. To secure payment of the note, VSI granted the debt holder a security interest in VSI's seven patents issued by the U.S. Patent & Trademark Office. In the event of default, the debt holder could foreclose on its security interest in the patents. VSI has not paid a $300,000 installment of principal under the term note, which installment was due February 16, 1999. The failure to make this payment subjects VSI to a $30,000 per month penalty fee until the full balance is repaid. If VSI does not repay the note on or before May 16, 1999, VSI will be obligated to pay the debt holder an additional penalty of $30,000 on the 16th of each month until the debt is paid. As of March 30, 1999, the outstanding balance under this note, including accrued interest and penalties, was $1,006,257. The Company is currently negotiating with Thomson Kernaghan to restructure the term note. The restructuring of this note may involve a cash payment by the Company and the issuance of shares of common stock of the Company to Thomson Kernaghan to repay the note. If the debt to Thomson Kernaghan cannot be restructured, Thomson Kernaghan may take possession of the Company's patents which secure this debt. In the event the Company is unable to license this technology from Thomson Kernaghan, the Company will be unable to manufacture, sell and service its videoconferencing systems. See "Factors Affecting Future Performance." 16 17 The cash redemption of a portion of the convertible debentures was funded in part from the proceeds of a private placement of term notes by the Company in October and November of 1998. The notes mature on March 31, 2000 and accrue interest at an annual rate of prime plus 3% per annum. Purchasers of notes also received a warrant to purchase one share of common stock of the Company for each $8.00 of notes purchased. Warrants have an exercise price of $1.68 per share and are exercisable commencing on April 1, 2000. The Company is delinquent in the payment of approximately $35,000 of interest due March 31, 1999 with respect to these term notes. Payment of this amount has been deferred pending resolution of the Company's negotiation regarding the restructuring of the Thomson Kernaghan term note. In December 1998, the Company received $250,000 from the sale of the Company's investment in Educational Video Conferencing, Inc., a New York-based provider of distance education services. In October 1998, the Company received $243,000 from the sale of the Company's investment in Global TeleMedix, Inc., a Massachusetts-based provider of telemedicine software. In October, 1998, the Board of Directors of the Company authorized a stock repurchase program pursuant to which management is authorized to repurchase up to 250,000 shares of common stock of the Company. As of March 15, 1999, the Company had not repurchased any shares of its common stock. Any future purchases will be financed from the Company's cash reserves. Credit Facilities VSI Since June 1995, Videoconferencing Systems, Inc. (VSI), a subsidiary of the Company, has had a revolving credit and security agreement with Fidelity Funding of California Inc. This credit facility provides the Company with up to $4,000,000 at an interest rate of prime plus 2% per annum. Funds available under the credit facility are based on 80% of eligible VSI accounts receivable invoices, with certain restrictions. The credit facility is secured by the accounts receivable, inventory and certain fixed assets of VSI. At December 31, 1998, approximately $83,000 was owed to Fidelity Funding. ETI On October 8, 1998, ETI entered into a financing agreement with RFC Capital, Inc., whereby RFC Capital, Inc. purchases eligible accounts receivable for 90% of the accounts receivable amount, up to $1,500,000, at an interest rate of prime plus 2.75% per annum. This amount may be increased, subject to additional payment of commitment fees by ETI, to $5,000,000. If any account receivable is not paid within 90 days, ETI is required to buy back the account receivable for the full purchase price. The credit facility is secured by eligible accounts receivable. As of December 31, 1998, approximately $1,403,000 was owed to RFC Capital, Inc. INS In December 1996, VSI Network Services, Inc. (d/b/a Integrated Network Services, or INS), a wholly owned subsidiary of the Company, established a revolving credit and security agreement with Presidential Financial Corporation. This credit facility provides INS with up to $750,000 at an interest rate of prime plus 3% per annum. Funds available under the credit facility are based on 80% of eligible accounts receivable invoices, with certain restrictions. The credit facility is secured by accounts 17 18 receivable, inventory and fixed assets of INS. At December 31, 1998, approximately $248,000 was owed to Presidential Financial Corporation. With INS ceasing operations on December 31, 1998, VSI is obligated to repay the balance owed Presidential Financial Corporation. On March 31, 1999, that amount was approximately $138,000. The Company expects to repay the full amount during 1999 upon the collection of outstanding INS accounts receivable. VSI n.v. In February 1998, Videoconferencing Systems, n.v., a wholly owned subsidiary of the Company, entered into a revolving credit and security agreement with Kredietbank, n.v. This credit facility provides Videoconferencing Systems, n.v. with up to $550,000 at an interest rate of 5% per annum. The credit facility is secured by 137,500 shares of common stock of the Company, held in escrow by Kredietbank, n.v. At December 31, 1998, approximately $253,000 was owed to Kredietbank, n.v. At December 31, 1998, Videoconferencing Systems, n.v. had a secured bank facility with Generale Bank of approximately $166,000, of which approximately $157,000 was outstanding at that time. OPERATING LOSS CARRYFORWARDS As of December 31, 1998, the Company had operating loss carryforwards for U.S. income tax purposes of approximately $29,389,000 available to reduce future taxable income through 2013. The Company also has investment and research and experimental credits of approximately $89,000 available to reduce future income taxes payable through 2013. During 1993, the Company experienced a change in control, as defined under Section 382 of the Internal Revenue Code. As a result, the utilization of approximately $7,000,000 in tax loss carryforwards will be limited to approximately $1,000,000 annually. Videoconferencing Systems, n.v. has net operating loss carryforwards of approximately $3,350,000 that can be used to offset future taxable income. These carryforwards can be carried forward indefinitely. The resulting deferred income tax asset has been reduced to zero by a related valuation allowance. YEAR 2000 The Company has assessed the impact of the Year 2000 issue on its computer systems and is in the process of remediating the affected hardware and software. The Company utilizes various computer workstations and software packages as tools in running its accounting and operations areas. Most are PC-based and are Year 2000 compliant, with the exception of some older workstations that will be phased out by 2000. Also, the primary accounting system is not currently Year 2000 compliant, and management plans during 1999 to implement any necessary vendor upgrades and modifications to ensure continued functionality with respect to any accounting software problems associated with Year 2000. With respect to the production of its own proprietary software and hardware, the Company has taken the necessary steps to ensure that its proprietary technology is Year 2000 compliant. The Company's videoconferencing products use PC controllers of recent vintage that are computed in and displayed in four-digit format. In addition, the Company's Omega(TM) software uses "C" libraries that compute the date based on a count 18 19 of the number of seconds from January 1970. Those software libraries are in no danger of being out of compliance before the year 2038. Also, the Company has surveyed the vendors who supply key computer-based components for its videoconferencing systems and services, and found that all are Year 2000 compliant. The Company will continue to monitor and assess the Year 2000 situation on an ongoing basis, especially in its dealings with new vendors or suppliers, and will take appropriate corrective action as needed. Contingency planning is a normal part of VSI's sales cycle, given lead time for parts and installation windows. VSI has included Year 2000 concerns into normal contingency planning without forming a separate department of task force to address these concerns. The Company has not developed a separate Year 2000 contingency plan, since to date no adverse effect from the Year 2000 issue has been identified. Should it be determined that any major vendors, service providers or partners may be negatively impacted by the Year 2000 issue, the Company will develop contingency plans for affected areas or make use of alternate suppliers. Expenditures for the Year 2000 project have to date been immaterial and are being expensed as incurred. These expenditures have not had, and are not expected to have, a material impact on the consolidated financial position, results of operation or cash flows of the Company. FORWARD-LOOKING STATEMENTS Certain statements contained in this filing are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements relating to financial results and plans for future business development activities, and are thus prospective. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Potential risks and uncertainties include, but are not limited to, economic conditions, competition and other uncertainties detailed from time to time in the Company's Securities and Exchange Commission filings. (See "Risk Factors" in the section that follows). FACTORS AFFECTING FUTURE PERFORMANCE The Company is subject to the risks associated with being wholly dependent upon the performance of its subsidiaries. The following summarizes certain of the risks inherent in the Company's business: Working Capital Requirements; Need for Additional Financing. The Company will require additional capital or other financing to finance its operations and continued growth. The Company may seek additional equity financing through the sale of securities on a public or a private placement basis on such terms as are reasonably attainable. There can be no assurance that the Company will be able to obtain such financing when needed, or that if obtained, it will be sufficient or on terms and conditions acceptable to the Company. No History of Profitability. After 13 years of operations, the Company has not reported any profits for a full year of operations. There can be no certainty regarding the Company's ability to achieve or sustain profitability in the future. Whether or not the Company is able to operate profitably, the Company will require additional capital to finance its operations. Restructuring of Indebtedness. The Company is currently in negotiations to restructure all indebtedness of the Company owing to Thomson Kernaghan, which currently totals 19 20 approximately $1.0 million. A substantial portion of this indebtedness may be retired in exchange for the issuance of shares of common stock of the Company, which will dilute the ownership of the Company's Shareholders. Additionally, sales and potential sales of substantial amounts of common stock of the Company in the public market could adversely affect the prevailing market prices for the common stock and impair the Company's ability to raise additional capital through the sale of equity securities. The failure of the Company to restructure its indebtedness to Thomson Kernaghan would result in the Company being unable to repay the term note when it comes due in May 1999. The failure of the Company to timely repay this indebtedness may result in Thomson Kernaghan taking possession of the Company's patents, which have been pledged by the Company as collateral for this debt. If Thomson Kernaghan takes possession of the patents, the Company will no longer have any rights in the technology described therein. To continue to be able to sell its videoconferencing products, which embody the technology covered by the patents, the Company will be required to license this technology from Thomson Kernaghan. There can be no assurance that any such license will be granted on commercially reasonable terms or at all. Accordingly, if the Company is unable to restructure its debt with Thomson Kernaghan, and is unable to license the technology covered by the patents on commercially reasonable terms, it will be unable to continue to sell its videoconferencing products, in which event, the Company may seek protection under federal bankruptcy laws. Integration of Acquired Businesses. An important element of the Company's growth strategy is to expand through acquisitions. The Company's future success is dependent upon its ability to finance and effectively integrate acquired businesses with the Company's operations. There can be no assurance that past or future acquisitions will be successfully integrated or that any such acquisition will otherwise be successful. In addition, the financial performance of the Company is now and will continue to be subject to various risks associated with the acquisition of businesses, including the financial effects associated with the integration of such businesses. There can be no assurance that the Company's acquisition strategy will be successful. Technological Change and New Products. The market for the Company's products is characterized by rapidly changing technology, evolving industry standards and frequent product introductions. Product introductions are generally characterized by increased functionality and better picture quality at reduced prices. The introduction of products embodying new technology may render existing products obsolete and unmarketable. The Company's ability to successfully develop and introduce on a timely basis new and enhanced products that embody new technology, and achieve levels of functionality and price acceptable to the market will be a significant factor in the Company's ability to grow and to remain competitive. If the Company is unable, for technological or other reasons, to develop competitive products in a timely manner in response to changes in the industry, the Company's business and operating results will be materially and adversely affected. Dependence on Third Parties. Substantially all of the Company's components, subsystems and assemblies are made by outside vendors. Disruption in supply, a significant increase in price of one or more of these components or failure of a third-party supplier to remain competitive in functionality or 20 21 price could have a material adverse effect on the Company's business and operating results. There can be no assurance that the Company will not experience such problems in the future. Similarly, excessive rework costs associated with defective components or process errors associated with the Company's anticipated new product line of videoconferencing systems could adversely affect the Company's business and operating results. Foreign Sales and Operations. During the year ended December 31, 1998, revenues from international sales represented approximately 27% of the Company's net product sales, as compared to 14% of net product sales during the year ended December 31, 1997. The Company's profitability and financial condition therefore will be impacted by the success of these foreign operations. International sales and operations are subject to inherent risks, including difficulties and delays in obtaining pricing approvals and reimbursement, unexpected changes in regulatory requirements, tariffs and other barriers, political instability, difficulties in staffing and managing foreign operations, longer payment cycles, greater difficulty in accounts receivable collection and adverse tax consequences. Currency translation gains and losses on the conversion to United States dollars from international operations could contribute to fluctuations in the Company's results of operations. If for any reason exchange or price controls or other restrictions on the conversion or repatriation of foreign currencies were imposed, the Company's operating results could be adversely affected. There can be no assurance that these factors will not have an adverse impact on the Company's future international sales and operations and, consequently, on the Company's operating results. Concentration of Customers. The Company sells videoconferencing and control systems and network services to a number of major customers. During the year ended December 31, 1998, approximately 37% of the Company's revenues were from Bell Atlantic. There can be no assurance that the loss of this or other customers will not have an adverse effect on the Company's operations. Dependence on Key Employees. The Company's development, management of its growth and other activities depend on the efforts of key management and technical employees. Competition for such persons is intense. The Company uses incentives, including competitive compensation and stock option plans, to attract and retain well-qualified employees. There can be no assurance, however, that the Company will continue to attract and retain personnel with the requisite capabilities and experience. The loss of one or more of the Company's key management or technical personnel also could adversely affect the Company. The Company does not have employment agreements with its key management personnel or technical employees. The Company's future success is also dependent upon its ability to effectively attract, retain, train, motivate and manage its employees. Failure to do so could have a material adverse effect on the Company's business and operating results. Competition. Competition in the video communications market is intense. In the videoconferencing market, the Company's primary competitors are PictureTel Corporation, VTEL Corporation and Polycom Inc. The Company expects other competitors, some with significantly greater technical and financial resources, to enter the videoconferencing market. If the Company cannot continue to offer new videoconferencing products with improved performance and reduced cost, its competitive position will erode. Moreover, competitive price reductions may adversely affect the Company's results of operations. Fluctuations in Quarterly Performance. The Company's product sales have historically been derived primarily from the sale of videoconferencing systems and related equipment, the market for which is still developing. In addition, the Company's revenues occur predominantly in the third month of each fiscal quarter. Accordingly, the Company's quarterly results of operations are difficult to predict, and 21 22 delays in the closing of sales near the end of the quarter could cause quarterly revenues and, to a greater degree, operating and net income to fall substantially short of anticipated levels. The Company's total revenues and net income levels could also be adversely affected by cancellations or delays of orders, interruptions or delays in the supply of key components, changes in customer base or product mix, seasonal patterns of capital spending by customers, delays in purchase decisions due to new product announcements by the Company or its competitors, increased competition and reductions in average selling prices. No Assurance of Continued Trading Market in Company Securities. The Company's Common Stock is traded on the Nasdaq SmallCap Market. While the Company believes there are several securities broker/dealers making a market in the Company's Common Stock, there is no assurance that a public market for the Company's Common Stock will continue to be made or that persons purchasing the Company's securities will be able to avail themselves of a public trading market for the Common Shares in the future. In order for the Company's Common Stock to be eligible for continued listing on the Nasdaq SmallCap Market, the Common Stock must, among other things, have a minimum bid price per share of $1.00 and net tangible assets of not less than $2.0 million. The Company's Common Stock currently is trading at a price below $1.00 per share and, as a result of the 1998 net loss, net tangible assets are less than $2.0 million, putting the Company in jeopardy of falling out of compliance with Nasdaq's continued listing requirements. There can be no assurance that the Company will remain in compliance with Nasdaq's continued listing requirements. If the Common Stock is delisted by Nasdaq, the trading market for the Common Stock could be adversely affected, as price quotations for the Common Stock will not be as readily obtainable. No Dividends. The Company has never paid cash dividends on its Common Stock and has no plans to pay cash dividends in the foreseeable future. The policy of the Company's Board of Directors is to retain all available earnings for use in the operation and expansion of the Company's business. Possible Issuance of Preferred Stock. The Company is authorized to issue up to 800,000 shares of Preferred Stock, $.00025 par value (the "Preferred Stock"). Preferred Stock may be issued in one or more series, the terms of which may be determined at the time of issuance by the Board of Directors, without further action by stockholders, and may include voting rights (including the right to vote as a series on particular matters), preferences as to dividends and liquidation, conversion and redemption rights and sinking fund provisions. No Preferred Stock is currently outstanding and the Company has no present plans for the issuance thereof. The issuance of any Preferred Stock could affect the rights of the holders of Common Stock, and therefore, reduce the value of the Common Stock and make it less likely that holders of Common Stock would receive a premium for the sale of their shares of Common Stock. In particular, specific rights granted to future holders of Preferred Stock could be issued to restrict the Company's ability to merge with or sell its assets to a third party. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The following financial statements are filed with this report: 22 23 Report of Independent Certified Public Accountants Report of Independent Public Accountants Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997 Consolidated Statements of Operations for Years Ended December 31, 1998, 1997 and 1996 Consolidated Statement of Stockholders' Equity for Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements 23 24 Report of Independent Certified Public Accountants To the Board of Directors and Stockholders of VSI Enterprises, Inc. We have audited the accompanying consolidated balance sheet of VSI Enterprises, Inc. (a Delaware corporation) and Subsidiaries as of December 31, 1998 and the related statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1998 and 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of VSI Enterprises, Inc. and subsidiaries as of December 31, 1998, and the results of their operations and their cash flows for the years ended December 31, 1998 and 1996, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note B to the financial statements, the Company has suffered recurring losses from operations and the Company's current liabilities exceed current assets. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note B. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Grant Thornton LLP Atlanta, Georgia March 5, 1999 24 25 Report of Independent Public Accountants To the Board of Directors and Stockholders of VSI Enterprises, Inc.: We have audited the accompanying consolidated balance sheet of VSI ENTERPRISES, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997 and the related statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards requires that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of VSI Enterprises, Inc. and subsidiaries as of December 31, 1997 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP Atlanta, Georgia April 12, 1999 25 26 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, ASSETS
1998 1997 ----------- ----------- CURRENT ASSETS Cash and cash equivalents $ 1,134,231 $ 859,684 Accounts receivable, less allowance for doubtful accounts of $1,141,091 and $415,989 at December 31, 1998 and 1997, respectively 5,975,254 5,703,560 Inventories, less allowance for obsolescence of $1,677,440 and $178,235 at December 31, 1998 and 1997, respectively 1,059,142 2,464,818 Demonstration inventory, net of allowance for obsolescence of $1,074,765 and $839,184 at December 31, 1998 and 1997, respectively 136,883 990,054 Prepaid expenses and other current assets 164,088 404,181 Current assets of discontinued operations, net 334,022 557,121 ----------- ----------- Total current assets 8,803,620 10,979,418 PROPERTY AND EQUIPMENT, net 1,048,983 1,071,381 OTHER ASSETS OF DISCONTINUED OPERATIONS -- 131,912 OTHER ASSETS Goodwill, net 955,688 9,020,715 Software development costs, net 75,349 658,052 Other long-term assets 77,325 1,018,981 ----------- ----------- 1,108,362 10,697,748 ----------- ----------- $10,960,965 $22,880,459 =========== ===========
The accompanying notes are an integral part of these statements. 26 27 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEETS - CONTINUED December 31, LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997 ----------- ----------- CURRENT LIABILITIES Current portion of notes payable $ 2,637,948 $ 1,143,012 Short-term borrowings 157,376 154,938 Accounts payable 2,235,852 3,036,587 Accrued expenses 1,463,536 878,813 Accrued commissions 501,515 849,078 Deferred revenue 1,522,416 445,245 Current liabilities of discontinued operations 334,022 781,862 ----------- ----------- Total current liabilities 8,852,665 7,289,535 NOTES PAYABLE, LESS CURRENT PORTION 1,105,655 -- COMMITMENTS AND CONTINGENCIES (Note L) STOCKHOLDERS' EQUITY Preferred stock, $.00025 par value; authorized 800,000 shares, none issued and outstanding -- -- Common stock, authorized 15,000,000 shares of $.001 par value; issued and outstanding 12,300,144 and 11,546,242 shares at December 31, 1998 and 1997, respectively 12,300 11,546 Additional paid-in capital 48,209,039 45,976,291 Accumulated deficit (46,877,847) (29,941,875) Cumulative comprehensive income (340,847) (455,038) ----------- ----------- 1,002,645 15,590,924 ----------- ----------- $10,960,965 $22,880,459 =========== ===========
The accompanying notes are an integral part of these statements. 27 28 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS Year ended December 31,
1998 1997 1996 ------------ ------------ ------------ Revenue Videoconferencing systems $ 13,574,213 $ 12,168,107 $ 11,159,943 Commissions from telephone network reselling 5,863,198 7,451,686 1,549,281 ------------ ------------ ------------ 19,437,411 19,619,793 12,709,224 ------------ ------------ ------------ Costs and expenses Cost of videoteleconferencing systems 12,242,823 9,686,633 9,115,556 Selling, general and administrative 13,023,732 13,503,540 8,255,087 Research and development 786,103 1,031,814 1,192,010 Impairment loss 7,767,444 -- -- ------------ ------------ ------------ 33,820,102 24,221,987 18,562,653 ------------ ------------ ------------ Loss from operations (14,382,691) (4,602,194) (5,853,429) Loss on sale of investments 452,005 -- -- Other expenses, primarily financing charges 1,682,303 76,169 139,048 ------------ ------------ ------------ Net loss from continuing operations before income taxes (16,516,999) (4,678,363) (5,992,477) Income taxes -- 193,241 -- ------------ ------------ ------------ Net loss from continuing operations (16,516,999) (4,871,604) (5,992,477) Discontinued operations Operating loss from discontinued operations (763,705) (945,762) (714,417) Gain on disposal of a subsidiary 344,732 -- -- ------------ ------------ ------------ Loss from discontinued operations (418,973) (945,762) (714,417) ------------ ------------ ------------ NET LOSS $(16,935,972) $ (5,817,366) $ (6,706,894) ============ ============ ============ Net loss per common share Loss from continuing operations $ (1.38) $ (0.45) $ (0.66) Loss from discontinued operations (0.04) (0.09) (0.08) ------------ ------------ ------------ $ (1.42) $ (0.53) $ (.74) ============ ============ ============ Weighted average shares outstanding 11,931,232 10,901,620 9,119,233 ============ ============ ============
The accompanying notes are an integral part of these statements. 28 29 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY For the years ended December 31, 1998, 1997 and 1996
Common stock -------------------------- Additional Number of paid-in Accumulated Shares Par value capital deficit ----------- --------- ----------- ------------ Balance, December 31, 1995 35,007,176 $8,751 $28,091,591 $(17,417,615) ----------- ------ ----------- ------------ Net loss for the year -- -- -- (6,706,894) Other comprehensive income Foreign currency translation adjustment -- -- -- -- ----------- ------ ----------- ------------ Comprehensive income -- -- -- (6,706,894) ----------- ------ ----------- ------------ Reverse common stock split (26,255,382) -- -- -- Issuance of common shares in lieu of cash compensation 27,694 28 139,464 -- Issuance of common shares for employee stock purchase plan 11,119 11 109,413 -- Exercise of stock options 76,408 76 298,789 -- Issuance of common shares for products and services 62,500 63 599,946 -- Issuance of common shares for conversion of notes payable 61,204 61 337,052 -- Private placement of common shares, net of issuance costs of $41,998 280,590 281 2,388,247 -- Issuance of common shares for acquisition of Eastern Telecom, Inc. 501,835 502 5,499,498 -- Issuance of common shares for conversion of convertible debentures 105,918 106 758,005 -- ----------- ------ ----------- ------------ Other comprehensive income Total ------------- ------------ Balance, December 31, 1995 $(147,669) $ 10,535,058 --------- ------------ Net loss for the year -- (6,706,894) Other comprehensive income Foreign currency translation adjustment (141,005) (141,005) --------- ------------ Comprehensive income (141,005) (6,847,899) --------- ------------ Reverse common stock split -- -- Issuance of common shares in lieu of cash compensation -- 139,492 Issuance of common shares for employee stock purchase plan -- 109,424 Exercise of stock options -- 298,865 Issuance of common shares for products and services -- 600,009 Issuance of common shares for conversion of notes payable -- 337,113 Private placement of common shares, net of issuance costs of $41,998 -- 2,388,528 Issuance of common shares for acquisition of Eastern Telecom, Inc. -- 5,500,000 Issuance of common shares for conversion of convertible debentures -- 758,111 --------- ------------
29 30 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED For the years ended December 31, 1998, 1997 and 1996
Common stock -------------------------- Additional Number of paid-in Accumulated Shares Par value capital deficit ----------- --------- ----------- ------------ Balance, December 31, 1996 9,879,062 9,879 38,222,005 (24,124,509) ----------- ------ ----------- ------------ Net loss for the year -- -- -- (5,817,366) Other comprehensive income Foreign currency translation adjustment -- -- -- -- ----------- ------ ----------- ------------ Comprehensive income -- -- -- (5,817,366) ----------- ------ ----------- ------------ Issuance of common shares for products and services 137,500 138 650,001 -- Issuance of common shares for conversion of convertible debentures 866,368 866 4,352,772 -- Issuance of common shares for employee stock purchase plan 36,653 37 156,002 -- Issuance of common shares for conversion of private placement 563,471 563 2,486,937 -- Exercise of stock options 63,188 63 108,574 -- ----------- ------ ----------- ------------ Balance, December 31, 1997 11,546,242 11,546 45,976,291 (29,941,875) ----------- ------ ----------- ------------ Net loss for the year -- -- -- (16,935,972) Other comprehensive income Foreign currency translation adjustment -- -- -- -- ----------- ------ ----------- ------------ Comprehensive income -- -- -- (16,935,972) ----------- ------ ----------- ------------ Issuance of common shares for products and services 237,500 238 516,606 -- Issuance of common shares for conversion of convertible debentures 445,956 446 702,097 -- Issuance of common shares for employee stock purchase plan 20,446 20 59,019 -- Exercise of stock options 50,000 50 124,969 -- Issuance of stock warrants -- -- 830,057 -- ----------- ------- ----------- ------------ Balance, December 31, 1998 12,300,144 $12,300 $48,209,039 $(46,877,847) =========== ======= =========== ============ Other comprehensive income Total ------------- ------------ Balance, December 31, 1996 (288,674) 13,818,701 --------- ------------ Net loss for the year -- (5,817,366) Other comprehensive income Foreign currency translation adjustment (166,364) (166,364) --------- ------------ Comprehensive income (166,364) (5,983,730) --------- ------------ Issuance of common shares for products and services -- 650,139 Issuance of common shares for conversion of convertible debentures -- 4,353,638 Issuance of common shares for employee stock purchase plan -- 156,039 Issuance of common shares for conversion of private placement -- 2,487,500 Exercise of stock options -- 108,637 --------- ------------ Balance, December 31, 1997 $(455,038) $ 15,590,924 --------- ------------ Net loss for the year -- (16,935,972) Other comprehensive income Foreign currency translation adjustment 114,191 114,191 --------- ------------ Comprehensive income 114,191 (16,821,781) --------- ------------ Issuance of common shares for products and services -- 516,844 Issuance of common shares for conversion of convertible debentures -- 702,543 Issuance of common shares for employee stock purchase plan -- 59,039 Exercise of stock options -- 125,019 Issuance of stock warrants -- 830,057 --------- ------------ Balance, December 31, 1998 $(340,847) $ 1,002,645 ========= ============
The accompanying notes are an integral part of this statement. 30 31 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31,
1998 1997 1996 ------------ ----------- ----------- Cash flows from operating activities: Net loss $(16,935,972) $(5,817,366) $(6,706,894) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 1,838,296 1,438,054 1,420,547 Provision for doubtful accounts 1,903,248 176,174 62,000 Allowance to reduce inventory to lower of cost or market 1,499,205 (315,645) 250,000 Issuance of common stock in lieu of cash compensation -- -- 139,492 Loss on sale of property and equipment -- -- 28,145 Impairment loss 7,767,444 -- -- Loss on sale of investments 452,005 -- -- Gain on disposal of discontinued operations (344,732) -- -- Changes in related assets and liabilities, net of businesses acquired: Accounts receivable (2,055,078) (900,018) 2,797,035 Inventories (211,748) 584,122 794,139 Demonstration inventory 617,590 568,877 (1,491,934) Prepaid expenses and other current assets 108,986 (73,230) 344,616 Accounts payable (156,758) 991,498 (139,772) Accrued expenses 806,863 339,554 (746,742) Deferred revenue 1,015,238 (218,484) 289,483 ------------ ----------- ----------- Net cash used in operating activities (3,695,413) (3,226,464) (2,959,885) ------------ ----------- ----------- Cash flows from investing activities: Cash paid for business acquisitions, net of cash acquired -- -- (3,668,131) Proceeds from sale of property and equipment -- -- 30,314 Purchases of property and equipment (381,348) (400,230) (418,304) Capitalized software development costs -- (77,886) (153,007) Other assets -- (442,596) (405,760) Proceeds from sale of investments 492,776 -- -- ------------ ----------- ----------- Net cash provided by (used in) investing activities 111,428 (920,712) (4,614,888) ------------ ----------- -----------
31 32 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED Year ended December 31,
1998 1997 1996 ------------ ----------- ----------- Cash flows from financing activities: Change in notes payable and short-term borrowings, net 2,008,468 (586,588) (2,062,849) Proceeds from convertible debentures 3,000,000 -- 5,000,000 Cash redemption of convertible debentures (1,440,000) -- -- Proceeds from exercise of stock options and warrants, net of related costs 125,000 264,676 298,865 Proceeds from issuance of common stock, net of issuance costs 59,058 650,139 109,424 Proceeds from private placement financings, net of issuance costs -- 2,487,500 2,388,528 ------------ ----------- ----------- Net cash provided by financing activities 3,752,526 2,815,727 5,733,968 ------------ ----------- ----------- Effect of exchange rate changes on cash and cash equivalents 114,191 (62,727) (101,623) ------------ ----------- ----------- Increase (decrease) in cash and cash equivalents 282,732 (1,394,176) (1,942,428) Change in cash and cash equivalents included in current assets of discontinued operations (8,185) (6,325) -- Cash and cash equivalents at beginning of year 859,684 2,260,185 4,202,613 ------------ ----------- ----------- Cash and cash equivalents at end of year $ 1,134,231 $ 859,684 $ 2,260,185 ============ =========== ===========
32 33 VSI Enterprises, Inc. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED Year ended December 31,
1998 1997 1996 --------- ----------- ----------- Supplementary disclosure: Interest paid $ 411,439 $ 247,744 $ 357,216 ========= =========== =========== Income taxes paid $ -- $ 180,000 $ -- ========= =========== =========== Supplemental schedule of noncash investing and financing activities: Noncash investing and financing activities: Conversion of debt to common stock $ 702,543 $ 4,353,638 $ 1,095,224 ========= =========== =========== Common stock issued for products and services $ 516,844 $ 650,139 $ 600,009 ========= =========== =========== Acquisition of businesses Fair value of assets acquired $ -- $ -- $ 9,540,923 Cash paid -- -- (3,685,128) Common stock and options issued -- -- (5,500,000) --------- ----------- ----------- Liabilities assumed $ -- $ -- $ 355,795 ========= =========== ===========
The accompanying notes are an integral part of these statements. 33 34 VSI Enterprises, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998 and 1997 NOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES VSI Enterprises, Inc. was incorporated in Delaware in September 1988 and, together with its wholly-owned subsidiaries (the "Company"), provides videoconferencing systems, software, and service; and commission-based reselling of telephone network services for telephone operating companies and related communication entities. 1. Accounting Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. 3. Cash and Cash Equivalents For financial reporting purposes, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. 4. Inventories Inventories consist of videoconferencing system components and parts and are valued at the lower of cost (first-in, first-out method) or market. 5. Demonstration Inventory Demonstration inventory is stated at cost. Demonstration inventory allowance is provided for in amounts sufficient to reflect the asset at its estimated fair value. 6. Property and Equipment Property and equipment are stated at cost. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated useful lives on a straight-line basis. 7. Goodwill The excess acquisition cost over the fair value of net assets of acquired businesses are amortized over 20 years on a straight-line basis. At December 31, 1998, an impairment loss of $6,995,211 was charged to operations as an impairment of the original goodwill recorded with the Company's acquisition of its telephone network reselling subsidiary, Eastern Telecom, Inc. ("ETI") due to a significant change in 1998 in ETI's anticipated income stream. Management decreased ETI's goodwill to its estimated value based on expected future undiscounted cash flows from ETI's operations. Also, based on changes in ETI's business, the remaining goodwill of $955,688 will be amortized over ten years on a straight-line basis. An additional 34 35 $577,077 impairment loss was recorded to eliminate all remaining goodwill related to the Company's European subsidiary. Management recorded the impairment loss in light of the Company's European subsidiary's continuing operating losses and expectations of future losses. Accumulated amortization of goodwill was $8,867,611 and $802,584 at December 31, 1998 and 1997, respectively. Amortization charged to operations (exclusive of the impairment loss) was $492,739, $492,738 and $156,784 for the years ended December 31, 1998, 1997 and 1996, respectively. 8. Software Development Costs All software development costs are charged to expense as incurred until technological feasibility has been established for the product. Software development costs incurred after technological feasibility has been established are capitalized and amortized, commencing with product release, on a straight-line basis over three years or the useful life of the product, whichever is shorter. Accumulated amortization of software development costs was $1,634,897 and $1,052,194 at December 31, 1998 and 1997, respectively. Amortization expense charged to operations was $582,703, $399,945, and $416,407 for the years ended December 31, 1998, 1997 and 1996, respectively. 9. Investments The Company accounts for investments in entities in which it owns less than 20% under the cost method. At December 31, 1997, other long-term assets included $944,781 representing the Company's cost investments in Global Telemedix and Educational Video Conferencing ("EVC"). Global Telemedix provides computer hardware and software to healthcare providers and EVC acts as a marketing and technological bridge between higher education institutions and corporations. During 1998, the Company sold its investments in these companies resulting in a loss of $452,005. At December 31, 1998 and 1997, receivables outstanding from investees were approximately $0 and $250,000, respectively. In addition, sales to investees were approximately $116,000, $1,038,000 and $35,000 for the years ended December 31, 1998, 1997 and 1996, respectively. 10. Accounting for Impairments in Long-Lived Assets Long-lived assets and identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amounts of assets may not be recoverable. Management periodically evaluates the carrying value and the economic useful life of its long-lived assets based on the Company's operating performance and the expected future undiscounted cash flows and will adjust the carrying amount of assets which may not be recoverable. At December 31, 1998, the Company recorded a charge against operations of $7,572,288 related to the writedown of goodwill previously recorded upon the Company's acquisition of its European subsidiary and telephone network reselling subsidiary (Note A-7). The Company recorded an additional impairment charge of $195,156 related to the writedown of the its European subsidiary's net asset value to zero based on the European subsidiary's continuing losses. Management believes that remaining long-lived assets in the accompanying consolidated balance sheets are appropriately valued. 11. Foreign Currency Translation The asset and liability accounts of the Company's foreign subsidiaries are translated into U.S. dollars at the current exchange rate in effect at the balance sheet date. Stockholders' equity is translated at historical rates. Income statement items are translated at average currency exchange rates. The resulting translation adjustment is recorded as a separate component of stockholder's equity. Translation gains and losses were not significant for any period presented. 12. Revenue Recognition Revenue from sales of videoconferencing systems and related maintenance contracts on these systems are included in videoconferencing systems revenues. Revenue on system sales are recognized upon shipment. Revenue on maintenance contracts are recognized over the term of the related contract. Commission revenue from telephone network service sales are recognized upon receipt of order and when the Company has no further obligation related to the order. 35 36 13. Income Taxes The Company accounts for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for deferred tax assets when it is more likely than not that the asset will not be realized. 14. Stock Based Compensation The Company accounts for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Effective in 1995, the Company adopted the disclosure option of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 required that companies that do not choose to account for stock-based compensation as prescribed by the statement, shall disclose the pro forma effects on earnings and earnings per share as if SFAS No. 123 had been adopted. Additionally, certain other disclosures are required with respect to stock compensation and the assumptions used to determine the pro forma effects of SFAS No. 123 (see Note H). 15. Net Loss Per Common Share In 1997, the Company adopted SFAS No. 128, Earnings Per Share. That statement requires the disclosure of basic net earnings (loss) per share and diluted net earnings (loss) per share when different from basic. Basic net earnings (loss) per share is computed by dividing net earnings (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net earnings (loss) per share gives effect to all potentially dilutive securities. There is no difference between basic loss per share and diluted loss per share for any period presented. During 1998, the shareholders approved a one-for-four reverse common stock split, effective January 15, 1999 to shareholders of record on January 14, 1999. All references to shares of common stock, stock options and per share amounts have been restated to reflect this reverse common stock split. 16. Fair Value of Financial Instruments The Company's financial instruments include cash, cash equivalents and notes payable. Estimates of fair value of these instruments are as follows: Cash and cash equivalents - The carrying amount of cash and cash equivalents approximates fair value due to the relatively short maturity of these instruments. Notes payable - The carrying amount of the Company's notes payable approximate fair value based on borrowing rates currently available to the Company for borrowings with comparable terms and conditions. 17. Technological Change and New Products The market for the Company's products is characterized by rapidly changing technology, evolving industry standards and frequent product introductions. Product introductions are generally characterized by increased functionality and better videoconferencing picture quality at reduced prices. The introduction of products embodying new technology may render existing products obsolete and unmarketable. The Company's ability to successfully develop and introduce on a timely basis new and enhanced products that embody new technology, and achieve levels of functionality at a price acceptable to the market, will be a significant factor in the Company's ability to grow and to remain competitive. If the Company is unable, for technological or other reasons, to develop competitive products in a timely manner in response to changes in the industry, the Company's business and operating results will be materially and adversely affected. 36 37 18. Dependence on Third Parties Substantially all of the Company's components, subsystems and assemblies are made by outside vendors. Disruption in supply, a significant increase in the price of one or more of these components, or failure of a third party supplier to remain competitive in functionality or price could have a material adverse effect on the Company's business and operating results. There can be no assurance that the Company will not experience such problems in the future. Similarly, excessive rework costs associated with defective components or process errors associated with the Company's anticipated new product line of videoconferencing systems could adversely affect the Company's business and operating results. 19. Foreign Sales and Operations International sales and operations are subject to inherent risks, including difficulties and delays in obtaining pricing approvals and reimbursement, unexpected changes in regulatory requirements, tariffs and other barriers, political instability, difficulties in staffing and managing foreign operations, longer payment cycles, greater difficulty in accounts receivable collection and adverse tax consequences. Currency translation gains and losses on the conversion to United States dollars and international operations could contribute to fluctuations in the Company's results of operations. If for any reason, exchange or price controls or other restrictions on the conversion or repatriation of foreign currencies were imposed, the Company's operating results could be adversely affected. There can be no assurance that these factors will not have an adverse impact on the Company's future international sales and operations and, consequently, on the Company's operating results. 20. Reclassifications Certain amounts in the 1997 financial statements have been reclassified to conform to the current year presentation. NOTE B - REALIZATION OF ASSETS The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern. However, the Company has sustained substantial losses from operations in recent years, and such losses have continued through March 5, 1999. Also, the Company has defaulted on the first installment of $300,000 due February 16, 1999 on its term note payable (Note F) an additional installment of $600,000 is due on May 16, 1999. In addition, the Company has used, rather than provided, cash in its operations. In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company's ability to meet its financing requirements on a continuing basis, to maintain present financing, and to succeed in its future operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence. In response to the matters described in the preceding paragraphs, management of the Company has undertaken a restructuring of the business operations that, when implemented, is intended to achieve profitable operations and provide positive operating cash flows as well as provide for additional equity capital investments. Subsequent to year end, the company has reviewed its operating expenses and substantially reduced fixed management and overhead expenses. Management also intends to close and or spin off non-strategic business operations and has recognized asset impairment losses that reflect its decisions. 37 38 NOTE C - MERGERS AND ACQUISITIONS INS Merger On June 25, 1996, the Company, through its wholly-owned subsidiary, INS Acquisition Co., issued 120,418 shares of its common stock in exchange for all of the outstanding common stock of Integrated Network Services, Inc. ("INS"). The merger has been accounted for as a pooling of interests and accordingly, the Company's consolidated financial statements have been restated to include the accounts and operations of INS for all periods prior to the merger. During 1998, the company discontinued operations of INS (see Note D). INS provided integration services for local and wide area networks. Separate results of operations for the periods prior to the merger are as follows for the year ending December 31, 1996. Revenue: VSI $ 12,709,224 INS 4,346,723 ------------- $ 17,055,947 ============= Net (loss) earnings from continuing operations: VSI $ (5,992,477) INS (714,417) ------------- $ (6,706,894) ============= Net loss: VSI $ (5,992,477) INS (714,417) ------------- $ (6,706,894) =============
Acquisitions In October 1996, the Company acquired all of the outstanding common stock of Eastern Telecom, Inc. ("ETI") in exchange for 501,835 shares of VSI common stock, 31,939 options to purchase VSI common stock at less than $.04 per share and $3,500,000 in cash. The cash portion of the purchase was funded from the issuance of $5,000,000 of convertible debentures. The acquisition was valued at approximately $9,185,000 including acquisition costs of approximately $185,000. ETI is engaged in the selling of network services of telephone operating companies and long distance carriers. The ETI acquisition was accounted for as a purchase. Accordingly, the purchase price was allocated to assets and liabilities based on their estimated fair values at the date of acquisition. Results of operations of ETI have been included in the consolidated financial statements from the respective date of acquisition. Goodwill of approximately $9,000,000 related to the purchase was being amortized on a straight-line basis over 20 years. At December 31, 1998, the Company recorded an impairment loss on this goodwill of $6,995,211 and reduced the amortization period to ten years reflecting 1998 changes in ETI's business and based on expected future undiscounted cash flows from ETI's operations (Note A-7). 38 39 NOTE D - DISCONTINUED OPERATIONS During the fourth quarter of 1998, the Company discontinued operations of its system integration subsidiary, Integrated Network Services, Inc. Accordingly, operating results for the discontinued operation have been reclassified and reported as discontinued operations in accordance with Accounting Principles Board Opinion No. 30 for the years ended December 31, 1998, 1997 and 1996. Summary operating results of the discontinued system integration operations are as follows:
1998 1997 1996 ------------ ------------ ------------ Revenues $ 1,518,952 $ 2,145,388 $ 4,346,723 Costs and expenses 2,282,657 3,091,150 5,061,140 ------------ ------------ ------------ Loss from discontinued operations $ (763,705) $ (945,762) $ (714,417) ============ ============ ============
Assets and liabilities of the discontinued system integration operations are included in the consolidated balance sheets as assets and liabilities of discontinued operations and are made up as follows:
1998 1997 -------- -------- Cash and cash equivalents $ 14,510 $ 6,325 Accounts receivable 319,512 439,376 Inventories -- 76,936 Other current assets -- 34,484 Property and equipment -- 123,527 Other assets -- 8,385 -------- -------- Total assets $334,022 $689,033 ======== ======== Notes payable $248,116 $279,355 Accounts payable -- 364,960 Accrued expenses 85,906 75,615 Deferred revenue -- 61,932 -------- -------- Total liabilities $334,022 781,862 ======== ========
The Company recognized a gain on disposal of the system integration segment at December 31, 1998 of approximately $345,000. 39 40 NOTE E - PROPERTY AND EQUIPMENT Property and equipment consist of the following as of December 31, 1998 and 1997:
Estimated Service 1998 1997 Life ----------- ----------- ---------- Machinery and equipment $ 3,468,988 $ 3,199,101 3-10 years Furniture and fixtures 723,132 668,132 10 years Leasehold improvements 203,656 169,857 5 years ----------- ----------- 4,395,776 4,037,090 Less accumulated depreciation (3,346,793) (2,842,182) Less amounts included in other assets of discontinued operations -- (123,527) ----------- ----------- $ 1,048,983 $ 1,071,381 =========== ===========
Depreciation expense charged to operations was approximately $527,000, $562,000 and $814,000 for the years ended December 31, 1998, 1997 and 1996, respectively and is included in selling, general and administrative expense in the accompanying consolidated statements of operations. NOTE F - NOTES PAYABLE AND SHORT-TERM BORROWINGS
Notes Payable ------------- 1998 1997 ---------- ---------- VSI line of credit; provides for maximum borrowings of $4,000,000, limited to 80% of eligible accounts receivable, interest payable monthly at the prime rate plus 2% (9.75% at December 31, 1998); collateralized by accounts receivable, certain property and equipment and inventory of VSI. $ 82,556 $ 905,684 VSI term note payable in two installments of $300,000 and $600,000 due on February 16, 1999 and May 16, 1999, respectively. Interest is payable upon retirement of note at 14%; collateralized by security interests in certain patents owned by VSI. Failure to pay the installments on these respective due dates will result in a penalty of $30,000 per month until the note is retired. 900,000 -- VSI term notes payable due on March 31, 2000; interest payable quarterly at the prime rate plus 3% (10.75% at December 31, 1998). These term notes are unsecured. The term notes payable are shown net of debt discount of $227,345. 1,105,655 -- INS line of credit; provides for maximum borrowings of $750,000, limited to 80% of eligible accounts receivable; interest payable monthly at the prime rate plus 3% (10.75% at December 31, 1998); collateralized by accounts receivable, property and equipment and inventory of INS. 248,116 279,355 ETI line of credit; provides for maximum borrowings of $1,500,000, limited to 90% of eligible accounts receivable; interest payable monthly at the prime rate plus 2.75% (10.50% at December 31, 1998); collateralized by eligible accounts receivable of ETI. 1,402,523 210,543 Note payable to bank of European subsidiary; provides for maximum borrowings of approximately $550,000; interest payable monthly at 5% This note is secured by 137,500 shares of the Company held in escrow by the European bank. 252,869 26,785 ---------- ---------- 3,991,719 1,422,367 Current portion of notes payable 2,637,948 1,143,012 ---------- ---------- 1,353,771 279,355 Less notes payable included in current liabilities of discontinued operations 248,116 279,355 ---------- ---------- $1,105,655 $ -- ========== ==========
40 41 In 1997, the Company adopted SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (the "Statement"). This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. At December 31, 1998 and 1997, the Company has recognized approximately $1,733,000 and $1,396,000 of accounts receivable financing, respectively, as notes payable in the accompanying balance sheets. During 1996, note agreements with directors were terminated. The remaining balances of these notes of $299,656 plus accrued interest of $37,457 were retired by the issuance of 61,204 common shares. Interest expense under notes due to directors totaled approximately $0, $0 and $16,000 for the years ended December 31, 1998, 1997 and 1996, respectively. In March 1998, the Company secured a working capital loan for approximately $2.0 million from AmTrade International Bank of Georgia. The loan was guaranteed by the Export-Import Bank of the United States, and was collateralized by a letter of credit from a VSI customer. Funds were used for pre-/post-export financing for the manufacture and delivery of videoconferencing equipment in China. The interest rate was prime plus 2.5%. Repayment was made in 1998 through proceeds of the letter of credit, which was applied first to the loan principal and interest, with the remaining amount remitted to VSI. Interest expense related to this note was approximately $57,000 for the year ended December 31, 1998. During September 1998, the Company began offering $3,000,000 of term notes. A minimum of $5,000 is required for each subscription and each purchaser of the term notes receives warrants to purchase shares of common stock of the company on the basis of one warrant for each $8.00 of term notes purchased. The warrants have a term of five years, expiring on October 1, 2003 and become exercisable on April 1, 2000 at an exercise price of $1.68 per share. At December 31, 1998, the Company has issued $1,333,000 of term notes and 166,625 warrants. The Company has valued these warrants at $270,645 using the Black-Scholes option-pricing model in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. This warrant value is recorded as debt discount to be amortized to interest expense over the period until the warrants become exercisable on April 1, 2000. Interest expense related to these warrants was $43,300 for the year ended December 31, 1998. Short-Term Borrowings At December 31, 1998 and 1997, the company's foreign subsidiary had short-term borrowings which provided for maximum borrowings of approximately $166,000 and $219,000, respectively . These bank credit facilities are collateralized by the subsidiary's accounts receivable and inventory and bear interest at 7%. Outstanding borrowings under these agreements were $157,376 and $154,938 at December 31, 1998 and 1997, respectively. NOTE G - CONVERTIBLE DEBENTURES On February 23, 1998, the Company issued $3,000,000 of 5% convertible Debentures due February 2000 (the "Debentures"), the proceeds of which were utilized for working capital purposes. In addition, the Company issued 9,375 common stock purchase warrants to the holder of the Debentures and 9,375 common stock purchase warrants to an agent involved in the transaction. The warrants, which expire on February 23, 2003, entitle the holder to purchase one common stock share of the Company at the price of $10.00. The Debentures were convertible at the lower of (i) $8.00 per share or (ii) 85% of the average closing bid price of the Company's common stock. "Average closing bid price" is defined to mean the lowest average of the daily last bid price for the common stock for any three trading days in any 20-day period preceding the conversion. During the year, $710,000 of Debentures plus accrued interest of $13,531 were converted into 445,956 common shares; $1,440,000 of the Debentures were redeemed by the Company at face value and the remaining Debentures were converted into a $900,000 term note (see Note F). 50,000 shares of the 445,956 issued in connection with the 41 42 conversion were held in escrow at December 31, 1998 with 25,000 of these issued in January 1999 and 25,000 issued in February 1999. On November 16, 1998, the Company issued an additional 25,000 stock purchase warrants to the holder of the Debentures to enable the Company to purchase the $1,440,000 outstanding Debentures at face value. The warrants, which expire on November 16, 2003, entitle the holder to shares of the common stock of the Company at a price of $2.40 per share. At this time, the Company also repriced the 9,375 warrants issued to the Debenture holder on February 23, 1998 to a price of $2.40 per share. This repricing had no impact on the consolidated statement of operations. In conjunction with the issuance of the 18,750 common stock warrants to the Debenture holder and agent, $529,412 of the debt issuance proceeds relating to the issuance of the Debentures was allocated to additional paid in capital in the accompanying consolidated balance sheet, to recognize the beneficial conversion feature of the Debentures. This debt discount was amortized to interest expense upon conversion and redemption of the Debentures and is included in other expenses in the consolidated statements of operations for the year ended December 31, 1998. In conjunction with the issuance of the additional 25,000 purchase warrants, the Company valued the warrants at $30,000 using the Black-Scholes option pricing model in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. This warrant value was recorded as interest expense upon issuance of the warrants. NOTE H - STOCK OPTIONS, WARRANTS, AND EMPLOYEE STOCK PURCHASE PLAN Stock Option Plan The Company's board of directors has approved a stock option plan which covers up to 915,514 shares of common stock. The plan provides for the expiration of options ten years from the date of grant and requires the exercise price of the options granted to be at least equal to 100% of market value on the date granted. Stock option transactions are summarized below:
1998 1997 1996 -------------------- --------------------- --------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------- ------- ------- -------- ------- -------- Outstanding, beginning of year 475,867 $ 6.88 480,856 $ 6.52 484,242 $ 5.92 Granted 196,250 1.75 84,000 6.20 137,738 9.08 Exercised (50,000) 2.50 (63,189) 3.36 (76,408) 3.92 Forfeited (28,795) 7.82 (25,800) 10.76 (64,716) 10.32 ------- ------- ------- -------- ------- -------- Outstanding, end of year 593,322 $ 5.46 475,867 $ 6.88 480,856 $ 6.52 ======= ======= ======= ======== ======= ========
The following table summarizes information about stock options outstanding at December 31, 1998:
Options Outstanding Options Exercisable ------------------------------------------- ------------------------------ Weighted Average Weighted Weighted Range of Number Remaining Average Number Average Exercise Outstanding at Contractual Exercise Exercisable at Exercise Price December 31, 1998 Life (Years) Price December 31, 1998 Price -------- ----------------- ------------ -------- ----------------- -------- $ 1.00 - $ 1.87 142,500 9.78 $ 1.08 38,750 $ 1.14 $ 2.50 - $ 3.76 60,667 8.02 2.80 29,417 2.63 $ 4.25 - $ 5.25 208,793 7.78 5.04 152,126 4.98 $ 5.50 - $ 7.76 57,333 6.62 6.77 53,166 6.80 $ 8.50 - $ 9.87 64,792 6.78 9.22 64,132 9.22 $11.00 - $14.75 41,600 7.30 13.83 37,354 13.80 $17.25 17,637 6.85 17.25 17,637 17.25 ------- ---- ------- ------- ------- 593,322 8.00 $ 5.46 392,582 $ 6.75 ======= ==== ======= ======= =======
42 43 The Company uses the intrinsic value method in accounting for its stock option plans. In applying this method, no compensation cost has been recognized. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates for awards under those plans, the Company's net loss and loss per share would have resulted in the pro forma amounts indicated below:
1998 1997 1996 -------------- ------------- ------------- Net loss As reported $ (16,935,972) $ (5,817,366) $ (6,706,894) Pro forma (17,248,878) (6,490,242) (7,509,903) Net loss per common share As reported $ (1.42) $ (0.53) $ (0.74) Pro forma (1.45) (0.60) (0.84)
For purposes of the pro forma amounts above, the fair value of each option grant was estimated on the date of grants using the Black-Scholes options pricing model with the following weighted average assumptions used for grants in 1998, 1997 and 1996, respectively; expected volatility of 87%, 88% and 110%, risk-free interest rates of $5.0%-6.1%, $5.9%-6.7% and 5.3%-6.6% and expected lives of 3-7 years for all periods presented. Warrants In connection with the purchase of the outstanding notes payable and establishment of a line of credit during 1994, 62,500 common stock purchase warrants were granted to a director at an exercise price of $1.60 per share. These warrants expire in July 2004. Employee Stock Purchase Plan The Company has an employee stock purchase plan ("Plan") that provides for the sale of up to 75,000 shares of common stock to eligible employees. The purchase price for shares of common stock purchased pursuant to the Plan is the lesser of: 85% of the fair market value of common stock on the first pay date or 85% of the fair market value of common stock on the last pay date of each plan period. 20,446 and 36,653 shares of common stock were purchased by employees under this Plan for the years ended December 31, 1998 and 1997, respectively. The Plan was suspended by the Board of Directors in September 1998. The Company has no current plans to reinstate the Plan. NOTE I - INCOME TAXES The Company's temporary differences result in a net deferred income tax asset which is reduced to zero by a related deferred tax valuation allowance, summarized as follows at December 31, 1998 and 1997:
1998 1997 ------------ ------------ Deferred income tax assets: Operating loss carryforwards $ 11,315,000 $ 7,700,000 Nondeductible accruals and allowances 1,117,000 758,000 Capitalized inventory costs 140,000 147,000 Tax credit carryforwards 89,000 89,000 Other 195,000 205,000 ------------ ------------ Gross deferred income tax assets 12,856,000 8,899,000 Deferred income tax asset valuation allowance (12,675,000) (8,689,000) ------------ ------------ Net deferred income tax asset $ 181,000 $ 210,000 ============ ============ Deferred income tax liabilities $ (181,000) $ (210,000) ============ ============ Net deferred income tax $ -- $ -- ============ ============
43 44 Income tax expense for 1997 of $193,241 represents state income taxes associated with the operations of ETI and was calculated using the statutory rates applicable in the various states to which income has been apportioned. At December 31, 1998, the Company had operating loss carryforwards for U.S. income tax purposes of approximately $29,389,000 available to reduce future taxable income and approximately $89,000 of investment and research and experimental credits available to reduce future income taxes payable, which expire in varying amounts through the year 2013. The Company's European subsidiary has net operating loss carryforwards of approximately $3,350,000 that can be used to offset future taxable income. These carryforwards can be carried forward indefinitely. The resulting deferred income tax asset has been reduced to zero by a related valuation allowance. The Company experienced a change in control, as defined under Section 382 of the Internal Revenue code during calendar year 1993. As a result, the utilization of approximately $7,000,000 in tax loss carryforwards will be limited to approximately $1,000,000 annually. NOTE J- MAJOR CUSTOMERS Revenue from health care providers and related entities comprised approximately 7%, 10% and 25% of consolidated revenues for the years ended December 31, 1998, 1997 and 1996, respectively. Revenue from telephone operating companies and related communications entities comprised approximately 36%, 43% and 23% of consolidated revenues for the years ended December 31, 1998, 1997 and 1996, respectively. At December 31, 1998 and 1997, accounts receivable from telephone operating companies and related communication entities comprised 43% and 44%, respectively, of consolidated receivables. Accounts receivable from healthcare providers comprised 6% and 7%, respectively, of consolidated receivables. Management believes that concentration of credit risk with respect to trade receivables is minimal due to the composition of the customer base. The Company's customers are primarily large national and multinational companies and agencies of the U.S. government. Allowances are maintained for potential credit losses, and such losses have been within management's expectations. The Company's operations are subject to rapid technological developments. Management periodically evaluates the realizability of its technology-related assets, including inventories, software development costs and goodwill. During the years ended December 31, 1998 and 1997, the Company recorded approximately $1,651,000 and $2,111,000 of additional cost of videoconferencing systems related to the write-down of certain inventories determined to be technologically obsolete. Management believes that no material impairment of remaining inventories and other assets existed at December 31, 1998 and 1997. It is possible, however, that management's estimates may change in the near term due to technological, regulatory, and other changes in the Company's industry. 44 45 NOTE K - OPERATING SEGMENTS AND RELATED INFORMATION In 1998, the Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. This statement requires the disclosure of certain information regarding the Company's operating segments. Prior to 1998, the Company's industry segments were made up of videoconferencing, computer system integration and telephone network reselling. These industry segments were all operating in separate, one hundred percent owned, subsidiaries. In 1998, the Company discontinued operations of its computer system integration subsidiary. As a result, at December 31, 1998, the Company is primarily operating in the videoconferencing segment and telephone network reselling segment as follows:
For the years ended December 31, -------------------------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Revenue: Videoconferencing systems $ 13,574,214 $ 12,168,107 $ 11,159,943 Network reselling 5,863,197 7,451,686 1,549,281 ------------ ------------ ------------ 19,437,411 19,619,793 12,709,224 Operating (loss) income: Videoconferencing systems (6,166,394) (5,903,979) (6,339,722) Network reselling (8,216,297) 1,301,785 486,293 ------------ ------------ ------------ (14,382,691) (4,602,194) (5,853,429) Capital expenditures: Videoconferencing systems 13,373 98,096 369,117 Network reselling 367,975 302,134 49,187 ------------ ------------ ------------ 381,348 400,230 418,304 Identifiable assets: Videoconferencing systems 6,274,667 10,659,140 13,344,581 Network reselling 4,352,276 11,532,286 10,267,688 System integration 334,022 689,033 1,219,988 ------------ ------------ ------------ $ 10,960,965 $ 22,880,459 $ 24,832,257 ============ ============ ============
The Company also has operations in the United States and Europe. Summary information related to the United States and European operations are as follows:
For the years ended December 31, -------------------------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Revenue: United States $ 16,515,355 $ 16,851,511 $ 10,209,556 Europe 2,922,056 2,768,282 2,499,668 ------------ ------------ ------------ $ 19,437,411 $ 19,619,793 $ 12,709,224 ============ ============ ============ Operating loss: United States $(13,953,057) $ (4,564,382) $ (5,126,073) Europe (429,634) (37,812) (727,356) ------------ ------------ ------------ $(14,382,691) $ (4,602,194) $ (5,853,429) ============ ============ ============ Capital expenditures: United States $ 373,018 $ 331,897 $ 333,588 Europe 8,330 68,333 84,716 ------------ ------------ ------------ $ 381,348 $ 400,230 $ 418,304 ============ ============ ============ December 31, ---------------------------------- 1998 1997 ------------ ------------ Identifiable assets: United States $ 10,203,619 $ 22,002,184 Europe 757,346 878,275 ------------ ------------ $ 10,960,965 $ 22,880,459 ============ ============
45 46 NOTE L - COMMITMENTS AND CONTINGENCIES Operating Leases The Company leases office space and equipment under noncancelable operating leases expiring at various dates through April 2003. Rent expense for the years ended December 31, 1998, 1997 and 1996 was approximately $660,000, $572,000 and $660,000, respectively. Approximate minimum annual future rental payments under the leases are as follows at December 31:
Year ending: 1999 $ 684,000 2000 633,000 2001 475,000 2002 382,000 2003 15,000 ------------ $ 2,189,000 ============
Litigation The Company is also involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position or results of operations. 46 47 NOTE M - SUBSEQUENT EVENT - UNAUDITED The Company is currently negotiating with a note holder to restructure a $900,000 term note. (See note F). The restructuring of this note may involve a cash payment by the Company and the issuance of shares of common stock of the Company to the note holder to repay the note. If the debt cannot be restructured, the note holder may take possession of the Company's patents which secure this debt. In the event the Company is unable to license this technology from the note holder, the Company will be unable to manufacture, sell and service its videoconferencing systems. 47 48 Report of Independent Certified Public Accountants on Schedule II Board of Directors VSI Enterprises, Inc. In connection with our audit of the consolidated financial statements of VSI Enterprises, Inc. and Subsidiaries referred to in our report dated March 5, 1999, which is included in this report, we have also audited Schedule II for the years ended December 31, 1998 and 1996. In our opinion, the schedule presents fairly, in all material respects, the information required to be set forth therein as of and for the years ending December 31, 1998 and 1996. /s/ Grant Thornton LLP Atlanta, Georgia March 5, 1999 48 49 \ Report of Independent Certified Public Accountants on Schedule II To the Board of Directors and Stockholders VSI Enterprises, Inc. We have audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of VSI ENTERPRISES, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997 and the related statements of operations, stockholders' equity, and cash flows for the year then ended and have issued our report thereon dated April 12, 1999. Our audit was made for the purposes of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 14 hereon is the responsibility of management and is presented for the purposes of complying with the Securities and Exchange Commission's rules and is not a required part of a the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects, the financial data for the year ended December 31, 1997 as required to be set forth therein in relation of the basic financial statements taken as a whole. /s/ Arthur Andersen LLP Atlanta, Georgia April 12, 1999 49 50 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E -------- ---------- ---------- --------------- ------------ Additions Balance at Charged to Balance at Beginning Costs and Deductions End of Description of Period Expenses Describe (1)(2) Period ----------- ---------- ---------- --------------- ---------- Year ended December 31, 1998 Reserve for obsolete inventory $ 178,235 $ 1,499,205 $ -- $ 1,677,440 Reserve for doubtful accounts receivable 447,174 1,903,248 1,209,331 1,141,091 Year ended December 31, 1997 Reserve for obsolete inventory $ 494,200 $ 557,060 $ 873,025 $ 178,235 Reserve for doubtful accounts receivable 271,000 332,633 156,459 447,174 Year ended December 31, 1996 Reserve for obsolete inventory $ 244,200 $ 250,000 $ -- $ 494,200 Reserve for doubtful accounts receivable 658,402 (28,558) 358,844 271,000
(1) - Obsolete items which have been disposed and bad debt write offs. (2) - Column C-2 "Charged to other accounts" has been omitted as the response is "none". 50 51 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. There have been no disagreements on accounting and financial disclosure matters which are required to be described by Item 304 of Regulation S-K. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information relating to directors and executive officers of the Company contained in the registrant's definitive proxy statement to be delivered to shareholders in connection with the 1999 annual meeting of shareholders scheduled to be held on June 11, 1999 are incorporated hereby by reference. ITEM 11. EXECUTIVE COMPENSATION. The information relating to executive compensation contained in the registrant's definitive proxy statement to be delivered to shareholders in connection with the 1999 annual meeting of shareholders scheduled to be held on June 11, 1999 are incorporated hereby by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information relating to security ownership of certain beneficial owners and management contained in the registrant's definitive proxy statement to be delivered to shareholders in connection with the 1999 annual meeting of shareholders scheduled to be held on June 11, 1999 are incorporated hereby by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information relating to related party transactions contained in the registrant's definitive proxy statement to be delivered to shareholders in connection with the 1999 annual meeting of shareholders scheduled to be held on June 11, 1999 are incorporated hereby by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) 1. Financial Statements. The following financial statements and accountant's report have been filed as Item 8 in Part II of this report: Report of Independent Certified Public Accountants Report of Independent Public Accountants Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997 Consolidated Statements of Operations for Years Ended December 31, 1998, 1997 and 1996 Consolidated Statement of Stockholders' Equity for Years Ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for Years Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements 2. Financial Statement Schedules. The following financial statement schedule, of VSI Enterprises, Inc. for the years ended December 31, 1998, 1997 and 1996 are included pursuant to Item B: Report of Independent Certified Public Accountants on Schedule II....48 Report of Independent Certified Public Accountants on Schedule II....49 Schedule II: Valuation and Qualifying Accounts.......................50 51 52 3. Exhibits. The following exhibits are filed with or incorporated by reference into this report. The exhibits which are denominated by an asterisk (*) were previously filed as a part of, and are hereby incorporated by reference from either (i) the Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-18 (File No. 33-27040-D) (referred to as "S-18 No. 1"), (ii) Post-Effective Amendment No. 2 to the Company's Registration Statement on Form S-18 (File No. 33-27040-D) (referred to as "S-18 No. 2"), (iii) Post-Effective Amendment No. 3 to the Company's Registration Statement on Form S-18 (File No. 33-27040-D) (referred to as "S-18 No. 3"); (iv) the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1992 (referred to as "1992 10-Q"); (v) the Company's Annual Report on Form 10-K for the year ended March 31, 1993 (referred to as "1993 10-K"); (vi) the Company's Registration Statement Form S-1 (File No. 33-85754) (referred to as "S-1"); (vii) the Company's Annual Report on Form 10-K for the year ended December 31, 1994 (referred to as "1994 10-K"); (viii) the Company's Annual Report on Form 10-K for the year ended December 31, 1995 (referred to as "1995 10-K"); (ix) the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 (referred to as "1997 10-Q"); (x) the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (referred to as "1996 10-K"); (xi) the Company's Form S-8 Registration Statement (File No. 333-18239), (referred to as "Warrant Plan S-8"), and (xii) the Company's Form S-8 Registration Statement (File No. 333-18237), (referred to as "Option Plan S-8").
EXHIBIT NO. DESCRIPTION OF EXHIBIT -------------------------------------------------------------------------- *3.1 Certificate of Incorporation, including Certificate of Stock Designation dated September 25, 1990, and amendments dated December 26, 1990, August 19, 1991 and October 17, 1991 (S-18 No. 3, Exhibit 3-1) *3.2 Amended Bylaws of the Registrant as presently in use (S-18 No. 1, Exhibit 3.2) *3.3 Certificate of Amendment to Certificate of Incorporation filed on February 10, 1993 (1992 10-Q) *3.6 Certificate of Amendment to Certificate of Incorporation filed on February 13, 1995 (1994 10-K) *3.7 Certificate of Amendment to Certificate of Incorporation filed on September 8, 1995 (1995 10-K) 3.9 Certificate of Amendment of Certificate of Incorporation filed on January 13, 1999 *10.3 1991 Stock Option Plan (S-18 No. 2, Exhibit 10.1(a)) *10.3.1 Amendment No. 1 to 1991 Stock Option Plan (1993 10-K) *10.3.2 Amendment No. 2 to 1991 Stock Option Plan (S-1) *10.3.3 Amendment No. 3 to 1991 Stock Option Plan (S-1) *10.3.4 Amendment No. 4 to 1991 Stock Option Plan (Option Plan S-8, Exhibit 4.5) 10.3.5 Amendment No. 5 to 1991 Stock Option Plan
52 53 *10.4 Revolving Credit and Security Agreement dated June 7, 1995 by and between Videoconferencing Systems, Inc. ("VSI") and Fidelity Funding of California, Inc. (1995 10-K) *10.5 1995 Performance Warrant Plan (Warrant Plan S-8, Exhibit 4.1) *10.6 Employment Agreement dated August 4, 1997, by and between the Registrant and Judi North *10.15 1994 Employee Stock Purchase Plan (1994 10-K) 10.16 Promissory Note, dated November 18, 1999, issued to Thomson Kernaghan & Co., Ltd. in the principal amount of $900,000 10.17 Assignment of Security Interest in Patents, dated November 18, 1999, by and between the Registrant and Thomson Kernaghan & Co., Ltd. 10.18 Receivable Sale Agreement, dated October 8, 1998, by and between VSI Network Solutions, Inc. and RFC Capital Corporation *21.1 Subsidiaries of the Registrant (1996 10-K) 23.1 Consent of Grant Thornton LLP 23.2 Consent of Arthur Andersen LLP 27.1 Financial Data Schedule (SEC use only) 27.2 Financial Data Schedule - Restated 1997 (SEC use only) 27.3 Financial Data Schedule - Restated 1996 (SEC use only)
(b) Reports on Form 8-K. The following report on Form 8-K was filed during the quarter ended December 31, 1998: Current Report on Form 8-K dated October 5, 1998 (relating to private placement of term notes and warrants). 53 54 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VSI ENTERPRISES, INC. By: /s/ Julia B. North -------------------------------- Date: April 15, 1999 Julia B. North, President & CEO Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the following capacities on the dates indicated.
Signature Title Date --------- ----- ---- /s/ Larry M. Carr Chairman of the Board April 15, 1999 - ----------------------------------- Larry M. Carr /s/ Julia B. North President and April 15, 1999 - ----------------------------------- Chief Executive Officer Julia B. North /s/ Samuel D. Horgan Chief Financial Officer April 15, 1999 - ----------------------------------- (Principal Financial and Samuel D. Horgan Accounting Officer) /s/ Harlan D. Platt, Ph.D. Director April 15, 1999 - ----------------------------------- Harlan D. Platt, Ph.D. /s/ Edward S. Redstone Director April 15, 1999 - ----------------------------------- Edward S. Redstone
54 55 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION OF EXHIBIT - ----------- ---------------------- 3.9 Certificate of Amendment of Certificate of Incorporation filed on January 13, 1999 10.3.5 Amendment No. 5 to 1991 Stock Option Plan 10.16 Promissory Note, dated November 18, 1999, issued to Thomson Kernaghan & Co., Ltd. in the principal amount of $900,000 10.17 Assignment of Security Interest in Patents, dated November 18, 1999, by and between the Registrant and Thomson Kernaghan & Co., Ltd. 10.18 Receivable Sale Agreement, dated October 8, 1998, by and between VSI Network Solutions, Inc. and RFC Capital Corporation 23.1 Consent of Grant Thornton LLP 23.2 Consent of Arthur Andersen LLP 27.1 Financial Data Schedule (SEC use only) 27.2 Financial Data Schedule - Restated 1997 (SEC use only) 27.3 Financial Data Schedule - Restated 1996 (SEC use only)
55 EX-3.9 2 CERTIFICATE OF AMENDMENT / FILED JANUARY 13, 1999 1 EXHIBIT 3.9 CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION OF VSI ENTERPRISES, INC. VSI Enterprises, Inc. (the "Company"), a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That at a meeting of the Board of Directors of the Company resolutions were duly adopted setting forth a proposed amendment of the Certificate of Incorporation of the Company, declaring said amendment to be advisable and directing that said amendment be considered at the next annual meeting of the stockholders of the Company. The resolution setting forth the proposed amendment is as follows: RESOLVED: That Section 5.01 of the Certificate of Incorporation, as heretofore added to or amended by certificates filed pursuant to law, is amended to read in its entirety as follows: "5.01 Authorized Shares. The aggregate number of shares which the Company shall have authority to issue is Fifteen Million Eight Hundred Thousand (15,800,000). Fifteen Million (15,000,000) shares shall be designated `Common Stock' and shall have a par value of $.001. Eight Hundred Thousand (800,000) shares shall be designated `Preferred Stock' and shall have a par value of $.001. All shares of the Company shall be issued for such consideration, as expressed in dollars, as the Board of Directors may from time to time determine. Effective with the filing of this Amendment, each one share of the Company's Common Stock issued and outstanding on the Effective Date of this Amendment shall be automatically changed without further action into one-fourth (1/4) of a fully paid and nonassessable share of the Company's Common Stock, provided that no fractional shares shall be issued pursuant to such change. The Company shall pay to each shareholder who would otherwise be entitled to a fractional share as a result of such change the cash value of such fractional share based upon the closing bid price per share of the Common Stock on the trading day preceding the Effective Date of this Amendment as quoted by The Nasdaq SmallCap Market." SECOND: That thereafter, pursuant to resolution of its Board of Directors, the annual meeting of stockholders of the Company was duly called and held, upon notice in accordance with Section 222 of the General Corporation Law of the State of Delaware, at which meeting the necessary number of shares as required by statute were voted in favor of the amendment. THIRD: That said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. FOURTH: That the capital of the Corporation shall not be reduced under or by reason of said amendment. FIFTH: That this Amendment shall be effective as of 12:01 a.m. on January 14, 1999. IN WITNESS WHEREOF, VSI Enterprises, Inc. has caused this Certificate of Amendment to be signed by its duly authorized officer, this 11th day of January, 1999. VSI ENTERPRISES, INC. By: /s/ Julia B. North ---------------------------------------- Julia B. North, President and Chief Executive Officer 56 EX-10.3.5 3 AMENDMENT #5 TO 1991 STOCK OPTION PLAN 1 EXHIBIT 10.3.5 AMENDMENT NO. 5 1991 STOCK OPTION PLAN VSI ENTERPRISES, INC. WHEREAS, the Board of Directors of VSI Enterprises, Inc. (the "Company") has previously adopted, as amended, and the shareholders of the Company have approved, the 1991 Stock Option Plan (the "Plan") pursuant to which options to purchase stock of the Company may be issued to eligible directors, officers and key employees of the Company; and WHEREAS, the Board of Directors of the Company deems it desirable to further amend the Plan as provided herein; NOW, THEREFORE, the Plan is amended upon the terms, and subject to the conditions, set forth herein: ARTICLE I AMENDMENTS TO PLAN 1.1 Section 4 of the Plan shall be amended by deleting the first sentence thereof in its entirety and substituting the following new sentence therefor: "An aggregate of 3,662,057 Shares will be authorized and reserved for issuance upon the exercise of Options granted under the Plan." ARTICLE II EFFECTIVE DATE OF AMENDMENT 2.1 The amendment effected hereby shall be effective for options granted under the Plan on or after the date this amendment is approved by the Board of Directors of the Company, but subject to approval of a majority of the shares of Common Stock of the Company entitled to vote thereon represented in person and by proxy at a meeting of shareholders. In the event shareholder approval of adoption of this amendment is not obtained within twelve months of the date this amendment is approved by the Board of Directors of the Company, then any option granted in the intervening period to persons who are not officers, directors or employees of the Company or any subsidiary of the Company, shall be void. 57 EX-10.16 4 PROMISSORY NOTE DATED NOVEMBER 18, 1999 1 EXHIBIT 10.16 PROMISSORY NOTE $900,000.00 November 16, 1998 FOR VALUE RECEIVED, VSI Enterprises, Inc., a Delaware corporation ("Maker"), promises to pay to the order of Thomson Kernaghan & Co., Ltd. (together with any other holder hereof, ("Payee"), at Payee's address at 75 Lowther Avenue, Toronto, Ontario, Canada M5R1C9 or at such other place as the Payee may from time to time designate in writing, in lawful money of the United States of America, the principal sum of NINE HUNDRED THOUSAND DOLLARS ($900,000.00) together with interest on so much thereof as is from time to time outstanding and unpaid, at the rate hereinafter set forth, said principal and all accrued but unpaid interest being due and payable as set forth below. Interest on the principal balance of this Note from time to time outstanding and unpaid shall be computed on the basis of a 360-day year for the actual number of days elapsed at a simple interest rate per annum equal to fourteen percent (14%) commencing on November 16, 1998. Principal and all accrued interest hereunder shall be payable on May 16, 1999, except as hereinafter provided. Maker agrees to pay a Three Hundred Thousand Dollar ($300,000.00) installment of principal hereunder on February 16, 1999; provided, however, that failure to pay such installment shall not constitute a default under this Note. If Maker fails to pay such installment when due, Maker shall pay Payee on February 16, 1999, and on the 16th day of each month thereafter until either the installment is paid or this Note is paid in full, liquidated damages in the amount of Thirty Thousand Dollars ($30,000.00). If Maker fails to make a Six Hundred Thousand Dollar ($600,000.00) principal payment on May 16, 1999, Maker shall pay Payee on May 16th 1999, and on the 16th day of each month thereafter until said $600,000 in principal is paid or this Note is paid in full, liquidated damages in the amount of Thirty Thousand Dollars ($30,000). If both installments are still unpaid on May 16, 1999, Maker shall pay Payee on May 16, 1999, and on the 16th day of each month thereafter Sixty thousand dollars ($60,000) as liquidated damages. Said liquidated damages shall be reduced to Thirty Thousand Dollars ($30,000) once the principal balance is reduced down to SIX HUNDRED THOUSAND DOLLARS ($600,000). Maker acknowledges that its failure to make the principal payment of Three Hundred Thousand ($300,000) and Six Hundred Thousand ($600,000) when due will cause the Payee to suffer damages in an amount that will be difficult to ascertain. Accordingly, the parties agree that it is appropriate to include in this Note a provision for liquidated damages. The parties acknowledge and agree that the liquidated damages provision set forth in this section represents the parties' good faith effort to qualify such damages and, as such, agree that the form and amount of such liquidated damages are reasonable and will not constitute a penalty. Maker may prepay this Note in whole or in part at any time without penalty or premium. The obligations of Maker under this Note are secured under the provisions of that certain Assignment of Security Interest in Patents, dated as of the date of this Note, by and between Maker and Payee a copy of which is attached hereto as Exhibit A. The maker does hereby represent to Payee that until such time as this Note is paid in full, it will not further encumber the collateral. Time is of the essence with respect to all of Maker's obligations and agreements under this Note. Events of Default. The following are Events of Default hereunder: (a) Any failure by the Maker to pay no later than June 16, 1999, all or any principal or interest or other payment hereunder or any breach of any representation or covenant made by Maker in this Note which relates to any security interests that may be granted by Maker to Payee; 58 2 (b) If the Maker (i) admits in writing its inability to pay generally its debts as they mature, or (ii) makes a general assignment for the benefit of creditors, or (iii) is adjudicated a bankrupt or insolvent, or (iv) files a voluntary petition in bankruptcy, or (v) takes advantage, as against its creditors, of any bankruptcy law or statue of the United States of America or any state or subdivision thereof now or hereafter in effect, or (vi) has a petition or proceeding filed against it under any provision of any bankruptcy or insolvency law or statute of the United States of America or any state or subdivision thereof, which petition or proceeding is not dismissed within sixty (60) days after the date of the commencement thereof, (vii) has a receiver, liquidator, trustee, custodian, conservator, sequestrator or other such person appointed by any court to take charge of its affairs or assets or business and such appointment is not vacated or discharged within sixty (60) days thereafter, or; (c) Any failure by the Maker to perform or observe any other agreement, covenant, term or condition contained in this Note or in any other agreement between the Maker and the Payee, and the continuance of such failure or non-performance for fifteen (15) days after receipt by Maker of written notice of such failure. Remedies on Default. If any Event of Default shall occur and be continuing, the holder hereof shall, in addition to any and all other available rights and remedies, have the right, at its option (except for an Event of Default under paragraph 3(b) above, the occurrence of which shall automatically effect acceleration hereunder), (a) to declare the entire unpaid principal balance of this Note, together with all accrued interest hereunder, to be immediately due and payable, and (b) to pursue any and all available remedies for the collection of such principal, interest, and liquidated damages including but not limited to the exercise of all rights and remedies against the Maker and the Patents securing this note. Waivers and Amendments. Neither any provision of this Note nor any performance hereunder may be amended or waived orally, but only by an agreement in writing and signed by the party against whom enforcement of any waiver, change, modification or discharge is sought. Cumulative Remedies. No right or remedy conferred upon the Payee under this Note is intended to be exclusive of any other right or remedy contained herein or in any instrument or document delivered in connection herewith, and every such right or remedy shall be cumulative and shall be in addition to every other such right or remedy contained herein and/or now or hereafter existing at law or in equity or otherwise. Waivers; Course of Dealing. No course of dealing between the Maker and the Payee, or any failure or delay on the part of the Payee in exercising any rights or remedies, or any single or partial exercise of any rights or remedies, shall operate as a waiver or preclude the exercise of any other rights or remedies available to the Payee. Governing Law: Consent to Jurisdiction: Waiver of Jury Trial. This Note shall be deemed to be a contract made under the laws of the State of Delaware and shall be governed by, and construed in accordance with, the laws of the State of Delaware. The Maker hereby irrevocably consents to the jurisdiction of all courts (state and federal) sitting in the State of Delaware in connection with any claim, action or proceeding relating to or for the collection or enforcement of this Note, and hereby waives any defense of forum non conveniens or other claim or defense in respect of the lodging of any such claim, action or proceeding in any such court. THE MAKER HEREBY IRREVOCABLY WAIVES ALL RIGHT TO TRIAL BY JURY IN ANY CLAIM, ACTION OR PROCEEDING RELATING TO OR FOR THE COLLECTION OR ENFORCEMENT OF THIS NOTE. Collection Costs. 59 3 In the event that the Payee shall, after the occurrence of an Event of Default, turn this Note over to an attorney for collection, the Maker shall further be liable for and shall pay to the Payee all collection costs and expenses incurred by the Payee, including reasonable attorneys' fees and expenses; and the Payee may take judgment for all such amounts in addition to all other sums due hereunder. Notices required or permitted to be given hereunder shall be in writing and shall be deemed to be sufficiently given when personally delivered or sent by registered mail, return receipt requested, addressed: (i) if to the Maker, at its executive offices and (ii) if to the Payee, c/o William S. Hechter, at 75 Lowther Avenue, Toronto, Ontario, Canada M5R 1C9. THE BORROWER ACKNOWLEDGES THAT THE TRANSACTIONS IN CONNECTION WITH WHICH THIS NOTE WAS EXECUTED AND DELIVERED AND WHICH ARE CONTEMPLATED BY THE TERMS OF THE AGREEMENT ARE, IN ALL CASES, COMMERCIAL TRANSACTIONS; AND THE BORROWER HEREBY EXPRESSLY WAIVES ANY AND ALL CONSTITUTIONAL RIGHTS IT MAY HAVE AS NOW CONSTITUTED OR HEREAFTER AMENDED, WITH REGARD TO NOTICE, ANY JUDICIAL PROCESS AND ANY AND ALL OTHER RIGHTS IT MAY HAVE, AND THE LENDER MAY INVOKE ANY PREJUDGMENT REMEDY AVAILABLE TO IT OR ITS SUCCESSORS OR ASSIGNS. MAKER, FOR ITSELF AND ITS SUCCESSORS OR ASSIGNS AND ALL OTHER PERSONS LIABLE FOR THE PAYMENT OF THIS NOTE, WAIVES PRESENTMENT FOR PAYMENT, DEMAND, PROTEST, AND NOTICE OF DEMAND, DISHONOR, PROTEST, AND NONPAYMENT, AND CONSENTS TO ANY AND ALL RENEWALS, EXTENSIONS OR MODIFICATIONS THAT MIGHT BE MADE BY PAYEE AS TO THE TIME OF PAYMENT OF THIS NOTE FROM TIME TO TIME, AND FURTHER AGREES THAT THE SECURITY, IF ANY, FOR THIS NOTE OR ANY PORTION THEREOF MAY FROM TIME TO TIME BE MODIFIED OR RELEASED IN WHOLE OR IN PART WITHOUT AFFECTING THE LIABILITY OF ANY PARTY LIABLE FOR THE PAYMENT OF THIS NOTE. IN WITNESS WHEREOF, Maker has caused this Note to be executed and its seal to be affixed on the date first above written. MAKER: VSI ENTERPRISES, INC. By: /s/ Julia B. North ------------------ Name: Julia B. North Title: President & CEO 60 EX-10.17 5 ASSIGNMENT OF SECURITY INTEREST IN PATENTS 1 EXHIBIT 10.17 ASSIGNMENT OF SECURITY INTEREST IN PATENTS THIS ASSIGNMENT of a security interest (the "Agreement") is made this 16th day of November, 1998, by VSI ENTERPRISES, INC., a Delaware corporation, having its principal place of business at 5801 Goshen Springs Road, Norcross, Georgia 30071 (hereinafter referred to as "Assignor"), to THOMSON KERNAGHAN & CO., LTD., having its principal place of business at 75 Lowther Avenue, Toronto, Ontario, Canada MR 1C9 (hereinafter referred to as "Assignee"): WITNESSETH: WHEREAS, Assignor is the maker of a promissory note, dated the date hereof, in the principal amount of $900,000.00, payable to the order of Assignee (the "Note"), and WHEREAS, Assignor is the sole and exclusive owner of United States Letters Patent Nos. 5,568,183; 5,515,099; 5,526,037; 5,598,209; 5,583,209; 5,583,565; 5,528,289; and 5,589,978 (collectively, the "Patents"); and WHEREAS, as security for the payment of the Note, Assignor desires to assign a security interest in its right, title and interest in and to said Patents and the inventions disclosed thereby to Assignee, and WHEREAS, Assignee desires to acquire a security interest in Assignor's right, title and interest in and to said Patents and the inventions disclosed thereby; NOW, THEREFORE, for good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Assignor hereby assigns and grants to Assignee, its successors and assigns, a security interest in all right, title and interest of Assignor in and to the Patents and the inventions disclosed thereby as security for the Note, such right, title and interest to be held until all principal, interest and liquidated damages due under the Note are paid in full or to the full end of the term for which said Patents or any reissues, renewals or extensions thereof have been or may be granted, whichever event shall first occur. Assignor covenants and agrees that it will at any time on request by Assignee execute and deliver any and all papers that may be reasonably necessary to perfect the security interest of Assignee in and to said Patents and the inventions disclosed thereby. Assignee agrees that upon payment in full of all principal, interest and liquidated damages due under this Note, Assignee will promptly execute and deliver to Assignor any and all documents, instruments and other papers that may be necessary, in the reasonable opinion of Assignor, to release and terminate the security interest granted herein and all right, title and interest of Assignee in, to and under the Patents. Assignor and Assignee acknowledge their mutual intent that all security interests contemplated herein are given as a contemporaneous exchange for new value to Assignor. No Transfer of Ownership Prior to Default. Assignor does hereby make, constitute and appoint Assignee and its designees, as Assignor's true and lawful attorney in fact, with full power of substitution, to transfer the Patents to the Assignee or such other name as designated by Assignee. Such power may be exercised in the sole discretion of Assignee, but only upon a default as set forth in the "Default" section of this Agreement. Assignor agrees to give full cooperation and to use its best efforts to take all such actions and to execute all such documents as may be necessary or appropriate to effect any sale, transfer or other disposition of the Patents, upon a default as set forth in the "Default" section of this Agreement. Assignor agrees to pay any and all expenses and out of pocket costs, including, reasonable attorneys fees and costs, incurred by Assignee in connection with enforcement of the terms of this Agreement upon a default by Assignor and the payment thereof shall be secured by the Patents. 61 2 Representations and Warranties Concerning the Patents. Assignor represents and warrants that: a. Assignor is the sole owner of the Patents. b. The Patents are not subject to any security interest, lien, prior assignment, or other encumbrance of any nature whatsoever except for current taxes and assessments, if any, which are not delinquent and the security interest created by this Agreement. Covenants Concerning the Patents. Assignor covenants that: a. Assignor will keep the Patents free and clear of any and all security interests, lien, assignments or other encumbrances, except those for current taxes and assessments, if any, which are not delinquent and those arising from this Agreement. b. Assignor agrees to give good faith, diligent cooperation to Assignee and to perform such other acts reasonably requested by Assignee for perfection and enforcement of said security interests. DEFAULT. TIME IS OF THE ESSENCE OF THIS AGREEMENT. THE OCCURRENCE OF ANY OF THE FOLLOWING EVENTS SHALL CONSTITUTE A DEFAULT UNDER THIS AGREEMENT: a. Any representation or warranty made by or on behalf of Assignor in this Agreement is materially false or materially misleading when made; b. Assignor fails in the payment or performance of any obligation, covenant, agreement or liability created by this Agreement; or c. Any Default under the Note referred to in this Agreement. No course of dealing or any delay or failure to assert any default shall constitute a waiver of that default or of any prior or subsequent default. Remedies. Upon the occurrence of any default under this Agreement, Assignee shall have the following rights and remedies, in addition to all other rights and remedies existing at law, in equity, or by statute or provided in the Note; a. Assignee shall have the rights and remedies available under the Uniform Commercial Code; b. If Assignor fails to cure any default within fifteen (15) days after Assignor's receipt of written notice of default from Assignee, Assignee may sell, assign, deliver or otherwise dispose of any or all of the Patents for cash and/or credit and upon such terms and at such place or places, and at such time or times, and to such person, firms, companies or corporation as Assignee reasonably believes expedient, without any advertisement whatsoever, and, after deducting the reasonable costs and out-of-pocket expenses incurred by Assignee, including, without limitation, (1) reasonable attorney fees and legal expenses, (2) advertising of sale of the Patents, (3) sale commissions, (4) sales tax, and (5) costs for preservation and protection of the Patents, apply the remainder to pay, or to hold as a reserve against, the obligations secured by this Agreement. Voidable Transfers. If the incurring of any debt by Assignor or the payment of any money or transfer of property to Assignee by or on behalf of Assignor should for any reason subsequently be determined to be "voidable" or "avoidable" in whole or in part within the meaning of any state or federal law (collectively "voidable transfer"), including, without limitation, fraudulent conveyances or preferential transfers under the United States Bankruptcy Code or any other federal or state law, and Assignee is required to repay or restore any voidable transfers or the amount of any portion thereof, or upon the advise of Assignee's counsel is advised to do so, then, as to any such amount or property repaid or restored, including all reasonable 62 3 costs, expenses, and attorneys fees of Assignee related thereto, the liability of Assignor, and each of them, and this Agreement, shall automatically be revived, reinstated and restored and shall exist as though the voidable transfers had never been made. Notice. Notices required or permitted to be given hereunder shall be in writing and shall be deemed to be sufficiently given when personally delivered or sent by registered mail, return receipt requested, addressed: (i) if to the Assignor at its executive offices and (ii) if to the Assignee, c/o William S. Hechter, at 75 Lowther Avenue, Toronto, Ontario, Canada M5R 1C9. Miscellaneous. The rights and remedies herein conferred are cumulative and not exclusive of any other rights and remedies and shall be in addition to every other right, power and remedy herein specifically granted or hereafter existing at law, in equity, or by statute which Assignee might otherwise have, and any and all such rights and remedies may be exercised from time to time and as often and in such order as Assignee may deem expedient. No delay or omission in the exercise of any such right, power or remedy or in the pursuance of any remedy shall impair any such right, power or remedy or be construed to be a waiver thereof or of any default or to be an acquiescence therein. In the event of breach or default under the terms of this Agreement by Assignor, Assignor agrees to pay all reasonable attorneys fees and legal expenses incurred by or on behalf of Assignee in enforcement of this Agreement, in exercising any remedy arising from such breach or default, or otherwise related to such breach or default. Assignor additionally agrees to pay all reasonable costs and out-of-pocket expenses, including, without limitation, reasonable attorneys fees and legal expenses incurred by Assignee in obtaining possession of Patents, and other otherwise incurred in foreclosing upon the Patents. Regardless of any breach or default, Assignor agrees to pay all expenses, including reasonable attorneys fees and legal expenses, incurred by Assignee in any bankruptcy proceeding of any type involving Assignor, the Patents, or this Agreement, including, without limitation, expenses incurred in modifying or lifting the automatic stay, determining adequate protection, use of cash Patents, or relating to any plan of reorganization. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware. Any provision of this Agreement which is prohibited and unenforceable in any jurisdiction shall, as to such jurisdiction only, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. All references in this Agreement to the singular shall be deemed to include the plural if the context so requires and vice versa. Reference in the collective or conjunctive shall also include the disjunctive unless the context otherwise clearly requires a different interpretation. All agreements, representations, warranties and covenants made by Assignor shall survive the execution and delivery of this Agreement, the filing and consummation of any bankruptcy proceedings, and shall continue in effect so long as any obligation to Assignee contemplated by this Agreement is outstanding and unpaid, notwithstanding any termination of this Agreement. All agreements, representations, warranties and covenants in this Agreement shall bind the party making the same and its heirs and successors, and shall be to the benefit of and be enforceable by each party for whom made their respective heirs, successors and assigns. This Agreement constitutes the entire agreement between Assignor and Assignee as to the subject matter hereof and may not be altered or amended except by written agreement signed by Assignor and Assignee. All other prior and contemporaneous understandings between the parties hereto as to the subject matter hereof are rescinded. 63 4 IN WITNESS WHEREOF, Assignor and Assignee have caused this Agreement to be executed by their respective duly authorized corporate officers as of the date and year first above written. ASSIGNOR: VSI ENTERPRISES, INC. By: /s/ Julia B. North ------------------ Name: Julia B. North Title: President & CEO ASSIGNEE: THOMSON KERNAGHAN & CO., INC. By: /s/ Mark Valentine ------------------ Name: Mark Valentine Title: Vice President & Director 64 EX-10.18 6 RECEIVABLE SALE AGREEMENT DATED OCTOBER 8, 1998 1 EXHIBIT 10.18 RECEIVABLES SALE AGREEMENT Dated as of October 8, 1998 by and between VSI NETWORK SOLUTIONS, INC., as Seller, and RFC CAPITAL CORPORATION, as Purchaser and Master Servicer RECEIVABLES SALE AGREEMENT (the "Agreement"), dated as of October 8, 1998, by and between VSI NETWORK SOLUTIONS, INC., a Delaware corporation, as Seller and Subservicer, and RFC CAPITAL CORPORATION, a Delaware corporation, as Purchaser and Master Servicer. WITNESSETH: WHEREAS, the Seller desires to sell certain of its telecommunication receivables and the Purchaser is a corporation formed for the purpose of purchasing certain telecommunication receivables from time to time; WHEREAS, the Purchaser shall act in its capacity as the Master Servicer to perform certain servicing, administrative and collection functions in respect of the receivables purchased by the Purchaser under this Agreement (the "Purchased Receivables"); WHEREAS, the Purchaser and the Master Servicer desire that the Subservicer be appointed to perform certain servicing, administrative and collection functions in respect of the Purchased Receivables; and WHEREAS, the Seller has been requested and is willing to act as the Subservicer. NOW, THEREFORE, the parties agree as follows: ARTICLE I - DEFINITIONS Section 1.1. Certain Defined Terms. The terms used in this Agreement shall have the respective meanings set forth on Exhibit A. Section 1.2. Other Terms. All accounting terms not specifically defined in this Agreement shall be construed in accordance with generally accepted accounting principles. All terms used in Article 9 of the UCC, and not specifically defined in this Agreement, are used in this Agreement as defined in such Article 9. ARTICLE II - PURCHASE AND SALE; ESTABLISHMENT OF ACCOUNTS 65 2 Section 2.1. Offer to Sell. Seller shall offer to sell, transfer, assign and set over to Purchaser those Eligible Receivables set forth on a list of such Eligible Receivables which such list shall be delivered by the Seller to the Purchaser no later than three (3) Business Days prior to each Purchase Date. Section 2.2. Purchase of Receivables. Upon receipt of the list of Eligible Receivables pursuant to Section 2.1, the Master Servicer, in its sole discretion, will confirm which of the Eligible Receivables offered by Seller that the Purchaser will Purchase. The Purchase of such Receivables shall occur upon payment of the Purchase Price. Upon Purchase of the Receivables, Seller will have sold, transferred, assigned, set over and conveyed to Purchaser, without recourse except as expressly provided herein, all of Seller's right, title and interest in and to the Purchased Receivables. The Seller shall not take any action inconsistent with such ownership and shall not claim any ownership in any Purchased Receivable. The Seller shall indicate in its Records that ownership interest in any Purchased Receivable is held by the Purchaser. In addition, the Seller shall respond to any inquiries with respect to ownership of a Purchased Receivable by stating that it is no longer the owner of such Purchased Receivable and that ownership of such Purchased Receivable is held by the Purchaser. Documents relating to the Purchased Receivables shall be held in trust by the Seller and the Subservicer, for the benefit of the Purchaser as the owner of the Purchased Receivables, and possession of any Required Information relating to the Purchased Receivables so retained is for the sole purpose of facilitating the servicing of the Purchased Receivables and carrying out the terms of this Agreement. Such retention and possession is at the will of the Purchaser and in a custodial capacity for the benefit of the Purchaser only. Section 2.3. Purchase Price and Payment. The Purchase Price for Receivables purchased on any Purchase Date and paid by the Purchaser to the Seller shall be an amount equal to the aggregate Net Values of such Purchased Receivables. The Purchase Price to be paid on such Purchase Date shall be reduced by (a) the Program Fees as of such Purchase Date, (b) the amount, if any, by which the Seller Credit Reserve Account (net of withdrawals required hereunder) is less than the Specified Credit Reserve Balance as of such Purchase Date, (c) any Rejected Receivable Amount, and (d) other amounts due the Purchaser in accordance with this Agreement. At any time the Net Value of Purchased Receivables plus the Purchase Price paid on any Purchase Date shall not exceed the Purchase Commitment. Section 2.4. Establishment of Accounts; Conveyance of Interests Therein; Investments. (a) A Lockbox Account will be established or assigned, as the case may be, for the benefit of the Purchaser into which all Collections from Payors with respect to Receivables shall be deposited. The Lockbox Account will be maintained at the expense of the Seller. The Seller agrees to deposit all Collections it receives with respect to Receivables in said Lockbox Account and will instruct all Payors to make all payments on Receivables to said Lockbox Account. All funds in said Lockbox Account will be remitted to the Collection Account as instructed by the Master Servicer. (b) The Purchaser has established and shall maintain the "Collection Account" (the "Collection Account") and the "Seller Credit Reserve Account" (the "Seller Credit Reserve Account"). (c) The Seller does hereby sell, transfer, assign, set over and convey to the Purchaser all right, title and interest of the Seller in and to all amounts deposited, from time to time, in the Lockbox Account, the Collection Account and the Seller Credit Reserve Account. Any Collections relating to Receivables held by the Seller or the Subservicer pending deposit to the Lockbox Account as provided in this Agreement, shall be held in trust for the benefit of the Purchaser until such amounts are deposited into the Lockbox Account. All Collections in respect of Purchased Receivables received by the Seller and not deposited directly by the Payor in the Lockbox Account shall be remitted to the Lockbox Account on the day of receipt or the following Business Day if the day of receipt is not a Business Day or if received after 3:00 p.m. on a Business Day, and if such Collections are not remitted on a timely basis, in addition to its other remedies hereunder, the Purchaser shall be entitled to receive a late charge (which shall be in addition to the Program Fee) equal to 12% per annum or the maximum rate legally permitted if less than such rate, calculated as of the first Business Day of such delinquency. Section 2.5. Grant of Security Interest. It is the intention of the parties to this Agreement that each payment of the Purchase Price by the Purchaser to the Seller for Purchased Receivables to be made under this Agreement shall constitute a sale of such Purchased Receivables and not a loan. In the event, however, that a court of competent jurisdiction were to hold that the transaction evidenced by this Agreement constitutes a loan and not a purchase and sale, it 66 3 is the intention of the parties that this Agreement shall constitute a security agreement under the UCC and any other applicable law, and that the Seller shall be deemed to have granted to the Purchaser a first priority perfected security interest in all of the Seller's right, title and interest in, to and under the Purchased Receivables; all payments of principal of or interest on such Purchased Receivables; all amounts on deposit from time to time in the Lockbox Account, the Collection Account and the Seller Credit Reserve Account; all other rights relating to and payments made under this Agreement, and all proceeds of any of the foregoing. Section 2.6. Further Action Evidencing Purchases. The Seller agrees that, from time to time, at its expense, it will promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or appropriate, or that the Purchaser may reasonably request, in order to perfect, protect or more fully evidence the transfer of ownership of the Purchased Receivables or to enable the Purchaser to exercise or enforce any of its rights hereunder. ARTICLE III - CONDITIONS OF PURCHASES Section 3.1. Conditions Precedent to All Purchases. Each Purchase from the Seller by the Purchaser shall be subject to the conditions precedent that: (a) No Event of Seller Default has occurred and the Seller is in compliance with each of its covenants and representations set forth in Sections 4.1 and 4.2 of this Agreement; (b) The Seller shall have delivered to the Purchaser a complete copy of each of the then current Carrier Agreements, Clearinghouse Agreements and Billing and Collection Agreements and any amendment or modification of such agreements; (c) The Seller shall have delivered to the Purchaser a copy of each written notice delivered by or received by either the Carrier, Billing and Collection Agent, Clearinghouse Agent or the Seller with respect to any Carrier Agreements, Clearinghouse Agreements and/or the Billing and Collection Agreements; (d) Commencing with the quarter ending September 30, 1998, the Seller shall direct its auditors, Arthur Anderson, to perform certain agreed upon procedures as set forth on Schedule 4 attached hereto on behalf of Purchaser, and shall deliver the results thereof to Purchaser within forty five (45) days following the end of each such quarter; (e) The Termination Date shall not have occurred; and (f) The Seller shall have taken such other action, including but not limited to delivery of an opinion of counsel in the form of Exhibit D hereto, or delivered such other approvals, opinions or documents to the Purchaser, as the Purchaser may reasonably request. ARTICLE IV - REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE SELLER Section 4.1. Representations, Warranties and Covenants as to the Seller. The Seller represents and warrants to the Purchaser and Master Servicer, as of the date of this Agreement and on each subsequent Purchase Date, as follows: (a) The Seller is a corporation duly organized, validly existing and in good standing under the laws of its state of incorporation and is duly qualified to do business and is in good standing in each jurisdiction in which it is doing business and has the power and authority to own and convey all of its properties and assets and to execute and deliver this Agreement and the Related Documents and to perform the transactions contemplated thereby; and each is the legal, valid and binding obligation of the Seller enforceable against the Seller in accordance with its terms; (b) The execution, delivery and performance by the Seller of this Agreement and the Related Documents and the transactions contemplated thereby (i) have been duly authorized by all necessary corporate or other action on the part 67 4 of the Seller, (ii) do not contravene or cause the Seller to be in default under (A) any contractual restriction contained in any loan or other agreement or instrument binding on or affecting the Seller or its property; or (B) any law, rule, regulation, order, writ, judgment, award, injunction, or decree applicable to, binding on or affecting the Seller or its property and (iii) does not result in or require the creation of any Adverse Claim upon or with respect to any of the property of the Seller (other than in favor of the Purchaser as contemplated hereunder); (c) There is no court order, judgment, writ, pending or threatened action, suit or proceeding, of a material nature against or affecting the Seller, its officers or directors, or the property of the Seller, in any court or tribunal, or before any arbitrator of any kind or before or by any Governmental Authority (i) asserting the invalidity of this Agreement or any of the Related Documents, (ii) seeking to prevent the sale and assignment of any Receivable or the consummation of any of the transactions contemplated thereby, (iii) seeking any determination or ruling that might materially and adversely affect the Seller, this Agreement, the Related Documents, the Receivables, the Contracts or any LOA, or (iv) asserting a claim for payment of money in excess of $50,000; (d) The primary business of the Seller is the provision of telecommunication services and/or equipment. All license numbers issued to the Seller by any Governmental Authority are set forth on Schedule I and the Seller has complied in all material respects with all applicable laws, rules, regulations, orders and related Contracts and all restrictions contained in any agreement or instrument binding on or affecting the Seller, and has and maintains all permits, licenses, certifications, authorizations, registrations, approvals and consents of Governmental Authorities or any other party necessary for the business of the Seller and each of its Subsidiaries; (e) The Seller (i) has filed on a timely basis all tax returns (federal, state, and local) required to be filed and has paid or made adequate provisions for the payment of all taxes, assessments, and other governmental charges due from the Seller; (ii) the financial statements of the Seller, copies of which have been furnished to the Purchaser, fairly present the financial condition of the Seller, all in accordance with generally accepted accounting principles consistently applied; (iii) since March 31, 1998, there has been no material adverse change in any such condition, business or operations; and (iv) the Seller has delivered to the Purchaser within 45 days after the end of each subsequent three-month period the financial statements, including balance sheet and income statement prepared in accordance with generally accepted accounting principles, of the Seller as of the end of such three-month period, certified by an officer of the Seller; (f) All information furnished by or on behalf of the Seller to the Master Servicer or the Purchaser in connection with this Agreement is true and complete in all material respects and does not omit to state a material fact and the sales of Purchased Receivables under this Agreement are made by the Seller in good faith and without intent to hinder, delay or defraud present or future creditors of the Seller; (g) The Lockbox Account is the only lockbox account to which Payors have been or will be instructed to direct Receivable proceeds and each Payor of an Eligible Receivable has been directed upon its receipt of the notice attached hereto as Exhibit B, which such notice was mailed within two Business Days following the Closing Date, to remit all payments with respect to such Receivable for deposit in the Lockbox Account; (h) The principal place of business and chief executive office of the Seller are located at the address of the Seller set forth under its signature below and there are not now, and during the past four months there have not been, any other locations where the Seller is located (as that term is used in the UCC) or keeps Records except as set forth in the designated space beneath its signature line in this Agreement; (i) The legal name of the Seller is as set forth at the beginning of this Agreement and the Seller has not changed its legal name in the last six years, and during such period, the Seller did not use, nor does the Seller now use any tradenames, fictitious names, assumed names or "doing business as" names other than those appearing on the signature page of this Agreement; (j) The Seller has not done anything to impede or interfere with the collection by the Purchaser of the Purchased Receivables and shall not amend, waive or otherwise permit or agree to any deviation from the terms or conditions of any Purchased Receivable or any related Carrier Agreement, Clearinghouse Agreement, Billing and Collection Agreement, Contract or LOA which (i) may create an Adverse Claim with respect to any Receivable or (ii) 68 5 would materially affect the ability of Subservicer or the Master Servicer to act in each's capacity as such; and shall not allow any invoice due and owing by the Seller relating to any Carrier Agreement, Clearinghouse Agreement or Billing and Collection Agreement to become any more than thirty days past due; and (k) For federal income tax reporting and accounting purposes, the Seller will treat the sale of each Purchased Receivable pursuant to this Agreement as a sale of, or absolute assignment of its full right, title and ownership interest in such Purchased Receivable to the Purchaser. Section 4.2. Representations and Warranties of the Seller as to Purchased Receivables. With respect to each Purchased Receivable sold pursuant to this Agreement the Seller represents and warrants, as of the date hereof and on each subsequent Purchase Date, as follows: (a) Such Purchased Receivable (i) consists of all the Required Information; (ii) is the liability of an Eligible Payor and (iii) was created by the provision or sale of telecommunication services or equipment by the Seller in the ordinary course of its business; (iv) has a Purchase Date no later than 90 days from its Billing Date, is not a Purchased Receivable which, as of any Determination Date, payment by the Payor of such Receivable has been received and is not duplicative of any other Receivable; and (v) is owned by the Seller free and clear of any Adverse Claim, and the Seller has the right to sell, assign and transfer the same and interests therein as contemplated under this Agreement and no consent other than those secured and delivered to the Purchaser on or prior to the Closing Date from any Governmental Authority, the Payor, a Carrier, the Billing and Collection Agent, the Clearinghouse Agent or any other Person shall be required to effect the sale of any Purchased Receivables; (b) The Eligible Receivable Amount set forth in the applicable Required Information of such Receivable is payable in United States Dollars and is not in excess of $15,000, or such other amount as the Purchaser and Seller may mutually agree in writing, with respect to any one individual Payor of any Payor Class other than an Eligible Receivable payable under a Billing and Collection Agreement as set forth on the attached Schedule 3, and is net of any adjustments or other modifications contemplated by any Carrier Agreement, Clearinghouse Agreement, Billing and Collection Agreement or otherwise and neither the Receivable nor the related Carrier Agreement, Clearinghouse Agreement, Billing and Collection Agreement or Contract has or will be compromised, adjusted, extended, satisfied, subordinated, rescinded, set-off or modified by the Seller, the Payor, the Carrier, the Clearinghouse Agent or the Billing and Collection Agent, and is not nor will be subject to compromise, adjustment, termination or modification, whether arising out of transactions concerning the Contract, any Carrier Agreement, Clearinghouse Agreement, Billing and Collection Agreement or otherwise; and (c) There are no procedures or investigations pending or threatened before any Governmental Authority (i) asserting the invalidity of such Receivable, Carrier Agreement, Clearinghouse Agreement, Billing and Collection Agreement, LOA or such Contract, (ii) asserting the bankruptcy or insolvency of the related Payor, (iii) seeking the payment of such Receivable or payment and performance of the related Carrier Agreement, Clearinghouse Agreement, Billing and Collection Agreement, or such other Contract or LOA, (iv) seeking any determination or ruling that might materially and adversely affect the validity or enforceability of such Receivable or the related Carrier Agreement, Clearinghouse Agreement, Billing and Collection Agreement, or such other Contract or LOA. Section 4.3. Negative Covenants of the Seller. The Seller shall not, without the written consent of the Purchaser and the Master Servicer, which such consent will not be unreasonably withheld: (a) Sell, assign or otherwise dispose of, or create or suffer to exist any Adverse Claim or lien upon any Receivable and related Contracts, its Customer Base, the Lockbox Account, the Collection Account, or any other account in which any Collections of any Receivable are deposited, or assign any right to receive income in respect of any Receivable; (b) Submit or permit to be submitted to Payors any invoice for telecommunication services or equipment rendered by or on behalf of Seller which contains a "pay to" address other than the Lockbox Account; 69 6 (c) Make any change to (i) the location of its chief executive office or the location of the office where Records are kept or (ii) its corporate name or use any tradenames, fictitious names, assumed names or "doing business as" names; or (d) Enter into or execute any Clearinghouse Agreement or Billing and Collection Agreement (other than those listed on Exhibit 3 hereof) or any amendment or modification thereof. Section 4.4. Repurchase Obligations. Upon discovery by any party to this Agreement of a breach of any representation or warranty in this Article IV which materially and adversely affects the value of a Purchased Receivable or the interests of the Purchaser therein (herein a "Rejected Receivable"), the party discovering such breach shall give prompt written notice to the other parties to this Agreement. Thereafter, on the next Purchase Date, the Net Value of the Rejected Receivables shall be deducted from the amount otherwise payable to the Seller pursuant to Section 2.3 and deposited in the Collection Account. In the event that the full Net Value of such Rejected Receivables is not deposited in the Collection Account pursuant to the foregoing sentence, the Purchaser shall deduct any such deficiency from the Excess Collection Amount and/or make demand upon the Seller to pay any such deficiency to the Purchaser for deposit to the Collection Account. ARTICLE V - ACCOUNTS ADMINISTRATION Section 5.1. Collection Account. The Purchaser and the Master Servicer acknowledge that certain amounts deposited in the Collection Account may relate to Receivables other than Purchased Receivables and that such amounts continue to be owned by the Seller. All such amounts shall be administered in accordance with Section 5.3. Section 5.2. Determinations of the Master Servicer. On each Determination Date, the Master Servicer will determine: (a) the Net Value of all Purchased Receivables which have become Rejected Receivables since the prior Purchase Date (the "Rejected Receivable Amount"); (b) the amount of Collections up to the Purchase Price of all Purchased Receivables received since the prior Determination Date (the "Paid Receivables Amount"); (c) the Net Value of all Purchased Receivables which have become Defaulted Receivables since the prior Purchase Date (the "Defaulted Receivable Amount"); (d) the aggregate amount deposited in the Collection Account in excess of the Purchase Price of each Purchased Receivable since the prior Determination Date (the "Excess Collection Amount"); and (e) the Net Value of all Purchased Receivables less the Rejected Receivable Amount and the Defaulted Receivable Amount as of the current Determination Date. The Master Servicer's determinations of the foregoing amounts shall be conclusive in the absence of manifest error. The Master Servicer shall notify the Purchaser and Seller of such determinations. Section 5.3. Distributions from Accounts. (a) No later than 11:00 a.m. on each Determination Date, following the determinations set forth in Section 5.2, the Master Servicer will make the following withdrawals and deposits: (i) the Paid Receivables Amount and the Rejected Receivable Amount plus any outstanding Rejected Receivable Amount applicable to any prior period, to the extent such Rejected Receivable Amount is not paid to the Purchaser as a reduction in Purchase Price to be paid to the Seller, from the Collection Account and deposit such amount in the Purchase Account; 70 7 (ii) the Defaulted Receivable Amount from the Seller Credit Reserve Account and deposit such amount in the Collection Account; and (iii) the Excess Collection Amount and deposit such amount in the Seller Credit Reserve Account to the extent that the Seller Credit Reserve Account is less than the Specified Credit Reserve Balance. (b) Until the Termination Date, with reasonable best efforts on each Purchase Date or in any event within two Business Days of each such Purchase Date, the Master Servicer shall withdraw all amounts deposited hereunder (net of withdrawals required hereunder) from the Seller Credit Reserve Account in excess of the Specified Credit Reserve Balance and shall pay to the Purchaser all amounts due and owing the Purchaser in accordance with Sections 2.3, 4.4, 5.2, 7.1(a) and (b), 8.1 and 9.4 and pay the balance, if any, to the Seller by wire transfer; provided, however, with respect to Receivables processed or cleared pursuant to any Carrier Agreement, Clearinghouse Agreement or Billing and Collection Agreement, if applicable, any Excess Collection Amount shall be retained by the Purchaser until such time that the Seller's billing cycle (or batch) to which such Excess Collection Amount applies is deemed closed by the Purchaser which, absent the occurrence of an Event of Seller Default and provided that the Purchaser has received information in sufficient form and format to allow the Purchaser to properly apply and/or post Collections against Purchased Receivables, will occur no later than the next immediate Purchase Date following such determination to an account designated by the Seller. Section 5.4. Allocation of Moneys following Termination Date. (a) Following the Termination Date and the Purchaser's receipt of the Termination Fee, if applicable, from the Seller, the Master Servicer shall, to the extent funds deposited hereunder (net of withdrawals required hereunder) are sufficient, withdraw an amount equal to the Program Fee from the Seller Credit Reserve Account on each Purchase Date and deposit it in the Purchase Account. To the extent that such funds do not equal the Program Fee, the Seller shall deposit in the Purchase Account the balance of the Program Fee within five Business Days following demand therefor. In any event, following the Termination Date and the Purchaser's receipt of the Termination Fee, if any, the Seller may repurchase all previously Purchased Receivables by depositing with the Purchaser the then aggregate Net Value of Purchased Receivables. Following such payment and any other amount due and owing the Purchaser under this Agreement, this Agreement shall be deemed terminated. (b) On the first Determination Date on which the aggregate Net Value of all Purchased Receivables (other than Defaulted Receivables) (i) is less than 10% of the aggregate Net Value of Purchased Receivables (other than Defaulted Receivables) on the Termination Date and (ii) is less than the aggregate amount remaining in the Seller Credit Reserve Account, the Master Servicer shall withdraw an amount equal to such aggregate Net Value from such accounts and deposit it in the Purchase Account. Thereupon the Master Servicer shall disburse all remaining amounts held in the Seller Credit Reserve Account to the Seller and all interests of the Purchaser in all Purchased Receivables owned by the Purchaser shall be reconveyed by the Purchaser to the Seller. Following such disbursement and reconveyance, this Agreement shall be deemed terminated. ARTICLE VI - APPOINTMENT OF THE SUBSERVICER Section 6.1. Appointment of the Subservicer. As consideration for the Seller's receipt of Excess Collection Amount, the Master Servicer and the Purchaser hereby appoint the Seller and the Seller hereby accepts such appointment to act as Subservicer under this Agreement. The Subservicer shall service the Purchased Receivables and enforce the Purchaser's respective rights and interests in and under each Purchased Receivable and each related Contract or LOA; and shall take, or cause to be taken, all such actions as may be necessary or advisable to service, administer and collect each Purchased Receivable all in accordance with (i) customary and prudent servicing procedures for telecommunication receivables of a similar type, and (ii) all applicable laws, rules and regulations; and shall serve in such capacity until the termination of its responsibilities pursuant to Section 6.4 or 7. 1. The Subservicer may, with the prior consent of the Purchaser, which consent shall not be unreasonably withheld, subcontract with a subservicer for billing, collection, servicing or administration of the Receivables. Any termination or resignation of the Subservicer under this Agreement shall not affect any claims that the Purchaser may have against the Subservicer for events or actions taken or not taken by the Subservicer arising prior to any such termination or resignation. 71 8 Section 6.2. Duties and Obligations of the Subservicer. (a) The Subservicer shall at any time permit the Purchaser or any of its representatives to visit the offices of the Subservicer and examine and make copies of all Servicing Records; (b) The Subservicer shall notify the Purchaser of any action, suit, proceeding, dispute, offset, deduction, defense or counterclaim that is or may be asserted by any Person with respect to any Purchased Receivable. (c) The Purchaser shall not have any obligation or liability with respect to any Purchased Receivables or related Contracts, nor shall it be obligated to perform any of the obligations of the Subservicer hereunder. Section 6.3. Subservicing Expenses. The Subservicer shall be required to pay for all expenses incurred by the Subservicer in connection with its activities hereunder (including any payments to accountants, counsel or any other Person) and shall not be entitled to any payment or reimbursement therefor by the Master Servicer or Purchaser. Section 6.4. Subservicer Not to Resign. The Subservicer shall not resign from the duties and responsibilities hereunder except upon determination that (a) the performance of its duties hereunder has become impermissible under applicable law and (b) there is no reasonable action which the Subservicer could take to make the performance of its duties hereunder permissible under applicable law evidenced as to clause (a) above by an opinion of counsel to such effect delivered to the Purchaser. Section 6.5. Authorization of the Master Servicer. The Seller hereby authorizes the Master Servicer (including any successors thereto) to take any and all reasonable steps in its name and on its behalf necessary or desirable in the determination of the Master Servicer to collect all amounts due under any and all Purchased Receivables, process all Collections, commence proceedings with respect to enforcing payment of such Purchased Receivables and the related Contracts, and adjusting, settling or compromising the account or payment thereof. The Seller shall furnish the Master Servicer (and any successors thereto) with any powers of attorney and other documents necessary or appropriate to enable the Master Servicer to carry out its servicing and administrative duties under this Agreement, and shall cooperate with the Master Servicer to the fullest extent in order to ensure the collectibility of the Purchased Receivables. ARTICLE VII - EVENTS OF SELLER DEFAULT Section 7.1. Events of Seller Default. If any of the following events (each, an "Event of Seller Default") shall occur and be continuing: (a) The Seller (either as Seller or Subservicer) shall materially fail to perform or observe any term, covenant or agreement contained in this Agreement; (b) An Insolvency Event shall have occurred; (c) There is a material breach of any of the representations and warranties of the Seller as stated in Sections 4.1 that has remained uncured for a period of 30 days, or with respect to a representation and warranty as stated in Section 4.2 as to which Seller has not repurchased such Rejected Receivable pursuant to Section 4.4; (d) Any Governmental Authority shall file notice of a lien with regard to any of the assets of the Seller or with regard to the Seller which remains undischarged for a period of 30 days; (e) As of the first day of any month, the aggregate Net Value of Purchased Receivables which became Defaulted Receivables or Rejected Receivables during the prior three-month period shall exceed 5.0% of the average aggregate Net Values of all Purchased Receivables then owned by the Purchaser at the end of each of such three months; (f) This Agreement shall for any reason cease to evidence the transfer to the Purchaser (or its assignees or transferees) of the legal and equitable title to, and ownership of, the Purchased Receivables; 72 9 (g) The termination of any Clearinghouse Agreement, if applicable, and/or any Carrier Agreement or Billing and Collection Agreement for any reason whatsoever absent the consummation of a substitute Clearinghouse Agreement, Carrier Agreement and/or Billing and Collections Agreement, as the case may be, within ten Business Days of the termination thereof, and/or, any invoice due and owing by the Seller relating to any Carrier Agreement, Clearinghouse Agreement or Billing and Collection Agreement has become more than thirty days past due; (h) The amount deposited hereunder (net of withdrawals required hereunder) in the Seller Credit Reserve Account has remained at less than the Specified Credit Reserve Balance for fourteen consecutive days; or (i) A Termination Event shall have occurred; then and in any such event, the Master Servicer may, by notice to the Seller and the Purchaser declare that an Event of Seller Default shall have occurred and, the Termination Date shall forthwith occur, without demand, protest or further notice of any kind, and the Purchaser shall make no further Purchases from the Seller. The Purchaser and the Master Servicer shall have, in addition to all other rights and remedies under this Agreement, all other rights and remedies provided under the UCC and other applicable law, which rights shall be cumulative. ARTICLE VIII - INDEMNIFICATION AND SECURITY INTEREST Section 8.1. Indemnities by the Seller. (a) Without limiting any other rights that the Purchaser, the Master Servicer, or any director, officer, employee or agent of either such party (each an "Indemnified Party") may have under this Agreement or under applicable law, the Seller hereby agrees to indemnify each Indemnified Party from and against any and all claims, losses, liabilities, obligations, damages, penalties, actions, judgments, suits, and related costs and expenses of any nature whatsoever, including reasonable attorneys' fees and disbursements (all of the foregoing being collectively referred to as "Indemnified Amounts") which may be imposed on, incurred by or asserted against an Indemnified Party in any way arising out of or relating to this Agreement or the ownership of the Purchased Receivables or in respect of any Receivable or any Contract, excluding, however, Indemnified Amounts to the extent resulting from gross negligence or willful misconduct on the part of such Indemnified Party. (b) Any Indemnified Amounts subject to the indemnification provisions of this Section shall be paid to the Indemnified Party within five Business Days following demand therefor, together with interest at the lesser of 12% per annum or the highest rate permitted by law from the date of demand for such Indemnified Amount. Section 8.2 Security Interest. The Seller hereby grants to the Purchaser a first priority perfected security interest in the Seller's Customer Base, including but not limited to, all past, present and future customer contracts, lists, agreements, LOA's or arrangements relating thereto; all of the Seller's right, title and interest in, to and under all of the Seller's Receivables not sold to the Purchaser hereunder, including all rights to payments under any related Contracts, contract rights, instruments, documents, chattel paper, general intangibles, LOA's or other agreements with all Payors and all the Collections, Records and proceeds thereof; any other obligations or rights of Seller to receive any payments in money or kind; all cash or non-cash proceeds of the foregoing; all of the right, title and interest of the Seller in and with respect to the goods, services or other property which gave rise to or which secure any of the foregoing as security for the timely payment and performance of any and all obligations the Seller or the Subservicer may owe the Purchaser under Sections 2.4, 4.4, 5.2, 7. 1 (a) and (b), 8.1 and 9.4, but excluding recourse for unpaid Purchased Receivables. This Section 8.2 shall constitute a security agreement under the UCC and any other applicable law and the Purchaser shall have the rights and remedies of a secured party thereunder. Such security interest shall be further evidenced by Seller's execution of appropriate UCC-I financing statements prepared by and acceptable to the Purchaser, and such other further assurances that may be reasonably requested by the Purchaser from time to time. 73 10 ARTICLE IX - MISCELLANEOUS Section 9.1. Notices, Etc. All notices, shall be in writing and mailed or telecommunicated, or delivered as to each party hereto, at its address set forth under its name on the signature pages hereof or at such other address as shall be designated by such party in a written notice to the other parties hereto. All such notices and communications shall not be effective until received by the party to whom such notice or communication is addressed. Section 9.2. Remedies. No failure or delay on the part of the Purchaser or the Master Servicer to exercise any right hereunder shall operate as a waiver or partial waiver thereof. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. Section 9.3. Binding Effect; Assignability. This Agreement shall be binding upon and inure to the benefit of the Seller, the Subservicer, the Purchaser, the Master Servicer and their respective successors and permitted assigns. Neither the Seller nor the Subservicer may assign any of their rights and obligations hereunder or any interest herein without the prior written consent of the Purchaser and the Master Servicer. The Purchaser may, at any time, without the consent of the Seller or the Subservicer, assign any of its rights and obligations hereunder or interest herein to any Person. Without limiting the generality of the foregoing, the Seller acknowledges that the Purchaser has assigned its collateral rights hereunder for the benefit of third parties. The Seller does hereby further agree to execute and deliver to the Purchaser all documents and amendments presented to the Seller by the Purchaser in order to effectuate the assignment by the Purchaser in furtherance of this Section 9.3 consistent with the terms and provisions of this Agreement. This Agreement shall create and constitute the continuing obligations of the parties hereto in accordance with its terms, and shall remain in full force and effect until its termination; provided, that the rights and remedies with respect to any breach of any representation and warranty made by the Seller or the Master Servicer pursuant to Article IV and the indemnification and payment provisions of Article VIII shall be continuing and shall survive any termination of this Agreement. Section 9.4. Costs, Expenses and Taxes. (a) In addition to the rights of indemnification under Article VIII, the Seller agrees to pay upon demand, all reasonable costs and expenses in connection with the administration (including periodic auditing, modification and amendment) of this Agreement, and the other documents to be delivered hereunder, including, without limitation: (i) the reasonable fees and out-of-pocket expenses of counsel for the Purchaser or the Master Servicer with respect to (A) advising the Purchaser as to its rights and remedies under this Agreement or (B) the enforcement (whether through negotiations, legal proceedings or otherwise) of this Agreement or the other documents to be delivered hereunder; (ii) any and all accrued Program Fee and amounts related thereto not yet paid to the Purchaser; and (iii) any and all stamp, sales, excise and other taxes and fees payable or determined to be payable in connection with the execution, delivery, filing or recording of this Agreement or the other agreements and documents to be delivered hereunder, and agrees to indemnify and save each Indemnified Party from and against any and all liabilities with respect to or resulting from any delay in paying or omission to pay such taxes and fees. (b) If the Seller or the Subservicer fails to pay any Lockbox Account fees or other charges or debits related to such accounts, to pay or perform any agreement or obligation contained under this Agreement, the Purchaser may, or may direct the Master Servicer to pay or perform, or cause payment or performance of, such agreement or obligation, and the expenses of the Purchaser or the Master Servicer incurred in connection therewith shall be payable by the party which has failed to so perform. Section 9.5. Amendments; Waivers; Consents. No modification, amendment or waiver of, or with respect to, any provision of this Agreement or the Related Documents, shall be effective unless it shall be in writing and signed by each of the parties hereto. This Agreement, the Related Documents and the documents referred to therein embody the entire agreement among the Seller, the Subservicer, the Purchaser and the Master Servicer, and supersede all prior agreements and understandings relating to the subject hereof, whether written or oral. Section 9.6. GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL. (a) THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (AS OPPOSED TO CONFLICT OF LAWS PROVISIONS) OF THE STATE OF OHIO, EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE INTERESTS OF THE PURCHASER IN THE PURCHASED 74 11 RECEIVABLES OR REMEDIES HEREUNDER OR THEREUNDER, IN RESPECT THEREOF, ARE GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF OHIO. (b) THE SELLER AND THE SUBSERVICER HEREBY SUBMIT TO THE EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF OHIO AND THE UNITED STATES DISTRICT COURT LOCATED IN THE SOUTHERN DISTRICT OF OHIO, AND EACH WAIVES PERSONAL SERVICE OF ANY AND ALL PROCESS UPON IT AND CONSENTS THAT ALL SUCH SERVICE OF PROCESS BE MADE BY REGISTERED MAIL DIRECTED TO THE ADDRESS SET FORTH ON THE SIGNATURE PAGE HEREOF AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED FIVE DAYS AFTER THE SAME SHALL HAVE BEEN DEPOSITED IN THE U.S. MAILS, POSTAGE PREPAID. THE SELLER AND THE SUBSERVICER EACH HEREBY WAIVES ANY OBJECTION BASED ON FORUM NON CONVENIENS, AND ANY OBJECTION TO VENUE OF ANY ACTION INSTITUTED HEREUNDER AND CONSENTS TO THE GRANTING OF SUCH LEGAL OR EQUITABLE RELIEF AS IS DEEMED APPROPRIATE BY THE COURT. NOTHING IN THIS SECTION SHALL AFFECT THE RIGHT OF THE PURCHASER TO SERVE LEGAL PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR AFFECT THE RIGHT OF THE PURCHASER TO BRING ANY ACTION OR PROCEEDING AGAINST THE SELLER OR ITS PROPERTY, OR THE SUBSERVICER OR ITS PROPERTY IN THE COURTS OF ANY OTHER JURISDICTION. THE SELLER AND THE SUBSERVICER EACH HEREBY AGREE THAT THE EXCLUSIVE AND APPROPRIATE FORUMS FOR ANY DISPUTE HEREUNDER ARE THE COURTS OF THE STATE OF OHIO AND THE UNITED STATES DISTRICT COURT LOCATED IN THE SOUTHERN DISTRICT OF OHIO AND AGREE NOT TO INSTITUTE ANY ACTION IN ANY OTHER FORUM. (c) THE SELLER, AND THE SUBSERVICER EACH HEREBY WAIVES ANY RIGHT TO HAVE A JURY PARTICIPATE IN RESOLVING ANY DISPUTE, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE ARISING OUT OF, CONNECTED WITH, RELATED TO, OR IN CONNECTION WITH THIS AGREEMENT. INSTEAD, ANY DISPUTE RESOLVED IN COURT WILL BE RESOLVED IN A BENCH TRIAL WITHOUT A JURY. Section 9.7. Execution in Counterparts; Severability. This Agreement may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. In case any provision in or obligation under this Agreement shall be invalid, illegal or unenforceable in any jurisdiction, the validity, legality and enforceability of the remaining provisions or obligations, or of such provision or obligation in any other jurisdiction, shall not in any way be affected or impaired thereby. 75 12 IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written. VSI NETWORK SOLUTIONS, INC., as Seller and as Subservicer By: /s/ Brian Rowley --------------------------------------------------- Name: Brian Rowley Title: President Address at which the chief executive office is located: Address: 300 Metro Center Boulevard Warwick, RI 02886 Attention: Brian Rowley Phone number: 401-736-7300 Telecopier number: 401/739-7072 Additional locations at which the Seller does business and maintains Records: 230 Washington Avenue Extension Albany, New York 12203 19 West 44th Street, Suite 415 New York, New York 10036 8 Fairfield Blvd. Wallingford, Connecticut 06492 270 Bridge Street Dedham, Massachusetts 02026 Additional names under which Seller does business: Eastern Telecom Eastern Telecom of New York Eastern Telecom of Connecticut RFC CAPITAL CORPORATION By: /s/ Mark D. Quinlan -------------------------------------------------- Name: Mark D. Quinlan Title: Vice President Address: 130 East Chestnut Street, Suite 400 Columbus, OH 43215 Attention: Mark D. Quinlan Phone number: (614) 229-7979 Telecopier number: (614) 229-7980 76 13 EXHIBIT A DEFINITIONS "ADVERSE CLAIM" means any claim of ownership, any lien, security interest or other charge or encumbrance, or any other type of preferential arrangement having the effect of a lien or security interest. "AFFILIATE" means, as to any Person, any other Person that, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person within the meaning of control under Section 15 of the Securities Act of 1933. "BASE RATE" means, as of any Purchase Date, a percentage equal to the then applicable Provident Bank prime lending rate plus 3.25% per annum; provided that upon Purchaser's satisfactory receipt of audited data, in a form acceptable to Purchaser, evidencing and confirming that Seller's attrition rate for customers originated by Seller for Bell Atlantic and SNET is an amount equal to or less than fifteen percent (15%) for two consecutive quarterly periods, the Base Rate shall mean, as of any Purchase Date, a percentage equal to the then applicable Provident Bank prime lending rate plus 2.75% per annum. "BILLED AMOUNT" means, with respect to any Receivable the amount billed or to be billed to the related Payor with respect thereto prior to the application of any Gross Liquidation Rate. "BILLING AND COLLECTION AGENT" means the party performing billing and collection services for and on behalf of the Seller pursuant to the terms of a Billing and Collection Agreement. "BILLING AND COLLECTION AGREEMENT" means any written agreement whereby a party is obligated to provide end-user billing and collection services with respect. to the Seller's accounts. "BILLING DATE" means the date on which the invoice with respect to a Receivable was submitted to the related Payor which shall be not more than 45 days from the date on which telecommunication services were provided to the end user of such services. "BUSINESS DAY" means any day of the year other than a Saturday, Sunday or any day on which banks are required, or authorized, by law to close in the State of Ohio. "CARRIER" means a provider of telecommunication services which such services are resold by the Seller. "CARRIER AGREEMENT" means any written agreement, contract or arrangement whereby a Carrier is obligated to provide certain services to the Seller. "CLEARINGHOUSE AGENT" means the party performing services for and on behalf of the Seller pursuant to the terms and provisions of a Clearinghouse Agreement. "CLEARINGHOUSE AGREEMENT" means any written agreement, contract or arrangement whereby a party is obligated to perform certain services for the Seller, including, without limitation, processing certain information provided by the Seller to the Clearinghouse Agent and remitting such processed information to one or more Billing and Collection Agents for billing and collection of Seller's accounts. "CLOSING DATE" means October 8, 1998. "COLLECTION ACCOUNT" means the account established pursuant to Section 2.4(b). "COLLECTIONS" means, with respect to any Receivable, all cash collections and other cash proceeds of such Receivable. 77 14 "CONTRACT" means an agreement (or agreements) pursuant to, or under which, a Payor shall be obligated to pay for telecommunication services rendered by the Seller from time to time. "CUSTOMER BASE" means all of the Seller's past, present and future customer contracts, agreements, LOA's or other arrangements, any customer list relating thereto and any information regarding prospective customers and contracts, agreements, LOA's or other arrangements and all of the goodwill and other intangible assets associated with any of the foregoing. "DEFAULTED RECEIVABLE" means a Receivable as to which, on any Determination Date (a) any part of the Net Value thereof remains unpaid for more than 90 days from the Billing Date for such Receivable; or (b) the Payor thereof has taken any action, or suffered any event to occur, of the type described in Section 7.1(f) or (g); or (c) the Master Servicer otherwise deems any part of the Net Value thereof to be uncollectible for reasons other than a breach of a representation or warranty under Article IV hereof. "DEFAULTED RECEIVABLE AMOUNT" has the meaning specified in Section 5.2(c). "DETERMINATION DATE" means the Business Day preceding the Purchase Date of each week. "ELIGIBLE PAYOR" means a Payor which is (a) (i) a corporation, limited liability company, partnership or any other statutory organization organized under the laws of any jurisdiction in the United States and having its principal office in the United States; (ii) an individual or sole proprietorship which is a resident of any jurisdiction in the United States; (iii) a Clearinghouse Agent; or (iv) a Billing and Collection Agent; (b) not an Affiliate of any of the parties hereto; (c) has executed and delivered to the Seller either (i) a Contract, (ii) an LOA, (iii) a Clearinghouse Agreement or (iv) a Billing and Collection Agreement; and (d) not subject to bankruptcy or insolvency proceedings at the time of sale of the Receivables to be purchased. "ELIGIBLE RECEIVABLE" means, at any time, a Receivable as to which the representations and warranties of Section 4.2 are true and correct in all respects at the time of Purchase. "ELIGIBLE RECEIVABLE AMOUNT" means, with respect to any Eligible Receivable, an amount equal to its Billed Amount after giving effect to the Gross Liquidation Rate associated with the Payor Class with respect to such Eligible Receivable. "EVENT OF SELLER DEFAULT" has the meaning specified in Section 7.1. "EXCESS COLLECTION AMOUNT" has the meaning specified in Section 5.2(d). "GOVERNMENTAL AUTHORITY" means the United States of America, Federal, any state, local or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions thereof or pertaining thereto. "GROSS LIQUIDATION RATE" means a factor, determined in good faith by the Master Servicer from time to time, with respect to a designated Payor Class based on (i) the Seller's historical experience with respect to Collections for such Payor Class, (ii) the terms and provisions of any Billing and Collection Agreement and (iii) the terms and provisions of any Clearinghouse Agreement, determined on the basis of actual Collections which are expected to be received on a Receivable within 90 days of its Billing Date. "INSOLVENCY EVENT" means the occurrence of an event whereby the Seller makes a general assignment for the benefit of creditors; or where any proceeding is instituted by or against the Seller seeking to adjudicate it a bankrupt or insolvent, or which seeks the liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of the Seller or any of its Debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, custodian or other similar official for it or for any substantial part of its property. 78 15 "LOA" means a letter of agency, or other authorization, obtained by the Seller from each Payor designating the Seller as its long distance telecommunications provider and otherwise of a type or in a form acceptable under applicable laws. "LOCKBOX ACCOUNT" means the account established pursuant to Section 2.4(a). "MASTER SERVICER" means RFC Capital Corporation, a Delaware corporation, or any Person designated as the successor Master Servicer, and its successors and assigns, from time to time. "NET VALUE" of any Receivable at any time means an amount (not less than zero) equal to (a)(i) the Eligible Receivable Amount multiplied by (ii) .90; minus (b) all Collections received with respect thereto; provided, that if the Master Servicer makes a determination that all payments by the Payor with respect to such Receivable have been made, the Net Value shall be zero. "PAID RECEIVABLES AMOUNT" has the meaning specified in Section 5.2(b). "PAYOR" means, the Person obligated to make payments in respect of any Receivables. "PAYOR CLASS" means, with respect to any Payor, one of the following: (a) Clearinghouse Agent; (b) Billing and Collection Agent; (c) statutory organization; or (d) individuals and sole proprietorships. "PERSON" means an individual, partnership, limited liability company, corporation (including a business trust), joint stock company, trust, voluntary association, joint venture, a government or any agency or political subdivision thereof, or any other entity of whatever nature. "PROGRAM FEE" means as of each Purchase Date, an amount equal to (i) 7/360 of the annualized Base Rate multiplied by (ii) the then current Net Value of all Purchased Receivables including (A) Rejected Receivables and (B) those Receivables to be purchased on such Purchase Date. "PURCHASE" means a purchase by the Purchaser of Eligible Receivables from the Seller pursuant to Section 2.2. "PURCHASE ACCOUNT" means the account of the Purchaser titled "Purchase Account." "PURCHASE COMMITMENT" means an amount not to exceed $1,500,000; provided, however, that with respect to the initial Purchase Date, such amount shall not exceed $1,100,000 and other than with respect to the initial Purchase Date, the aggregate Net Value of Purchased Receivables on the first Purchase Date of any month may not be greater than $200,000, or such other amount as the Purchaser and Seller may otherwise agree in writing, over the highest aggregate Net Value of Purchased Receivables at any time during the immediately preceding month. Subject to the prior written approval by the Purchaser and payment by the Seller of all applicable fees as agreed by and between the Seller and Purchaser, the Seller may request, in writing, that the Purchase Commitment be increased to $5,000,000 provided, however, that no single incremental increase in such Purchase Commitment may be less than $500,000. "PURCHASE DATE" means the date on which the Purchaser initially Purchases Receivables from the Seller and thereafter, such other date of each week or month, as the case may be, that the Seller and Purchaser mutually agree. "PURCHASE PRICE" has the meaning specified in Section 2.3. "PURCHASED RECEIVABLE" means any Receivable which has been purchased by the Purchaser hereunder including a Rejected Receivable prior to its repurchase. 79 16 "PURCHASER" means RFC Capital Corporation, a Delaware corporation, together with its successors and assigns. "RECEIVABLE" means (a) an account receivable arising from the provision or sale of telecommunication services (and any services or sales ancillary thereto) by the Seller including the. right to payment of any interest or finance charges and other obligations of such Payor with respect thereto; (b) all security interests or liens and property subject thereto from time to time purporting to secure payment by the Payor; (c) all rights, remedies, guarantees, indemnities and warranties and proceeds thereof, proceeds of insurance policies, UCC financing statements and other agreements or arrangements of whatever character from time to time supporting or securing payment of such Receivable including, but not limited to, any Billing and Collection Agreement and any Clearinghouse Agreement-, and (d) all Collections, Records and proceeds with respect to any of the foregoing. In the instance of a Receivable with respect to which the Payor is a Billing and Collection Agent pursuant to a Billing and Collection Agreement, the amount owed to the Seller by the Billing and Collection Agent is the "Receivable" which is eligible for Purchase by the Purchaser and not the amount owing to, or collected by, the Billing and Collection Agent from the end user of telecommunication services provided by the Seller. "RECORDS" means all Contracts, LOA's and other documents, books, records and other information (including, without limitation, computer programs, tapes, disks, punch cards, data processing software and related property and rights) prepared and maintained by the Seller, the Subservicer or Additional Subservicer with respect to Receivables (including Purchased Receivables) and the related Payors. "REJECTED RECEIVABLE AMOUNT" has the meaning specified in Section 5.2(a). "REJECTED RECEIVABLE" has the meaning specified in Section 4.4. "RELATED DOCUMENTS" means all documents required to be delivered thereunder and under this Agreement. "REQUIRED INFORMATION" means, with respect to a Receivable, (a) the Payor, (b) the Eligible Receivable Amount, (c) the Billing Date, (d) the Payor telephone number and (e) the Payor account number, if applicable. "SELLER" means VSI Network Solutions, Inc., a Delaware corporation, together with its successors and assigns. "SELLER CREDIT RESERVE ACCOUNT" means the account established pursuant to Section 2.4(b). "SERVICING RECORDS" means all documents, books, records and other information (including, without limitation, computer programs, tapes, disks, punch cards, data processing software and related property and rights) prepared and maintained by the Subservicer, Additional Subservicer or the Master Servicer with respect to the Purchased Receivables and the related Payors. "SPECIFIED CREDIT RESERVE BALANCE" means, as of any Purchase Date, an amount equal to 5.00% of the Net Value of Purchased Receivables including (a) Rejected Receivables (net of recoveries) and (b) those Receivables to be purchased on such Purchase Date. "SUBSERVICER" means the Seller, or any Person designated as Subservicer hereunder. 80 17 "TERMINATION DATE" means the earlier of (a) October 8, 2000; (b) a Termination Event; (c) the occurrence of an Event of Seller Default as set forth in Section 7.1 of this Agreement; or (d) ninety days following the Seller's delivery of a written notice to the Purchaser setting forth Seller's desire to terminate this Agreement and the payment of the Termination Fee with respect thereto. "TERMINATION EVENT" means the occurrence of an event under any loan agreement, indenture or governing document following which the funding of the Purchaser to be utilized in purchasing Receivables hereunder may be terminated. "TERMINATION FEE" means an amount to be paid by the Seller to the Purchaser equal to 4.0% of the Purchase Commitment in the event of an occurrence of an Event of Seller Default resulting in the termination of this Agreement; or in the event the Seller desires to terminate this Agreement, whereby such termination shall be effective only in the event that (a) the Seller has provided the Purchaser prior written notice thereof; and (b) the Seller has paid to Purchaser and Purchaser has received from Seller an amount equal to (i) 4.0% of the Purchase Commitment if such notice of termination is provided to the Purchaser during the one year period commencing on the Closing Date and ending on the one year anniversary of the Closing Date, or (ii) 3.0% in the event such notice of termination is provided to the Purchaser during the period commencing the day after the one year anniversary of the Closing Date through the Termination Date. "UCC" means the Uniform Commercial Code as from time to time in effect in the state of the location of the Seller's chief executive office. 81 EX-23.1 7 CONSENT OF GRANT THORNTON, LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS As independent public accounts, we hereby consent to the inclusion in this Form 10-K of our report dated March 18, 1998, included in this Annual Report into VSI Enterprises, Inc. previously filed Registration Statement No. 33-44036 on Form S-8 dated November 14, 1991, Registration Statement No. 33-44035 on Form S-8 dated November 14, 1991, Registration Statement No. 33-55094 on Form S-3 dated November 25, 1992, Registration Statement No. 33-56856 on Form S-8 dated January 8, 1993, Registration Statement No. 33-72512 on Form S-8 dated December 3, 1993, Registration Statement No. 33-81314 on Form S-8 dated July 7, 1994, Registration Statement No. 333-728 on Form S-3 dated January 30, 1996, Registration Statement No. 33-85754 on Form S-3 dated January 30, 1996 (Post-Effective Amendment No. 1), Registration Statement No. 333-15123 on Form S-3 dated October 30, 1996, Registration Statement No. 333-18237 on Form S-8 dated December 19, 1996, Registration Statement No. 333-18239 on Form S-8 dated December 19, 1996, Registration Statement No. 333-30597 on Form S-3 dated June 30, 1997, Registration Statement No. 333-44407 on Form S-3 dated January 14, 1998 and Registration Statement No. 333-48635 on Form S-3 dated March 25, 1998, of our report dated March 5, 1999, relating to the consolidated financial statements of VSI Enterprises, Inc. and subsidiaries appearing in the Company's annual report on Form 10-K for the year ended December 31, 1998. /s/ Grant Thornton LLP Atlanta, Georgia April 12, 1999 82 EX-23.2 8 CONSENT OF ARTHUR ANDERSEN, LLP 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our report dated April 12, 1999, related to the consolidated balance sheet of VSI Enterprises, Inc. and subsidiaries ("the Company") as of December 31, 1997 and the related statements of operations, stockholders' equity and cash flows for the year then ended, included in this Annual Report on Form 10-K, into the Company's previously filed Registration Statements (Files Nos. 33-44036, 33-44035, 33-55094, 33-56856, 33-72512, 33-81314, 333-728, 33-85754, 333-15123, 333-18237, 333-18239, 333-30597, 333-44407, and 333-48635). /s/ Arthur Andersen LLP Atlanta, Georgia April 12, 1999 83 EX-27.1 9 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1,134 0 5,975 0 1,059 8,804 1,049 0 10,961 8,853 0 0 0 12 991 10,961 19,437 19,437 12,243 33,820 2,134 0 0 (16,517) 0 (16,517) (419) 0 0 (16,936) (1.42) (1.42)
EX-27.2 10 FINANCIAL DATA SCHEDULE - RESTATED 1997
5 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 860 0 5,704 0 2,465 10,979 1,063 0 22,880 7,290 0 0 0 12 15,579 22,880 19,620 19,620 9,687 24,222 76 0 0 (4,678) 193 (4,872) (946) 0 0 (5,817) (0.53) (0.53)
EX-27.3 11 FINANCIAL DATA SCHEDULE - RESTATED 1996
5 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 12,709 12,709 9,116 18,563 139 0 0 (5,992) 0 (5,992) (714) 0 0 (6,707) (0.74) (0.74)
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